Wilson Asset Management

The ultimate success or failure of a company rests with its board. However, despite the growing expectation that directors enshrine Corporations Act ethics and responsibility while creating and protecting shareholder wealth, many investors overlook this important board function when making investment decisions.

Directors are, in effect, the stewards of a company and must act in the best interests of all shareholders. With responsibility for the leadership and direction of the company, its directors influence performance in a few crucial functions, such as strategy, corporate governance and risk management.

Importantly, the board also hires and fires the CEO and this, together with incentive structures, has a massive impact on the creation of value for shareholders. The ability and merits of the board will be reflected in its CEO appointment, with a high-quality board likely to ensure a high-quality CEO. By the same token, an effective board is unlikely to tolerate a poorly performing CEO.

A board of directors sets the expectations for the management and operations, which includes responsibility for fostering and guiding corporate culture. Based on Wilson’s investing experience, a business’s performance is positively correlated with its culture. This is backed by a body of evidence, with research showing that a strong, values-driven culture gives a company a powerful competitive advantage compared to its peers.

For example, a positive culture can drive financial performance through greater productivity and higher levels of employee engagement. This relationship is becoming accepted as fact within the investment profession. However, the importance of the board in creating and overseeing a positive culture is less well understood.

Assessing a board

As part of our rigorous investment process, we assess a board based on the following factors:

Composition. The benefits derived from a diversity of skills and experience on a board are well understood and a growing body of research shows gender diversity also has a positive effect on company performance, yet women account for just 25.4 per cent of ASX 200 directorships. A diversity of behaviours is also important. The composition of the board affects how it functions; for example, ensuring robust debate in the boardroom.

Experience and track record. As the saying goes, “past success is the best predictor of future success”, so the directors’ depth of experience, skill set and judgement demonstrated during their executive and board careers is vital to a board’s credibility.

Remuneration. We believe remuneration must be commensurate with the directors’ level of responsibility and complexity of the board’s role. As an example, we believe directors of listed investment companies (LICs) should receive less remuneration given their lighter workload compared with the board of an operating company.

Similarly, the board is responsible for setting appropriate remuneration and incentive structures for senior executives, which should align with shareholders’ interests to ensure management is motivated to achieve sustainable growth.

Relationship with management. An effective relationship between the board and management, especially the CEO, is necessary for a company’s successful operation. Ideally, a board strikes the right balance between providing guidance and giving the CEO and executive team a level of autonomy and a mandate to execute the agreed strategy. This oversight role is achieved by the board asking the right questions of the management team.

Vested interests and motivations. We consider board members’ individual motivations and vested interests, and the potential for partiality. For example, if a director represents a major shareholder on the board, they may be motivated to act in that individual shareholder’s best interests.

An understanding of board members’ relevant financial interests is important. For example, if a director is a substantial shareholder, they may have a vested interest in ensuring the share price goes up quickly. As a result, they may set executive remuneration structures that achieve this short-term outcome, but are harmful to the business’s long-term interests.

Corporate governance practices. We look at how the board creates and fosters best-practice governance principles, given the potential for this factor to affect performance. To this end, Australia’s regulatory regime ensures companies are held to account. The ASX Corporate Governance Principles framework creates an obligation for companies to comply with the governance recommendations and if they do not, explain why.

Other factors. Directors’ tenure is another relevant consideration, with regular board renewal seen as a positive. It can also be useful to consider directors’ other board commitments and if they have sufficient time to dedicate to the company.

Resources

There are a range of resources to draw on when assessing the above factors. The annual report is a useful starting point as it includes details of remuneration structures and directors’ qualifications and experience.

Companies are obliged to provide details of directors’ current and previous directorships over the past three years only, but a Google search can reveal further historical details. Other sources, such as chairmen’s addresses, presentations and AGMs, offer an insight into how a board functions.