GUIDING PRINCIPLES OF CORPORATE GOVERNANCE IN THE PUBLIC SECTOR

Presentation to
IPAA – Spotlight on Spring Street Series

By Wayne Cameron,
Auditor-General of Victoria

18 June 2003

What is corporate governance?

“Governance is concerned with structures and processes for decision making, accountability, control and behaviour at the top of an entity”. (IFAC)

“It influences how the objectives of an organisation are set and achieved, how risk is monitored and assessed and how performance is optimised”. (ASX)

It is generally understood to encompass authority, stewardship, leadership, behaviour, direction and control.

Good governance will result from behaviour rather than process

Good governance will not guarantee good practice, but it does provide a discipline around which to frame quality processes and relationships.

“If nobody makes the rules then it turns into a game without rules – and nobody wins that kind of game”. (John Macdonald)

Counsel assisting the HIH Royal Commission was recently reported as saying that corporate Australia should aspire to improved moral and ethical standards rather than tick-in-a-box corporate governance. Processes are important as the means to the end - not the end in itself!

Governance framework

This diagram is a modification of my Office’s 2003-04 Annual Plan. I share it with you to demonstrate how the elements of an effective governance structure are inter-related.

I will now discuss each of the 4 pillars.

Leadership, stewardship, management control and risk management are included at the centre to ensure that they are not overlooked by those holding governance responsibility.

Proposed Minister of Finance Directions require that:

“A public sector agency … have a financial code of practice setting out a cohesive statement of the agency’s internal processes to ensure probity in the agency’s management”. The guide goes on to set out what the agency’s code of practice must include.

• tendering, conflict of interest confidentiality, unlawful or unethical behaviour

• it also requires that each agency maintain appropriate structures and responsibilities to ensure compliance with the code.

Much of the public debate has centered on the corporates and on issues unique to the corporate sector – I hope! - issues such as incentivised remuneration arrangements, related party abuse, conflict of interest issues.

But we should not dismiss the debate as irrelevant. I am hear to tell you that we have our share of governance issues to be concerned about as well. We should take this opportunity to make sure that we all learn from the debate and ensure that we in the Victorian public service apply best governance practice at all times.

Strategy and direction

Those with governance responsibilities must establish the entity’s strategy and direction.

Goals should be explicit about performance objectives and relate those objectives, supported by plans covering finance/costs, assets, technology and personnel requirements.

Both long and short-term goals and objectives need to be supported by specific strategies for their achievement.

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 be clear.

Departments – Strategies and directions will be developed by the respective secretaries/ministers in the context of the government’s goals and desired outcomes.

Local government – Strategies and directions will be developed by the council in consultation with the local community (through best value) within the constraints of enabling statute.

Statutory boards – Strategies and directions will be developed in the context of enabling statute having regard for the government’s 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 retained certain rights, usually espoused in legislation, which are exercised through the responsible minister, namely:

• to exercise control over the entity and determine its direction, as expressed in legislation;

• to appoint and dismiss members of the board

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

• 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 the entity is managed in the Crown’s interests, and so plays a key part in the governance framework for the entity.

Structures and relationships

Effective governance requires explicit role definition of key participants in the governance process and the control, reporting and accountability structures established to facilitate communication, action and monitoring.

Governing body members need a proper induction process to ensure that they are clear about their role and about that of management, and the nature of the relationship with the government (usually the responsible minister) and the department.

Determinations should be made about powers and delegations (this must be done in the context of the governing legislation).

The nature, timing and method of information flows need to be defined.

Clear views are needed about what must be referred to owners (minister) for consideration or information:

• business plan (including financial plans) – define nature, scope and location of business

• strategy, policy, performance monitoring information

• regular assessment of relevant risks and proposals with potential to impact on the risk profile of the organisation

• investment/divestment considerations

• information about the public profile.

Business structures

A clear view is required of:

• purpose of business structure

• expectations of stakeholders

• determination of powers/delegations

• information flows

• explicit definition of relationship between parent and subsidiary (e.g. entity and committee).

Boards

“Governing board members are accountable for their conduct and 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 operates and the issues it faces. (Refer to AICD Checklist for guidance on what prospective directors ought to do before accepting appointment to a board body.)

Subsidiary company model

Changes rights and responsibilities – from parent to the subsidiary company.

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

Changing delivery arrangements

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.

Boards

Appointment and membership

• Requisite skills, tidy and transparent appointment process, induction, review.

• Mixed board membership confuses accountability and roles, and distort information flows.

• Should CEO be on the board?

Common expectations

• Explicit record of the relationship between the board, and responsible minister about shared understanding between the 2 about what the board is there to do.

• Clear lines of accountability and authority between the board, CEO and responsible Minister.

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

Obligations of being a public body

• Board member to understand public sector conventions and practices.

• Standard of behavior.

• Identification and management of conflicting interests.

• Understand relationship with government.

Staff skills

• Recent survey of sample Fortune 500 US companies revealed that 20 per cent of CFOs were qualified accounting professionals.

• CPA survey in May 2003 reported that 81 per cent of organisations preferred a CPA as CFO; and 74 per cent wanted a CPA as audit committee chair.

Committees

Advisory committees to:

• minister – ensure objective advice: perception of independence

• CEO and board/councils.

Any advisory committee structure (e.g. economic development, audit etc.) needs to be mandated explicitly with a clearly set out charter, powers functions and duties.

Management committee – what are they but a form of internal communication and method of achieving consensus. They must not undermine primary accountabilities.

Audit committee

• Established feature of corporate governance is having an effective audit and risk committee with an independent chair to oversee compliance and risk management.

• Members must have a knowledge of the business.

Ministry of Finance Directions

• At least 2 members must be independent and appear as such in the annual report.

• Must have a charter.

• Must be fully accountable to the responsible body.

• Accountable officer and CFO not to be members.

• Chair to be independent and cannot be the chair of a governing body, unless exempted.

• Sets out requisite skills.

• Sets out functions, powers and responsibilities.

• Oversight of risk management framework.

Minister/Board/Management relationships

I want to talk briefly about Minister/Board/Management relationships – an area which requires careful management.

Role of the responsible minister

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

• regular communication

• formal reporting arrangements by the board against agreed objectives

Role of advisors – just that, needs explicit understanding by all the parties about the role of advisors – best dealt with formally in writing.

Ministerial directives – Such directives should be transparent. Need to be explicit - affects accountabilities

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

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

Governing board relationships with Responsible Minister – See WA Better Practice Guide.

Codes of conduct

Minimum standards of corporate behavior

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

• 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

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

Conflict of interest

Conflict of interest takes many forms and is worthy of a separate discussion on its own merits

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.”

A person can’t serve 2 masters!

There should be explicit guidelines about what constitutes a conflict of interest and what to do about it whenever the possibility occurs, or might occur A register of conflicts of interest should be maintained for all board members.

I don’t deny the difficulty. I recently attended a forum on the changing arrangements for auditing standards, and the subject of independence was traversed – 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!

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

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.

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.

Performance monitoring

Determine what should come to the board – content and frequency - governing bodies should be monitoring the big things.

Tracking against agreed goals, money, tasks and risk management activities

The monitoring and reporting systems need to be timely for senior management and the governing body when things begin to divert from planned outcomes.

This means coherent data collection and reporting systems that need to be co-ordinated, integrated and accurate. There is some evidence that some entities continue to struggle in this area post-amalgamation.

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.

This may be an area for future audit attention

Monitoring of risks needs to be targeted

There are 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 needs to reflect an assessment of the risks and opportunities facing the business, with a view to protecting and promoting the owners’ interests.

Our recent report on Managing business risk in the Victorian public sector identified some progress, but there is still some way to go – especially in internal awareness about what constitutes risk, and in reporting procedures.

When do you need to alert the minister about matters which may materially affect the Crowns’ interests?

Compliance and accountability

It is important to monitor compliance. There is a need for proper reporting processes for surfacing non-compliance.

The Public Sector Management and Employment Act 1998 sets out obligations of an agency head – supported by a Code of Conduct published by the Commissioner for Public Employment.

Section 13. 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.

The Financial Management Act 1994, s. 42 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.

Importance of recognising trade-offs between performance and compliance

The public sector is under the public gaze; all the more reason to invest in explicit processes so that our talented people can seek innovative solutions.

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

APRA winners of Good Governance disclosures – Melbourne Health, CSR Ltd.

Research show that in the corporate world, openness and transparency in reporting is rewarded (market capitalisation). Yet corporates continue to fight it.

Key pre-requisites

• Clear roles and responsibilities.

• Constructive relationships and accountabilities.

• Effective governing body.

• Effective monitoring.

• Effective communication.

• Good external reporting.

• Sound risk management practices.

In bringing this presentation to a close, in my view, the pre-requisites for effective governance are:

• establishing clear roles for each of the parties, and ensuring that all parties understand their own roles, and those of the other parties

• constructive relationships and accountabilities based on those roles

• an effective governing body

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

• effective communications

• good external reporting

• sound risk management practices.

Organisations frequently fail when there is:

• lack of sound goals

• inadequate internal control and non-disclosure

• dominance of individuals

• deficiency of values, ethics

• absence of arms-length approach to some transactions;

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

• poor risk management and poor reporting to the board. “Not to know is bad; not to wish to know is worse”. (West African proverb)

Good corporate governance

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

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 Carbines/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.

Much more guidance is around now:

• PAEC Report on examination of Corporate Governance Issues in Victoria – Checklist

• WA and Queensland Public Service guidance

• ANAO Better Practice Guide

• New MOF Directions effective 1 July 2003

• We will also await John Uhrig’s review of corporate governance of Commonwealth statutory authorities and office holders.

Much of the governance debate has been about the rules – principles … BUT … Its not just about applying corporate governance principles, its also about the PRINCIPLED application of those principles.