StockVal's Code of Good Corporate Practice Contents PART 1. ACCOUNTING ISSUES 1.1 Abnormals
1.2 Verification of Asset Values
1.4 Imputation Credits
1.5 Presentation of Company Accounts
1.6 Movements in Shareholder's Equity
1.7 Tax reconciliation Statement
1.8 Accounting for Equity Funds
1.9 Terminating Resources
PART 2. DIRECTORS GUIDELINES 2.1 Dividends
2.2 Take-Overs and Mergers
2.3 Interest in Acquiring a Controlling Interest
2.4 Directors Defense against a Take-Over Offer
2.5 Employee Options
PART 3. DISSEMINATION of INFORMATION 3.1 Dissemination of Interim Results, News and
Preliminary Profit Announcements 3.2 Events Likely to Impact of Future Profitability
PART 4. CORPORATE GOVERNANCE 4.1 Corporate Governance Director
PART 1. ACCOUNTING ISSUES 1.1 Abnormals The Problem A. Most shareholders and analysts tend to consider a company's declared preabnormal profit as the operating profit from the core activity of the business and abnormals to be of an extraneous or non-repetitive nature. When a company capitalizes expenses to the balance sheet as an asset, the declared profit is enhanced to the extent of the excluded capitalized expenses. If such expenses or part thereof are later found to have no value, it is misleading to declare a profit overstatement in one year to be an abnormal expense in a later year. Many companies, particularly in the resource sector, have a periodic spring clean whereby the value of capitalized expenses are reviewed and if deemed necessary written off as abnormal losses. A business is therefore able to continuously declare pre-abnormal profits based on misrepresentation or lack of diligence in differentiating between non-recoverable expenses and assets. When asset value recognition is deferred until the periodic spring-clean when write-offs can be swept under the carpet as abnormals, the deferred need for due diligence of asset value recognition gives shareholders a misleading interim impression of profitability.
Recommendation A. In order to encourage directors to more diligently assess the value of the deemed asset at the time that the expense is capitalized, expenses capitalized as an asset in previous years cannot be subsequently written-off as abnormals.
The Problem B. Many companies due to the nature of the business or perhaps managerial neglect, appear to have a periodic need for restructuring and rationalization. In these circumstances the costs can hardly be considered to be abnormal.
Recommendation B. Under certain circumstances, such as to effect synergy after an acquisition or relocation, it is reasonable to assume that Restructuring and Rationalization costs are an abnormal cost from which benefits will ensue in future years. However, due to their subjective nature, rather than be included as an abnormal, we would prefer that they were capitalized and expensed (amortized) to the Profit and Loss account as a normal expense over a five year period commencing in the same accounting period in which they were incurred. The residual "Deferred Expenditure" to be included as an intangible asset.
1.2 Verification of Asset Values The Problem Shareholders are entitled to expect the Balance Sheet to be a fair and reasonable representation of asset values. Often the diminution in value of an asset has occurred over a period of time but its recognition deferred until the periodic spring clean. The appointment of a new CEO (if he or she have any sense) signals an opportune time for a spring clean. A substantial asset write-down in a single year may reflect a lack of proper provisioning or asset value recognition in previous years. Directors should be required to acknowledge their lack of recognition of fair assessment of asset values in previous accounting periods.
Recommendation If in the opinion of the directors the whole of the diminution in value is not attributable to the current accounting period, the notes to the accounts should acknowledge the fact and provide an estimate of diminution for previous years. In the absence of such notation, the directors are deemed to have confirmed that the diminution occurred in the current accounting period. When the diminution exceeds 25% of the asset value at the commencement of the current accounting period, a brief explanation should be provided. When a significant asset is retained at cost or cost less depreciation and the book value is less than the market value, the market value of the asset should be declared in the notes. A significant asset might be deemed as having a market value of 5% or more of the company's gross assets.
1.3 Intangibles Background Goodwill, trademarks, brand names, mastheads, patents, management agreements, intellectual property and the like are considered to be intangibles. License costs, Tax benefits, Deferred Expenses and Exploration and Evaluation costs are not. While goodwill is required to be written off over a period of 20 years, other intangibles and license costs are subject to director's or independent valuation. Goodwill cannot be arbitrarily created but occurs as a result of the difference between the acquisition cost of an entity and its NTA. If the assets of the entity are acquired rather than the corporate structure, goodwill can be avoided by allocating the difference between cost and NTA to other intangibles that do not require to be amortized. The goodwill value of any business or its intrinsic value in intangibles is the difference between its NTA and value or market capitalization. Because the market decides the intangible value of a business, other than to provide window dressing for creditors and shareholders, the book value of intangibles is not only highly subjective but also superfluous. Indeed, analysts in assessing the true operating profit of the business, except in circumstances which suggest a true diminution in value, usually treat them as non-existent by writing amortization of intangibles back to profits. While license costs or their deemed value undeniably have a value like goodwill and other intangibles, they are not part of the physical or tangible assets of the business which have a more readily assessable market value. Because the true value of license costs is dependent upon the fortunes of the licensed business, their value is likely to be volatile. Furthermore, if Australia was to fully embrace free enterprise and deregulate the media, the value of TV licenses might be a fraction of their current declared values. The practice of mining companies is to carry Exploration and Evaluation costs on the books as "Exploration Phase" until such time that a reasonable assessment of the existence of economically recoverable reserves enables their allocation to the "Development or Production Phase". Alternatively, if so deemed, they are written off as non-recoverable. While future tax benefits (excluding prepaid taxes) might represent a future saving in tax liabilities, the fact that they have no realizable value and that tax free profits deny shareholders the benefit of franking credits, some doubt must be cast as to their legitimacy as a tangible asset.
The Problem A conceptual problem arises when the declared equity (inclusive of intangibles, license costs, deferred expenditure, tax benefits and Exploration Phase exploration and evaluation) consistently exceeds a company's market capitalization. The inference from this is that the market considers the intangibles and other subjective assets to have a lesser value than the director's declaration. In some instances the director's intangible values are considered by the market to have a negative value. While this interpretation can be said to be a matter of opinion for which neither party can be categorically proven to be right or wrong, shareholders are sometimes comforted by the declared equity per share. If the equity per share has been bolstered by intangible values and pseudo intangibles whose values are unsustainable by the performance of the business, shareholders can be misled into believing that book values are realistic and that the share price represents a discount to realizable asset values.
StockVal's Position We believe that the nature of a license giving rights to produce goods or render a service or utility, exclusive or otherwise, is indistinguishable in its nature from the exclusivity of a companies brand names or trade-marks which are deemed to be intangibles. We believe that until such time that exploration and evaluation costs are deemed by directors to have a tangible value, they should be considered as intangibles. While we do not believe that a prescribed fixed rate for amortization of goodwill or any other intangible serves any useful purpose, we object to companies that fail to reduce the book value of their intangibles and other subjective so called tangibles when the performance of the business or market price suggests that their true value is much less than the book value.
Recommendation That license costs, Exploration Phase exploration and evaluation expenditure, deferred expenditure and future tax benefits be included in the Balance Sheet as intangibles. We further recommend that in the event of a company company's market capitalization based on the average five days preceding the balance date being less than equity, that the market appraisal of intangibles capitalization less NTA in the notes.
having intangibles and the closing share price for the the declared shareholder's be expressed as market
1.4 Imputation Credits Accumulated Imputation or Franking credits have a tangible value to the proprietors and provided the business has retained profits, the accumulated or residual franking credits that could be applied to future dividend distributions (excluding current provisions) should be recognized as an asset in the Balance Sheet.
1.5 Presentation of Company Accounts The Problem The performance of the business over a given review period cannot be accurately measured without reference to certain basic rudimentary information and its location in the annual report should not be made into a game of hide and seek. The proprietors are entitled to access core information quickly and easily and directors have a responsibility to ensure that they are able to do so.
Recommendation In addition to the manner in which convention currently dictates the presentation of accounts, the following ancillary format would give shareholders an overall view of the company's core results and profitability in a single consolidated statement:
6 Shareholders Equity Summary $ millions Tangible assets Intangible assets Total gross assets
2,900 100 3,000
97 % 3% 100%
Funded by: Liabilities Converting preference shares Ordinary shareholders equity
number Ordinary Capital as at 30/6/2000 80,000,000 Plus new capital issued 20,000,000 Total Ordinary Capital 30/6/2001 100,000,000 Preference Capital 30/6/2000 20,000,000 Plus increase (decrease) in Pref. Capital Preference Capital 30/6/2001 Total issued capital Reserves as at 30/6/2000 95 Revaluation of assets 20 Change in A$ value of foreign interests (15) Reserves as at 30/6/2001 Retained profits as at 30/6/2000 Pre tax profit for year ended 30/6/2001 160 Less amortisation of intangibles (10) Provision for tax (54) Net profit after tax 96 Dividends on Preference shares at 8% 16 Profit attributable to Ordinary shareholders 80 # Dividends on Ordinary shares 50 Retained Profit for current period Retained Profits as at 30/6/2001 All classes of Shareholders Funds at 30/6/2001
1,500 50 % 200 7% 1,300 43% 3,000 100%
800 200 1,000 200 200 1,200
30 200 1,500
# Ordinary dividends were 100% franked at the corporate tax rate of 36%. Beneficial Earnings on ordinary shares Dividends Imputation credits Amortization of intangibles Retained profits Changes in reserves Beneficial Earnings Less Changes in reserves Adjusted Beneficial Earnings
50 28.125 10 30 5 123.125 5 118.125
* Unadjusted BROE 10.26% Adjusted BROE 9.84%
*Unadjusted Beneficial Return on Equity on average ordinary shareholders funds of $1,200m
1.6 Movements in Shareholder's Equity The Problem Because details of changes in reserves under Australian accounting convention are hidden in the notes to the accounts rather than embodied in the main statements, there is a tendency for less experienced shareholders to overlook them or consider their relevance of minor importance.
Recommendation In accordance with the practice of some other countries, we believe that capital movements and changes in reserves should be brought to the attention of shareholders as one of the prime account statements.
Ordinary shareholders capital at 30/6/2000 New capital subscribed Less capital redemptions Capital at 30/6/2001 Retained profit at 30/6/2000 Plus declared profit Less paid/declared dividends Retained profit 30/6/2001 Reserves at 30/6/2000 Plus asset revaluation Less foreign currency translation provision Reserves 30/6/2001 Ordinary shareholders funds at 30/6/2001 Ordinary shareholders funds at 30/6/2000 Increase (decrease) in shareholders equity
$ millions 100 5 (2) 103 40 15 (10) 45 30 5 (3) 32 180 170 10
number 100 4 (1.5) 102.5
1.7 Tax Reconciliation Statement The Problem The present format used in the annual report is confusing and meaningless to most shareholders. The proprietors have a right to know the tax assessable profit as presented to the ATO and the adjustments used in arriving at the declared profit as per the Profit and Loss account viz: Tax assessable profit for period ended 30/6/2001 Tax paid/payable at 30% Net profit after tax Capitalized tax deductible expenses [List other adjustments] Declared profit
20 6 14 1 15
Or in the event of tax losses carried forward Tax assessable profit for period ended 30/6/2001 Prior losses carried forward Tax paid/payable Capitalized tax deductible expenses [List other adjustments] Declared profit
20 20 0 1 21
1.8 Accounting for Equity Funds An Equity Fund is defined here as an entity that primarily invests shareholder's or unit-holder's funds in securities such as shares, debentures, unsecured notes, unit trusts, fixed interest securities and other passive investments.
The Problem The profit of an Equity Fund is generally determined by interest, dividend and trust income, trading profits from the purchase and sale of securities and unrealized gains on securities held either as current (short term) or non current (long term) assets. Although unrealized gains and losses are dependent on the market sentiment that determines prices, they are nonetheless a necessary ingredient in determining the performance of the fund.
9 Listed Equity Funds adopt a wide variation of practices in the presentation of their accounts, particularly in the manner of expressing profit and investment portfolio value. Some show investments at cost, others at the lower of cost or market prices, others at market prices or market prices less provision for realisation costs such as capital gains tax, while others are not specific. Sometimes the accounts helpfully provide a notation as to the value based on market prices after tax on net unrealised gains. One major fund that splits its investments between current and non-current assets (at market prices) states that there is no need to allow for tax on unrealised gains because the directors have no intention of selling any of the non current assets. At least management is being honest in admitting that it has no ability to determine value and therefore will not be selling over-priced stocks to realise funds to buy under-priced stocks. If unrealised gains are to be included as profit and profit is subject to tax, then quite clearly the declared profit will be false if a provision for tax is not included. The NTA per share will also be false if it does not make provision for all liabilities including tax. The presentation of the accounts should reflect the true state of affairs by showing investments at their net value to shareholders based on closing prices, which means the inclusion of a provision for tax on net unrealised gains where applicable. Similarly, the profit should include net unrealized gains or losses less a provision for tax. However, in order for investors to compare the performance of the Fund with nominated indices that make no provision for tax or expenses, a separate table can be construed for that purpose. Because the published performance statistics in the media often use the same specifications to measure both apples and oranges, the comparative performance errors in some cases tend to be quite outrageous. Misconceptions occur when an Equity Fund shows a healthy profit from trading and other income in the same year as a large diminution in the asset values that is not reflected in the Profit and Loss account. Conversely, an increase in the Asset Revaluation Reserve might not be reflected in the Profit and Loss account. Although the notes to the accounts sometimes contain this information, the question arises as to whether the proprietors are entitled to have the accounts presented in a simple comprehendible format.
Recommendation The following simple format as an adjunct to the conventional presentation would give investors a much clearer idea of how their fund is performing and enable apples for apples comparison with other funds.
Profit Reconciliation $millions Cost Investment Portfolio Investments at as at 30/6/2000 Plus purchases Less cost of investments sold Investments as at 30/6/2001 Increase (decrease) for period Net gain (loss) after tax on unrealized gains for the period
100 50 150 40 110
Unrealized Provision Gains for tax
Trading Net sales revenue of investments sold Cost of investments sold Profit from trading securities
45 40 5
Other Income Interest Dividends received Imputation credits on dividends Total grossed up income
1.0 2.9 1.1 10.0
Less expenses and fees as detailed Profit before tax on realized income Pro forma tax 2.7 Less dividend rebates 1.1 Provision for tax Profit after tax from realized income Plus profit (loss) after tax on unrealized gains Net profit after tax Beneficial Earnings Dividends declared for period Imputation credits Retained profits from realized income Changes in reserves after provision for tax Ordinary shareholders Beneficial Earnings
(2.5) 7.5 (1.6) 5.9 3.2 9.1 9.1% 5 2.8 0.9 3.2 11.9
* BROE 11.9%
*Unadjusted Beneficial Return on Equity on average ordinary shareholders funds of $100m
Performance before expenses and tax $ millions Increase in unrealized profits 5 Trading profit 5 Other income 3.9 Profit before taxes and expenses 13.9 ROE before tax and expenses 13.9% Expenses 2.5 Profit after expenses before tax 11.4 ROE after expenses before tax 11.4% Funds employed at Liabilities Shareholders equity 30/6/2000
120 20 100
Return on gross assets
Any changes in capital during the year would be reflected as the weighted average of funds employed at the beginning of the year so as to present an accurate reflection of the funds performance.
1.9 Terminating Resources The Problem There is a natural assumption that failing insolvency, merger or takeover, a business that is profitable continues in perpetuity and does not consume itself by exhausting its assets. While this assumption is valid for most businesses, it cannot be said to apply to a mining company whose resources have an economic life expectancy. If directors have a vested interest in extending the life of the business, they may expend more money that can be economically justified on new exploration. Shareholders can therefore find themselves in a dual type of company âˆ’ the business of mining the existing resources and by default a pseudo exploration company of the same name but without a prospectus. Exploration is a subjective probability gamble whereby the dividing line between a valued judgement and foolishness is often indistinguishable.
Recommendation That the proprietors are entitled to know the success rate of the company's previous expenditure on exploration and evaluation during the previous ten years. The notes to Exploration and Evaluation in the annual report should show total expenditure and the amount written off as valueless, not including normal amortization from the Development and Production Phase in the past ten years or for such lesser period since the company's establishment. To show in the annual report their estimated cash flow from mining and oil production declaring the assumptions used for cost, tax and revenue for the next ten years. Most, if not all resource companies already have this information which is regularly updated but rarely make it available to the proprietors.
PART 2. DIRECTORS GUIDELINES 2.1 Dividends The Problem The expectation that shareholders have in relation to dividends can cause directors to act in a manner that is contrary to the majority of shareholder's interests. While acknowledging that many shareholders have a need for cash flow, we believe that the majority of shareholders are interested in wealth creation, which in turn creates the ability to generate cash flow from the partial sale of ones enhanced share value. Although few companies have the Berkshire Hathaway like qualities of owner wealth creation whereby the business has the ability to reinvest 100% of profits at a continuously high rate of return, directors should be discouraged from adopting a dividend policy that is detrimental to the interests of the majority of shareholders. To encumber shareholders with tax liabilities by paying unfranked dividends in the same year that the business has confirmed its need for more capital by new share issues is detrimental to shareholders interests. To do so when the Dividend Reinvestment Plan (DRP) is operative is to incur unwitting shareholders with a tax liability for what is effectively a book entry. A shareholder's acquisition cost of new shares under the DRP is increased by the amount of the tax liability on the notional dividend payment reinvested in new shares. The additional tax liability can cause shareholders to unwittingly pay a premium for their new shares that is well in excess of the current market price. We do not believe that the fiscal naivetĂŠ of directors is such that they are unaware of the negative outcome of paying unfranked dividends in a year in which new capital is needed, but pursue this policy as a perceived means of supporting the share price. The $60,000 plus share price of Berkshire Hathaway that has failed to pay a dividend for the past 32 years is evidence of the foolishness of this belief. We believe it is incongruous for a company to declare future tax benefits as an asset when historically it has not been adverse towards dissipating that asset by passing tax liabilities to the proprietors by way of unfranked dividends.
Recommendation That unfranked dividends only be paid to the extent that the directors deem them to be surplus to the company's fiscal requirements or ability to gainfully reinvest at a rate of return that would exceed that which shareholders might otherwise reasonably achieve. That when a company contemporaneously declares future tax benefits as an asset and declares unfranked dividends, that the asset value of those tax benefits be written off in the accounts.
2.2 Take-Overs and Mergers The Problem When directors come up for re-election, shareholders have little or no criteria by which to distinguish the performance and value to the business of individual directors. Following a period of poor business performance, there is a tendency to blame the board collectively rather than individuals that may have been primarily responsible for the outcome. We believe that one of the greatest destroyers of shareholder wealth is egotistical empire building. There is a wealth of evidence to suggest that for logical reasons take-overs normally occur at prices that far exceed the economic value of the acquired entity. There is a natural reluctance on the part of directors of the target company to forego their board seats unless the offer is undeniably generous, pecuniary compensation is adequate or their positions are retained in the merged entity.
Recommendation Directors agreeing to the terms and conditions of a proposal to acquire a controlling interest in another entity should sign the feasibility study and due diligence report upon which their decision was based. The minutes should note those for and against the proposal and their reasons. Details of any pecuniary benefits accruing to the directors of both entities that would not otherwise have accrued had the merger or take-over not proceeded should be detailed in the minutes and disclosed in the interim and or annual report to shareholders. In the event of a formal offer being made to acquire another entity at a cost that is 25% or more of the market capitalization of the acquiring entity, written notices must be posted or emailed to shareholders within two working days. Such notice to provide details of the offer together with a summarized feasibility report which
15 must include the projected profit of the target entity for the next two years including the projected ROE and the means proposed to fund the acquisition.
2.3 Interest in Acquiring a Controlling Interest When one or more directors receive an offer or have reason to believe that an approach may lead to an offer that is likely if accepted by their shareholders to change the control of the business.
The problem Shareholders have right to feel aggrieved and disenchanted when they belatedly learn of an offer or approach made to their directors that has not been conveyed to the proprietors. Irrespective of the director's opinion as to whether the offer is fair and reasonable, the proprietors have the right to be advised of the offer or the existence of negotiations or talks that may eventuate in an offer.
Recommendation The ASX should be immediately notified of any offer submitted to one or more directors or if there are reasonable grounds to believe that a formal offer is a possibility, which if accepted by the owners would be likely to change the existing control of the business. Directors should ensure that the shareholders are notified forthwith and ask the ASX to immediately suspend the stock, which shall remain suspended until five business days after notification has been mailed or emailed to the proprietors.
2.4 Directors Defense against a Take-Over Offer The Problem Directors normally have a personal pecuniary interest in retaining their board seat and will often go to great lengths and shareholder expense to defend the status quo. While shareholders are naturally delighted to entertain any offer that exceeds recent share prices, the media refers to such offers as hostile. Presumably the hostility is engendered by the indignity of directors with little to gain and much to lose. In such instances there is always a risk that the directors might misrepresent the entities true status in attempting to convince shareholders to reject the offer, thus causing shareholders to be financially disadvantaged by rejection of what may well prove to be an overly generous offer. In order to support their position directors will obtain a so-called independent valuation. While such valuations provide an estimate of the upper and lower range of value, they neither provide the assumptions used in its determination nor the required rate of return (RR) by which the value was calculated. The valuation of all financial securities (other than those that merely value asset backing) is dependent upon the adoption of a RR, the absence of which makes the value declaration meaningless. The fact that directors only feel beholden to advise shareholders of the advisability of selling when the director's pecuniary interest is at stake, makes a mockery of such advice. This charade is highlighted when the directors have caused the company to purchase back shareholders interests at a lesser price or have not seen fit to comment when shareholders have sold at prices that are less than the takeover offer.
Recommendation In advising shareholders of the terms and conditions of the offer, that directors provide the following information: An historical chart of the company's share price over the past three years and such other financial information and business prospects that may be deemed pertinent in assisting shareholders to make a decision. Any specific reasons or advantages to the party making the offer and the likelihood of a competing offer from another party. Each director should declare their numerical interest in the shares and declare whether or not they intend to accept the offer in the absence of a better offer. That while they are free to express an opinion as to whether they consider the offer to be fair and reasonable, they be specifically prohibited from providing an opinion, independent or otherwise, as to value.
2.5 Employee Options The problem Employee options that lack incentive hurdles are frequently issued on terms and conditions including low exercise prices, which when combined with other remuneration benefits, cause the total remuneration package to far exceed the market value of the employees' services. Because the ultimate reward from such options is dependent upon the share price at the exercise date, the incentive to promote the share price rather than the long term underlying business performance can lead to actions, embellished statements and representations which are contrary to reality or the shareholder's best interests. While the negative influence on shareholder interests of employee options has been adequately demonstrated in the past, there is little evidence to suggest that the issue of employee options is helpful to shareholder wealth creation. Employees have a tendency to be transient and the nature of executive options can provide an incentive for the executive to make a killing and move on by adopting short-term policies that are contrary to the long-term interest of the business. The existence of options can be instrumental in determining dividend policy. If a business ceases to pay dividends, the share price will escalate more quickly by virtue of the increased level of retained profits. Dividend policy should be determined by economic issues and not influenced by vested interests.
Recommendation That while employees should be encouraged to have equity in the business, employee remuneration exclude share options. As is common practice in some other countries, the date and price of sale and purchase of shares by directors or entities in which they have an interest or some degree of control be disclosed in the annual report.
PART 3. DISSEMENATION OF INFORMATION 3.1 Dissemination of Interim Results, News and Preliminary Profit Announcements The Problem Share prices tend to react to knowledge of events that are likely to impact on profitability. Small shareholders often see dramatic changes in the price of their holdings without being aware of the reason, if any, for such changes. While companies are required to lodge half-year financial statements and directors' report with the ASX, there is no requirement under the Corporations Law that companies provide shareholders with copies of their half-year results. Because the ASX does not make all company announcements freely available on its web site, few small shareholders are aware of preliminary profit announcements or other information that might impact on investment decisions. Even when interim reports are provided by the corporate entity, there is usually a considerable time lag between publication and distribution of interim and annual reports and the preliminary profit announcement. Shareholders must therefore subscribe to a service provider or pay the ASX to be kept informed. The printing and postage cost of keeping small shareholders advised, many of whom might hold little more than a marketable parcel, is a factor that must be taken into consideration.
Recommendation In order to minimize cost while at the same time improving the current level of continuous disclosure and information dissemination, we recommend all or at least a combination of two of the following requirements: A. In the interests of ensuring that the market is kept fully informed, the ASX should make all listed entity announcements freely available on its web site or provide a hyperlink to the entities web site containing that information. B. That all listed entities are required within a given time frame to have their own web site and contemporaneous with information required to be forwarded to the ASX, post the same information to their web site.
19 C. That listed entities invite their members to provide their email address for the purpose of being alerted to news releases and other information required to be distributed to statutory bodies. Emails to members may contain comprehensive text or simply a reference to the content and a hyperlink to the entities web site where the information can be viewed, downloaded and printed.
3.2 Events Likely to Impact on Future Profitability The problem Share prices tend to react to knowledge of events that are likely to impact on profitability. Small shareholders often see dramatic changes in the price of their holdings without being aware of the reason, if any, for such changes. Institutional and larger shareholders that conduct a dialog with listed entities are sometimes advantaged in as far as they are privy to information and events that are not commonly known to the market as a whole.
Recommendation That no party, whether they are a shareholder or otherwise be given information which is not currently available in accordance with the recommended means of information dissemination in 3.1. At such time that the directors are of the opinion that ROE for the current accounting period is likely to vary by more than 25% from the previous year, dissemination of such information including explanations and profit projections should be made forthwith in accordance with the recommendations of 3.1. Example: If the ROE for the previous year happened to be 20% and the directors were of the opinion that the ROE for the current year was likely to be greater than 25% or less than 15%, they would be obliged to make this information available in accordance with the recommended means of information dissemination of 3.1. When applicable, such information should also be presented in the annual report for the preceding year and interim report for the current year. In the absence of such advice, the directors are deemed to be of the opinion that the ROE for the current year will not vary by more than 25% of the ROE for the previous year. While directors should not be held accountable for minor errors of judgement, they must provide adequate explanations in the annual report for major errors of judgement.
PART 4. CORPORATE GOVERNANCE 4.1 Corporate Governance Director Background During debate in the senate on the Company Law Review Bill 1997, amendments were moved to the Bill relating to the requirement that listed companies must establish a corporate governance board to perform specific functions to the exclusion of the main board. The board was to be separate and distinct from its company's board of directors and elected by shareholders on the basis of one vote per member. While accepting the need for improved standards of corporate governance and the desirability of less prescriptive law, the bill was rejected for many practical reasons, not the least of which was duplication of existing responsibility and the additional cost burden placed upon the company. Coles Myer Ltd estimated the total annual cost of compliance with the proposed amendments was $1.2million. Research conducted in the USA demonstrated "a clear correlation between sound corporate governance practices and good financial performance." Implementing good corporate practices was therefore in the interests of shareholders.
The Problem While existing directors and their replacements are ostensibly appointed by the shareholders, if the board controls the proxies, the board controls the appointment of directors. Therefore a separate CG board of director nominees is likely to be less effective that an independently appointed member with certified qualifications. For the same reason that it would be inappropriate for a director or other employee to be the company's auditor, one would imagine that it would be inappropriate for an existing director to be responsible for the corporate governance of himself and fellow directors. The requirement to have the books audited is based on the premise that the company's directors or employees lack the qualifications or integrity to comply with accounting standards. Corporate governance requirements should be seen in no lesser light than audit requirements. In view of the scope that compliance with accounting standards provides for profit interpretation and subjective asset
21 valuations, there are strong arguments to suggest that compliance with the practices outlined in this Code is of predominant importance. The present system that largely relies on self-regulation and self-accountability has proven to be ineffective in protecting shareholder's rights and interests. The club syndrome of directorates that fosters collusion can lead to the promotion of self-interest, dissemination of misinformation, embellishment of the positives, avoidance of negatives and misrepresentation of profit declarations. Such actions that weaken public confidence in capital markets are detrimental to a financial system whose proper functioning is reliant upon its good reputation. From the foregoing and the research conducted in the USA, it can be reasonably assumed that providing the CG director is qualified, independent, effective and cost efficient, shareholders have a great deal to gain and nothing to lose.
Recommendation That a company's directors focus on running the business and that an independently appointed Certified Corporate Governance Director (CCGD) be responsible for ensuring compliance with the Code and the principles of good corporate governance. Short term interim measure: That the board of each listed entity appoint one of the existing directors to be directly responsible for the observance of the entities existing corporate governance obligations and to disclose and report on same in the annual report. Permanent solution: That a curriculum encompassing the subjects and course of study for a CCGD is prepared and a diploma course established for the purpose of examination and certification. That a board is established to interview and appoint CCGD's to each listed entity, commencing initially with entities having the highest market capitalization. As a mandatory requirement of listing, each listed entity would be required to employ any pay the fees and reasonable out of pocket expenses associated with attending meetings and other necessary costs incurred in the performance of the CCGD's duties. The "Appointment Board" would establish a scale of fees with due reference to the size or market capitalization of the entity and the number of board meetings held each year.
22 The prime functions of the CCGD would be as follows: A. To attend all directors and audit committee meetings and ensure that the minutes reflect the issues raised by the CCGD. B. To ensure compliance with statutory requirements. C. To ensure compliance with the "Code of Good Corporate Practice" D. To ensure proper disclosure in the annual report of business transacted between the entity and interests associated with directors and other required disclosure issues. E. To report to the Appointment Board particulars of any unresolved matters considered to be in breach of compliance issues. F. To write the CG report for the annual report highlighting any major unresolved or contentious issues or general areas of concern or disagreement. The Appointment Board would be required to review the report making such amendments or deletions, as it may deem appropriate prior to requiring the directors to ensure its inclusion and publication. The Appointment Board would have no authority to impose penalties but would decide if the complaint or breach should be passed onto the appropriate authority such as the ASX, ASIC or other applicable regulatory authority. Conclusion: As was the case when company books were first required to be audited, many directors are likely to consider the appointment of a CCGD as an unwarranted intrusion into their affairs. Others who recognize the relevance of supporting, protecting and advancing the interests of all proprietors will welcome the CCGD as an ally in a common cause.