Posted by: graemebird | October 18, 2011

Shock: An Important Scoop In “The Australian” Business Pages.

I’ll shamelessly cut and paste for now, but later I’ll link and comment.  Here is some real research, and real helpful research, just for a change.   Something in the Australian newspaper that goes beyond the rolling thunder of Keynesian appeasement and propaganda, and digs deeper than  mere current events of bigshots, keyed into the money creation scam, chasing Cantillion gains.

Actually there was a second pretty interesting article, which was a summary of former Macquarie bank boss Ian Moss’ statements at some venue or other.  But here is the vital article I am mainly referring too. And this article goes some ways in shining a light on the sort of interim regulatory changes that we need, on our way to a better version of capitalism:

COMMON sense suggests company boards are best composed of directors who hold shares in the business because any poor performance is effectively skin off their noses.

Evidence also implies this is the case. During the global financial crisis when the S&P/ASX 200 fell nearly 40 per cent, boards with stakes in their companies suffered fewer relative stock price falls.

Yet this advantage can be lost if a company’s board has too many outside directors or if the board members are too compliant to the chief executive. They fail to ask the tough questions.

The size of boards is the main issue. Having executive board members who share ownership directly benefits firm performance and lowers chief executive pay, although less so when ownership is combined with large boards.

It seems when a firm performs poorly, too many independent directors can impede critical action such as firing an underperforming chief executive. A “smallish” board with a low proportion of outside directors, and instead just of five or six directors with incentives in the company and who are prepared to monitor management, is optimal, according to my research with Serkan Honeine.

Poor governance can squander a firm’s wealth, and our study into how well the interests of independent board members and shareholders are aligned in larger Australian companies suggests large boards can be very destructive for shareholder value.

The average market-to-book ratio of companies with smaller boards of seven or less directors is 50 per cent higher than those with eight or more, and nearly 40 per cent higher when debt-financed assets are included.

Preliminary estimates show poor board monitoring and weak decision-making is collectively costing shareholders hundreds of millions of dollars.

We studied 284 major Australian listed companies over the decade to last year. Our analysis shows a consistent underlying story of board manipulation to the detriment of investors.

Larger boards appear to substantially drag on overall firm performance through a variety of mechanisms, such as reducing non-executive director incentive pay and raising base pay for outside directors.

Such actions encourage a board, dominated by outside directors who have no incentives, to entrench poorly performing chief executives.

Large boards are also more cautious as they can have more difficulty making a collective decision. This constrained risk-taking results in reduced stock price volatility, which is harmful to shareholder value.

Bigger boards, dominated by outsiders unlikely to be informed of company affairs, have a tendency to keep growing. Large, externally dominated boards appoint more and more directors like themselves with little or no regard for shareholders. Shareholders not only pay for the salaries of surplus directors but also suffer performance decline into the bargain.

Our research measured performance by comparing companies’ market values to book values. (The market-to-book ratio attempts to identify undervalued or overvalued securities by taking the market value and dividing it by book value. As a general rule, ratios well above 1 indicate better valued or high-performing stocks while those below 1 are considered exceedingly undervalued or poorly performing).

We calculate that, based on last year’s values, property group Westfield and National Australia Bank had below-average market-to-book ratios of 1.34 and 1.39, respectively, and 13 board members each. Publisher Fairfax Media, with 11 board members, carried a very depressed ratio of 0.58, which is well below 1 (and even lower in this year). Qantas had 10 members on its board and its value ratio was less than 1 (at 0.83).

Investment and financial services provider Macquarie Group had 10 members with a ratio of 1.03.

In contrast, with only five directors on their boards, investment fund Platinum Asset Management and high-technology company Silex Systems had ratios of 11.7 and 9, respectively.

Meanwhile travel brand group, Wotif, and electronics retailer JB Hi-Fi, each with six directors, had ratios of 13.2 and 7, respectively.

In theory, Australian boards appear to be wide open to influence by outside directors. Unlike the US corporate landscape, no chief executive was chair of a big Australian publicly listed company board. As a result, non-executive directors have a greater ability to intervene in a firm’s activities.

Shareholders are in a particularly weak position. Only 40 per cent of Australian shareholders vote at company meetings on proposals from the directors – half the US rate.

So large shareholders of Australian companies may not need as much stock to maintain control and can make critical decisions, which puts the onus on independent directors to apply greater scrutiny.

Our findings on the harmful effects of outside directors’ dominance and large boards are directly contrary to the views held by regulators, which have been shaped by big corporate collapses. Virtually every country has mandated a majority of independent directors based on little more than what may be simply a coincidence: the failed US energy company, Enron, happened to have a majority of executives on their board.

We question the regulators’ decision – in Australia in particular – to make share ownership a barrier to independence. The New York Stock Exchange and Nasdaq listing rules adopt a neutral stance: stock ownership per se is not a barrier to independence, and they set the barrier at 10 per cent of stock for directors taking on an audit committee role.

This suits Australian chief executives. Regulators, in their quest to free management of burdensome shareholder concerns, have taken Australia way out of the mainstream at a huge cost to investors and for no apparent reason other than to appease the privileged managerial class at the big end of town.

A standard justification for large boards may be the need for these knowledgeable or well-connected outside directors to act as advisers, particularly in big complex companies. The Centro judgment declares that an advisory role does not absolve the director from taking responsibility for the company’s actions.

Greg Medcraft, the new chairman of the Australian Securities & Investments Commission, has warned boards they will be held to account.

Our findings are a challenge to the ASX, which discourages outside directors from owning shares in companies they hold board roles in for fear it undermines their independence. ”

Supposing people with their snouts in the trough, and even pretty good people like Barnaby, and I suppose Tony, all did the right thing, and were willing to step aside and hand me power … Well I’d have to call up this Swan fellow right away. As quickly as people were being sacked and leaving Canberra to find work, still you would have to be calling people in for consultation.

The above information is so vital because we need to work hard on interim regulations, and we need to start thinking about how to figure out the best long-term regulations as well.

My feeling is that directors ought never be paid directors fees, because it looks to me like unjust enrichment. At first blush it looks like the first five humans through the door, ranked in terms of the number of shares they hold, ought to be the directors, unless they pass their position onto the sixth biggest shareholder.

But obviously no companies need apply for any of their men on the board, as proxy. Now actually that would seem to be close to the best law you could have IN THE FINAL ANALYSIS.

But for the meantime, it is my feeling, that the current system has yielded such unequal distributions of wealth, that the interim regulations may be right to take another factor into account. For the moment you might have three directors, as the top three shareholders. But the next two could be taken from a pool of people who had pretty much ALL their assets in the shares of the company.

I don’t have a formula in mind, and I recognize that we cannot have such a requirement, as some sort of expression of natural law, when we get closer to the voluntary society. But for sunsetted regulations, some sort of weighting may be okay. What is NOT-OKAY …. what is far from fucking-okay ………. is the current setup, and with Penny Wong attempting to share the spoils out to privileged white women. Yes these directorships are a rort. But lets end the rort, and not merely try to divide the loot up in accordance with race and gender.


  1. […] Go here to see the original: Shock: An Important Scoop In “The Australian” Business Pages. « A … […]

  2. The current system has most definitely yielded unequal distributions of wealth. Regardless of how directors are appointed, they are their to represent shareholders and therefore their interests MUST align to the shareholders they represent.

    It is not enough to pay a board member a fixed fee x times a year to attend regular meetings. They need skin in the game, a large equity component as you suggested above so they bear the consequences of their actions more directly.

    Thanks for your interest in the article.

  3. No thank you for the information. Its just one of those articles that is absolutely critical to making decisions about how we regulate companies. You read so much nonsense and dross, and then POW something comes along like this that could not be more important.

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