If you've taken any interest in financial markets over the last year (and if you either borrow money or have some to invest, it would be a good idea - especially now - to take an interest), you'll know that a number of finance companies in New Zealand have found themselves in difficulties.
You're also likely to have heard various commentators allocating blame. Some commentators have known what they're talking about, but others we might describe, charitably, as having less than a full understanding.
I thought it might help to explain some of the basic duties of directors in these situations (remembering that I'm a company director, not a lawyer, so I'm drawing any inference as an informed layman, rather than a legal expert), so you'll be in a better position to judge the facts:
1. Dividends
In general terms, dividends are income that shareholders receive as a return on their investment, usually paid from the company's tax-paid profit. Section 52 of the Companies Act says that the Board of directors may authorise the payment of a dividend if it is 'satisfied on reasonable grounds that the company will, immediately after the distribution, satisfy the solvency test' - together with a few other conditions.
So what's the 'solvency test'? For this we look at Section 6: '... A company satisfies the solvency test if -
(a) The company is able to pay its debts as they become due in the normal course of business [my italics]; and
(b) The value of the company's assets is greater than the value of its liabilities.'
My guess would be that finance company deposits which fall due on a particular date would be classed as 'in the normal course of business'. In determining the value of the company's assets, 'the directors must have regard to the most recent financial statements of the company ... and all other circumstances that the directors know or ought to know ...' [again, my italics].
Even allowing for the tidal wave of changes in financial market conditions, and the precipitous decline in reinvestment rates (the amount of deposits that are renewed when they fall due, rather than being repaid to the investor), which has led to the liquidity difficulties of some finance companies, these provisions in the Act should prompt some searching questions of a few people who are known to have been paid large dividends in the not too distant past.
2. Reckless trading
There's another Section (135) in the Act, entitled 'Reckless trading' which may also turn out to be relevant. Under this, a director 'must not agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss ...' to the people the company owes money to.
The Act provides various defences for people charged under these Sections, so you can expect any legal actions to be lengthy, strongly contested, affairs and, naturally, to be far more complicated than this simple explanation.
But I hope that, after reading this, you will be better able to form your own view of the actions and responsibilities of various parties likely to feature in the news in coming months.
Friday, 25 July 2008
Monday, 14 July 2008
Does absolute power corrupt absolutely?
Last week British retailer Marks & Spencer faced attacks from shareholders and members of the financial press, when Chief Executive Sir Stuart Rose was promoted to Executive Chairman.
23% of shareholders abstained or voted against Sir Stuart's re-appointment to the Board because they considered it went against good governance principles to have one person holding both positions, Chief Executive and Chairman.
This is an old debate and I think it's very easy to over-simplify it - right or wrong. The real answer, as always, is much more complex and depends on the substance rather than the form of the appointment.
If we start with what we're trying to achieve - a successful company - we can find case studies that both support and oppose the appointment.
In many large American companies (which Marks & Spencer is not, of course), the roles are combined. This has often been quoted as one of the weaknesses that led to the fall of companies like Enron and Worldcom. I think it's always a risk if one person holds too much power in an organisation, but the American system provides balance by having, usually, one or two other positions in addition to the Chairman and CEO: we usually find a President and Chief Operating Officer and, since Sarbanes-Oxley, the position of Lead Independent Director. So, in practice, this 'standard' American model builds in some real checks and balances on each individual.
What really matters is not so much the Board's structure, but how (and if) Board members fulfil their roles adequately. There's plenty of evidence to show that the difference between effective and ineffective Boards comes down to how Board members act, whether they deal with the tough issues and have the necessary debates, and that this matters far more than details about the Board's structure. If you've got the right behaviours in the boardroom, you can deal with deficiencies in the Board's structure or composition. But not vice versa.
As has been in the case in several of my previous 'posts', it comes down to the substance of the matter, not just the form.
Marks & Spencer will be an interesting case to watch. As an English company, it would not be typical to have the President/COO and the Lead Independent providing balance. However, my guess is that the Deputy Chairman and other Board members will be very conscious of their obligations to perform: perhaps we'll have material for another comment in a couple of years.
23% of shareholders abstained or voted against Sir Stuart's re-appointment to the Board because they considered it went against good governance principles to have one person holding both positions, Chief Executive and Chairman.
This is an old debate and I think it's very easy to over-simplify it - right or wrong. The real answer, as always, is much more complex and depends on the substance rather than the form of the appointment.
If we start with what we're trying to achieve - a successful company - we can find case studies that both support and oppose the appointment.
In many large American companies (which Marks & Spencer is not, of course), the roles are combined. This has often been quoted as one of the weaknesses that led to the fall of companies like Enron and Worldcom. I think it's always a risk if one person holds too much power in an organisation, but the American system provides balance by having, usually, one or two other positions in addition to the Chairman and CEO: we usually find a President and Chief Operating Officer and, since Sarbanes-Oxley, the position of Lead Independent Director. So, in practice, this 'standard' American model builds in some real checks and balances on each individual.
What really matters is not so much the Board's structure, but how (and if) Board members fulfil their roles adequately. There's plenty of evidence to show that the difference between effective and ineffective Boards comes down to how Board members act, whether they deal with the tough issues and have the necessary debates, and that this matters far more than details about the Board's structure. If you've got the right behaviours in the boardroom, you can deal with deficiencies in the Board's structure or composition. But not vice versa.
As has been in the case in several of my previous 'posts', it comes down to the substance of the matter, not just the form.
Marks & Spencer will be an interesting case to watch. As an English company, it would not be typical to have the President/COO and the Lead Independent providing balance. However, my guess is that the Deputy Chairman and other Board members will be very conscious of their obligations to perform: perhaps we'll have material for another comment in a couple of years.
Wednesday, 9 July 2008
I learned about succession from that
They say we learn best from our mistakes ... some people would say that explains why I never stop learning.
I was reminded the other day of one of the biggest boardroom mistakes of my career. If it's any comfort - which it wasn't to me - it was in an area that many boards fail to deal with well, board succession; or in this case choosing a successor for the Board Chair.
I had been Chair of a medium-sized non-profit organisation for about six years and we had agreed it was time for a change, for both the Board and me. First, breaking all my own rules (see my recent post 'How do we fill his boots now he's gone?'), I agreed to lead the succession process. Without realising it at the time, that alone probably restricted our search criteria to people I thought would be good for the role.
After defining the attributes we were after, we developed a list of possible targets. Our preferred choice, from what we knew of the people, was a just-retired highly-successful Chief Executive who we knew had a passion for our sector. Although several of us had met him a few times, none of us could say we really knew him. (Does anybody hear warning bells yet?) I was given the job of phoning him to ask if he'd be interested.
Well, he joined, was elected Chair and I left the board. I've never believed in hanging around once you stop being the Chair: it's the governance equivalent of 'Dead Man Walking', when you don't want to be there and you know nobody else wants you around either.
From almost his first meeting, the appointment was a disaster. He started behaving as the 'super-CEO', over-ruling the employed CEO, getting involved in management details and barely including the rest of the Board in most decisions. Get the picture? Much to the Board's credit, they realised very quickly the damage this was causing and he was a very short-term Chair of that Board.
So what did we (or I) learn from all that?
First, there are very good reasons for checking references. We've seen several public examples of what happens when nobody did. Only a few months after these events, someone I knew quite well asked me quietly, but obviously in frustration, why I hadn't checked with him (yes, I know, there's a small thing about Privacy Law as well). He told me - too late of course - that the person in question was a superb CEO, but terrible to work with as a director, because he could never remove his CEO 'hat'. However big the reputation, we need to check whether it is relevant to the role we're considering: it's a big change in approach from being a CEO to joining a Board as a non-executive member (even as Chair), where effective decision-making comes from building consensus, and where we don't manage the business hands-on.
This example showed me that checking those references is vital, even for a voluntary, non-profit position, because the consequence of not doing so can be disastrous.
Secondly, should I have been involved in the process at all, considering it was my successor we were looking for? In an ideal world, I don't think so. Perhaps I was so keen to move on that I allowed (possibly even encouraged) some short cuts in the process. In retrospect, if I hadn't been involved, the rest of the Board might have been more rigorous in interviewing and checking references, rather than letting me influence the appointment too much. In my defence, none of the other Board members showed a lot of enthusiasm for putting in the time that was needed to find someone and make the appointment.
On the scale of how wrong things can go, this was possibly not too bad. But the lessons were clear, and more importantly they taught me that we've developed some good basic principles of how Boards should do things.
These principles have evolved through other people's mistakes: disregard them and people will be learning from yours!
So what did we (or I) learn from all that?
First, there are very good reasons for checking references. We've seen several public examples of what happens when nobody did. Only a few months after these events, someone I knew quite well asked me quietly, but obviously in frustration, why I hadn't checked with him (yes, I know, there's a small thing about Privacy Law as well). He told me - too late of course - that the person in question was a superb CEO, but terrible to work with as a director, because he could never remove his CEO 'hat'. However big the reputation, we need to check whether it is relevant to the role we're considering: it's a big change in approach from being a CEO to joining a Board as a non-executive member (even as Chair), where effective decision-making comes from building consensus, and where we don't manage the business hands-on.
This example showed me that checking those references is vital, even for a voluntary, non-profit position, because the consequence of not doing so can be disastrous.
Secondly, should I have been involved in the process at all, considering it was my successor we were looking for? In an ideal world, I don't think so. Perhaps I was so keen to move on that I allowed (possibly even encouraged) some short cuts in the process. In retrospect, if I hadn't been involved, the rest of the Board might have been more rigorous in interviewing and checking references, rather than letting me influence the appointment too much. In my defence, none of the other Board members showed a lot of enthusiasm for putting in the time that was needed to find someone and make the appointment.
On the scale of how wrong things can go, this was possibly not too bad. But the lessons were clear, and more importantly they taught me that we've developed some good basic principles of how Boards should do things.
These principles have evolved through other people's mistakes: disregard them and people will be learning from yours!
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