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In this news update, Directors must begin asking awkward questions.

In a market dominated by deals and high-profile chief executives, challenges for boards are acute. How they handle them depends on how effectively the non-executive directors work with management and advisers.

The job specification for
non-executive directors is a tough
one: be proactive in seeking
knowledge, have the intelligence
to assimilate it, then have the
judgement and courage to apply it
in testing the propositions coming
from management. All this has
to happen in the context of a
constructive working relationship
with the people being tested, whose
self-concept is usually quite high.
None of this is new. However,
recent experience highlights
some areas where the delicate
corporate governance balance is
likely to be tested again in 2007.

Corporate culture

It begins with corporate culture. You
can’t set the tone at the top without
understanding the culture in the
real world below. Getting a read
on what is really happening in the
company is hard for a non-executive
director. Things to watch for are
signs of hubris, disregard for values
and suppression of bad news. Staff
surveys, whistleblower processes, exit
interviews and site visits can all be
useful channels. Perceptive listening
and effective questioning are key
skills for non-executive directors.

Ask any top manager in a listed
company, and they’ll tell you how
few directors do these things well.

Integrity

Closely related to this is the integrity
issue. Recent royal commissions
into corporations focused on why
no one was asking, “Is this right?”.
In the real world, there are very
good reasons why people working
for corporations don’t ask this
question. If the executive team is
saying, “Do what it takes to get
the sale/deal/fee”, and rewarding
value-suppressing behaviour, both
the stick and the carrot discourage
moral inquiry about what is right.

Peer pressure

Added to this is peer pressure to
conform within a dominant, amoral
culture. Non-executive directors
are not immune from these valuesuppressing
influences. But it’s
wise to profit by the experience of
others – asking difficult questions
now makes more sense than trying
to answer them in the witness box
later, let alone dealing with the
consequences in terms of liability,
cost and reputational damage.
Apply the “front page” test.
Conflicts of interest
Conflict of interest, in particular,
is a topical issue. The law and the
community share a fundamental
expectation of directors: they will exercise an honest, independent
judgement in the best interests
of the company. The community
expectation may be even higher than
the legal standard. Perceived failure
to meet community expectations
may not result in legal liability, but
it may well result in reputational
damage. Today, this is not only
about avoiding direct personal
conflicts. Boards must also monitor
conflict situations involving advisers,
auditors and independent experts.

Continuous disclosure

The community also has a strong
and well-justified expectation that
companies will keep the market
fully informed through continuous
and periodic disclosure. These
days, investors who say they
were not informed of material
information have no hesitation in
beginning legal action. If investors
are slow to perceive litigation
possibilities, there are law firms
and litigation funders ready to
help. The Australian Securities
and Investments Commission has
effective and immediate disclosure
as an enforcement priority.

Against this background, it’s easy
to see why an effective continuous
disclosure system is a must-have
for listed entities in 2007, and it’s
the board’s responsibility to make
sure the company has one in
place. It’s wise for non-executive
directors to remember that negative
disclosure is counter-intuitive for top
management, whose personal and
financial interests are likely to be
adversely affected by the publication
of bad news about the company.
Experience suggests that in the listedcompany
environment, the level
of self-belief about achieving best
practice in disclosure requirements
considerably exceeds the reality. That
kind of complacency can be costly.
Performance in disclosure – for that
matter, performance in corporate
governance generally – can be only as
good as the information that comes
to top management, and through top
management to the board. It’s a pure
survival measure for non-executive
directors to take a proactive interest
in two things: first, the quality of the
management information system, and
second, the integrity and judgement
of top management in bringing
important issues to the board.

Role of Chairman

Last but not least, the role of the
chairman. The law’s increasing
expectations of a chairman have
generated controversy. But from the
observations above, it’s clear that
someone has to take responsibility for
the flow of information to the board,
for the performance and integrity of
the board, and for the relationship
between the board and top
management. If the chairman doesn’t
do this, who will? That’s what the
community expects. If anything, the
law has been too slow, not too quick,
in picking up on this expectation.