Magazine article New Zealand Management

"Principles" in Place: What Law Changes Will Follow?

Magazine article New Zealand Management

"Principles" in Place: What Law Changes Will Follow?

Article excerpt

In September 2003, the Securities Commission sought submissions on nine key issues relating to corporate governance. The Commission's inquiry resulted in a report entitled Corporate Governance in New Zealand--Principles and Guidelines.

It sets out nine "principles" of corporate governance, each accompanied by a set of guidelines which are intended to elaborate on how an organisation can implement the principles, key findings arising from the consultation process and the Securities Commission's view on each principle.

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Responding to public support, the Commission adopted what it calls a "principles-based" approach in relation to the promotion/regulation of corporate governance. It means the principles are not enacted into legislation but are merely intended to set "guidelines for behaviour" which organisations may choose to follow and report on. The Commission suggests organisations disclose their corporate governance practices through mediums such as the annual report.

By contrast, the United States adopted a "rules-based" approach by enacting the Public Company Accounting and Investor Protection Act 2002 (also called the Sarbanes-Oxley Act), which prescribes specific rules relating to financial disclosure and other corporate governance practices and includes specific sanctions if companies breach particular rules.

One of the advantages of a "principles-based" approach is that management retains the discretion to decide whether it is appropriate or feasible for its organisation to comply with each or any of the principles identified, and the extent and method of compliance and disclosure. However, inherent in providing that discretion is the risk that no proactive action is taken to implement the suggestions contained in the guidelines.

What is required is an incentive to act. An increase in obligations to spend more time and effort (and consequently costs) on corporate governance issues is unlikely to provide the motivation some boards of directors need to act. Consider for a moment the principle requiring a board of directors to have a clear policy in respect of stakeholder relationships. Designing, enforcing, reviewing and updating a policy, monitoring and reporting on compliance, and dealing with non-compliance is a labour and cost intensive process.

The Commission's principle six ("Risk Management") requires a board to "regularly verify" that the company has rigorous processes to identify and manage risk. This principle addresses an important issue which is not currently legislated for in this form. Administration of risk management procedures can be onerous. Overseas banking organisations find that many man hours and considerable cost are committed to defining levels of risk, and to developing systems for reporting, monitoring and managing it.

The Commission acknowledged submitters' concerns over the issue of risk management by suggesting in its key consultation findings that "focus on risk should not stifle business". This is essentially a reference to the importance of balancing risk management with the effort involved and the overall effectiveness of instituting policies, procedures, reviews etc.

One way of helping organisations achieve a more positive balance would have been for the Commission to provide some guidance on the type and level of risk (at the most basic level, "real" commercial risk as opposed to everyday operational risk) and the manner of managing risk the Commission perceives is important in promoting corporate governance. …

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