ESG Stalemate: The Fifth Edition That Never Came

Where does corporate governance hail from, and how can we fix it?

In Tuesday’s AFR, the boss of the AICD, Mark Rigotti, jumped on the ASX Corporate Governance Council reform bandwagon. He argued that something needs to be done about the outmoded and dysfunctional Council. The rationale? After two years of deliberation, the Council couldn’t come to a consensus on what the fifth edition of the Corporate Governance Principles and Recommendations should look like. Too much DEI and ESG, according to commentators—including the secretive, anonymous deep-throat insider who opined in the AFR on 20 February.

The central sticking point: the recommendation that directors be encouraged to disclose not only their genders but also their sexualities, ethnicities, and disabilities. This was clearly a bridge too far for the business-oriented side of the membership, and they rejected the proposal. Accordingly, the fourth edition stands.

This is a watershed moment for listed company corporate governance in Australia. Reaching an impasse after a two-year process will have many smart heads thinking about what the next step will involve. One imagines that the process will be very different from the one currently in place.

In an editorial in the AFR on 18 February, John Wylie, listed-company veteran and head of Tanarra Capital (with more than $3 billion under management), suggested a complete overhaul of the guidelines is necessary. His position is backed by many of Australia’s top businesspeople, all arguing that the burdens of compliance and regulation are driving directors off boards and companies toward private equity. The most interesting of his proposals is that directors should be up for election each year. This is consistent with U.S. and UK best practices, and it hasn’t seemed to result in a corporate apocalypse in those jurisdictions.

Many of the criticisms of the recent principles suggest that the Council has lost its way. Indeed, corporate governance was developed in the heady days of the 1980s when U.S. pension funds and institutions began to worry that their good-old corporate executives were strangely not acting in the best interests of shareholders. Hostile takeovers—actions that ostensibly would increase shareholder value—were being parried away by poison pills and greenmail payments that entrenched management rather than maximized value.

In an interesting article, Brian Cheffins suggests that the outside director was introduced to allow executive management to protect itself from shareholder lawsuits. He says that the "judiciary generally upheld steps taken if outside directors exercising independent judgment endorsed what was done." Accordingly, if the executive wanted to execute a poison pill, they would bring in an independent director to second the decision. The courts would look at the business judgment rule and give the green light.

So, if you are an institution in this situation and the management of your company is paying greenmail premiums to some other guy who is threatening a takeover, what do you do? You set up a lobby group and ensure the companies you invest in exercise good corporate governance.

Indeed, you make sure there are benchmarks for management and boards. You ensure that underperforming CEOs are fired, that executive remuneration (including options) is tied to performance, and that shareholders have a greater say in corporate affairs. In short, you write down corporate governance processes and policies. Fair enough—the investors must be protected.

Corporate governance was taken up by U.S. pension funds in the 1980s and 1990s, and then it was imported to Australia. Once the disaster of HIH was recognised as principally a failure of effective oversight and accountability by the board, everyone in Australia was receptive to the introduction of the ASX Corporate Governance Council, tasked with creating good and wholesome—yet non-mandated—corporate governance guidelines. The Council was set in motion in 2002.

But, like any rule-making body, the scope of its work tends to expand. With the rise of corporate social responsibility (CSR) worldviews, the ASX Council began incorporating social, environmental, and governance risks into corporate governance principles. Boards were tasked with disclosing these external risks and managing them. In an age of gender equality, companies were also required to disclose their gender diversity—essentially, how many women were on the board and in top management.

In the recent deliberations of the ASX Governance Council and the proposed fifth edition, it seems that this encouragement to disclose diversity has been extended to other markers of identity, including sexuality, ethnicity, and disability. For the business side of the Council, this was an overreach by the superannuation lobby. And backed by the confidence created by the worldwide repositioning of the DEI paradigm—caused in part by Donald Trump’s overhaul of his federal civil service—half the Council reached a breaking point.

So, the fourth edition stands, and life will carry on. But it will be interesting to see if Wylie’s new proposals make any headway, especially the idea of annual elections for the entire board. Institutions can rattle their sabres with the threat of their votes every year, and it seems like a viable alternative to the overly complicated two-strike board spill mechanism.

Only time will tell.

In the meantime, it is business as usual for us company secretaries.