Reimagining The Future Of Corporate Governance In Australia

Reimagining The Future Of Corporate Governance In Australia

The events of the Financial Services (Banking) Royal Commission (FSRC) have brought the corporate governance practices of some of Australia’s largest public companies into plain view. The insights revealed have been shocking, and shown that directors have not listened to internal whistle-blowers exposing misconduct, not asked the hard questions internally to fulfil their directors’ duties, nor acted in public interest. At the same time, these directors have been remunerated well, and yet rarely recommended to reduce each others’ remuneration in the light of scandal and poor performance. Where they have, it has been retrospectively, as if to send the right signals and manage appearances externally.

The systemic misconduct and governance failures revealed throughout the FSRC hearings presents an opportunity upon which to reflect and re-imagine the future of corporate governance in Australia. It has seen many scholars and commentators question the assumptions that underpin corporate governance in Australia, whilst those from the business sector have jockeyed to influence any proposed changes. It appears that those within the system would prefer to maintain a system built on the self-governance ‘comply or explain’ corporate governance codes and light touch regulation, and they can only envisage minor tweaks to the status quo of the unitary board system.

The systemic misconduct and governance failures revealed throughout the FSRC hearings presents an opportunity upon which to reflect and re-imagine the future of corporate governance in Australia.

In this chapter, we present some historical background on corporate governance, and critique some of the major features of the dominant Anglo-American inspired model of corporate governance – the unitary board. We then present its fatal flaw, that it mixes executive and non-executive directors on that same board. Finally, we discuss a range of possible solutions to these problems being discussed in Australia and abroad, to propose some tangible ways forward, such as mandated two-tiered board structures, increased worker representation on boards, and rewriting governance codes of practice.

Dispersed ownership and its implications

The birth of corporate governance in Australia can be traced to the enactment of corporations legislation influenced and inspired by the Joint Stock Companies Act 1856 (UK) and its key principles of limited liability, and laissez faire capitalism (McQueen 1991). Limited liability enabled investors to buy a stake/share/security in a venture knowing that the only loss they would incur if the entrepreneurial venture was unsuccessful was the money they had invested to buy that stake. Laissez faire capitalism inspired a sense that businesses should be somewhat unencumbered by regulation, and would therefore govern, and to a degree regulate, themselves.

The dispersed joint-stock ownership structure created the separation of ownership and control, where those who managed the firm (agents), did not own the firm (principals). Further, it meant that no single shareholder possessed the power to control management.

Adam Smith famously highlighted the governance challenge implied herein, in overseeing managers appointed to run publicly-listed companies:

The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. (Smith 1776)

Berle and Means (1932) penned a withering critique of the direction, in their opinion, of the dispersed ownership structure in which no single shareholder has the power to control management. They viewed it is as leading to the creation of an elite class of executives or managers who owners would find difficult to hold accountable, and who managed largely for their own interests. More recently, Bloom and Rhodes (2018) have perhaps advanced similar critiques as to whether this has spread further than just the corporate sphere. In their final chapter, Berle and Means (1932) recommend the public chartering of corporations because they viewed the shareholder (agency theory monitoring) or managerial stewardship as sub-optimal and anti-democratic.

The agency problem (also known as the principal-agent problem) created by the separation of ownership and control has been central to corporate governance thinking and practice. Jensen and Meckling (1976) proposed agency theory where managers are rational, self-interested agents (homo economicus) motivated to maximise their own financial lot in life and not necessarily to serve the interests of shareholders. In other words, managers, who were not owners, did not serve the interests of owners, and managed the firm largely in their own interests. At the same time, there is an information asymmetry in this principal-agent relationship where those who managed the firm know far more about the operations of the firm than those who oversee them. Resolving this agency problem, that managers are self-interested and have more operational knowledge of the firm, than principals, has been central to theorising in the field of corporate governance. Further, this thinking positions the owners (shareholders) as the central actors for whom the firm should be run, and somewhat ignores the public nature of publicly listed companies, and the duties of directors to the corporation itself and the broader public.

Feature of Modern Corporate Governance

To address this agency problem, the Anglo-American Business Model’s primary governance model, the unitary board, contains several features. These include prominent roles for board committees (auditing, nomination and remuneration), Independent Non-Executive Directors (INEDs) and Institutional Investors (IIs) in the governance of firms.

Independent non-executive directors

Under the unitary board, independent non-executive directors (INEDs), non-executive directors, and executive directors are all members of the board of directors. Corporate governance codes usually require a strong presence of independent (outside) directors on a unitary board. Directors are viewed as independent when there are no relationships or circumstances which could affect the director’s judgement. They are seen as playing the most important role on a board, to monitor management activities, reduce managers’ opportunistic behaviour and drive better firm financial performance. Directors of public companies have specific responsibilities and duties, to govern in the corporation’s best interests and ensure that corporations do not impose costs on the wider community. The downside is that independent directors may lack in-depth knowledge of company operations; may be busy with multiple directorships; and may not be truly independent. All of these downsides can undermine their ability to be effective as directors, and can be exploited by executive directors who are in the position to set the agenda and gate-keep what information gets to the board.

Board committees

Building on the assumptions of agency theory, a key practical responsibility of the directors is the selection of a CEO and the overseeing of that CEO and other senior managers of the corporation on a day-to-day basis. In the unitary board system, the board delegates vital oversight functions to its sub-committees. These committees perform an important function in terms of cordoning off certain aspects of the work of the board from the executive (agent) members. In corporate governance codes and best practice guidance, including the Australian Stock Exchange (ASX) Corporate Governance Principles and Recommendations, it is advocated that committees have at least three members, a majority of whom are independent directors, and are chaired by INEDs (ASX Corporate Governance Council 2014). Boards generally contain a number of sub-committees that have an important role in monitoring senior management with the audit, nomination and remuneration committees being historically the most common with the presence of risk and or corporate governance committees being a more recent development.

The role of the audit committee is crucial in determining whether the accounts of the firm do indeed represent an accurate picture of the company’s finance. It is chaired by INEDs, where the engagement of an independent auditor is a requirement for listing on a stock exchange. It is a concerning sign for a company to be constantly changing auditor and suggests something is not quite right.

The nomination committee’s role is to nominate new board members and prospective executives to the firm and like all committees should have an INED as chair and be majority composed of INEDs. CEOs, in practice, often help select directors and exert substantial power over the board as a function of their operational expertise. Directors often recommend the nomination of directors that are known to them through their networks (Smith 2018).

The remuneration committee is responsible for determining the remuneration packages of the senior executives and directors. It stands to reason that we would not ask a room full of executives to decide their own level of remuneration or bonuses. Under an agency theory view of the world, one way we deal with executives is to incentivise them do what we want. In other words, we reward them in such a way that they focus on what the owners want them to do. In this way, remuneration packages of executives have grown ever more complicated in Annual Report disclosures, to seemingly justify an ever-rising tide of higher remuneration for senior executives and directors. A key component of the modern remuneration package is stock options and grants – where we transfer ownership rights to the executives, making them owners of firm stock. This is an attempt to align the interests of executives with that of the shareholders, although potentially bringing them into conflict with broader societal or environmental interests.

Remuneration is one corporate governance mechanism viewed as being able to address the agency problem where ownership is viewed as conferring divine rights to the owner.

Martin (2011) proposes that stock based remuneration for executives and directors is tantamount to allowing professional sports people to gamble on the outcomes of the games, and should be outlawed. It leads to a short term thinking and manipulation of performance metrics and stock prices for their rewards. In other words, Martin argues that it exacerbates the agency problem, and advocates keeping the people involved in the ‘real game’ of running the company or sitting on the board separate from the expectations game of the stock market.

Remuneration is one corporate governance mechanism viewed as being able to address the agency problem where ownership is viewed as conferring divine rights to the owner.

Ownership conflated with control

Modern corporate governance makes executives (agents) owners in order to incentivise them and align their interests with that of owners (principals). In the past, corporations have sought to make workers owners through Employee Share Ownership Plans (ESOPs), in the hope of extracting more commitment and productivity by also aligning their financial interests with that of the firm. In Australia, the now well-developed system of industry super funds has made workers participants in the financial system as a source of capital. All of these mechanisms have strengthened the logic that firms should be governed for their owners, even though legally they are not proprietary owners of the corporation.

Shareholders – Institutional Investors

The logic of the unitary board is that the owners’ (shareholders’) interests are those who should be served, with directors monitoring managers on their behalf. Increasingly, share ownership is held by institutional investors (IIs) where pension/superannuation, banks, insurance and other investment firms hold shares on behalf of others. The corporate governance codes and best practice guidelines advocate for these IIs to engage with the firms they own shares in, vote, and use their voice to affect positive changes to the governance of the firm. However, research shows that institutional investors do not engage and attempt to improve the corporate governance of the firms in which they are invested, and instead focus on return on investment (Tilba and McNulty 2013; McNulty and Nordberg 2016). If a stock performs poorly, the institutional investors exit and take their money elsewhere, instead of engaging and attempting to improve corporate governance of the companies in which they invest in.

Fatal flaws

The fatal flaw inherent in the unitary board is that it mixes executive and non-executive directors. The problem has always been that executive directors have been able to capture boards and, whilst the features outlined attempt to fix this problem, using committees has

not been effective. All of these committees are dominated by INEDs but their decisions continue to perpetuate problems with executive remuneration, lack of board diversity, and reluctance to challenge executive directors. And that’s exactly the problem that was revealed in Australian Prudential Regulation Authority’s review of Commonwealth Bank of Australia (CBA) (APRA 2018).

Similar to the arguments of John Quiggin on legislating property rights for nature in this issue, boards should be re-structured and much more diverse. It is open to Parliament to change how boards are structured and who sits on them. We also argue that consumer and other voices should be prominent in the regulatory oversight of particular industry sectors like banking and finance.

In light of recent governance failures in Australia and elsewhere, there have been a number of movements globally to reform the nature of shareholder capitalism and its associated corporate governance practices.

International ideas

In the USA, Elizabeth Warren has proposed the Accountable Capitalism Act to de-emphasise the idea that the mission is to pursue shareholder value above all else, and emphasise that corporations “consider the ramifications of their actions on others, including their families, neighbours, communities, and broader society”. The Act attempts to hold corporations accountable for their actions, and to confer a legal obligation to a broader set of stakeholders.

In the USA, Elizabeth Warren has proposed the Accountable Capitalism Act to de-emphasise the idea that the mission is to pursue shareholder value above all else, and emphasise that corporations “consider the ramifications of their actions on others, including their families, neighbours, communities, and broader society”.

The legislation relies on the assumption that managers are accountable to the directors of the firms, and this is not always the case as executives often dominate the boardroom landscape. It advocates that firm governance become more democratic with 40% of the board elected by the employees. It also contains rules constraining executives from engaging in short-term share trading and requires a supermajority agreement (3/4) of the board and shareholders to vote before the company uses funds for political purposes.

In the UK in 2016, whilst campaigning to be Prime Minister, Theresa May suggested there would be changes to the way corporations were run under her leadership, and raised the idea of mandating worker directors. After May’s victory, the Financial Reporting Council (FRC) undertook consultation on the proposal of worker directors. The May Conservative government then watered down its position from initially mandating worker directors to providing a range of options to firms including 1) assigning a non-executive director to represent employees, 2) creating an employee advisory council or 3) nominating a director from the workforce. This enabled companies to choose how they intend to heed the views of employees.

In September 2018, British Labour Shadow Chancellor John McDonnell outlined his party’s vision for worker directors and employee ownership. It proposed that all companies with over 250 employees would be required to have one third of their board composed of employee representatives. Additionally, McDonnell proposed that “all UK listed companies

with more than 250 staff would be legally required to transfer 1% of their ownership into an “inclusive ownership fund” of collectively held shares”.

In the UK, even if the Conservative party has weakened its position on the matter, it would seem that the worker director is an idea whose time has almost come. However, in Australia few of the proposals being discussed incorporate worker directors, and indeed many commentators in the wake of the #BankingRC have rallied against ideas of worker directors and German-style corporate governance. Instead, promises have been made to do better, weak regulators have been blamed, but structural change is being resisted.

How to fix corporate governance in Australia

Research into European banks suggests having employee and union representation on supervisory boards, combined with introduction of employee-elected works councils to deal with management over day-to-day issues, reduces systemic risk and holds executives accountable (Anginer et al 2014; Ferri et al 2015).

To address the confusion created by mixing executive and non-executive directors on one board, Australia should mandate a two-tiered board structure for corporations and large companies. This is similar to the largely successful German system of co-determination. This would separate non-executive from executive directors and create clear, legally separate roles for both groups.

On the upper, supervisory boards’ non-executive directors would be legally tasked with monitoring and control. This includes approving strategy and appointing auditors. A lower, management board made up of executive directors would be responsible for implementing the approved strategy and day-to-day management.

This is important given the findings of an Australian Prudential Regulatory Authority report into culture at the Commonwealth Bank (APRA 2018). It found a board in awe of the CEO and executive committees unwilling to challenge him, not to mention their lack of detailed operational and regulatory knowledge.

It’s noteworthy that it was operational-level employees who acted as whistleblowers and brought on the banking royal commission. Employee-elected directors would systemise this process. Employees often have a much better understanding of what is happening inside large corporations than any independent non-executive director could. And by electing employee directors, boards become more democratic and better proxies of the public interest – not just the interest of shareholders.

The ASX code is bad and ineffective (Linden 2017). It is written by corporate insiders for corporate insiders, under the aegis of a listed corporation (the Australian Stock Exchange) (ASX Corporate Governance Council 2014).

This is why responsibility for writing and amplifying governance practice should fall to a regulatory (APRA, Australian Securities and Investments Commission and the Australian Competition and Consumer Commission) convened panel comprised of community and consumer advocates.

These reforms are important but they are just the start. They need to be complemented by wide-ranging initiatives in prudential regulation, corporate law, competition law, electoral law (Goss 2017) and industrial relations (Klikauer 2005). All of this is necessary to constrain inappropriate corporate influence over regulators, politicians and wider public discourse.

These reforms are important but they are just the start. They need to be complemented by wide-ranging initiatives in prudential regulation, corporate law, competition law, electoral law (Goss 2017) and industrial relations (Klikauer 2005).

The laundry list of necessary reforms includes breaking up the big four accounting firms, capping executive remuneration and banning variable incentives, banning corporate political donations and heavily restricting lobbying (Chin et al 2013), better resourcing regulators and working to prevent regulatory capture (Porter et al 2014), and closing loopholes in the corporate law.

Finally, intensifying proactive surveillance would increase the number of criminal prosecutions of directors and senior executives.


Anginer, D., Demirguc-Kunt, A., Huizinga, H., & Ma, K. (2014). Corporate governance and bank insolvency risk: international evidence. The World Bank

APRA (2018) Prudential Inquiry into the Commonwealth Bank of Australia (CBA) Final Report Accessed at: [Accessed 30 June 2018]

ASX Corporate Governance Council (2014) Corporate Governance Principles and Recommendations (3rd Ed.) [Accessed 30 June 2018]

Berle, A., & Means, G. (1932). Private property and the modern corporation. New York: Macmillan.

Bloom, P., & Rhodes, C. (2018). The CEO Society. University of Chicago Press.

Chin, M. K., Hambrick, D. C., & Treviño, L. K. (2013). Political ideologies of CEOs: The influence of executives’ values on corporate social responsibility. Administrative Science Quarterly, 58(2), 197-232.

Ferri, G., Kalmi, P., & Kerola, E. (2015). Organizational structure and performance in European Banks: A reassessment. In Advances in the economic analysis of participatory & labor-managed firms (pp.109-141). Emerald Group Publishing Limited, UK,.

Goss, R. (2014). Votes for corporations and extra votes for property owners: why local council elections are undemocratic, The Conversation [Accessed 30 November 2018]

Joint Stock Companies Act 1856 (UK)

Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360.

Klikauer, T. (2005). Forcing German managers to focus on productivity. Employee relations, 27(5), 459-477.

Linden, A. and Staples, W. (2018). ‘Solving deep problems with corporate governance requires more than rearranging deck chairs’ The Conversation [Accessed 7 October 2018]

Linden, A. (2017). ‘The CPA saga demonstrates why Australia’s corporate governance code needs replacing’ The Conversation

[Accessed 7 October 2018]

Martin, R (2011). Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL, Harvard Business Press, USA.

McQueen, R. (1991) Limited Liability Company Legislation-The Australian Experience. Australian Journal of Corporate Law, 1(1), 22-54.

McNulty, T., & Nordberg, D. (2016). Ownership, activism and engagement: Institutional investors as active owners. Corporate Governance: An International Review, 24(3), 346-358.

Potter, M. R., Olejarski, A. M., & Pfister, S. M. (2014). Capture theory and the public interest: Balancing competing values to ensure regulatory effectiveness. International Journal of Public Administration, 37(10), 638-645.

Sitaraman G (2018) ‘We must hold capitalism accountable. Elizabeth Warren shows how’ [Accessed 28 November 2018]

Smith, S (2018) ‘Company boards are stacked with friends of friends so how can we expect change?’, [Accessed 28 November 2018]

Tilba, A., & McNulty, T. (2013). Engaged versus disengaged ownership: The case of pension funds in the UK. Corporate Governance: An International Review, 21(2), 165-182.