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Top five issues for directors in 2018

Dec 16 2017

Directors operate in a complex and dynamic environment that features rapid technological change and increasing scrutiny of social, political and corporate behaviour. Global trends show stakeholder values and expectations are increasingly focused on social and environmental issues and licence to operate. Under the new government we can expect to see more change, including a focus on reducing disparities.

Felicity Caird, GM Governance Leadership Centre, identifies five issues that should be top of mind for directors, and we ask three senior directors for their views on the issues for 2018.

Trust and confidence
Foster transparency and engagement with stakeholders to help build trust and business legitimacy.

Trust in business and society is vital to New Zealand’s prosperity. Businesses and leaders are increasingly under public scrutiny, particularly due to the use, speed and ubiquity of social media. Reputations and trust can take decades to build and just seconds to destroy.

The 2017 Edelman Trust Barometer reveals a global crisis in trust in business, government and the media. In New Zealand, only 47% trust business, 46% the government and 29% the media. Of real concern, nearly half of New Zealand respondents (47% compared to 53% globally) believe the system is failing them.

Reasons for the decline in trust are wide ranging: repercussions from the global financial crisis, technological disruption, digital connectedness, social media (including fake news), privacy breaches and corporate failures. Parts of society feel left behind and disenfranchised due to growing inequalities and income disparities.

We are seeing a convergence of commercial and social drivers in progressive companies, with a greater focus beyond profit to purpose, people and planet. Proactive engagement with the community and stakeholders helps build (or rebuild) trust and business legitimacy and licence to operate.

It’s important to tell your story. Frameworks and expectations of corporate reporting are evolving, but regulatory settings can be slow to change. Governance leadership is about thinking beyond compliance and acting on what’s relevant and meaningful.

The 2017 NZX Corporate Governance Code steps up expectations of disclosure and transparency on a broader range of environmental, social and governance matters. Many boards are already meeting these requirements, for example, by producing integrated reports (NZ Post, Sanford, Z Energy and Meridian).

TIPS FOR DIRECTORS

Tell your story in a holistic and transparent way – meaningful reporting helps build trust and confidence.

Engage with the community and other stakeholders to build and protect business legitimacy and licence to operate.

Be prepared to respond quickly and constructively to public scrutiny and criticism, including in social media.

Ethical behaviour
Ethical behaviour and a healthy corporate culture are critical to current and future business success.

The board has a core role in overseeing corporate culture, conduct risk and setting high standards of ethical behaviour. It means, thinking beyond compliance, taking the lead and setting the tone for the organisation.

The digitally connected world means workers and stakeholders (investors, employees, consumers and media) have instant access to information about an organisation and its activities. Social media has changed the game, and corporate behaviour and practices are in the spotlight. And the lens is wide, extending to how diversity and inclusion is promoted and the organisation’s approach to social and environmental issues.

Conduct risk, such as fraud, corruption, bribery and unethical behaviour, can cause significant financial and reputational damage. The 2017 Director Sentiment Survey found that only 40% of boards receive comprehensive reporting from management on ethical matters, and just 44% assessed ethics risks in the past 12 months. Less than two-thirds discussed whistleblowing.

Boards need to insist there is an effective whistleblowing culture and mechanisms are in place to support it. We don’t have to look far to see why – Harvey Weinstein, Fuji Xerox and the Ministry of Transport fraud case. A good indicator of an effective culture, and that systems are working, is when the board hears about incidents and bad news. Decisive leadership in following up on incidents and potential risks is critical.

It is crucial boards get robust reporting from management so they can effectively oversee direction and risks. Internal audits can provide independent assurance to the board through testing controls for culture such as complaints processes and follow through. External sources of information (for example, social media monitoring and independent reviews) can also help the board gain assurance.

Having a discussion in board-only time, as well as with management, provides a good opportunity for free and frank discussion about corporate culture and ethical behaviour and to consider any potential red flags.

TIPS FOR DIRECTORS

Set the tone – promote, inspire and embody organisational values and expected behaviours. Oversee conduct risk and drive expectations about high standards of ethical behaviour.

Ensure there is an effective whistleblowing culture and systems in place and monitor them.

Ensure there is comprehensive and timely reporting from management. Utilise internal audits and board only time to ensure robust scrutiny and discussion.

[Director Speak]

JOANNA PERRY CFInstD

Change up
“There is a tsunami of change coming, and boards need to be ready for it,” suggests Joanna Perry MNZM.

Perry currently holds directorships on a number of organisations including Genesis, Trade Me and Regional Facilities Auckland. She argues boards in 2018 need to focus strongly on the strategic opportunities – and challenges – that are emerging rapidly in the business environment.

“Boards need to ask: What are these changes? What is our business?” she says.

“And boards need to say, ‘We need to be nimble. We need to be agile. We need to be change oriented. We need to have a growth mind set.’

“It’s a joint management and director responsibility to make sure our agendas are focused on the future.”

New ideas
On a recent tour of Australia and New Zealand to meet key institutional stakeholders, it was driven home to Perry how valuable it can be for a board to leverage the knowledge of its investors.

“Some of them have great ideas. They look across the industry. They look across the world. I’m not saying we have to follow their advice, but let’s engage with them on the things that are happening and find out what some people are doing in a better way.”

Perry suggests boards invite investors and talk about where the organisation is heading at a formal investor strategy day. However, she says there are members of both boards and management who are reluctant to “show our hand”.

“It takes people around the board table to be brave, quite frankly.

“One of my companies has done it – we did it last year, and the investors really engaged. They are trying to understand. They are not trying to second guess us or criticise us. The reason they invest is they believe in the company.”

Being more transparent about strategy can make it easier for stakeholders to see when plans go awry. But that is just part of the business of governance, Perry says.

“What if we don’t achieve it? Well, we have to talk about it and look at the options. We can’t be scared of not achieving our goals. We adopt a strategy because we believe in it. Why don’t we share it so others can believe in it as well?

“You do it at a level that is not giving away anything to your competitors. You don’t give away your tactics. The investors love it. They absolutely love it.”

Trust issues
While building trust among stakeholders is important, Perry argues there is a broader societal-level issue with trust that business needs to be cognisant of. And here again she sees opportunity in disruption.

“Technology and digitisation are driving change. People are scared of the changes that are coming and what it means for their jobs, for their livelihoods.

“Education is one area where this is clear – what our kids are learning today will not be what is needed when they leave school. What should they learn? Nobody knows the answer. But that says to me that we should be teaching them how to be curious.”

As strong corporate citizens, businesses must work with government to ensure our systems, such as education, change in ways that benefit business and society, she says.

Access to talent
“Business wants its people to be curious, agile and nimble. How do we get there? We need to help our kids develop the ability to pick up ideas and skills and be interested in things.

“That is one of the roles business can have with government, to help government think like that. It’s not lobbying, it’s collaboration.”

Perry describes the strategic issue facing business as posing much larger questions than businesses have traditionally tried to deal with.

“It’s not about business skills per se or environmental issues per se. It’s much wider than that. It is a societal change that business can be part of. That’s what I truly believe."

[Director Speak]

MARK CROSS CMInstD

Board responsibility
Z Energy, Chorus, Genesis, and Argosy Property director and Milford Asset Management chair Mark Cross addressed shareholder activism on the MinterEllisonRuddWatts Corporate Governance Symposium panel earlier this year. “It’s on people’s minds,” he says.

Globally, shareholder activism is on the rise with activist hedge funds such as Pershing Square Capital and Elliott Advisors making headlines through public attacks on board performance.

“In New Zealand, it is more subtle than that,” Cross says. “We don’t tend to see specialist funds taking a 3% position then trying to take the board down. Activism is typically more behind the scenes.”

A common concern of shareholders in New Zealand is perceived shortcomings in performance or governance. This may result in larger institutional investors making contact with board or management.

The purpose of that contact is primarily collaboration and communication to acknowledge and address issues, Cross says.

“The preference of all the institutions I speak to would be to collaborate in a way that achieves both parties’ aims.

“That’s certainly the aim – although I suspect if you ask the boards on the receiving end they probably wouldn’t feel like it is collaborative.”

Engagement works
Managing shareholder activism effectively starts with engagement, Cross says.

“They [institutional investors] would rather be engaging with the company all along than simply when there is a problem.”

Cross notes an overseas trend, typified by the Stewardship Code maintained by the UK Financial Reporting Council, to encourage institutional investors to promote long-term profitability in the companies in which they invest.

“It’s turning it around so that it’s not just boards that have a responsibility to investors. Under the concept of stewardship, investors, usually larger institutional shareholders, have a responsibility to engage with boards in a constructive way and to not pressure a company to deliver short-term returns.”

Issues for activist investors
“Typically, I would say it starts with the share price – poor performance relative to an index or relative to an industry,” Cross says.

“The next popular area is remuneration. That’s right at the top of the list. Particularly if you look at Australia, it is remuneration that evokes the ire of shareholders – remuneration of CEOs, sometimes boards, where there is perceived to be a lack of alignment between remuneration and performance.

“I’ve yet to hear a consensus view on what a proper remuneration structure looks like, but the investors certainly know what they don’t like.”

There is also increasing activism around governance and management weaknesses. Cross cites the Commonwealth Bank of Australia case in which money was being laundered through the bank’s ATM system.

“You get investors following up and asking, ‘How did this happen, and what are you going to do about it?’

“You could broadly group that into ESG-type concerns – environmental, social and corporate governance – that are an increasing trigger for activism.

“If you draw ESG activism back to its origins, it is often the smaller retail investors into the large institutional funds who are demanding that the funds take responsibility. So it is client-driven activism in many respects.”

Engaging with the future
Cross argues boards in 2018 should be developing strategies to maintain their companies as sustainable entities. A sustainable strategy should acknowledge the aims of a very broad stakeholder group and take into account the position of the business in society. Developing this is a big task, he says.

“Ultimately, it is boards that have to decide to do that. Shareholders can buy and sell shares and don’t have a fiduciary obligation to the companies they invest in. But directors do have a fiduciary responsibility to the company and have to make the ultimate calls.”

Shareholder activism
Understand shareholder expectations and have a continued focus on how to improve effective engagement.

Shareholder activism is not new to New Zealand, but it is increasing in line with global trends.

Institutional investors are pushing strongly on governance, social and environmental issues to help enable better performance and long-term sustainability. Two key areas of focus include board composition (diversity, tenure, director independence) and remuneration (director fees and in particular executive pay).

And it’s not just institutional investors. The New Zealand Shareholders' Association (NZSA) has been increasingly active over the past year, including on virtual-only AGMs, getting enough proxy votes from Rakon shareholders to vote out one of the directors and surveying members ahead of the Fletcher Building AGM to add weight to issues (such as performance and director remuneration) it was pushing with the board.

Scrutiny of CEO pay is increasing in New Zealand (for example, at Fonterra, Sky City, Fletcher Building, NZ Super Fund and TVNZ), again following global trends. More questions are being asked about how pay aligns with company performance, including the CEO’s contribution, and about disparities with workforce pay.

Open disclosure by boards of CEO remuneration, and the rationale behind it, is important. The NZSA Framework for Reporting of CEO Remuneration in New Zealand Companies provides a useful framework for boards.

This year, 67% of boards in the Director Sentiment Survey said they discussed how they could engage more effectively with shareholders. It’s important to keep up with shareholder expectations. Technology and digital connectedness enable more diverse and direct engagement, for example, through social media, roadshows, websites and electronic briefings, and more use of virtual AGMs, often in conjunction with a physical meeting.

TIPS FOR DIRECTORS

Have regular discussions about how to engage more effectively with shareholders.

Consider what opportunities (and risks) technology offers for better engagement, including getting more out of AGMs and social media.

Provide open and understandable disclosure of director and executive remuneration (use the IoD and NZSA guides). Provide a rationale and context about alignment with strategic objectives and performance.

Data governance
Maximise the benefits from data and prioritise protecting personal data.

Cyber security is on the agenda for many boards (50%, up from 32% in 2016) and is recognised as a core risk for organisations. Another aspect of data governance is the use of data analytics to drive innovation and business performance and the protection of personal data.

Managing this unlimited and valuable resource is a growing challenge presenting major opportunities and risks in a digital global environment without borders.

More large organisations are taking advantage of big data, which is defined by the Oxford Dictionary as “extremely large data sets that may be analysed computationally to reveal patterns, trends, and associations, especially relating to human behaviour and interactions”.

Possible uses include the development and personalisation of new services and products driven by machine analysis of detailed information about consumer behaviours, preferences and needs.

Although some commentators may say privacy is dead in a online world, privacy is a current and real issue.

Regulatory environments are evolving, and we can expect to see more change.

Europe’s General Data Protection Regulation (GDPR) comes into effect in May 2018 and aims to better protect data privacy in the digital world. Boards and executive management will be held responsible, and regulator breaches and non-compliance can have high costs (fines up to €20 million or 4% of global turnover). The regime has global reach, applying to any company handling EU citizen data.

The NZ Data Futures Partnership is working to strengthen our data ecosystem and drive more effective,

trusted data use. Guidelines released in August aim to help users develop social licence for their data activity to gain community acceptance.

The Privacy Act 1993 is being reviewed to ensure it is fit for purpose in a modern world and is expected to include mandatory reporting of data breaches.

TIPS FOR DIRECTORS

Align insights from data analytics with business strategy. Use data to support innovation and decision making, for example by better understanding consumer behaviours, patterns and risks.

Understand what and where your data is, how it is collected, used and shared and the applicability of global regimes such as the GDPR.

Ensure transparency about how data will be used and protected and aspects such as anonymity, consent, who benefits and how.

[Director Speak]

MARK VERBIEST CFInstD

Building trust
Mark Verbiest sits on the boards of Meridian, ANZ and Freightways and the advisory board to NZ Treasury. He is the immediate past chair of both Spark and Transpower and chair of Willis Bond Capital Partners Limited.

For Verbiest, the issue of trust and confidence goes broader than business.

“It is trust across a number of entities,” Verbiest says.

“Underlying that is an increasing level of uncertainty in society as to what the future holds.”

“At least two of the boards I am on have specifically considered the Edelman Trust Barometer, and there have generally been discussions around it. I think what you are seeing, particularly at the top end of town, is that business leaders are taking the lead on some of the broader issues at play.”

Verbiest says New Zealand is fortunate to have a group of CEOs prepared to take on issues such as societal trust.

“That being said, they won’t be able to do it alone. Policy makers, government, educational institutions … everyone has a role.”

At a minimum, businesses in 2018 need to recognise that the age of social media is the age of customer power, he says.

“The company’s approach to issues such as the environment, sustainability, more generally what the values of the company are, how transparent it is and how it operates in favour or not of the customer are going to be critical to a company’s licence to operate.”

Shareholder activism
A corollary of the rise of customer power is a rise in shareholder activism and company transparency, Verbiest says.

“You are finding an increase in transparency, and that is ultimately a result of shareholder activism. Probably the most obvious example of that is around executive remuneration and the appropriateness of the structure that a company might have in place.

“I have to say that, on ESG [environmental, social and corporate governance] matters, more generally there is a mixed response from investors. All investors will tell you these matters are important, but some still make decisions based primarily on financial metrics.

Skill shortage
Issues included in this space include the impact of technology on the workplace and how expectations of work are changing and how that effects culture, engagement and hiring and retention.

“The nature of work is changing. A lot of that is technology driven. There is a growing recognition of the need to train people with relevant skills and, just as importantly, to look at potentially retraining people who are capable of moving into different roles with more relevant skills.

“I think that, among business leaders, there is a growing recognition business has to be a part of, and lead, the conversation about the future of work. A cultural mantra is developing along the lines of ‘no one should get left behind’. Everybody has to be catered for. That isn’t something business can solve alone, but it is something that everyone should be concerned about.”

Part of maximising talent in an organisation is considering diversity and inclusion policies, he says.

“It’s the need to make sure that we’re maximising access to talent, for example, through outside partnerships with the likes of TupuToa (internships with young Pasifika) and starting to consider what kind of vocational retraining we should be looking at.

“I think it is worth acknowledging and recognising that we are genuinely quite fortunate in New Zealand to have a group of CEOs who are concerned about broader issues around sustainability, around work, around the environment, and they in conjunction with government and policy makers actually can make a real, positive difference to New Zealand.”

This could happen partly because of our small population, Verbiest says, but predominantly it’s because we have a group of people who are committed and really want to make a difference.

Access to skills and talent
Ensure the organisation’s talent strategy is adaptive and fit for future needs.

For the fourth consecutive year, labour quality and capability has been identified in the 2017 Director Sentiment Survey as the top risk for businesses. A tightening labour market saw the unemployment rate at 4.6% in September, the lowest in 9 years.

Challenges for boards include labour shortages and changing skills needs. We are also hearing about more boards struggling to attract executive talent due to global shortages, competition and greater mobility of executive skills and experience.

Technology is fundamentally changing how we live, work and relate to each other. Workforces are becoming more transient and mobile. Deloitte’s 2017 Global Human Capital Trends describes our changing workforce as “more digital, more global, diverse, automation-savvy, and social-media proficient”.

A job for life has become a rare (perhaps extinct) concept. The 40-hour week is also declining as the default option, with many workers opting for greater flexibility of hours and roles.

We can see this in the growth of the gig economy. It means significant change to the composition of the

workforce and the nature of work. Gig or independent, workers take on (contract) temporary, specialist, often parttime work and sometimes multiple jobs at a time. Workers cover the spectrum from low to highly skilled.

This type of work/worker isn’t new, but the growth and extent of it is. McKinsey & Company (2016) estimates 20–30% of the working-age population in Europe and the United States is in the gig economy, with about two-thirds doing it through choice, preferring the independence and flexibility. This preference is evident from millennials seeking greater work-life balance to older workers phasing their approach to retirement.

It’s widely accepted that pay is only one of many drivers of worker engagement and satisfaction. Workplace culture, fairness, business values and societal contribution are also of key importance and can be the point of difference in attracting and retaining talent. Embedding an adaptive and learning culture to help develop new worker skills can help enable workplace transformation in a rapidly changing and disrupted world.

TIPS FOR DIRECTORS

Prioritise strategic discussions about disruption, innovation and future workforce and skills needs.

Understand worker (as well as organisational) needs and how flexible workplace practices can enable participation and enhance productivity for your business.

Ensure the organisation is adapting its talent strategy to a transforming workforce and future needs.

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