PRINCIPLES OF CORPORATE GOVERNANCE IN THE PUBLIC SECTOR: TAKING CARE OF BUSINESS

Presentation to
National Legal Aid Best Practice Conference

By Wayne Cameron,
Auditor-General of Victoria

6 June 2003

What is corporate governance about?

Governance is the manner in which an organisation is managed and governed in order to achieve its strategic and operational objectives.

It is generally understood to encompass authority, stewardship, leadership, direction and control. Governance refers to the process by which organisations are directed and held to account.

“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 for effective accountability.” (Henry Bosch, Working group on corporate practices a conduct, 1995)

However, good governance in itself does not guarantee good practice and good outcomes. This will result from behaviour, rather than processes.

The importance of the behavioural aspect of good governance is reinforced in the Australian National Audit Office’s (ANAO’s) approach and guidelines on the subject. The ANAO expresses good governance through 4 principles – transparency, integrity, accountability and stewardship.

Whichever framework an organisation shapes its governance principles around, they are at best a guide on how to frame organisational arrangements and behaviours in a manner that should optimise the chance of successful operational and organisational achievement of outcomes.

Why the increased focus on corporate governance?

Corporate governance is receiving increasing attention across both the private and public sectors due to factors such as:

• corporate failures;

• increasing pressure to perform through globalisation;

• emergence of new risks;

• increasing complexity of stakeholder relationships and expectations; and

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

In the public sector, “corporate governance” is the term nowadays expressing the importance assigned by the community of its expectations regarding performance, transparency, integrity and accountability, recognising changes in the ranges of services provided by public agencies and in the manner in which it delivers these services.

Corporate governance has developed from the increasing demands on governing bodies to be more accountable for their actions. As the needs of stakeholders evolve, so does the meaning of good governance.

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

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 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.

What is needed for good corporate governance?

In my view, the prerequisites for effective governance (in addition to acting at all times in the interest of the entity) are:

1. Establishing clear roles and responsibilities throughout the organisation (and ensuring that these roles and responsibilities are understood by everyone);

2. Constructive relationships and accountabilities based on these roles;

3. An effective governing body;

4. Effective monitoring arrangements, including internal audit and an audit committee;

5. Effective communication;

6. Transparency through good external reporting; and

7. Maintaining a systematic and integrated risk management system.

In August 2001, the International Federation of Accountants (IFAC) and the Public Sector Committee (PSC) issued a checklist of good corporate governance for public sector bodies, adapted from the Chartered Institute of Public Finance and Accountancy (CIPFA) guide.

The checklist encompassed the following elements:

1. Standards of behaviour

Leadership

Code of conduct

Objectivity, integrity and honesty

2. Organisation structures and processes

Statutory accountability

Accountability for public purse/performance

Communication with stakeholders

Roles and responsibilities

3.Control

Risk management

Internal audit

Audit committees

Internal control

Budgeting and financial management

Staff training

4. External reporting

Annual reporting

Performance measures

Other guidance continues to become available – such as the recent guidelines issued by the ASX for application by Australian companies, the draft corporate governance standards released by Standards Australia, and Mr John Uhrig’s AC recent review of governance in statutory authorities and office holders.

Irrespective of the varying elements of focus in this guidance I still find it helpful by keeping the framework clear and simple. The diagram below, included in my Office’s 2002-03 Annual Plan, groups the various aspects of good governance into 4 key elements:

• Strategy and direction;

• Structure and relationships;

• Performance monitoring; and

• Compliance and accountability.

A governance framework

I will now take each of these key elements of the framework in turn and discuss them.

Strategy and direction

Those with governance responsibilities are required to establish the entity’s strategy and direction.

For statutory boards that have been created under legislation, strategy and direction will be developed in the context of the enabling statute having regard for government goals and desired outcomes:

• 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 these 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 the 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; and

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

What then of the role of the Department/Ministers advisors? The main reason for establishing statutory boards is that their functions cannot be performed by a department or it would be inappropriate for them to be performed by a department. A statutory authority’s functions must be at arms-length from departmental control and direction, and the authority must be seen to exercise its functions or powers independently of Ministers and government. This may be because it is important to signal publicly that a function is carried out free of political interference, or the Government itself may be bound by the decisions of the authority.

Having said that, in many cases Ministers, with backing by legislation, often have reserve power to issue directions. Where this is the case, in the interests of transparency and clarity of accountability, there is frequently a corresponding requirement for any such directions to be made in writing and to be declared in the annual report.

It is important that strategy, policies and other directions be clearly specified, communicated and understood by those parties responsible for their implementation. These must be explicit. responsibilities, and accountabilities must also be clear.

Both long and short-term goals need to be informed by the needs and expectations of the community, and supported by specific strategies for their achievement. Goals should be explicit about performance objectives contained in the strategic plan, and relate those objectives to costs and funding.

Structure and relationships

Because of the number of parties and the complexity of interrelationships, it is important to define clearly the respective roles, responsibilities and powers of each party. From a governance perspective, there is a need for Ministers, boards and CEOs to have clear and appropriate roles, responsibilities and powers – defined in legislation and clarified in guidelines, protocols or charters.

A key principle of effective public sector governance is that boards should retain full and effective control, and monitor executive management and leadership. (One of my more recent reports to Parliament serves to underscore the importance of this principle.)

In seeking to maximise the value of public sector boards, studies have constantly emphasised the importance of establishing an effective overall framework and getting the settings right.

There are a number of common expectations of statutory boards:

• explicit record of the relationship between the board and the Responsible Minister regarding shared understanding between the 2 about what the board is there to do – this does not always happen!;

• clear lines of accountability and authority between the board, the CEO and the Responsible Minister; and

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

In all the areas of difficulty I have observed in the public sector, problems attaching to poorly determined boundaries of responsibilities and accountabilities must rate as one of the most telling areas of vulnerability.

It is necessary to set the agency’s values and the minimum standard of behaviour that should be adopted. This is usually achieved through a code of conduct.

Codes of conduct should cover expectations of both employees and of those responsible for governance in the organisation. Clear policies and guidelines should be available to ensure that there is a clear understanding of the boundaries of activities by individuals, compliance of the entity with relevant laws or ministerial directions, clear ethical and behavioural guidance established, and a sense of responsibility for the use of public sector resources.

There needs to be explicit guidelines about what constitutes a conflict of interest and what to do about it whenever the possibility occurs or might occur - one person can’t serve 2 masters! A register of conflicts of interest should be maintained for all board members.

I recently attended a forum on the development of auditing standards, and the subject of independence was traverses – in the context of the HIH Royal Commission findings. I was intrigued to hear the speaker refer to the difficulty people have in grasping the notion of conflict of interest. That too is my experience. People may understand the notion as it applies to others (especially competitors), but just don’t see it when they are involved!

Conflict of interest takes many forms and is worthy of a separate discussion on its own merits. The common practice in the public sector arena of having a senior departmental official on the board of a statutory agency is one such issue, as is the practice of one’s CEO also being on the Board. These practices work well when they work well, but when they don’t the tension that exists when the person seeks to fulfil the dual/ or multiple role rapidly comes to the surface. I believe we still have a way to go here in the Victorian public service to simplify these lines of responsibility and accountability.

Governing bodies of public sector entities need to meet regularly, with a frequency that enables members to discharge their responsibilities. Agenda papers should be prepared and circulated on a timely basis, and resolutions well documented and communicated to appropriate parties, with a robust system to follow-up decisions to ensure implementation.

Members of governing boards should receive appropriate induction training to gain an understanding of the operating environment, and ongoing training to maintain and enhance skills.

Compliance and accountability

A critical element of effective corporate governance in government is that agency decisions are not only fair, open and accountable, but are seen to be so.

Board members must ensure that they are familiar with the primary legislation of their organisation.

Mechanisms should be established to ensure that the organisation is at all times acting with integrity, in a timely and responsible manner, and in compliance with enabling legislation, other primary legislation and Ministerial Directions.

These mechanisms should include an effective internal audit function and audit committee. The audit committee should be chaired by an independent Chair overseeing the audit function, compliance and risk management. Members must have a knowledge of the business.

Conformance and compliance control structures are a particularly important element of corporate governance because of their importance in promoting effective performance and ensuring accountability obligations are appropriately discharged. The notion of good control should start from the top down.

One of the greatest challenges for the public sector is managing the relationship between conformance and performance – past focus has been on ensuring conformation with legislation etc., however, with recent focus on outputs and outcomes, performance of public sector agencies has become more important. Good corporate governance reflects the ability to find an appropriate balance.

Organisations should maintain, and have freely available, current management policies and standards covering general administrative matters, internal controls, financial management, human resource management, information technology management and operations policies.

The agency’s approach to control and compliance should be integrated with its overall approach to risk management in order to determine and prioritise the agency functions and activities that need to be controlled.

It wouldn’t surprise you to hear that I believe that external reporting rates as an important feature of effective governance in the public sector. It provides an important opportunity to review the organisation’s performance in perspective – against their raison d’etre. The key to effective public accountability is the provision of timely, relevant and reliable information that sets out clearly the performance of an organisation.

Increasingly, the better public bodies are including in their annual reports some of the key aspects of governance structures and operations within the organisation. The following features will meet this need for stakeholders to know about the organisation’s governance, management and performance:

• information about governance arrangements, including internal audit and audit committee activities;

• a meaningful narrative about the performance of the organisation over the year compared with expectations – including comment about future years;

• information about the external interests of governing members together with adequate disclosure of related party transactions;

• a good standard of financial statements;

• details of the organisation’s risk management philosophy and how the organisation manages its risks; and

• other matters of public interest.

Performance monitoring

A major function of corporate governance is monitoring and reviewing organisational performance.

Central to public accountability is that agencies report to their Minister, and the Minister reports to Parliament. This means that the information needs of the Minister must be met and understood. This satisfies the agency’s accountability requirements to the Minister and provides the required information for the Minister’s and the Government’s accountability requirements to be met.

Governing bodies rely on agency information as a basis for strategic decision-making and to assist in monitoring agency performance and compliance with various requirements. The board should be monitoring the big picture – tracking against agreed goals, budgets, tasks and risk management activities.

It is important for the board and the CEO to agree on the level of information to be provided to the board. This will require criteria to be developed that filters out minor and irrelevant detail.

Assessing whether information is relevant requires careful consideration. Where the agency provides too much information, board members may become inundated with the detail. It may sidetrack the board into operational matters, which are the responsibility of the CEO. Conversely, where too little information is provided, boards are not in a position to make informed decisions and effectively monitor compliance and performance against goals and other requirements.

In my experience, the lack of discipline about information requirements would rank as the single most 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.

Performance management in the public service continues to be about more than just the financial bottom line. Use of a balanced scorecard approach complements financial measures with operational measures on customer satisfaction, internal processes, and the organisations innovation and improvement activities – these operational measures are the drivers of future performance.

Monitoring of risks needs to be targeted. Risks in the public sector come in a range of shapes and sizes, i.e. more than merely financial risk, also political risk – community confidence, social risk, environmental risk and public safety risk. Monitoring arrangements for an agency need to reflect an assessment of the risks and opportunities facing the business, with a view to protecting and promoting the owners’ interests. Owners should be informed of emerging risks. Boards should always be clear about when they need to alert the Minister about matters that may materially affect the Crown’s interests.

Corporate governance issues related to statutory boards

Public sector boards are mainly created by law. In doing so, Parliaments distinguish these bodies from other government bodies with the presumed intention that statutory bodies in the exercise of their duties and powers will not be subject to day-to-day oversight by government.

Corporate boards can be classified as either “advisory” or “governing”. The primary function of an advisory board it to provide advice and guidance to either the agency or Minister. Such advice and guidance is used as one of many sources of input considered when formulating the agency’s strategic direction. Advisory boards are not responsible for the agency’s performance or conduct. This responsibility remains with the CEO of the department that supports the advisory board, who is directly accountable to the responsible Minister.

In contrast, governing boards are responsible for setting the strategic direction of the agency, its performance and its compliance with various requirements. The board is held to account by the Minister and it relies on, and holds to account, the CEO for the operational management of the agency.

In the exercise of these powers, governing boards are expected to represent the interests of "shareholders", that is, the public. At the same time, they are regarded as an agent of government. In some cases, the definition and separation of responsibilities and powers of boards, Ministers and CEOs is not clear, even in legislation. Thus, how boards define their governance roles and what functions they perform varies considerably, even for government businesses.

The public sector board often finds itself balancing between managing an agency and setting strategic direction.

Powers and responsibilities

The complexity of public sector governance often generates tensions arising from interaction between Ministers, boards and CEOs. In situations where the roles and decision-making powers of the board, the CEO and the Minister are confused, boards may become high level advisory boards, rather than true governing boards.

Better practice in governance allows boards to be effective by providing them with clear and appropriate powers to exercise their statutory responsibilities. For most statutory authorities in Victoria and other States, the Government selects and appoints the CEO or equivalent (through the Governor in Council or Minister), who is responsible and accountable to the Minister rather than the board. Governing boards that do not have the power to appoint and remove their CEO have reduced control and authority. At the very least, there can be confusion about lines of responsibility and reporting. This mismatch between the board’s authority and its powers, responsibilities and accountability is increased when a CEO has his or her performance agreement with the Minister, rather than with the Board.

I recognise that the method of appointment of CEOs and board members varies for each Legal Aid Commission – ACT Legal Aid Commission has the ability to appoint its own CEO, however, for most Legal Aid Commissions, this is carried out by the Minister or Governor in Council. In Victoria, the Attorney General nominates all board members to be appointed, whereas in some States – such as South Australia and Western Australia – other Ministers or bodies are also involved in the nominations.

Elected governments will clearly have an interest in what boards are doing and will also expect boards to account to the Government for actions and achievements. This is an unavoidable consequence of a board being part of the State’s public sector machinery, but one that needs to be accommodated without excessively undermining the principle of statutory independence of boards.

Statutory governing boards will be able to add the most value when there is a clear separation of powers between the Government/Minister and the board. The Minister should be seen not to be responsible for the business, other than as part of regulating that industry.

A number of adverse situations may arise if the above measures are absent:

• Boards and Ministers becoming embroiled in power struggles;

• The CEO reporting to, and being given directions by, both the board and Minister. These directions may often be in conflict;

• Ministers tending not to put directions in writing; and

• Boards failing to effectively discharge their role.

Representation of board members

Boards perform other functions in addition to governance. Conflicts can arise when boards have directors who are selected because they represent certain interests, or have certain backgrounds and experiences.

In a number of instances, enabling legislation requires that boards have a certain representation or mix. This is often the case with Legal Aid Commissions where board members may be nominated by, and represent, a range of key groups including the government, welfare groups and the legal profession.

The following issues are relevant here:

• When making decisions, directors are required to act in the best interests of the board and the organisation, not in the interests of the group they represent. This may not always be easy and can lead to conflicts of interest. This can also be the case where board directors may be from another level of government. For example, when the board member has duties involving the provision of ministerial advice in relation to the board and its affairs, or when the board member is expected within his/her department to act as a conduit to the Minister concerning the board and its affairs, e.g. a board member of the Legal Services Commission of South Australia is also the Director, Strategic and Financial Services, Justice Portfolio);

• There can be high and unrealistic expectations placed on the board member by the group he or she represents;

• The "best interests" of the organisation as perceived by the "representative" directors may not be consistent with the "best interests" of the Government as perceived by Ministers or central agencies; and

• Information flows can become informal leading to the “leaking” phenomena.

Most legislation recognises the potential for conflicts of interest to arise and sets out clearly, as is the case in Victoria, the actions required when potential conflicts of interest might arise. Notwithstanding these safeguards, I do believe that it is infinitely better to minimise the risk of conflict arising by ensuring that all of those around the board table are there to serve the interests of the agency at all times, rather than build into the governance arrangements structures that could produce that risk on a regular basis.

Concluding Remarks

The subject of good governance has been the subject of much consideration and public debate in recent times. And for good reason.

The community is entitled to be assured that practices in the public and private sectors are as they should be in order to maintain confidence.

Where confidence is eroded, governments must act to re-establish confidence in our institutions – hence the Sorbones/Oxley legislation in the USA, and CLERP 9 here in Australia.

The public sector – as we are all too aware – is not immune from these winds of change and must collectively and individually re-examine its own practice to ensure that the community trust is maintained.

The purpose of my presentation to you this morning has been to provide my perspective on what constitutes good governance.

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