Learning from history: ethical conduct is a business basic
Read Nicki Crauford's article (DominionPost 11 May 2009). The historian G M Trevelyan commented that the statements ‘history repeats itself’ and ‘history never repeats itself’ are about equally true. “We never know enough about the infinitely complex circumstances of any past event to prophesy the future by analogy" he said.
A recent report by the Registrar of Companies to parliament’s commerce committee on the failure of the finance sector suggests was there was an element of history repeating itself. And there are lessons to be learnt. Finance companies emerged as mezzanine financiers particularly to the property market.
In the late 1980s, this role was performed by contributory mortgage companies such as Registered Securities Limited, which collapsed in not dissimilar circumstances. The business model for these morphed into the finance company model, with some of the same players involved in both. Shouldn’t someone have foreseen the recent failures?
There are some strong performers in this sector, with solid balance sheets and highly effective governance. The difference between those that succeeded and those that failed was, according to the Registrar of Companies, the appetite for risk and the quality of governance, some of which centred on ethical values - the ‘glue which holds together a company’, according to Sir Adrian Cadbury, author of the Cadbury Report on corporate governance.
The Securities Commission identified several governance failures – too few directors, even sole directors or no independent directors, or directors taking insufficient interest in the business. Somewhat tellingly, neither the Commission nor the Registrar said much about their roles, and possible shortcomings, as regulators. Instead, they point to a litany of poor performance (boards, directors, trustees, second-tier auditors and CEOs with dubious records) and questionable practice – loan book management and reporting, concentration of loan risk and related-party lending. The Registrar concluded that in the end there was little to distinguish many operations from the Ponzi scheme that enabled Madoff to defraud billions.
The Independent Financial Review’s columnist ‘Chalkie’ recently asked rhetorically “Would the public know the difference between nobody directors and someone who was really good?” Some well-known and highly respected directors were invited onto the boards of finance companies. Whether this was to add experience and not just the gloss of gravitas is anyone’s guess. A number accepted, and some subsequently departed. Was it that some recognised that they were the sole voice on a board dominated by the owner and their associates and decided that their business integrity was being compromised?
Good corporate governance is not just a fashionable term to use as PR candy. It is at the heart of effective as well as lawful business. Directors owe duties to the company, to its shareholders, and to others dealing with the company. Directors must act honestly in what they believe to be the best interests of the company and with such care as may reasonably be expected of them. They must not act in a manner likely to create a substantial risk of serious loss to the company’s creditors. Independent directors can provide an important check and balance to those working in the firm. With the benefit of hindsight (that exact science) a major part of the finance sector problem appeared to be the small size, skill-set and balance of boards. Many appeared thrown together without due regard for creating an effective governance culture and team.
What sort of person is best suited for the role of director? Three requirements spring to mind immediately. First, there has to be competence. An effective director’s experience may be sector specific or gained from different types of industry. If they have not had exposure to the specific industry and markets in which the company operates, the board should arrange orientation. This should then ensure the director has the required knowledge background against which general principles of governance will be applied. Secondly, demonstrated governance expertise and a commitment to high standards of directorial professionalism can reassure shareholders and investors. Thirdly, the best current research on governance is finding that effective boards are characterised by a high performance culture that celebrates debate, commitment and trust. The types of personalities that mix on a board, and how they interact as a team are just as important as specific skills or governance discipline.
Business is a continual calculation of risk, an instinctive exercise in foresight, according to 20th century publisher Henry Luce. No-one begrudges success to those who achieve it with ingenuity and honesty. However, foresight should not be confused with insight or the capacity to understand hidden truths, which is one of the most important requirements of a company director. Nor should it proceed without an ethical foundation.
As we are seeing internationally, the instinctive institutional urge is to tighten regulation, and by implication compliance costs. Structures are relatively easy to create, behaviour more difficult to modify. However, good governance is a combination of the best of both, which is why the motto of the Institute of Directors is ‘Integrity and Enterprise’.