CORPORATE GOVERNANCE IN THE PUBLIC SECTOR

Presentation to
Clayton Utz CEO Breakfast Seminar

By Wayne Cameron,
Auditor-General of Victoria

8 February 2002

What is corporate governance, and why is it receiving so much attention in recent times?

Corporate governance has emerged as a mainstream topic and is receiving increasing attention across both the private and public sectors due to a range of factors, including:

• corporate failures;

• increasing pressure to perform, through globalisation;

• public sector scandals;

• emergence of new risks;

• increasing complexity of stakeholder relationships and expectations; and

• regulators and standard-setters are increasingly requiring organisations to adopt best corporate governance standards.

Principles of corporate governance are derived from common law, statute and recognised good practice. Corporate governance has developed from the increasing demands on Boards of Directors to be more accountable for their actions. As the needs of stakeholders, including shareholders evolve, so does the meaning of good governance.

In the public sector, corporate governance must recognise the different accountability relationships that exist, e.g. ownership rests with the community/taxpayers represented by Parliament, while management responsibility rests with the Government (Ministers and public sector agencies).

The term “governance” is used frequently, yet no single definition is universally accepted.

Nevertheless, it is generally understood to encompass authority, stewardship, leadership, direction and control.

Governance refers to the process by which organisations are directed, controlled and held to account.

Pre-requisites for effective governance are:

• establishing a role for each of the parties, which is clearly understood by the other parties;

• constructive relationships and accountabilities based on those roles;

• an effective governing body; and

• effective monitoring arrangements which reflect a balance between the interests of Parliament, Executive oversight and the autonomy of the governing body and/or management.

Why is it of increasing importance in the public sector?

A number of issues have contributed to the growing importance of corporate governance –especially within the public sector:

• increasing community expectations re: performance and transparency/openness of process;

• changes in the way the public sector is conducting its business, e.g. how many of you are involved in outsourcing? … what were some of the first things that you found you had to do? … there would have been a need to clearly define your service requirements … but did you also give enough attention to your changed business relationships? … and how did you ensure that the core public service ethical, informational, consultative, collaborative arrangements remain effective?

Corporate governance in the public sector has to satisfy a more complex range of political, economic, environmental and social objectives, according to a greater variety of external constraints and influences than do businesses in the private sector. For instance, agencies must operate openly and in accordance with the checks and balances imposed on public bodies by – Parliament, the Government, and central agencies. “The essence of any system of good governance is to allow the board and management freedom to drive their organisation forward but to exercise that freedom within a framework of effective accountability”.
(Henry Bosch – working group on corporate practices and conduct 1995.)

In August 2001, IFAC and the PSC issued a checklist of good corporate governance for public sector bodies, adapted from the CIPFA guide published 1995. The checklist is summarised as follows.

1.Standards of behaviour

• Leadership;

• Code of conduct; and

• Objectivity, integrity and honesty.

2.Organisational structures and processes

• Statutory accountability;

• Accountability for public money/performance;

• Communication with stakeholders; and

• Roles and responsibilities.

3.Control

• Risk management;

• Internal audit;

• Audit committees;

• Internal control;

• Budgeting and financial management; and

• Staff training.

4.External reporting

• Annual reporting;

• Performance measures; and

• External audit.

For the purposes of our discussion this morning it is helpful to group the numerous elements of Corporate Governance into 4 Key elements.

It is up to you to choose between the 2 schematics (i.e. IFAC or the next diagram) – the elements are the same but the emphases are a little different.

You will need to establish the model which best suits your organisation, its goals and the nature of its relationships with the various stakeholders.

The diagram that follows shows these elements more clearly:

Departments

S&D will be developed by the respective Secretaries/Ministers in the context of the Government’s goals and desired outcomes.

Local government

S&D will be developed by the council in meeting local community needs within the constraints of enabling statute.

Statutory boards

S&D will be developed in the context of enabling statute having regard for government goals and desired outcomes.

An Example: Statutory Bodies:

Parliament has established Boards to oversee the management of the entity. The Board is responsible for setting corporate objectives, developing policies governing day-to-day operations, and overseeing the implementation of those policies through the CEO. The Crown has important rights, usually espoused in legislation, which are exercised through the Responsible Minister, namely:

• to exercise control over the entity and determine its direction, using the provisions of legislation;

• to appoint and dismiss members of the Board;

• to approve the size, shape and scope of the entity’s operations, and

• exercise other rights contained in legislation.

The Board is immediately accountable to the responsible Minister for the performance of the entity. The Minister is responsible for ensuring that the entity is managed in the Crown’s interests, and so plays a key part in the governance framework for the entity.

It is important that strategy, policies and other directions be clearly specified, communicated and understood by those parties responsible for their implementation. Responsibilities and accountabilities must also be clear. There is no doubt that the development of alternative service delivery models in the public service will continue out into the future just as it has in the recent past. At times of such change, clear and explicit consideration, decision and communication must be given to the impacts of these changes on maintaining effective governance arrangements.

Whenever services are performed by other providers – whether they be on contract, through franchising arrangements or partnerships or joint ventures – the governance arrangements must be accorded priority.

The same is as true in local government as it is in State Government. Refer to the recent study in NZ by the Auditor-General.

Management standards

Leadership, development, explicit expectations, define relationships, regular monitoring and feedback. A clear view is required of:

• purpose of business structures;

• expectations of stakeholders;

• determination of powers/delegations;

• information flows;

• understanding of relationship between parent and subsidiary;

• avoid conflict of interest;

• approval of business plan – nature and scope of business;

• clear view of what must be referred to owners for consideration/information;

• financial plans;

• assessment of public risks, including guarantees/backing;

• political risks;

• investment/divestment considerations; and

• changes in nature/location and scope of business and business risks.

Holding company model

Often formed to take advantage of various financial benefits associated with managing trading activities within a group. Changes rights and responsibilities – from council to the holding company.

Any transfer of the legal ownership makes it essential that council keeps close control over its holding company – can be achieved through direct representation by council on the Board of the holding company, and oversight of the business direction taken by the companies in the group.

Such arrangements are established to protect the ability of the shareholding local authority to exercise strategic oversight of its investment portfolio.

Advisory committees to:

• Minister – ensure objective advice - perception of independence; and

• EO and Board Councils - need adequate expertise and independence in reporting; and breadth of knowledge/experience.

Audit committee:

• much merit in having an effective audit and risk committee with an independent chair to oversee compliance and risk management; and

• member must have a knowledge of the business.

Terms of reference of committees, as well as composition, roles, responsibilities and reporting requirements are important and must be made explicit. Informal arrangement have adverse consequences.

“Governing board members are accountable for their conduct and performance, the strategic direction and performance of the agency as well as the agency’s compliance with other requirements”. (WA Public Service guide.) They must have a full understanding of the organisation, the environment in which it is operating and the issues it faces. (Refer to AICD Checklist for guidance on what prospective directors ought to do before accepting appointment to a Board/governing body.)

Common expectations

Explicit record of the relationship between the Board, and responsible minister re shared understanding between the 2 about what the Board is there to do;

• Clear lines of accountability and authority between Board, CEO and responsible Minister; and

• Board members to understand public sector legislation, procedures and practices, and awareness of the importance of following acceptable standards of corporate conduct and behaviour.

Barriers to effective operation of the Board

• Differing expectations about role and performance of Board – special role of chair;

• Participation level by Board members at Board meetings;

• Clear ministerial expectations of the Board;

• Relationship between Minister and CEO; and

• Nature of involvement in government policy development processes.

Obligations of being a public body

• Board member to understand public sector conventions and practices;

• Standard of corporate behaviour;

• Boards and members to identify and manage conflicting interests; and

• Understand relationship with government.

Information that should come to the Board

• Strategy, policy, performance monitoring information, regular assessment of relevant risks, and information about the public profile. Governing Board relationships with Responsible Minister. (See WA Better Practice Guide.).

NZ Study – Role of the responsible Minister

Each Minister is free to determine how best to undertake their responsibilities, but core features should include:

• regular communication, and

• formal reporting arrangements by the Board against agreed objectives.

Role of advisors – need explicit understanding by all the parties about the role of advisors – best dealt with formally in writing.

Ministerial directives – need to be explicit since it affects accountabilities. Such directives should be transparent.

Board/management relationships:

The relationship between the Board and management is critical to an organisation’s long-term success. However, problems do arise when the different interests of the Board and management are not defined. Some common problems include:

• interference by Board members in operational matters;

• managers become hesitant to make decisions;

• managers delegate difficult decisions upward which leads to a risk-averse or conservative culture; and

• Boards spend too much time on minor matters and thus overlook the major ones.

Minimum standards of corporate behaviour

Cue is taken from the top – shared vision, collaboration/openness, ethical values, respect for different views. Examples include:

• compliance with law;

• treatment of employees - fair and reasonable;

• unbiased tendering and purchasing;

• control over sensitive expenditures e.g. travel, hospitality, sponsorship;

• management of potential or actual conflicts of interest;

• use of transparent/open processes to distribute funds; and

• provision of public access to information about the organisation and its operations.

Conflict of interest

A person can’t serve 2 masters!

Need to have explicit guidelines about what constitutes conflict of interest and what to do about it whenever the possibility occurs or might occur.

Examples of conflict of interest, e.g. ENRON, HIH Insurance: “ENRON board’s worst failure, governance experts say, was to overlook the dual role of the Company’s CFO who reaped $30m by simultaneously running limited partnerships that did business with ENRON. – Should have been a red flag to the board. Having your CFO on both sides of a transaction reflected badly on the judgment of management”.

1. Monitoring arrangements and information flows: Need to be explicitly & formally prescribed, both as to content and frequency. Relying on a particular Board member because they are Council nominee is a recipe for future difficulties – confuses primary accountabilities.

2. Business and planning approval

3. Disclosure of corporate governance practices: In ex ante documents and ex post reports.

4. Public servants on the Board – Conflict of roles; not the best of positions, observer status may be a better compromise.

5. Nominee directors:

Nominee directors face conflict between their responsibilities to the entity and the Board/council to which they were primarily appointed. Elected representatives are responsible for promoting community interests which may conflict with the commercial objectives of the commercial entity.

Nominee directors should not be a substitute for formal monitoring arrangements between subsidiaries and the council.

CEOs should not be put in a position of conflict between their roles as advisors to council and their obligations as company directors.

6. Monitoring of risks needs to be targeted - Different types of risk in the public sector. i.e. more than merely financial risk, also political risk- community confidence, social risk, environmental risk, public safety risk. Monitoring arrangements for an entity need to reflect an assessment of the risks and opportunities facing the business, with a view to protecting and promoting the owner’s interests.

Owners should be informed of emerging risks. Boards should be clear about when they need to alert Minister about matters which may materially affect the Crown’s interests.

VPS – Corporate governance requirements

1. Public Sector Management and Employment Act 1998

Sets out obligations of Agency Head – Supported by a “Code of Conduct” published by the Commissioner for Public Employment. S13. Department Heads are responsible to Agency Minister or Ministers for the general conduct and the effective, efficient and economical management of the functions and activities of the Department.

2. Financial Management Act 1994

S42 requires that there be an accountable officer for each department and public body. An accountable officer has certain obligations/responsibilities mainly related to financial management and maintenance of proper systems, compliance with directions issued by the Minister of Finance and which includes reporting performance and preparing financial statements and a report on operations each year.

I continue to be amazed at the number of those with governance responsibilities not familiarising themselves with the primary legislation of their organisation.

Ownership is a little more diffuse in the public sector. There is high level public interest, because there are public resources involved – either present or at risk in the future. So, effective risk management, based on regular information flows of the required information upon which to form competent judgments, is mandatory.

In my experience, the lack of discipline about information requirements would rank as the most single common reason why difficulties develop and may frequently become terminal in organisations. The lack of complete information denies timely intervention to turn adverse circumstances around.

In summary

• Substantial progress in recent years.

• Increasing awareness of importance.

• Generally good and improving.

• Scope remains to further strengthen processes.

• Special difficulties in establishing quality relationships with subsidiaries.

Examples of corporate failures when governance is poor

• Inadequate internal control and non-disclosure.

• Dominance of individuals.

• Absence of arms-length approach to some deals.

• Lack of action by other directors to scrutinise/challenge the financial information.

• Poor reporting to the Board.

Issues for further attention

• Better defining relationships/responsibilities of all players (including Boards, Ministers, departments etc.).

• Accountability for performance (non-financial, performance reporting).

• Accountability for related entities/subsidiaries of public bodies.