Following a year of scandals, what’s the future for boards?

As guardians of moral behaviour, company boards continue to be challenged. After a year of wall-to-wall scandals, especially within the Banking and Finance sector, many are asking whether there are better ways to oversee what is going on in a business.

A series of damning inquiries, including the recent Royal Commission into Financial Services, has spurred much discussion about holding boards to account – but far less about the structure of boards and whose interests they serve.

Ethicist Lesley Cannold expressed her frustration at this state of affairs in a speech to the finance industry, saying the Royal Commission was a lost opportunity to look at “root and branch” reform.

“We need to think of changes that will propel different kinds of leaders into place and rate their performance according to different criteria – criteria that relate to the wellbeing of a range of stakeholders, not just shareholders,” she said at the Crossroads: The 2019 Banking and Finance Oath Conference in Sydney in August.

This issue is close to the heart of Andrew Linden, PhD researcher on German corporate governance and a sessional Lecturer in RMIT’s School of Management. Linden favours the German system of having an upper supervisory board, with 50 per cent of directors elected by employees, and a lower management board to handle the day-to-day operations.

This system was imposed on the Germans after World War II to ensure companies were more socially responsible but, despite its advantages, has not spread to the English-speaking world, says Linden.

“For 40 years, corporate Australia has been allowed to get away with the idea that all they had to do was to serve shareholders and to maximise the value returned to shareholders.

“Now, that’s never been a feature of the Corporate Law. And directors have had very specific duties, publicly imposed duties, that they ought to have been fulfilling – but they haven’t.”

It is the responsibility of directors of public companies to govern in the corporation’s best interests and also ensure that corporations do not impose costs on the wider community, he says.

“All these piecemeal responses to the Banking Royal Commission are just Band-Aids on bullet wounds. They are not actually going to fix the problem. All through these corporate governance debates, there has not been too much of a focus on board design.”

The German solution – a two-tier model

This board structure, proposed by Linden, would have non-executive directors on an upper (supervisory) board, which would be legally tasked with monitoring and control, approving strategy and appointing auditors.

A lower management board would have executive directors responsible for implementing the approved strategy and day-to-day management.

This structure would separate non-executive from executive directors and create clear, legally separate roles for both groups, he says.

“Research into European banks suggests having employee and union representation on supervisory boards, combined with introduction of employee elected works councils to deal with management over day-to-day issues, reduces systemic risk and holds executives accountable,” according to Linden, who wrote about the subject with Warren Staples (senior lecturer in Management, RMIT University) in The Conversation last year.

Denmark, Norway and Sweden also have employee directors on corporate boards and the model is being proposed in the US by Democratic presidential hopefuls, including Senators Elizabeth Warren and Bernie Sanders.

As Linden said, “All the solutions that people in the English-speaking world typically think about are ownership-based solutions. So, you either go for co-operative ownership as an alternative to shareholder ownership, or, alternatively, it’s public ownership. All of these debates over decades have been about ‘who are the best owners’, not necessarily about the design of their governing bodies.”

Linden says research shows the riskiest banks are those that are English-speaking, for-profit, shareholder-dominated, overseen by an independent-director-dominated board.

“And they have been the ones that have imposed the most cost on communities,” he says.

 Outsourcing the board

Allowing consultant-like companies to oversee governance is a solution proposed by two law academics in the US, who say they are “trying to encourage people to innovate in governance in ways that are fundamentally different than just little tweaks at the edges”.

Law professors Stephen Bainbridge (UCLA) and  Todd Henderson (University of Chicago) say organisations are familiar with the idea of outsourcing responsibilities to lawyers, accountants, financial service providers.

“We envision a corporation, say Microsoft or ExxonMobil, hiring another company, say Boards-R-Us, to provide it with director services, instead of hiring 10 or so separate ‘companies’ to do so,” Henderson explained in an article.

 “Just as other service firms, like Kirkland and Ellis, McKinsey and Company, or KPMG, are staffed by professionals with large support networks, so too would BSPs [board service providers] bring the various aspects of director services under a single roof. We expect the gains to efficiency from such a move to be quite large.

“We argue that hiring a BSP to provide board services instead of a loose group of sole proprietorships [non-executive directors] will increase board accountability, both from markets and judicial supervision.”

Outsourcing to specialists is a familiar concept, said Bainbridge in a video interview with The Conference Board.

“Would you rather deal with you know twelve part-timers who get hired in off the street, or would you rather deal with a professional with a team of professionals?”

Your director is a robot

A Hong Kong venture capital firm, Deep Knowledge Ventures, appointed the first-ever robot director to its board in 2014, giving it the power to veto investment decisions deemed as too risky by its artificial intelligence.

Australia’s Chief Scientist, Dr Alan Finkel, told company directors that he had initially thought the robo-director, named Vital, was a mere publicity stunt.

However, five years on “… the company is still in business. Vital is still on the Board. And waiting in the wings is her successor: Vital 2.0,” Finkel said at a governance summit held by the Australian Institute of Company Directors in March.

“The experiment was so successful that the CEO predicts we’ll see fully autonomous companies – able to operate without any human involvement – in the coming decade.

Stop and think about it: fully autonomous companies able to operate without any human involvement. There’d be no-one to come along to AICD summits!”

Dr Finkel reassured his audience that their jobs were safe … for now.

“… those director-bots would still lack something vital – something truly vital – and that’s what we call artificial general intelligence: the digital equivalent of the package deal of human abilities, human insights and human experiences,” he said.

“The experts tell us that the world of artificial general intelligence is unlikely to be with us until 2050, perhaps longer. Thus, shareholders, customers and governments who want that package deal will have to look to you for quite some time,” he told the audience.

“They will rely on the value that you, and only you, can bring, as a highly capable human being, to your role.”

Linden agrees that robo-directors have limitations and that, before people get too excited about the prospect of technology providing the solution to governance, they need to get back to basics.

“All these issues to do with governance failures get down to questions of ethics and morality and lawfulness – on making judgments about what is appropriate conduct,” he says, adding that it was “hopelessly naïve” to expect machines to be able to make moral judgements.

“These systems depend on who designs them, what kind of data goes into them. That old analogy ‘garbage in, garbage out’ is just as applicable to artificial intelligence as it is to human systems.”