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Principles of Contemporary Corporate Governance

Second edition

Following the success of the first edition, Principles of Contemporary Corporate

Governance Second Edition maintains the delineation of core principles of corpo-
rate governance and provides a concise presentation of vital topics and emerging
themes in corporate governance within the private sector. This definitive book
not only exposes the fundamental principles of corporate governance, it builds
upon them by illustrating how they are applied. It includes several prominent
case studies, and directors’ duties and liabilities are illustrated by drawing on the
most recent Australian court cases.
Although grounded in Australian corporate governance, the book will appeal
to practitioners and students of law and business management internationally.
Principles of corporate governance are explicated for readers in all jurisdic-
tions, with specific reference to the global financial crisis and the implications
for corporate governance developments in the future. The OECD Principles of
Corporate Governance are addressed, and specific chapters on corporate gover-
nance debates in the United States, United Kingdom, Canada, Germany, Japan
and China have been provided by expert contributors for this new edition.
Jean Jacques du Plessis is Professor in the School of Law at Deakin University.

Anil Hargovan is Associate Professor in the School of Business Law and Taxation
at the University of New South Wales.
Mirko Bagaric is Professor in the School of Law at Deakin University.
Principles of Contemporary
Corporate Governance
Second edition

Jean Jacques du Plessis

Anil Hargovan
Mirko Bagaric
Contributors
Vivienne Bath
Christine Jubb
Luke Nottage
cambridge university press
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National Library of Australia Cataloguing in Publication data

Du Plessis, Jean J.
Principles of contemporary corporate governance / Jean Jacques du Plessis, Mirko Bagaric,
Anil Hargovan.
2nd ed
ISBN 9780521138031 (pbk.)
Includes index.
Corporate governance–Law and legislation.
Corporate governance–Australia.
Directors of corporations–Australia.
Bagaric, Mirko.
Hargovan, Anil, 1962–
346.94066

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Contents

Contributors xv
Table of cases xvii
Table of statutes xxi
Preface xxiii
Preface to the first edition xxv

PART ONE BASIC CONCEPTS, BOARD STRUCTURES AND

COMPANY OFFICERS 1
1 The concept ‘corporate governance’ and ‘essential’ principles of
corporate governance 3
1.1 The meaning of corporate governance 3
1.1.1 Generally 3
1.1.2 Origins of the corporate governance debate and the stakeholder
debate 5
1.1.3 Definition of ‘corporate governance’ 10
1.2 ‘Essential’ principles of corporate governance 11
1.3 Is ‘good corporate governance’ important and does it add value? 14
1.4 Are corporate governance models converging? 18
1.5 Conclusion 19

2 Stakeholders in corporate governance and corporate social

responsibility 20
2.1 Introduction 20
2.2 Stakeholders in the corporation: An overview 22
2.2.1 What is a stakeholder? 22
2.2.2 Discussion of different stakeholders 24
2.2.2.1 Shareholders 25
2.2.2.2 Employees 25
2.2.2.3 Creditors 29
2.2.2.4 Customers 30
2.2.2.5 The community 31
2.2.2.6 The environment 31
2.2.2.7 Government 35
2.2.2.8 All stakeholders have vested interests in the sustainability of
corporations 35

v
vi CONTENTS

2.3 Stakeholders’ interests and the corporation: The role of the law 36
2.3.1 The Australian position 36
2.3.2 Overseas position: A snapshot 40
2.3.2.1 OECD 40
2.3.2.2 European Union (EU) 41
2.3.2.3 United States 43
2.3.2.4 United Kingdom 45
2.3.2.5 Canada 49
2.3.2.6 New Zealand 49
2.3.2.7 South Africa 51
2.4 Stakeholder interests, good governance and the interests of the
corporation: A mutual relationship 53
2.4.1 General analysis 53
2.4.2 Case study of James Hardie’s asbestos compensation settlement 56
2.5 CSR and directors’ duties 65
2.6 Conclusion 69

3 Board functions and structures 71

3.1 Higher community expectation of directors 71
3.1.1 Initially low standards of care, skill and diligence expected of
directors 71
3.1.2 Legal recognition of changed community expectation of directors 73
3.2 The organs of governance 75
3.3 Board functions 77
3.4 Board structures 83
3.5 Board structures in the broader context of a good corporate
governance model 90
3.5.1 Overview 90
3.5.2 Effective board structure 91
3.5.3 Effective support mechanisms to assist the board in properly fulfilling
its functions 93
3.5.4 Effective statutory provisions 93
3.5.5 Effective regulators 94
3.5.6 Effective charters, policies and codes of best practice and conduct 96
3.5.7 Corporate governance rating systems for companies 98
3.6 Conclusion 100

4 Types of company directors and officers 101

4.1 Overview 101
4.2 Definition of ‘director’ 102
4.2.1 De jure and de facto directors covered 102
4.2.2 Shadow director 103
4.2.3 Nominee directors 104
4.3 Definition of ‘officer’ 106
4.3.1 Statutory definition 106
4.3.2 Senior employees and senior executives as ‘officers’ 107
4.3.3 Middle management as ‘officers’? 108
 CONTENTS vii

4.4 Types of company officers 109

4.4.1 Executive and non-executive directors 109
4.4.2 Independent non-executive directors 110
4.4.3 Connected non-executive directors 116
4.4.4 Lead independent directors or senior independent directors 117
4.4.5 The managing director, managing directors, the chief executive officer
and executive directors 117
4.4.6 Chairperson 118
4.4.7 Alternate director 120
4.4.8 Secretary 120
4.5 Training and induction of directors 122
4.5.1 Training 122
4.5.2 Induction of new directors 124
4.6 Ethical behaviour by directors 125
4.7 Remuneration of directors and executives 127
(with contributions by Christine Jubb)
4.7.1 A controversial issue 127
4.7.2 Disclosure of remuneration and emoluments in Australia 128
4.7.3 Investigations into excessive remuneration of directors and
executives 128
4.8 Conclusion 129

PART TWO CORPORATE GOVERNANCE IN AUSTRALIA 131

5 Corporate governance in Australia – background and business
initiatives 133
5.1 Background to the corporate governance debate in Australia 133
5.2 The Bosch Report 136
5.2.1 Background 136
5.2.2 The Bosch Report (1991) 137
5.2.3 The Bosch Report (1993) 139
5.2.4 The Bosch Report (1995) 141
5.3 Divergence from UK practice: 1995 to early 2003 142
5.4 The Hilmer Report 142
5.4.1 Background 142
5.4.2 The Hilmer Report (1993) 144
5.4.3 The Hilmer Report (1998) 145
5.5 The virtues of good corporate governance in Australia between 1991
and 1998 146
5.6 The IFSA Blue Book 146
5.7 Standards Australia 152
5.8 Conclusion 154

6 Regulation of corporate governance 156

6.1 Overview 156
6.2 Regulation generally 157
6.3 Objectives in regulating corporate governance 159
viii CONTENTS

6.4 Sources of regulation in Australia 161

6.4.1 ‘Hard law’ 162
6.4.1.1 Statutory regulation – corporate law 162
6.4.1.2 Statutory regulation – other than corporate law 165
6.4.1.3 ‘Corporate governance and the judges’ – the place of
judge-made law 165
6.4.2 ‘Hybrids’ 166
6.4.2.1 ASX Listing Rules 166
6.4.2.2 ASX Corporate Governance Principles and
Recommendations 168
6.4.2.3 Accounting standards 169
6.4.2.4 Auditing standards 169
6.4.3 ‘Soft law’ 170
6.4.4 The role of market forces 172
6.5 Towards an effective supervision of financial markets regulatory
framework in Australia – analysis 174
6.5.1 OECD’s guidelines for achieving an effective governance
framework 174
6.5.2 Division of responsibilities between ASX and ASIC 176
6.6 Conclusion 178

7 The role of the regulators: ASIC and ASX 179

7.1 Introduction 179
7.2 The Australian Securities and Investments Commission 180
7.2.1 Overview 180
7.2.2 Statutory powers under the ASIC Act 181
7.2.3 The role of ASIC in corporate governance 182
7.2.4 ASIC enforcement patterns 185
7.3 The Australian Securities Exchange Ltd 187
7.3.1 Slow to get out of the blocks 187
7.3.2 Rapid change in attitude since the end of 2002 189
7.3.3 ASX Corporate Governance Council’s Principles of Good Corporate
Governance and Best Practice Recommendations 190
7.3.3.1 Changes in 2007 190
7.3.3.2 Structure 190
7.3.3.3 Recommendations 191
7.3.3.4 The roles and relationship between ASX and ASIC 193
7.4 Conclusion 195

8 Accounting governance 198

8.1 Overview 198
8.2 Background to the Corporate Law Economic Reform Program and
some later developments 199
8.3 The Corporate Law Economic Reform Program 200
8.4 Impetus for CLERP 9: Responding to corporate collapses 202
8.5 Explanation of key CLERP 9 reforms 205
8.5.1 Audit reform 205
 CONTENTS ix

8.5.2 Corporate disclosure 206

8.5.2.1 Remuneration of directors and executives 206
8.5.2.2 Financial reporting 207
8.5.2.3 Continuous disclosure 208
8.5.2.4 Shareholder participation 209
8.5.2.5 Whistleblowers 209
8.5.2.6 Disclosure rules 211
8.5.3 Miscellaneous 213
8.5.3.1 Managing conflict by financial services licensees 213
8.5.3.2 Register of relevant interests 213
8.5.3.3 Officers, senior managers and employees 214
8.5.3.4 Enforcement 214
8.5.3.5 Proportionate liability 214
8.6 Accounting standards 215
8.7 Conclusion 216

9 Auditors and audits 219

(with contributions by Christine Jubb)
9.1 Introduction: The audit role and where it fits into corporate
governance 219
9.1.1 Overview of the audit role 219
9.1.2 The link between the audit role and corporate governance 221
9.2 CLERP 9 changes to audit role 222
9.3 Auditor independence 224
9.3.1 Overview of rationale behind independence requirement 224
9.3.2 General requirement for auditor independence 225
9.3.3 Meaning of ‘conflict of interest situation’ 225
9.3.4 Disclosing and resolving conflicts 226
9.3.5 Specific independence requirements – minimising conflict of interest
through employment and financial restrictions 226
9.3.6 Auditor rotation 228
9.3.7 Disclosure of non-audit services 228
9.4 Auditors and the AGM 229
9.5 Auditors’ duties 229
9.6 Reducing the legal exposure of auditors 231
9.6.1 Overview of auditors’ liability 231
9.6.2 Registration of audit companies 232
9.6.3 Proportionate liability 233
9.7 Qualification of auditors 235
9.8 Uniform auditing standards 235
9.9 Audit oversight 236
9.10 Audit committees 237
9.11 Conclusion 239

10 Directors’ duties and liability 240

10.1 Introduction 240
x CONTENTS

10.2 Part 9.4B – civil penalty provisions or pecuniary penalty

provisions 243
10.2.1 Overview 243
10.2.2 The civil penalty provisions in particular 244
10.2.2.1 Section 180: Duty of care and diligence – civil
obligation 244
10.2.2.2 Section 181: Duty of good faith – civil obligation 247
10.2.2.3 Sections 182 and 183: Duty not to use position or
information to gain personally or cause detriment to the
corporation 248
10.2.2.4 Part 2E: Duty relating to related party
transactions 249
10.2.2.5 Part 2H: Duty relating to share capital transactions 250
10.2.2.6 Part 2M.2 and 2M.3: Duty relating to requirements for
financial reports 251
10.2.2.7 Part 5.7B: Duty to prevent insolvent trading 251
10.2.2.8 Part 5C: Duties relating to managed investment
schemes 254
10.2.2.9 Chapter 6CA: Duty relating to continuous
disclosure 255
10.2.2.10 Part 7.10: Duty not to be involved in market misconduct
and other prohibited conduct relating to financial
products and financial services 255
10.2.2.11 Subclause 29(6) of Schedule 4: Duty relating to disclosure
for proposed demutualisation 258
10.2.2.12 Relief from civil liability 258
10.3 Case studies regarding civil penalty provisions or pecuniary penalty
provisions 260
10.3.1 Overview 260
10.3.2 ASIC v Adler [2002] 41 ACSR 72 260
10.3.2.1 Summary of the facts 260
10.3.2.2 Contraventions of civil penalty provisions 261
10.3.2.3 Court orders 264
10.3.3 ASIC v Macdonald (No 11) (2009) 256 ALR 199 – James Hardie
litigation 265
10.3.3.1 Background and summary of the facts 265
10.3.3.2 Legal issues 266
10.3.3.3 Decision and significance of the decision 267
10.3.3.4 Court orders 271
10.3.4 ASIC v Rich [2009] NSWSC 1229 272
10.3.4.1 Background and basic facts 272
10.3.4.2 Legal issue 273
10.3.4.3 The decision and its significance 273
10.4 Conclusion 277

11 Enforcement of directors’ duties 279

11.1 Introduction 279
11.2 The statutory derivative action: Part 2F.1A 281
 CONTENTS xi

11.2.1 The case to introduce a statutory derivative action 281

11.2.2 Eligible applicant 282
11.2.3 Cause of action 283
11.2.4 Leave of court required to institute the statutory derivative
action 283
11.3 Oppressive conduct of affairs: Part 2F.1 284
11.3.1 Type of conduct covered by Part 2F.1 284
11.3.2 Who may apply for relief under Part 2F.1? 285
11.3.3 Nature of relief available under Part 2F.1 286
11.4 Section 1324 injunctions 287
11.4.1 Introduction 287
11.4.2 Section 1324(1) 287
11.4.3 The court’s discretion 288
11.4.4 Remedies in particular 289
11.5 Criminal liability of directors 290
11.5.1 The importance of the criminal sanction in the corporations
law 290
11.5.2 Selected criminal offences directors and other officers can commit
under the Corporations Act 293
11.5.2.1 General 293
11.5.2.2 Specific offences for breaches of duties 294
11.6 Conclusion 294

PART THREE CORPORATE GOVERNANCE IN

INTERNATIONAL AND GLOBAL CONTEXTS 297
12 Corporate governance in the USA, the UK and Canada 299
12.1 Introduction 299
12.2 United States 300
12.2.1 Background to the corporate governance debate in the USA 300
12.2.2 The American Law Institute’s involvement in the corporate
governance debate 301
12.2.2.1 Basic aims of the project 301
12.2.2.2 Impact and importance of the project 301
12.2.2.3 Some of the key aspects addressed 302
12.2.3 The Securities Exchange Commission 303
12.2.4 The Sarbanes-Oxley Act of 2002 – the US response to collapses such
as Enron and WorldCom 304
12.2.4.1 Backdrop 304
12.2.4.2 Aims and objectives 305
12.2.4.3 Some perspectives on SOX and its effect 307
12.2.5 NYSE: Sections 303 and 303A – corporate governance rules 309
12.2.5.1 Background 309
12.2.5.2 Summary of the most important NYSE corporate
governance rules 310
12.3 United Kingdom 312
12.3.1 Background to the corporate governance debate in the UK 312
12.3.2 The Cadbury Report and the unfolding of the concept of ‘corporate
governance’ in the UK 312
xii CONTENTS

12.3.2.1 Context of the Cadbury Report 312

12.3.2.2 Code of Best Practice 313
12.3.2.3 Further developments 314
12.3.3 The Greenbury, Hampel, Smith and Higgs reports 316
12.3.3.1 The Greenbury Report (1995) 316
12.3.3.2 The Hampel Report (1998) 316
12.3.3.4 The Higgs Report (2003) and the Smith Report (2003)
317
12.3.4 The 2008 UK Combined Code and the 2010 UK Corporate
Governance Code 317
12.4 Canada 320
12.4.1 Overview 320
12.4.2 Regulatory environment 321
12.4.3 Proposed National Policy 58–201: Corporate governance
principles 323
12.4.4 Current National Policy 58–201: Corporate governance
guidelines 330
12.4.5 National Instrument 58–101: Disclosure of Corporate Governance
Practices 330
12.4.6 National Instrument 52–110 and Companion Policy 52–110CP Audit
Committees 331
12.4.7 Future direction 334
12.5 Conclusion 336

13 OECD Principles of Corporate Governance, and corporate governance

in Germany, Japan and China 337
13.1 Introduction 337
13.2 OECD Principles of Corporate Governance 338
13.2.1 Background 338
13.2.2 Broad aims and application 338
13.2.3 Structure 339
13.2.4 Ensuring the basis for an effective corporate governance
framework 339
13.2.5 Disclosure and transparency 341
13.2.6 Conclusions on OECD corporate governance principles 342
13.3 Germany 342
13.3.1 Background to the corporate governance debate in Germany 342
13.3.2 The German Corporate Governance Code 345
13.3.2.1 Background to its adoption 345
13.3.2.2 Structure and explanatory nature of the German
code 347
13.3.3 Employee participation at supervisory board level –
co-determination 348
13.3.4 The German board structure 351
13.3.5 Conclusions on Germany 351
13.4 Japan 352
(by Luke Nottage)
13.4.1 Introduction 352
 CONTENTS xiii

13.4.2 Japan and debates on comparative capitalism and corporate

governance 353
13.4.3 Historical transformations in Japanese corporate law and
practice 359
13.4.4 Japanese corporate forms and internal governance
mechanisms 363
13.4.4.1 Overview 363
13.4.4.2 Companies with committees versus companies with
boards of auditors 365
13.4.4.3 Directors’ duties and derivative actions 369
13.4.5 Shareholder versus bank finance 373
13.4.5.1 Overview 373
13.4.5.2 Share-class diversification 374
13.4.5.3 Takeovers regulation 375
13.4.5.4 Main banks 379
13.4.6 Core employees 382
13.4.7 Conclusions on Japan 385
13.5 China 386
(by Vivienne Bath)
13.5.1 Introduction 386
13.5.2 Government and legislation in China 387
13.5.3 Corporate entities in China 390
13.5.3.1 State-owned enterprises 390
13.5.3.2 Foreign-investment enterprises 392
13.5.3.3 Companies under the Company Law 393
13.5.4 Corporate governance – issues and resolutions 395
13.5.5 Controlling the board of directors and the managers – the
supervisory board 397
13.5.6 Increasing the duties of directors 398
13.5.7 Independent directors 401
13.5.8 Committees 402
13.5.9 The issue of the controlling shareholder – protection for minority
shareholders under the Company Law 403
13.5.10 Improved disclosure requirements 406
13.5.11 Imposing additional requirements on the sponsors of public
offerings 408
13.5.12 Higher standards of accounting 408
13.5.13 Direct intervention – the case of dividends 409
13.5.14 Enforcement 410
13.5.15 Consequences of breach 410
13.5.16 Conclusions on China 413
13.6 Conclusion 415

PART FOUR BUSINESS ETHICS AND FUTURE DIRECTION 417

14 The ethical obligations of corporations 419
14.1 Introduction – the nature of morality 419
14.2 The threshold issue: Is there a role for ethical considerations in
business? 424
xiv CONTENTS

14.2.1 A brief look at the short history of business ethics 424

14.2.2 The disunity between business and ethics argument 427
14.2.3 Morality applies to business because moral judgments are
universalisable 427
14.2.4 Exception to universalisation – activities with internal settled
rules? 428
14.2.5 Are moral norms too vague to apply to business? 429
14.2.6 Promise to shareholders to maximise profits as a basis for rejecting
application of moral principles to business? 430
14.2.7 Summary of the general link between business and ethics 431
14.3 Application of moral principles to a business setting 432
14.3.1 Types of duties imposed on corporations – proscriptions against
causing harm, lying and environmental damage already legally
enforced 432
14.3.2 Additional duties imposed on corporations – a duty of
benevolence? 434
14.3.2.1 Acts and omissions doctrine serves to minimise
obligations on corporations 434
14.3.2.2 Principal duty is for corporations to comply with law –
business is morally neutral 436
14.3.2.3 A more elaborate duty – extreme wealth and a maxim of
positive duty 437
14.3.2.4 Requirement to pay social dividend 439
14.3.3 Extreme wealth and duty to not frustrate access to justice 441
14.3.4 Is corporate social responsibility the answer? 442
14.4 Conclusion 444

15 Reflections on contemporary corporate governance and its future

direction 446
15.1 Introduction 446
15.2 Regulatory pyramid and the cycles of regulation: A perspective on
contemporary corporate governance regulation 447
15.3 Interaction of cycles of regulation and ‘law and norms’
discourse 451
15.3.1 The significance of norms 451
15.3.2 Norms, corporate governance and the utility of behavioural
analysis 457
15.4 Conclusion: The future of corporate governance regulation 465

Index 469
Contributors

Jean Jacques du Plessis is Professor in the School of Law at Deakin University.

He is an Alexander von Humboldt Scholar, and since 2004 he has assisted with the
South African Corporate Law Reform Program as a member of the International
Reference Group for the South African Corporate Law Reform Program. He is a
member of the Executive Committee of the Corporate Law Teachers Association
and was the President of this Association in 2008 and 2009.
Anil Hargovan is Associate Professor in the School of Business Law and Tax-
ation at the University of New South Wales. His research interests are in the
area of corporate and insolvency law, a discipline in which he has presented
many conference papers and published widely in refereed Australian and inter-
national law journals. He has recently edited a volume of the Australian Journal
of Corporate Law dedicated to the legal and policy issues arising from the Sons of
Gwalia litigation, concerning the treatment of shareholders as creditors in cor-
porate insolvencies. Anil has authored and co-authored several books, including
Australian Corporate Law (2008). He is a member of the Executive Committee
of the Corporate Law Teachers Association and convenor of the Company Law
Interest Group for the Australasian Law Teachers Association. Anil teaches cor-
porate governance in the MBA program at the AGSM at the University of New
South Wales, and is a member of the Corporate Governance Subject Advisory
Committee for Chartered Secretaries, Australia.
Mirko Bagaric is Professor in the School of Law at Deakin University. He has
published several articles with James McConvill on policy issues and future
developments in corporate governance. He also researches very actively in such
fields as criminal law, the law of evidence, privacy and family law. Mirko has
already published on his own or as co-author of textbooks or monographs in each
of these areas. He is also a practising lawyer.
Vivienne Bath is Associate Professor in the Faculty of Law at the University of
Sydney. She has first class honours in Chinese and in Law from the Australian
National University, and a Master of Laws from Harvard University. Prior to
joining the Faculty of Law, she was a partner in international firm Coudert
Brothers, working in the Hong Kong and Sydney offices and specialising in
commercial law, with a focus on foreign investment and commercial transactions
in the People’s Republic of China. Vivienne has published widely in the area of

xv
xvi CONTRIBUTORS

Chinese law and is a frequent participant in conferences and seminars focusing

on developments in international economic law and the Chinese legal regime.
Christine Jubb is Research Fellow in the Australian National Centre for Audit
and Assurance Research at the Australian National University. She was formerly
Professor of Accounting at the Deakin Business School, Deakin University. She
was appointed, by the Financial Reporting Council, to the Australian Auditing
and Assurance Standards Board in 2005 and reappointed for a second three-year
term to the Board in 2008. Christine has taught auditing and financial reporting
at undergraduate and postgraduate levels, supervised auditing-related research
at Honours, Master and PhD levels and published articles and textbooks on
Auditing and Assurance. She is a member of the CPA Australia Exam Policy
Advisory Committee and the Exam Special Consideration Committee. She is an
author for the Assurance and Auditing CPA segment.
Luke Nottage is Associate Professor in the Faculty of Law at the University of Syd-
ney, Associate Director (Japan) at its Centre for Asian and Pacific Law, Program
Director (Comparative and Global Law) at the Sydney Centre for International
Law and founding Co-Director of the Australian Network for Japanese Law.
He specialises in comparative and transnational commercial and consumer law,
and has published more than 100 works, including Nottage, Wolff & Anderson
(eds) Corporate Governance in the 21st Century: Japan’s Gradual Transformation
(2008). Luke is qualified in New South Wales and New Zealand, has worked
closely with law firms in Japan since 1990, and is a Director of Japanese Law
Links Pty Ltd. He has served as expert witness and consulted for many law
firms worldwide, as well as for the Organisation for Economic Co-operation and
Development (OECD), the European Commission, Japanese Cabinet Office and
the United Nations Development Programme.
Table of cases

Re a Company [1989] BCLC 13 104

Adler v ASIC & 4 Ors [2002] NSWSC 483 264
Airpeak Pty Ltd v Jetstream Aircraft (1997) 15 ACLC 715 287; 720 290
Alexander v Cambridge Credit Corp Ltd (1987) 9 NSWL 310 231
Allen v Atalay (1993) 11 ACSR 753 287
ASIC v Adler [2002] 41 ACSR 72 246, 260; NSWSC 483 (30 May 2002) 244, 260;
(2002) 41 ACSR 72 245, 247, 250, 268; 42 ACSR 80 75
ASIC v Dawson Nominees Pty Ltd (2008) 169 FCR 227 211
ASIC v Elliot (2004) 48 ACSR 621 75
ASIC v Fortescue Metals Group Ltd [No 5] [2009] FCA 1586 186
ASIC v Macdonald and Others (No 11) [2009] NSWSC 287 (23 April 2009) 80, 83;
(2009) 256 ALR 199 56, 57, 59, 65, 183; 256 ALR 199 75, 102, 245, 247, 265
ASIC v Macdonald (No 12) [2009] NSWSC 714 56, 265, 271; (2009) 259 ALR 116
75, 265
ASIC v Maxwell (2006) 59 ACSR 373 75, 245, 268
ASIC v Murdaca (2008) 68 ACSR 66 103
ASIC v Plymin (No 1) (2003) 175 FLR 124 254; 46 ACSR 126 251–2
ASIC v Rich (2003) 44 ACSR 44 75; 44 ASCR 341 171; [2009] NSWSC 1229
186, 245, 246, 272; [7193] 241; [7203] 109
ASIC v Triton Understanding Insurance Agency Pty Ltd and Others (2003) 48 ACSR
244, 256 289–90
ASIC v Vines (2005) 55 ACSR 617 75; 56 ACSR 528 259
ASIC v Vizard (2005) 145 FCR 57 75, 241, 249; 219 ALR 714 186
Australian Securities and Investments Commission v Mauer-Suisse Securities Ltd
(2002) 42 ACSR 605 289
AWA Ltd v Daniels (Trading as Deloitte Haskins & Sells & Ors) (1992) 7
ACSR 759 77, 80, 142, 268; 9 ACSR 983 231; 867 109, 143; 10 ACLC 933
87
Re AWB Ltd (No 10) [2009] VSC 566 186

Barnes v Andrews 298 Fed 614 (1924) 73

Bateman v Newhaven Park Stud Ltd (2004) 49 ACSR 454 168
BGJ Holdings Pty Ltd v Touche Ross & Co (1987) 12 ACLR 481 220–1
Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 425 72
Brunninghausen v Glavanics (1999) 46 NSWLR 538 240

Campbell v Backoffice Investments Pty Ltd [2009] HCA 25 285

Canadian Aero Service Ltd v O’Malley (1973) 40 DLR (3d) 371 107

xvii
xviii TABLE OF CASES

Re Cardiff Savings Bank (Marquis of Bute’s case) [1892] 2 Ch 100 242

Chahwan v Euphoric Pty Ltd (2008) 65 ACSR 661 283
Charterhouse Investment Trust Ltd v Tempest Diesels Ltd [1986] PCLC 1 262
City Equitable Fire Insurance Co Ltd [1925] Ch 407 73
Re City Equitable Fire Insurance Co Ltd [1925] Ch 407 72, 74, 241, 245
Columbia Coffee & Tea Pty Ltd v Churchill t/as Nelson Parkhill (1992) 29 NSWLR 141
231
Commonwealth Bank of Australia v Friedrich (1991) 5 ASCR 115, 187 80, 242, 253,
259; 9 ACLC 946 74, 259

Re Damilock Pty Ltd (In Liq); Lewis and Carter as Liquidators of Damilock Pty Ltd (In
Liq) v VI SA Australia Pty Ltd (2009) 252 ALR 533 251–2
Daniels v Anderson [1995] 13 ACLC 614 109; (1995) 13 ACLC 614 80, 143, 144,
242; 16 ACSR 607 (CA (NSW)) 72, 73, 74, 241, 268; 37 NSWLR 438 244,
247, 259
DCT v Clarke [2003] NSWCA 91 254; (2003) 57 NSWLR 113 254
Re Denham and Co (1883) 25 CH D 752 242
Dodge v Ford Motor 170 N.W. 668 (Mich. 1919); (1919) 204 Mich. 459 6
Dodrill v The Irish Restaurant & Bar Co Pty Ltd [2009] QSC 317 285

Edwards v ASIC [2009] NSWCA 424 251, 252

Edwards v Attorney General (NSW) [2004] NSWCA 272 60; (2004) 50 ACSR 122
Elliot v ASIC (2004) 48 ACSR 621 254
Esanda Finance Corp Ltd v Peat Marwick Hungerfords (1997) 188 CLR 241 231

Re Faure Electric Accumulator Co (1888) 40 Ch D 141 72

Fiduciary Ltd v Morningstar Research Pty ltd (2005) 53 ACSR 732 283
Fire and All Risk Insurance Ltd v Pioneer Concrete Services Ltd (1986) 10 ACLR 760
168
Re Forest of Dean Coal Mining Co (1878) 10 Ch D 450 72
Frankston & Hastings Corp v Cohen (1960) 102 CLR 607 231
Furs Ltd v Tomkies (1936) 54 CLR 583 241

Gambotto v WCP Ltd (1995) 182 CLR 432 51

Goozee v Graphic World Group Holdings Pty Ltd [2002] NSWSC 640 (25 July 2002)
282
Group Four Industries Pty Ltd v Brosnan (1992) 8 ACSR 463 268

Hall v Poolman (2007) 65 ACSR 123 252, 253, 259, 260

Harman v Energy Research Group Australia Ltd (1985) 9 ACLR 897 168
Harris v Sheperd (1975) 1 ACLR 50 (on appeal) [1976] ACLC 28, 614 104
Hawkins v Bank of China (1992) 7 ACSR 349 252
Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549 118
Ho v Akai Pty Ltd (in liq) (2006) 24 ACLC 1526 104
Hospital Products Ltd v United States Surgical Corporation (1984) 55 ALR 417
248

Industrial Equity Ltd v Blackburn (1977) 13 CLR 567 58

Insurances Ltd v Pioneer Concrete Services Ltd (No 2) (1986) 10 ACLR 801 169
 TABLE OF CASES xix

John J Starr (Real Estate) Pty Ltd v Robert R Andrew (A’asia) Pty Ltd (1991) 6 ACSR
63 285

Katz v Oak Industries, Inc., 508 A.2d 873, 879 (Del. Ch. 1986) 6
Kenna & Brown Pty Ltd v Kenna (1999) 32 ACSR 430 259
Re Kingston Cotton Mill (No 2) [1896] 2 Ch 270 220–221
Kuwait Asia Bank v National Mutual Life Nominees Ltd [1991] AC 187 105

Lagunas Nitrate Company v Lagunas Syndicate [1899] 2 Ch 392 72; 435 241
Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 705, 713 75

Manpac Industries Pty Ltd v Ceccattini (2002) 20 ACLC 1304 254

McLellan (in the matter of The Stake Man Pty Ltd) v Carroll [2009] FCA 1415 253,
254, 259
Metropolitan Fire Systems v Miller (1997) 23 ACSR 699 253
Metyor Inc v Queensland Electronic Switching P/L [2002] QCA 269 (30 July 2002)
281
Morley v Statewide Tobacco Services Ltd, (1992) 14 Syd LR 504 74
Murdaca v ASIC [2009] FCAFC 92 102

Natcomp Technology Australia Pty Ltd v Graiche [2001] NSWCA 120 (30 April 2001)
104
Re National Bank of Wales Ltd [1899] 2 Ch 629 72
Re New Mashonaland Exploration Co [1892] 3 Ch D 577 72
Niord Pty Ltd v Adelaide Petroleum NL (1990) 8 ACLC 684 286
Northumberland Insurance Ltd (in liq) v Alexander (1988) 13 ACLR 170 231

Oates v Consolidated Capital Services Ltd (2009) 72 ACSR 506 283

Overend, Gurney & Co. v. Gibb (1872) LR 5 HL 480 72

Pacific Acceptance Corporation v Forsyth (1970) 92 WN (NSW) 29 220–1

Parke v Daily News Ltd [1962] Ch 927 46
Percival v Wright [1902] 2 Ch 421 240
Permanent Building Society v Wheeler (1994) 14 ACSR 109 268
Playspace Playground Pty Ltd v Osborn [2009] FCA 1486 252

R v Dytham [1979] QB 722 436

R v Pittwood (1902) 19 TLR 37 436
Ragless v IPA Holdings Pty Ltd (in liq) (2008) 65 ACSR 700 283
Regal (Hastings) Ltd v Gulliver [1942] UKHL 249; [1967] 2 AC 134 241, 249
Revlon, Inc v McAndrews & Forbes Holdings, Inc 506 A.2d 173 (Del. 1986) 43
Rich v ASIC [2004] HCA 42 134, 146
RTP Holdings Pty Ltd v Roberts [2000] SASC 386 (8 November 2000) 284

Salomon v Salomon & Co Ltd [1897] AC 22 58

Sandell v Porter (1966) 115 CLR 666 251–2
Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324 105, 285
Somerville v ASIC (1995) 131 ALR 517 280
Spies v R (2000) 201 CLR 603 29, 68
xx TABLE OF CASES

Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405 242, 253, 254, 268;
8 ACLC 827 74
Strategic Minerals Corp NL v Basham (1996) 15 ACLC 1155 231
Swansson v Pratt (2002) 42 ACSR 313 283

Re Tasbian (No 3) [1992] BCC 358 104

Tekinvest Pty Ltd v Lazarom [2004] NSWSC 940 (11 October 2004), [21]-[22]
289–90
Tesco Supermarkets v Nattrass [1971] 2 All ER 127 291
The Australian Metropolitan Life Assurance Co Ltd v Ure (1923) 33 CLR 199 241
The Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) [2008] WASC 239
(28 October 2008) [4362] 5, 75; (2008) 70 ACSR 1 29
Tourprint International Pty Ltd v Bott (1999) 32 ACSR 201 253
Turquand v Marshall (1869) LR 4 Ch App 376 72, 74, 242

United States v Arthur Young, 465 US 805, 817–18 (1984) 224

Unocal Corp. v Mesa Petroleum Co. 493 A.2d 946 (Del. 1985) 43

Vanmarc Holdings Pty Ltd v PW Jess & Associates Pty Ltd (2000) 34 ACSR 222
289–90
Vines v ASIC (2007) 62 ACSR 1 75, 259, 268
Vrisakis v ASC (1993) 11 ACSR 162 268

Walker v Wimborne (1976) 137 CLR 1 58

Wayde v NSW Rugby League Ltd (1985) 180 CLR 459 285
Western Areas Exploration Pty Ltd v Streeter [No 3] (2009) 73 ACSR 494 241
Whitlam v Australian Securities and Investments Commission (2003) 21 ACLC 1259
118
Williams v ASIC (2003) 46 ASCR 504 264
Williams v Scholz [2007] QSC 266 254; [2008] QCA 94 259
Table of statutes
China
Company Law 1993 387–8, 390, 391,
393–5, 397–401, 403–7, 409–11,
414
Criminal Law of the People’s Republic of
China 1997 387–8
Enterprise State-owned Assets Law of the
People’s Republic of China 2009
391–2
General Principles of Civil Law 1987
392
Law of the People’s Republic of China on
Chinese-foreign Cooperative Joint
Ventures 1988 392
Law of the People’s Republic on Foreign
Capital Enterprises 1986 392
Law of the People’s Republic of China on
Industrial Enterprises owned by the
Whole People 1988 390–1
Law on Securities Investment Funds
2003 387–8
Securities Law of the People’s Republic of
China 1998 387–8, 393, 396, 407,
410
Commonwealth
Audit Reform and Corporate Disclosure
Act 2004 128, 147
Australian Prudential Regulation
Authority Amendment Act 2003 95
Australian Securities and Investments
Commission Act 2001 26, 181–2,
207, 233–5, 236, 237
Australian Securities and Investments
Commission Amendment (Audit
Inspection) Act 2007 237
Company Law Review Act 1998 229
Corporate Law Economic Reform
Program Act 1999 201
Corporate Law Economic Reform
Program (Audit Reform and
Corporate Disclosure) Act 2004 94,
108, 159, 160–1, 169, 170, 171,
198–9, 219, 293, 448, 456
Corporations Act 2001 26, 30, 50, 51,
59, 60, 67, 75, 76, 94, 102, 103, 104,
105–7, 109, 117–20, 121, 128, 134,
144, 147, 160–1, 162–5, 167, 169,
182, 193, 199, 206–7, 209, 220,
225–30, 232–3, 235, 236, 242–60,
262–4, 266–7, 268–78, 281–95
Criminal Code Act 1995 290–2
Cross-Border Insolvency Act 2008 201
Environment Protection and Biodiversity
Conservation Act 1999 32
Fair Work Act 2009 26
Financial Services Reform Act 2001
184, 201
Public Interest Disclosure Act 2003
210
Trade Practices Act 1974 30, 232, 235
Germany
Stock Corporation Act 1937 360
Japan
Child Care and Family Care Leave Law
2004 384
Companies Act 2005 363–5, 372
Equal Employment Opportunity Law
1997 384
Equal Employment Opportunity Law
2006 384
xxi
xxii TABLE OF STATUTES

New Zealand United States

Companies Act 1993 49
United Kingdom
Companies Act 1985 46, 49
Companies Act 2006 45, 46, 67, 68,
121, 280
Companies (Audit, Investigations and
Community Enterprise) Act 2004
47
Model Business Corporations Act 2002
78
Sarbanes-Oxley Act 2002 94, 97, 159,
168, 205, 218, 304–9, 317, 448,
456
Securities Act 1933 303–4,
449
Securities Exchange Act 1934 303–4,
309–10, 449
Preface

Corporate governance has increased in prominence over the past 30 years or so.
It has long been an area of rapid development and, in some instances, following
dramatic corporate collapses, drastic measures were required to ensure adher-
ence to good practice in corporate governance. Since the appearance of the first
edition of Principles of Contemporary Corporate Governance in 2005, develop-
ments have not only gained velocity, but the volume of materials on corporate
governance has grown exponentially. This made the appearance of a second
edition inevitable. In addition, the global financial crisis that emerged in 2008
and global financial uncertainties related to some worrying revelations in the
first half of 2010 about the financial stability of several European Union member
countries make it easy to predict that the discipline of corporate governance will
retain its prominence in future.
In this second edition of Principles of Contemporary Corporate Governance, the
basic approach was again to extract the fundamental and contemporary princi-
ples of corporate governance. The majority of authors have a legal background,
which reflects an emphasis on legal aspects of corporate governance. However,
care has been taken also to focus on managerial and accounting perspectives of
corporate governance. It should be emphasised that this book deals primarily
with corporate governance of large public corporations. It does not focus sepa-
rately on small and medium-sized enterprises (SMEs), non-government organ-
isations (NGOs) or public-sector corporate governance. It goes without saying
that many of the good principles in corporate governance that are generally
applicable to large public corporations are transplantable to other enterprises,
organisations and governmental agencies.
Although grounded in Australian corporate governance, it will be apparent to
the reader that international perspectives are interwoven throughout the book.
In addition, there is a prominent multi-jurisdictional focus in Part Three, where
the OECD Principles of Corporate Governance are discussed and where specific
chapters address corporate governance debates in the USA, the UK, Canada,
Germany, Japan and China. Readers familiar with the first edition will notice
that separate parts on corporate governance in Canada, Japan and China have
been added.
The second edition provides an extensive and comprehensive update, and
expands the areas covered in the first edition. In the current Chapter 8 there
is a broader focus on ‘accounting governance’, replacing the narrower focus on

xxiii
xxiv PREFACE

CLERP 9 in the first edition. The chapter on business ethics (Chapter 14) has
been expanded and greater attention devoted to the importance of business
ethics. In Chapter 10 (Directors’ duties and liabilities), recent Australian cases
(up to May 2010) in the area of corporate law and directors’ duties are included.
We have also updated all references, including discussions of the most recent
corporate governance reports and codes in Australia and in the other jurisdic-
tions covered. The chapter on accounting and auditing (Chapter 9) has been
expanded and updated to position the Australian jurisdictional characteristics in
an international context.
There are five distinctive parts in Principles of Contemporary Corporate Gover-
nance, each carrying through a consistent theme: Part One introduces the reader
to basic concepts on different types of board structures and company officers.
Part Two focuses on corporate governance in Australia; Part Three adds an
international perspective to corporate governance. Basic corporate governance
principles in selected jurisdictions, including the USA, the UK, Canada, Germany,
Japan and China are discussed, while the OECD Principles of Corporate Gover-
nance are also covered in some detail. Part Four deals with business ethics and
possible future developments and trends in corporate governance.
We are confident that this edition will again broaden the perspectives and
understanding of all people interested in corporate governance and corporate
regulation and management, including company secretaries, compliance offi-
cers, judicial officer, lawyers, accountants, academics and students of law and
business management.
We would like to thank James McConvill, second author of the first edition,
for giving us permission to use the parts he prepared for the first edition, in this
second edition of Principles of Contemporary Corporate Governance. Although
several parts were changed extensively, there are still parts that we adopted in the
second edition that we have not changed. We would also like to recognise James’
considerable input in the first edition. Circumstance beyond James’ control made
it impossible for him to be an author of the second edition.

THE AUTHORS
May 2010
Preface to the first edition

Corporate governance concerns the manner in which corporations are regulated

and managed. Corporations control a significant portion of the world’s wealth
and other resources. The dominance of the corporation as the central agent
in the market economy is increasing. Corporate behaviour impacts on every
individual – often in very profound and significant ways. A fundamental tension
in the corporate governance debate is balancing the profit making objective of
corporations and company officers against broader social responsibilities owed
to the wider community. This tension has not been adequately resolved. Thus,
corporate governance is a very complex and controversial area of the law.
This book sets out to demystify corporate governance regulation. It explains
the rules and principles that regulate corporate behaviour in Australia and a
number of other jurisdictions, including the United States, the United Kingdom
and Germany. As well as dealing with corporate governance regulation today, the
book provides an extensive analysis of the wider moral and policy considerations
underpinning corporate governance. It evaluates existing standards pertaining
to corporate governance, makes proposals for change and suggests ways in which
this area of law and practice can be made more coherent and principled. The
book argues that corporate governance regulation and management is in need
of fundamental reform and explains in detail the direction that these reforms
should take.
The primary aim with Principles of Contemporary Corporate Governance is to
extract and evaluate the core principles of this subject area. However, it also gives
context to these principles by way of to-the-point discussions and explanations as
well as through carefully selected diagrams, case studies and real-life examples
of corporate governance practices.
The book is written for all people who have an interest in corporate regu-
lation and management, including company officers, judicial officers, lawyers,
accountants and students.
There are five distinct parts in Principles of Contemporary Corporate Gover-
nance, but they carry a consistent theme through the book. In Part One the
reader is introduced to some of the most basic aspects regarding corporate gov-
ernance, namely the meaning of the concept ‘corporate governance’; corporate
stakeholders and participants; board structures (in particular the unitary and
two-tier board structure); and types of company officers (executive and non-
executive directors; alternate director; secretary, etc).

xxv
xxvi PREFACE TO THE FIRST EDITION

Part Two focuses on corporate governance in Australia, covering the ASX

Corporate Governance Council’s Principles of Good Corporate Governance and
Best Practice Recommendations (applicable to listed companies), other corpo-
rate governance guidelines and recommendations, the main governance and
accountability mechanisms under the Australian Corporations Act 2001 and the
recent Corporate Law Economic Reform Program 9 (CLERP 9) reforms to the
Act.
Part Three considers corporate governance in practice. Specific topics covered
include board and committee structures and risk management policies; auditors
and audits; and an overview of directors’ duties and liabilities.
Part Four adds an international perspective to corporate governance. Basic
corporate governance principles in selected jurisdictions such as the USA, UK
and Germany are dealt with; the OECD Principles of Corporate Governance are
also covered in some detail.
Part Five deals with some policy issues, and likely future developments and
possible corporate governance trends.
We trust that our readers will find as much satisfaction in reading Principles
of Contemporary Corporate Governance as we did in writing it.

Jean Jacques du Plessis, James McConvill and Mirko Bagaric

May 2005
 PART ONE
BASIC CONCEPTS, BOARD STRUCTURES
AND COMPANY OFFICERS
1
The concept ‘corporate governance’
and ‘essential’ principles of
corporate governance

It is necessary only for the good man to do nothing for evil to triumph.
– Attributed to Edmund Burke (18th-century English political philosopher)
– The Australian, Monday 6 December 2004, 4, reporting on the most
favoured phrase of quotation-lovers, as determined by an
Oxford University Press poll

1.1 The meaning of corporate governance

1.1.1 Generally
Corporate governance is as old as the corporate form itself,1 although Tricker
correctly points out that the phrase ‘corporate governance’ was scarcely used
until the 1980s.2 In the first edition (2005) of this book we pointed out that
there is no set definition for the concept of corporate governance. This has not
changed. Commentators still speak of corporate governance as an indefinable
term, something – like love and happiness – of which we know the essential
nature, but for which words do not provide an accurate description. Many have
attempted to lay down a general working definition of corporate governance,
yet one definition varies from another, and this often leads to confusion. Early
attempts to define the concept of corporate governance appear in the United
Kingdom Cadbury Report (1992) and the South African King Report (1994),
defining corporate governance as ‘the system by which companies are directed
and controlled’. That seems not particularly helpful in clarifying the meaning
of corporate governance. Over the past decade or so, there have been further
attempts at a definition, bringing in additional aspects or elements under the
term ‘corporate governance’.

1 J J du Plessis, ‘Corporate law and corporate governance lessons from the past: Ebbs and flows, but far from
“The end of History . . . : Part 1” ’ (2009) 30 Company Lawyer 43 at 44.
2 Bob Tricker, Corporate Governance: Principles, Policies and Practices, Oxford, Oxford University Press,
(2009) 7.

3
4 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

In a background paper published prior to the Report of the HIH Royal Commis-
sion (the Owen report) on the collapse of HIH Insurance Ltd – one of Australia’s
largest corporate collapses – a clearer definition began to emerge:

Corporate governance refers generally to the legal and organisational framework

within which, and the principles and processes by which, corporations are governed.
It refers in particular to the powers, accountability and relationships of those who
participate in the direction and control of a company. Chief among these participants
are the board of directors, and management. There are aspects of the corporate gover-
nance regime that have an impact on the relationship between shareholders and the
company.3

In this report, Justice Owen considered the meaning of the term ‘corporate
governance’ in two instances. In the introductory part of the Report, under
the heading, ‘Corporate governance: A poor role model’, he reflected that the
term ‘corporate governance’ was used so widely and so generally that the term
‘corporate governance’ was potentially meaningless. Justice Owen then provided
some substance to the concept:

Corporate governance – as properly understood – describes the framework of rules,

relationships, systems and processes within and by which authority is exercised and
controlled in corporations. Understood in this way, the expression ‘corporate gover-
nance’ embraces not only the models or systems themselves but also the practices by
which that exercise and control of authority is in fact effected.4

This description of corporate governance focused on specific elements or aspects

of corporate governance.
The trend to define corporate governance more precisely continued in 2003
with the appearance of the Australian Securities Exchange’s (ASX) Principles of
Good Corporate Governance and Best Practice Recommendations.5 The description
used in 2003 was slightly different from the description of corporate governance
contained in the 2007 ASX’s Principles of Good Corporate Governance and Best
Practice Recommendations:

Corporate governance is ‘the framework of rules, relationships, systems and pro-

cesses within and by which authority is exercised and controlled in corporations’.
It encompasses the mechanisms by which companies, and those in control, are held
to account. Corporate governance influences how the objectives of the company are

3 Background Paper 11 (HIH Royal Commission) Directors’ Duties and Other Obligations under the Corpora-
tions Act (November 2001) 27 para 76.
4 Report of the HIH Royal Commission (Owen Report), The Failure of HIH Insurance – Volume I: A Corporate
Collapse and its Lessons, Canberra, Commonwealth of Australia (2003) xxxiii.
5 ASX, Principles of Good Corporate Governance and Best Practice Recommendations (March 2003) 3,
available at <http://203.15.147.66/about/corporate governance/principles good corporate governance.
htm>. ‘What is corporate governance? Corporate governance is the system by which companies are directed
and managed. It influences how the objectives of the company are set and achieved, how risk is monitored
and assessed, and how performance is optimised. Good corporate governance structures encourage com-
panies to create value (through entrepreneurism, innovation, development and exploration) and provide
accountability and control systems commensurate with the risks involved.’
 CONCEPT AND ESSENTIALS 5

set and achieved, how risk is monitored and assessed, and how performance is opti-
mised. Effective corporate governance structures encourage companies to create value,
through entrepreneurialism, innovation, development and exploration, and provide
accountability and control systems commensurate with the risks involved.6

It is useful to quote another, realistic and open-ended description of corporate

governance from a United States perspective, but the absence of a reference to
stakeholders as part of this definition and the focus on shareholder primacy (see
below), is conspicuous:
Simply defined, corporate governance consists of all people, processes, and activities in
place to help ensure the proper stewardship over a company’s assets. Corporate gover-
nance is the implementation and execution of processes to ensure that those managing
a company properly utilize the time, talents, and available resources in the best interests
of absentee owners. These processes include all aspects of a company’s performance
including risk management, operational and marketing strategies, internal control,
conformance with applicable laws and regulation, public relations, communication,
and financial reporting.7

While a closer description of corporate governance was required, the concept

‘corporate governance’ remains one that does not lend itself to a single, specific
or narrow definition. Several differences remain, sometimes only subtle ones,
but in other instances they are more fundamental. In 2008, Justice Owen made
the following comments in The Bell Group Ltd v Westpac Banking Corporation
(No 9):8
[D]irectors are in control of the assets of a corporation but they do not own those assets.
They control the assets on behalf of the corporation and, through the corporation, others
having an interest in the wellbeing of the entity. There are no hard and fast rules that
constitute ‘corporate governance’. But there are some basic underlying principles that
help to explain the guidelines and legal principles that have developed over time and
now dictate how a director is expected to carry out her or his responsibilities.

Before we attempt to give our own definition, it is important to consider the

origins of both the corporate governance and the stakeholder debates.

1.1.2 Origins of the corporate governance debate and the

stakeholder debate
It is difficult to determine exactly when the corporate governance debate started.9
However, there is little doubt that there were many factors that brought the corpo-
rate governance debate to prominence: the separation of ownership and control

6 ASX, Principles of Good Corporate Governance and Best Practice (2nd edn, August 2007) 3, avail-
able at <http://203.15.147.66/about/corporate governance/revised corporate governance principles
recommendations.htm>.
7 K Fred Skousen, Steven M Glover and Douglas F Prawitt, An Introduction to Corporate Governance and the
SEC, Mason, Thomson South-Western, (2005) 7.
8 [2008] WASC 239 (28 October 2008) [4362].
9 See John Farrar, Corporate Governance: Theories, Principles and Practice, Melbourne, Oxford University
Press (3rd edn, 2008) 8–120.
6 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

(so pertinently illustrated in 1932 by Berle and Means in their book, The Modern
Corporation and Private Property), which resulted in the so-called ‘managerial
revolution’10 or ‘managerialism’;11 the pivotal role of the corporate form in gen-
erating wealth for nations; the huge powers of corporations, and the effects of
these on our daily lives; the enormous consequences that flow from collapses of
large public corporations;12 and what we would like to call the ‘boardtorial rev-
olution’ or ‘directorial revolution’, based on what Stephen Bainbridge recently
identified as ‘the director primacy model of corporate governance’ (see discus-
sion below and Chapter 3). We are, indeed, as Allan Hutchinson describes it so
appropriately, living in an age of corpocracy.13
It is also beyond dispute that the corporate governance debate became par-
ticularly prominent when the basic perception of the company changed. At first
the only real concern for a company was the maximisation of profits.14 Profits
for whom? – the shareholders.15 This was confirmed in 1919 in the case of Dodge
v Ford Motor16 and is a view many commentators adhered to for a consider-
able period of time, with a further confirmation of the Dodge theory in 1986 in
the case of Katz v Oak Industries17 . According to this view, the shareholders
are the ‘owners of the company’, the primary stakeholders and most important
providers of capital to enable the company to conduct business. Gradually this
perception changed, and the company, especially the large public company, came
to be seen in a different light. People realised that there were other stakeholders
in a company, too; that if the only purpose of a company was ‘the maximisation
of profits for the shareholders’, the society as such could suffer tremendously –
poor working conditions for workers, exploitation of the environment, pollution
and so on. Then came the realisation that:

enterprise, private as well as public, because it both contributes to and benefits from
society (local, national and larger), can be said to have rights and duties vis-à-vis that
society in somewhat the same way as has an individual;18

10 See, for example, Klaus J Hopt, ‘Preface’ in Institutional Investors and Corporate Governance. Theodor
Baums, Richard M Buxbaum and Klaus J Hopt (eds), Berlin, W de Gruyter (1994) I; and OECD Principles of
Corporate Governance (April 2004) <http://www.oecd.org/dataoecd/32/18/31557724.pdf> 12.
11 Stephen M Bainbridge, The New Corporate Governance in Theory and Practice, Oxford, Oxford University
Press (2008) 9, 19–20 and 155 et seq.
12 See generally Roberta Romano, The Genius of American Corporate Law, Washington, DC, AEI Press (1993);
and David S R Leighton and Donald H Thain, Making Boards Work, Whitby, Ontario, McGraw-Hill Ryerson
(1997) 9–10.
13 Allan C Hutchinson, The Companies We Keep, Toronto, Irwin Law (2005) 8.
14 Adolf A Berle, ‘The Impact of the Corporation on Classical Theory’ in Thomas Clarke (ed.), Theories of
Corporate Governance: The Philosophical Foundations of Corporate Governance, London, Routledge (2004) 45,
49 et seq.
15 Margaret M Blair, ‘Ownership and Control: Rethinking Corporate Governance for the Twenty-First Cen-
tury’ in Thomas Clarke (ed.), Theories of Corporate Governance: The Philosophical Foundations of Corporate
Governance, London, Routledge (2004) 175, 181. See also Bainbridge, above n 11, 53.
16 Dodge v Ford Motor 170 N.W. 668 (Mich. 1919) at 684; (1919) 204 Mich. 459 at 507: ‘A business
corporation is organized and carried on primarily for the profit of the stockholders The powers of the
directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means
to attain that end, and does not extend to the change of the end itself, to the reduction of profits, or to the
nondistribution of profits among stockholders in order to devote them to other purposes.’
17 Katz v Oak Indus., Inc., 508 A.2d 873, 879 (Del. Ch. 1986).
18 Charles de Hoghton (ed.), The Company: Law, Structure and Reform in Eleven Countries, London, Allen &
Unwin (1970) 7.
 CONCEPT AND ESSENTIALS 7

and

[t]he limited liability company does not simply represent one interest. It represents an
arena in which there is a potential clash of many interests. We may identify the interests
underlying it as: (1) investors – share capital/loan capital; (2) outside creditors –
commercial finance/trade creditors; (3) employees; (4) consumers; (5) the public.19

The concept of ‘managing the corporation’ then came to be expressed in terms

of these other interests:

The balancing of the company’s responsibilities – to workers as members of the com-

pany, to consumers of the goods and services it provides, and to the community of
which it is a citizen – with its primary one of operating at maximum efficiency and
lowest cost, so as to make profits and discharge its obligations to its shareholders,
represents the full scope of management.20

Thus, the concept of ‘corporate governance’ began to adopt this new articula-
tion of ‘managing the corporation’, with a central focus on the interrelationship
between internal groups and individuals such as the board of directors, the share-
holders in general meeting, employees, managing directors, executive directors,
non-executive directors, managers, audit committees and other committees of
the board. However, outside interests are also at stake; for example, those of
creditors, potential investors, consumers and the public or community at large
(so-called stakeholders). Traditional wisdom regarding shareholder primacy21
versus other stakeholders began to be challenged with statements like ‘manage-
rial accountability to shareholders is corporate law’s central problem’,22 ‘corpo-
rate law is currently in the midst of crisis, because of the exhaustion of the share-
holder primacy model’23 and ‘[s]hareholder dominance should be questioned’.24
Nowadays, it is fairly generally accepted that ‘in future the development of loyal,
inclusive stakeholder relationships will become one of the most important deter-
minants of commercial viability and business success’;25 that ‘recognition of
stakeholder concern is not only good business, but politically expedient and
morally and ethically just, even if in the strict legal sense [corporations] remain
directly accountable only to shareholders’;26 and that ‘[t]he corporation as a legal
entity grew out of its ability to protect not only the shareholders but also other

19 John J Farrar et al., Farrar’s Company Law, London, Butterworths (1991) 13.
20 George Goyder, The Responsible Company, Oxford, Blackwell (1961) 45.
21 See generally on the theory of ‘shareholder primacy’ Irene-Marié Esser, Recognition of Various
Stakeholder Interests in the Company Management: Corporate Social Responsibility and Directors’ Duties,
Saarbrüken, VDM Verlag Dr Müller, (2009) 19–23.
22 David Millon, ‘New Directions in Corporate Law: Communitarians, Contractarians, and the Crisis in
Corporate Law’ 1993 (50) Washington & Lee Law Review 1373, 1374.
23 Ibid, 1390.
24 Morten Huse, Boards, Governance and Value Creation: The Human Side of Corporate Governance,
Cambridge, Cambridge University Press (2007) 29.
25 David Wheeler and Maria Sillanpää, The Stakeholder Corporation, London, Pitmann (1997) ix. See further
James E Post, Lee E Preston and Sybille Sach, Redefining the Corporation: Stakeholder Management and
Organizational Wealth, Stanford, Stanford Business Books (2002), 1–3; and Mark J Roe, ‘Preface’ in Margaret
M Blair and Mark J Roe (eds), Employees & Corporate Governance, Washington, DC, Brookings Institute
(1999) v.
26 Leighton and Thain, above n 12, 23.
8 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

stakeholders’.27 This, in turn, made the concepts of ‘corporate social responsibil-

ity’ (the CSR debate) and ‘corporate citizenship’ highly prominent. Entire books
are dedicated to discussion of corporate citizenship and the importance of com-
panies being good corporate citizens. Examples include Mervyn King’s The Cor-
porate Citizen28 and Corporate Citizenship, Contractarianism and Ethical Theory,
edited by Jesús Conill, Christoph Luetge and Tantjana Schönwälder-Kuntze.29
Also, a spate of books have been published recently on the CSR debate.30 It seems
as though we have truly and inevitably moved away from the view that the pri-
mary aim of corporations is ‘to make a profit’, towards a view that corporations,
especially large public corporations, should primarily strive ‘to build a better
society’.31
The stakeholder debate, the CSR debate and ‘corporate citizenship’, therefore,
are integral and prominent in most of the recent corporate governance discus-
sions and reports. We consider stakeholders in greater detail in Chapter 2, but it is
useful to refer at an early stage to some of the most prominent statements on the
role and importance of stakeholders. The importance of stakeholders was clearly
illustrated in the European Union Report, Comparative Study of Corporate Gov-
ernance Codes Relevant to the European Union and its Members (January 2002),32
the South African King Report on Corporate Governance (March 2002)33 and the
ASX Corporate Governance Council’s Principles of Good Corporate Governance
and Best Practice Recommendations (March 2003)34 .

27 Huse, above n 24, 29.

28 Mervyn King, The Corporate Citizen: Governance for All Entities, Johannesburg, Penguin Books (2006).
29 Jesús Conaill, Christoph Luetge and Tanjanna Schönwälder-Kuntze (eds), Corporate Citizenship, Con-
tractarianism and Ethical Theory: On Philosophical Foundations of Business Ethics, Burlington, Ashgate
(2008).
30 Güler Aras and David Crowther (eds), Global Perspectives on Corporate Governance and CSR, Farnham,
Gower Publishing Ltd (2009); Frank den Hond, Frank G A de Bakker and Peter Neergaard, Managing
Corporate Social Responsibility in Action: Talking, Doing and Measuring, Aldershot, Ashgate Publishing
Ltd (2007); Ana Maria Dávila Gómez and David Crowther (eds), Ethics, Psyche and Social Responsibil-
ity, Aldershot, Ashgate Publishing Ltd (2007); Wim Vandekerckhove, Whistleblowing and Organizational
Social Responsibility: A Global Assessment, Aldershot, Ashgate Publishing Ltd (2006); David Crowther and
Lez Rayman-Bacchus (eds), Perspectives on Corporate Social Responsibility, Aldershot, Ashgate Publishing
Ltd (2004).
31 Hutchinson, above n 13, 326.
32 Comparative Study of Corporate Governance Codes Relevant to the European Union and its Members
(hereafter referred to as European Commission Comparative Study) (January 2002) <http://ec.europa.
eu/internal market/company/docs/corpgov/corp-gov-codes-rpt-part1 en.pdf> 4: ‘Although the compar-
ative corporate governance literature and popular discussion tend to emphasise “fundamental” differ-
ences between stakeholder and shareholder interests, the extent to which these interests are different
can be debated. The majority of corporate governance codes expressly recognise that corporate suc-
cess, shareholder profit, employee security and well being, and the interests of other stakeholders are
intertwined and co-dependent. This co-dependency is emphasised even in codes issued by the investor
community.’
33 Executive Summary – King Report on Corporate Governance (King Report (2002)), Parktown, South Africa,
Institute of Directors in Southern Africa (March 2002) para 5.3: ‘The inclusive approach recognises that
stakeholders such as the community in which the company operates, its customers, its employees and its
suppliers need to be considered when developing the strategy of a company. The relationship between a
company and these stakeholders is either contractual or non-contractual.’
34 Principles of Good Corporate Governance and Best Practice Recommendations (2003), above n 5, 59: ‘There
is growing acceptance of the view that organisations can create value by better managing natural, human,
social and other forms of capital. Increasingly the performance of companies is being scrutinised from a
perspective that recognises these other forms of capital. That being the case, it is important for companies to
demonstrate their commitment to appropriate corporate practices.’
 CONCEPT AND ESSENTIALS 9

A particularly good summary of the importance of the stakeholder debate, as

an integral part of the corporate governance debate, appears in the Organisation
for Economic Cooperation and Development (OECD) Principles of Corporate Gover-
nance (April 2004):
A key aspect of corporate governance is concerned with ensuring the flow of external
capital to companies both in the form of equity and credit. Corporate governance is
also concerned with finding ways to encourage various stakeholders in the firm to
undertake economically optimal levels of investment in firm-specific human and phys-
ical capital. The competitiveness and ultimate success of a corporation is the result of
teamwork that embodies contributions from a range of different resource providers
including investors, employees, creditors, and suppliers. Corporations should recog-
nise that the contributions of stakeholders constitute a valuable resource for building
competitive and profitable companies. It is, therefore, in the long-term interest of cor-
porations to foster wealth-creating co-operation among stakeholders. The governance
framework should recognise that the interests of the corporation are served by recog-
nising the interests of stakeholders and their contribution to the long-term success of
the corporation.35

Thus, since 2004, the OECD Principles of Corporate Governance has referred to
corporate governance as ‘a set of relationships between a company’s manage-
ment, its board, its shareholders and other stakeholders’.36 Also, because of
the prominence of the stakeholder debate in recent times and the realisation
that stakeholders form an integral part of any corporation’s existence and long-
term prosperity, some commentators have moved away from the traditional
‘ownership-orientated’ definition of the corporation to a broader ‘stakeholder-
orientated’ definition. James E Post, Lee E Preston and Sybille Sach offer the
following definition of a corporation:
The corporation is an organisation engaged in mobilising resources for productive
users in order to create wealth and other benefits (and not to intentionally destroy
wealth, increase risk, or cause harm) for its multiple constituents, or stakeholders.37

We deal with this expanded definition in much greater detail in Chapter 2. How-
ever, it is worthwhile pointing out that over time these developments have made
commentators and researchers pick up some definite trends, and increasingly
theories and models of the corporation and of corporate governance have been
identified.38 Until very recently, the ‘shareholder primacy model’ and ‘stake-
holder primacy model’ of corporate governance have been the most prominent
models, but Stephen Bainbridge, in his excellent work, The New Corporate Gover-
nance in Theory and Practice, analyses these theories and provides some exciting
new perspectives on corporate governance models by expanding on the ‘direc-
tor primacy model’ that he developed recently. Bainbridge began to develop
35 OECD Principles of Corporate Governance, above n 10, 46.
36 Ibid, 11. See also Etsuo Abe, ‘What is Corporate Governance? The historical implications’ in The Develop-
ment of Corporate Governance in Japan and Britain (edited by Robert Fitzgerald and Etsua Abe), Aldershot,
Ashgate Publishing Ltd (2004) 1.
37 Post, Preston and Sach, above n 25, 17.
38 See Esser, above n 21, 19–36 for a useful summary of these theories.
10 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

this model with his research paper ‘Director Primacy: The Means and Ends of
Corporate Governance’ in 2002 and in a comprehensive article, titled ‘Direc-
tor Primacy and Shareholder Disempowerment’, published in the Harvard Law
Review in 2006.39 We discuss the ‘director primacy model’ in greater detail in
Chapter 3, but it can be summarised here: It is boards of directors, and not the
shareholders, other stakeholders or managers in large corporations, that actually
control the corporation and ‘have the ultimate right of fiat’.40 This, in our view,
could be described as the ‘boardtorial revolution’ or ‘directorial revolution’, in
a similar vein to what has been identified as the ‘managerial revolution’ (see
reference above) several years ago.

1.1.3 Definition of ‘corporate governance’

If one takes into consideration recent developments, corporate governance could
be defined as follows:
The system of regulating and overseeing corporate conduct and of balancing the inter-
ests of all internal stakeholders and other parties (external stakeholders, governments
and local communities – see Chapter 2) who can be affected by the corporation’s
conduct, in order to ensure responsible behaviour by corporations and to achieve the
maximum level of efficiency and profitability for a corporation.41

Thus, the most important components of this definition are that corporate
governance:
● is the system of regulating and overseeing corporate conduct
● takes into consideration the interests of internal stakeholders and other
parties who can be affected by the corporation’s conduct
● aims at ensuring responsible behaviour by corporations
● has the ultimate goal of achieving the maximum level of efficiency and
profitability for a corporation.
A comparison with the definition provided in the first edition of this work will
reveal that we have changed the first part of the definition from ‘a process of
controlling management’ to ‘the system of regulating and overseeing corpo-
rate conduct’. This adjustment was required to reflect a widening of the cor-
porate governance debate and the prominence that regulating and overseeing
corporate conduct has gained since 2005. The global financial crisis (GFC) of
2008–9 provided further impetus to view corporate governance in an even wider
context. Although views differ on this,42 it is important to note that the GFC was

39 Stephen M Bainbridge, ‘Director Primacy and Shareholder Disempowerment’ (2006) 119 Harvard Law
Review 1735.
40 Bainbridge, above n 11, 11.
41 For other useful definitions of corporate governance, see Ken Rushton, ‘Introduction’ in The Business Case
for Corporate Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008) 2–3; Huse,
above n 24, 15 and 18–24; Bob Garratt, Thin on Top, London, Nicholas Brealey Publishing (2003) 12; John
Farrar, ‘Corporate Governance and the Judges’ (2003) Bond Law Review 49; and Güler Manisali Darman,
Corporate Governance Worldwide: A Guide to Best Practices and Managers, Paris, ICC Publishing (2004) 9–11.
42 See Thomas Clarke and Jean-Francois Chanlat, ‘Introduction: A new world disorder?’ in European
Corporate Governance (Thomas Clarke and Jean-Francois Chanlat, eds), London, Routledge (2009) 1 and
 CONCEPT AND ESSENTIALS 11

no indication of a total failure of corporate governance. This is explained in the

King Report (2009) from a South African and United Kingdom perspective, but
it rings true much wider:

The credit crunch, and the resulting crisis among leading financial institutions, is
increasingly presented as a crisis of corporate governance. However, although current
problems are to an extent indicative of shortcomings in the global financial architecture,
they should not be interpreted as reflecting dysfunction in the broader South African
and UK corporate governance models where values-based principles are followed and
governance is applied, not only in form but also in substance.43

What we need to establish is how the principles of contemporary corporate gover-

nance contribute towards ensuring better governance of large public companies.
This will become clear in the following chapters of this book.

1.2 ‘Essential’ principles of corporate governance

In recent years there have been several attempts to identify and explain what
are the ‘essential’ principles of corporate governance. Although there are several
examples,44 it will be seen that different principles are identified as ‘essential’
and, over time, views have changed on what could be considered as ‘essential’
corporate governance principles. There is nothing wrong or inconsistent with
this evolutionary process. Corporate governance is a subject area that grows and
expands, and it adjusts according to new insights and new challenges. As Mervyn
King puts it, ‘good governance is a journey and not a destination’45 or, as Bob
Tricker puts it:

Overall, corporate governance continues to evolve. The metamorphosis that will deter-
mine the bounds and the structure of the subject has yet to occur. Present practice is still
rooted in the 19th century legal concept of the corporation that is totally inadequate
in the emerging global business environment.46

A good illustration of this is provided by the various South African King Reports.
In the King Report (2002), seven ‘essential’ principles of corporate governance
were identified, namely:
1. discipline
2. transparency
3. independence

13–18. See generally, and for a more radical plea for a total overhaul and new perspectives on the state of
health of corporate governance, Hutchinson, above n 13, 12–19 and 203 et seq.
43 King Report on Governance for South Africa 2009 (King Report (2009)), Johannesburg, Institute of Directors
(2009) 9 <http://african.ipapercms.dk/IOD/KINGIII/kingiiireport/>.
44 See, for example, OECD Principles of Corporate Governance, above n 10, and The Combined Code on Cor-
porate Governance (UK Combined Code (2008)), available at <www.frc.org.uk/corporate/combinedcode.
cfm>.
45 King, above n 28, 4.
46 Tricker, above n 2, 22.
12 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

4. accountability
5. responsibility
6. fairness
7. social responsibility.
In the King Report (2009), the emphasis shifted slightly towards some ‘key
aspects of the report’, which are explained as follows:
The philosophy of the Report revolves around leadership, sustainability and corporate
citizenship. To facilitate an understanding of the thought process, debate and changes
in the Report, the following key principles should be highlighted:
1. Good governance is essentially about effective leadership. Leaders should rise to the
challenges of modern governance. Such leadership is characterised by the ethical
values of responsibly, accountability, fairness and transparency and based on moral
duties . . . Responsible leaders direct company strategies and operation with a view
to achieving sustainable economic, social and environmental performance.
2. Sustainability is the primary moral and economic imperative for the 21st century. It
is one of the most important sources of both opportunities and risks for businesses.
Nature, society, and business are interconnected in complex ways that need to be
understood by decision-makers. Most importantly, current, incremental changes
towards sustainability are not sufficient – we need a fundamental shift in the way
companies and directors act and organise themselves.
3. The concept of corporate citizenship which flows from the fact that the company is
a person and should operate in a sustainable manner . . .

Another illustration of changing views on ‘essential’ principles of corporate gover-

nance is revealed by comparing the 2003 and 2007 Principles of Good Corporate
Governance and Best Practice Recommendations of ASX Corporate Governance
Council. In 2003, 10 essential principles of good corporate governance were
identified:
1. Lay solid foundations for management oversight – recognise and publish
the respective roles and responsibilities of board and management.
2. Structure the board to add value – have a board of an effective composition,
size and commitment to adequately discharge its responsibilities and
duties.
3. Promote ethical and responsible decision making – actively promote ethical
and responsible decision making.
4. Safeguard integrity in financial reporting – have a structure to inde-
pendently verify and safeguard the integrity of the company’s financial
reporting.
5. Make timely and balanced disclosure – promote timely and balanced dis-
closure of all material matters concerning the company.
6. Respect the rights of shareholders – respect the rights of shareholders and
facilitate the effective exercising of those rights.
7. Recognise and manage risk – establish a sound system of risk oversight
and management and internal control.
8. Encourage enhanced performance – fairly review and actively encourage
enhanced board and management effectiveness.
 CONCEPT AND ESSENTIALS 13

9. Remunerate fairly and responsibly – ensure that the level and composition
of remuneration is sufficient and reasonable, and that its relationship to
corporate and individual performance is defined.
10. Recognise the legitimate interests of stakeholders – recognise legal and other
obligations to all legitimate stakeholders.
The 2007 Principles of Good Corporate Governance and Best Practice Recommen-
dations contains only eight principles. According to the ‘Comparative Table of
Changes to the Principles and Recommendations’ the two principles deleted were
Principle 8, ‘Encourage enhanced performance’ and Principle 10, ‘Recognise the
legitimate interests of stakeholders’. However, although these principles seem to
have disappeared, they were in fact incorporated into other principles. Principle
8 has been incorporated into principles 1 and 2, while Principle 2 has been incor-
porated into principles 3 and 7. Principle 9 became Principle 8. The current eight
principles of corporate governance promoted by ASX’s Corporate Governance
Council are the following:

Principle 1 – Lay solid foundations for management and oversight.

Companies should establish and disclose the respective roles and responsibilities of
board and management.
Principle 2 – Structure the board to add value.
Companies should have a board of an effective composition, size and commitment to
adequately discharge its responsibilities and duties.
Principle 3 – Promote ethical and responsible decision making.
Companies should actively promote ethical and responsible decision making.
Principle 4 – Safeguard integrity in financial reporting.
Companies should have a structure to independently verify and safeguard the integrity
of their financial reporting.
Principle 5 – Make timely and balanced disclosure.
Companies should promote timely and balanced disclosure of all material matters
concerning the company.
Principle 6 – Respect the rights of shareholders.
Companies should respect the rights of shareholders and facilitate the effective exercise
of those rights.
Principle 7 – Recognise and manage risk.
Companies should establish a sound system of risk oversight and management and
internal control.
Principle 8 – Remunerate fairly and responsibly.
Companies should ensure that the level and composition of remuneration is sufficient
and reasonable and that its relationship to performance is clear.
14 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

The ASX Corporate Governance Council specifically recognises the evolving

nature of corporate governance by stating that ‘[c]orporate governance prac-
tices will evolve in the light of the changing circumstances of a company and
must be tailored to meet those circumstances’.47 Corporate governance prac-
tices will naturally evolve in the context of developments, both in Australia and
internationally.

1.3 Is ‘good corporate governance’ important and

does it add value?

When corporate governance was raised in conversation and commentaries a few

years ago, there were often references to the need for corporations to implement
and maintain ‘good governance practices’. However, there has been a continu-
ing debate as to whether a focus on governance practices comes at the expense
of what is really important to the company and its shareholders – the bottom
line! Did providing attention to ‘conformance’, in terms of adhering to corporate
governance rules and principles, come at the expense of ‘performance’? Was
implementing practices in good corporate governance a necessary ingredient for
corporate success, or merely a distraction from the real business of the company?
Naturally, given that there is still debate and uncertainty as to what ‘corporate
governance’ means, there are varying perspectives on what constitutes good prac-
tice in corporate governance, and whether good corporate governance is indeed
important to the company and actually adds value or ‘makes a difference’.48
Nowadays, however, these questions seem almost rhetoric, as it is easy to find
numerous very good reasons – and even empirical proof – that good corporate
governance is important to companies and that it does add value and it makes
a difference. We are, however, of the opinion that it is still important to at least
provide some indications as to how the debate in favour of the importance of
good corporate governance gained momentum over recent years.
In the Report of the HIH Royal Commission, Justice Owen opined that to achieve
good practice in governance in Australia’s companies, corporate governance
must not succumb to a ‘one size fits all’ approach, which involves heavy regula-
tion of companies and does not give companies much opportunity to implement
practices that are best for the company. Rather, good governance naturally devel-
ops within companies by setting down voluntary guidelines, which can be used
by companies to develop a model that best suits their particular circumstances.
Justice Owen stated that:

For me, the key to good corporate governance lies in substance, not form. It is about
the way the directors of a company create and develop a model to fit the circumstances
of the company and then test it periodically for its practical effectiveness.

47 Principles of Good Corporate Governance and Best Practice Recommendations (2007), above n 6, at 3.
48 See generally Jonathan Charkham, Keeping Better Company, Oxford, Oxford University Press, (2nd edn,
2005) 23–4; Sir Geoffrey Owen, ‘The Role of the Board’ in The Business Case for Corporate Governance (Ken
Rushton ed.), Cambridge, Cambridge University Press (2008) 10 at 11.
 CONCEPT AND ESSENTIALS 15

One thing is clear though. Whatever the model, the public must know about it and
how it is operating in practice. Disclosure should be a central feature of any corporate
governance regime.49

Given that some of the companies involved in the recent international spate of
corporate collapses actually had in place generally good governance practices,
the question has also been raised as to whether good practices in governance are
important in terms of ensuring company success. In Australia, the adherence to
corporate governance principles was, in the late 1990s, considered as placing an
unnecessary burden on Australian businesses. Strict corporate governance rules
have even been blamed for the under-performance of Australian companies.50
Nowadays, the general consensus (at least in Australia, New Zealand, South
Africa and the United Kingdom)51 appears to be that while heavy regulation
and ‘one size fits all’ approaches to corporate governance should be avoided,52
it is at the very least important that companies are good corporate governance
citizens. In an article entitled ‘The Changing Face of Corporate Governance’,
which appeared in a special symposium edition of the University of New South
Wales Law Journal53 dedicated to corporate governance, former Chairman of
the National Companies and Securities Commission, Henry Bosch, made the
following useful remark about the importance of good corporate governance:
Good corporate governance is desirable and important for two reasons. First, in a
well-governed company, the risks of fraud and corporate collapse are reduced, and
there are mechanisms which reduce the likelihood of company controllers enriching
themselves at the expense of investors. Considerable evidence has emerged in the hear-
ings of the HIH Royal Commission, and from the court cases involving One.Tel and
Harris Scarfe, that governance practices in those companies were poor and account-
ability lax . . . Good governance is desirable and important for a second reason: it can
increase the creation of wealth by improving the performance of honestly managed
and financially sound companies.54

Similarly, Justice Owen noted, in the Report of the HIH Royal Commission, the
economic benefits that arise from good corporate governance:
There is continuing debate about the existence or otherwise of a correlation between
good corporate governance and successful performance. Good governance processes
are likely in my view to create an environment that is conducive to success. It does not
follow that those who have good governance processes will perform well or be immune

49 Owen Report, above n 4, 133 para 6.6.

50 Rick Sarre, ‘Responding to Corporate Collapses: Is There a Role for Corporate Social Respon-
sibility’ (2002) 7 Deakin Law Review 1; David Knott, ‘Protecting the Investor: The Regulator and
Audit’, Address to the CPA Congress 2002 Conference, Perth, Western Australia, 15 May 2002
<http://www.asic.gov.au/asic/asic_pub.nsf> (Publications / Speeches / 2002) 4. The pdf version of
Knott’s speech is available at: <http://www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/CPA_Speech_
150502.pdf/$file/CPA_Speech_150502.pdf>.
51 See, for instance King Report (2009), above n 43, 9 Peter Montagnon ‘The Role of the Shareholder’ in The
Business Case for Corporate Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008)
81 at 83–4.
52 Sir Bryan Nicholson, ‘The Role of the Regulator’ in The Business Case for Corporate Governance (Ken
Rushton ed.), Cambridge, Cambridge University Press (2008) 100.
53 Henry Bosch, ‘The Changing Face of Corporate Governance’ (2002) 25 University of New South Wales Law
Journal 270.
54 Ibid 271.
16 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

from failure. Risk exists to some extent at the heart of any business. Risks are taken
in the search for rewards. No system of corporate governance can prevent mistakes or
shield companies and their stakeholders from the consequences of error.55

These sentiments are also echoed internationally. The South African King Report
(2002) relied on an Investment Opinion Survey by McKinsey & Co (June 2000)
and a study by Stanford University (March 2001) to illustrate the profound
implications of adhering to good corporate governance practices. By developing
good governance practices, managers can add significant shareholder value;
institutional investors are willing to pay a premium for shares in well-governed
companies; and good corporate governance practices are now widely recognised
as part of international financial architecture and make countries, especially in
the emerging markets, a magnet for global capital.56 This conclusion has been
confirmed by later research,57 and there is now little doubt that a good business
case could be made for following good practice in corporate governance.58 In
fact, as Durnev and Kim point out, companies who rely more heavily on external
finance can use a reputation for effective governance to raise global equity and
debt at lower costs, effectively increasing a company’s value by reducing its cost
of capital59 and boosting investor confidence.60
In an interesting chapter, in the book, The Business Case for Corporate Gover-
nance, Colin Melvin and Hans-Christoph Hirt analyse the link between corporate
governance and performance. They discuss and evaluate most of the research
undertaken indicating that it is inconclusive that there is a direct link between
good corporate governance and good company performance. However, they
point out that, at the very least, sensible corporate governance activities may
prevent the destruction of value. They then conclude that they are convinced
that active ownership based on good corporate governance is an investment
technique that effectively improves performance and ultimately increases the
value of a portfolio of investee companies.61 The contrary, bad corporate gov-
ernance practices, combined with some other factors, have exactly the opposite
effect, as was illustrated by the East Asia experience in the late 1990s.62

55 Owen Report, above n 4, 104–5 para 6.1.2.

56 King Report (2002), above n 33, 12–14 paras 19–23. See also Richard Smerdon, A Practical Guide to
Corporate Governance, London, Sweet & Maxwell (2nd edn, 2004) 16; Low Chee Keong, ‘The Corporate
Governance Debate’ in Low Chee Keong (ed.), Corporate Governance: An Asian-Pacific Critique, Hong Kong,
Sweet & Maxwell (2002) 1, 8–10 – other contributions in this collection confirm the same point (see 49–50
and 57 et seq).
57 See Donald H Chew and Stuart L Gillan, ‘Introduction’ in Global Corporate Governance (Donald H Chew
and Stuart L Gillan eds), New York, Columbia Business School (2009) IX; and René M Stulz, ‘Globalization,
Corporate Finance, and the Cost of Capital’, in Global Corporate Governance (Donald H Chew and Stuart L
Gillan eds), New York, Columbia Business School (2009) 106 at 108 et seq.
58 Ken Rushton (ed.), The Business Case for Corporate Governance, Cambridge, Cambridge University Press
(2008).
59 Art Durnev and E Han Kim, ‘Explaining differences in the quality of governance among companies’, in
Global Corporate Governance (Donald H Chew and Stuart L Gillan, eds), New York, Columbia Business School
(2009) 52 at 53–4.
60 Ibid 54 and 63.
61 Colin Melvin and Hans-Christoph Hirt, ‘Corporate Governance and Performance’ in The Business Case for
Corporate Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008) 201 at 217.
62 See King Report (2002), above n 33, 12–14 para 22.
 CONCEPT AND ESSENTIALS 17

Evidence of the significance of good practice in corporate governance also

comes from the OECD Principles of Corporate Governance (2004). The OECD
found that corporate governance was a key element in improving economic effi-
ciency and growth, as well as in enhancing investor confidence.63 It also observed
that if countries were to reap the full benefits of the global market, and attract
long-term ‘patient’ capital, corporate governance arrangements had to be credi-
ble, well understood across borders and adhere to internationally accepted prin-
ciples. Even if corporations did not rely primarily on foreign sources of capital,
adherence to good practice in corporate governance would help to improve the
confidence of domestic investors, reduce the cost of capital, underpin the good
functioning of financial markets and, ultimately, induce more stable sources of
financing.64 The OECD pointed out that companies with a good corporate gov-
ernance record were often able to borrow larger sums and on more favourable
terms than those that had poor records or operated in non-transparent markets.65
In Chapter 5 we expand on the important link between effective corporate gov-
ernance and healthy global capital markets.
More recently, there has been more hard evidence suggesting that there is
indeed a correlation between good corporate governance, operating perfor-
mance and share-price returns. In the United Kingdom, between 2003 and 2007
a comprehensive survey was conducted on listed companies by Selvaggi and
Upton. They tested the strength and direction of any potential link between the
good corporate governance and operating and share-price returns. They found
a direct and robust link between good corporate governance and superior com-
pany performance.66 The study shows that good corporate governance leads
to better performance, and that the impact of governance on performance was
long-term in nature. It should, however, be pointed out that Bagat, Bolton and
Romano identified some shortcomings in the study.67
In an interesting 2009 Treasury Working Paper, Corporate Governance and
Financial Performance in an Australian Context, Rebecca Brown and Tue Gørgens
referred to several studies that found evidence for good corporate governance
adding financial value to a company.68 Rebecca Brown and Tue Gørgens sum-
marised their findings as follows, focussing on the top 300 Australian listed
companies:
63 OECD Principles of Corporate Governance, above n 10, 11.
64 Ibid 13.
65 Ibid 48. See generally also Darman, above n 41, 12–13 and 31 for more positive spin-offs from following
good corporate governance practices.
66 M Selvaggi and J Upton, Governance and Performance in Corporate Britain: Evidence from the IVIS colour-
rating system ABI Research Paper 7, Report from ABI Research and Investment Affairs Department (February
2008).
67 Tricker, above n 2, 221. Note that some shortcomings in the Selvaggi and Upton research and surveys
were identified by Sanjai Bhagat, Brian J Bolton and Roberta Romano, ‘The Promise and Peril in Corporate
Governance Indices’ ECGI Working Paper No 89/2007, Yale Law & Economics Research Paper no. 367, Social
Science Research Network (2007) <http://papers.ssrn.com/sol3/papers.cfm?abstract id=1019921>.
68 Rebecca Brown and Tue Gørgens, Corporate Governance and Financial Performance in an Australian
Context, Treasury Working Paper 2009 – 02 (March 2009) <http://www.treasury.gov.au/documents/1495/
PDF/TWP 2009–02.pdf> 8–9. See also Xavier Vives, ‘Corporate Governance: Does it Matter?’ in Corporate
Governance: Theoretical & Empirical Perspectives (Xavier Vives, ed.), Cambridge, Cambridge University Press,
(2000) 1 at 12–13.
18 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

We find that companies with better corporate governance outperform poorly governed
companies, particularly in relation to earnings per share and return on assets. Fur-
thermore, we find that companies that are fully compliant with the ASX Corporate
Governance Principles perform better than companies that are only partially compli-
ant. Our results also indicate that companies may find it beneficial to focus their efforts
on improving corporate governance in the areas of board composition, remuneration,
the formation of committees (that is, board, audit and remuneration committees), and
those principles related to the structure of the company.69

1.4 Are corporate governance models converging?

The question of the convergence of corporate governance models was seriously

debated after publication of an article with the provocative title ‘The End of
History for Corporate Law’ by two leading United States academics, Hansmann
and Kraakman.70 It was to be expected that their proposition that all corpo-
rate governance models in actual fact converged into the United States corpo-
rate governance model would be challenged. Douglas Branson wrote an arti-
cle titled, ‘The Very Uncertain Prospect of “Global” Convergence in Corporate
Governance’71 and many other articles followed that challenged Hansmann and
Kraakman’s hypothesis. This debate is still alive, with part of Thomas Clarke and
Jean-Francois Chanlat’s (eds) European Corporate Governance dedicated to the
question of convergence or diversity of corporate governance systems.72
Tricker correctly pointed out that cultural differences will always play a role
in development of the most appropriate corporate governance model for a par-
ticular country – such differences will almost guarantee that there will always
be differences in the corporate governance principles and corporate governance
models of different countries and jurisdictions.73 Tricker lists the forces that
could lead to convergence of corporate governance principles, and also those
that accentuate divergence, or at least cause differentiation among corporate
governance principles applied in different countries and jurisdictions:

Converging forces:74
• corporate governance codes of good practice
• securities regulation
• international accounting standards
• global concentration of audit practices

69 Brown and Gørgens, above n 68, at 3–4.

70 Henry Hansmann and Reiner Kraakman, ‘The End of History for Corporate Law’ (2001) 89 Georgetown
Law Journal 439. Also see Jeffrey N Gordon and Mark J Roe (eds), Convergence and Persistence in Corporate
Governance, Cambridge, Cambridge University Press (2004).
71 Douglas M Branson, ‘The Very Uncertain Prospect of “Global” Convergence in Corporate Governance’
(2001) 34 Cornell International Law Journal (Cornell Int’l LJ) 321.
72 Thomas Clarke and Jean-Francois Chanlat (eds), in European Corporate Governance, London, Routledge
(2009) Part 3, 141–97.
73 Tricker, above n 2, 183. See also Chew and Gillan, ‘Introduction’ in Global Corporate Governance (Donald
H Chew and Stuart L Gillan, eds), above n 57, X; Huse, above n 24, 103–4.
74 Tricker, above n 2, 208–9.
 CONCEPT AND ESSENTIALS 19

• globalisation of companies75
• raising capital on overseas stock exchanges
• research publications, international conferences and professional journals.

Diverging forces:76
• legal differences
• standards in the legal process
• stock market differences
• ownership structures
• history, cultural, and ethical groupings.

1.5 Conclusion

There are various definitions of corporate governance. We believe, however,

that the most realistic approach to corporate governance is the so-called inclu-
sive approach – to view all stakeholders as part of the corporate governance
debate. At the end of the day, corporate governance deals with the system of
regulating and overseeing corporate conduct, balancing the interests of all inter-
nal stakeholders and other parties who may be affected by the corporation’s
conduct in order to ensure responsible behaviour by corporations and to achieve
the maximum level of efficiency and profitability for a corporation. There is
ample evidence that there are real economic benefits in following good practice
in corporate governance – by doing so, managers potentially will be able to add
significant shareholder value and investors will be prepared to pay a premium
for investments in companies in which good corporate governance practices are
followed. There are some powerful forces responsible for the convergence of cor-
porate governance principles and models. However, there are also several forces
and factors that will almost guarantee that there will always be differences in
the corporate governance models for different countries and jurisdictions. We
agree with Bob Garratt’s convincing arguments about the increasing importance
of corporate governance.77
75 Globalisation’s impact on university governance is well illustrated in Simon Markinson and Mark Consi-
dine, The Enterprise University, Cambridge, Cambridge University Press (2000) 41, 45–51.
76 Tricker, above n 2, 209–10.
77 Garratt, above n 41, Chapter 2, 29–64.
2
Stakeholders in corporate
governance and corporate
social responsibility

It is conceivable, indeed it seems almost essential if the corporate system is

to survive, that the ‘control’ of the great corporations should develop into a
purely neutral technocracy, balancing a variety of claims by various groups
in the community and assigning to each a portion of the income streams
on the basis of public policy rather than private cupidity.
Berle and Means, The Modern Corporation and Private Property (1932), 356.
What we are witnessing is a shift in the content of the shareholder value
norm, so that it comes to represent the idea that shareholders exercise their
powers not as representatives of the market, but as agents of society as a
whole. The corporate governance of the future will be centrally concerned
with how this idea is worked out in practice.
Simon Deakin, ‘The Coming Transformation of Shareholder Value’ (2005)
13 Corporate Governance: An International Review 11, 16.

2.1 Introduction

Contemporary commentary on corporate governance can, in general terms, be

divided into two main camps, between those who consider corporate governance
as being about building effective mechanisms and measures to satisfy either: (1)
the expectations of the variety of individuals, groups and entities (collectively
‘stakeholders’) that inevitably interact with the corporation;1 or (2) the narrower
expectations of shareholders (shareholder primacy).2
This chapter focuses on the first of these objectives,3 with attention being
given to the stakeholders of the company, how the law influences corporations
to recognise and protect the interests of these stakeholders, and the relationship

1 E M Dodd, ‘For Whom are Corporate Managers Trustees?’ (1932) 45 Harvard Law Review 1145.
2 A Berle, ‘Corporate Powers as Powers in Trust’ (1931) 44 Harvard Law Review 1049; A Berle, ‘For Whom
Corporate Managers Are Trustees: A Note’ (1932) 45 Harvard Law Review 1365.
3 For a broader discussion on competing corporate law theories and the public and private dimensions of
corporate law, see Stephen Bottomley, The Constitutional Corporation – Rethinking Corporate Governance
Ashgate, England (2007).

20
 STAKEHOLDERS AND CSR 21

between these stakeholders and the underlying objective of companies of achiev-

ing and maintaining good corporate governance.
Letza, Sun and Kirkbride explain the difference between the two corporate
governance paradigms, ‘shareholding’ and ‘stakeholding’ as follows:
Such a division hinges on the purpose of the corporation and its associated structure
of governance arrangements understood and justified in theory. On one side is the tra-
ditional shareholding perspective, which regards the corporation as a legal instrument
for shareholders to maximise their own interests – investment returns. A three-tier
hierarchical structure, i.e. the shareholder general meeting, the board of directors and
executive managers, is given in company law in an attempt to secure shareholders’
interests . . .
On the other side is the stakeholding perspective newly emerged in the later 20th
century, which positions itself on the contrary to the traditional wisdom and views the
corporation as a locus in relation to wider external stakeholders’ interests rather than
merely shareholders’ wealth. Employees, creditors, suppliers, customers and the local
community are major stakeholders often mentioned and emphasised within a broad
definition of stakeholding.4

The central place of non-shareholder stakeholders in corporate governance has

been explicitly recognised by the Organisation for Economic Co-operation and
Development (OECD) in the preamble to the revised 2004 OECD Principles of
Corporate Governance:
Corporate governance involves a set of relationships between a company’s manage-
ment, its board, its shareholders and other stakeholders. Corporate governance also
provides the structure through which the objectives of the company are set, and the
means of attaining those objectives and monitoring performance are determined.5
(emphasis added)

Also contained in the OECD Principles of Corporate Governance is the follow-

ing statement, recognising three key non-shareholder stakeholders (creditors,
employees and government):
Corporate governance is affected by the relationships among participants in the gov-
ernance system. Controlling shareholders, which may be individuals, family holdings,
bloc alliances, or other corporations acting through a holding company or cross share-
holdings, can significantly influence corporate behaviour. As owners of equity, institu-
tional investors are increasingly demanding a voice in corporate governance in some
markets. Individual shareholders usually do not seek to exercise governance rights but
may be highly concerned about obtaining fair treatment from controlling shareholders
and management. Creditors play an important role in a number of governance systems
and can serve as external monitors over corporate performance. Employees and other
stakeholders play an important role in contributing to the long-term success and per-
formance of the corporation, while governments establish the overall institutional and
legal framework for corporate governance.6

4 See Steve Letza, Xiuping Sun and James Kirkbride, ‘Shareholding versus Stakeholding: A Critical Review
of Corporate Governance’ (2004) 12 Corporate Governance: An International Review, Oxford, Blackwell 242,
243.
5 OECD Principles of Corporate Governance (April 2004) <http://www.oecd.org/dataoecd/32/18/
31557724.pdf> 11.
6 Ibid 12.
22 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

The OECD Principles of Corporate Governance, a non-binding statement of

what the OECD believes to constitute best practice in corporate governance,
is discussed extensively in this book.
The structure of this chapter is as follows. Section two below commences
by acknowledging that there is no fixed definition of what a ‘stakeholder’ is;
however, it provides some useful examples of definitions that have been adopted
in mainstream literature, and which can be used for the purposes of this chapter.
This section then proceeds to identify, and provide a brief explanation of, the
nature and corporate governance role of each ‘stakeholder’ recognised by the
OECD Principles of Corporate Governance.
Having provided this general understanding of what is meant by ‘stakeholder’
and to whom this concept applies, section three then explains whether and how
the law requires – or at least encourages – companies and their directors and
executives to take into account the interests of these stakeholders. The principal
focus of this section is the requirement for listed companies to have in place a ‘code
of conduct’ specifying how the company intends to deal with its stakeholders –
particularly employees. The section also discusses similar obligations for non-
listed companies, as well as legal obligations applying to companies (both listed
and non-listed) – outside of company law and corporate governance – requiring
that they protect and respect the interests of stakeholders.
Having considered how the law requires or encourages companies, both listed
and non-listed, to take into consideration and protect the interests of a variety of
stakeholders, section four then discusses why a stakeholder-orientated approach
to management (known as the ‘stakeholder model’) is considered to be impor-
tant from the perspective of good corporate governance. This includes discussion
(albeit brief) on emerging trends and issues in relation to the role of particular
stakeholders in the corporation from the perspective of good corporate gov-
ernance, particularly employees, in maintaining a sound internal governance
framework.
The concluding section revisits the debate on the interaction of the ‘share-
holder primacy’ approach to corporate decision-making with the ‘enlightened
self-interest’ approach.

2.2 Stakeholders in the corporation: An overview

2.2.1 What is a stakeholder?

The definition of ‘stakeholder’ is not set in stone7 . Indeed, there are almost as
many varying definitions of what a ‘stakeholder’ is and who can be characterised

7 The Social Responsibility of Corporations Report (December 2006), Corporations and Markets Advi-
sory Committee (Australian Government) <http://www.camac.gov.au/camac/camac.nsf/byHeadline/
PDFFinal+Reports+2006/$file/CSR_Report.pdf> at [2.4] notes that the notion of ‘stakeholders’ has no
precise or commonly agreed meaning. See Further, B Horirigan, ‘Fault Lines in the Intersection between
Corporate Governance and Social Responsibility’ (2002) 25 University of New South Wales Law Journal
515.
 STAKEHOLDERS AND CSR 23

as a stakeholder as there are individuals who have written about stakeholders in

corporate governance.
Christine Mallin provides the following explanation:
The term ‘stakeholder’ can encompass a wide range of interests: it refers to any indi-
vidual or group on which the activities of the company have an impact.8

According to Mallin, apart from shareholders, ‘stakeholder’ encompasses

employees, suppliers, customers, banks and other creditors, the government,
various ‘pressure groups’ – in fact, anyone upon whom the activities of the com-
pany may have an impact. This is a useful definition, although it fails to include
within the realm of ‘stakeholder’ those individuals or entities whose activities
have impact upon the company.
Perhaps a better definition of stakeholder, which does recognise such a mutual
relationship between stakeholders and the corporation, is that provided in
Redefining the Corporation: Stakeholder Management and Organizational Wealth
by James E Post, Lee E Preston and Sybille Sachs9 (who have also established a
‘Redefining the Corporation’ website with information and links on stakeholder
management).10 They define ‘stakeholder’ as follows:
The stakeholders in a corporation are the individuals and constituencies that con-
tribute, either voluntarily or involuntarily, to its wealth-creating capacity and activities,
and that are therefore its potential beneficiaries and/or risk bearers.11

The authors go on to explain:

The fundamental idea is that stakeholders have a stake in the operation of the firm, in
the same sense that business partners have a common stake in their venture or players
on a team a common stake in the outcome of a game. Stakeholders share a common
risk, a possibility of gaining benefits or experiencing losses or harms, as a result of
corporate operations.

In developing a ‘stakeholder model’ of the corporation, Post et al. posit that there
are a series of flows running through the corporation, with stakeholders holding
a central position:
The flows between the firm and its stakeholders run in both directions; each stakeholder
is perceived as contributing something and receiving something from the corporation
(even involuntary and essentially passive stakeholders contribute by tolerating the
existence and operation of the firm, and receive some combination of benefits and
harms as a result).12

Another important perspective on stakeholders and the corporation is contained

in the scholarly article, ‘Corporate Governance: A Stakeholder Interpretation’,
by R E Freeman and W M Reed, published in 1990.13 Freeman and Reed refer
8 Christine Mallin, Corporate Governance, Oxford, Oxford University Press (2nd edn, 2007) 49.
9 J E Post, L E Preston and S Sachs, Redefining the Corporation: Stakeholder Management and Organizational
Wealth, Stanford, CA, Stanford Business Books (2002).
10 <http://www.rotman.utoronto.ca/∼stake/>.
11 Post, Preston and Sachs, above n 9, 19.
12 Ibid 22.
13 See Journal of Behavioural Economics 19 (1990) 337.
24 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

to the organisation as being a ‘multiple agreement’ between the enterprise and

its stakeholders, and suggest that there are ‘external’ and ‘internal’ stakeholders.
The ‘internal’ stakeholders include employees, managers and owners. Employees
are included because management depends upon employees to fulfil strategic
intentions. ‘External’ stakeholders include customers, suppliers, competitors and
‘special interest’ groups – with each relationship constrained by formal and infor-
mal rules. Finally, governments and local communities set the legal and formal
rules within which businesses must operate.
Due to the quite broad, and to some degree ‘vague’, definition of stakeholder
that has been put forward in various ways by commentators, the question has
been raised – mainly in management and finance literature – about who the
stakeholders in the corporation actually are, with this flowing on to further
questions about the practice of stakeholder management.
Perhaps the most inclusive definition of stakeholders, as recognised by the
Corporate and Markets Advisory Committee (CAMAC) report on The Social
Responsibility of Corporations,14 is the following:15
those groups or individuals that: (a) can be reasonably be expected to be significantly
affected by the organisation’s activities, products and/or service; or (b) whose actions
can reasonably be expected to affect the ability of the organization to successfully
implement its strategies and achieve its objectives.

This broad definition can therefore include all of the constituents discussed
earlier, as well as pressure groups or non-government organisations (NGOs),
usually characterised as public interest bodies that espouse social goals relevant
to the activities of the company.
It is important to note that different attitudes towards the place of stakeholders
in corporate governance are evident in different jurisdictions, and are influenced
by differences in tradition and culture. Mallin, for example, notes that:
In the UK and the US, the emphasis is on the relationship between the shareholders
(owners), and the directors (managers). In contrast, the German and French corporate
governance systems, which view companies as more of a partnership between capital
and labour, provide for employee representation at board level, whilst banks (providers
of finance) may also be represented on the supervisory board.16

2.2.2 Discussion of different stakeholders

This section provides a general and necessarily brief account of the role of some
of the key stakeholders in the context of the governance of a company. The expla-
nation provided for each stakeholder draws heavily on Mallin’s book, which con-
tains a clear and concise description of the place of stakeholders in contemporary
corporate governance.

14 The Social Responsibility of Corporations Report above n 7, at [2.4]

15 Global, 40 <http://www.globalreporting.org/NR/rdonlyres/ED9E9B36-AB54–4DE1-BFF2–
5F735235CA44/0/G3 GuidelinesENU.pdf>.
16 Mallin, above n 8, 57.
 STAKEHOLDERS AND CSR 25

What is emphasised below in the discussion of the different stakeholders

is that, apart from shareholders, discrete areas of legal regulation operating
independently of company law and corporate governance principles have a direct
and significant impact on the relationship between particular stakeholders and
the company.

2.2.2.1 Shareholders
As stakeholder management is often discussed as an alternative to the tradi-
tional shareholder-oriented approach to corporate governance (emphasising
wealth maximisation), shareholders are regularly excluded from the definition
of ‘stakeholder’.
Mallin includes shareholders as part of her concept of ‘stakeholder’, but deals
with shareholders separately to all the other constituents that are also stakehold-
ers. She defines ‘shareholder’ as ‘an individual, institution, firm, or other entity
that owns shares in a company.’17 As Mallin appreciates, however, the reality
of shareholding is more complex than this definition suggests, once beneficial
ownership and cross-holdings are considered.
Mallin treats shareholders differently from other stakeholders for two reasons:
‘[F]irst, shareholders invest their money to provide risk capital for the company
and, secondly, in many legal jurisdictions, shareholders’ rights are enshrined in
law whereas those of the wider group of stakeholders are not.’18 Mallin goes on
to say that a rationale for privileging shareholder interests over the interests of
other stakeholders is that they are ‘the recipients of the residual free cash flow
(being the profits remaining once other stakeholders, such as loan creditors, have
been paid). This means that the shareholders have a vested interest in trying to
ensure that resources are used to maximum effect, which in turn should be to
the benefit of society as a whole’.19
Justice Owen, in the Report of the HIH Royal Commission, articulates a similar
conception of corporate governance when explaining the ‘organs of governance’:

[P]rimary governance responsibility lies with the board of directors. In formal terms
the directors are appointed by, and are accountable to, the body of shareholders . . .
The role of the shareholders is to exercise the powers that are reposed in them by the
Corporations Act and the constitution of the corporation. The perceived wisdom is,
I think, that shareholders play a passive role as the objects of corporate governance
rather than an active role as part of it.20

2.2.2.2 Employees
Following is a summary of the explanation given by Mallin of the role of employ-
ees as stakeholders in the corporation:

17 Ibid 49.
18 Ibid.
19 Ibid.
20 Report of the HIH Royal Commission (Owen Report), The Failure of HIH Insurance – Volume I: A Corporate
Collapse and its Lessons, Canberra, Commonwealth of Australia (2003) 103 para 6.1.1.
26 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

The employees of a company have an interest in the company as it provides their

livelihood in the present day and at some future point, employees would often also be
in receipt of a pension provided by the company’s pension scheme. In terms of present
day employment, employees will be concerned with their pay and working conditions,
and how the company’s strategy will impact on these. Of course the long-term growth
and prosperity of the company is important for the longer term view of the employees,
particularly as concerns pension benefits in the future . . .
Many companies have employee share schemes which give the employees the oppor-
tunity to own shares in the company, and feel more of a part of it; the theory being that
the better the company does (through employees’ efforts, etc), the more the employees
themselves will benefit as their shares increase in price . . .
Companies need to also consider and comply with employee legislation whether related to
equal opportunities, health and safety at work, or any other aspect. Companies should
also have in place appropriate whistle-blowing procedures for helping to ensure that
if employees feel that there is inappropriate behaviour in the company, they can ‘blow
the whistle’ on these activities whilst minimizing the risk of adverse consequences for
themselves as a result of this action.21 (emphasis added)

It is important to note that Australia has in place a sophisticated array of leg-

islation and regulations, both at state/territory and federal levels, which are
designed to protect the interests of employees in relation to their interaction
with the employer and the workplace. At the state/territory level, there exists
equal opportunity legislation, occupational health and safety legislation (the
obligations under which also operate to preserve the well-being, health and
safety of contractors and customers, in addition to employees), as well as gen-
eral regulations and criminal laws to protect employee rights. At federal level, the
principal legislation designed to uphold and protect the interests of employees
is the Fair Work Act 2009 (Cth), which regulates workplace conditions, wage-
setting arrangements and the conciliation and arbitration of workplace disputes
over pay and working conditions.
Australia has also recently introduced new rules, both under the Corporations
Act 2001 (Cth) (the Act) and as part of the Australian Securities Exchange (ASX)
Revised Corporate Governance Principles and Recommendations (August 2007, dis-
cussed throughout this book), to provide protection for genuine ‘whistleblower’
employees. Part 9.4AAA of the Act (effective from 1 July 2004) operates to pro-
hibit employers from victimising whistleblowers when they have acted in good
faith and on reasonable grounds, and also provides the whistleblower with qual-
ified privilege when information regarding a suspected breach of the law (being
the Act or the Australian Securities and Investments Commission Act or regula-
tions made under either Act) has been reported to the Australian Securities and
Investments Commission (ASIC) or another person specified in the Act. Princi-
ple 3 of the ASX Revised Corporate Governance Principles and Recommendations
states that public companies should establish a code of conduct for directors

21 Mallin, above n 8, 51.

 STAKEHOLDERS AND CSR 27

and senior executives to, among other things, encourage the reporting of unlaw-
ful/unethical behaviour by employees and others, and to identify measures the
company follows to protect whistleblowers who report violations in good faith.22
Another useful explanation of the role of the employee in the corporation,
and the significance of this role in terms of contemporary corporate governance,
comes from the HIH Royal Commission’s Final Report. In the part of the report
discussing ‘Organs of governance’, Justice Owen states:

It is difficult to define with precision the part that employees play in corporate gov-
ernance. It will depend on the extent to which the employee is involved in or can
influence the decision-making process. Senior management is more likely to have such
a role. But in large corporations or complex groups it may be that employees further
down the corporate hierarchy have a decision-making function that involves elements
of control in the process. There is a danger in the current emphasis on the role and
responsibilities of boards of directors. It may cause to be overlooked the reality of the
necessarily greater part that executives and other employees play in the day-to-day
running of many corporate businesses.23

As to how employees can become important stakeholders in the corporation,

again the OECD Principles of Corporate Governance provides a useful discussion:

The degree to which employees participate in corporate governance depends on

national laws and practices, and may vary from company to company as well. In
the context of corporate governance, performance enhancing mechanisms for par-
ticipation may benefit companies directly as well as indirectly through the readiness
by employees to invest in firm specific skills. Examples of mechanisms for employee
participation include: employee representation on boards; and governance processes
such as works councils that consider employee viewpoints in certain key decisions.
With respect to performance enhancing mechanisms, employee stock ownership plans
or other profit sharing mechanisms are to be found in many countries.24

The topic of employee participation, and more generally the role of employees as
stakeholders, has been written about and commented upon a great deal over the
past decade, and is still heavily debated and returned to regularly when consider-
ing reform options to improve corporate regulation and the governance practices
of corporations.25 In the Anglo-American, or ‘outsider’ system of corporate gov-
ernance (which loosely describes Australia’s system of corporate governance),
neither employees nor shareholders have a particularly prominent role in the day-
to-day governance arrangements of the corporation. However, in some European
countries, most notably Germany, employees (as well as shareholders) are cen-
tral to a company’s governance practices through a two-tier board structure and

22 For guidance on the provision of a whistleblowing service, ASX recommends the Australian Standard on
Whistleblowing Protection Programs for Entities (AS 8004).
23 Owen Report, above n 20, 104 para 6.1.1.
24 OECD Principles of Corporate Governance, above n 5, 47.
25 See Irene Lynch-Fannon, ‘Employees as Corporate Stakeholders: Theory and Reality in a Transatlantic
Context’ (2004) 4(1) Journal of Corporate Law Studies 155 (which contains a fresh analysis of what is
meant by ‘ownership’ in order to argue for a central relationship between the corporation and employees
in the corporate governance mix), and a collection of essays, Howard Gospel and Andrew Pendleton (eds),
Corporate Governance and Labour Management, Oxford, Oxford University Press (2005).
28 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

a legislated system of ‘co-determination’ (see further Chapter 13 for a discussion

of Germany’s system of corporate governance). An ‘insider’ system of corporate
governance reigns supreme.
In the United States, in particular, a lot of attention has been given over the
past decade to the concept of ‘wealth creation’, which embodies a view that a
long-term focus on wealth, rather than a short-term focus on returns to share-
holders, is truly in the best interests of the company. Respect for employees
is central to this emerging perspective on corporate governance, as the devel-
opment of firm-specific skills by loyal and happy employees is considered an
integral ingredient of ‘wealth creation’. In the leading work to date on wealth
creation, Ownership and Control: Rethinking Corporate Governance for the 21st
Century, published in 1995, Margaret Blair argues that corporations should
not be regarded as ‘bundles of assets’ being the sole property of shareholders,
but rather as institutional arrangements governing the relationship between
all parties contributing firm-specific assets – embracing not only sharehold-
ers, but also employees who develop specialised skills being of value to the
enterprise.
Blair explains that the idea of ‘wealth creation’ for the corporation extends
beyond short-term profit taking by shareholders to include the corporation’s
long-term interests, and thus includes employees, customers, creditors etc. as
integral to ensuring the best interests of the corporation from the perspective of
wealth creation. Blair strongly associates achievement of wealth creation with
recognition and respect for human capital; that is, employees. According to
Blair:

[I]n the 1990’s, fewer and fewer publicly traded corporations actually look like the
factory model. Much of the wealth-generating capacity of most modern firms is based
on the skills and knowledge of the employees and the ability of the organization as a
whole to put those skills to work for customers and clients. Even for manufacturing
firms, physical plant and equipment make up a rapidly declining share of the assets,
while a growing share consists of intangibles . . . such as patent rights, brand reputation,
service capabilities, and the ability to innovate and get the next generation product to
market in a timely manner.26

Another emerging area of discourse that emphasises the importance of employee

involvement in the overall governance framework of the corporation is the ‘par-
ticipatory management’ philosophy. Commentators have referred to participa-
tory management as the most important industrial relations phenomenon of
the past three decades.27 According to Stephen Bainbridge, there are two basic
forms of participatory management – operational participation and strategic
participation:

26 Margaret Blair, Ownership and Control: Rethinking Corporate Governance for the 21st Century, Washington,
DC, Brookings Institute (1995) Ch 1 (Primer on Corporate Governance).
27 Stephen M Bainbridge, ‘Corporate Decision-Making and the Moral Rights of Employees: Participatory
Management and Natural Law’ (1998) 43 Villanova Law Review 741.
 STAKEHOLDERS AND CSR 29

Operational participation refers to programs in which employee involvement is limited

to day-to-day issues of productivity and working conditions at the plant level . . .
Strategic participation refers to programs in which employees participate in major
policy decisions, such as those traditionally viewed as falling within the realm of
corporate governance.28

2.2.2.3 Creditors
Creditors always rate a mention as one of the key stakeholders in the corporation.
Apart from the rapidly increasing literature on corporate governance, over the
years many commentators have examined whether company directors can29 and
should owe a duty to act in the best interests of creditors while serving the
company.30
In discussing the place of creditors as company stakeholders, Mallin separates
creditors into two categories: ‘providers of credit’ and ‘suppliers’.31 As to the
former:

Providers of credit include banks and other financial institutions. Providers of credit
want to be confident that the companies that they lend to are going to be able to
repay their debts . . . It is in the company’s best interest to maintain the confidence of
providers of finance to ensure that no calls are made for repayment of funds, that they
are willing to lend to them in the future, and that the company is able to borrow at the
best possible rate.

As to the latter:

Suppliers have an interest in the companies which they supply on two grounds. First,
having supplied the company with goods and services, they want to be sure that they
will be paid for these and in a timely fashion. Secondly, they will be interested in the
continuance of the company as they will wish to have a sustainable outlet for their
goods and services.

The OECD Principles of Corporate Governance also discusses the significant place
of creditors in contemporary corporate governance, and the various ways by
which creditor interests may be, or in fact are, protected by law. Importantly,
rather than requiring the internal governance arrangements of corporations to
recognise and embrace creditor interests, reference is made to the discrete area

28 Ibid 742.
29 Directors have no direct fiduciary duties to creditors: Spies v R (2000) 201 CLR 603.
30 For a discussion of the much-vexed issue of director’s duties to creditors following the High Court decision
in Spies, see the scholarly debate between James McConvill, ‘Directors’ Duties towards Creditors in Australia
after Spies v The Queen’ (2002) 20 Company and Securities Law Journal 4; in reply Anil Hargovan, ‘Directors’
Duties to Creditors in Australia after Spies v The Queen – Is the Development of an Independent Fiduciary
Duty Dead or Alive?’ (2003) 21 Company and Securities Law Journal 390; James McConvill, ‘Geneva Finance
and the “Duty” of Directors to Creditors: Imperfect Obligation and other Imperfections’ (2003) 11 Insolvency
Law Journal 7; in reply Anil Hargovan, ‘Geneva Finance and the “Duty” of Directors to Creditors: Imperfect
Obligation and Critique’ (2004) 12 Insolvency Law Journal 134. The debate appears to be resolved: Justice
Owen in The Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) (2008) 70 ACSR 1 at [4398] held
that the question was ‘determined authoritatively’ by the High Court in Spies. For comprehensive examination
of this topic, see Andrew Keay, Company Directors’ Responsibilities to Creditors, London, Routledge-Cavendish
(2006).
31 See Mallin, above n 8, 51–2.
30 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

of insolvency law (which generally includes directors’ duties to creditors) to

protect creditors in their relationship with the corporation.
Especially in emerging markets, creditors are a key stakeholder and the terms, volume
and type of credit extended to firms will depend importantly on their rights and on
their enforceability. Companies with a good corporate governance record are often
able to borrow larger sums and on more favourable terms than those with poor records
or which operate in non-transparent markets. The framework for corporate insolvency
varies widely across countries. In some countries, when companies are nearing insol-
vency, the legislative framework imposes a duty on directors to act in the best interests
of creditors, who might therefore play a prominent role in the governance of the com-
pany. Other countries have mechanisms which encourage the debtor to reveal timely
information about the company’s difficulties so that a consensual solution can be found
between the debtor and its creditors.
Creditors’ rights vary, ranging from secured bond holders to unsecured creditors. Insol-
vency procedures usually require efficient mechanisms for reconciling the interests of
different classes of creditors. In many jurisdictions provision is made for special rights
such as through ‘debtor in possession’ financing which provides incentives/protection
for new funds made available to the enterprise in bankruptcy.32

2.2.2.4 Customers
Mallin provides the following very brief explanation of how a company’s cus-
tomers also fit the description of ‘stakeholder’ from a corporate governance
perspective:
Increasingly customers are also more aware of social, environmental, and ethical
aspects of corporate behaviour and will try to ensure that the company supplying
them is acting in a corporately socially responsible manner.33

As will be explained below, under the 2007 ASX Revised Corporate Governance
Principles and Recommendations, listed entities are advised to have a code of
conduct that identifies the company’s core values and they should consider the
reasonable expectations of their stakeholders. Furthermore, under Chapter 7 of
the Corporations Act (dealing with financial services and markets), retail clients
of a financial product must receive a ‘product disclosure statement’, which must
provide an explanation, among other things, of the extent to which labour stan-
dards or environmental, social or ethical considerations are taken into account
in the selection, retention or realisation of an investment if the product has an
‘investment component’ (see s 1013D(1)(l) of the Act).
Australia’s Trade Practices Act 1974 (Cth) is also important in ensuring that
the interests of customers are a central consideration of the corporation in its
day-to-day activities. The Act contains an extensive number of rules under Part V,
‘Consumer Protection’, including the general prohibition on misleading and
deceptive conduct, and further aims to protect and uphold the interests of
32 OECD Principles of Corporate Governance, above n 5, 48.
33 Mallin above, n 8, 52.
 STAKEHOLDERS AND CSR 31

consumers through rules on product recalls, defective goods and anti-competitive

conduct (Part IV).
These requirements (as well as a number of others) work together so that, in
Australia, the role of customers in corporate governance is neatly aligned with
Mallin’s description above.

2.2.2.5 The community

A great deal has been written about whether society as a whole is also a specific
stakeholder of the modern corporation, and the implications for directors’ duties
and corporate regulation more generally if society is, indeed, a stakeholder.
Referring to ‘society’ as a whole as being a stakeholder presents some difficulties,
as this makes it very difficult to provide any meaningful conception of what obli-
gation this imposes on the corporation. Mallin’s approach of examining society
at the micro-level of the ‘local community’ seems useful and workable. According
to Mallin:

Local communities have a number of interests in the companies which operate in their
region . . . companies will be employing large numbers of local people and it will be in
the interest of sustained employment levels that companies in the locality operate in an
efficient way. Should the company’s fortunes start to decline then unemployment might
rise and could lead to part of the workforce moving away from the area to seek jobs
elsewhere . . . However, local communities would also be concerned that companies in
the area act in an environmentally-friendly way as the last thing they would want is
pollution in local rivers, in the soil or in the atmosphere generally. It is therefore in the
local community’s interest that companies in their locality continue to thrive but do so
in a way that takes account of local and national concerns.34

2.2.2.6 The environment

In the first edition of the book, it was noted that ‘just as contentious as the
question of whether “society” is a stakeholder of the corporation is whether
“the environment” can be considered to be a stakeholder. Perhaps this is because
the implications of both, in terms of how a company must structure its affairs and
do business, are enormous’. The call for environmental change has progressed
rapidly since then with a growing sense of urgency35 that negates the need for
the ‘contentious’ claim made earlier.
Following the launch of the Kyoto Protocol in 2005,36 managing green-
house gas emissions has become a routine part of doing business in key global

34 Ibid.
35 For example, see Intergovernmental Panel on Climate Change, Climate Change 2007: The Physical Science
Basis – Contribution of Working Group 1 to the Fourth Assessment Report of the Intergovernmental Panel on
Climate Change, Cambridge, Cambridge University Press (2007).
36 The Kyoto Protocol was adopted at the Third Session of the Conference of the Parties to the United
Nations Framework Convention on Climate Change in 1997, in Japan. Countries signatory to the Protocol
undertook legally binding commitments to reduce greenhouse-gas emissions in the commitment period 2008
to 2012.
32 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

trading markets, and shareholders and financial analysts increasingly assign

value to companies that prepare for and capitalise upon business opportuni-
ties posed by climate change – whether from greenhouse-gas regulations, direct
physical impacts or changes in corporate reputation.37 In a recent report on
climate change and corporate governance, the following observations were
made:38

For corporations, climate change is a financial problem that presents significant eco-
nomic and competitive risks and opportunities. Corporate boards, executives and share-
holders simply cannot afford to ignore it39 . . . Given the sweeping global nature of
climate change, climate risk has become embedded, to a greater or lesser extent, in
every business and investment portfolio.40

In Corporate Governance, Mallin speaks not just of the ‘environment’ as being a

stakeholder, but also the various environmental lobby groups that operate both
on the domestic level and the international level to ensure that companies meet
environmental standards. These standards comprise self-imposed standards and
standards derived from obligations under environment protection and other
legislation (for example, the Environment Protection Act 1970 (Vic) and the
Environment Protection and Biodiversity Conservation Act 1999 (Cth)).41
Tied in with the concept of ‘wealth creation’ discussed above is the concept of
‘sustainability’. That is, growth can only be maintained over the long term if the
manner in which resources (both natural and human) are used and treated is
sustainable. Thus, attention must quickly turn to the environment and the ways
in which it is being used and protected, with a view to maintaining long-term
growth. Put simply, if the manner in which resources are being used to achieve
growth now cannot be sustained, then long-term growth is not achievable. What
is needed is long-term, sustainable growth.
According to Mallin, for companies to promote sustainability, they must be
environmentally responsible. Mallin explains that an environmentally respon-
sible company must not subject its workers to potentially hazardous processes
without adequate protection, must not pollute the environment and should,
where possible, use recyclable materials and engage in a recycling process.
Mallin states that: ‘Ultimately all of these things will benefit society at large
and the company itself.’42

37 This account is drawn from Douglas Cogan, ‘Corporate Governance and Climate Change: Making the
Connection’ (March 2006) at 1 – Report commissioned by Ceres from the Investor Responsibility Center.
38 Ibid at 11. The report is the first comprehensive examination of how 100 of the world’s largest corporations
are positioning themselves to compete in a carbon-constrained world.
39 For an interesting discourse on the corporate and securities law obligations on United States companies in
the context of climate change, see Perry Wallace, ‘Climate Change, Fiduciary Duty, and Corporate Disclosure:
Are Things Heating Up in the Boardroom?’ (2008) 26 Virginia Environmental Law Journal 293.
40 ‘Between 1994 and 2002, 62 shareholder resolutions on global warming issues were filed with the SEC
in the US and 26 of them came to votes’: E Hancock, ‘Corporate Risk of Liability for Global Climate Change
and SEC Disclosure Dilemma’ (2005) 17 Georgetown International Environmental Law Review 233 at 249.
41 The Australian Government’s Carbon Pollution Reduction Schemes Bill (2009) was rejected by the Senate
in December 2009. See further, ‘Garnaut Climate Change Review: Emissions Trading Scheme Discussion
Paper’ (March 2008) available at <www.garnautreview.org.au/index.htm>.
42 Mallin, above n 8, 53.
 STAKEHOLDERS AND CSR 33

In an excellent contribution to his 2004 collection of essays, Thomas Clarke

emphasises the importance of protecting ‘the environment’ from a stakeholder–
management perspective. According to Clarke:

It is time for the principal-agent problematic to be reinforced with the environment-

trustee problematic in both theory and practice. The competitive struggle to grow
business and accumulate capital (whether measured by shareholder value or not)
has disturbed the natural balance of the earth and threatened essential life-support
systems . . . 43

Clarke discusses how, incrementally, management philosophy and practice has

embraced the concept of sustainability, rather than remaining focused purely on
profit maximisation. The literature stresses that the way in which economic activ-
ity has recently been organised is not sustainable – which (as explained above)
sits uncomfortably with a more long-term perspective of growth. According to
Clarke:

In the past, companies did not recognize or acknowledge the environmental or social
effects of their operations . . . The environmental context in which business must oper-
ate in the future suggests the following imperatives which all corporations will face, and
all corporate governance systems will need to resolve: maintaining a licence to operate
via transparency and accountability; generating more value with minimum impact;
preserving the natural resource base, and doing business in a networked, intelligent
multi-stakeholder world.44

With a more long-term approach to management, based on a wealth-creation

perspective of corporate governance, it is clear that the environment is a central
stakeholder of the corporation – in terms both of what the environment offers
the corporation (being long-term growth) and of the risk to the environment as
a result of corporate activities.
From a practical perspective, the place of the environment as a principal
stakeholder of the corporation has been emphasised not only in company codes
of conduct and ethics that have become a recent feature of Australian corpo-
rate governance arrangements (as discussed in greater detail below), but also
through discrete environmental policies that companies have adopted. These are
designed to ensure that companies fulfil their core environmental obligations,
and require employees and managers to act in an environmentally sensitive
manner when at work and utilising the company’s resources. Indeed, some com-
panies have gone even further and implemented ‘environmental procurement
policies’ requiring that, in order for suppliers to maintain business with the
company, they need to maintain certain environmental ‘KPIs’ (key performance
indicators).

43 See Thomas Clarke, ‘Theories of Governance – Reconceptualizing Corporate Governance Theory after the
Enron Experience’ in Thomas Clarke (ed.), Theories of Corporate Governance – The Philosophical Foundations
of Corporate Governance, London, Routledge (2004) 25.
44 Ibid.
34 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

One of the progressive listed companies in Australia, in terms of expressing

a commitment to the environment, is the National Australia Bank (NAB). NAB
has a Group Environment Policy that sets a global reference point for its envi-
ronmental commitments and management practices. In responding to climate
change as a large global company, NAB states that ‘it is our responsibility to play
a part in addressing the unprecedented challenges of climate change, and to
help our employees, customers and suppliers do the same’.45 Furthermore, ‘our
aim is to ensure environmental considerations are integrated throughout the
organisation’.46 To encourage sustainable travel, NAB states that an interest-free
public transport loan is available to employees based in Melbourne and Sydney,
and that some 800 bike racks are installed across Australia.47
In 2002, NAB became a signatory to the United Nations Environment Pro-
gramme Statement for Financial Institutions on the Environment and Sustain-
able Development, which promotes sustainable development and environmen-
tally sustainable business practices in the international financial services sector.
In 2007, NAB announced its intention to become a carbon neutral organisation
by September 2010. According to NAB, ‘these are both clear signals that as a
global provider of financial products and services, we recognise the pivotal role
financial institutions play in environmental management and the sustainability
of the communities in which we operate’.
In 2007, NAB agreed to a global social and environmental benchmark for
financing projects greater than US$10 million by adopting the Equator Principle,
a voluntary set of guidelines to assess and manage social and environmental
project financing risk, especially in emerging markets.48
In terms of the company’s environmental policy statement, NAB states that it
offers the following commitments to its customers:49

• Reviewing and continuously improving lending policy which includes where appro-
priate, environmental risk assessment to assist in the consideration and management
of indirect environmental impacts;
• Wherever possible supporting the investment choice of customers to invest in
Socially Responsible Investment products;
• Looking for opportunities to offer customers ‘green’ choices in financial products
and services;
• Wherever possible assisting business and corporate clients to operate their busi-
nesses in an environmentally sustainable manner, by providing appropriate banking
and risk management products and services.

The commitment accorded to environmental issues is reflected in the Group Chief

Executive Officer (CEO) having ultimate responsibility for the environmental
performance of the NAB Group, with the Group’s Environmental Management

45 NAB Enviroment policy, available at <www.nab.com.au/wps/wcm/connect/nab/nab/home/

about_us/7/5>.
46 Ibid.
47 Ibid.
48 The Equator principles can be found at <http://equator-principles.com/>.
49 NAB Enviroment policy, n 45.
 STAKEHOLDERS AND CSR 35

Committee being responsible for the implementation of the environment policy

throughout the organisation.

2.2.2.7 Government
As noted earlier, Mallin’s account of the place of stakeholders in contemporary
corporate governance identifies government as a key stakeholder. In discussing
the role of government as stakeholder, Mallin states:

The government has an interest in companies for several diverse reasons.

Firstly, as with the local and environmental groups – although not always with such
commitment – it will try to make sure that companies act in a socially responsible way
taking account of social, ethical, and environmental considerations. Secondly, it will
analyse corporate trends for various purposes such as employment levels, monetary
policy, and market supply and demand of goods and services. Lastly, but not least, it
will be looking at various aspects to do with fiscal policy such as capital allowances,
incentives for investing in various industries or various parts of the country, and of
course the taxation raised from companies!50

2.2.2.8 All stakeholders have vested interests in the sustainability

of corporations
At the end of the day, it is not difficult to conclude that all stakeholders have vested
interests in the sustainability of corporations.51 The shareholders want to max-
imise returns on their investment, not only by receiving good dividends, but also
by making profits when they sell securities in a corporation. The employees are
dependent on the company, not only to support themselves and their families, but
in some cases also as holders of employee benefits, including securing retirement
benefits from the company. The creditors also have a strong interest in the sus-
tainability of the company as their expectation is that they are paid in accordance
with the conditions agreed upon with the corporation, while supplier–creditors
are of necessity dependent upon corporations to continue manufacturing prod-
ucts and services. Customers want to continue trading with corporations that
provide excellent goods and services, and they will deal with the company to
enforce guarantees and warranties against suppliers. The communities in which
corporations do business, manufacture their goods or deliver their services gain
by corporations providing job opportunities and creating wealth that leads to
the improvement of living conditions, as long as the corporations adhere to good
practice in corporate governance and do business in an environmentally friendly
manner. The environment is our ‘pearl’ and is highly dependent on sustainable
and environmentally friendly corporations. The government has an interest in
the sustainability of corporations, as not only do they provide job opportuni-
ties to citizens, also are responsible for the majority of governmental income
through taxes, levies, licenses etc., which income is eventually re-invested into

50 Mallin, above n 8, 53.

51 Mervyn King, The Corporate Citizen, Johannesburg, Penguin Books (2006) 63.
36 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

a country’s infrastructure, health, education etc. to ensure prosperity for its

citizens.

2.3 Stakeholders’ interests and the corporation:

The role of the law

A major work titled The Anatomy of Corporate Law: A Comparative and Functional
Approach, produced by seven leading corporate law and corporate governance
scholars,52 emphasises the important role of company law (including rules of
corporate governance) in protecting stakeholder interests. Indeed, recognition
and protection of stakeholder interests is regarded as one of the key functions
of company law. The underlying thesis of this work is that in every jurisdiction
(whether it be a developing country in Europe, or a developed country such
as the United States) the central issue for corporate law is how to mediate
three different kinds of ‘agency conflicts’: between managers and shareholders;
between majority and minority shareholders; and between the firm and third
parties (that is, stakeholders).
In this section we extend beyond the rules of company law to look at how
corporate governance regulation, in general, manages and protects stakeholder
interests. We begin by examining a recent development in corporate governance
regulation in Australia that has ensured a more prominent place for stakeholders
in contemporary corporate governance, particularly in relation to listed compa-
nies. We also illustrate issues in corporate social responsibilities (CSR) arising
from a September 2004 report of the Special Commission of Inquiry into the
James Hardie asbestos compensation case.
A short discussion of the overseas position with respect to the recognition and
protection of stakeholder interests is also provided in this section.

2.3.1 The Australian position

Since 1 July 2004, listed companies in Australia have been required, in order to
comply with ASX Best Practice Recommendations (as it was originally titled in
2003), to have in place and posted on their websites a code of conduct and ethics
indicating how they intended to deal with stakeholder concerns and interests.
As explained in Chapter 7, the now revised ASX Corporate Governance Princi-
ples and Recommendations (2007) represent Australia’s attempt to develop a
regulatory framework that promotes adherence to best practice in corporate
governance, in response to a series of corporate collapses in the earlier part
of this decade. From an international perspective, the treatment of stakehold-
ers through the sophisticated development of a model code of conduct is quite
52 Reiner Kraakman, Henry Hansmann, Edward Rock, Paul Davies, Gerhard Hertig, Klaus Hopt and Hideki
Kand all made contributions to The Anatomy of Corporate Law: A Comparative and Functional Approach,
Oxford, Oxford University Press (2004).
 STAKEHOLDERS AND CSR 37

progressive – with neither of the recent reform ‘movements’ in the United States
or the United Kingdom directly dealing with stakeholders’ interests in terms of
how to achieve best practice in corporate governance. Rather, the USA and the
UK movements were focused on more specific aspects of corporate governance –
financial reporting and audit in the USA, and the role of non-executive directors in
the UK.
As explained in greater detail in Chapter 7, ASX Corporate Governance Prin-
ciples and Recommendations operate according to a ‘comply or explain’ regime:
pursuant to Listing Rule 4.10.3, listed companies must either comply with each
recommendation, or clearly explain the reasons for their non-compliance in the
annual report of the company. The recommendations build upon eight core
principles, with each principle explained in detail and with commentary about
implementation in the form of Recommendations. For the present discussion,
Principle 3 (Promote ethical conduct and responsible decision-making) is most
relevant. Recommendation 3.1 states that, in order to actively promote such
conduct and decision making, listed companies need to ‘take into account their
legal obligations and reasonable expectations of their stakeholders’.
The commentary attached to Principle 3, designed to provide assistance (but
does not give rise to a reporting obligation) advises that companies should not
only comply with their legal obligations, but ‘should also consider the reason-
able expectations of their stakeholders, including: shareholders, employees, cus-
tomers, suppliers, creditors, consumers and the broader community in which
they operate. It is a matter for the board to consider and assess what is appro-
priate in each company’s circumstances.’ Recommendation 3.1 then goes on to
provide that to achieve this, listed companies should establish and disclose a code
of conduct to guide compliance with legal and other obligations, in order to meet
the reasonable expectations of stakeholders.
Box 3.1 goes further in setting out some comprehensive guidelines as to the
type of content that should be included in a code of conduct:

1. Clear Commitment by Board and Senior Executives to the Code of Conduct

– This is often linked to statements about the aspirations or objectives of the
company; its core values; and its views about the expectations of shareholders,
employees, customers, suppliers, creditors, consumers and the broader commu-
nity.
2. Responsibilities to Shareholders and the Financial Community Generally
– This might include reference to the company’s commitment to delivering share-
holder value and how they will do this, the company’s approach to accounting
policies and practices, and disclosure.
3. Responsibilities to Stakeholders (identified above)
– This might include reference to standards of product quality or service, com-
mitments to fair value, fair dealing and fair trading, and the safety of goods
produced.
4. Approach to Community
– This might include environmental protection policies, support for community
activities, and donation or sponsorship policies.
38 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

5. Responsibilities to the Individual

– This might include the company’s privacy policy, and its policy on the use of
privileged or confidential information.
6. Employment Practices
– This might include reference to occupational health and safety; employment
opportunity practices; special entitlements about the statutory minimum;
employee security trading policies; training and further education support;
policies and practices on drug and alcohol usage and on outside employment.
7. Approach to Business Standards
– Policies on the company’s approach to business courtesies; bribes, facilitation
payments, inducements and commissions. This might include how the com-
pany regulates such conduct and prevents the misuse of company assets and
resources.
8. How the Company Complies with Legislation Affecting Its Operations
– For company operations outside of Australia, particularly in developing coun-
tries, the code of conduct should state whether those operations comply with
Australian or local legal requirements regarding employment practices, respon-
sibilities to the community and responsibilities to the individual, particularly
if the host country adopts lower standards than those prescribed by Australian
law or international protocols.
9. Approach to Conflicts of Interests
– Specify how the company handles actual or potential conflicts of interest. This
might include reference to how the company manages situations where the
interests of a private individual interferes or appears to interfere with the inter-
ests of the company as a whole, and how the company prevents directors, senior
executives and employees from taking improper advantage of property, infor-
mation or position, or opportunities arising from these, for personal gain or to
compete with the company.
10. Promotion of Ethical Behaviour
– Identify measures the company follows to encourage the reporting of unlawful
or unethical behaviour and to actively promote ethical behaviour. This might
include reference to how the company protects those, such as whistleblowers,
who report violations in good faith, and its processes for dealing with such
reports.53
11. How the Company Monitors and Ensures Compliance with its Code

The ASX Corporate Governance Principles and Recommendations state that

Box 3.1 contains some suggestions for the content of the corporate code of con-
duct, and therefore, of course, companies have flexibility to include or exclude
some of the above matters, or include others that may be more specifically rele-
vant to their business.
The explanatory text accompanying the original ASX Best Practice Recom-
mendations (2003), indicates that codes of conduct are intended to state the
values and policies of the company, in order to ensure adequate public or social
accountability by corporations.

53 For guidance on the provision of a whistleblowing service, ASX recommends the Australian Standard on
Whistleblowing Protection Programs for Entities [AS 8004].
 STAKEHOLDERS AND CSR 39

Highlighting the role of areas outside company law rules and corporate gover-
nance principles in accounting for the interests of stakeholders, the 2003 explana-
tory text states that codes of conduct ‘should address matters relevant to the
company’s compliance with its legal obligations to stakeholders’. Further, ‘the
company should have a system for ensuring compliance with its Code of Conduct
and for dealing with complaints’. The compliance aspect of the code of conduct
should complement the company’s risk management practices.
Principle 7 of ASX Corporate Governance Principles and Recommendations,
dealing with the recognition and management of risk, recommends that listed
companies structure their affairs to ensure compliance with legal obligations –
therefore complementing Principle 3, given that many of the legal obliga-
tions imposed on listed companies have a direct bearing on the interests of
stakeholders.
Principle 7 states that good corporate governance can be achieved through
establishing ‘a sound system of risk oversight and management and internal con-
trol’. Recommendation 7.1 then states that ‘the company should establish policies
for the oversight and management of material business risks and disclose a sum-
mary of those policies’. Further explanation is provided in the accompanying
recommendations (7.2–7.3), that the policies should include the following com-
ponents: oversight, risk profile, risk management, compliance and control, and
assessment of effectiveness.
Commentators, focusing on a range of empirical studies demonstrating
that while an increasing number of companies since the mid-1990s have
adopted policies consistent with the concept of CSR, have made the following
observation:54

the studies conducted to date suggest that the ‘Australian approach’ to CSR is still
largely characterized by tentative and short term initiatives of a philanthropic nature.
While there are exceptions, most businesses in Australia have not yet sought to integrate
the precepts of CSR or corporate citizenship into their strategic approach or corporate
culture.

In 2004, the question of whether corporate governance, and more specifically

rules concerning the duties of company directors, should be oriented towards pro-
tecting the interests of stakeholders, became a heavily debated issue in Australia.
This debate resulted from a major scandal involving manufacturer James Hardie
and that company’s under-funding of an entity set up to compensate claimants of
asbestos-related illnesses who had come into contact with James Hardie build-
ing products. More details of the James Hardie asbestos compensation affair are
discussed later in this chapter. The potential for future asbestos victims to go
uncompensated due to the arrangements set up by James Hardie led to calls for
company law reform so that directors of the James Hardie parent company, and
directors in the future under similar circumstances, could be made personally

54 H Anderson and I Landau, in ‘Corporate Social Responsibility in Australia: A Review’ Corporate Law and
Accountability Research Group Working Paper No. 4, Monash University (October 2006).
40 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

liable for claimant (that is, stakeholder) debts. In light of this, in March 2005 the
Australian Government asked its Corporations and Markets Advisory Committee
to consider and report on whether the statutory duties of directors should be
amended to clarify the extent to which directors can take into account stake-
holder interests, or require directors to take into account stakeholder interests.55
The findings of the report, and its implications for stakeholders, are considered
later in the chapter with reference to the debate on the interaction of the ‘share-
holder primacy’ approach to corporate decision making with the ‘enlightened
self-interest’ approach.

2.3.2 Overseas position: A snapshot

What follows is a brief discussion of the approaches of the OECD, the European
Union, the USA, Canada, the UK, New Zealand and South Africa, to recognis-
ing and protecting the interests of company stakeholders, through corporate
governance principles and/or company law rules.56

2.3.2.1 OECD
The OECD Principles of Corporate Governance is very useful when considering
how the regulation of corporate governance has recognised the importance of
companies accommodating stakeholder interests. The OECD principles state
that:

The corporate governance framework should recognise the rights of stakeholders

established by law or through mutual agreements and encourage active co-operation
between corporations and stakeholders in creating wealth, jobs, and the sustainability
of financially sound enterprises.57

More specifically, the OECD principles recommend that OECD countries adhere
to this principle:
(a) Laws and mutual agreements with stakeholders are to be respected.
(b) Where stakeholder interests are protected by law, stakeholders should
have the opportunity to obtain effective redress for violation of their
rights.
(c) Performance-enhancing mechanisms for employee participation should be
permitted to develop.
(d) Where stakeholders participate in the corporate governance process, they
should have access to relevant, sufficient and reliable information on a
timely and regular basis.

55 See further The Social Responsibility of Corporations Report (December 2006), above n 7.
56 For insights into CSR in different European countries, see Andre Habisch, Jan Jonker, Martina Wegner
and Rene Schmidpeter (eds), Corporate Social Responsibility Across Europe, Germany, Springer (2005).
57 OECD Principles of Corporate Governance, above n 5, 16 – 17.
 STAKEHOLDERS AND CSR 41

(e) Stakeholders, including individual employees and their representative

bodies, should be able to freely communicate to the board their concerns
about illegal or unethical practices, and their rights should not be compro-
mised for doing this.
(f) The corporate governance framework should be complemented by an effec-
tive, efficient insolvency framework and by effective enforcement of cred-
itor rights.58

2.3.2.2 European Union (EU)59

The EU Green Paper, Promoting a European Framework for Corporate Social
Responsibility (2001), described CSR as ‘a concept whereby companies integrate
social and environmental concerns in their business operations and in their
interaction with their stakeholders on a voluntary basis’. Although the emphasis
on the voluntary nature of CSR did not find favour with some of the respondents
to the Green Paper,60 this definition was reaffirmed by the European Commission
(the executive arm of the EU) in its policy communication in 200661 and remains
current.
The philosophical approach behind this definition, which integrates social
and environmental concerns with business, was described as follows:62
It is essentially about companies being prepared to take the lead, and illustrate to the
Commission and to their stakeholders voluntarily that they take CSR seriously. CSR
is always about going beyond the law. Ideally, CSR is a win-win scenario, whereby
companies increase their profitability and society benefits at the same time.

In July 2002, the Commission commented on the conflict between maximising

short-term profits and achieving shareholder value by noting:63
the growing perception among enterprises that sustainable business success and share-
holder value cannot be achieved solely through maximising short-term profits, but
instead through market-oriented yet responsible behaviour.

In May 2003, the European Commission released a communication titled ‘Mod-

ernising Company Law and Enhancing Corporate Governance in the European
Union: A Plan to Move Forward’. This document outlines the approach that the
58 Ibid 46–8.
59 For a description of the development of CSR in the EU, see Sorcha Macleod, ‘Corporate Social Responsibil-
ity Within the European Union Framework’ (2005) 23 Wisconsin International Law Journal 541. For a broader
perspective, see Sorcha Macleod, ‘Reconciling Regulatory Approaches to Corporate Social Responsibility:
The European Union, OECD and United Nations Compared (2007) 13 European Public Law 671.
60 For a summary of criticisms directed to this definition in the Green Paper by trade unions and NGOs,
see Sorcha Macleod, ‘Corporate Social Responsibility Within the European Union Framework’, (2005) 23
Washington International Law Journal 541, 545–7.
61 Implementing the Partnership for Growth and Jobs: Making Europe a Pole of Excellence on CSR, COM (22
March 2006).
62 See EU Corporate Social Responsibility Briefing (16 March 2009), available at <www.eubusiness.com/
topics/social/csr-guide/?searchterm=16%20March%202009%20corporate%20social>.
63 The Commission Communication Concerning Corporate Social Responsibility: A Business Contribution to
Sustainable Development, COM (2 July 2002), at 5.
42 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

Commission intends to follow specifically in the area of company law and corpo-
rate governance. Importantly, the Commission’s position is that member states
of the EU should provide for an inclusive approach – recognising and protecting
the interests of key corporate stakeholders – as a priority in moving forward with
reforming company law and corporate governance regulation. The Communica-
tion states:
Ensuring effective and proportionate protection of shareholders and third parties must
be at the core of any company law policy. A sound framework for protection of mem-
bers and third parties, which properly achieves a high-degree of confidence in business
relationships, is a fundamental condition for business efficiency and competitiveness.
In particular, an effective regime for the protection of shareholders and their rights,
protecting the savings and pensions of millions of people and strengthening the foun-
dations of capital markets for the long term in a context of diversified shareholding
within the EU, is essential if companies are to raise capital at the lowest cost.64

This general communication on company law and corporate governance follows

the communication on CSR of 2002. The document addressed the social and
environmental aspects of doing business in the global economy, and led to the
setting up by the EU of a European Multi-Stakeholder Forum with a view to
promoting voluntary social and environmental practices of business – linked
to their core activities. Indeed, a stakeholder-oriented approach to corporate
governance is heavily emphasised and promoted in EU countries, with the Multi-
Stakeholder Forum (formed in 2002) bringing together employers, employees,
NGOs, academics and socially responsible investors every two years to discuss
further steps for the EU to raise awareness of CSR, to encourage its adoption and
to facilitate exchange of best practices across Europe.65 In addition, the European
Coalition for Corporate Justice (ECCJ) was formed in 2006.
A renewed EU strategy on CSR of the European Union was launched in 2006,
leading to the creation of the European Alliance for CSR, which is viewed as an
important pillar of European policy on CSR. The CSR Alliance lays the foundation
for the partners to promote CSR in the future around the following three areas
of activity:66
● Raising awareness and improving knowledge on CSR and reporting on its
achievements
● Helping to mainstream and develop open coalitions of cooperation
● Ensuring an enabling environment for CSR.

64 European Commission, Modernising Company Law and Enhancing Corporate Governance in the Euro-
pean Union: A Plan to move Forward COM (2003) 284 (May 2003) <http://eur-lex.europa.eu/LexUriServ/
LexUriServ.do?uri=COM:2003:0284:FIN:EN:PDF> at 8 (emphasis added).
65 Other EU initiatives include, inter alia, a High-Level Group of Members States’ representatives, which
meets every six months to share different approaches to CSR and encourage peer learning. A Commission
inter-service group on CSR has the task to ensure a coherent approach across the different Commission
services concerned. It involves the following policy areas: environment, justice, liberty and security; internal
market; health and consumer affairs; and external affairs.
66 For identification of the several priority areas, inspired by the European Roadmap for Businesses launched
by CSR Europe in March 2005, which reflect the wide-ranging nature of CSR – see the mission statement of
the Alliance available at <www.csreurope.org/pages/en/priorityareas.html>.
 STAKEHOLDERS AND CSR 43

2.3.2.3 United States

In the USA,67 a concept of ‘corporate constituency’ – by which the interests of
stakeholders have been recognised – has been embedded in the takeover laws of
the various states (corporate law in the USA is predominantly regulated at state
level) since the 1980s,68 in response to strong hostile takeover activity during
that decade.69 By 1998, over 30 state legislatures had introduced ‘corporate
constituency’ laws, designed to protect companies in their local economies from
hostile takeovers by enabling or requiring directors to consider the impact of
their activities (including decisions whether to accept or reject a takeover offer)
on constituencies other than shareholders – including employees, customers,
suppliers and the community. For example, the statute in Illinois provides:70

in discharging the duties of their respective positions, the board of directors, commit-
tees of the board, individual directors and individual officers may, in considering the
best interests of the corporation, consider the effects of any action upon employees,
suppliers, and customers of the corporation, communities in which offices or other
establishments of the corporations are located and all other pertinent factors.

Hence, while in Australia the notion of directors owing a duty to stakeholders is

not stated explicitly in statute law, in the USA it is the norm, at least in relation
to takeovers regulation.
According to Margaret Blair in Ownership and Control: Rethinking Corpo-
rate Governance for the 21st Century, the constituency statutes make it legal for
directors to consider other interests in addition to those of shareholders when
making major decisions. Typically, the statutes require directors to consider the
‘best interests of the corporation’ as a whole, and then to identify a specific
set of stakeholders, including employees, creditors, suppliers and the commu-
nity in general, whose interests are tied to the corporation. However, the exact
nature and scope of these provisions are still uncertain71 – see also discussion in
Chapter 12.
It is worth noting that Australia considered the pluralist approach in the
USA and rejected any move to introduce legislation obliging directors to have
regard to the interests of groups other than shareholders in making decisions.72

67 For an overview of the development of CSR in the USA, see C A Harwell Wells, ‘The Cycles of Corporate
Social Responsibility: An Historical Perspective for the Twenty-first Century’ (2002) 51 Kansas Law Review
77.
68 For a summary of the USA state statutes, see K Hale, ‘Corporate Law and Stakeholders: Moving Beyond
Stakeholder Statutes’ (2003) 45 Arizona Law Review 823. For criticism of corporate constituency statutes, see
S Bainbridge, ‘Interpreting Nonshareholder Constituency Statutes’ (1992) 19 Pepperdine Law Review 971.
69 See, for example, decisions of the Delaware Supreme Court in Unocal Corp. v Mesa Petroleum Co. 493 A.2d
946 (Del. 1985); Revlon, Inc v McAndrews & Forbes Holdings, Inc 506 A.2d 173 (Del. 1986).
70 For a listing of the states that have enacted non-shareholder constituency statutes, see Alissa Mickels,
‘Beyond Corporate Social Responsibility: Reconciling the Ideals of a For-Benefit Corporation with Director
Fiduciary Duties in the US and Europe’ (2009) 32 Hastings International and Comparative Law Review 271. For
an analysis of the corporate constituency statutes, see E Orts, ‘Beyond Shareholders: Interpreting Corporate
Constituency Statutes’ (1992) 61 George Washington Law Review 14.
71 Bayless Manning, ‘Principles of Corporate Governance: One Viewer’s Perspective on the ALI Project’
(1993) 48 The Business Lawyer 1319.
72 The Report of the Senate Standing Committee on Legal and Constitutional Affairs, Company Directors’
Duties: Report on the Social and Fiduciary Duties and Obligations of Company Directors (November 1989).
44 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

Similarly, more recent Australian reports have adopted a similar approach,73

and are considered later in the chapter.
According to some commentators,74 ‘the US is in the process of moving
beyond the traditional conception of society as divided neatly into three sectors –
business, non-profit, and government – and is witnessing the emergence of a new
fourth sector that encompasses elements of both the business and non-profit
sectors’.75 Some USA states have recently introduced a new corporate structure,
known as the ‘low-profit limited liability company’ (L3C), for business entities
whose primary goal is to achieve a socially beneficial objective.76 This is a new
hybrid structure for profit-making ventures that have profits as a secondary goal
of the entity; hence, they are called ‘low-profit’ companies. The L3C is a varia-
tion of the limited liability company (LLC) that currently exists in the USA and
shares many of its characteristics. The L3C is a for-profit entity and is treated
like an LLC for tax purposes, rather than a not-for-profit entity, and its members
enjoy limited liability.77 L3Cs can distribute their profits to shareholders, a major
distinction from non-profit companies.
In order for an entity to qualify as a L3C, it must be established to significantly
further one or more charitable or educational purposes. Furthermore, it must
not have as a significant purpose the production of income or the appreciation of
property (though it is permissible to earn profits). Additionally, the entity must
not be organised to accomplish any political or legislative purposes. These three
characteristics of L3Cs mirror the Program-Related Investment (PRI) require-
ments under the United States federal tax laws, which allow private foundations
to invest in business entities without triggering tax penalties.78
This new company structure is designed to make it easier for social enterprises
to attract capital and offer investors a financial return. It is envisaged that the
L3C could create new jobs by supporting social enterprises that otherwise could
not exist, and the timing of its introduction has been opportune given the credit

73 See further, The Social Responsibility of Corporations Report, above n 7; The Commonwealth of Aus-
tralia, Parliamentary Joint Committee on Corporations and Financial Services Report, Corporate Respon-
sibility and Managing Risk and Creating Value (June 2006), available at <www.aph.gov.au/senate/
committee/corporations_ctte/completed_inquiries/2004-07/corporate_responsibility/report/index.htm>.
74 See, for example, Thomas Billitteri, Mixing Mission and Business: Does Social Enterprise Need a New Legal
Approach? (2007), available at <www.nonprofitresearch.org/usr doc/New Legal Forms Report FINAL.
pdf> (Report of an Aspen Institute Round Table Discussion). Google.org is a celebrated example of a
for-profit organisation formed largely for the purpose of providing social benefit.
75 Thomas Kelley, ‘Law and Choice of Entity on the Social Enterprise Frontier’ (2009) 84 Tulane Law
Review 337.
76 See further, James Austin Roberto Gutiérrez, Enrique Ogliastri and Ezequiel A Reficco, ‘Capitaliz-
ing on Converge’, (2007) 24 Stanford Social Innovation Review 24 – available at <http://ssrn.com/
abstract=1011017>; Andrew Wolk, ‘Social Entrepreneurship & Government: A New Breed of Entrepreneurs
Developing Solutions to Social Problems’ (2007), available at <www.rootcause.org/social-entrepreneurship-
government-new-breed-entrepreneurs-developing-solutions-social-problems>.
77 Acumen Law Group, ‘The Low-Profit LLC: A New Entity in Illinois’ (9 December 2009), available at <www.
acumenlawgroup.com/index.php?s=Low+Profit+LLC>.
78 ‘Illinois Recognizes New Business Entity that Mixes For-Profit and Nonprofit Elements’, Tax Law
Centre, Practitioners’ Corner, State Taxation (28 August 2009), available at <http://law.lexisnexis.com/
practiceareas/Practitioners-Corner/Tax/lllinois-Recognizes-New-Business-Entity-That-Mixes-For-Profit-
and-Nonprofit-Elements>.
 STAKEHOLDERS AND CSR 45

crunch and global financial crisis.79 On 1 January 2010, Illinois became one
of five states to recognise such a structure (and joins the states of Michigan,
Wyoming, Utah and Vermont, which passed the first law on 30 April 2008 and
lists about 60 L3Cs in the state database).
The United States legislatures’ creation of a new type of corporate structure
for blended enterprise (cross between a non-profit and for-profit corporation)
demonstrates the bridging of the gap and a movement away from the traditional
boundary between for-profit and non-profit organisations, and is in line with
the development of the community interest company (CIC) in the UK, designed
to meet community needs, discussed below. It remains to be seen whether this
interesting development ‘holds particular promise for responding to the legal
needs of the emerging fourth sector’,80 particularly beyond the time when the
stimulus funds supplied to communities by the United States government (arising
from the global financial crisis) are exhausted.

2.3.2.4 United Kingdom

The embodiment of the concept of ‘enlightened shareholder value’ is a key aspect
of the new corporate law regulatory environment in the United Kingdom.81
Section 172 of the Companies Act 2006 (UK) adopts the ‘enlightened shareholder
value’ approach to directors’ duties, which is described under the Act as ‘a duty
to promote the success of the company’.82 According to the Department of Trade
and Industry, this will ensure that ‘regard has to be paid by directors to the
long term as well as the short term, and to wider factors where relevant such
as employees, effects on the environment, suppliers and customers’.83 This will
principally be achieved through the high-level ‘statement of directors’ duties’ set
out in the Act (reproduced below) to clarify the duties and responsibilities of
directors.
The genesis of section 172, discussed below, can be traced to the work of the
UK Company Law Steering Group, which viewed the ‘enlightened shareholder
value’ as being different from the pluralist approach (in the USA) and explained
the concept as follows:84

There will inevitably be situations in which the interests of shareholders and other
participants will clash, even when the interests of shareholders are viewed as long-
term ones. Examples include a decision whether to close a plant, with associated

79 ‘New Corporate Structure Could Give Social Entrepreneurs New Funding Stream’, Chicago Tribune
(10 August 2009).
80 Kelley, above n 75, at 342.
81 For critical appraisal, see Andrew Keay, ‘Tackling the Issue of the Corporate Objective: An Analysis of the
United Kingdom’s “Enlightened Shareholder Value”’ (2007) 29 Sydney Law Review 577. See also I Esser and
J J du Plessis, ‘The Stakeholder Debate and Directors’ Fiduciary Duties’ (2007) 19 South African Mercantile
Law Journal 346 at 355–6.
82 See generally Esser and Du Plessis, ibid, at 351–6.
83 Press Release of 17 March 2005, ‘Draft Company Law Reform Bill Puts Small Business First’, available at
<http://www.parliament.uk/documents/commons/lib/research/rp2006/rp06-030.pdf>.
84 UK Company Law Steering Group Consultation Paper, Modern Company Law for a Competitive Environ-
ment: The Strategic Framework (February 1999) at para 5.1.15.
46 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

redundancies, or to terminate a long-term supply relationship, when continuation

in either case is expected to make a negative contribution to shareholder returns.
In such circumstances, the law must indicate whether shareholder interests are to
be regarded as overriding, or some other balance should be struck. This requires
a choice . . . between the enlightened shareholder value and pluralist approaches. An
appeal to the ‘interests of the company’ will not resolve the issue, unless it is first decided
whether the ‘the company’ is to be equated with its shareholders alone (enlightened
shareholder value) or the shareholders plus other participants (pluralism).

In line with the above philosophical approach, section 172 of the Companies
Act 2006 (UK) makes it clear that directors owe their fiduciary duty only to
the shareholders generally, rather than a range of interest groups, but seek to
provide a broader context for fulfilling that duty. Section 172 (in effect from
October 2007) sets out a non-exhaustive list of matters to which directors must
have regard and provides as follows:85

Duty to promote the success of the company

(1) A director of a company must act in the way he considers, in good faith, would be
most likely to promote the success of the company for the benefit of its members
as a whole, and in doing so have regard (amongst other matters) to:
(a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,86
(c) the need to foster the company’s business relationships with suppliers, cus-
tomers and others,
(d) the impact of the company’s operations on the community and the environ-
ment,
(e) the desirability of the company maintaining a reputation for high standards
of business conduct, and
(f) the need to act fairly as between members of the company.
(2) Where or to the extent that the purposes of the company consist of or include
purposes other than the benefit of its members, subsection (1) has effect as if the
reference to promoting the success of the company for the benefit of its members
were to achieving those purposes.
(3) The duty imposed by this section has effect subject to any enactment or rule of law
requiring directors, in certain circumstances, to consider or act in the interests of
creditors of the company.

Two principal reasons for the law reform, closely linked with one another, are
identified by Davies:87

85 See further, Andrew Keay ‘Section 172(1) of the Companies Act 2006: An Interpretation and Assessment’
(2007) 28 Company Lawyer 106. For some critical views on the UK approach, see Esser and Du Plessis, above
n 81, at 355–6.
86 This provision replaces the repealed s 309 of the Companies Act 1985 (UK), which recognised the interests
of company employees in a manner similar to the position in Parke v Daily News Ltd [1962] Ch 927. Fur-
thermore, under the repealed provision, employees were expressly denied the ability to enforce s 309. The
current provision does not appear to be an improvement on the employees’ position under the 1985 Act. Note
that s 247 of the current Act, similar to its predecessor, confers power upon the company to make provisions
for the benefit of employees on cessation or transfer of its business – notwithstanding the provisions of s 172.
87 Paul L Davies, Gower and Davies Principles of Modern Company Law, London, Sweet & Maxwell (8th edn,
2008) at 507–8.
 STAKEHOLDERS AND CSR 47

The first . . . was that the existing common law duty was thought to be insufficiently
precise in the guidance it gave to directors about whose interests should be promoted
in the exercise of their discretion . . . the [old formulation] that directors must act in
the interests of ‘the company’ comes close to being meaningless. This is because the
company is an artificial legal person and it is impossible to assign interests to it unless
one goes further and identifies with the company the interests of one or more groups
of human persons.
[The second] . . . the statutory formulation clearly rejects the ‘pluralist’ approach to the
law of directors’ duties . . . however, the rule of shareholder primacy was not intended
by the Government to be adopted in an unsophisticated way. Instead, the degree
of overlap between the interests of the members and those of other stakeholders is
emphasised through the directors’ duty to ‘have regard’ to the interests of other stake-
holders . . . [giving rise to] adopting a modernised version of shareholder primacy . . .

According to the then UK Trade and Industry Secretary, Patricia Hewitt: ‘The
proposals [now law] are part of a wide programme of action to boost enterprise,
encourage investment and promote long-term company performance.’
Express recognition of the importance of stakeholders, and stakeholder inter-
ests, within the general business community is also reflected in a major initiative
introduced in the UK in 2005. Under the Companies (Audit, Investigations and
Community Enterprise) Act 2004 (UK), which received royal assent on 29 October
2004 (and came into force in July 2005),88 a new type of company called the
CIC may be established. The CIC is a limited liability business form designed for
enterprises that wish to use their profits and assets for the ‘public good’.
The CIC is similar to the European Economic Interest Grouping (EEIG), a
specialised form of incorporation facilitated by European Community law and
based on the model of the French Groupement d’Intérêt Economique.89 According
to Davies, this form of incorporation is designed to enable existing business
undertakings in different EU member states to form an autonomous body to
provide services ancillary to the primary activities of its members.90 The EEIG
has not been popular in the UK, with as few as 185 set up there by 2006.91
The reason for the unpopularity of EEIGs, and what distinguishes the new CIC
business form from the EEIG, is that members of an EEIG are not protected by
limited liability; meaning that members are – personally – jointly and severally
liable for its debts.
Under the 2004 Act, an enterprise that wishes to be a CIC can choose one of
three company forms: (1) private company limited by shares; (2) private com-
pany limited by guarantee, or (3) public limited company. Social enterprises
tackle a wide range of social and environmental issues and operate in all parts

88 For proposed amendments, see Department for Business Enterprise & Regulatory Reform: Amendments
to the Community Interest Company Regulations 2005 – Summary of Responses and Government Response to
Consultation (2009), available at <www.berr.gov.uk/files/file51508.pdf>.
89 European Council Regulation 2137/85, [1985] 0.J. L199/1, Art. 16.
90 See Davies, above n 87, 27.
91 Ibid 28.
48 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

of the economy. The introduction of CICs came about because of the UK govern-
ment’s belief that social enterprises have a distinct and valuable role to play in
helping create a strong, sustainable and socially inclusive economy.
While CICs will provide the same certainty and flexibility as a standard com-
pany, they will be subject to a unique requirement – a so-called ‘asset lock’,
limiting the ability of CICs to distribute profits to members in the form of divi-
dends, or to distribute assets to members. This is to ensure that (subject to certain
exceptions and exemptions) the assets and profits of CICs will be used for the
community interest, rather than for private gain. It is intended that CICs will
be subject to less formal legal requirements than charities, but will not enjoy
the same tax benefits as charities. An organisation cannot be both a CIC and a
charity.
According to the Act, CICs are overseen by an independent regulator. The reg-
ulator has responsibility for considering CICs’ constitutions (including proposed
changes) and for providing ‘general guidance’ to CICs and their stakeholders,
and generally aims to maintain public confidence in CICs.
As an overview, the new regulatory regime has been designed so that CICs
will be:
● easy to set up, subject to adopting a suitable constitution and satisfying an
objective and transparent ‘community interest’ test (the test is whether
a reasonable person would consider the CIC’s activities to benefit the
community)
● able to issue shares to raise investment, but the dividends paid on those
shares would be capped (by the independent regulator, after consultation),
to protect the ‘asset lock’
● required to produce annual ‘community interest’ reports (which will be
made publicly available) on how they have pursued their social or com-
munity objectives and how they have worked with their stakeholders. This
requirement is to ensure that the community served by the CIC will have
easy access to the key information on its activities
● allowed to transfer assets to other suitable organisations, such as other
CICs or charities.92
It is considered that a CIC may be a suitable vehicle for an enterprise engaging
in social purposes, so that shareholders, financial backers, customers and other
stakeholders are clear that the enterprise is working principally for the benefit
of the community rather than private gain, thus avoiding potential liability for
breaches of directors’ duties, oppression or other action, for not focusing on
commercial objectives and maximising profits and dividends for shareholders.93
Thus, while the UK common law continues to uphold the traditional principle
that directors owe their duty to the company, and that this requires directors to
92 See ‘New Corporate Governance Laws for UK’, Corporate Law Electronic Bulletin, Lawlex, November 2004,
1.12; Department of Trade and Industry (UK), ‘An Introduction to Community Interest Companies’, December
2004, available at <www.ssec.org.uk/files/cicfactsheet1.pdf>.
93 As at 26 April 2010, some 3630 CICs had been registered – see <www.cicregulator.gov.uk/coSearch/
companyList.shtml>.
 STAKEHOLDERS AND CSR 49

focus on maximising profits, the recent introduction of the CIC has changed the
landscape somewhat by enabling this form of company to give priority to social
objectives – with non-shareholder stakeholders being the principal beneficiaries.

2.3.2.5 Canada
Operators of social or community enterprises have been creatively working with
the available patchwork of legal structures in Canada under provincial or fed-
eral legislation (partnerships, companies, cooperatives, non-profit organisations,
registered charities) with ‘virtually no corresponding legislative or regulatory
innovation’94 comparable to the position in the UK (CICs) and the USA (L3Cs).
Researchers at the British Columbia Centre for Social Enterprise have made, inter
alia, the following law reform recommendations in an effort to modernise the
organisational infrastructure that applies to social enterprise to better enable it
to flourish:95
● That the Government of Canada enact a Community Enterprise Act, which
draws upon the best of the recent legislative innovations in the UK (CICs)
and the USA.
● That this Community Enterprise Act enable new organisations to incorpo-
rate as ‘Community Enterprises’ – similar to CICs in the UK. They should
have the capacity to issue shares to investors, subject to limitations on
scope of activities and on investment returns, and a capital lock to ensure
that assets remain primarily for community benefit.
● That this Community Enterprise Act should define ‘community benefit’
and provide a mechanism for entities incorporated under other federal or
provisional legislation that meet that test to be eligible for favourable tax
treatment and other incentives the government may decide to establish.
The impetus for the above call to law reform comes from the global financial crisis
of 2008 and the preceding fundamental economic changes in Canada (such as the
potential collapse of the automotive manufacturing industry) which, according
to Bridge and Corriveau,96 underscores the urgency of the need to adopt and
redesign the ways in which the economy and communities function. In their
view, as the old industrial model will not return in its old form, social enterprise
should be at the forefront of this redesign.

2.3.2.6 New Zealand

New Zealand has, under its Companies Act 1993, a provision similar to the now-
repealed section 309 of the Companies Act 1985 (UK), although it is expressed
slightly differently. Section 132(2) of the New Zealand Act states:

94 Richard Bridge and Stacey Corriveau, Legislative Innovations and Social Enterprise: Structural Lessons for
Canada, BC Centre for Social Enterprise (February 2009) 3, available at <www.centreforsocialenterprise.
com/f/Legislative Innovations and Social Enterprise Structural Lessons for Canada Feb 2009.pdf>. This
article provides a useful overview of legal structures available for blended enterprise in North America.
95 Ibid, 12–13.
96 Ibid, 2.
50 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

The constitution of a company may provide that a director may, when exercising powers
or performing duties as a director, act in a manner which he or she believes on reason-
able grounds is in the best interests of a shareholder or group of shareholders, or any
other entitled persons, notwithstanding that such action may not be in the best interests
of the company. (emphasis added)

Section 132(2) is expressed such that ‘any other entitled persons’ could presum-
ably include creditors, employees, charitable organisations, perhaps even society
at large or the environment, depending on how the relevant provision in the com-
pany’s constitution is framed. The section therefore appears to embrace a wider
range of stakeholders, and is not limited to employees. Like the repealed section
309 of the UK Act, section 132(2) may appear at first glance to transcend the
narrow confines of the common law and provide directors with a licence to place
stakeholder interests ahead of the interests of the company and its shareholders.
But, again, a closer analysis demonstrates otherwise.
Section 132(2) does not establish fresh directors’ duties towards the ‘entitled
persons’ that come within the section, but simply makes it clear that the interests
of these ‘entitled persons’ can be taken into account by directors as part of
their function of administering the company in the company’s best interests
(meaning, with a view to achieving profits). That is, section 132(2) is only a
clarification of the existing position at common law, rather than an alteration of
the law. Similar confirmation of the interests that directors can take into account
when performing their functions could be obtained through reference to judicial
decisions.
Furthermore, the reference in section 132(2) to the ability of companies
to specify in the constitution the manner in which directors can exercise their
duties provides no additional power to companies, but again simply confirms the
position at common law, reinforced by statutory provisions.
In Australia, at common law and supplemented by general statutory
provisions,97 the company has tremendous freedom (subject to approval by
shareholders via a special resolution) to structure its constitution to determine
the corporate governance rules and procedures it will follow, and in doing so
shape the nature and content of the duties of directors98 – see Chapter 4.
The company’s constitution can set out the manner in which the duties of its
directors shall be performed, and whose interests may be be considered when
performing these duties, even if this departs from the traditional conception of
how the particular duties are to be exercised99 – although the company and

97 See s 136 of the Corporations Act 2001 (Cth), which sets out that the company’s constitution can be
adopted or modified, and does not expressly prohibit any particular clauses or matters being dealt with by
the company in its constitution.
98 See Robert Baxt, Keith Fletcher and Saul Fridman, Corporations and Associations: Cases and Materials,
Sydney, LexisNexis Butterworths (10th edn, 2009) 299: ‘ . . . by and large a company may control its own
destiny by the terms of its constitution’.
99 See R P Austin and I M Ramsay, Ford’s Principles of Corporations Law, Chatswood, LexisNexis (14th edn,
2010) 459 para 8.370: ‘It is a central principle of the law of fiduciaries that the principal may authorise the
fiduciary to engage in conduct which would otherwise be a breach of fiduciary duty, and may condone or ratify
 STAKEHOLDERS AND CSR 51

its directors must refrain from conduct that may be considered oppressive or
unfairly prejudicial to a particular shareholder or class of shareholders (see Part
2F.1 of the Corporations Act, and Chapter 12 of this book).100 Indeed, there is an
inherent logic in allowing modification of directors’ duties through the provisions
of the company constitution. As the duties are owed to the company, the company
(through the general body of shareholders passing a special resolution to support
a constitutional amendment) should be allowed some say as to how these duties
will apply (if at all) to their directors. Confirming that the company can use its
constitution to determine how directors may act when performing their duties,
which section 132(2) does, could be described as legislative overkill.

2.3.2.7 South Africa

In September 2009, a new King Report was released, also known generally as
the King III Report.101 The King Report (2009) is accompanied by a separate
volume, ‘King Code of Governance Principles for South Africa 2009’. The main
difference between King Report (2002)102 and the King Report (2009) is that
the latter is much shorter and concentrates more on the principles of corporate
governance than by comprehensive discussion of the principles. Most of the
principles discussed in the King Report (2002) still form part of the King Report
(2009).
The King Report (2002) is a comprehensive document that sets in place guide-
lines for best practice in corporate governance in South Africa. The King Report
was first released in 1994, and then revised in 2002 and, as mentioned, it is the
King Report (2009) that will apply in South Africa in future. When first released,
the King Report was revolutionary, in providing a very clear and extensive expla-
nation of how companies in South Africa should account for the interests of
stakeholders, and articulating the benefits that such an ‘inclusive approach’ to
governance could provide companies. Indeed, so-called ‘integrated sustainabil-
ity reporting’ was recognised over and above the financial and regulatory aspects
of corporate governance.
The King Report (2002) acknowledged a shift away from the single ‘bot-
tom line’ (meaning, the approach of businesses focusing on generating prof-
its for shareholders) to a triple bottom line, which embraces the economic,

a breach which has already occurred.’ Also, in the specific context of the duty of directors to avoid conflicts
of interests, it is noted that in large companies it is common for a company to alter the content of the duty to
avoid conflicts so that conflicts do not need to be put to the general meeting for a vote: [9.120]. However,
[8.385] of Ford’s Principles of Corporations Law notes that there are arguments as to why the equivalent
statutory duties should not be as easy to ‘opt out’ of, although case law in Australia has not endorsed these
arguments.
100 See also Gambotto v WCP Ltd (1995) 182 CLR 432; Ian Ramsay (ed.), Gambotto v WCP Limited: Its
Implications for Corporate Regulation, Melbourne, Faculty of Law, The University of Melbourne (1996).
101 King Report on Governance for South Africa 2009 (King Report (2009)), Johannesburg, Institute of
Directors (2009), available at <http://african.ipapercms.dk/IOD/KINGIII/kingiiireport/>.
102 King Report on Corporate Governance (King Report (2002)), Parktown, South Africa, Institute of Directors
in Southern Africa (March 2002).
52 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

environmental and social aspects of a company’s activities. The concepts of

‘sustainability’ and the ‘triple bottom line’ are used interchangeably in the
report.
In accommodating the interests of stakeholders, by ‘recognising the impor-
tance of the relationship between an enterprise and the community in which it
exists’, the revised Report states that integrated sustainability reporting is to be
achieved as follows:
2.1: Every company should report at least annually on the nature and extent of
its social, transformation, ethical, safety, health and environmental man-
agement policies and practices.
2.2: The board of directors should, in determining what is relevant for disclo-
sure, take into account the environment in which the company operates.
3.1: A company should demonstrate its commitment to organisational integrity
by qualifying its standards in a code of ethics.
3.2: Each company should demonstrate its commitment to its code of ethics by:
● creating systems and procedures to introduce, monitor and enforce its
ethical code;
● assessing high level individuals to oversee compliance with the ethical
code;
● assessing the integrity of new appointees in selection and promotion
procedures;
● exercising due care in delegating discretionary authority;
● communicating with and training all employees regarding enterprise
values, standards and compliance procedures;
● providing, monitoring and auditing safe systems for reporting of uneth-
ical or risky behaviour;
● consistently enforcing appropriate discipline;
● responding to offences and preventing reoccurrences.
Chapter 8 of the King Report (2009) deals extensively with ‘governing stakehold-
ers’ relationships. In Chapter 9 of the King Report (2009) the important issue of
‘Integrated reporting and disclosure’ is discussed.
The King Report (2009) deals with ‘emerging governance trends’ incorporated
in the Report, focusing on:103
● Alternative dispute resolution;
● Risk-based internal audit;
● Shareholders and remuneration; and
● Evaluation of board and director performance.
The new issues included in the King Report (2009) are:104
● Information technology governance;
● Business rescues; and
● Fundamental and affected transactions.

103 King Report (2009), above n 101, 11–14.

104 Ibid 14–17.
 STAKEHOLDERS AND CSR 53

2.4 Stakeholder interests, good governance

and the interests of the corporation:
A mutual relationship

2.4.1 General analysis

How does taking into account, and protecting, the interests of stakeholders
contribute towards good corporate governance? Can taking into account a broad
constituency of interests actually lead to poor corporate governance? Whether or
not an integrated approach to managing the corporation is consistent with good
corporate governance, and in the best interests of the corporation, is a question
upon which divergent views are held, and upon which – especially recently –
there has been a great deal of commentary.
While the virtue of protecting the interests of the collection of stakeholders
is generally acknowledged, there are some who believe that any approach to
corporate governance that departs from a strict wealth-maximisation view is
simply unworkable. For example, Mallin contends:

Another very important point is that if the directors of a company were held to be respon-
sible to shareholders and the various stakeholders groups alike, then what would be
the corporate objective? How could the board function effectively if there were a mul-
tiplicity of different objectives, no one of which took priority over the others? . . . This
could actually lead to quite a dangerous situation where directors and managers were
not really accountable.105

In a similar vein, Thomas Clarke writes that:

The difficulty is whether in trying to represent the interests of all stakeholders, com-
pany directors simply slip the leash of the only true restraint that regulates their
behaviour – their relationship with shareholders. In apparently seeking to become
the arbiter of the general interest, all that occurs is that executives become a self-
perpetuating group of princes.106

In our view, an integrated approach to corporate governance, by which directors

and management not only consider the impact that company decisions will
have on the bottom line but also the broader social, political and economic
impacts of the decision, is desirable and is the most effective way to ensure that
a company achieves long-term, sustainable growth. This section of the chapter
briefly explores the importance of ‘redefining the corporation’ by integrating
stakeholder interests as a component of managing the corporation. The recent
James Hardie asbestos scandal in Australia, in which James Hardie’s parent
company ultimately agreed to provide compensation to asbestos victims (who
could be viewed as employees, creditors or both) even though there was no clear

105 Mallin, above n 8, 58.

106 Thomas Clarke, ‘The Stakeholder Corporation: A Business Philosophy for the Information Age’ in Theories
of the Corporation: The Philosophical Foundations of Corporate Governance, London, Routledge (2004) 189,
193.
54 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

legal obligation to do so, is used as a case study highlighting how adoption of

an integrated approach to management is more in tune with the best interests
of the corporation over the long term than taking a short-term, narrow focus on
the company’s share price and what is best for shareholders.
In Redefining the Corporation – perhaps the most important work so far this
decade on the role of stakeholders in corporate governance, and mentioned
earlier in this chapter – the authors explain that:
The modern corporation is the center of a network of interdependent interests and
constituents, each contributing (voluntarily or involuntarily) to its performance, and
each anticipating benefits (or at least no uncompensated harms) as a result of the
corporation’s activities.107

Indeed, a field of ‘stakeholder management’ has emerged as a distinctive compo-

nent of strategic management, out of recognition of how so-called ‘stakeholder
linkages’ can contribute to organisational wealth and to the overall well-being
and success of the corporation. Most of the constituents in the corporation are
essential to the operations of the corporation because they contribute inputs,
receive outputs, or – whether actively or passively – provide its ‘license to oper-
ate’ as an institution within the economy and society.108 Post, Preston and Sachs
express the positive interrelationship between respect for stakeholder interests
and the best interests of the corporation, as follows:
Although the ultimate justification for the existence of the corporation is its ability
to create wealth, the legitimacy of the contemporary corporation as an institution
within society – its social charter, or ‘license to operate’ – depends on its ability to meet
the expectations of an increasingly numerous and diverse array of constituents. The
modern, large, professionally managed corporation is expected to create wealth for its
constituents in a responsible manner (that is, not by theft or deception). The connection
between wealth and responsibility has been stressed by both business leaders and critics
for more than a century, and if the corporation can continue to survive and succeed
today it must continue to adapt to social change.109

In presenting the case for a ‘stakeholder model’ of the corporation, based on their
wider definition of ‘stakeholder’110 (discussed earlier in this chapter), Post and
colleagues argue that there are two principal reasons to reassess and redefine
the large, well-established corporation to accommodate or integrate stakeholder
interests:
1. Size and socioeconomic power – Leading global corporations have access
to vast resources (including specialised knowledge), overwhelming bar-
gaining power with respect to most of their constituents, and extraordinary
ability to influence their environments. They are not microscopic economic
actors at the mercy of market forces and omnipotent governments.
107 Post, Preston and Sachs, above n 9, 8.
108 Ibid 229.
109 Ibid 9.
110 Ibid 10.
 STAKEHOLDERS AND CSR 55

2. Inaccuracy of the ‘ownership’ model and its implications – Shareowners hold

securities, but they do not own the corporation in any meaningful sense,
nor are they the only constituents vital to its existence and success. The
notion that shareowner interests should dominate those of all other corpo-
rate constituents is inconsistent with the observed behaviour of successful
firms. Therefore, the conventional shareowner-dominant model of the
corporation is unrealistic, as well as normatively unacceptable.111
In light of the above reasons, Post, Preston and Sachs then emphasise the com-
mercial imperative of stakeholder management, stating:

The corporation requires and receives inputs, some of them involuntary, from multiple
sources, and has an impact on many constituents, favourable or otherwise. The corpo-
ration cannot – and should not – survive if it does not take responsibility for the welfare
of all of its constituents, and for the well-being of the larger society within which it
operates.112

And further:

In democratic political systems, which are uniquely hospitable to market-oriented

economic arrangements, no business activity that causes substantive negative impact
on any significant group of people or interests can be expected to survive, unless it
offers conspicuous and broadly distributed offsetting benefits.113

In addition to the significant work undertaken by the ‘Redefining the Corporation’

project in alerting interested observers to the important link between recognition
of stakeholders and good corporate governance and performance, the OECD
Principles of Corporate Governance is another excellent source in this area. See
discussion above and in Chapter 1.
The article by Steve Letza, Xiuping Sun and James Kirkbride114 explains that
this consequentialist view of stakeholder management, stressing the important
connection between protecting stakeholder interests and good corporate gover-
nance and performance, is referred to in the management literature as ‘instru-
mental stakeholder theory’ – as distinct from social entity theory (a general theory
that the company should serve multiple stakeholder interests).115 According to
Letza and colleagues, rather than justifying stakeholder interests on the basis of
moral value and fundamental human rights, the ‘instrumental stakeholder the-
ory’ legitimises stakeholder value on the grounds that stakeholder management
is an effective means to improvement of efficiency, profitability, competition and
economic success.

111 Ibid 10–11.

112 Ibid 16.
113 Ibid 21.
114 Letza, Sun and Kirkbride, above n 4, 242.
115 Ibid 251.
56 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

2.4.2 Case study of James Hardie’s asbestos

compensation settlement116
The James Hardie asbestos scandal – which filled Australian newspapers in
2004 and was the subject of a Special Commission of Inquiry117 – and the com-
pany’s historic settlement with claimants just before Christmas 2004 is an excel-
lent case study supporting what has been stated above about the positive link
between respect for stakeholder interests and good corporate governance and
performance. The lessons from the James Hardie experience are not purely legal
ones.118 One salient lesson concerns the need for ethical standards and increased
social responsibility.119 The strategy embarked upon by James Hardie, to divest
itself of its asbestos liabilities, has been described by the Australian Council of
Trade Unions as ‘one of the most morally and legally repugnant acts in Australian
corporate history’.120 Although the actions of James Hardie (discussed below) is
not unprecedented,121 the conscience of the former directors of James Hardie, in
relation to its strategic behaviour in the separation plan and the limited funding
of claims by its asbestos victims, has been found to be sorely wanting.122
Some background on James Hardie and the 2004 asbestos scandal is required
in order to appreciate the significance of the agreement negotiated in Decem-
ber 2004, and its direct relevance to the present discussion on the relationship
between stakeholders and corporate governance and performance.
Companies in the James Hardie group were major participants in the man-
ufacture of asbestos products, in the 1920s, which were used extensively in
Australia during the major part of the past century, particularly in building prod-
ucts and insulation materials. James Hardie had been responsible for 70 per cent
of Australian asbestos consumption.123 Asbestos, however, is injurious to health
and its fibres can give rise to asbestosis, lung cancer and mesothelioma, which is
often fatal. The disease may not manifest itself immediately, and it is not uncom-
mon for a severe medical condition to arise some decades after exposure to the
asbestos fibre. Asbestosis was common in the 1920s, and the insidious effect of
asbestos and its link to mesothelioma was established in 1960.124

116 The following discussion draws largely from Anil Hargovan, ‘Corporate Governance Lessons from James
Hardie’ (2009) 33 Melbourne University Law Review (forthcoming).
117 David Jackson, ‘Report of the Special Commission of Inquiry into the Medical Research and Com-
pensation Foundation’ (Jackson Report) (September 2004), available at <http://www.dpc.nsw.gov.au/
data/assets/pdf file/0020/11387/Part A.pdf>.
118 See Chapter 10 (Directors’ duties and liability) for discussion on the legal lessons that emerged from the
decisions in ASIC v Macdonald (No 11) (2009) 256 ALR 199; ASIC v Macdonald (No 12) [2009] NSWSC 714.
119 For the views of the leading advocate on corporate goals and social responsibilities, see Dodd, above
n 1, 1145.
120 ABC 7.30 Report Transcript, ‘James Hardie Executives Accused of Fraud’ (29 July 2004), available at
<www.abc.net.au/7.30/content/2004/s1164158.htm>.
121 For a critical and valuable examination of the use of the limited fund strategy by the largest manufacturer
and supplier of asbestos products in the USA, see Peta Spender, ‘Blue Asbestos and Golden Eggs: Evaluating
Bankruptcy and Class Actions as Just Responses to Mass Tort Liability’ (2003) 25 Sydney Law Review 223.
122 Peta Spender, ‘Weapons of Mass Dispassion: James Hardie and Corporate Law’ (2005) 14 Griffith Law
Review 280.
123 Jackson Report, above n 117, 59.
124 Ibid at 18.
 STAKEHOLDERS AND CSR 57

James Hardie Industries Ltd (now ABN 60 Pty Ltd) manufactured asbestos
products until 1937, whereupon this activity was taken over by its subsidiary,
James Hardie & Coy Pty Ltd (now Amaca Pty Ltd), which became a substantial
producer until it ceased this business activity in the 1980s. Another business arm
of the corporate group manufactured brake-lining products (formerly Jsekarb
Pty Ltd, now Amaba Pty Ltd) until its sale to an independent party in 1987.
These three companies in the James Hardie Group were the main participants
in the manufacture and distribution of asbestos products. These companies,
together with Mr Macdonald as its CEO, Mr Shafron as the company secretary
and general counsel and Mr Morley as the chief financial officer (CFO), were to
form the dramatis personae in the corporate reconstruction of James Hardie125
and the subsequent litigation in ASIC v Macdonald (No 11) (2009) 256 ALR 199
discussed in Chapter 10.

Impetus for corporate restructure

A switch in business focus to the USA, and the development of new, non-asbestos
products in the 1980s proved successful for the James Hardie Group and provided
the impetus to separate the accruing asbestos liabilities in Australia from the
Group’s core business in the USA. The impetus to divest itself of its asbestos
liabilities also came from the desire of the Group to remove what it perceived as
an obstacle to its aspirations to access the capital market in the USA. An aborted
attempt to issue 15 per cent of the shares of a related Dutch company (JH NV) on
the New York Stock Exchange added to the impetus for a corporate restructure
to ‘fully realise the value of JHIL, and for its growth prospects to be realised’126
by adopting the USA as the Group’s base. Without separation of the asbestos-
related liabilities on its balance sheet, it was thought that listing in the USA was
commercially unrealistic.127
Three other influential factors impacted on the momentum towards corporate
reconstruction and its timing. The first factor included the desire to avoid the
impact of a proposed new Australian Accounting Standard, due to come into
force in October 2001, which would require disclosure of the total of the Group’s
estimated asbestos liabilities.128 The second factor was the desire to capitalise on
the timing of the announcement of the Group’s third quarter results to the market
on 16 February 2001.129 It was envisaged that simultaneous announcement of
the Group’s profits, together with the corporate restructure plan, would deflect
from a controversial issue that might otherwise attract undesirable publicity.
The third factor related to the effluxion of time and the Group’s new business
and stewardship of the business. Within this context, the James Hardie Group’s

125 There have been many changes in the identity and names of the James Hardie companies over the years.
This chapter, however, refers to the three companies relevant for purposes of this discussion as James Hardie
Industries Ltd (JHIL), Amaca and Amaba.
126 Jackson Report, above n 117, 24.
127 Ibid 340.
128 Ibid 25.
129 Ibid 26, 351.
58 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

asbestos liabilities were treated as ‘non-core issues’,130 a source of ‘management

distraction’131 and regarded as ‘legacy issues’132 that formed ‘part of the rump’.133
Against this backdrop of corporate aspiration and apparent indifference to
the fact that the James Hardie Group remained accountable for negligence in the
manufacture or distribution of asbestos products over the past century, notwith-
standing cessation of that business, the Group marched forward with a separation
plan that was poorly executed, as illustrated below.

Key features of the separation plan

In the period from 2000 to 15 February 2001, management of JHIL worked on
a plan (known as Project Green) to divest the Group of its asbestos liabilities
through the use of a trust structure in the following way. Amaca and Amaba
were to remain responsible to claimants for asbestos-related liabilities, to the
extent of their existing assets, but ownership of both these companies would
pass from JHIL to a new company unrelated to JHIL, known as the Medical
Research and Compensation Foundation Ltd (Foundation) which would operate
as a trust. The Foundation, a company limited by guarantee, became the trustee
of the Foundation trust. New directors were appointed to the trust and to Amaca
and Amaba. The structure adopted sought to exploit the benefits of the separate
legal entity rule134 and limited liability ordinarily conferred on companies by the
corporate veil and extended to corporate groups.135
Furthermore, as part of the concerted effort to quarantine JHIL from its
asbestos liabilities, the following arrangements were put in place. In return
for payments to be made over time by JHIL to each of Amaca and Amaba, JHIL
was to be indemnified by both these companies against any asbestos-related lia-
bilities that JHIL might have. Moreover, both these companies agreed to forego
any claims against JHIL arising from any past dealings with it, including the pay-
ment of dividends or management fees. Recovery of such intra-group payments

130 Ibid 19.

131 Ibid.
132 Ibid.
133 Ibid.
134 Salomon v Salomon & Co Ltd [1897] AC 22.
135 Walker v Wimborne (1976) 137 CLR 1; Industrial Equity Ltd v Blackburn (1977) 13 CLR 567. The ques-
tion whether existing laws concerning the operation of limited liability or the corporate veil within corporate
groups requires reform is explored in a wealth of literature. See, for example, F Easterbrook and D Fischel,
‘Limited Liability and the Corporation’ (1985) 52 University of Chicago Law Review 89; P Blumberg, ‘Limited
Liability and Corporate Groups’ (1986) 11 Journal of Corporation Law 573; P Blumberg, ‘The Transforma-
tion of Modern Corporation Law: The Law of Corporate Groups’ (2005) 37 Conn L Rev 605; K Strasser,
‘Piercing the Veil in Corporate Groups’ (2005) 37 Conn L Rev 637; James McConvill, ‘Revisiting Holding
Company Liability For Subsidiary Company Debts in Australia: A Response To The James Hardy Controversy’
(2005) 7 The University of Notre Dame Australia Law Review 23; Anil Hargovan and Jason Harris, ‘Piercing
the Corporate Veil in Canada: A Comparative Analysis’ (2007) 28 The Company Lawyer (UK) 58; P Prince,
J Davidson and S Dudley, ‘In the Shadow of the Corporate Veil: James Hardie and Asbestos Compensa-
tion’ (2004), available at <http://parlinfo.aph.gov.au/parlInfo/download/library/prspub/KXED6/upload
binary/kxed65.pdf;fileType=application%2Fpdf#search=%22Prince%20Davidson%20Dudley%22>. The
deficiencies in Australian corporate law concerning the operation of limited liability within corporate groups
were noted in the Jackson Report, above n 118, 571–3.
 STAKEHOLDERS AND CSR 59

was barred by a deed of covenant and indemnity (DOCI) entered into by the
contracting parties.136

Public announcement of the separation

The events surrounding the public announcement of the separation were also
germane to the litigation in ASIC v Macdonald (No 11) (2009) 256 ALR 199. The
draft ASX announcement media, which ASIC alleged was before the board on
15 February 2001137 and which was subsequently released to the public on 16
February 2001, was an integral part of the public relations planning in relation
to the separation. The theme of certainty of sufficient funding pervaded this, and
future, media statements that became the focus of attention in the Macdonald lit-
igation, discussed further in Chapter 10. The final ASX announcement included,
inter alia, the following statements, which ASIC alleged to be false or misleading
and the basis of the directors’ breach of the statutory duty of care and diligence
in section 180(1) of the Corporations Act 2001 (Cth):138
The Foundation has sufficient funds to meet all legitimate compensation claims . . . Mr
Peter Macdonald said that the establishment of a fully-funded Foundation provided
certainty for both claimants and shareholders . . . In establishing the Foundation, James
Hardie sought expert advice . . . James Hardie is satisfied that the Foundation has
sufficient funds to meet anticipated future claims . . .

Scheme of arrangement and relocation to The Netherlands

After the establishment of the Foundation in February 2001, steps were imple-
mented in October pursuant to a scheme of arrangement139 to substitute a new
Dutch company (JHI NV) for JHIL as the holding company of the Group – with
JHIL becoming a wholly owned subsidiary of JHI NV. The impetus for the move
to the Netherlands centred on the prospect of further international growth for
the Group, as well as being in the best interests of the shareholders as a whole
due also to the improvement in the after-tax returns to shareholders.140
A brief overview of the mechanics of the scheme is relevant to the legal issues
subsequently raised in ASIC v Macdonald (No 11) (2009) 256 ALR 199. One of
the main features of the scheme involved JHI NV subscribing for partly paid
shares in JHIL. Consequently, JHIL could call on its holding company to pay any
or all of the remainder of the issue price of those shares at any time in the future.
Significantly, the amount callable under the partly paid shares would be equal to
the market value of the James Hardie Group less the subscription monies already
136 The events surrounding the execution of the separation plan were relevant to the litigation in ASIC v
Macdonald (No 11) (2009) 256 ALR 199.
137 This point was contested, unsuccessfully, by the 10 former directors and officers who claimed that they
had no recollection of this document being tabled at the board meeting. See further, Macdonald (2009) 256
ALR 199, 239–44.
138 Ibid 229–30.
139 Corporations Act 2001 (Cth) s 411.
140 Jackson Report, above n 117, 33. James Hardie, ironically, offered a similar reason for its plan to move its
corporate domicile from the Netherlands to Ireland following approval by the Federal Treasurer, but subject
to approval of a meeting of shareholders anticipated in early 2010. ‘James Hardie Cleared for Ireland Move’
Sydney Morning Herald (22 September 2009).
60 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

paid up. This sum was considerable and was likely to be in the region of $1.9
billion.141 The significance of this feature of the scheme was underscored when
JHIL assured Justice Santow, during the application for approval of the scheme
in the New South Wales Supreme Court in October 2001, that JHIL had the
ability to satisfy any asbestos-related liabilities by calling upon the partly paid
shares.142
The cancellation of the partly paid shares, and the formation of a new founda-
tion in March 2003 to acquire the shares in JHIL, ensured the complete removal
of JHIL from the James Hardie Group. The subsequent failure to inform the pub-
lic immediately of this development also became the focus of attention in the
Macdonald litigation.
It is against this background of the very large discrepancy between the initial
funding of the Foundation and the actuarial assessments of its liabilities that
gave rise to controversy and the appointment of the Commission of Inquiry.
Concerns above the adequacy of arrangements available to the Foundation to
meet its liabilities were also underscored by its application to court143 to seek
relief that would permit payments to claimants in full, notwithstanding statutory
provisions that prohibit insolvent trading.144

Jackson Report and its significance

Because of the emerging crisis facing the Foundation and asbestos victims, in
February 2004 the New South Wales Government set up a Special Commission
of Inquiry, chaired by David Jackson QC, to put on the record how the crisis had
developed, who was responsible, what had gone wrong and why, with a view
to determining whether imposing liability on the ultimate holding company
of James Hardie was an appropriate and reasonable course of action to take.
Specifically, Commissioner Jackson was to report on:
1.1 the current financial position of the Foundation, and whether it was likely
to meet its future asbestos related liabilities in the medium to long term
1.2 the circumstances in which the Foundation was separated from the James
Hardie Group, and whether this may have resulted in or contributed to a
possible insufficiency of assets to meet its future asbestos-related liability
1.3 the circumstances in which any corporate reconstruction or asset transfers
occurred within or in relation to the James Hardie Group prior to the
separation of the Foundation from the James Hardie Group, to the extent
that this may have affected the ability of the Foundation to meet its current
and future asbestos-related liabilities

141 Ibid 34.

142 Management of JHIL did not alert the court of the Foundation’s concerns over the inadequacy of the
initial funding and the Foundation’s fears of being unable to meet the claims of all asbestos victims that were
expressed by the Foundation in a director’s letter dated 24 September 2001. Justice Santow approved the
scheme under these circumstances.
143 Edwards v Attorney General (NSW) (2004) 50 ACSR 122; [2004] NSWCA 272.
144 Corporations Act 2001 (Cth) s 588G.
 STAKEHOLDERS AND CSR 61

1.4 the adequacy of current arrangements available to the Foundation under

the Corporations Act to assist the Foundation to manage its liabilities, and
whether reform is desirable to those arrangements to assist the Foundation
to manage its obligations to current and future claimants.145
The first, and most important, term of reference dealt with in the Report related
to ‘the circumstances in which MRCF [the Foundation] was separated from the
James Hardie Group and whether this may have resulted in or contributed to a
possible insufficiency of assets to meet its future asbestos-related liabilities’.
Commissioner Jackson explained in his report that the restructuring of the
James Hardie Group and the separation of the asbestos-liable subsidiary com-
panies – Amaca and Amaba – from the Group was not illegal, and indeed was a
valid arrangement by the company, with a view to elevating its share price and
attracting capital from the USA. Commissioner Jackson did find, however, that
the separation from the Group was a cause of the Foundation’s dilemma, and that
on the facts the Group did bear some responsibility for this. The Commissioner
remarked incredulously:

‘ . . . I find it difficult to accept that management could really have believed that the funds
of the Foundation would have been sufficient . . . yet that was the message that JHIL
propounded . . . the day after separation, to the Australian Stock Exchange (ASX), to
government, the media, its shareholders, unions, plaintiffs’ solicitors, asbestos victims
and anybody else it felt the need to convince.’146

Later in the Report, Commissioner Jackson stated that:

. . . there was no legal obligation on JHIL to provide Amaca and Amaba, on separation,
with any funds in addition to the assets of those companies. Amaca and Amaba were not
stripped of assets; they retained them. Indeed they obtained more than those assets by
reason of the additional periodic payments . . . But in practical terms, separation was,
in my opinion, likely to have an effect of that kind. If separation had not taken place
in February 2001, it seems likely that, for the indefinite future, the asbestos liabilities
would have been treated, as they had been for years, as one of the annual expenses of
the Group.147

After the wide-ranging enquiry on the financial position of the Foundation, its
likelihood to meet its asbestos-related liabilities into the future and the circum-
stances of the corporate reconstruction of James Hardie, Commissioner Jackson
came to the following conclusions that are relevant for the purposes of this dis-
cussion and the litigation in ASIC v Macdonald (No 11) (2009) 256 ALR 199,
discussed in Chapter 10:
● As at 30 June 2004, liabilities of the Foundation were estimated at not less
than $1.5 billion. Against that, the value of the total assets acquired by the
Foundation was $293 million;148

145 See Jackson Report, above n 117, Part A, 1.

146 Ibid [1.1.4].
147 Ibid [1.23] (emphasis added).
148 Ibid, 8.
62 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

There was no prospect of the Foundation meeting the liabilities of Amaca

●
and Amaba in either the medium or long term due to the rapid depletion
of the funds used in the payment of current claims149 and that the life of
the Foundation was about three years or a little less;150
● The actuarial report produced by Trowbridge (February 2001) provided no
satisfactory basis for the assertion that the MRCF [the Foundation] would
have sufficient funds to meet all future claims;151
● The evidence demonstrated that the February 2001 estimates of future
liabilities were ‘far too low and that the results of the financial modelling
were wildly optimistic’;152
● The public announcements made by JHIL at the time of separation (16
February 2001) emphasised that JHIL had provided for a Foundation
which had sufficient funds to satisfy all future legitimate asbestos-related
claims;153
● The media release sent to ASX, conveying the idea of ‘certainty’ with respect
to the Foundation’s funding, was seriously misleading and also conveyed
the misleading impression that the funding amount JHIL arrived at was
checked by independent experts;154
● Contrary to the claims in the media release sent to ASX, the Foundation
was not ‘fully-funded’. It was massively under-funded;155 and
● The JHIL board meeting of 15 February 2001 approved ASX announcement
to be made by JHIL.156 This view, however, was unsuccessfully challenged
by the board in Macdonald despite the absence of direct evidence of board
approval.
The company’s patent failure to observe CSR norms was crystallised in the Jack-
son Report with the following observation:157

The notion that the holding company would make the cheapest provision thought
‘marketable’ in respect of those [asbestos] liabilities so that it could go off to pursue its
other more lucrative interests insulated from these liabilities is singularly unattractive.
Why should the victims and the public bear the cost not provided for?

Aftermath
Despite the fact that it was made clear in the Special Commissioner’s report that
James Hardie had no legal obligation to make up for the shortfall of funds in the
Foundation, the company was pressured to do so by a sliding share price and the
implementation of government bans on the purchase of James Hardie products,
as well as by the threat of specific legislation being introduced to, in effect, unwind

149 Ibid 7.
150 Ibid 63.
151 Ibid 9.
152 Ibid 12.
153 Ibid 8.
154 Ibid 10.
155 Ibid 356.
156 Ibid 351.
157 Ibid 13.
 STAKEHOLDERS AND CSR 63

the company’s 2001 restructure so that liability could be imposed on the parent
company. Accordingly, over a period of 13 weeks following the handing down
of Commissioner Jackson’s report, James Hardie entered into negotiations with
the New South Wales Government and the Australian Council of Trade Unions
(ACTU) to find a mutually satisfying way to resolve the impending funding
crisis. The willingness of James Hardie to agree to negotiations was significant,
given that the predominant reason for its move to the Netherlands in 2001 was,
allegedly, to avoid having to fund the asbestos claims.
On 21 December 2004, an agreement between James Hardie, the ACTU and
the New South Wales Government was announced. The agreement detailed
the way in which James Hardie would compensate asbestos victims for at least
40 years. James Hardie agreed to make annual payments to a special-purpose
fund, capped at 35 per cent of its free cash flow. Initially, James Hardie agreed to
inject into the special-purpose fund three years’ worth of funding (approximately
$240 million).158 The total value of the agreement was estimated to be as high
as $4.5 billion.159
The decision by James Hardie to negotiate a settlement was obviously
designed with shareholder interests in mind, with the agreement seen as a way
to improve the company’s economic and share price performance – indeed, on
the day of the announcement the company’s share price rose by 6 per cent and
a number of boycotts on James Hardie products were lifted. It was, in effect,
the lesser of two evils (the other option being specific legislation). Nevertheless,
commentators emphasised that there was also a moral element to the agreement.
One commentator described the James Hardie episode as ‘one of Australia’s
most protracted and bitter fights for moral justice [by] James Hardie Industries
signing the nation’s largest compensation settlement, worth up to $4.5 billion’.160
Indeed, James Hardie’s CEO, Meredith Hellicar, described the agreement as a
‘compassionate’ outcome.161 Another commentator stated:

This year’s Special Commission found there was ‘no fundamental legal impediment’
to what Hardie did before it moved offshore; divorce itself from subsidiaries that had
manufactured building products and brake linings containing the deadly fibre.
Hardie therefore gets some credit for negotiating a new funding deal and not relying
on the letter of the law to try to avoid its moral responsibility. Only some, however,
because it had next to no choice.162

As alluded to above, James Hardie provides a significant recent case study of

a large corporation recognising and embracing the importance of stakeholder

158 See Anthony Marx, ‘Accord Fires Up Hardie’, The Australian (Sydney) (22 December 2004).
159 See ‘James Hardie Signs Compo Deal’, The Australian (Sydney) (21 December 2004).
160 See Roz Alderton, Bianca Wordley and Kaaren Morrissey, ‘Hardie Agrees to $4.5bn Payout’, The Age
(Melbourne) (22 December 2004).
161 In response, Peta Spender, above n 122, 292 makes the following observation: ‘I suppose I have a
different understanding of compassion as a spontaneous response to the human condition rather than one
based on institutional pressure.’
162 Malcolm Maiden, ‘Cost of Asbestos Exposure Does Not End Here’, The Age (Melbourne) (22 December
2004).
64 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

management from the point of view of corporate performance and good gover-
nance. Through the historic agreement reached in December 2004, the interests
of some of the company’s stakeholders – the increasing number of claimants who
had contracted asbestos-related diseases from James Hardie products – were
placed above the short-term interests of shareholders. Reference to the historic
agreement being a ‘moral’ development emphasises the point that James Hardie
has aligned itself with a stakeholder model of governance; a consistent theme in
stakeholder literature is that there is considered to be an ‘intrinsic moral value
in business operation’.163
As a result of the agreement, the company’s performance and future prospects
have improved. The company’s share price gained ground after deteriorating to
historic lows during the course of the Special Commission inquiry; the September
2004 bans on the purchase of company products have been lifted; and represen-
tatives of union organisations appear to be prepared to deal with the company.
It is hoped that the James Hardie affair will generate a genuine change of
culture within organisations.164 This historic agreement, the largest personal-
injury settlement in Australian history, could potentially represent – or at least
heavily influence – a turning of the tide in the attitude of management towards
stakeholder interests, with companies genuinely appreciating the intrinsic value
of an integrated approach to management – as opposed to regarding recognition
of stakeholder interests (through codes of conduct etc.) as a mere compliance
burden.
It is an important case study that highlights how embracing a stakeholder-
oriented approach to management can ultimately be more beneficial to share-
holders than a narrowly focused approach of maximising wealth in the short
term. As Robert E Wood, CEO of Sears in the 1980s, once said, in explaining
why his company adhered to a stakeholder model of governance, ‘shareholders’
long-term project [can] be enhanced by satisfying the needs and expectations of
other stakeholders’.165
The Commissioner’s Report (2004) had a direct bearing on ASIC’s decision
to launch civil penalty proceedings in February 2007 against James Hardie, its
directors and officers. The Jackson Report was used as a springboard to launch
further investigations into the activities of the James Hardie Group. ASIC inves-
tigated the conduct of JHIL and that of both executive and non-executive direc-
tors, and sought court declarations that a range of directors and officers had
breached their duties owed to JHIL.166 The practical application of the scope
and content of directors’ and officers’ duties, particularly the statutory duty of

163 Letza, Sun and Kirkbride, above n 4, 253.

164 For an exploration of the concept of corporate responsibility and its relationship with international
human rights law, see Justine Nolan, ‘Corporate Responsibility in Australia: Rhetoric or Reality?’ (2007)
University of New South Wales Faculty of Law Research Series 47.
165 Ibid 252–3.
166 The investigation spanned three countries (the USA, the UK and Australia) and it involved about
348 billion documents, 72 examinations and the issuing of 284 notices to obtain evidence: ASIC, ‘ASIC
Commences Proceedings Relating to James Hardie’ (Media Release 07–35, 15 February 2007), avail-
able at <www.asic.gov.au/asic/asic.nsf/byheadline/07-35+ASIC+commences+proceedings+relating+
to+James+Hardie?openDocument>.
 STAKEHOLDERS AND CSR 65

care and diligence, was one of the essential tasks requiring judicial determina-
tion in ASIC v Macdonald (No 11) (2009) 256 ALR 199, which is addressed in
Chapter 10.

2.5 CSR and directors’ duties

This part of the chapter addresses general concerns when seeking to achieve
the correct balance in corporate governance regulation and then focuses, in
particular, on the key issue of whether Australian law reform is desirable in
order to clearly articulate the duties of company directors.
The ASX Best Practice Recommendations document itself recognises that there
are different sources of legal obligations – apart from company law rules and cor-
porate governance principles – designed to ensure that corporations are obliged
to take into account the interests of stakeholders other than shareholders:
Most companies are subject to a number of legal requirements that affect the way
business is conducted. These include trade practices and fair dealing laws, consumer
protection, respect for privacy, employment law, occupational health and safety, equal
employment opportunities, superannuation, environment and pollution controls. In
several areas, directors and officers are held personally responsible for corporate
behaviour inconsistent with these requirements, and penalties can be severe.167

The OECD Principles of Corporate Governance recognise the danger in seeking to

over-use corporate governance regulation in order to achieve corporate gover-
nance objectives:
Corporate governance requirements and practices are typically influenced by an array
of legal domains, such as company law, securities regulation, accounting and auditing
standards, insolvency law, contract law, labour law and tax law. Under these circum-
stances, there is a risk that the variety of legal influences may cause unintentional
overlaps and even conflicts, which may frustrate the ability to pursue key corporate
governance objectives. It is important that policy-makers are aware of this risk and
take measures to limit it.168

Indeed, as explained by the Corporations and Markets Advisory Committee

(CAMAC) in its May 2005 discussion paper, ‘Personal Liability for Corporate
Fault’, in addition to companies, company directors can be personally liable by
virtue of their position as directors under a raft of federal and state/territory leg-
islation (in relation to, inter alia, environmental regulation, occupational health
and safety, hazardous goods and fair trading). This complex area of the law,
concerning ‘derivative liability’ of directors, is subject to ongoing review.
The repeated call for law reform over the years to extend the duties of company
directors was quickly countered by commentary from some of Australia’s leading
corporate lawyers. For example, soon after the Special Commission of Inquiry
167 ASX, Principles of Good Corporate Governance and Best Practice Recommendations, (March 2003),
available at <http://203.15.147.66/about/corporate governance/principles good corporate governance.
htm>.
168 OECD Principles of Corporate Governance, above n 5, 31.
66 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

examining the James Hardie affair handed down its report, Bob Baxt wrote in
The Australian Financial Review:

. . . from time to time we have flirted with allowing wider interests to be taken into
account by directors in running the company (for example, in takeovers). But, in fact,
those obligations are already imposed on them and their companies in a different
form. Directors of companies must obey the laws relating to environmental protection,
taxation, occupational health and safety, trade practices and consumer protection as
well as many others. Failure to comply with these laws not only exposes companies
to potential fines but, in appropriate cases, directors and officers to potential fines or
even jail.
Directors who act negligently in such cases run the added risk that they will be liable
for a breach of duty to act with appropriate care and diligence and may be sued by the
company.169

The basic point made by Baxt and others is that if (in light of recent developments)
corporate governance is to be taken seriously as a sophisticated and discrete area
of legal regulation, then what is required is an examination of where corporate
governance fits into the overall jigsaw of rules and regulations – rather than
continuing to accept the commonly held perception that corporate governance
is an intangible, ‘airy fairy’ (or what Justice Owen in the HIH Royal Commission
Final Report referred to as ‘hortatory’170 ), amorphous concept that is allowed
to overlap and intrude into areas already well and truly covered by discrete,
self-contained areas of law.
As alluded to earlier, the James Hardie scandal was the catalyst for the topic
of CSR to receive renewed popular and government interest. This is not surpris-
ing, as recognised by CAMAC,171 given the prominence of corporate enterprises
in contemporary society, the considerable power and influence of particular
companies, the ways in which companies conduct themselves and the extent to
which they are perceived to be taking responsibility for the consequences of their
actions can be expected to attract continuing scrutiny.
Against this backdrop, in March 2005 CAMAC was requested by the govern-
ment to consider and report on a range of matters, including:

Should the Corporations Act be revised to clarify the extent to which directors may
take into account, or be required to take into account, the interests of specific classes
of stakeholders or the broader community when making corporate decisions?

The Annotations to the OECD Principles of Corporate Governance also recognise

the need to consider the interests of a range of stakeholders:

169 ‘Corporations Law a Fragile Structure’, The Australian Financial Review (19 November 2004), 55. See
also Ian Ramsay, ‘Pushing the Limits for Directors’, The Australian Financial Review (Sydney) (5 April 2005),
63. Angus Corbett and Stephen Bottomley, ‘Regulating Corporate Governance’ in Christine Parker, Colin
Scott, Nicola Lacey and John Braithwaite (eds), Regulating Law, Oxford, Oxford University Press (2004) 60,
65: ‘There are many different regulatory schemes which affect the conduct of directors and the system of
corporate governance adopted by companies.’
170 Owen Report, above n 20, 102 para 6.1.
171 The Social Responsibility of Corporations Report, above n 7, at [iii].
 STAKEHOLDERS AND CSR 67

In all OECD countries, the rights of stakeholders are established by law (e.g. labour,
business, commercial and insolvency laws) or by contractual relations. Even in areas
where stakeholder interests are not legislated, many firms make additional commit-
ments to stakeholders, and concern over corporate reputation and corporate perfor-
mance often requires the recognition of broader interests.172

The traditional position in Australia, as we explore further in Chapter 10, dealing

with directors’ duties and liability, is that the overriding duty of directors is to act
in the best interests of the company – a separate legal entity – to which they have
been appointed and which they are meant to be representing. There are very
limited circumstances in which Australian courts have held that directors owe a
duty to creditors or individual shareholders, but almost always the expression of
such a duty is qualified or followed by a statement that the ultimate loyalty of
directors is to the company.
Prior to the issuance of the CAMAC Report in December 2006, a parallel
inquiry by the Parliamentary Joint Committee on Corporations and Financial
Services (PJC) reported in June 2006 and recommended no changes to the
provisions concerning directors’ duties.173 Similarly, the CAMAC Report did not
support revision of the Corporations Act to either clarify or increase its width of
coverage, for the following reasons:174

The Committee considers that the current common law and statutory requirements
on directors and others to act in the interests of their companies . . . are sufficiently
broad to enable corporate decision-makers to take into account the environmental and
other social impacts of their decisions, including changes in societal expectations about
the role of companies and how they should conduct their affairs . . . a non-exhaustive
catalogue of interests to be taken into account serves little useful purpose for directors
and affords them no guidance on how various interests are to be weighted, prioritised
or reconciled.

CAMAC was also of the view that the current legal requirements for directors
to act in the ‘best interests of the company’ can assist in aligning corporate
behaviour with changing community expectations.175 Given this, CAMAC con-
sidered it unnecessary to amend the Corporations Act 2001 (Cth) to comport
with section 172 of the Companies Act 2006 (UK) (discussed earlier) because ‘no
worthwhile benefit is to be gained’.176 In fact, CAMAC thought alignment with
the ‘enlightened shareholder value’ approach in the UK could be ‘counterproduc-
tive’ because in the Committees’ view ‘there is a real danger that such a provision
would blur rather than clarify the purpose that directors are expected to serve.
In so doing, it could make directors less accountable to shareholders without
significantly enhancing the rights of other parties.’177

172 OECD Principles of Corporate Governance, above n 5, 46

173 Corporate Responsibility: Managing Risk and Creating Value, above n 73.
174 Ibid at 3.12.
175 Ibid.
176 Ibid.
177 Ibid.
68 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

Justice Austin, writing in a non-judicial capacity, was critical of the findings

in both Australian law reform reports.178 In particular, his Honour was struck by
the disparities in the reasoning of both reports when compared with the depth
of analysis under by the UK law reform bodies in the lead up to the passage of
section 172 of the Companies Act 2006 (UK), which embodies the ‘enlightened
shareholder value’ approach to directors’ duties discussed earlier.179 His Honour
queried why the existing approach in Australia (for directors to act in the ‘best
interests of the company’) was preferable to declaring a duty of directors to take
stakeholder interests into account in the course of promoting the success of the
company for the benefit of its members as a whole (as the UK Act does).180
According to his Honour:181

The ‘flexibility’ that [CAMAC] wishes to maintain [in relation to the traditional for-
mulation of directors’ duties] is really . . . a profound lack of clarity; and I see no good
reason for giving directors a discretion to do or not to do something which, on any
rational public policy basis, they should be duty-bound to do . . . [CAMAC] has not
given sufficient weight to the argument that a provision like s 172 will clarify the law
for the benefit of everyone concerned, including directors themselves182 , fortifying
them to resist the pressures of short-termism.

These contrasting perspectives on the question of whether Australian directors

may or must take into account the interests of non-shareholder stakeholders con-
tinues to be a vexed issue183 and, except as regards the interests of creditors,184
there is no authoritative pronouncement at the appellate level, as noted by Justice
Austin.
Section 172 of the UK Act rejects a pluralist approach in favour of the ‘enlight-
ened shareholder value’ approach, which retains the overall objective to promote
the success of the company for the benefit of its shareholders. To that extent, it
is arguably a better approach to the current position in Australia for the reasons
proffered by Justice Austin185 – if it is accepted that the UK approach is devoid of
uncertainty.186 That caveat, however, will only be known when the boundaries

178 Robert Austin, ‘Remarks on the Launching of Company Directors and Corporate Social Responsibility:
UK and Australian Perspective’ (16 March 2007), available at <www.lawlink.nsw.gov.au/lawlink/Supreme
Court/ll sc.nsf/pages/SCO austin160307>.
179 Ibid.
180 Ibid. For exploration of directors’ duty to act in the best interests of the company, see Ian Ramsay,
‘The Duty to Act in the Best Interests of the Company (Including Creditors)’ in Directors in Troubled Times:
Monograph 7 (R P Austin and A Y Bilski, eds) Sydney, Ross Parsons Centre of Commercial, Corporate and
Taxation Law (2009) at 24.
181 Ibid.
182 Cf, above n 81, 577.
183 For a wide-ranging discussion on shareholders as the conduit of CSR and the capacity of the board to
integrate the interests of stakeholders into corporate decision making, see the book review essay by Angus
Corbett and Peta Spender, ‘Corporate Constitutionalism’ (2009) 31 Sydney Law Review 147.
184 Spies v R (2000) 201 CLR 603.
185 Cf Particia Dermansky, ‘Should Australia Replace Section 181 of the Corporations Act 2001 (Cth) with
Wording Similar to Section 172 of the Companies Act 2006 (UK)?’, available at <http://cclsr.law.unimelb.
edu.au/go/centre-activities/research/research-reports-and-research-papers/index.cfm>.
186 For identification of some of the uncertainties that may be associated with the construction of s 172, see
The Social Responsibility of Corporations Report, above n 7, at [3.9.2].
 STAKEHOLDERS AND CSR 69

and operation of section 172 of the UK Act are fully tested with the passage of
time.

2.6 Conclusion

The inherent tension remains between the shareholder primacy theory and the
stakeholder theory, famously identified in the public debate in the 1930s in the
Harvard Law Review between Berle and Dodd.187 The alignment of CSR concerns
with legal duties continues to be a vexed issue, particularly in light of the credit
crunch, which has transformed into the global financial crisis. According to one
commentator,188 ‘in the current market-based economy, directors all over the
world are questioning whether corporations should exist solely to maximize
shareholder profit’ and that ‘many corporate directors no longer abide by Milton
Friedman’s famous declaration that a corporation’s only social responsibility is
to provide a profit for its owners’. Despite the sweeping nature of these claims,
which are incapable of precise measure, it is suspected that they do, however,
embody some measure of truth.
The stress of the current global economic crisis, and the emergence of of the
‘fourth sector’189 of the USA, UK and other economies (the ‘for-benefit’ companies
that measure profitability by financial and social components) highlights the
importance of CSR initiatives as a means to promote economic prosperity via
long-term business expectations. The impact of this innovative development in
the USA and UK on the existing business landscape (dominated by large, for-
profit corporations), however, remains to be seen.
In the wake of the global financial crisis, the United States government’s
entanglement (or temporary partial nationalisation) of industries within the
financial190 and automobile sectors191 and President Obama’s mandate for a
new era of responsibility,192 Janet Kerr explores how the long-standing Berle-
Dodd theory of the corporations debate might play out in the distressed economic
climate.193 In the commentator’s view:194
187 See, for instance, Esser and Du Plessis, above n 81, at 347–51.
188 Mickels, above n 70, at 272.
189 For a description of over 20 different names used to describe activity within the fourth sector (such as
‘hybrid organisations’, ‘corporate citizenship’, ‘social enterprise’, ‘social business’ and ‘entrepreneurship’), see
Mickels, above n 70.
190 IndyMac, a major mortgage lender with US$34 billion in assets, was government-owned for six months
in 2008. Citigroup, one of the largest financial institutions in the world, agreed to convert US$25 billion worth
of preferred stock to common stock, giving the United States government 36 per cent of the total shares in the
bank. In 2008, the United States government invested US$150 billion in insurance gaint AIG and acquired
almost 80 per cent ownership rights of the company. These facts are drawn from Janet Kerr, ‘A New Era of
Responsibility: A Modern American Mandate for Corporate Social Responsibility’ (2009) 78 UMKC L. Rev.
327 at 336–8.
191 Ibid at 338: ‘Detroit Auto Manufacturers Received More than 17 billion dollars in Loans and Increased
Government Oversight.’
192 Barack Obama, President of the USA, Inaugural Address (20 January 2009), available at <www.cnn.
com/2009/POLITICS/01/20/obama.politics/index.html>.
193 Janet Kerr, ‘A New Era of Responsibility: A Modern American Mandate for Corporate Social Responsi-
bility’, n 189.
194 Ibid at 365.
70 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

the interconnectedness of world economies, and the current economic crisis, [makes]
it necessary to advance a new plane of discussion surrounding the debate of CSR.
This discussion must not only encompass the historic debate between shareholder
primacy and constituency concerns, but it must also reflect the pragmatic reality that
as corporations provide services traditionally administered by governments, society
will expect that boards of directors will consider non-shareholder interests.

The global financial crisis raises the pertinent question as to whether CSR, and
the interests of stakeholders, are still relevant during hard economic times. On
one view, in the line with the shareholder primacy model, the corporate focus
should be exclusively on survival and shareholder interests. An alternate view, as
espoused by the European Commission, is that CSR remains relevant during times
of economic crisis and should not be jettisoned in times of economic hardship.
According to the Commission, ‘overcoming the economic recession and finding
solutions to our environmental and social problems must not be a zero sum game.
If we make the right decisions, we can show that European leadership on social
and environment issues will contribute to our competitiveness’.195 As the global
financial crises plays out, it remains to be seen in which direction the pendulum
will swing with regard to the conundrum over shareholder versus stakeholder
interests.196
195 V P Verheugen, Speech at CSR Alliance event, 4 December 2008, available at <www.csreurope.
org/data/files/press/20081204 verheugen equippedforcsr.pdf>. For a similar proposition, where it has
been argued that corporate decision-making is not a ‘zero sum’ game in which the interests of one group
can only be advanced at the expense of another group, see Orts, above n 70, 14.
196 For a discussion on the pivotal role of shareholder primacy in corporate law, Stephen Bottomley, The
Constitutional Corporation – Rethinking Corporate Governance Ashgate, Aldershot (2007); Andrew Keay,
‘Shareholder Primacy in Corporate Law: Can it Survive? Should it Survive?’ 1 (November 2009), available at
<http://papers.ssrn.com/sol3/papers.cfm?abstract id=1498065>.
3
Board functions and structures

There is now overwhelming evidence that the board system is falling well
short of adequately performing its assigned duties. Without fundamental
improvement by individual boards, the entire board system will continue
to be attacked as impotent and irrelevant and the boards of troubled and
failing companies will, with good reason, increasingly become the targets
of not only aggrieved and angry shareholders but also employees, creditors,
suppliers, governments, and the public.
David SR Leighton and Donald H Thain, Making Boards Work (1997) 3.
Until they served on a board, people may well imagine that directors behave
rationally, that board level discussions are analytical, and that decisions
are reached after careful consideration of alternatives. Not often. Experi-
ence of board meetings, or of the activities of any governing body for that
matter, shows that reality can be quite different. Directors’ behaviour is
influenced by interpersonal relationships, by perceptions of position and
prestige, and by the process of power. Board and committee meetings
involve a political process.
Bob Tricker, Corporate Governance: Principles, Policies and Practices
(2008) 241.

3.1 Higher community expectation of directors

3.1.1 Initially low standards of care, skill and diligence

expected of directors
Directors’ statutory duties and liability are discussed in greater detail in
Chapter 10. It is, however, important first to make a few observations regarding
the higher community expectations of directors.
Based on English precedents, it has been accepted that directors are not
liable for a breach in their duty of care, skill and diligence if they merely acted
negligently. One of the first indications that more than ordinary negligence was
required is found in an English case decided in 1872, where it was held that
directors are liable only for a breach in their duty of care, skill and diligence if
they acted with crassa negligentia (gross negligence).1 This rule was confirmed

1 Overend & Gurney Company v Gibb [1872] LR HL 480 at 487, 488, 489, 493, 496 and 500.

71
72 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

in a later case (1899) by Lord Lindley MR, one of the most famous English
commercial Lords:

The inquiry, therefore, is reduced to want of care and bona fides with a view to the
interests of the nitrate company. The amount of care to be taken is difficult to define;
but it is plain that directors are not liable for all the mistakes they may make, although
if they had taken more care they might have avoided them: see Overend, Gurney &
Co. v. Gibb (1872) LR 5 HL 480. Their negligence must be not the omission to take all
possible care; it must be much more blameable than that: it must be in a business sense
culpable or gross. I do not know how better to describe it.2

These sentiments were repeated in several later English cases,3 and the fact
that negligence alone was not enough to hold directors liable for a breach of
their common law duties or equitable duties, was also recognised in the leading
Australian case, Daniels v Anderson.4 In Daniels v Anderson the majority (Clark and
Sheller JJA) referred to the concept of ‘negligence’ as used in context of equitable
remedies, and concluded that ‘[t]he negligence spoken of was something grosser
or more culpable determined by subjective rather than objective tests’.5 The
subjective test referred to by Clark and Sheller JJA alludes to the test that a
director was to exercise only the care which can reasonably be expected of a person
of his knowledge and experience.
The combined effect of a higher requirement than ordinary negligence and
the fact that subjective elements were used to judge whether a particular director
was in breach of her or his duty of care, skill and diligence, ensured that it was
very rare to find cases in which directors were held liable for a breach of their
duty of care, skill and diligence.
In Daniels v Anderson6 the court referred to the low standards of care, skill
and diligence expected of directors in the past and observed that ‘[h]owever
ridiculous and absurd the conduct of the directors, it was the company’s mis-
fortune that such unwise directors were chosen’.7 There were several reasons
given by the courts and commentators as to why in the past the courts were
reluctant to expect high standards of care, skill and diligence of directors. Or, to

2 Lagunas Nitrate Company v Lagunas Syndicate [1899] 2 Ch 392 at 435.

3 Re National Bank of Wales Ltd [1899] 2 Ch 629 at 672; In re Brazilian Rubber Plantation and Estates Ltd
[1911] 1 Ch 425; In re City Equitable Fire Insurance Company Limited [1925] 1 Ch 407 at 427.
4 (1995)16 ACSR 607 (CA (NSW)) at 657.
5 Ibid.
6 (1995) 16 ACSR 607 (CA(NSW)).
7 Ibid 658–9, which is in actual fact a reference to what was said in Turquand v Marshall (1869) LR 4 Ch
App 376 at 386: ‘It was within the powers of the deed to lend to a brother director, and however foolish the
loan might have been, so long as it was within the powers of the directors, the Court could not interfere and
make them liable . . . Whatever may have been the amount lent to anybody, however ridiculous and absurd
their conduct might seem, it was the misfortune of the company that they chose such unwise directors; but as
long as they kept within the powers of their deed, the Court could not interfere with the discretion exercised
by them.’ The Cooney Report Senate Standing Committee on Legal and Constitutional Affairs, Company
Directors’ Duties—Report on the Social and Fiduciary Duties and Obligations of Company Directors (Cooney
Report) (1989) at 20 para. 3.3 fn 2, also cites the following cases for similar sentiments: ‘Re New Mashonaland
Exploration Co [1892] 3 Ch D 577 at 585 per Vaughan Williams J; Re Forest of Dean Coal Mining Co (1878)
10 Ch D 450 at 453 per Jessel MR; Re Faure Electric Accumulator Co (1888) 40 Ch D 141 at 152 per Kay J. See
J Dodds, ‘New Developments in Directors Duties – The Victorian Stance on Financial Competence’ (1991) 17
Monash University Law Review 133 at 133 and 134–6.
 BOARD FUNCTIONS AND STRUCTURES 73

put it differently, why the courts were reluctant to scrutinise closely the business
decisions taken by directors. Some of the reasons given were that:
● taking up a position as non-executive director on a part-time basis was
simply ‘an appropriate diversion for gentlemen but should not be coupled
with onerous obligations’8
9
● ‘directors are not specialists, like lawyers and doctors’
● directors are expected to take risks and they are dealing with uncertainties,
which would be compromised if too high standards of care were expected
of directors
● courts are ill-equipped to second-guess directors’ business decisions
● the internal management of the company is one that companies can arrange
as they wish, and courts should be reluctant to interfere with internal
company matters etc.
As will be seen below, the scene has changed considerably, and nowadays there
are much higher expectations of directors to act with due care and diligence, and
these higher expectations are reflected in several court cases decided since the
early 1990s.

3.1.2 Legal recognition of changed community expectation

of directors
That the scene has changed considerably for directors in recent years was strik-
ingly illustrated by the case of Daniels v Anderson.10 Although the court specifi-
cally recognised the potential tension between expecting objective professional
standards of all directors in all types of companies, the court did not hesitate
to conclude that community expectations of the standards of performance of
directors have increased since the case of City Equitable Fire Insurance Co Ltd
(decided in 1925). Thus, the court held that it is the modern law of negligence
that should be used to determine whether a director was in breach of his or her
duty of care, skill and diligence.11 In actual fact, the court held that the modern
law of negligence (also called the tort of negligence) can cope with the potential
tension between expecting objective professional standards of all directors in all
types of companies.
The court adopted the general principles of the tort of negligence and the duty
of care after drawing attention to three very important things. First, there were
historic reasons why directors’ duty of care, skill and diligence were viewed in a
particular manner by the English courts of the late 1800s and early 1900s. Refer-
ring to the article by Jennifer Hill,12 the court made the following observation:

8 RBS Macfarlan, ‘Directors’ Duties after the National Safety Council Case: Directors’ Duty of Care’, (1992)
3 Australian Bar Review 269 at 270. See also Dodds, above n 7, at 134.
9 P Redmond, ‘The Reform of Directors’ Duties’ (1992) 15 UNSWLJ 86 at 98, quoting from Barnes v Andrews
298 Fed 614 (1924) at 618.
10 (1995)16 ACSR 607 (CA (NSW)).
11 at 664–5.
12 J Hill, ‘The Liability of Passive Directors: Morley v Statewide Tobacco Services Ltd’, (1992) 14 Syd LR 504.
74 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

The nature and extent of directors’ liability for their acts and omissions developed as
the body corporate evolved from the unincorporated joint stock company regulated
by a deed of settlement and was influenced by the partnership theory of corpora-
tion whereunder shareholders were ultimately responsible for unwise appointment of
directors.13

Second, in embracing the tort of negligence as the basis of liability for a breach of
a director’s duty of care, skill and diligence, the court took into consideration that
‘the law about the duty of directors’ had developed considerably since the decision
in Re City Equitable Fire Insurance Co (1925).14 The court then, in roughly seven
pages,15 painstakingly quoted from contemporary cases before reaching the con-
clusion that the tort of negligence and the modern concept of a duty of care now
forms an acceptable basis for liability of directors’ breach of their duty of care.16
Third, the court mentions the law of negligence has developed considerably in the
70 years (Daniel’s case was decided in 1995) since the decision in Re City Equitable
Fire Insurance Co.17
Daniels v Anderson represents the pinnacle in Australia (and probably also in
other jurisdictions influenced by English law!) of the development of directors’
duty of care, skill and diligence, which only began to emerge in greater detail in
about 1869, with the case of Turquand v Marshall. Daniels v Anderson was decided
in 1995, and since then it can safely be stated that the standards of care expected
of Australian directors under the common law has reached new heights – Daniels
v Anderson brought an abrupt end to the notions that directors’ duty of care, skill
and diligence should be judged subjectively and that their negligence ‘must be
in a business sense culpable or gross’. Although Daniels v Anderson represents
the pinnacle of developments in this regard, there were at least two earlier cases
that sent a wake-up call to sleeping or dormant directors in Australia – they were
the cases of Statewide Tobacco Services Ltd v Morley18 and Commonwealth Bank
of Australia v Friedrich,19 which served as the catalysts for the development of
contemporary standards in this area of the law.
Similar developments, and the fact that there are nowadays higher expecta-
tions of directors, are neatly summarised by Tricker, with reference to interna-
tional developments:

Once upon a time a directorship was a sinecure – an occasional meeting between

friends, maybe a few supportive questions, then a fee and probably lunch. Not now.
Today more is expected of company directors, indeed the members of all governing
bodies, than ever. The work of governing corporate entities has become demanding,

13 Daniels v Anderson (1995) 16 ACSR 607 (CA (NSW)) at 657.

14 Ibid at 661. See also The Honourable Sir Douglas Menzies ‘Company Directors’ (1959) 33 The Australian
Law Journal 156 at 156–8 and 163–4; Macfarlan, above n 8, 272–3.
15 Daniels v Anderson (1995) 16 ACSR 607 (CA (NSW)) at 661–7.
16 Ibid at 668.
17 Ibid at 661.
18 (1990) 8 ACLC 827.
19 (1991) 9 ACLC 946. See generally A S Sievers ‘Farewell to the Sleeping Director—The Modern Judicial
and Legislative Approach to Directors Duties of Care, Skill and Diligence’ (1993) 21 Australian Business Law
Review 111.
 BOARD FUNCTIONS AND STRUCTURES 75

often difficult, and open to challenge. Nevertheless, the work and responsibility is often
crucial and can be rewarding, both financially and personally.20

As will be seen in Chapter 10, director liability in Australia is dominated by

liability for a breach of their statutory duties. Also, it will be seen that it is the
primary corporate regulator (the Australian Securities and Investments Com-
mission (ASIC)) that takes a lead role in instituting actions against directors for
a breach of their statutory duties.21 However, as was illustrated above, also in
terms of case law based on the breach of directors’ common law duties or equi-
table duties, the standards of skill, care and diligence expected of directors have
risen considerably over the past two decades, and the statutory standards of care
found under section 180(1) of the Corporations Act 2001 (Cth) (the Act) reflects
the common law standard.22

3.2 The organs of governance

The Report of the HIH Royal Commission (Owen Report)23 summarises very well
the concept of organs of a corporation in the context of corporate governance.24
Justice Owen explained that a corporation is a legal entity separate and apart
from its board of directors (one of the primary organs of a corporation) and
shareholders (the other primary organ of a corporation), and that the corporation
can only ‘act through the intervention of the human condition’.25 The classic
statement of this principle is to be found in Lennard’s Carrying Co Ltd v Asiatic
Petroleum Co Ltd per Lord Haldane:
My Lords, a corporation is an abstraction. It has no mind of its own any more than it
has a body of its own; its active and directing will must consequently be sought in the
person of somebody who is really the directing mind and will of the corporation, the
very ego and centre of the personality of the corporation.26

In 2008, Justice Owen again explained as follows in The Bell Group Ltd v Westpac
Banking Corporation (No 9):27
There are various organs that influence the decision-making processes of a corporation
and which are involved in corporate governance. But primary governance responsibility
lies with the board of directors. In formal terms the directors are appointed by, and
are accountable to, the body of shareholders. As a general rule it is the directors who

20 Bob Tricker, Corporate Governance: Principles, Policies and Practices, Oxford University Press, Oxford
(2009) 17.
21 See, for example, ASIC v Adler (2002) 42 ACSR 80; ASIC v Rich (2003) 44 ACSR 44; ASIC v Elliot (2004)
48 ACSR 621; ASIC v Vines (2005) 55 ACSR 617; ASIC v Vizard (2005) 145 FCR 57; ASIC v Maxwell (2006) 59
ACSR 373; ASIC v Macdonald (No 11) (2009) 256 ALR 199l; ASIC v Macdonald (No 12) (2009) 259 ALR 116.
22 Vines v ASIC (2007) 62 ACSR 1; ASIC v Macdonald (No 11) (2009) 256 ALR 199.
23 Report of the HIH Royal Commission (Owen Report), The Failure of HIH Insurance – Volume I: A Corporate
Collapse and its Lessons, Canberra, Commonwealth of Australia (2003).
24 Ibid 103 (Ch 6, s 6.1.1).
25 Ibid.
26 [1915] AC 705, 713.
27 [2008] WASC 239 (28 October 2008) [4365].
76 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

are ‘the directing mind and will of the corporation, the very ego and centre of the
personality of the corporation’: Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd,
at 713. The power to manage the business of the company has been delegated to the
directors. The delegation arises as part of, or by virtue of, the contract between the
shareholders and the company represented by the Articles of association.

Historically, the power to manage the business of all companies and corpora-
tions was conferred upon the board of directors. The practical reality that it was
impossible for a board of directors to manage the day-to-day business of large
public corporations was realised only quite recently (see discussion under ‘Board
functions’, below). Nowadays, the board of directors is seen as the primary gov-
ernance or supervisory organ. The 2007 Australian Securities Exchange (ASX)
Principles of Good Corporate Governance and Best Practice defines the term ‘board’
as:

the directors of a company acting as a board and, in the case of listed trusts and
externally managed entities, references to ‘boards’ and ‘directors’ are references to the
boards and directors of the responsible entity of the trust and to equivalent roles in
respect of other externally managed entities.28

The powers conferred upon shareholders are primarily conferred upon them by
the Act. The powers to appoint directors and to remove directors are some of the
most important powers of shareholders, but there are also several other decisions
in a company that cannot be taken without the approval of the shareholders by
way of a special resolution (a 75 per cent majority of the shareholders present at
a shareholders’ meeting in person or by proxy).29 Justice Owen commented on
the legal status of the two primary organs of a corporation:

In formal terms the directors are appointed by, and are accountable to, the body
of shareholders. The board will usually be constituted (and in the case of HIH was
constituted) by a chair, executive directors and non-executive directors.30

One of the most interesting aspects revealed by the Owen Report was that employ-
ees, falling in the group of middle management, have considerable powers in
large public corporations and often take decisions that may have huge conse-
quences for the corporation. Justice Owen explained this as follows:

It is difficult to define with precision the part that employees play in corporate gov-
ernance. It will depend on the extent to which the employee is involved in or can
influence the decision-making process. Senior management is more likely to have such
a role. But in large corporations or complex groups it may be that employees further
down the corporate hierarchy have a decision-making function that involves elements
of control of the process. There is a danger in the current emphasis on the role and

28 ASX, Principles of Good Corporate Governance and Best Practice (2nd edn, August 2007) 39, avail-
able at <http://203.15.147.66/about/corporate governance/revised corporate governance principles
recommendations.htm>.
29 One of the most important powers that the shareholders have is to change the company’s constitution (if
any) by way of a special resolution – see s 136(2) of the Corporations Act 2001 (Cth).
30 Owen Report, above n 23, 103 para 6.1.1.
 BOARD FUNCTIONS AND STRUCTURES 77

responsibilities of boards of directors. It may cause to be overlooked the reality of the

necessarily greater part that executives and other employees play in the day-to-day
running of many corporate businesses.31

3.3 Board functions32

AWA Ltd v Daniels (Trading as Deloitte Haskins & Sells & Ors)33 is one of the
very few cases in which an attempt was made to explain the division of func-
tions between the board of directors and management; non-executive directors
and the chief executive officer (CEO) or managing director; and the chairman
and the board of directors.34 Rogers CJ explained that, apart from statutory
ones, a board’s functions are said to be normally four-fold, namely ‘(1) to set
goals for the corporation; (2) to appoint the corporation’s chief executive; (3)
to oversee the plans of managers for the acquisition and organisation of finan-
cial and human resources towards attainment of the corporation’s goals; and
(4) review, at reasonable intervals, the corporation’s progress towards attaining
its goals’.35
Rogers CJ pointed out the practical limitations on the ability of the board of a
large public corporation to manage the day to day business of the corporation:
The Board of a large public corporation cannot manage the corporation’s day to day
business. That function must of necessity be left to the corporation’s executives. If the
directors of a large public corporation were to be immersed in the details of the day
to day operations the directors would be incapable of taking more abstract, important
decisions at board level . . . 36

This distinction is nowadays also widely accepted in legislation. In the past

the power ‘to manage the business of the company’ was invariably conferred
upon the board of directors by way of the model set of articles of association
(Table A) that accompanied most of the Companies Acts that preceded the Act.
The current statutory recognition reflecting the practical reality that in large
public corporations the business of the corporation is not done by the board
as such, but under the direction of the board, is contained in section 198A(1)
(replaceable rule – see Chapter 6 for the meaning of the term ‘replaceable rule’)
of the Act, providing that ‘[t]he business of a company is to be managed by or
under the direction of the directors’. In proprietary companies, the business of the

31 Ibid.
32 For some interesting reflections on the gap between what directors in fact do and what the business
literature professes they should do, see Myles L Mace, ‘Directors: Myth and Reality’ in Thomas Clarke (ed.),
Theories of Corporate Governance: The Philosophical Foundations of Corporate Governance, London, Routledge
(2004) 96 et seq, based on his book, Myles L Mace, Directors: Myth and Reality, Boston, Division of Research,
Graduate School of Business Administration, Harvard University (1971). For a more theoretical analysis,
distinguishing between ‘board tasks’ and ‘board functions’, see Morten Huse, Boards, Governance and Value
Creation, Cambridge, Cambridge University Press (2007) 33 and 38–40.
33 (1992) 7 ACSR 759.
34 At 865–8.
35 At 865–6.
36 At 866.
78 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

company will be managed ‘by’ the board, but in large public corporations it will be
managed ‘under the direction’ of the board. A similar recognition of the practical
realities in large public corporations is found in the American Law Institute’s
(ALI) Principles of Corporate Governance and Structure where § 2.01(a) provides
that ‘[t]he management of the business of a publicly held corporation should be
conducted by or under the supervision of such principal senior executives as are
designated by the board of directors’.37 § 8.01(b) of the American Model Business
Corporations Act captures this by providing that ‘[a]ll corporate powers shall be
exercised by or under the authority of the board of directors of the corporation,
and the business and affairs of the corporation shall be managed by or under,
and subject to the oversight, of its board of directors’.38
Stephen Bainbridge refers to § 141(a) of the Delaware General Corporation
Act, which provides that ‘[t]he business and affairs of every corporation orga-
nized under this chapter shall be managed by or under the direction of a board of
directors . . . ’ and mentions that this power conferred upon the board is enshrined
in every piece of state legislation, except in Missouri. He then calls the statutory
recognition of directors powers ‘the director primacy mode’39 and points out
that this ‘director primacy model’ he has developed ‘has been recognised by
several other commentators’.40 This is, indeed, a new and clever way to con-
trast that model with what has been called the ‘shareholder primacy model’ and
the ‘stakeholder primacy model’ (see discussion in Chapters 1 and 2) for many
years.
Bainbrige’s ‘director primacy model’ is based on the simple reality that even
though it is said that the shareholders ‘own’ the corporation, they have virtually no
power to control either its day-to-day operation or its long-term policies. Instead,
Bainbridge argues, the corporation is controlled by its board of directors.41 It is
the boards of the directors, and not the shareholders, other stakeholders or
managers, in large public corporations that actually control the corporation and
‘have the ultimate right of fiat’.42 This, in our view, could be described as the
‘boardtorial revolution’, or ‘directorial revolution’, in similar vein to what has
been identified as the ‘managerial revolution’ (see reference in Chapter 1).
The distinction between managing and directing the business of a corporation
is nowadays well accepted in managerial circles. As early as 1997, Bob Garratt
explained as follows:

But there is a vast difference between ‘directing’ and ‘managing’ an organisation.

Managing is literally, given its Latin root, a hands-on activity thriving on crisis action.
On the operations side of an organisation it is a crucial role. Directing is different.

37 ALI, Principles of Corporate Governance: Analysis and Recommendations, St Paul, American Law Institute
Publishers (1994) 82.
38 American Bar Association, Model Business Corporations Act: Official Text with Official Comments and
Statutory Cross-References Revised through June 2005, Chicago, American Bar Association (2005) 8–4.
39 Stephen M Bainbridge, The New Corporate Governance in Theory and Practice, Oxford, Oxford University
Press, (2008) ix.
40 Ibid, xi-xii.
41 Ibid, 3.
42 Ibid, 11.
 BOARD FUNCTIONS AND STRUCTURES 79

Directing is essentially an intellectual activity. It is about showing the way ahead,

giving leadership. It is thoughtful and reflective and requires the acquisition by each
director of a portfolio of completely different thinking skills.43

He repeated these sentiments in 2003:

We seem to rely excessively on an ill defined and weakly assessed notion called
‘experience’ to get by. Unfortunately such experience is rarely directoral. It is usu-
ally managerial and professional, and so concerned with the day-to-day operations of a
business – these are not directoral roles and there is a big difference between managing
and directing an organization.44

Because of the different role of the modern board, it is often difficult for man-
agers who are promoted internally as directors to properly fulfil their directorial
responsibilities. There is a natural tendency for directors promoted internally
‘to ensure that their managerial successor does not mess up what they have so
painfully achieved’.45 These newly appointed directors also naturally have a ten-
dency to ‘sit on their [successors’] shoulders’, and that can lead to considerable
friction.46 That is also a forceful argument against the CEO of a company becom-
ing the same company’s chair of the board. As John B Reid, AO, former CEO of
BHP Ltd, puts it:

I think it can be argued that everything is working against CEOs in asking them to
detach themselves from thinking like an operational manager and to change their
thought process vis-a-vis every senior executive in the operation and to focus on the
issues that are the responsibility of the chairman. Not only that, but directors would be
asking the CEO to deliberately walk away from thinking about the matters that were his
or her earlier managerial responsibilities and to be detached from them. There are not
many people who can rejig their processes so easily and it is even harder in a familiar
environment where colleagues assume that the CEO has not changed very much. They
are probably right.47

The argument in favour of allowing a retiring CEO to become the chairperson

is based upon the notion of continuity and the desire to retain the experience
and intimate knowledge of the retiring CEO within the company. It is, however,
submitted that from a corporate governance perspective this is not a good enough
reason to allow this to happen. At the most, the retiring CEO can become a non-
executive director, but he or she will not be considered to be an independent,
non-executive director. A better practice probably is to agree, under specific
conditions that are clarified with the new CEO and the board, that the retiring

43 Bob Garratt, The Fish Rots from the Head, London, Harper Collins Business (1997) 4. See also Robert AG
Monks and Nell Minow, Corporate Governance, Oxford, Blackwell (3rd edn, 2004) 195 and 202–3; J B Reid,
Commonsense Corporate Governance, Sydney, Australian Institute of Company Directors (2002) 22; Stephen
M Bainbridge, Corporation Law and Economics, New York, Foundation Press (2002) 194–5.
44 Bob Garratt, Thin on Top, London, Nicholas Brealey Publishing (2003) 69.
45 Garratt, above n 43, 3; Nigel Kendall and Arthur Kendall, Real-World Corporate Governance, New York,
Foundation Press (1998) 8.
46 Garratt, above n 43, 3; Kendall and Kendall, above n 45, 15.
47 Reid, above n 43, 31. See also Tricker above n 20, at 60.
80 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

CEO can be consulted by the new CEO or the board. In this way he or she has
no continuing involvement with the company as a director who is expected to
attend all board meetings, but the experience and knowledge of the retiring CEO
could be retained as an ‘external’ consultant.
ASX’s Principles of Good Corporate Governance and Best Practice
Recommendations48 summarises the responsibilities of the board slightly more
elaborately than did Rogers CJ in the AWA Ltd case:
● overseeing of the company, including its control and accountability systems
● appointing and removing the CEO (or equivalent)
● where appropriate, ratifying the appointment and the removal of senior
executives49
● providing input into and final approval of management’s development of
corporate strategy and performance objectives
● reviewing, ratifying and monitoring systems of risk management and inter-
nal control, codes of conduct and legal compliance
● monitoring senior executives’ performance and implementation of strategy
● ensuring appropriate resources are available to senior executives
● approving and monitoring the progress of major capital expenditure, cap-
ital management, and acquisitions and divestitures
● approving and monitoring financial and other reporting.
The board’s responsibility ‘to guide and monitor the management of the cor-
poration’ has been emphasised in several Australian cases.50 The OECD, in its
Principles of Corporate Governance, considers it an important attribute of an effec-
tive corporate governance framework that the board should ‘ensure the strategic
guidance of the company’; should ensure ‘effective monitoring of management’;
and should be ‘accountable to the company and the shareholders’.51 Functions
such as ‘reviewing’, ‘monitoring’ and ‘overseeing’ are mentioned repeatedly in
the OECD Principles of Corporate Governance as core functions of the board.52
The board is indeed ‘the centre of the enterprise – “business brain” or central
processor – monitoring and coping with the results of the external and internal
processes of the whole enterprise’.53 The UK Institute of Directors identifies the
key purpose of the board as being to seek to ensure the company’s prosperity by
collectively directing the company’s affairs, while meeting the appropriate inter-
ests of its shareholders and relevant stakeholders.54 Bob Garratt explains that

48 Principles of Good Corporate Governance and Best Practice (2nd edn, August 2007), above n 28, 13.
49 Senior executives include all officers and employees who have the opportunity to materially influence the
integrity, strategy and operation of the company and its financial performance.
50 Commonwealth Bank v Friedrich (1991) 5 ASCR 115, 187; AWA Ltd v Daniels (Trading as Deloitte Haskins
& Sells & Ors) (1992) 7 ACSR 759, 864; Daniels v Anderson (1995) 13 ACLC 614, 614; ASIC v Macdonald (No
11) [2009] NSWSC 287 (23 April 2009), available at <www.austlii.edu.au/au/cases/nsw/NSWSC/2009/
287.html> at paras 101 and 255 et seq.
51 OECD Principles of Corporate Governance (April 2004), available at <www.oecd.org/dataoecd/32/18/
31557724.pdf> 22.
52 Ibid 60–3.
53 Garratt, above n 43, 9.
54 UK Institute of Directors, Standards for the Board: Improving the Effectiveness of Your Board, London,
Institute of Directors (2001) 4, 28.
 BOARD FUNCTIONS AND STRUCTURES 81

boards are responsible for strategic decisions and, in order to direct strategically,
boards must agree on three things:55
● In which direction are we going?
● On which ideas are we working to get us there?
● On which information sources will we rely?
Taking all these aspects together, the board’s functions and responsibilities could
be summarised as to ‘direct, govern, guide, monitor, oversee, supervise and com-
ply’. The literature on management and managerial strategy makes a distinction
between two primary roles of the board, namely a ‘performance role’ and a ‘con-
formance role’. Robert I Tricker classifies ‘contributing know-how, expertise and
external information’; and ‘networking, representing the company and adding
status’ as being part of directors’ performance role. Under their conformance role
he includes ‘judging, questioning and supervising executive management’; and
a ‘watchdog, confidant and safety-valve role’.56 Bob Garratt sees accountability
(for quality of thinking, high ethical standards and values, to obey the law and to
treat stakeholders in a consistent way) and supervision of management (confor-
mance to key performance indicators, cash flow, budgets and projects) as part
of the board’s conformance task.57 Under its performance task he lists policy
formulation and foresight and strategic thinking.58 The distinction between the
board’s ‘performance’ and ‘conformance’ tasks seems a realistic explanation of
directors’ roles and mirrors the primary functions of the board. However, the
problem lies in the practical application of these roles or, to put it differently, to
strike the right balance. As Tricker puts it:

[E]very board faces a challenge to strike a reasonable balance between formulation and
policy making, the performance roles, on the one hand, and executive supervision and
accountability, the conformance roles on the other . . . The problem is that the more a
board concentrates its efforts on the conformance activity – management supervision
and accountability – the more that board comes to see its work as ensuring compliance
with the corporate governance requirements of respective codes, regulations, and the
law . . . The formulation of strategy and policy making is then largely delegated to top
management. By focusing on compliance, such boards tend to see corporate governance
activities as an expense and wonder whether it is cost-effective.’59

From a more practical point of view, the members of the board should not only
concentrate on the formal responsibilities they have, as explained above, but
should also ask some fundamental questions about their performance, account-
ability, effectiveness, the governance risks they face and improving their effec-
tiveness. Bob Garratt argues for a change in directoral mindset; directors should

55 Garratt, above n 44, 124.

56 Robert I Tricker, International Corporate Governance, London, Prentice-Hall (1994) 98–100. See also
Bob Tricker, ‘From Manager to Director: Developing Corporate Governors’ Strategic Thinking’ in Developing
Strategic Thought: Rediscovering the Art of Direction-giving (Bob Garratt, ed.), London, McGraw-Hill Book
Company (1995) 11 at 16–18.
57 Bob Garratt, The Fish Rots from the Head, London, P Profile Books (2003) 109 et seq and 131 et seq.
58 Ibid, 57 et seq and 88 et seq.
59 Tricker above n 20, 139. See also Ken Rushton, ‘Introduction’ in The Business Case for Corporate Governance
(Ken Rushton ed.), Cambridge, Cambridge University Press (2008) 5.
82 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

not see themselves as sitting at the apex of a pyramid, but rather should see
themselves as the centre of the enterprise, the ‘business brain’ or central proces-
sor that monitors and copes with the results of the external and internal learning
processes of the enterprise.60 Leighton and Thain suggest that the board should
ask itself the following fundamental questions:61
1. How satisfied are our shareholders, and other stakeholders, with the per-
formance and accountability of the company and its board?
2. How effective is the board?
3. What are the governance risks and problems we face?
4. What exactly should we be doing to anticipate and avoid the embarras-
sing and costly mistakes in governance that have plagued so many other
companies?
5. What should we be doing to make our board more effective and how should
we do it?
From the discussion above it will be apparent that the board’s role is a complex
one. This is neatly illustrated by the UK Institute of Directors:

In pursuing its key purpose, a board of directors faces a uniquely demanding set of
responsibilities and challenges, the complexity of which can be seen in some of the
seemingly contradictory pressures it faces:
• The board must simultaneously be entrepreneurial and drive the business forward
while keeping it under prudent control.
• The board is required to be sufficiently knowledgeable about the workings of the
company to be answerable for its actions, yet to be able to stand back from the
day-to-day management of the company and retain an objective, long-term view.
• The board must be sensitive to the pressures of short-term issues and yet be informed
about broader, long-term trends.
• The board must be knowledgeable about ‘local’ issues and yet aware of potential
and actual non-local, increasingly international, competitive and other influences.
• The board is expected to be focused upon the commercial needs of its business while
acting responsibly towards its employees, business partners and society as a whole.62

Directors need to have some practical guidelines to ensure that they fulfil their
duties and responsibilities diligently. Mervyn King, in his book, The Corporate
Citizen, provides some excellent guidelines to directors in taking decisions or
making business judgments. He suggests that directors, taking decisions or mak-
ing business judgments, must ask 10 questions:
1. Do I as a director of this board have any conflict in regard to the issue
before the board?
2. Do I have all the facts to enable me to make a decision on the issue before
the board?

60 Bob Garratt, The Fish Rots from the Head, P Profile Books, London (2003) 4. See also Bob Tricker (Developing
Strategic Thought: Rediscovering the Art of Direction-giving) above n 56, 11.
61 David S R Leighton and Donald H Thain, Making Boards Work, Whitby, Ontario, McGraw-Hill Ryerson
(1997) 34.
62 UK Institute of Directors, above n 54, 4–5.
 BOARD FUNCTIONS AND STRUCTURES 83

3. Is the decision being made a rational business decision based on all the
facts available at the time of the board meeting?
4. Is the decision in the best interests of the company?
5. Is the communication of the decision to the stakeholders of the company
transparent, with substance over form, and does it contain all the negative
and positive features bound up in that decision?
6. Will the company be seen as a good corporate citizen as a result of the
decision?
7. Am I acting as a good steward of the company’s assets in making this
decision?
8. Have I exercised the concepts of intellectual honesty and intellectual
naivety in acting on behalf of this incapacitated company?
9. Have I understood the material in the board pack and the discussion at
the boardroom table?
10. Will the board be embarrassed if its decision and the process employed
in arriving at its decision were to appear on the front page of the national
newspaper?
Bearing in mind the realities of decision-taking processes as described by Bob
Tricker in the second opening quote to this chapter, some may say it is unrealistic
to expect of directors, taking decision ‘on the run’, to ask all these questions.
On the other hand, especially as far as Australian directors are concerned, there
is very little doubt that if all the directors of James Hardie did ask all these 10
questions and could answer ‘no’ on questions 1 and 10 and ‘yes’ on questions
2–9, they would not have been held liable.63 Also, the names of the directors of
Centro Properties Group would not have been mentioned so prominently in the
media during October 2009 when ASIC announced that it would institute action
against the directors for a breach of their statutory duty of care and diligence64
if those directors had asked the 10 questions Mervyn King suggests and could
answer ‘no’ on questions 1 and 10 and ‘yes’ on questions 2–9.

3.4 Board structures

Generally speaking, there are two types of board structures, namely the unitary
board and the two-tier board. It is, however, not easy nowadays to make an exact
distinction between these two board structures, as most developed countries have
moved away from the traditional ‘unitary board’ structure in the case of large
public corporations. In most developed countries, board structures for large cor-
porations have some characteristics that are reminiscent of the more traditional
‘two-tier board’. A good way to illustrate this point is to start with a very basic
63 See ASIC v Macdonald (No 11) [2009] NSWSC 287 (23 April 2009), available at <www.austlii.edu.au/
au/cases/nsw/NSWSC/2009/287.html>.
64 See ‘ASIC Commences Proceedings Against Current and Former Directors of Centro’, ASIC Media Release
09–202 AD (21 October 2009), available at <www.asic.gov.au/asic/asic.nsf/byheadline/09-202AD+ASIC+
commences+proceedings+against+current+and+former+officers+of+Centro?openDocument>.
84 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

Board
Governance

Management Management
organization

Figure 3.1 [2.1]: The board and management differentiated

Figure 3.2 [2.2]: All-executive board

Figure 3.3 [2.3]: Majority executive board

distinction drawn by Tricker in his books International Corporate Governance65

and Corporate Governance: Principles, Policies and Practices66 between a so-called
‘managerial pyramid’ and a ‘governance circle’, and illustrates this by way of
five figures (reproduced with Tricker’s original numbering in square brack-
ets, figures 3.1–3.4 reproduced from International Corporate Governance and

65 Tricker (International Corporate Governance), above n 56, 44–5. See also Tricker, above n 20, 35–6
and 61–4.
66 Tricker, above n 20, 35–6 and 61–4.
 BOARD FUNCTIONS AND STRUCTURES 85

Figure 3.4 [2.4]: Majority outside board

Figure 3.5 [2.5]: Two-tier board

figure 3.5 reproduced from Corporate Governance: Principles, Policies and

Practices):
Figure 3.2 portrays the typical board structure for proprietary companies and
also, in the past, the board structure of most public corporations. However, with
the drive to have objective checks on management and to bring independence
into the board, the move has clearly been towards the board structure depicted
in Figure 3.3. More recently there have been several moves to have a majority
of non-executive directors and, in particular, a majority of independent non-
executive directors (Figure 3.4). The German system is perhaps best described
by Figure 3.5, with the governance circle representing the supervisory board
and the managerial pyramid representing the management board. The most
recent trends towards independent non-executive directors will be explained
in greating detail in Chapter 4, while the German two-tier board will be dis-
cussed in Chapter 13. Figure 3.6 illustrates a board with no executive director.
86 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

Figure 3.6 [3.4]: The all non-executive director board

1-10 individuals

Figure 3.7: The statutory arrangement for South African close corporations

It is rare to find this in listed public companies, but Tricker points out that it is
sometimes the board structure for not-for-profit entities such as charitable organ-
isations, arts, health and sports organisations, and ‘qualgos’ (quasi-autonomous
non-government organisations)’.67 Figure 3.7 depicts the South African close
corporation, where the statutory presumed or default arrangement is based on
the premise that there is a complete overlap between the governance circle and
the managerial triangle in small businesses.68
Tricker’s basic models could be used to further refine and explain board struc-
tures and an effective corporate governance model (see discussion and illustra-
tions). There are several indications that traditional common law jurisdictions
recognise the distinctive roles of ‘the board’ and ‘management’. The primary

67 Ibid, 64.
68 See further Jean J du Plessis, ‘Reflections and Perspectives on the South African Close Corporation as
Business Vehicle for SMEs’ (2009) 15 (4) New Zealand Business Law Quarterly 250 at 252–3 and 257 for some
of the reasons for having separate legislation applying to SMEs.
 BOARD FUNCTIONS AND STRUCTURES 87

function of ‘the board’ is to ‘direct, govern, guide, monitor, oversee, supervise

and comply’, and ‘management’s’ function is to ‘manage the day-to-day business
of the corporation’. This becomes clear if one looks at what is nowadays under-
stood under the ‘functions of the board’, as explained above. There is no longer a
place in large corporations for the board to ‘manage the business of the corpora-
tion’, but to provide strategic direction to the corporation and the development
and implementation of risk management policies are key functions of the board.
For these reasons, these days it is misleading to express a preference for ‘a unitary
board’ or ‘a two-tier board’ without clarifying what is meant by these terms.69
It is also unfounded to make a prediction of a ‘convergence towards a unitary
board approach’, without defining what is meant by a ‘unitary board’.70
Where the business of the corporation is not managed by the board but is
‘under the direction of the directors’71 – with a majority of independent (or
outside) non-executive directors, a senior independent director, an independent
non-executive director as chair and several sub-committees72 – it can hardly be
said that such a corporation has a ‘unitary board’ comparable to the ‘unitary
board’ (see again Figure 3.3 above) that was the focus of attention of many
studies over many years.73
It is nowadays beyond dispute that the contemporary – or should we say,
reinvented – ‘unitary board’ has much more in common with the traditional
‘two-tier board’ than some would be prepared to admit.74 The modern ‘unitary
board’ does not look as one-dimensional as some would have us believe. On
the other hand, the modern German ‘two-tier board’ is not as two-dimensional
as it has been made out to be.75 Due to the way in which the traditional ‘uni-
tary board’ has been reinvented, the score would probably be slightly in favour
of the ‘two-tier board’76 if a winner had to be selected in the ‘unitary board’

69 For a typical example of such a misleading approach, which seems to have been perpetuated over
time in the various South African King Reports, see King Report on Governance for South Africa 2009 (King
Report (2009)), Institute of directors (2009) 9, available at <http://african.ipapercms.dk/IOD/KINGIII/
kingiiireport/> at 39 para 62.
70 Cf Garratt, above n 43, 42–3.
71 See s 198A(1) of the Corporations Act. See further AWA Ltd v Daniels (Trading as Deloitte Haskins & Sells
& Ors) (1992) 10 ACLC 933.
72 See Financial Reporting Council, The Combined Code on Corporate Governance (UK Combined
Code (2008)) (June 2008), available at <www.frc.org.uk/corporate/combinedcode.cfm>; and ASX,
Principles of Good Corporate Governance and Best Practice (2nd edn, August 2007) 3, avail-
able at <http://203.15.147.66/about/corporate_governance/revised_corporate_governance_principles_
recommendations.htm>. See also Review of the Role and Effectiveness of Non-Executive Directors (Higgs Report),
(January 2003), available at <www.berr.gov.uk/files/file23012.pdf>.
73 See Tricker (International Corporate Governance), above n 56, 44–5.
74 See Comparative Study of Corporate Governance Codes Relevant to the European Union and its Members
(hereafter ‘European Commission Comparative Study’) (January 2002) 4–5; The German Corporate Gover-
nance Code (hereafter ‘the German Code’) (May 2003), available at <www.corporate-governance-code.de/
eng/download/DCG K E200305-m.pdf> 1; Sir Geoffrey Owen, ‘The Role of the Board’ in The Business Case
for Corporate Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008) 10 at 21–2.
75 See Carsten Berrar, ‘Die zustimmungspflichtigen Geschäfte nach § 111 Abs. 4 AktG im Lichte der Corporate
Governance-Diskussion’ (2001) 54 Der Betrieb (Zeitschrift) 2181, 2185–6.
76 Garratt, above n 43, 187 has no hesitation in stating that United States boards are ‘closer to the German two-
tier board’, while John L Colley (Jr), Jacqueline L Doyle, George W Logan and Wallace Stettinius, Corporate
Governance, New York, McGraw-Hill (2003) 43, state that ‘[t]he committee of outside directors is somewhat
similar to the European two-tiered model of governance, in which there is a supervisory board and an executive
board’. See also Alistair Howard, ‘UK Corporate Governance: To What End a New Regulatory State?’ in
88 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

versus ‘two-tier board’ contest, but at the end of the day it is perhaps best to
accept that the so-called ‘fit-all board structure’ does not – and probably never
will – exist.77
The frequent overstatement of the differences between the contemporary
‘two-tier board’ and the contemporary ‘unitary board’ is neatly summarised by
Weil, Gotshal and Manges (on behalf of the European Commission, Internal
Market Directorate General) in their report, Comparative Study of Corporate
Governance Codes Relevant to the European Union and its Members:78

Another major corporate governance difference embedded in law relates to board

structure – the use of a unitary versus a two-tier board. However, notwithstanding
structural differences between two-tier and unitary board systems, the similarities in
actual board practices are significant. Both types of systems recognise a supervisory
function and a managerial function, although the distinctions between the two func-
tions tend to be more formalised in the two-tier structure. Generally, both the unitary
board of directors and the supervisory board (in the two-tier structure) are elected
by shareholders although . . . in some countries employees may elect some supervisory
body members as well. Typically, both the unitary board and the supervisory board
appoint the members of the managerial body – either the management board in the
two-tier system, or a group of managers to whom the unitary board delegates authority
in the unitary system. In addition, both the unitary board and the supervisory board
usually have responsibility for ensuring that financial reporting and control systems
are functioning appropriately and for ensuring that the corporation is in compliance
with law.
Each board system has been perceived to offer unique benefits. The one-tier system
may result in a closer relation and better information flow between the supervisory and
managerial bodies; however, the two-tier system encompasses a clearer, formal sepa-
ration between the supervisory body and those being ‘supervised’. With the influence
of the corporate governance best practice movement, the distinct perceived benefits
traditionally attributed to each system appear to be lessening as practices converge.

In various reports, such as the Cadbury Report (UK), King Report (South Africa)
(1994, 2002 and 2009), Higgs Report (UK), and Owen Report (Australia), the
‘unitary board’ structure was preferred to the ‘two-tier structure’ but, as men-
tioned above, these so-called alternative board structures are not really alterna-
tive in the strict sense of the word, but rather have some similarities and some
differences. Another problem with simply accepting the ‘unitary board’ as the
preferred structure is that it does not open up consideration of other possibil-
ities, nor does it stimulate debate on the best possible board structure or on
the relative merits of alternative board structures. There were some indications

European Corporate Governance (Thomas Clarke and Jean-Francois Chanlat, eds), London, Routledge (2009)
218 at 226.
77 As Paul Davies, ‘Employee Representation and Corporate Law Reform: A Comment from the United
Kingdom’ (2000) 22 Comparative Labor Law and Policy Journal 135, 137, points out, ‘there is no one best-
system of corporate governance’.
78 European Commission Comparative Study, above n 74, 4–5.
 BOARD FUNCTIONS AND STRUCTURES 89

that the Hampel Committee (UK) was at least prepared to compare other board
models with the ‘unitary board’,79 but in the end nothing came of it.
The resistance even to discussion of alternative board structures is probably
directly linked to the vested interests of groups such as the shareholders and cur-
rent directors, who may fear that a ‘two-tier board’ would open the door for other
stakeholders, such as employees, to gain representation on the board. However,
a two-tier board does not equate to co-determination or, to put it differently,
does not have to embrace the concept of co-determination (employee partici-
pation at supervisory board level: see Chapter 13 for further discussion of this
concept). Even in Germany there is currently considerable debate surrounding
co-determination and the actual advantages of employee participation at super-
visory board level.80 This debate is continuing within the context of the two-tier
board, which is accepted as the norm in Germany for large public companies. The
German two-tier board has been considerably improved over the past 10 years or
so,81 but there are strong indications of mounting pressure in Germany against
co-determination or employee participation at supervisory board level. It is not
the German two-tier system as such that is in danger, but co-determination.82
We do not propose that one board structure is superior to the other, but rather
that a ‘unitary board structure’ could not simply be rejected in favour of a ‘two-
tier board structure’ or vice versa. Deciding on a particular board structure will
depend on many variables (for example, the size of the company, the quality
of persons sitting as non-executive directors, the corporate culture within a
particular corporation etc). As Justice Owen put it:

I think that any attempt to impose governance systems or structures that are overly
prescriptive or specific is fraught with danger. By its very nature corporate governance
is not something where ‘one size fits all’. Even with companies within a class, such
as public listed companies, their capital base, risk profile, corporate history, business
activity and management and personnel arrangements will be varied. It would be
impracticable and undesirable to attempt to place them all within a single straitjacket
of structures and processes. A degree of flexibility and an acceptance that systems can
and should be modified to suit the particular attributes and needs of each company is
necessary if the objectives of improved corporate governance are to be achieved.83

Promoting the concept of objective overseers or outsiders (that is, independent

non-executive directors) in a unitary board structure is nothing but a move

79 Kevin Keasey and Mike Wright, ‘Introduction: Corporate Governance, Accountability and Enterprise’ in
Kevin Keasey and Mike Wright (eds), Corporate Governance: Responsibility, Risks and Remuneration, New
York, Wiley (1997) 17.
80 See Otto Sandrock and Jean J du Plessis, ‘The German Corporate Governance Model in the Wake of
Company Law Harmonisation in the European Union’ (2005) 26 Company Lawyer 88–95; Jean J du Plessis and
Otto Sandrock, ‘The Rise and the Fall of Supervisory Codetermination in Germany?’ (2005) 16 International
and Commercial Law Review 67–79.
81 Jean J du Plessis, ‘Reflections on Some Recent Corporate Governance Reforms in Germany: A Transfor-
mation of the German Aktienrecht?’ (2003) 8 Deakin Law Review 389.
82 Jean J du Plessis, ‘The German Two-Tier Board and the German Corporate Governance Code’ (2004) 15
European Business Law Review 1139, 1164.
83 Owen Report (2003), above n 23, 105 para 6.12.
90 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

towards a quasi – or perhaps even a de facto84 – two-tier board structure; namely,

the managers and executive as one tier and a board consisting of a majority of
non-executive directors as the second tier. Recognising that the board of directors
cannot manage the day-to-day business of a large public corporation, and that
the business of the corporation could at most be managed ‘under the direction
of the board’85 is another indication that the division between managerial and
supervisory functions is becoming a practical reality in large public corporations.
It is for these reasons that the ‘two-tier board structure’ has been studied with
renewed interest, and has even gained some ground in certain circles.86
The Japanese Suzuki Report also stated unequivocally that the ‘functions of
the board of directors and any management board should be separate so that
corporate decision-making and business execution are clearly distinguished’.87
It is, however, to be expected that – depending on one’s understanding and
definition of a ‘unitary board’ – strong support for such a board system will
continue to be expressed in certain circles.88

3.5 Board structures in the broader context of a

good corporate governance model

3.5.1 Overview
Good corporate governance practices require more than just effective board
structures. The view presented here is that corporate governance, and in particu-
lar a good corporate governance model for any specific country, should be judged
against several other criteria. The South African King Report (2002) argued as
follows:89

22. . . . In East Asia, in 1997 and 1998, it was demonstrated that macro-economic
difficulties could be worsened by systematic failure of corporate governance,
stemming from:
22.1 weak legal and regulatory systems;
22.2 poor banking regulation and practices;

84 John C Shaw, ‘The Cadbury Report, Two Years Later’, in K J Hopt, K Kanda, M J Roe, E Wymeersch
and S Priggle (eds), Comparative Corporate Governance: The State of the Art and Emerging Research, Oxford,
Clarendon Press (1998) 21, 22.
85 An author like Huse, above n 32, 106 generalises that ‘[i]n the Anglo-American model there is one board,
which also has direct responsibility for the day-to-day running of the firm’. The statement may be correct in
so far as he refers to ‘one board’ and also if the statement is applied to the majority SMEs, but it is not correct
in so far as large public companies are concerned, where ‘the board’ nowadays will not and cannot run the
day-to-day business, as was pointed out above.
86 Thomas Sheridan and Nigel Kendall, Corporate Governance, London, Pitman (1992) 161; John Brewer,
‘Hong Kong Society of Accountants’ Report on Corporate Governance’ (1996) (June) The Corporate Gover-
nance Quarterly 10, 12.
87 Corporate Governance Committee of the Corporate Forum of Japan, Corporate Governance Principles: A
Japanese View (Final Report) (Suzuki Report), 26 May 1998, 48 (Principle 7A).
88 See Garratt, above n 43, 42–3 and 210.
89 Executive Summary–King Report on Corporate Governance (King Report (2002)), Parktown, South Africa,
Institute of Directors in Southern Africa (March 2002) para 22. See also Güler Manisali Darman, Corporate
Governance Worldwide: A Guide to Best Practices and Managers, Paris, ICC Publishing (2004) 30.
 BOARD FUNCTIONS AND STRUCTURES 91

22.3 inconsistent accounting and auditing standards;

22.4 improperly regulated capital markets;
22.5 ineffective oversight by corporate boards, and scant recognition of the rights of
minority shareowners.

Justice Owen in the HIH Royal Commission Report adopted a highly realistic and
broad approach to corporate governance, observing that:

The relevant [corporate governance] rules include applicable laws of the land as well
as the internal rules of a corporation. The relationships include those between the
shareholders or owners and the directors who oversee the affairs of the corporation on
their behalf, between the directors and those who manage the affairs of the corporation
and carry out its business, and within the ranks of management, as well as between the
corporation and others to whom it must account, such as regulators. The systems and
processes may be formal or informal and may deal with such matters as delegations
of authority, performance measures, assurance mechanisms, reporting requirements
and accountabilities.90

It will be clear from the quotes above that several factors play a role in determin-
ing the effectiveness of a good corporate governance model for any particular
country. We are of the opinion that the following criteria will all, to a greater or
lesser extent, play a role in ensuring good corporate governance practices:
● effective board structures, recognising the supervisory role of the board
and the managerial role of management
● effective support mechanisms to assist the board in fulfilling its functions
properly; for instance, board committees (appointment, remuneration,
audit, risk management, shareholders etc.) and the company secretary
● effective statutory provisions, in particular in the areas of corporations law,
banking law, regulating capital markets and ensuring auditing standards
● effective regulators, in particular in the areas of corporations law and
capital markets
● effective codes of best practice and conduct.
We will now discuss each of these criteria in turn.

3.5.2 Effective board structure

As explained above, the ‘fit-all board structure’ does not exist, but that does
not mean that sound corporate governance principles to ensure an effective
board structure could not be extracted generally. As has already been pointed
out, the board’s functions to ‘direct, govern, guide, monitor, oversee, supervise
and comply’ should be distinguished from management’s function to ‘manage
the day to day business of the corporation’. This could be illustrated by using
Tricker’s ‘governance circle’ and ‘managerial pyramid’, but placing them at an
equal level rather than having the ‘governance circle’ on top of the ‘managerial

90 Owen Report (2003), above n 23, 101–2 para 6.1.

92 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

Figure 3.8: Separation and interaction of management and governance

pyramid’ – they function ‘side-by-side’.91 There should be a healthy interaction

between the ‘governance circle’ and the ‘managerial pyramid’.
The functions of the ‘governance circle’ and the ‘managerial pyramid’ should
be separated, as illustrated by the perforated vertical line in Figure 3.8, but
there should be a healthy interaction between those who fulfil the respective
functions, as illustrated by the horizontal arrow pointing in both directions.
Exchange of information, consultation and collaboration should be key features
of the division between the function to ‘direct, govern, guide, monitor, oversee,
supervise and comply’ and the function to ‘manage the day to day business of
the corporation’. The composition of the ‘governance circle’ and the ‘managerial
pyramid’ may differ considerably, depending on the corporations law of a par-
ticular country. At one extreme is the German system, where the ‘governance
circle’ consists of one-third or one-half employee representatives and two-thirds
or one-half shareholder representatives, with no overlap between the ‘gover-
nance circle’ and the ‘managerial pyramid’. At the other end of the scale is a
model in which there is considerable overlap between the ‘governance circle’
and the ‘managerial pyramid’, but with at least some (not the majority) of the
members not part of the ‘managerial pyramid’. The position preferred by sev-
eral recent corporate governance reports, which could probably be described
as roughly the middle position, would have a majority of independent mem-
bers in the ‘governance circle’. Some reports suggest that at least half of the
‘governance circle’ should consist of independent members. This has been the
recommendation in the earlier UK Combined Code and ASX’s Corporate Gover-
nance Council in Australia. The South African King Report (2009) is currently
one of the only leading corporate governance reports not requiring a majority
independent non-executive directors to fill the board. The requirement is only
that there should be majority non-executive directors and that the majority of
them should be independent.92 The argument has consistently been that the

91 Kendall and Kendall, above n 45, 53.

92 Principle 2.9, King Code of Governance Principles for South Africa, Johannesburg, Institute of Directors in
South Africa (2009) 25.
 BOARD FUNCTIONS AND STRUCTURES 93

board should comprise a balance of power – ‘[n]o one individual or block of indi-
viduals should be able to dominate the board’s decision-making’.93 In theory this
approach makes sense, but the practical reality is that the potential is there in any
case that a majority non-executive director (even if not all of them are ‘indepen-
dent’), can dominate the board’s decision making. However, as will be seen in
Chapter 4, the expectation of having a majority independent directors on the
board to ensure independence is open for criticism.

3.5.3 Effective support mechanisms to assist the board in

properly fulfilling its functions
The idea that the board should be assisted by several standing board committees
in fulfilling its primary functions to ‘direct, govern, guide, monitor, oversee,
supervise and comply’, has gained considerable support over recent years. In
this regard, appointment committees, nomination committees, remuneration
committees, audit committees, risk management committees and shareholder
committees have become particularly prominent. Some of these committees were
pertinently mentioned in the American Law Institute’s Principles of Corporate
Governance: Analysis and Recommendations; some were also promoted in the
Cadbury, Hampel, Greenbury, King and Higgs Reports. One key feature of most
of these committees is that they are supposed to fulfil their tasks independently
of management, and ensure that they bring some objectivity to the tasks they
fulfil.
Another key position mentioned in several recent reports as being able to
assist the board in fulfilling its tasks properly is the company secretary. The
company secretary can play a vital role, not only in assisting the board to fulfil
its tasks, but also in ensuring a healthy and free flow of information between the
‘governance circle’ and the ‘managerial pyramid’. If these aspects are taken into
consideration, our corporate governance model can be illustrated as shown in
Figure 3.9.

3.5.4 Effective statutory provisions

It is important that effective legislation exists to ensure a proper corporate gov-
ernance model for any country. The areas of most importance are those of cor-
porations law, banking law, regulating capital markets and ensuring auditing
standards. It is necessary to have effective legislation, not only to ensure that cer-
tain abuses and misuses are identified, but also to provide for effective remedies
and penalties. The remedies and penalties should be civil as well as criminal and
should be aimed at punishing corporations contravening the legislation and the
individuals who are responsible for the acts of corporations. The list of possible

93 King Report (2009), above n 69, at 39 paras 62–5.

94 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

Company
secretary

Appointment or nomination committees

Compensation or remuneration committee
Audit committee
Risk management committee
Shareholder committee

Figure 3.9: Support mechanisms to assist the board

remedies and penalties is far too long to include here,94 but in Australia there has
been considerable success in using disqualification orders, compensation orders
and civil penalties orders against directors of several corporations that collapsed
after 2001.95
There have in recent years been considerable changes to legislation in sev-
eral countries to ensure proper audit standards. The main impetus for better
regulation in this area came from collapses such as those of Enron, WorldCom,
Tyco, HIH, One.Tel etc. Perhaps the most far-reaching reforms in this area were
implemented in the USA through the Sarbanes-Oxley Act of 2002. In Australia,
the Corporate Law Economic Reform Program (Audit Reform and Corporate Dis-
closure) Act 2004 (the so-called CLERP 9 Act) introduced into the Corporations
Act some drastic changes to regulation of the audit profession and new provi-
sions regarding continuous disclosure and protection for whistleblowers. These
developments will be discussed in greater detail in later chapters.

3.5.5 Effective regulators

As was pointed out in the King Report (2002), effective regulation in the areas
of corporations law and the capital markets is essential to ensure good corporate
governance. The importance of this principle was again emphasised in Australia

94 See Mirko Bagaric and Jean J du Plessis, ‘Expanding Criminal Sanctions for Corporate Crimes – Deprivation
of Right to Work and Cancellation of Education Qualifications’ (2003) 21 Company and Securities Law Journal
7–25.
95 See Jean J du Plessis, ‘Reverberations after the HIH and other Recent Australian Corporate Collapses:
The Role of ASIC’ (2003) 15 Australian Journal of Corporate Law 225, 225–45.
 BOARD FUNCTIONS AND STRUCTURES 95

with the collapse of the HIH group of insurance companies. The Australian Pru-
dential Regulatory Authority (APRA) has been heavily criticised for not reading
the signs of doom for HIH sooner and for not stepping in earlier.96 There were
serious allegations that APRA had been made aware of financial difficulties in
HIH at least six months before HIH went into provisional liquidation in March
2001.97 Although the Report of the HIH Royal Commission (Owen Report) did
not go so far as to blame APRA for not picking up earlier on financial difficulties
experienced in HIH, or suggest that it could have prevented the collapse, Justice
Owen did not hesitate to explain the reasons for APRA’s inaction, and mentioned
that ‘[i]n many instances – even taking account of the constraints it was under –
APRA did not react appropriately’.98 Amendment of the legislation to improve
the effectiveness of APRA followed this criticism.99 The importance of effective
regulators has again been emphasised with the 2008–9 global financial crisis,
and it is to be expected that there would be an increasing expectation of regu-
lators to regulate effectively and perform their regulatory duty properly. There
is little doubt that, globally, increasing regulation of the financial markets and
corporate law began to emerge100 and at the end of 2009 there were predictions
that in Australia more regulation can be expected.101
With the collapse of the Geelong-based Chartwell Enterprise Group, there
were some serious speculations that the Australian Tax Office (ATO) did not
fulfil its duty to inform ASIC earlier that Chartwell Enterprises had not paid taxes
for a considerable period of time before it eventually collapsed. During this time,
several investors invested in Chartwell Enterprises, believing that the company
was just going through a natural downturn, rather than experiencing serious
financial problems. These investors argued that they would not have invested
if ASIC had been informed by the ATO of the company’s taxation status, and
ASIC had begun an investigation. ASIC itself was criticised for not acting sooner.
There were some speculations that ASIC was made aware of serious problems in
Chartwell Enterprises long before the company actually collapsed. Thus, an area
that will have to receive serious attention in future is the nature of the respective
duties of all the corporate regulators and how their regulatory tasks and roles
can be coordinated to make the regulatory environment as effective as possible
without restraining business unnecessarily. It is accepted that it is a formidable
task and that striking the right balance would require careful consideration,

96 M De Martinis, ‘Do Directors, Regulators, and Auditors Speak, Hear, and See No Evil? Evidence from
Enron, HIH, and One.Tel’ (2002) 15 Australian Journal of Corporate Law 66 at 72–3; Rick Sarre, ‘Responding
to Corporate Collapses: Is There a Role for Corporate Social Responsibility’ (2002) 7 Deakin Law Review 1.
97 Stephen Bartholomeusz, ‘After Enron: The New Reform Debate’ (2002) 25 University of New South Wales
Law Journal 580, 581.
98 Owen Report (2003), above n 23, li.
99 See the Australian Prudential Regulation Authority Amendment Act 2003 (Cth) – an important amendment
was the replacement of the APRA Board and CEO with a full-time executive governing body.
100 See in particular Stilpon Nestor, ‘Regulatory Trends and Their Impact on Corporate Governance’ in The
Business Case for Corporate Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008)
176 et seq.
101 Kate Gibbs, ‘General Counsel Prepare for Regulation Onslaught’, TheNewLawyer, 17 December 2009
at 3, available at <www.thenewlawyer.com.au/article/general-counsel-prepare-for-regulation-onslaught-
in-2010/508724.aspx>.
96 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

but it is something that cannot be postponed indefinitely. It is, therefore, to be

welcomed that ‘the role of the regulator’ becomes more prominent, also in other
books dealing with corporate governance.102 However, it is a case ‘of finding the
right balance’. As Sir Bryan Nicholson puts it:

While comply-or-explain and the market-based approach to raising standards are

preferable to prescriptive regulation, they nonetheless have to be backed up by a
supportive regulatory framework. Government and regulators should not act as a sub-
stitute for the market, but they do have an important role to play in making sure that
the market works effectively.103

Since the first edition of Principles of Contemporary Corporate Governance, we

have emphasised the importance of effective regulators as part of the complete
picture of developing an effective corporate governance system.

3.5.6 Effective charters, policies and codes of best practice

and conduct
Since the Cadbury Report in 1992, the idea of self-imposed, good practices in
corporate governance through codes of good practice has become prominent.
Huse explains that most of the recent reports on corporate governance have
contributed to developing and formalising structures and norms by way of codes
of conduct, but he explains that in fact, ‘[c]odes are important when other
mechanisms attempting to improve governance fail’.104 He then asks some very
pertinent questions:

Which problems do codes solve? Should there be the same codes for all kinds of
firms – small as well as large – and all kinds of ownerships? Should family firms and
firms listed on stock exchanges have the same codes?105

Just as with corporate governance generally, the one-size-fits all code of conduct
is not achievable. In the UK, the UK Code of Corporate Governance sets the cor-
porate governance standards for listed corporations; comparable standards are
required of corporations listed on ASX through the ASX Corporate Governance
Council’s Principles of Good Corporate Governance and Best Practice Recommen-
dation. However, the King Report (2009) has now gone further. It recommends
that the so-called ‘King Code of Governance Principles’ should apply much wider:

In contrast to the King I and II codes, King III applies to all entities regardless of the
manner and form of incorporation or establishment and whether public, private sectors
or non-profit sectors. We have drafted the principles so that every entity can apply them
and, in doing so, achieve good governance.106

102 Sir Bryan Nicholson, ‘The Role of the Regulator’ in The Business Case for Corporate Governance (Ken
Rushton, ed.), Cambridge, Cambridge University Press (2008) 100.
103 Ibid, at 106.
104 Huse, above n 32, 176 and 181.
105 Ibid, 182.
106 King Report (2009), above n 69, at 17.
 BOARD FUNCTIONS AND STRUCTURES 97

A common feature of these codes is that it is not mandatory to follow the principles
of the code. Some form of explanation is, however, required if a core principle or
recommendation is not followed. This approach has been called the ‘comply or
explain principle’, ‘if not, why not?’ principle, or, as has more recently become
fashionable, the principle of ‘apply or explain’. The problem identified with the
principle of ‘comply or explain’ was that it could lead to ‘mindless compliance’,
rather than acceptable appliance with good corporate governance principles.
Thus, there was a move by the United Nations to promote the principle of ‘adopt
or explain’, which was refined slightly in the Netherlands code, referring to ‘apply
or explain’. This is also the current principle adopted in the King Report (2009).
The approach followed in the USA after the adoption of the Sarbanes-Oxley Act
2002 (see discussion in Chapter 12) has been described as the ‘comply or else’
approach.107
In recent years it has become apparent that a code of best practice could be used
just as effectively in a jurisdiction in which a traditional two-tier board structure
is the norm for large corporations. Thus, in 2002 Germany adopted a Corporate
Governance Code for listed corporations. The ‘comply or explain principle’ was
also introduced, showing that there are several principles of good corporate
governance that can be superimposed upon a traditional ‘unitary board’ as well
as on a traditional ‘two-tier board’.108
Lately, it has also been recommended that companies should develop internal
codes of conduct. In this regard, ASX’s Principles of Good Corporate Governance
and Best Practice Recommendations sets an excellent example. It requires com-
panies to have a code of conduct. Recommendation 3.1 expects companies to
establish a code of conduct and disclose the code or a summary of the code as to:
● the practices necessary to maintain confidence in the company’s integrity
● the practices necessary to take into account their legal obligations and the
reasonable expectations of their stakeholders the responsibility and
● the responsibility and accountability of individuals for reporting and inves-
tigating reports of unethical practices.
The purpose of a code of conduct is explained as follows:
The board has a responsibility to set the ethical tone and standards of the company.
Senior executives have a responsibility to implement practices consistent with those
standards. Company codes of conduct which state the values and policies of the com-
pany can assist the board and senior executives in this task and complement the
company’s risk management practices.109

It is interesting to note that under the 2007 ASX Principles of Good Corporate
Governance and Best Practice it is specifically provided that it is not necessary for
companies to establish a separate code for directors and senior executives. It is
explained that, depending on the nature and size of the company’s operations,
107 Ibid, at 6 and 7. Also see Peter Montagnon, ‘The Role of the Shareholder’ in The Business Case for
Corporate Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008) 81 at 83–4.
108 See Du Plessis, above n 81, 389–404.
109 ASX Principles of Good Corporate Governance and Best Practice (2nd edn, August 2007), above n 28, 21.
98 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

the code of conduct for directors and senior executives may stand alone or be part
of the corporate code of conduct.110 It is also interesting to note the difference
from the 2003 ASX Principles of Good Corporate Governance and Best Practice;
the 2007 ASX Principles of Good Corporate Governance and Best Practice does not
require a separate code on ethical and legal conduct or a code of conduct towards
stakeholders. This is unfortunate as these different codes were considered to be
useful instruments to accentuate the importance of ethical and legal behaviour
and also to recognise the importance of stakeholders other than shareholders
in the corporation. They were also seen as promoting an inclusive approach to
corporate governance, as reflected in the definition of corporate governance set
out in Chapter 1.
Building upon the previous illustrations, a good corporate governance model
would, therefore, look as follows:

Effective legislation Effective regulators

Duties Charters,
policies
and codes
Remedies of best
practice
and
conduct

Company
secretary

Appointment or nomination committees ASX

Compensation or remuneration committee Legal and ethical behaviour

Audit committee Stakeholders:
Risk management committee Employees
Clients
Customers
Shareholder committee Consumers
Community

Figure 3.10: Complete corporate governance model

3.5.7 Corporate governance rating systems for companies

Over recent years it has become increasingly important for companies to achieve
financial ratings as an indicator of their financial credibility. A few problems were

110 Ibid, 22.

 BOARD FUNCTIONS AND STRUCTURES 99

identified with the system of financial rating.111 First, there is only a limited
number of companies and institutions that provides this rating, most promi-
nently, Standard and Poor which, to a large extend monopolises the market.
Second, over time the independence of these financial rating institutions or
organisations could be compromised because they do not provide these ser-
vices free of charge. A poor financial rating will almost inevitably lead a client to
attempt to get a better financial rating from another company or organisation.112
Third, different criteria are used for such ratings. All these factors together led to
situations in which companies and, in particular financial institutions, received
AA or even AAA financial ratings, but the global financial crisis revealed that
several of them were not as financially stable as what the ratings indicated.113
Another rating system that has become popular in recent times is corporate
governance rating systems. It goes almost without saying that most of the prob-
lems identified with the financial ratings apply to corporate governance ratings.
For current purposes it suffices to list some of the corporate governance rating
agencies:114
● Standard and Poor’s <http://www.standardandpoors.com/home/en/us>
● The FTSE Group <http://www.ftse.com> in collaboration with
International Shareholder Services (ISS) <www.answers.com/topic/
institutional-shareholder-services-iss#>
● RiskMetrics Group (RMG) <www.riskmetrics.com>
115

● GovernanceMetrics International (GMI) <www.gmiratings.com/(k11w1

m45uhzr1tzqm3y45355)/Default.aspx>
● Deminor corporate governance ratings <www.deminor.com>
● Thai Rating and Information Service (TRIs) <http://thaiwebdirectories.
meelink.com/company_profile/index/Company/id/18965/Company
Name/TRIS.CO.TH>
● The International Finance Corporation (IFC) <www.ifc.org>.

111 For a more comprehensive discussion on the failure of credit-rating agencies as gatekeepers, see John
Coffee, ‘Understanding Enron: It’s About the Gatekeepers, Stupid’ (2002) 57 Business Law 1403; Claire Hill,
‘Rating Agencies Behaving Badly: The Case of Enron’ (2003) 35 Connecticut Law Review 1145; Claire Hill,
‘Regulating the Rating Agencies’ (2004) 82 Washington University Law Quarterly 43; John Hunt, ‘Credit
Rating Agencies and the “Worldwide Credit Crisis”: The Limits of Reputation, the Insufficiency of Reform
and a Proposal for Improvement’ (2008), available at <http://preprodpapers.ssrn.com/sol3/papers.cfm?
abstract_id=1267625&rec=1&srcabs=991821>.
112 Patrick Boltion, Xavier Freixas and Joel Shapiro, ‘The Credit Ratings Game’, Working Paper (February
2009), available at <www.nber.org/papers/w14712>.
113 See, for example, Marco Pagano and Paolo Volpin, ‘Credit Ratings Failures and Policy Options’,
Centre for Studies in Economics and Finance, Working Paper no. 239 (November 2009), avail-
able at <www.csef.it/WP/wp239.pdf>. For law reform proposals, see ‘Joint Report by the Trea-
sury and ASIC: Review of Credit Rating Agencies and Research Houses’ (October 2008), available at
<www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/rep143.pdf/$file/rep143.pdf>; Technical Commit-
tee of International Organisation of Securities Commissions (IOSCO), ‘Code of Conduct Fundamentals for
CRAs’ (revised May 2008), available at <www.iosco.org/library/pubdocs/pdf/IOSCOPD271.pdf>; US Secu-
rities and Exchange Commission, ‘SEC Votes on Measures to Further Strengthen Oversight of Credit Rating
Agencies’, (September 2009), available at <www.sec.gov/news/press/2009/2009-200.htm>. See generally
Thomas Clarke and Jean-Francois Chanlat, ‘Introduction: A New World Disorder?’ in European Corporate
Governance, London, Routledge (2009) 1 at 15–16.
114 See Tricker, above n 20, 322–4 for a short explanation of all these agencies and organistions.
115 In March 2010, RMG announced a comprehensive review of its corporate governance rating system and
introduced several new Governance Risk Indicators (GRIds). This was done in direct response to the global
financial crisis and unreliable past governance risk indicators.
100 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

3.6 Conclusion

We started this chapter by focusing on the organs of a company and then discussed
the main functions of a board of directors. It was pointed out that although
there is no ‘one-size-fits’ all governance model, there are certain general criteria
that can be used to judge whether a particular country has a good corporate
governance model. Effective board structures, effective support mechanisms to
assist the board in fulfilling its functions properly, effective statutory provisions
and effective regulators have all been identified as elements from which it could
be judged whether a country adheres to a good corporate governance model.
At the end of the day, a good corporate governance model will translate into
well-governed corporations. This in turn, will ensure that investors will see the
benefits of investing in well-governed companies to maximise the return on their
investments. An additional advantage is that all of this leads to the creation
of wealth, which will stimulate a country’s economy and improve the living
standards of its citizens.
Because of these factors, Durnev and Kim have established that often corpor-
ations in countries with weak investor protection mechanisms in place and only
requiring minimum corporate governance standards, will do more than just the
minimum to adhere to good corporate governance practices. In fact, they were
surprised by the number of high-quality governance firms in such countries.116
Also, increasingly, more research is being done and studies undertaken on the
key elements of an effective corporate governance system. This ensures that
investors are able to quantify the benefits that they get from investing in well-
governed companies, also called ‘private benefit of control’ by economists.117 In
our view, together, all these factors will ensure that corporate governance as a
subject area will remain of considerable importance in future.
116 Art Durnev and E Han Kim, ‘Explaining Differences in the Quality of Governance Among Companies’, in
Global Corporate Governance (Donald H Chew and Stuart L Gillan, eds), New York, Columbia Business School
(2009) 52 at 53.
117 Alexander Dyck and Luigi Zingales, ‘Control Premiums and the Effectiveness of Corporate Governance
Systems’, in Global Corporate Governance (Donald H Chew and Stuart L Gillan, eds), New York, Columbia
Business School (2009) 73. See also Sir Bryan Nicholson, ‘The Role of the Regulator’ in The Business Case for
Corporate Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008) 100 at 101–3.
4
Types of company directors
and officers

As the cigar smoke in the boardrooms clears, the comfortably reclining

figures are instantly revealed as being of two types: the executive directors
who run the business and take the rap, and the non-executive directors who,
having read their papers carefully for the pre-lunch board meeting, asked
their statutory question, and enjoyed a reasonable rib of beef, are ready to
depart blamelessly to their bank, chambers, farm or villa for another two
months.
PLR Mitchell, ‘Non-executive Directors’ (1985) Business Law Review 173
The key directors on our board all know what I have done to make our
company perform. They made me the CEO because I was the best candidate
they could find. I have worked my butt off at great sacrifice to my family
and personal life to transform this company and make it perform better
than it ever had before. I don’t need any of their penetrating questions or
second-guessing. Thanks to my own tough bargaining, I am financially
secure and set for life. If they can get someone better than me to do the job,
then that’s what they should do. Until then let them back off and stay out
of my way.
David SR Leighton and Donald H Thain, Making Boards Work, Whitby,
Ontario, McGraw-Hill Ryerson Ltd (1997) 6 (quote from an anonymous,
skeptical Canadian CEO)
We trained hard – but every time we were beginning to form up into teams,
we would be reorganised. I was to learn later in life that we tend to meet any
new situation by reorganising, and [what] a wonderful method it can be
for creating the illusion of progress while producing confusion, inefficiency
and demoralisation.
The famous words of Roman writer Gaius Petronius: Petronii Arbitri
Satyricon, 66 ad, as quoted by Nigel Kendall and Arthur Kendall,
Real-World Corporate Governance, London, Pitman Publishing (1998) 212

4.1 Overview

Comparing the first two opening quotes to this chapter with current realities
illustrates very well how things have changed over a relatively short period of

101
102 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

time. In the previous chapter we have seen that there are nowadays much higher
community expectations that all types of directors fulfil their duties of care and
diligence meticulously. No longer may directors hide behind ignorance or inac-
tion, nor are the duties of non-executive directors seen as being of an intermittent
nature. All directors have a positive duty to challenge, enquire and investigate
when controversial or potentially risky matters are discussed at board level, as
was illustrated by the 2009 case of ASIC v Macdonald (No 11).1 In this chapter
it will also become clear that the traditional and simplistic distinction between
executive and non-executive directors no longer holds true, although as a general
rule it can be said that the legal duties of all types of directors are the same.

4.2 Definition of ‘director’

The identification of who is a director has practical significance for the law on
directors’ duties and sanctions for breach under the Corporations Act 2001 (Cth)
(the Act), with particular reference to the civil penalty provisions (pecuniary
penalty, compensation and disqualification orders) discussed in Chapter 10. The
court in Murdaca v ASIC2 reminds us that a person who is not, strictly speaking,
a director may nevertheless be disqualified from managing a company if that
person is involved in management in ways that are considered to constitute
directing or controlling the affairs of that company, either alone or jointly with
others. The expansive definition of director also has significant ramifications
for those people who occupy the position of director and cause the company
to trade while insolvent. Section 588G of the Act, discussed in greater detail in
Chapter 10, imposes personal liability upon those persons who occupy the office
of director or who discharge functions attaching to that office of the kind normally
performed by a director.

4.2.1 De jure and de facto directors covered

The corporations laws of most common-law jurisdictions contain a definition of
‘director’. Although there are some differences in the respective definitions, a
common feature is that each aims to define the term quite widely in order to
ensure that those who fulfil directorial functions do not escape the provisions
of the corporations legislation. Thus, the definition of a ‘director’ will typically
include a reference to the fact that a person could still be considered to be a
director irrespective of the fact that the person is not called a director,3 but is
known by a name such as ‘governor’, ‘executive’, ‘manager’ etc. The definitions of
‘director’ will also, as a general rule, not only cover those individuals who were

1 [2009] NSWSC 287 (23 April 2009), available at <www.austlii.edu.au/au/cases/nsw/NSWSC/2009/

287.html>.
2 [2009] FCAFC 92.
3 See also Robert I Tricker, International Corporate Governance, London, Prentice Hall (1994) 42.
 COMPANY DIRECTORS AND OFFICERS 103

validly appointed to the position of ‘director’ (de jure directors), but also extend
to those acting as a ‘director’ (de facto directors). A recent trend in legislation
was also to include so-called ‘shadow directors’ under the definition. These are
individuals who are neither appointed to the position nor directly act as directors,
but who manipulate the board ‘from behind the scenes’.
Section 9 of the Act contains a typical definition of ‘director’, which includes
all the features of the definition mentioned above:
‘director’ of a company or other body means:
(a) a person who:
(i) is appointed to the position of a director; or
(ii) is appointed to the position of alternate director and is acting in that capacity,
regardless of the name that is given to their position; and
(b) unless the contrary intention appears, a person who is not validly appointed as a
director if:
(i) they act in the position of a director; or
(ii) the directors of the company or body are accustomed to act in accordance
with the person’s instructions or wishes.
Subparagraph (b)(ii) does not apply merely because the directors act on advice given by
the person in the proper performance of functions attaching to the person’s professional
capacity, or the person’s business relationship with the directors or the company or
body.

The labels accorded to directors, as ‘de facto’ or ‘shadow’ directors are intended
to be prescriptive. In expressing caution on becoming fixated with labels, Justice
Gordon in 2008 in ASIC v Murdaca4 warned:
Such descriptions can, at times, be misleading. Names and labels aside, what is required
is a critical assessment of the way in which a corporation is managed and then an
assessment as to whether the conduct of the person concerned falls with one or more
of the categories identified.

4.2.2 Shadow director

Subparagraph (b)(ii) covers so-called ‘shadow directors’, but the proviso to
subparagraph (b)(ii) (last paragraph quoted above) was included in order to
exclude from its parameters those persons in accordance with whose directions
the directors usually act, where that advice is given by the outsider in that per-
son’s professional capacity (for example, solicitor or accountant) or because of
their business relationship with the directors or company (for example, as the
company’s banker).
The expanded definition of ‘director’ has caused concern among banks, finan-
cial institutions and business and professional advisers. These institutions and
persons clearly have a strong interest in the company’s affairs, especially when
companies are in financial difficulty and steps are being taken to send repre-
sentatives to the board to investigate affairs and make suggestions on how to
4 (2008) 68 ACSR 66 at [11].
104 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

overcome the company’s financial difficulties. The problem is succinctly stated

by Vinelott J in Re Tasbian (No 3):5

The dividing line between the position of a watchdog or adviser imposed by an outsider
investor and a de facto or shadow director is difficult to draw.

The use of the plural, ‘directors’, in subparagraph (b)(ii) suggests that the board,
rather than a single director, must be accustomed to acting in accordance with
the shadow director’s directions or instructions before the subsection is satisfied.
While such an interpretation has been adopted with respect to the equivalent to
subparagraph (b)(ii) of the definition in other jurisdictions (Re a Company6 ) the
treatment of the subsection in Harris v Sheperd7 suggests that the court believed
it sufficient for a single director, there the managing director, to be accustomed
to acting on the outsider’s directions.
That ‘accustomed to act’ is a tough threshold to satisfy is highlighted further
in the recent case Natcomp Technology Australia Pty Ltd v Graiche,8 in which Stein
JA said that in order for directors to be ‘accustomed to act’ on the instructions
or directions of an outsider for the purposes of the Act, it must be established
that the outsider is involved in the principal aspects of the company’s business.
This threshold, nonetheless, is not insurmountable, as evidenced in Ho v Akai Pty
Ltd (in liq)9 where it was found that the directors or officers of Akai Australia (a
company in financial difficulty) were accustomed to acting in accordance with
the instructions and wishes of Grande Holdings (a Singaporean company) – the
latter being held to be a shadow director and therefore exposed to liability under
the insolvent trading provisions in section 588G of the Act.

4.2.3 Nominee directors

The term ‘nominee director’ is sometimes loosely used to refer to a director
who has been nominated to the board by a majority shareholder or other
stakeholder.10 This practice is common in company groups in which the holding
company appoints directors to the boards of its subsidiaries. Conflicts of interest
may easily arise for these so-called ‘nominee directors’, putting them in an unen-
viable position where they need to consider their duties towards the company
upon whose board they serve or the shareholder (another company in the group
context) that appointed them, and in groups of companies they will often be
senior managers or executives of the holding company. The law is very clear.
A director owes his or her duties to the company upon whose board he or she
serves, not to the shareholder or stakeholder who nominated the person to be a

5 Re Tasbian (No 3) [1992] BCC 358 at 363.

6 [1989] BCLC 13.
7 (1975) 1 ACLR 50 (on appeal) [1976] ACLC 28, 614.
8 [2001] NSWCA 120 (30 April 2001).
9 (2006) 24 ACLC 1526.
10 See Bob Tricker, Corporate Governance: Principles, Policies and Practices, Oxford, Oxford University Press,
(2009) 53.
 COMPANY DIRECTORS AND OFFICERS 105

director.11 Thus, the director will be in breach of his or her statutory, common
law or equitable duties if he or she does not act in good faith and the best interest
of the company upon whose board he or she serves, but in the best interests of
the nominator or appointer. There is one exception, and that is provided for in
section 187 of the Act. In terms of this section, a director of a corporation that is
a wholly owned subsidiary of a body corporate is taken to act in good faith in the
best interests of the subsidiary if the following three conditions apply:
● the constitution of the subsidiary expressly authorises the director to act in
the best interests of the holding company; and
● the director acts in good faith in the best interests of the holding company;
and
● the subsidiary is not insolvent at the time the director acts and does not
become insolvent because of the director’s act.
Apart from the obvious dilemma for the ‘nominee director’ as far as conflicts of
interests are concerned, there are also other dangers involved for the nomina-
tor or appointer. First, the nominator or appointer could be considered to be
a ‘shadow director’ (see discussion above), thus owing duties similar to other
directors towards the company (the holding company in the group context).12
Second, if the ‘nominee directors’ are controlled and manipulated by the nomi-
nator or appointer, the nominator or appointer could be held liable vicariously
for the acts and conduct of the ‘nominee directors’.13
Although the term ‘nominee director’ is not used in the Act, there is, in the con-
cluding sentence of section 203D(1), a recognition of the practice that directors
may be appointed by specific shareholders or debenture holders:

203D(1) If the director was appointed to represent the interests of particular

shareholders or debenture holders, the resolution to remove the director [under s
203D(1)] does not take effect until a replacement to represent their interests has been
appointed.

A few additional, general observations can be made regarding so-called ‘nominee

directors’. It should be noted that in fact all non-executive directors are ‘nominee
directors’ in the strict sense of the word, as they are all nominated by the board
of directors or by shareholders to be appointed by the general meeting.
Although these provisions can be replaced by provisions in a company’s con-
stitution, if a company has a constitution, two sections in the Act confirm the
practice that non-executive directors are nominated by the board of directors or
by shareholders and then appointed by the shareholders in general meeting.
Section 202G provides that ‘[a] company may appoint a person as a direc-
tor by resolution passed in general meeting’, while section 203H provides as
follows:

11 Scottish Co-operative Society v Meyer [1959] AC 324 at 367 per Lord Denning.
12 Standard Chartered Bank of Australia v Antico (1995) 18 ACSR 1.
13 Kuwait Asia Bank v National Mutual Life Nominees Ltd [1991] AC 187.
106 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

(1) The directors of a company may appoint a person as a director. A person can be
appointed as a director in order to make up a quorum for a directors’ meeting even if
the total number of directors of the company is not enough to make up that quorum.
(2) If a person is appointed under this section as a director of a proprietary company,
the company must confirm the appointment by resolution within 2 months after
the appointment is made. If the appointment is not confirmed, the person ceases
to be a director of the company at the end of those 2 months.
(3) If a person is appointed by the other directors as a director of a public company,
the company must confirm the appointment by resolution at the company’s next
AGM. If the appointment is not confirmed, the person ceases to be a director of the
company at the end of the AGM.

Thus, whether their appointment was approved by one majority shareholder or

two minority shareholders in concert, or by several shareholders as associates
voting for their appointment, all non-executive directors are normally appointed
by the general meeting if the company did not replace sections 202G and 202H
by way of custamised appointment provisions in its constitution. Furthermore, it
is often the board of directors, through appointment or nomination committees,
that nominates non-executive directors to be appointed by the general meeting.
In fact, if the term ‘nominee director’ is the correct description of a director
nominated by and appointed by a majority shareholder, such a director will not
pass the common test of ‘independence’ contained in most codes of practice.
Under the first guideline (Box 2.1) of the 2007 Australian Securities Exchange
(ASX) Principles of Good Corporate Governance and Best Practice it is expected
that the board, in order to determine the ‘independence’ of a non-executive
director, has to consider whether the director is ‘associated’ with a ‘substantial
shareholder’. It is inevitable that there will be such ‘an association’ between the
director and the ‘substantial shareholder’ if the director was appointed by the
‘substantial shareholder’.14
It will be noted that the discussion regarding ‘nominee directors’ has been lim-
ited to non-executive directors. The reason is that the appointment of managing
or executive directors is governed by section 201J of the Act, which is discussed
below.

4.3 Definition of ‘officer’

4.3.1 Statutory definition

The provisions of the Act often extends beyond directors to any ‘officer’. The
aim with such a definition is to ensure that other individuals in the company,

14 ASX, Principles of Good Corporate Governance and Best Practice, (2nd edn, August 2007) 3 <http://203.15.
147.66/about/corporate governance/revised corporate governance principles recommendations.htm> at
17 fn 13, defines ‘substantial shareholder’ as ‘a person with a substantial holding as defined in section 9 of
the Corporations Act’. S9 of the Corporations Act 2001 (Cth) basically classifies a ‘substantial holding’ as a
holding by a person and associates of ‘5% or more of the total number of votes attached to voting shares’ in a
body corporate.
 COMPANY DIRECTORS AND OFFICERS 107

not appointed as directors or acting as directors or shadow directors, are also

covered by certain provisions of the Act and that they cannot escape liability if
they are in breach of certain provisions.
Under section 9 of the Act, ‘officer of a corporation means’:
(a) a director or secretary of the corporation; or
(b) a person:
(i) who makes, or participates in making, decisions that affect the whole,
or a substantial part, of the business of the corporation; or
(ii) who has the capacity to affect significantly the corporation’s financial
standing; or
(iii) in accordance with whose instructions or wishes the directors of the
corporation are accustomed to act (excluding advice given by the per-
son in the proper performance of functions attaching to the person’s
professional capacity or their business relationship with the directors
or the corporation); or
(c) a receiver, or receiver and manager, of the property of the corporation; or
(d) an administrator of the corporation; or
(e) an administrator of a deed of company arrangement executed by the cor-
poration; or
(f) a liquidator of the corporation; or
(g) a trustee or other person administering a compromise or arrangement
made between the corporation and someone else.
Note: Section 201B contains rules about who can be a director of a corporation:
(1) Only an individual who is at least 18 may be appointed as a director of a
company.
(2) A person who is disqualified from managing corporations under Part 2D.6
may only be appointed as director of a company if the appointment is made with
permission granted by ASIC under section 206F or leave granted by the Court
under section 206G.

4.3.2 Senior employees and senior executives as ‘officers’

The aim with the broad statutory definition of ‘officer’ is also to ensure that
there is no doubt that certain duties imposed by the corporations law apply to
a group of people who will not necessarily fall under the definition of ‘director’.
It is a well-established principle that senior employees or senior officers of a
corporation owe duties similar to those of directors towards the company. The
clearest expression of this principle, adopted in most common-law jurisdictions,
is the case of Canadian Aero Service Ltd v O’Malley:15

I do not think it matters whether O’Malley and Zarzycki were properly appointed as
directors of Canaero or whether they did or did not act as directors. What is not in doubt
is that they acted respectively as president and executive vice-president of Canaero for

15 (1973) 40 DLR (3d) 371.

108 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

about two years prior to their resignations. To paraphrase the findings of the trial Judge
in this respect, they acted in these positions and their remuneration and responsibilities
verified their status as senior officers of Canaero. They were ‘top management’ and not
mere employees whose duty to their employer, unless enlarged by contract, consisted
only in respect for trade secrets and for confidentiality of customer lists. Theirs was a
larger, more exacting duty which, unless modified by statute or contract (and there
is nothing of this sort here), was similar to that owed to a corporate employer by its
directors.16

4.3.3 Middle management as ‘officers’?

In the HIH Royal Commission Report, Justice Owen was struck by the role of
middle management as a component of a company’s governance systems. He
observed that it is customary to focus upon the role of senior or executive level
management when the organs of governance are discussed. However, Justice
Owen observed that ‘middle management’ had played a significant role in HIH
and that they were involved in undesirable practices. He was frustrated by the dis-
inclination of those persons to accept responsibility in relation to such practices.
Justice Owen then observed as follows regarding middle management:
I have therefore had occasion to review the current legal regime governing the duties
imposed upon persons other than directors. These issues seem to me to be of con-
siderable significance, because it is clear that in larger companies many significant
decisions are made by management without reference to the board. It follows that any
legal regime for the enforcement of corporate governance standards which does not
extend to the acts or omissions of at least some levels of management is unlikely to be
wholly effective.
The evidence I have heard also suggests that it is common for management decisions
to be made on a collective or collegiate basis, or at least after interaction with other
managers. There is therefore an opportunity for the law significantly to influence the
mind-set or culture of those managers, and reinforce their obligations to the company
and its shareholders.17

As part of the CLERP 9 amendments to the Act in 2004 (see Chapter 8) the
term ‘employee’ was included in several of the provisions of the Act.18 However,
the legislature did not accept Justice Owen’s suggestion to make the primary
duties imposed upon directors and officers applicable to middle managers. The
question of reform in this area was, however, referred to the Corporations and
Markets Advisory Committee (CAMAC) for consideration. In May 2005, CAMAC
released a discussion paper titled Corporate Duties Below Board Level. In that
paper, CAMAC put forward preliminary proposals to, inter alia, (i) extend the
duties in section 180 (due care and diligence), and section 181 (good faith
16 At 381, para. 22.
17 Report of the HIH Royal Commission (Owen Report), The Failure of HIH Insurance – Volume I: A Corporate
Collapse and its Lessons, Canberra, Commonwealth of Australia (2003) 122 para 6.4.
18 See the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (the
so-called CLERP 9 Act), amending inter alia the following sections to include ‘employees’ – ss 411, 418, 422,
436 etc.
 COMPANY DIRECTORS AND OFFICERS 109

and proper purpose) to apply to ‘any other person who takes part in, or is con-
cerned, in the management of that corporation’, and (ii) extend the prohibitions
in section 182 and section 183 (regarding improper use of company position
or information) to apply to ‘any other person who performs functions, or other-
wise acts, for or on behalf of that corporation’. CAMAC sought comments as to
whether ‘management’ should be defined and, if so, whether it should be defined
along the lines of activities that involve policy and decision making related to
the business affairs of a corporation, to the extent that the consequences of the
formation of those policies or making of those decisions may have some signif-
icant bearing on the financial standing of the corporation or the conduct of its
affairs. It is still unclear whether these proposals would be adopted and, if so,
when.

4.4 Types of company officers

4.4.1 Executive and non-executive directors19

It will be clear from the discussion above that the Act makes no distinction
between ‘executive’ and ‘non-executive’ directors. All ‘directors’ fall under the
same definition and, as general rule,20 have the same duties. That this is the
correct interpretation of the Act as confirmed in Daniels v Anderson.21
Although there is, as general rule, no difference in the duties expected of ‘exec-
utive’ and ‘non-executive’ directors in the Act, the distinction between ‘executive’
and ‘non-executive’ directors is nowadays a very important one in practice.22 This
distinction has become progressively more important with the emphasis on the
board’s role to ‘direct, govern, guide, monitor, oversee, supervise or comply’, as
explained in greater detail in the previous chapter. The more prominent role
of ‘independent non-executive directors’ has further accentuated this practical
distinction between ‘executive’ and ‘non-executive’ directors.23
Executive directors wear two hats. On the one hand, they are executives
working full-time in the corporation, and in this capacity they will normally have a
contract of service with the corporation.24 On the other hand, executive directors

19 In the USA, the term ‘outside director’ is used rather than ‘non-executive director’.
20 The words, ‘as general rule’ are emphasised, because there is a clear recognition in s 180(1) of the Act
that although all directors or other officers of a corporation ‘must exercise their powers and discharge their
duties with the degree of care and diligence that a reasonable person would exercise’, the specific type of
corporation (for instance a small proprietary company or a large multinational, listed public company) in
which the director fulfilled his or her duties and the specific position the person occupied and the specific
responsibilities allocated to the person (for instance an independent non-executive director or the chief
financial officer or CEO, who are also board members) will be taken into consideration in determining
whether there was a breach of a particular director’s duty of care and diligence under s 180(1) of the
Corporations Act 2001.
21 [1995] 13 ACLC 614.
22 ASIC v Rich [2009] NSWSC 1229 [7203].
23 See generally Murray Steele ‘The Role of the Non-executive Director’ in The Business Case for Corporate
Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008) 50.
24 See AWA Ltd v Daniels (Trading as Deloitte Haskins & Sells & Ors) (1992) 7 ACSR 759, 867.
110 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

are office-bearers of the company, falling under the statutory and common-
law duties expected of a ‘director’. The 2007 ASX Principles of Good Corporate
Governance and Best Practice simply defines ‘executive director’ as ‘a director who
is an executive of the company’.25
Non-executive directors have the same statutory and common-law duties
as executive directors, but they do not work in the company on a full-time
basis. Their labour is first and foremost directed toward the matters dealt with
at board meetings. They serve on the board, and the board’s functions and
responsibilities are to ‘direct, govern, guide, monitor, oversee, supervise and
comply’. In this sense their duties and responsibilities are of a continuing nature.
The 2007 ASX Principles of Good Corporate Governance and Best Practice simply
defines ‘non-executive director’ as ‘a director who is not an executive of the
Company’.26

4.4.2 Independent non-executive directors

It has been realised for several years that non-executive directors can play an
important role on boards, in particular, of larger corporations, because they
‘bring to bear a broader perspective, more background, a wider range of skills
on a particular issue or indeed on the management of the company . . . ’27 Thus,
apart from any expertise they may bring to the company, non-executive directors
often provide a beneficial objective/independent viewpoint and thus a crucial
check on self-interest and abuse within corporate management. Tricker explains
the shift away from boards controlled by inside directors and also the reason for
this shift:

In the last several decades there has been a dramatic shift away from boards dominated
by inside directors towards boards dominated by outside directors . . . A principal rea-
son for this change has been the growing concern that inside directors (ie corporate
employees) tend to be self-serving.28

In 1992, the Cadbury Report emphasised the important role of non-executive

directors in bringing an ‘independent judgment’ into the boardroom.29
However, the committee responsible for the Report stopped short of recommend-
ing that the majority of the board should consist of ‘independent non-executive
directors’. The only recommendation was that there should be at least three non-
executive directors on the boards of listed companies and that the majority of
non-executive directors should be ‘independent of the company’.30 The Cadbury

25 Principles of Good Corporate Governance and Best Practice (2007), above n 14, 39.
26 Ibid.
27 Evidence presented to the Senate Standing Committee on Legal and Constitutional Affairs, Report on the
Social and Fiduciary Duties and Obligations of Company Directors (1989) 618.
28 Tricker, above n 3, 15.
29 Committee on the Financial Aspects of Corporate Governance, Report of the Committee on the Financial
Aspects of Corporate Governance (Cadbury Report (1992)) (1992) para 4.10 et seq.
30 Ibid para 4.11 and 4.12.
 COMPANY DIRECTORS AND OFFICERS 111

Report only defined independence as ‘independent of management and free

from any business or other relationship which could materially interfere with
the exercise of their independent judgment’.31 The Hampel Committee (1998),
‘after careful consideration’, observed that it ‘[does] not consider that it is practi-
cable to lay down more precise criteria for independence’;32 and in 2002, it was
stated that there were in the United Kingdom only minimal indications of what is
meant by ‘independence’ and that it was primarily for the board to set standards
regarding the definition of independence.33
Subsequently, however, there has been a considerable change of heart in the
UK. The Higgs Report (2003) not only recommended that at least half of the
board (excluding the chair) should be ‘independent non-executive directors’,34
but also defined ‘independence’ in great detail.35 These recommendations were
accepted and formed part of the 2008 UK Combined Code (see further Chapter 12
and note that a new UK Corporate Governance Code will become effective from
29 June 2010 – also discussed further in Chapter 12). A person may only be
considered to be an ‘independent non-executive director’ if the following criteria
are met:

Code Principle A.3.1 The board should identify in the annual report each non-
executive director it considers to be independent. The board should determine whether
the director is independent in character and judgement and whether there are rela-
tionships or circumstances which are likely to affect, or could appear to affect, the
director’s judgement. The board should state its reasons if it determines that a director
is independent notwithstanding the existence of relationships or circumstances which
may appear relevant to its determination, including if the director:
• has been an employee of the company or group within the last five years;
• has, or has had within the last three years, a material business relationship with the
company either directly, or as a partner, shareholder, director or senior employee of
a body that has such a relationship with the company;
• has received or receives additional remuneration from the company apart from a
director’s fee, participates in the company’s share option or a performance-related
pay scheme, or is a member of the company’s pension scheme;
• has close family ties with any of the company’s advisers, directors or senior
employees;
• holds cross-directorships or has significant links with other directors through involve-
ment in other companies or bodies;
• represents a significant shareholder; or
• has served on the board for more than nine years from the date of their first election.

31 Ibid para 4.12.

32 Committee on Corporate Governance, Final Report (Hampel Report (1998)), para 3.9, available at
<www.econsense.de/_CSR_INFO_POOL/_CORP_GOVERNANCE/images/hampel_report.pdf>.
33 Stephen M Davis, ‘Leading Corporate Governance Indicators’, in Low Chee Keong (ed.), Corporate Gov-
ernance: An Asian-Pacific Critique, Hong Kong, Sweet & Maxwell (2002) 57, 61.
34 Review of the Role and Effectiveness of Non-Executive Directors (Higgs Report), (January 2003), available
at <www.berr.gov.uk/files/file23012.pdf> para 9.5.
35 Ibid para 9.11 and box following para 9.13 on 37. See also Richard Smerdon, A Practical Guide to Corporate
Governance, London, Sweet & Maxwell (2nd edn, 2004) 67 et seq.
112 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

In Australia, it is now expected that listed companies must explain if they do not
have at least half of the board (excluding the chair) consisting of ‘independent
directors’; there are now also extensive guidelines in the ASX Principles of Good
Corporate Governance and Best Practice Recommendations for assessing whether
a non-executive director is ‘independent’.36 These guidelines were originally
(2003) adapted from the Investment and Financial Services Association (IFSA)
Blue Book (2002):37
Assessing the independence of directors An independent director is a non-executive
director (ie is not a member of management) and:
1. is not a substantial shareholder of the company or an officer of, or otherwise asso-
ciated directly with, a substantial shareholder of the company;
2. within the last three years has not been employed in an executive capacity by the
company or another group member, or been a director after ceasing to hold any
such employment;
3. within the last three years has not been a principal of a material professional adviser
or a material consultant to the company or another group member, or an employee
materially associated with the service provided;
4. is not a material supplier or customer of the company or other group member, or
an officer of or otherwise associated directly or indirectly with a material supplier
or customer;
5. has no material contractual relationship with the company or another group mem-
ber other than as a director of the company;
6. has not served on the board for a period which could, or could reasonably be
perceived to, materially interfere with the director’s ability to act in the best interests
of the company;
7. is free from any interest and any business or other relationship which could, or
could reasonably be perceived to, materially interfere with the director’s ability to
act in the best interests of the company.

These guidelines were simplified, and the 2007 ASX’s Principles of Good Corporate
Governance and Best Practice Recommendations currently contains the following
guidelines:
Box 2.1: Relationships affecting independent status
When determining the independent status of a director the board should consider
whether the director:
1. is a substantial shareholder of the company or an officer of, or otherwise associated
directly with, a substantial shareholder of the company
2. is employed, or has previously been employed in an executive capacity by the
company or another group member, and there has not been a period of at least
three years between ceasing such employment and serving on the board
3. has within the last three years been a principal of a material professional adviser or
a material consultant to the company or another group member, or an employee
materially associated with the service provided

36 ASX, Principles of Good Corporate Governance and Best Practice Recommendations, (March 2003), available
at <http://203.15.147.66/about/corporate_governance/principles_good_corporate_governance.htm>.
37 Guidance Note No. 2.00: Corporate Governance: A Guide for Fund Managers and Corporations (hereafter
referred to as ‘IFSA Blue Book (2002)’), (December 2002), 18 – see ASX, Principles of Good Corporate
Governance and Best Practice Recommendations (March 2003) above n 36, 20 fn 5.
 COMPANY DIRECTORS AND OFFICERS 113

4. is a material supplier or customer of the company or other group member, or an

officer of or otherwise associated directly or indirectly with a material supplier or
customer
5. has a material contractual relationship with the company or another group member
other than as a director.

The shift towards expecting a majority of the directors of listed corporations to

be ‘independent non-executive directors’ went hand-in-hand with a considerable
expansion of the role envisaged for independent non-executive directors over
recent years. Perceptions of what an ‘independence director’ is has also changed
rapidly over recent times.38 As recently as 1998, Kendall and Kendall explained
as follows:

An independent director may represent particular key stakeholder groups, such as

shareholders, employees or a major trading partner, or he or she may have a more
general purpose, representing all interested parties.39

It will be apparent from both the 2008 UK Combined Code and the ASX’s Prin-
ciples of Good Corporate Governance and Best Practice Recommendations, quoted
above, that such a director (called ‘connected independent director’ (CNED) –
see discussion below) will no longer pass the test of independence. Companies
will nowadays have to explain why they consider a director to be ‘independent’
if he or she represents the interest of a stakeholder such as a ‘significant share-
holder’ or is himself or herself ‘a substantial shareholder of the company or an
officer of, or otherwise associated directly with, a substantial shareholder of the
company’.
Only time will tell whether non-executive directors can live up to the huge
expectations for them not only to ‘bring to bear a broader perspective, more
background, a wider range of skills on a particular issue or indeed on the man-
agement of the company . . . ’,40 but also to fulfil their newly acquired monitoring
or supervisory roles. It should be kept in mind that several factors or barriers may
stand in the way of non-executive directors fulfilling their role effectively: the
appointment processes for non-executive directors are often inadequate – nom-
ination by the board based on close personal relationships with board members,
the chief executive officer (CEO) or the chairperson of the board etc;41 some
are still too closely allied with management; they rely of necessity on informa-
tion prepared by and received from management to fulfil their monitoring or
supervisory functions;42 there is no guarantee that they will challenge the CEO;

38 See generally Robert AG Monks and Nell Minow, Corporate Governance, Oxford, Blackwell (3rd edn,
2004) 227 et seq.
39 Nigel Kendall and Arthur Kendall, Real-World Corporate Governance, London, Pitman (1998) 107.
40 Evidence presented to the Senate Standing Committee on Legal and Constitutional Affairs, Report on the
Social and Fiduciary Duties and Obligations of Company Directors, Canberra, AGPS (1989), 618.
41 See generally Tricker, above n 10, 57.
42 For some very skeptical, but enlightening, views of the role of boards by young CEOs in Canada, see David
Leighton and Donald H Thain, Making Boards Work, Whitby, Ontario, McGraw-Hill Ryerson (1997) 6–7.
Also see Lawrence Mitchell, ‘Structural Holes, CEOs and the Informational Monopolies: The Missing Link in
Corporate Governance’, (2005) 70 Brook Law Review 1313.
114 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

they lack detailed knowledge of the company’s business; they have limited time
to spend on their directorships;43 ‘independence’ is a state of mind, rather than
something to be determined by ticking a few boxes to illustrate that the person
is ‘independent’;44 there are different meanings attached to ‘independence’;45
the more ‘involved and engaged’ non-executive directors become, the less inde-
pendent they become; lack of time commitment to the company; and a lack of
knowledge and understanding of the company46 . Murray Steele summarises the
challenges for non-executive directors very well:

[A]s a result both of their responsibilities and of the rapidly changing environment in
which companies operate, the NED role today is complex and demanding. It requires
skills, experience, integrity, and particular behaviours and personal attributes. NEDs
have to deal with interesting dilemmas: they need both to challenge and support the
executive directors; be both engaged and non-executive; and both independent and
involved.47

We will also have to wait and see whether the role and effectiveness of indepen-
dent non-executive directors will improve corporate governance practices and
make corporations more responsible, efficient and profitable (see the definition
of ‘corporate governance’ in Chapter 1). There are widely diverging views on
what the actual effect of ‘independence’48 is on directors’ perceptions of their
role and functions. It has been argued that all directors should have an inter-
est in the corporation through shareholdings;49 that ‘the best boards consist of
directors who are also substantial, as opposed to nominal, shareholders’;50 and
that it ‘has [been] proven [to be] hollow at best’ to expect outside directors with
little or no equity stake in the company to effectively monitor and discipline the
managers who selected them.51
It seems to us that the ‘monitoring, overseeing, supervisory and compliance’
roles (see Chapter 3) – and the fulfillment of these roles through independent
non-executive directors – have become so dominant that the other roles of the
board (‘directing, governing and guiding’) could suffer as a result. This trend
could be described as the dominance of responsible corporate behaviour over

43 Bonnie Buchanan, Tom Arnold and Lance Nail, ‘Beware the Ides of March: The Collapse of HIH Insurance’
in Jonathan A Batten and Thomas A Fetherston (eds), Social Responsibility: Corporate Governance Issues,
London, JAI (2003) 199, 213; John C Shaw, ‘The Cadbury Report, Two Years Later’ in K J Hopt, K Kanda, M J
Roe, E Wymeersch and S Priggle (eds), Comparative Corporate Governance: The State of the Art and Emerging
Research, Oxford, Clarendon Press (1998) 21, 27–9; and Tricker, above n 3, 15.
44 See also Bob Tricker, above n 10, 51.
45 See in particular Donald Clarke, ‘Three Concepts of the Independent Director’, (2007) 32 Delaware Journal
of Corporate Law 73.
46 Steele, above n 23, 50 at 56–9.
47 Ibid, 50 at 65.
48 Leighton and Thain, above n 42, 64–5, give good reasons for their belief that ‘director independence is a
myth’.
49 See further Mirko Bagaric and James McConvill, ‘Why All Directors Should be Shareholders in the
Company: The Case Against “Independence” ’ (2004) 16 Bond Law Review 40.
50 John L Colley (Jr), Jacqueline L Doyle, George W Logan and Wallace Stettinius, Corporate Governance,
London, McGraw-Hill (2003) 78.
51 Jensen, as quoted by Mahmoud Ezzamel and Robert Watson, ‘Executive Remuneration and Corporate
Performance’ in Kevin Keasey and Mike Wright (eds), Corporate Governance: Responsibility, Risks and Remu-
neration, New York, Wiley (1997) 61, 70.
 COMPANY DIRECTORS AND OFFICERS 115

corporate performance,52 and one wonders whether the scale has not perhaps
tilted too far in favour of responsible corporate behaviour.53
We are of the opinion that the role and effectiveness of independent non-
executive directors has been over-emphasised in recent years or, to put it dif-
ferently, there is an unrealistic expectation of what non-executive directors can
achieve.54 We agree with Justice Owen, who had some difficulty in accepting
the wisdom of the current trend to expect listed companies to have a majority of
independent non-executive directors:

The weight of current opinion is that it is desirable to have a majority of independent

directors on a public company board. The board of HIH had several ‘independent’
directors but this provided little protection against the folly of management. I am not
convinced that a mandatory requirement for boards to have a majority of non-executive
directors is either necessary or desirable. In most cases it will be desirable (assuming the
non-executive directors are truly independent) but flexibility ought to be maintained
to enable corporations to be structured in a way that best suits their circumstances.
Nonetheless, the trend in the prescription of codes of conduct seems to assume the
premise. My recommendations have been developed accordingly.55

It is also particularly noteworthy that the 2010 UK Corporate Governance Code

moved away from the requirement that the boards of listed UK companies should
comprise a majority independent, non-executive directors. The current require-
ment reads as follows:

The board should include a strong presence of executive and non-executive direc-
tors (and in particular independent non-executive directors) such that no individual
or small group of individuals can dominate the board’s decision taking (Supporting
Principle to B.1).56

With their monitoring role in mind, and the huge potential of personal liability, in
future will there be any real incentive for ‘independent non-executive directors’
to work and see the company through difficult times rather than just abandoning
ship at the earliest possible time when the corporation goes through troubled
times? There is a risk that in future ‘independent non-executive directors’ will
become no more than professional whistleblowers in order to fulfil their moni-
toring role and to avoid the danger of huge personal liability. The upshot of this
is that it will lead to a reality check – the current over-emphasis on the role and
effectiveness of ‘independent non-executive directors’ is creating an unrealistic

52 See generally Thomas Clarke, ‘Risks and Reform in Corporate Governance’ in 3R’s of Corporate Governance,
Kuala Lumpur, Malaysian Institute of Corporate Governance (2001) 116, 116.
53 See also Leighton and Thain, above n 42, 23–4; and Sir Geoffrey Owen, ‘The Role of the Board’ in The
Business Case for Corporate Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008)
10 at 22–3 and 28; Sanjai Bhagat and Bernard S Black, ‘Non-correlation Between Board Independence and
Long-term Firm Performance’ (2002) 27 Journal of Corporate Law 231.
54 Ken Rushton, ‘Introduction’ in The Business Case for Corporate Governance (Ken Rushton, ed.), Cambridge,
Cambridge University Press (2008) 1 at 6–7.
55 Owen Report, above n 17, 112 para 6.2.6.
56 FRC, Consultation on the Revised UK Corporate Governance Code (December 2009), available
at <www.frc.org.uk/images/uploaded/documents/Consultation%20on%20the%20Revised%20Corporate
%20Governance%20Code1.pdf> at 22.
116 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

expectation, a rapidly widening ‘expectation gap’. Over time, that has the poten-
tial to cause the demise of the ‘independent non-executive director’ as one of the
useful devices invented to ensure that corporations adhere to good corporate
governance practices.
Although we do not deny there is a definite place in the complete corporate
governance picture for independent non-executive directors, it is barking up the
wrong tree to over-emphasise their role and effectiveness. Time, energy and
money would, in our view, better be spent in adopting an open-minded and
inclusive approach to corporate governance (see the definition of corporate gov-
ernance in Chapter 1) rather than taking a narrow approach that focuses only on
selected areas such as the financial aspects of corporate governance or the role
and effectiveness of independent non-executive directors. As Rodrigues justly
points out, recent corporate history and corporate scandals (Enron, Hewlett
Packard and United Health) teach us that the ‘independent board’ can be of cold
comfort and that we should guard against over reliance on independence. The
argument is that to expect independence in order to achieve more, to require
super majority independent boards and expect them to make better business
decisions and govern the corporation better is to misconceive the role of the inde-
pendent director and to fetishise independence.57 Another danger emphasised
by Mitchell is that on boards in which there is a super majority of independent
board members, the function of the board shifts, of necessity, to the monitoring
role of the board. In addition, with so few insiders on the board, the CEO becomes
the main avenue for providing internal information, which increases the risk of
fraud.58

4.4.3 Connected non-executive directors

Tricker uses the term ‘connected non-executive directors (CNEDs)’ in reference
to categories of directors who are not part of the company’s management but
have some relationship with the company.59 CNEDs are also called ‘affiliated
directors’.60 In other words, they are the non-executive directors who do not
meet one or more of the criteria stipulated to classify them as ‘independent
non-executive directors’. These directors will, therefore, have to be disregarded
when a company wants to determine whether it complies with the expectation
in several international voluntary codes of best practice that the boards of listed
public companies must have a majority ‘independent non-executive directors’.
Alternatively, a company will have to explain why it considers a person still to be
‘independent’ irrespective of the required connections with the company.

57 Usha Rodrigues, ‘The Fetishization of Independence’ (2008) 33 Journal of Corporate Law 447.
58 Lawrence Mitchell, ‘Structural Holes, CEOs and the Informational Monopolies: The Missing Link in
Corporate Governance’, (2005) 70 Brook Law Review 1313.
59 Tricker, above n 10, 51.
60 Stephen M Bainbridge, The New Corporate Governance in Theory and Practice, Oxford, Oxford University
Press, (2008) 188.
 COMPANY DIRECTORS AND OFFICERS 117

4.4.4 Lead independent directors or senior

independent directors
The 2010 UK Corporate Governance Code requires that the board appoint one of
the independent non-executive directors to be ‘the senior independent director’.
It is expected of the senior independent director to provide a sounding board
for the chairman and to serve as an intermediary for the other directors when
necessary. The senior independent director should also be available to share-
holders if they have concerns about which contact through the normal channels
of chairperson, CEO or other executive directors has failed to resolve or for which
such contact is inappropriate.61 The Code further provides that the annual report
should identify ‘the senior independent director’.62 It also requires that ‘the senior
independent director’ should lead a meeting with all the non-executive directors
at least annually, without the chairperson, in order to appraise the chairperson’s
performance, and on such other occasions as are deemed appropriate.63 This
performance evaluation of the chairperson should take into account the views
of executive directors.64 Furthermore, the senior independent director should
attend sufficient meetings with a range of major shareholders to listen to their
views in order to develop a balanced understanding of the issues and concerns
of major shareholders.65
The ASX Corporate Governance Council’s Principles of Good Corporate Gover-
nance and Best Practice Recommendations contains no specific recommendation
for a ‘senior independent director’ to be appointed and identified. However, there
is a suggestion that where the chairperson is not an independent director, it may
be beneficial to consider the appointment of a ‘lead independent director’.66

4.4.5 The managing director, managing directors, the chief

executive officer and executive directors
In terms of section 201J (replaceable rule) of the Australian Corporations Act
2001 (Cth), the directors of a company may appoint one or more of themselves
to the office of managing director for such period, and on such terms (including
remuneration), as the directors may think fit. Section 198C (replaceable rule)
specifically allows the directors to confer on a managing director any of the
powers that the directors may exercise.
Note that there is no definition of ‘managing director’ in the Act. The term
has also been used, especially in the past, to indicate all those directors involved
in managerial functions. There is also no definition of ‘executive director’ in
the Act. Thus, it is only by inference that it could be concluded that a board

61 FRC, above n 56, Code Provision A.4.1.

62 Ibid, Code Provision A.1.2.
63 Ibid, Code Provisions B.6.3.
64 Ibid.
65 Ibid, Code Provision E.1.1.
66 Principles of Good Corporate Governance and Best Practice (2007), above n 14, 17.
118 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

will, under sections 201J and 198C of the Act have the power to appoint one
or more of themselves to the office of ‘executive director’ and confer on an
executive director any of the powers the directors may exercise. The reason for
this inference is that it is less common to use the terms ‘managing directors’ or
‘the managing director’ in public companies. Under the influence of the USA, it is
nowadays common to use the terms ‘executive directors’, ‘chief executive officer’
or ‘principal executive officer’ rather than ‘managing directors’ or ‘the managing
director’.67 In most large Australian corporations, the CEO will also be a director,
but listed companies will have to explain (under the ‘if not, why not’ principle)
if the CEO is also the chair of the board.68
It is interesting to note that there is no reference to ‘the managing director’
or ‘managing directors’ in the 2007 ASX Principles of Good Corporate Governance
and Best Practice. The term ‘senior executives’ is used and defined as ‘the senior
management team as distinct from the board, being those who have the opportu-
nity to materially influence the integrity, strategy and operation of the company
and its financial performance’.69

4.4.6 Chairperson
Section 248E (replaceable rule) of the Act allows the board to appoint one
director to chair their meetings. This section further provides that the directors
must elect a director present to chair a meeting, or part of it, if: (a) a director
has not already been elected to chair the meeting; or (b) a previously elected
chair is not available or declines to act for the meeting or part of the meeting. It
is unclear, however, whether the chairperson has any implied authority beyond
the usual authority of a single director. This was doubted in Hely-Hutchinson v
Brayhead Ltd.70
If a director is the chairperson of a meeting, he or she is still acting in his
or her capacity as a director of the company. If, however, the chairperson is
acting as a proxy (an agent for the member), the chairperson owes duties to the
individual members who directed their proxies to him or her. Accordingly, in
such circumstances a chairperson owes duties distinct from the duties owed by a
director – they are not mutually exclusive – both sets of duties must be complied
with: Whitlam v Australian Securities and Investments Commission.71
As pointed out in Chapter 3, it is considered not to be a good corporate
governance practice to combine the role of CEO and chairperson of the board.
The reasons are, firstly, roles of management and the board are considered
to be different and it is almost impossible for the same individual to properly
fulfil the respective roles of the most senior manager of the company and the

67 J B Reid, Commonsense Corporate Governance, Sydney, Australian Institute of Company Directors

(2002) 68.
68 Principles of Good Corporate Governance and Best Practice (2007), above n 14, Recommendation 2.2.
69 Ibid, 39.
70 [1968] 1 QB 549.
71 (2003) 21 ACLC 1259.
 COMPANY DIRECTORS AND OFFICERS 119

role as chairperson of the board, with an expectation that the board should
‘direct, govern, guide, monitor, oversee, supervise and comply’ – see discussion
in Chapter 3. Second, it is also considered to be too much of a concentration
of power vested in one person to combine the roles of CEO and chairperson.72
However, it should be pointed out that whether or not the CEO is also the
chairperson, it is unlikely that other executive directors serving on the board will
challenge the CEO on managerial decisions taken by the CEO at board level. The
reason for this is simply that such a challenge will probably result in them having
to face the wrath of the CEO the next day, when they will again be seen as the
subordinates of the CEO, who is after all their boss as far as line management is
concerned. One can also imagine that executive directors will normally not like
their internal differences to be displayed at board level, as that can easily get in
the way of an harmonious and collegial way in which the business of the company
is run by the senior executives. Having a different person as chairperson of the
board provides a mechanism through which sensitive issues can be discussed with
the chairperson on all executive matters, rather than taking up these matters at
board level.
Mervyn King, in his book, The Corporate Citizen, devotes a chapter to the role
of the chairperson. Some of the key aspects that chairpersons should keep in
mind could be extracted from this chapter:73
● A good chairperson will be able to prepare a meeting in such a way that it
will finish within two to three hours;
● Because body language is important, members of the board need to be in
a place where they can not only hear each other clearly but can see each
other as well.
● The chairperson needs to prepare for the meeting by ensuring that he or she
has read all the documents carefully, understands them, and, in addition
has spent time with senior management prior to the meeting.
● The chairman has to ensure that the board does not get involved in man-
agement – he or she has to remember that the board’s role is a reflective
one; strategy rather than activity.
● A good chairman is also a good listener.
● It is important for the chairperson to liaise with the chairperson of every
board committee (especially the audit committee) and have an under-
standing between them in regard to the presentation of any matter with
which the respective subcommittees is concerned.
● While the chairperson has to be collegiate, he or she has to be at
arm’s length (which is impossible if the role of CEO and chairperson is
combined) because at some time the chairperson is going to be called upon

72 See generally Ken Rushton, ‘The Role of the Chairman’ in The Business Case for Corporate Governance (Ken
Rushton, ed.), Cambridge, Cambridge University Press (2008) 29.
73 Mervyn King, The Corporate Citizen: Governance for All Entities, Johannesburg, Penguin Books (2006) at
39–45. For another discussion of the practical importance of the chairperson, see Bob Tricker, above n 10,
255–9.
120 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

to arbitrate issues, dismiss a senior executive or call on a colleague to

resign.
● The chairperson should try to meet at least twice a year with the non-
executive directors so that a discussion without management present can
be held about, inter alia, issues such as the ability of the management team
and succession planning.
● The chairperson must endeavor to find ways in which bad news will reach
the top more quickly and he or she must become an expert in asking a
critical intellectually naı̈ve question when he or she does intervene in a
debate.
● A chairperson needs to know that the members of the board have done their
homework by sometimes asking any of the board members to summarise
an issue and motivate why he or she voted in a particular way on an
issue.

4.4.7 Alternate director

Section 201K (replaceable rule) of the Act empowers a director to appoint an
alternate director to exercise some or all of the director’s powers for a specific
period. This power is useful when a director is unable to be present at meetings.
The appointment of an alternate director must be in writing74 and must be
approved by the other directors.75 This approval will presumably be by way
of a resolution of the board. If so requested by the appointing director, the
company must give the alternate director notice of directors’ meetings.76 When
an alternate exercises the appointing director’s powers, it is just as effective as if
the powers were exercised by the appointing director.77 Although the alternate
director may be appointed to act as agent of the appointing director, the alternate
is nevertheless a director in the eyes of the law, with the same rights, duties and
responsibilities of a director.78
The appointing director may terminate the alternate’s appointment at any
time.79 It is important to note that the Australian Securities and Investments
Commission (ASIC) must be given notice of the appointment and termination of
appointment of an alternate director.80

4.4.8 Secretary
The Cadbury Report (1992) dealt with the vital role the company secretary should
play in ensuring that correct procedures and good corporate governance practices
74 Section 201K(5) of the Corporations Act.
75 Section 225K(1).
76 Section 201K(2).
77 Section 201K(3).
78 Business Council of Australia, Corporate Practices and Conduct (hereafter referred to as the ‘Bosch Report
(1993)’), Melbourne, Information Australia (1993) 18.
79 Section 201K(4).
80 Section 205B(2) and (5).
 COMPANY DIRECTORS AND OFFICERS 121

are followed.81 This has been confirmed by the Hampel Report (1998).82
In the Cadbury Report, the role of the company secretary was explained as
follows:

4.25 The company secretary has a key role to play in ensuring that board procedures
are both followed and regularly reviewed. The chairman and the board will look to
the company secretary for guidance on what their responsibilities are under the rules
and regulations to which they are subject and on how those responsibilities should be
discharged. All directors should have access to the advice and services of the company
secretary and should recognise that the chairman is entitled to the strong and positive
support of the company secretary in ensuring the effective functioning of the board.
It should be standard practice for the company secretary to administer, attend and
prepare minutes of board proceedings (original emphasis).83

In Australia, a public company must have at least one secretary.84 A proprietary

company is no longer required to appoint a secretary, but if it does have one
or more secretaries, at least one must ordinarily reside in Australia.85 Section
188(2) of the Act serves as an encouragement for even proprietary companies
to appoint a secretary, by providing that the directors of such a company will be
liable if sections 142, 145, 205B or 345 are contravened.
The power to appoint a company secretary rests with the board86 and the
appointee holds office on the terms and conditions (including remuneration)
that the directors determine.87 The secretary must be a natural person who is at
least 18 years old, and no person disqualified to be a director may be a secretary
without the approval of ASIC.88 The secretary, or one of the secretaries, must
be ordinarily a resident in Australia.89 The company secretary may also be a
director of the company. Unlike in the UK,90 there is no requirement in Australia
that the company secretary should have any relevant business experience or
formal educational qualifications.
As pointed out in the previous chapter, we are of the opinion that the company
secretary should play a vital role, not only in assisting the board to fulfil its tasks,
but also in ensuring a healthy and free flow of information between the board and
management.91 The importance of the company secretary is recognised in the
Australian legislation by way of section 300A(1B)(a) of the Act, stating clearly
that ‘a person is a company executive of the company if the person is a secretary
or senior manager of the company’.

81 Cadbury Report (1992), above n 29, paras 4.25–4.27.

82 Hampel Report (1998), above n 32, para 1.7.
83 Cadbury Report (1992), above n 29, para 4.25. See generally Smerdon, above n 35, 93 et seq.
84 Section 204A(2) Corporations Act 2001.
85 Section 204A(1).
86 Section 204D.
87 Section 204F (replaceable rule).
88 Section 204B(2).
89 Section 204A(2).
90 Section 273 Companies Act 2006 (UK). This section applies to secretaries of public companies.
91 See further David Jackson, ‘The Role of the Company Secretary’ in The Business Case for Corporate
Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008) 67.
122 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

4.5 Training and induction of directors

4.5.1 Training
After the collapse of the HIH Insurance company, Trevor Sykes, one of the lead-
ing commentators on corporate collapses and the impact they have on society,
commented as follows:

The whole [HIH] episode underlines the long-established lesson that whatever struc-
tures are devised to impose corporate honesty, they won’t work unless you have the
right people in them.92

This is almost stating the obvious as, in practical terms, the real difficulty is to
find the right people and, once they have been found, to train them and then to
monitor, over time, that they perform efficiently and adhere to good corporate
governance practices. Whether the task of ensuring proper performance and
adhering to good corporate governance practices is one for the company itself
on a voluntary basis or for a regulator is a controversial issue. After the HIH
collapse there were suggestions that a regulator such as ASIC should assume
some responsibility for monitoring companies to detect the signs of possible
corporate collapses at the earliest possible time, but it was acknowledged that it
would indeed be challenging to assume such a role.93
The importance of training directors was emphasised in the Cadbury
Report. Training was considered to be ‘highly desirable’ because directors come
from different backgrounds and their qualifications and experience may vary
considerably.94 It was also emphasised that the training of directors is a very
important way to ensure that directors adhere to good corporate governance
practices.95 The simple reality is that directors should be trained so that they can
be adequately prepared to understand and discharge their duties as directors.96
Bob Garatt, however, exposed a serious problem with director training in the past;
that is, that the training was based upon a managerial training at a higher level, or
a type of ‘mini-MBA’ training. Garratt argues that the distinction between ‘man-
aging’ and ‘directing’ requires a completely different type of training.97 Thus,
to get the directors in the mindset of what they really need to do, namely to
‘direct, govern, guide, monitor, oversee, supervise or comply’ as pointed out in
Chapter 3.
Kendall and Kendall emphasise the need for director training in at least the
following areas:98

92 Trevor Sykes, ‘Cocktail of Greed, Folly and Incompetence’, The Australian Financial Review, 14 January
2003.
93 Jean J du Plessis, ‘Reverberations after the HIH and other Recent Australian Corporate Collapses: The
Role of ASIC’ (2003) 15 Australian Journal of Corporate Law 225, 245.
94 Cadbury Report (1992), above n 29, para 4.19.
95 Ibid.
96 Shaw, above n 43, 27.
97 Garratt, Thin on Top, London, Nicholas Brealey Publishing (2003) 214–15.
98 Ibid 9.
 COMPANY DIRECTORS AND OFFICERS 123

their statutory and regulatory obligations;

●
their ethical obligations; and
●
● what constitutes good operational practice.
Tricker provides a useful list of types of director training:99
● Formal external training courses on aspects of the director’s work;
● In-house board development programmes designed specifically for the
entire board;
● Updating and briefing sessions for the board, or individual directors;
● Relevant higher degree courses in corporate governance, corporate strat-
egy and other board related topics;
● Experiential sponsorship programmes;
● Mentoring, with a one to one personal trainer;
● Self-directed learning and continuous self-development; and
● Board experience itself provides one of the best learning experiences.
The need for formal director training has led to the prediction that ‘a director
accreditation and registration process’, at least for directors of listed companies,
is inevitable.100 This in turn may ‘turn directing into a profession’.101 As Bob
Garratt puts it in one of his later works (2003):

Directing will become a recognized profession internationally over the next two
decades. The pressure for improving board performance . . . are growing too strongly
for them to be stopped. What is now obsolescent, and will soon be obsolete, is the
all-too-common notion that a few amateur friends of the chief executive and chairman
can enjoy some good food and wine, lots of golf, and somehow fit in a bit of time to
give guidance to the company and add value for the owners in the long term.102

We agree with these sentiments. Not only have the rights, duties and respon-
sibilities of directors been defined in much greater detail over recent years,
but the principles of contemporary corporate governance are now also being
extracted with much greater clarity. We are indeed very close to the recog-
nition of a ‘directors’ profession’, no different from the legal, accounting and
medical professions. With such recognition will come a greater emphasis on
the rights, duties and responsibilities associated with the position of director,
and that will necessarily increase adherence to good corporate governance
practices. However, we are also of the opinion that the ‘professionalisation’ of
the position of director will not guarantee adherence to good corporate gover-
nance practices, stop malpractices or miraculously prevent corporate collapses.
However, the recognition of the directors’ profession will ensure that profes-
sional standards for directors will become even more formalised, prominent
and accentuated, and that will be another positive step in enhancing corporate
governance.

99 Bob Tricker, above n 10, 295–6.

100 Garratt, above n 97, 208–9.
101 Ibid 207.
102 Ibid.
124 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

4.5.2 Induction of new directors

As part of the training process for directors, they should be properly introduced
to the company, especially independent outside directors. This is important as
the ways in which companies conduct their business may vary considerably or,
to put it differently, ‘corporate cultures’ may be hugely different among cor-
porations. Appointment of directors will normally be based upon their proven
skills, experience, qualifications and past track record, but they may know noth-
ing about the ‘corporate culture’ of their new corporation or about the other
directors and senior executives of the corporation. A good induction process
for non-executive directors was considered to be of great importance by a large
number of the non-executive directors surveyed two years after the Cadbury
Report.103
Probably the most useful and comprehensive guidelines regarding a proper
induction program are to be found in the 2003 UK Combined Code, based on
the recommendations of the Higgs Committee (2003). These suggest that the
induction process should aim at achieving the following:104
1. Building an understanding of the nature of the company, its business and
the markets in which it operates. For example, induction should cover:
● the company’s products or services;
● group structure/subsidiaries/joint ventures;
● the company’s constitution, board procedures and matters reserved for
the board;
● summary details of the company’s principal assets, liabilities, significant
contracts and major competitors;
● the company’s major risks and risk management strategy;
● key performance indicators; and regulatory constraints.
2. Building a link with the company’s people including;
● meetings with senior management;
● visits to company sites other than the headquarters, to learn about pro-
duction or services and meet employees in an informal setting. It is
important not only for the board to get to know the new non-executive
director, but also for the non-executive director to build a profile with
employees below board level; and
● participating in board strategy development. ‘Awaydays’ enable a new
non-executive director to begin to build working relationships away
from the formal setting of the boardroom.
3. Building an understanding of the company’s main relationships including
meeting with the auditors and developing a knowledge of, in particular:
● who are the major customers;
● who are the major suppliers; and

103 Shaw, above n 43, 30.

104 The Combined Code on Corporate Governance (UK Combined Code (2003)) (July 2003), available at
<www.fsa.gov.uk/pubs/ukla/lr_comcode2003.pdf> 75–6; Higgs Report, above note 34, 111–12. See also
Smerdon, above n 35, 38–40.
 COMPANY DIRECTORS AND OFFICERS 125

● who are the major shareholders and what is the shareholder relations
policy – participation in meetings with shareholders can help give a first
hand feel as well as letting shareholders know who the non-executive
directors are.

4.6 Ethical behaviour by directors

Ethical behaviour by directors is one of the most important cornerstones of

good corporate governance, as it sets the tone for the ethical behaviour of the
corporation and that, in turn, goes a long way to ensure that the corporation
adheres to good corporate governance practices. We have dedicated a whole
chapter (Chapter 14) to the ethical behaviour of corporations. It is, however,
necessary at an early stage to make a few general observations about the ethical
behaviour of directors.
As was pointed out in Chapter 1, Principle 3 of the 2007 ASX’s Principles
of Good Corporate Governance and Best Practice Recommendations states that
ethical behaviour by the corporation should be promoted. The expectation that
a corporation must have ‘ethics, morals and values’ became prominent with
the recognition of the corporation as a person and of the ‘social responsibilities
of corporations’.105 It is primarily a responsibility of the board of directors to
promote ethical decision making in the corporation.106
The 2003 ASX’s Principles of Good Corporate Governance and Best Practice Rec-
ommendations was one of the first corporate governance reports to deal specifi-
cally with the ethical behaviour of directors. It recommended that corporations
should establish a code of ethical and legal conduct to guide the board and
executives as to:
(a) the practices necessary to maintain confidence in the company’s integrity;
and responsibility; and
(b) accountability of individuals for reporting and investigating reports of
unethical practices.107
The current expectation in the 2007 ASX Principles of Good Corporate Governance
and Best Practice is that these aspects are dealt with in the code of conduct.
The importance of ‘ethics, morals and values’ was also commented on by
Justice Owen in the HIH Royal Commission Report, under the heading ‘The
Royal Commission: A personal perspective’:

Right and wrong are moral concepts, and morality does not exist in a vacuum. I think
all those who participate in the direction and management of public companies, as well

105 Kendall and Kendall, above n 39, 17 and 139 et seq. See also Batten and Fetherston, above n 43, 1,
5–6; Philip T N Koh, ‘Responsibilities of Corporate Governance and Control of Corporate Powers’ in 3R’s
of Corporate Governance, Malaysian Institute of Corporate Governance, Kuala Lumpur (2001) 1, 5–6; and
Monks and Minow, above n 38, 17–18 and 77 et seq.
106 Principles of Good Corporate Governance and Best Practice (2007), above n 14, 3: ‘There is a basic need
for integrity among those who can influence a company’s strategy and financial performance, together with
responsible and ethical decision-making.’
107 Ibid, 25.
126 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

as their professional advisers, need to identify and examine what they regard as the
basic moral underpinning of their system of values. They must then apply those tenets
in the decision-making process.108

We are of the opinion that in future ‘ethics, morals and values’ for corpora-
tions will become increasingly important considerations for corporations. As we
pointed out in Chapter 1, just as good corporate governance adds value to a
corporation, so also does ‘ethical behaviour’:

[A] highly ethical operation is likely to spend much less on protecting itself against
fraud and will probably have to spend much less on industrial relations to maintain
morale and common purpose.109

Corporate collapses happen for many reasons, but there is little doubt that uneth-
ical behaviour plays some part in contributing towards such collapses.110
We accept that it is difficult to define ‘business ethics’: it is often very closely
linked to concepts like ‘business culture’ and ‘cultural values generally’, as well as
to perceptions about business in a particular country or community. Some would
say that business ‘is all about business’, and that ethics has little place in the hard
business world (in Chapter 14 we comment in greater detail on ‘The disunity
between business and ethics argument’ and why some would argue that business
and ethics should be separated). Others would simply say that the ways in which
people view ethics differ so much that we will never be able to find common
ground on what is meant by ‘ethical behaviour’ – what is seen as a good and
sound business deal or a clever business strategy by some would be considered
by others to be ‘unethical behaviour’. However, as Kendall and Kendall illustrate,
there are certain general guidelines against which ‘ethical behaviour’ can be
judged, and which will assist in detecting ‘unethical behaviour’. They list the
following aspects:111
1. General views on ethics – what and how important the issues are, such as:
● consideration and protection of the environment;
● fair trading, especially with poor countries;
● defending human rights, for example non-exploitation of workers in
poor countries;
● not investing in countries with unacceptable regimes;
● supporting local communities;
● fair treatment of staff.
2. Particular stakeholder views/angles, such as:
● customers’ beliefs when purchasing – how much do ethical issues actually
affect their buying behaviour?

108 Owen Report, above n 17, lxiii.

109 Kendall and Kendall, above n 39, 139. See also Stephen Cohen and Damien Grace, ‘Ethics and the
Sustainability of Business’ in Collapse Incorporated: Tales, Safeguards & Responsibilities of Corporate Australia,
Sydney, CCH Australia (2001) 99, 105–6.
110 Cohen and Grace, ibid, 99–100.
111 Kendall and Kendall, above n 39, 142.
 COMPANY DIRECTORS AND OFFICERS 127

●employees’ moral values – how important is it for them to work in an

ethically sound company?
● shareholders’ feeling of responsibility – to what extent do they feel
obliged to enforce ethical behaviour?
● local community’s interest – how much are they interested in the com-
pany’s active involvement in the community?
The internationalisation and globalisation of business make it imperative that
we strive to find common ground on what is meant by ‘ethical behaviour’ by
corporations, and that we promote such behaviour as a core practice in good
corporate governance.

4.7 Remuneration of directors and executives

4.7.1 A controversial issue

The debate on excessive executive remuneration became particularly sensitive
politically as a result of the global financial crisis, but it is not a new topic. In
1995, in the UK the Greenbury Report was one of the first corporate governance
reports promoting transparency and disclosure of executive remuneration. This
was taken further in the 1998 UK Hampel Report, and Australia followed suit
by repeating sentiments of disclosure of executive remuneration in the Bosch
and Hilmer Corporate Governance Reports (see Chapter 12). As a result of this
legislation was introduced to ensure disclosure in both jurisdictions.
However, because of the global financial crisis, director and executive remu-
neration caused a renewed public outcry and politicians were quick to pick up on
this. The nexus between pay and performance and the role of short-term versus
long-term incentives built into compensation packages to better align manage-
rial and shareholder interests112 has been to the fore recently in particular. It is
not remuneration of directors and executives as such that caused angst among
the public and politicians, but ‘excessive’ remuneration. In addition, the huge
differences between remuneration of executives and that of other employees,
which has been illustrated by disturbing statistics, has been of concern.113 In the
wake of the global financial crisis, public outrage at the level of remuneration
paid to executives heightened, particularly in relation to banking personnel at
a time when countries across the Western world were propping up banks using
taxpayer funds. The perception was, justly or unjustly, that these executives had
‘milked’ staggering corporate cows, and eventually taxpayers’ money was used to
bail out the banks. As recently as 2004, the Business Council of Australia (BCA)

112 See, for instance, Michael C Jensen and Kevin J Murphy ‘Performance Pay and Top Management
Incentives’, (1990) 98 Journal of Political Economy 225–64.
113 See John Shields, 2005, ‘Setting the Double Standard: Chief Executive Pay the BCA Way’, Journal
of Australian Political Economy, Edition 56, 2005, 299 at 302, available at <www.jape.org/component/
option,com_remository/Itemid,26/func,startdown/id,36>.
128 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

warned against additional regulation of executive remuneration,114 but it was

clear in 2009 that the BCA had conceded that steps needed to be taken to curb
excessive executive remuneration.115 In early 2009, the Australian Institute of
Directors (AIOD) issued some new guidelines for boards on executive remunera-
tion as a result of the global financial crisis.116 In short, the global financial crisis
drew the attention of the public, politicians and business to excessive executive
remuneration.

4.7.2 Disclosure of remuneration and emoluments in Australia

Australia has one of the most extensive disclosure regimes in the world in relation
to the remuneration of directors and key management personnel. The Corporate
Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004
introduced section 300A into the Corporations Act 2001 (Cth), which requires
enhanced disclosures, either in the directors’ remuneration report or the financial
report, which are audited. These disclosures include:
i) the board’s remuneration policy [s 300A(1)(a)];
ii) the relationship between remuneration policy and company performance
[s 300A(1)(ba)];
iii) details of remuneration of key personnel [s 300A(1)(c)];
iv) reasons for failing to subject to performance conditions any remuneration
made via shares or options [s 300A(1)(d)];
v) the relative proportion of remuneration related to performance, value of
options granted and aggregate and percentage values of remuneration via
options [s 300A(1)(e)].
Additionally, a non-binding advisory resolution must be put to shareholders
[s 250R(2) & (3)].
Further major reforms to both disclosure of and accounting for share-based
payments have occurred since 2004. In particular, Accounting Standard AASB
2 Share-based Payment requires calculation of the ‘fair value’ of options granted
under remuneration packages and expensing of this value, along with disclosures
around the method and assumptions involved in calculating the fair value.

4.7.3 Investigations into excessive remuneration of directors

and executives
In Australia, the Federal Government requested the Australian Prudential
Regulation Authority (APRA), which regulates entities in the insur-
ance, superannuation and authorised deposit-taking industries, to produce
114 BCA. Executive Remuneration: A Position Paper Prepared by the Business Council of Australia. June 2004,
available at <www.bca.com.au/Content/101416.aspx>.
115 For example, the BCA’s submission of 2 September 2009 to the Australian Parliamentary Senate Eco-
nomics Legislation Committee re the Corporations Amendment (Improving Accountability Termination Pay-
ments Bill) 2009, available at <www.bca.com.au/DisplayFile.aspx?FileID=563>.
116 AIOD, ACID Issues New Guidelines for Boards on Executive Remuneration. Media Release 12 February
2009, available at <www.companydirectors.com.au/Media/Media+Releases/2009/AICD+issues+new+
Guidelines+for+Boards+on+Executive+Remuneration.htm>.
 COMPANY DIRECTORS AND OFFICERS 129

best-practice guidelines for both the design and disclosure of executive remu-
neration. On 28 May 2009, APRA released a consultation paper117 with draft
proposals released on 7 September 2009.118 On 30 November 2009, Prudential
Practice Guide PPG 511 – Remuneration was released by APRA.
Briefly, the governance standards require the establishment of remuneration
committees and the design of remuneration policy that, in rewarding individual
performance, is designed to encourage behaviour that supports the risk manage-
ment framework of the regulated institution (para. 43). Further, in designing
remuneration arrangements, the board remuneration committee will need to
consider, among other matters:
● the balance between fixed (salary) and variable (performance-based)
components of remuneration. Performance-based components include all
short-term and longer-term incentive remuneration, payable with or with-
out deferral; and
● whether cash or equity-related payments are used and, in each case, the
terms of the entitlements including vesting and deferral arrangements
(para. 44).
The Federal Government also, in March 2009, initiated a review into the Regu-
lation of Director and Executive Remuneration in Australia by the Productivity
Commission. The Productivity Commission’s final report119 was released pub-
licly in January 2010. Perhaps the most noteworthy120 conclusion in the Report
is that if 25 per cent or more of shareholders at two successive annual general
meetings vote negatively on the board’s pay report there should be an immediate
vote on whether the entire board should face re-election. If this is carried by a
majority of those voting at the meeting, all board positions would be up for elec-
tion, one by one, at a special meeting held within three months. This is referred to
as the ‘two-strikes plus a resolution to “spill” the board’ approach.121 Currently,
under section 250R of the Act, shareholder votes on remuneration reports are
not binding and have no other legal consequences. At the time of writing, it is
not known which, if any, of the conclusions in the report will be acted upon by
the Federal Government.

4.8 Conclusion

There is no doubt that nowadays there are much higher community expecta-
tions of company directors and company officers than in the past. These higher

117 Discussion Paper, Remuneration – Proposed extensions to governance requirements for APRA-regulated
institutions, 28 May 2009.
118 Response to Submissions, Remuneration – Proposed extensions to governance requirements for APRA-
regulated institutions, 7 September 2009.
119 Productivity Commission, Executive Remuneration in Australia, Report No. 49, Final Inquiry Report,
Melbourne, Commonwealth of Australia (December 2009), available at <www.pc.gov.au/projects/inquiry/
executive-remuneration/report>.
120 See, for instance, Allan Fels, ‘Shareholders Can Turn Up the Heat on Executive Pay’, Sydney Morning
Herald, 5 January 2010, 20.
121 See Productivity Commission, above note 119, at XXXII and 296–301.
130 BASIC CONCEPTS, BOARD STRUCTURES AND COMPANY OFFICERS

expectations do not apply only to the exercise of directors’ and other officers’
general duties, but also their ethical behaviour – company directors’ and com-
pany officers’ conduct is under constant scrutiny not only by the media and the
general public, but also the regulators. As a corollary, there is constant pressure
on politicians to ensure that the law is adequate to be able to enforce these higher
community expectations of company directors and company officers.
In this chapter we have seen that there are various types of company directors
and officers that can be identified, although the basic understanding is that the
law will expect the same duties of all directors and that senior employees and
senior executives owe duties to the company comparable to that of directors. The
discussion in this chapter also reveals that the practical distinction between, and
expectations of, the various types of directors (for example, independent non-
executive directors, executive directors, senior or lead independent directors),
are becoming increasingly important. Also, the roles, functions and expectations
of CEOs and chairpersons have become more easily identifiable over time. This
is the case not only because various corporate governance reports have begun to
accentuate the various responsibilities associated with these positions, but also
because the courts have begun to focus on the higher responsibilities associated
with, and higher standards expected of, persons occupying certain key positions
in large public corporations.
Three specific topics have been identified as particularly important in so far as
different types of directors are concerned. They were the training and induction
of directors; the ethical behaviour of directors; and the remuneration of direc-
tors and executives. It is submitted that these topics will become of increasing
importance in future.
 PART TWO
CORPORATE GOVERNANCE
IN AUSTRALIA
5
Corporate governance in Australia –
background and business initiatives

At some point over the last several years the debate about what boards of
directors ought to do and be responsible for took a wrong turn. In almost
every other area of economic life the debate has been about how various
participants can improve the quality and volume of their productive contri-
butions. For example, workplace reforms, management developments and
financial deregulation are all about increasing competitiveness and pro-
ductivity and achieving standards of best practice. In contrast, the debate
about directors has become preoccupied with criminality, fraud, negligence
and minimum standards. The worry about the rotten apple – and there
have been a number – has deflected attention from the main game of wealth
creation which is, in turn, the driver of new investment and job creation.
Frederick G Hilmer, Strictly Boardroom: Improving Governance to Enhance
Company Performance (Hilmer Report (1993)), Preface

5.1 Background to the corporate governance

debate in Australia1

John Farrar reflects as follows on perceptions regarding corporate governance

and corporate law in Australia:

Every country approaches corporate governance from the background of its own dis-
tinctive culture. New Zealand has tended in the past towards a pragmatic adaptation
of the UK model but has recently adopted a more North American approach. In the
case of Australia one sometimes has the impression that this is based on either Ned
Kelly or his jailer. We love a larrikin and are a little too tolerant of corruption but we
are inclined to come down heavily on ‘tall poppies’ and to be excessively penal in our
approach. The attitude to the excesses of the 1980s and their aftermath reflects this.
We also have a tendency to over-legislate and the result is obese and user-unfriendly
legislation.2

1 This part is based on Jean J du Plessis, ‘Reverberations after the HIH and other Recent Australian Corporate
Collapses: The Role of ASIC’ (2003) 15 Australian Journal of Corporate Law 225, 227–30.
2 John Farrar, Corporate Governance in Australia and New Zealand, Melbourne, Oxford University Press (3rd
edn, 2008) 6–7.

133
134 CORPORATE GOVERNANCE IN AUSTRALIA

The ‘excesses of the 1980s’ were also emphasised in corporate governance reports
in the early 1990s.3 Having some knowledge of the ‘excesses of the 80s’ is indeed
essential in understanding and explaining many of the statutory provisions in
the Australian Corporations Act 2001 (Cth) (the Act) and in appreciating pre-
vailing perceptions regarding corporate governance in Australia. Trevor Sykes’
fascinating account of the abuses of the 1980s in his book, The Bold Riders,4
reveals much of the evils that flourished then and is a good starting point from
which to obtain a deeper insight into the current Australian corporate law and
corporate governance. Names like Christopher Skase, Alan Bond, John Friedrich
and Abe Goldberg are often mentioned in discussions of corporate law5 and,
as though these characters are omnipresent, names like Ray Williams, Rodney
Adler, Dominic Fodera, Brad Cooper, Jodee Rich, Brad Keeling, John Greaves,
Rene Rivkin, Bill Howard and John Elliott had been mentioned regularly in the
financial and other press in the period 2001–4.
The importance of interpreting legislation in a broader context – and in
particular in context of the ratio for the legislation and the abuses it aims at
preventing – was recently emphasised by Kirby J in his minority judgment in
Rich v ASIC.6 With specific reference to the abuses of the 1980s, Kirby J reiter-
ated that the legislation was intended to address the negative consequences of
those abuses and to improve the standards of corporate governance in Australia.
He argued, therefore, that remedies such as disqualification orders and civil
penalty orders should not be interpreted narrowly, but rather in the context of
the intention of the legislature, and in particular as remedies aimed at particular
evils.7
With spectacular corporate collapses like those of HIH, Harris Scarfe, One.Tel,
Pasminco, Centaur, Ansett, Westpoint, Fincorp, Opes Prime, Chartwell Enter-
prises, Kleenmate etc. (the list has grown considerably since the 2005 edition of
this book) in mind, it is obvious that it is not the existence of ‘obese . . . legislation’
that prevents corporate collapses, and that it was a misconception to rely on
Corporate Law Simplification or Corporate Law Economic Reform Programs to
provide the answer to the ‘excesses of the 80s’.8 There is also very little use in
governments constantly acting on an ad hoc basis to deal with specific problems.
This makes the law ‘too cumbersome’ and, as Bob Baxt also points out fittingly,
‘make[s] it more and more difficult to discern a clear theme underpinning the
legislation, and to provide a clear message to the courts in deciding cases that are

3 Frederick G Hilmer, Strictly Boardroom: Improving Governance to Enhance Company Performance,

Melbourne, Business Library (1993), 1 and 4.
4 First published in 1994; Sydney, Allen & Unwin (2nd edn, 1996).
5 See Rick Sarre, ‘Responding to Corporate Collapses: Is There a Role for Corporate Social Responsibility’
(2002) 7 Deakin Law Review 1.
6 [2004] HCA 42 (9 September 2004), [62].
7 [117]–[118].
8 See generally HIH Royal Commission (Owen Report), The Failure of HIH Insurance – Volume I: A Corporate
Collapse and its Lessons, Canberra, Commonwealth of Australia (2003) xiii–xiv and F Clarke and G Dean,
‘Corporate Collapses Analysed’, in Collapse Incorporated: Tales, Safeguards & Responsibilities of Corporate
Australia, Sydney, CCH Australia (2001) 72, 89.
 BACKGROUND AND INITIATIVES 135

brought before them’.9 It is true that the breadth and depth of the provisions in
the Act covering directors’ duties and responsibilities – and the remedies avail-
able for breaches of these – are impressive. The Act has imbedded in it a very
finely woven legislative net that will catch even the smallest fish, but it would be
very interesting to conduct research to establish whether the bulky Australian
corporations legislation is more foolproof than core Corporations Acts such as
those of New Zealand or Canada.10
In Australia corporate governance was, in the late 1990s, considered to be
almost an unnecessary burden upon Australian businesses. Strict corporate gov-
ernance rules have even been blamed for the under-performance of Australian
companies.11 David Knott, the then-Chairman of the Australian Securities and
Invesments Commission (ASIC), neatly captures the prevailing mood of the late
1990s: ‘Directors started to question [corporate governance’s] relevance. Cor-
porate governance became formalistic, even ritualistic. It lost momentum as an
effective program for corporate risk management. We probably paid a price for
that.’12 But in the early 2000s corporate governance was once again on the front
pages of newspapers and uppermost in the minds of directors and most regula-
tors in Australia.13 This has been an international trend and one explained well
by Morten Huse in 2007:

A governance revolution seems to be taking place . . . The recent scandals now give us
the opportunity to ask if there is need for a new paradigm for governance. Governance
reforms now ranks high on the priority list of policy-makers and regulators.14

The corporate collapses in Australia between 2000 and 2003 also brought a
sudden end to the complacency that had prevailed on corporate governance in
Australia after many years of sustained growth and Australia’s remarkable sur-
vival of the Asian financial crisis.15 Solutions to ‘bad corporate governance’ were
sought along a broad and varied front, including continuous disclosure; codes
of good practice; disqualification of auditors; and the role and functions of the
auditor, audit committees, independent directors, and non-executive directors.16
Most recently, the focus has been on excessive executive remuneration (see also

9 Robert Baxt, ‘The Necessity of Appropriate Reform’ in Collapse Incorporated: Tales, Safeguards & Respon-
sibilities of Corporate Australia, Sydney, CCH Australia (2001) 325, 329 (see also Baxt’s critical comments on
several recent pieces of legislation at 329–34).
10 It is promising to note that there seems to be some mention of a core and modern corporate law – Baxt,
above n 9, 335.
11 Sarre, above n 5, at 1; Rick Sarre, ‘Risk Management and Regulatory Weakness’ in Collapse Incorporated:
Tales, Safeguards & Responsibilities of Corporate Australia, Sydney, CCH Australia (2001) 291, 295.
12 David Knott, ‘Protecting the Investor: The Regulator and Audit’, Address to the CPA Congress
2002 Conference Perth Western Australia, 15 May 2002, available at <www.asic.gov.au/asic/pdflib.nsf/
LookupByFileName/CPA_Speech_150502.pdf/$file/CPA_Speech_150502.pdf> 4.
13 See David Knott, ‘Corporate Governance: The 1980s Revisited?’ Monash Law School Foundation
Lecture, 23 August 2001, available at <www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/monash_
801.pdf/$file/monash_801.pdf> 3–4; Jillian Segal, ‘Corporate Governance: Substance over Form’ (2002)
25 University of New South Wales Law Journal 320.
14 Morten Huse, Boards, Governance and Value Creation, Cambridge, Cambridge University Press (2007)
26–7.
15 Knott, above n 12, 11.
16 For an excellent address covering almost all relevant aspects of good corporate governance, see Pat
Barrett, ‘Corporate Governance – More Than a Passing Fad’, Alfred Deakin Club Luncheon, 12 June 2002.
136 CORPORATE GOVERNANCE IN AUSTRALIA

Chapter 4) and the Australian Government is seriously considering legislation

to cap executive regulation – again a knee-jerk reaction, focusing on one aspect
rather than seeing corporate governance reform in its totality. Many of these
mechanisms to curb poor corporate governance practices were implemented in
2000–4, with CLERP 9 probably being the best example with its aims of restor-
ing confidence in the accounting profession, improving disclosure and financial
reporting, and protecting those who reveal and report contraventions of the Act
(see discussion of CLERP 9 in Chapter 8).
Almost ‘forgotten’ debates have been reopened, including the debate on board
structures – in particular the two-tier board system versus the unitary board
system (see discussion in Chapter 3) – and it is clear that, as in the ‘old days’,
the strong preferences for the one or the other board structure still exist among
commentators.17

5.2 The Bosch Report

5.2.1 Background
In or around 1990 a Working Group, chaired by Henry Bosch (AO) (former
chairman of the National Companies and Securities Commission (NCSC)), was
established by several leading players in the financial markets. They included
the Australian Merchant Bankers Association, the Australian Stock Exchange
Ltd, the Australian Institute of Company Directors and the Securities Institute
of Australia. In June 1990 this Working Group released a paper on ‘Corporate
Practices and Conduct’, which was widely discussed before its first report was
published in 1991 under the same title.18
There are often references to ‘the Bosch Report’, but in fact there were three
Bosch Reports: the original one in 1991, and two reviews of the 1991 report, in
1993 and 1995 (with a 1996 reprint). Although all deal with ‘Corporate Practices
and Conduct’ or corporate governance as it is now more generally known, the
three reports differ considerably in detail and it could lead to confusion if the
particular year of the report is not mentioned. We will refer to the original
Bosch report as the Bosch Report (1991) and to the 1993 and 1995 reviews as
respectively the Bosch Report (1993)19 and the Bosch Report (1995).20

17 Cf Jillian Segal, ‘The Future of Corporate Regulation in Australia’, Address to the 18th Annual Com-
pany Secretaries’ Conference, Surfers Paradise, 19 November 2001, available at <www.asic.gov.au/
asic/pdflib.nsf/LookupByFileName/CSAConf_131101.pdf/$file/CSAConf_131101.pdf> 3; Jillian Segal,
‘Everything the Company Director Must Know about Corporate Financial Disclosure and Continuous Dis-
closure’, Address to the Australian Institute of Company Directors Conference, Governance & Disclo-
sure – A Forum for Company Directors, Sydney 31 October 2001, available at <www.asic.gov.au/asic/
pdflib.nsf/LookupByFileName/AICD_Conf_311001.pdf/$file/AICD_Conf_311001.pdf> 11–12; and Knott,
above n 13, 4–7.
18 Business Council of Australia (BCA), Corporate Practices and Conduct, Melbourne, Information Australia
(the Bosch Report (1991)), (1991).
19 BCA, Corporate Practices and Conduct (the Bosch Report (1993)), Melbourne, Information Australia (2nd
edn, 1993).
20 BCA, Corporate Practices and Conduct (the Bosch Report (1995)), Melbourne, Pitman (3rd edn, 1995).
 BACKGROUND AND INITIATIVES 137

5.2.2 The Bosch Report (1991)

The Bosch Report (1991) stated that it represented ‘wide consensus in the corpo-
rate community of the substantive issues’ and attempted ‘only to set out general
principles of practice and conduct’. A strong call was made for the corporate
sector to establish its own framework for acceptable standards of behaviour,
irrespective of existing or prospective regulatory and legislative rules.21
Four aspects of the Bosch Report (1991) deserve special mention. First, with
its release in 1991 the Bosch Report was ahead of the United Kingdom: the UK
Cadbury Committee was established in May 1991, and released its draft report
in May 1992 and its final report in December 1992.22
Second, although the abuses of the 1980s surely contributed to the establish-
ment of the Working Group, it does not seem that it was specific scandals – such
as Maxwell and BCCI23 in the UK – that triggered this self-regulatory move by
the business community in Australia. However, the Working Group’s main and
general aim with its report, namely ‘to improve the performance and reputa-
tion of Australian business by encouraging and assisting the general adoption of
the highest standards of corporate conduct’,24 suggests at least that there were
concerns about the ‘underperformance’ and ‘bad reputation’ of Australian busi-
nesses. The last-mentioned aspect could surely be traced back to the abuses of
the 1980s.
Third, the term ‘corporate governance’ appears as only one of three main
headings (the other two headings being ‘Company Code of Ethics’ and ‘Guidelines
for Conduct of Directors’) in the Bosch Report (1991). There is, however, little
doubt that what was then understood as ‘Corporate Practices and Conduct’ (the
full title of the Bosch Report (1991)), would nowadays sit comfortably under the
title ‘Corporate Governance’. One wonders what the impact of the Bosch Report
would have been if the term ‘corporate governance’ had been used – as was the
case with the Cadbury Report in the UK.
Fourth, whereas the Cadbury Report is hailed for its clarity of expression,25
it would not be an overstatement to say that the Bosch Report (1991) should
receive recognition not only for its clarity of expression but also for its brevity
and for being at the forefront in introducing several principles of good corpo-
rate governance that became the standard of good corporate governance prac-
tices in other countries only several years later. For example, the Bosch Report
(1991):

21 Bosch Report (1991), above n 18, ‘Foreword’.

22 Committee on the Financial Aspects of Corporate Governance, Report of the Committee on the Financial
Aspects of Corporate Governance (‘Cadbury Report’), UK, (1992).
23 John C Shaw, ‘The Cadbury Report, Two Years Later’ in K J Hopt, K Kanda, M J Roe, E Wymeersch
and S Priggle (eds), Comparative Corporate Governance: The State of the Art and Emerging Research, Oxford,
Clarendon Press (1998) 21, 23; Stanley Christopher, ‘Corporate Accountability: Cadbury Committee: Part 1’
(1993) 11 International Banking and Financial Law 104.
24 Bosch Report (1991), above n 18, ‘Foreword’.
25 Owen Report, above n 8, 102 para 6.1.
138 CORPORATE GOVERNANCE IN AUSTRALIA

● recommended that the annual reports of all public companies should

include a statement by the directors that the company supports and has
adhered to the principles set out in the ‘Corporate Practice and Conduct
Paper’
● recommended that any departures from the principles set out in the Corpo-
rate Practice and Conduct Paper (that is, the Bosch Report (1991)), ‘should
be noted and the reasons for them given’ – in other words, one of the first
corporate governance reports relying on the principle of ‘if not, why not?’
or ‘comply or explain’26
● identified the most important functions of the board
● recommended that the roles of chairman and chief executive should be
separate
● recommended that each public company’s board should appoint an audit
committee with at least a majority of non-executive directors
● identified the primary functions of audit committees
● without over-emphasising the monitoring role of non-executive directors,
recognised that they should bring an independent view to the board’s
deliberations and help the Board provide the company with effective
leadership
● recognised the importance of independent non-executive directors, but
defined ‘independence’ quite generally by reference to ‘a contractual rela-
tionship’ or ‘any relationship with the company which could affect the
exercise of independent judgment’
● rather than recommending any particular number of ‘independent non-
executive directors’ to be appointed to the board, suggested that ‘it is a
useful safeguard to appoint to the Board at least two directors who have
no [personal or professional association with the company]’
● recommended that the company auditor should attend the board or audit
committee meetings at which the statutory accounts and directors’ reports
are approved for issue, and should have the right of access to the board
where appropriate
● recommended the development, publication and enforcement of company
codes of ethics
● provided guidelines for conduct of directors to assist them to carry out their
duties and responsibilities
● recognised that directors should be provided with expert advice, particu-
larly on legal and financial matters, to assist them to properly discharge
their fiduciary duties.

26 See further Ian Ramsay and Richard Hoad, Disclosure of Corporate Governance Practices by Australian
Companies, Research Paper, Centre for Corporate Law and Securities Regulation, University of Melbourne
(1997), available at <http://cclsr.law.unimelb.edu.au/go/centre-activities/research/research-reports-and-
research-papers/> 3 – also published as Ian M Ramsay and Richard Hoad, ‘Disclosure of Corporate Governance
Practices by Australian Companies’ (1997) 15 Company and Securities Law Journal 454.
 BACKGROUND AND INITIATIVES 139

5.2.3 The Bosch Report (1993)

The foreword to the Bosch Report (1993) makes immediately apparent the
impact of the UK Cadbury Report (1992), as well as the huge impression that the
concept ‘corporate governance’ has made upon the Working Group.27 ‘Corporate
governance’, rather than being used only once as a main heading, is now pivotal:
it appears four times in the foreword, and the heading ‘Corporate Governance’
has been supplemented with a definition of corporate governance – ‘the system
by which Companies are controlled’ – and with a very specific message, that
‘[t]he essence of any system of good corporate governance is to allow Directors
the freedom to drive their Companies forward but to exercise that freedom
within a framework of effective accountability’.28 The desire to keep adherence
to good corporate governance practices within the realm of self-regulation is
again expressed in no uncertain terms:

[T]he corporate sector is making a significant effort to create its own framework
of acceptable standards of behaviour irrespective of existing or prospective legisla-
tion . . . 29 The second edition of the Corporate Practices and Conduct booklet rep-
resents a continuing commitment by Australia’s leading business and professional
organisations to lift the standards of corporate governance which will enhance investor
confidence both here and overseas.30

The order in which the organisations that produced the booklet were listed
has also changed slightly since the previous report. The Australian Institute of
Directors, mentioned third last in 1991, has now moved to the top of the list.
The Australian Investment Managers’ Group has been added to the list, and the
Australian Merchant Bankers Association has been replaced by the International
Banks and Securities Association of Australia.
The following aspects could be listed as the core differences between the
Bosch Report (1991) and the Bosch Report (1993):
● The Bosch Report (1993) is longer by 17 pages (22 in 1991, 39 in 1993).
● The functions of the Board are explained in much greater detail (six bullet
points in 1991, 17 points in 1993).
● There is a toning down of the 1991 expectation that ‘all public compa-
nies’ should comply with the Corporate Practices and Conduct Paper. The
Bosch Report (1993) makes certain recommendations just for ‘listed pub-
lic companies’; others ‘for public companies, and in particular companies
listed on the Australian Stock Exchange’; and others for ‘public companies,
of sufficient size’ (emphasis added).
● The role of non-executive directors has been expanded in the Bosch Report
(1993). Not only is their role to bring an independent view to the board’s

27 Bosch Report (1993), above n 19, 1–2.

28 Ibid 9.
29 Ibid 1.
30 Ibid 2.
140 CORPORATE GOVERNANCE IN AUSTRALIA

deliberations and help the board provide the company with effective lead-
ership, but they are now also ‘[t]o foster the continuing effectiveness of
Executive Directors and management’31 – a pertinent expansion of their
monitoring role.
● Independent non-executive directors have become more prominent – it is
now suggested (not recommended) that ‘preferably the majority of Non-
Executive Directors should be independent, not only of Management but
of any external influence that could detract from their ability to act in the
interest of the Company as a whole’.32
● What is actually meant by ‘independence’ has begun to emerge – ‘indepen-
dence’ is now considered to be ‘more likely to be assured when the Director’
does not have any of the following five affiliations with the company:
– a substantial shareholder of the company
– employed in any executive capacity by the company within the last few
years
– a professional adviser of the company (either personally or through
his/her firm)
– a significant supplier or customer of the company
– a significant contractual relationship with the company other than as a
director.
● The influence of the UK Cadbury Report (1992) (see discussion in
Chapter 12) is clearly noticeable, for instance in the suggestion that boards
should include ‘sufficient directors who are generally independent in their
views to carry significant weight on the Board’,33 and the recognition of
the important role of the company secretary.34
● It is now recommended that companies disclose in their annual reports any
material contracts, other than memberships of the Board, that directors
have with the company.35
● Although not specifically recommended to do so, public companies, ‘in
particular [those] listed on the Australian Stock Exchange’, are urged that
they ‘should consider’ the appointment of compensation committees and
nomination committees.36
● Apart from ‘non-executive directors’, the roles and functions of three other
types of directors – ‘executive directors’; ‘nominee directors’; and ‘alternate
directors’ – are described in general terms.37
● Two new parts have been added to the booklet, namely ‘Company Accoun-
tants and Auditors’; and ‘Shareholders’ – clearly also under the influence
of the UK Cadbury Report (1992).

31 Ibid 15.
32 Ibid 16.
33 Ibid 16.
34 Ibid 18.
35 Ibid 17.
36 Ibid14–15.
37 Ibid 17–18.
 BACKGROUND AND INITIATIVES 141

5.2.4 The Bosch Report (1995)

It is not necessary to say much about the Bosch Report (1995), as in substance lit-
tle has been added since the Bosch Report (1991) and the Bosch Report (1993).
Although the objectives of the report were now specifically articulated,38 there
is little doubt that these same objectives underlie the two prior reports. The
Bosch Report (1995) grew in size (now 58 pages, in comparison with the 22
pages of the Bosch Report (1991) and 39 of the Bosch Report (1993)); the
formatting and presentation improved slightly (probably because of the involve-
ment of a commercial publisher); and the Report became more tiresome to
apprehend because further explanations and specific ‘considerations’, ‘beliefs’
and ‘general comments’ were added by the Working Group by way of para-
graphs highlighted using horizontal lines in the page margins. The ‘consider-
ations’, ‘beliefs’ and ‘general comments’, in particular, leave some impression
of tugs-of-war taking place between influential role players in the financial
and securities markets. It is interesting to note that of the nine organisations
that contributed to the Bosch Report (1993), only six remained in 1995 –
the Australian Investments Group, Australian Stock Exchange Ltd, and Inter-
national Bankers and Securities Association of Australia have disappeared from
the list.
The Bosch Report (1995) has some hallmarks of a report that has lost its
original focus on core principles of corporate practice and conduct – probably
because the work evolved over a period of approximately six years (1990–5). It
has also attempted to accommodate and reflect rapidly changing and expanding
international developments in the area of corporate governance.39 The Work-
ing Group seems to have been overwhelmed by development in the area of
corporate governance: ‘[s]ince the first edition of this book was published in
1991, there have been many new laws and regulations, and many court judg-
ments, that have made the task of governing corporations more complex and
difficult’.40
Several of the recommendations, suggestions and proposals of the Bosch
Report (1991) and Bosch Report (1993) have either disappeared from the Bosch
Report (1995) or have been modified to such an extent that it is difficult to
recognise them or trace them back to the original report. It is also interesting to
note that ‘the Bosch Report’ nowadays receives only scant attention in most of
the leading Australian corporate governance and corporate law textbooks.41
This said, there is no doubt that the Bosch Report (1995) was another well-
intended effort to promote good corporate governance practices in Australia and
to keep corporate governance self-regulated.

38 Ibid 1.
39 See Bosch Report (1995), above n 20, 4–5.
40 Ibid 1.
41 Cf (for example) Farrar, above n 2, 381–2; R P Austin, H A J Ford and I M Ramsay, Company Directors:
Principles of Law and Corporate Governance, Sydney, LexisNexis (2005) 15–17.
142 CORPORATE GOVERNANCE IN AUSTRALIA

5.3 Divergence from UK practice: 1995 to early 2003

On 1 July 1995 a rule (originally Rule 3C(3)(j) and later Rule 4.10.3, and
applying to reporting periods ending on or after 30 June 1996) was introduced
into the Australian Securities Exchange (ASX) Listing Rules,42 requiring listed
companies to disclose in their annual reports the main corporate governance
practices that they had had in place during the year. An appendix to the Listing
Rules (originally Appendix 33 and later Appendix 4A) listed typical matters (a
so-called ‘indicative list of corporate governance matters’) that companies could
take into consideration in complying with Listing Rule 3C(3)(j)/4.10.3.43 Phillip
Lipton explains the differences, at that stage, to the UK approach and also what
the Australian approach was intended to achieve:

The Australian approach does not require specific corporate governance practices to
be adopted by listed companies. Rather, there is a list of indicative practices and it
is up to individual companies to establish their own effective system of governance
and disclose it to the market. This approach seeks to ensure that corporate governance
practices evolve and improve over time to meet the needs and expectations of the
market and companies.
Best practice does not become rigid and formulaic and it is hoped that thought is given
by boards as to what is appropriate and why, rather than a checklist approach involved
in ticking off prescribed practices in a non-analytic way. A prescriptive approach could
discourage innovation and development of better practices by setting a minimum
standard. A non-prescriptive approach also tries to ensure that smaller companies do
not have unrealistic compliance burdens imposed upon them.44

It was only after the establishment of ASX’s Corporate Governance Council in

August 2002 and the release of its Principles of Good Corporate Governance and
Best Practice Recommendations in March 2003 that the corporate governance
practices in the UK and Australia again converged – see discussion in Chapter 7.

5.4 The Hilmer Report

5.4.1 Background
The case of AWA Ltd v Daniels (Trading as Deloitte Haskins & Sells & Ors)45 caused
considerable anxiety among directors in Australia. In AWA Ltd v Daniels Rogers
CJ was required to consider, in a practical context and in a complicated factual
context, what the duties and responsibilities of directors really were. Rogers CJ
himself admitted that the theories regarding directors’ duties and responsibilities

42 Bosch Report (1995), above n 20, 3; Phillip Lipton, ‘The Practice of Corporate Governance in Australia:
Regulation, Disclosure and Case Studies’ in Low Chee Keong (ed.), Corporate Governance: An Asian-Pacific
Critique, Hong Kong, Sweet & Maxwell (2002) 105, 131.
43 See Lipton, above n 42, 132–3 for the matters listed in Appendix 4A.
44 Ibid 131–2.
45 (1992) 7 ACSR 759.
 BACKGROUND AND INITIATIVES 143

were not always easy to apply in practice. For this reason he approached the
Sydney Institute to facilitate discussions on corporate governance. The outcome
of these discussions, by a working group under the chairmanship of Fredrick
G Hilmer, was the release in 1993 of a report, Strictly Boardroom: Improving
Governance to Enhance Company Performance (the Hilmer Report (1993)).46
In hindsight, the Hilmer Report (1993) was particularly appropriate, as the
appeal of AWA Ltd v Daniels, namely Daniels v Anderson,47 emphasised that the
Australian courts expected high standards of care and diligence of directors,
including non-executive directors. In AWA Ltd v Daniels Rogers CJ had suggested
that non-executive officers may only be expected to pronounce on matters of
policy and may rely on management to inform them of anything important. The
Royal Commission into the Tricontinental Group of Companies48 believed such
was not sufficient to satisfy the director’s duty of care, asserting that the director
must provide an independent enquiring mind. For this reason, the Commission
questioned the authority of AWA Ltd v Daniels, suggesting that subsequent ‘courts
are likely to examine critically any failure by directors to be sufficiently well-
informed about matters affecting the financial performance and health of their
corporations, even if they are non-executive directors’.
This proved to become the norm. In Daniels v Anderson, Clarke and Sheller JJA
specifically referred to Rogers CJ’s views on the duties of non-executive directors.
They considered, among others, Roger CJ’s comments that ‘a director is justified
in trusting [officers of the company] to perform duties that, having regard to
the exigencies of business, the intelligent devotion of labour and the articles
of association, may properly be left to them’; and that ‘a director is entitled to
rely on the judgment, information and advice of the officers so entrusted and
on management to go through relevant financial and other information of the
corporation and draw to the board’s attention any matter requiring their consid-
eration’. Clarke and Sheller JJA said in no uncertain terms that they did not think
that these statements ‘accurately state the extent of the duty of directors whether
non-executive or not in a modern company’.49 Their own views – that there is
a positive duty on directors to investigate and to query management, especially
when there is notice of mismanagement, and that directors are under a contin-
uing obligation to keep informed about activities of the corporation50 – caused
alarm bells to ring, especially for non-executive directors. Rogers, commenting
on Clarke and Sheller JJA’s decision in a paper included as part of the Hilmer
Report (1998), said that they had ‘struck out a radically different direction’ as
far as directors’ duties were concerned generally, and in particular their view
that no distinction should be drawn between the obligations of executive and

46 Frederick G Hilmer, Strictly Boardroom: Improving Governance to Enhance Company Performance (Hilmer
Report (1993)) Melbourne, Business Library (1993) 1–3.
47 (1995) 13 ACLC 614.
48 Final Report of the Royal Commission of Inquiry into the Tricontinental Group of Companies, Melbourne,
Business Library (1992), vol 2, ch 19, paras 19.53–19.56.
49 Daniels v Anderson (1995) 13 ACLC 614 at 663.
50 Ibid 663–4.
144 CORPORATE GOVERNANCE IN AUSTRALIA

non-executive directors.51 Following the concerns raised by the New South Wales
Court of Appeal’s approach in Daniels v Anderson, amendments to the Corpora-
tions Act were required to make it clear under which circumstances directors
could delegate powers to others and when they would be protected for rely-
ing on the information provided to them by those to whom they had delegated
certain powers.52

5.4.2 The Hilmer Report (1993)

The Hilmer Report (1993) deals primarily with the following three questions:53
● What is the principal contemporary concern about the roles of the board,
directors, management and auditors?
● What are the key functions of a board that require greater emphasis if this
concern is to be addressed?
● To carry out these functions, what should be the responsibility of directors
and other parties involved in corporate governance and what other changes
are needed in board composition and processes?
One of the key aspects emphasised by the Hilmer Report (1993) was that poor
corporate performance, not fraud or misconduct, should be the main contempo-
rary concern of corporate governance.54 For this reason a chapter was dedicated
to the functions of the board55 and another chapter to improving governance.56
Some notable aspects of the ‘summary of recommendations’ in the Hilmer
Report (1993) are that:
1. The board’s key role is to ensure that corporate management is contin-
uously and effectively striving for above-average performance, taking
account of the risk.
2. Each board should clearly define what is meant by sustainable, above-
average performance in its particular situation.
3. Each board should monitor performance in terms of performance so
defined: in each case the extent and type of monitoring should reflect the
strength of the board’s reasons for scrutinising performance on an issue,
as well as the importance of the issue to the corporation.
4. Boards should define their roles in each of the following five areas in
a way that reflects the prime responsibility for setting and monitoring
achievement of performance goals and management’s responsibility for
formulating proposals and monitoring implementation in a way that
enhances managerial accountability:

51 Andrew Rogers, ‘Update’, in Frederick G Hilmer, Strictly Boardroom: Improving Governance to Enhance
Company Performance, Melbourne, Information Australia (2nd edn, 1998) 77.
52 See Explanatory Memorandum to the CLERP Bill 1998, paras 6.98–6.105; and the current ss 189–190
and 198D of the Corporations Act 2001 (Cth).
53 Hilmer Report (1993), above n 46, 3.
54 Ibid 4.
55 Chapter 3 of the Hilmer Report, above n 46.
56 Chapter 4, ibid.
 BACKGROUND AND INITIATIVES 145

● appointment of the chief executive officer (CEO) and human resources

issues
● strategy and policy
● budgeting and planning
● reporting to shareholders and regulatory compliance
● ensuring own effectiveness.
5. Non-executive directors should concentrate on keeping the board’s pri-
mary performance responsibility at the top of the agenda.
6. The non-executive chair has a critical additional responsibility in ensuring
that the agenda, information flow, time spent and processes of the board
maintain a performance emphasis while not losing sight of conformance
responsibilities.
7. Executive directors have a special responsibility to inform the board on
issues about which the executive has special and relevant knowledge.
8. Each company should have an audit committee comprised of non-
executive directors, with the chair of the committee and the majority
of its members also independent in the sense of not having a business
relationship with the company that might interfere with their judgment.
9. The appointment of an independent and properly qualified external audi-
tor is also a critical responsibility of the [audit] committee and the board.
10. Boards should consider a number of mechanisms that would build the
cohesiveness of the non-executives as a group.
11. Boards should pay greater attention to the calibre as well as mix of direc-
tors, recognising that effective board membership requires high levels of
intellectual ability, experience, soundness of judgment and integrity.
12. Boards should look favourably at remuneration packages that include
incentive elements for senior management.

5.4.3 The Hilmer Report (1998)

Several international developments in the area of corporate governance after
1993 resulted in a second Hilmer report in 1998 under the same title: Strictly
Boardroom: Improving Governance to Enhance Company Performance.57 There
were no radical changes in approach between the 1993 and 1998 Hilmer Reports.
The same sentiments underpinned the Hilmer Report (1998)58 and there were
very few changes to the 12 numbered paragraphs under the heading ‘Summary
of Recommendations’.59 However, an extract of a publication by Frederick G
Hilmer and Lex Donaldson on ‘The Fallacy of Independence’ was included as
Appendix 1 to the Hilmer Report (1998). This article makes it clear that the real

57 Frederick G Hilmer, Strictly Boardroom: Improving Governance to Enhance Company Performance,

Melbourne, Information Australia (2nd edn, 1998) (Hilmer Report (1998)), i–ii.
58 Ibid 1–7.
59 Frederick G Hilmer and Lex Donaldson, ‘The Fallacy of Independence’ in Hilmer Report (1998), above
n 57, 81.
146 CORPORATE GOVERNANCE IN AUSTRALIA

challenge for boards is not independence, but performance.60 It also points out
that research has failed to support the idea that a large number of independent
directors leads to fewer illegal acts by corporations.61 This conclusion seems
to be supported by several corporate collapses in Australia and other parts of
the world: there were several independent directors serving on the boards of
the majority of these companies, but poor corporate governance practices and
contraventions of the corporations laws still thrived – the corporate governance
watchdogs, the outside and non-executive directors, as well as the independent
outside and non-executive directors were obviously all still fast asleep at that
stage.

5.5 The virtues of good corporate governance in

Australia between 1991 and 1998

The excellent intentions of the Bosch Reports (1991, and the 1993 and 1995
reviews) and the Hilmer Reports (1993 and 1998) to promote good corporate
governance principles did not, unfortunately, pay the dividends one would have
expected of them – as was so cruelly illustrated by the investigations into and
court cases dealing with the spate of collapses of large Australian public cor-
porations between 2000 and 2003. Several reasons could be given for the poor
corporate governance practices identified in reports and court cases following
these collapses: for example, the lack of vigorous scrutiny of whether professed
good corporate governance practices were actually followed; poor accounting
standards; lack of independence of auditors; lack of proper disclosure of mate-
rial; price-sensitive information; and lack of statutory protection for those who
knew about poor corporate governance practices to encourage them to bring
those practices to light.
However, it is probable that complacency about corporate governance, after
many years of sustained growth in Australia in the middle to late 1990s and early
2000s, was one of the biggest contributing factors in allowing poor corporate
governance practices62 to thrive again in an environment in which there was
surely no lack of appreciation of the virtues of good corporate governance – as is
so strikingly illustrated by the commendable recommendations of the Bosch and
Hilmer reports released between 1991 and 1998.

5.6 The IFSA Blue Book

In 1995, the Australian Investment Managers’ Association (AIMA, or IFSA

(Investment and Financial Services Association Ltd) as it is now known),
60 Hilmer Report (1998), above n 57.
61 Hilmer and Donaldson, above n 59, 86.
62 See Du Plessis, above n 1, 229 and Rich v ASIC [2004] HCA 42 (9 September 2004), [117].
 BACKGROUND AND INITIATIVES 147

published a guide on good corporate governance practices for investment man-

agers, under the title Corporate Governance: A Guide for Investment Managers
and a Statement of Recommended Corporate Practice.63 A second edition of the
guide appeared in July 1997.64 This guide was revised and was re-released in
July 1999 (3rd edition) under the name IFSA Guidance Note No. 2.00: Corporate
Governance: A Guide for Investment Managers and a Statement of Recommended
Corporate Practice.65 It was republished in December 2002 (4th edition) as IFSA
Guidance Note No. 2.00: Corporate Governance: A Guide for Fund Managers and
Corporations – commonly known as the IFSA Blue Book.66 The 5th edition was
released in October 2004.67 Several significant changes were made to the IFSA
Blue Book (2004), as a result both of amendments to the Corporations Act 2001
effected by the Corporate Law Economic Reform Program (Audit Reform and Corpo-
rate Disclosure) Act 2004 and of the release in March 2003 of the ASX’s Principles
of Good Corporate Governance and Best Practice Recommendations.68 The current,
6th edition of the IFSA Blue Book (2009) was released in June 2009.69
It was not until 2002 that the IFSA Blue Book included a definition of ‘corporate
governance’.70 The definition IFSA uses is, understandably, very much focused
on shareholders and management:
Corporate Governance concerns the conduct of the board of directors and the relation-
ships between the board, management and shareholders. The transparency of major
corporate decisions and accountability to shareholders is at the core of governance
issues. Shareholders should be treated equitably and there should be the appropriate
distribution of risks and rewards between shareholders and company management.71

Interestingly, the term ‘stakeholder’ is only used twice in the IFSA Blue Book
(2009). In the IFSA Blue Book (2004) there was only one such a reference under
Guideline 10. Currently it is explained in Part 3 (Guidelines for Corporations),
under Guideline 1 (Annual Disclosure) that poor management of the environ-
ment and social risks facing a company can significantly detract from community
and stakeholder support of the company. This was probably added because of the
James Hardie case as well as the case of the Australian Wheat Board (AWB case).
The second reference occurs also in Part 3 (Guidelines for Corporations), under
63 As referred to in Ramsay and Hoad, above n 26, 10 fn 25.
64 Guidance Note No. 2.00: Corporate Governance: A Guide for Investment Managers and A Statement of
Recommended Corporate Practice (IFSA Guidance Note No. 2.00 (1999)), 3rd edn, (July 1999) 5, para 8.3 –
available at <www.ecgi.org/codes/documents/ifsa july1999.pdf>.
65 Ibid 1.
66 Guidance Note No. 2.00: Corporate Governance: A Guide for Fund Managers and Corporations (December
2002) (IFSA Blue Book (2002).
67 Guidance Note No. 2.00: Corporate Governance: A Guide for Fund Managers and Corporations (October
2004) (IFSA Blue Book (2004)) – available at <www.ifsa.com.au/documents/IFSA%20Guidance%20Note%
20No%202.pdf>.
68 IFSA Media Release, ‘Enhanced Corporate Governance Guidelines Issued by IFSA: Proxy Voting Summary
to Appear on Member Company Websites’, 21 October 2004, available at <www.ifsa.com.au/documents/
2004 1021 EnhancedCorpGovt.pdf>.
69 Guidance Note No. 2.00: Corporate Governance: A Guide for Fund Managers and Corporations (June
2009) (IFSA Blue Book (2009) – available at <www.ifsa.com.au//2009%20Documents/2009 0703 June%
202009%20Blue%20Book%20FINAL.pdf>.
70 IFSA Blue Book (2002), above n 66, 9, para 9.2.1.
71 Ibid, 10, para 9.2.1.
148 CORPORATE GOVERNANCE IN AUSTRALIA

Guideline 10 (Performance Evaluation), where it is stated that ‘the board should

also determine policies where the interests of shareholders and other stakehold-
ers require them to limit the discretion of management to act in particular areas
such as legal compliance and environmental policy’ (emphasis added).72
Since 1999, the IFSA Guidelines have been divided into two parts. First, some
guidelines are given specifically for ‘Fund Managers’ regarding their approach
to corporate governance, voting and other issues proposed by public companies
in which they invest. Second, there are some general guidelines for ‘Corpora-
tions’. In this part, IFSA outlines what it believes are best practice corporate
governance standards for companies in which its fund manager clients have
invested.
There were four guidelines presented under the first part from 1999–2004.
They were presented in the following order: communication (Guideline 1); vot-
ing scope (Guideline 2); corporate governance policy and procedures (Guideline
3); and reporting to clients (Guideline 4). Currently there are five guidelines
under the first part and they are presented in the following order:

Guideline 1 – Corporate Governance Policy and Procedures

Fund Managers should have a written Corporate Governance policy which is made
available on their website. The policy should be approved by the board of the Fund
Manager and should note the general principles underpinning formal internal proce-
dures to ensure that the policy is applied consistently.
Guideline 2 – Communication with Companies
Fund Managers should establish direct contact with companies in accordance with
their Corporate Governance Policy. Engagement with companies should include
constructive communication with both senior management and board members
about performance, Corporate Governance and other matters affecting shareholders’
interests.
Guideline 3 – Voting on Company Resolutions
Fund Managers should vote on all Australian company resolutions where they have
the voting authority and responsibility to do so. An aggregate summary of a Fund
Manager’s Australian proxy voting record must be published at least annually and
within 2 months of the end of the financial year.
Guideline 4 – Reporting to Clients
Wherever a client delegates responsibility for exercising proxy votes, the Fund Manager
should report in a manner required by the client. Reporting on voting and, where
required, other corporate governance activities, should be a part of the regular reporting
process to each client. The report should include a positive statement that the Fund
Manager has complied with its obligation to exercise voting rights only in the client’s
interest only. If a Fund Manager is unable to make the statement without qualification,
the report should include an explanation.

72 Ibid 26, para 11.11.

 BACKGROUND AND INITIATIVES 149

Guideline 5 – Environmental and Social Issues and Corporate Governance

Fund Managers should engage companies on significant environmental and social
issues that have the potential to impact on current or future company reputation and
performance.

The second set of guidelines (Guidelines for Corporations) numbered 14 in 1999,

but this was expanded to the 17 in 2004 and there are currently 18 in the IFSA
Blue Book (2009):

Guideline 1 – Annual Disclosure

The board of directors of a listed company should prominently and clearly disclose,
in a separate section of its annual report, its approach to Corporate Governance. This
should include an analysis of the Corporate Governance issues specific to the company
so that shareholders understand how the company deals with those issues. If the
particular circumstances of a company warrant departure from these guidelines, the
company should clearly explain the reason for an alternative approach. A company
should also disclose its policies and performance regarding other issues, including its
risk management framework and material environmental and social issues.
Guideline 2 – Composition of the Board of Directors: Competency
The board of directors of a listed company should be comprised of competent indi-
viduals who have the requisite skills and experience to fully discharge their directors’
duties. It is important to ensure that the board as a whole has the necessary breadth
of experience and diversity of skills to enable it to discharge its functions. The board
should review and disclose in the annual report its required mix of skills, experience
and other qualities, including the core competencies that each director brings to the
board.
Guideline 3 – Composition of the Board of Directors: Independence
The board of directors of a listed company should be constituted with a majority of
individuals who qualify as independent directors as defined in this Guideline.
Guideline 4 – Number of Permissible Directorships an Individual May Hold
Individual directors must commit an appropriate amount of time to board matters and,
where appointed, to relevant board committees. It is appropriate to limit the number
of board positions held in order to ensure that the individual fulfils their duties to each
particular company.
Guideline 5 – Chairperson to be an Independent Director
The Chairperson should be an independent director.
Guideline 6 – Board Committees
Committees of the board of directors should:
• generally be constituted with a majority who are independent directors, although
all members of the Audit Committee should be independent directors (see Recom-
mendation 4.2 of ASX Principle 4: Safeguard integrity in financial reporting);
• be entitled to obtain independent professional or other advice of their choice at the
reasonable cost of the company; and
150 CORPORATE GOVERNANCE IN AUSTRALIA

• be entitled to obtain such resources and information from the company, including
direct access to employees and advisers to the company.
Guideline 7 – Key Board Committees
The board should appoint a nomination committee, an audit committee, a remunera-
tion committee and such other committees required by law. These committees should
be constituted as defined in this Guideline.
Guideline 8 – Election of Directors
The method for electing directors must be fair and transparent.
Guideline 9 – Appointment of Non-executive Directors
Before accepting appointment, non-executive directors should be formally advised of
the reasons they have been asked to join the board and given an outline of what the
board expects of them. They should be advised of their rights as a director, including
their access to company employees and access to information and resources. Addition-
ally, they should be advised of their entitlement to obtain independent professional or
other advice of their choice at the reasonable cost of the company. The terms of any
pre-nuptial agreement73 should not diminish shareholder rights.
Guideline 10 – Performance Evaluation
The board should develop a formal performance evaluation process for the regular
review of its performance, the performance of individual directors, the company and
management. As a key part of that process, the independent directors should meet on
their own at least once annually to review performance.
Guideline 11 – Equity Participation by Non-executive Directors
The board should establish and disclose in the annual report a policy to encourage
non-executive directors to invest their own capital in the company or to acquire shares
from an allocation of a portion of their fees.
Guideline 12 – Trading by Directors and Senior Management [added in 2009]
Companies must develop, enforce and monitor policies on director and executive
trading in accordance with the Corporations Act 2001, and which reflect their own
circumstances. This should include monitoring, enforcement and reporting on trading
within any trading windows and ‘blackout’ trading periods. The policy should include
appropriate restrictions and disclosure regarding margin lending arrangements over
the company’s stock.
Guideline 13 – Respective roles of the Board and Management
The board should, at least annually, review the respective roles and the allocation of
responsibilities between the board and management.
Guideline 14 – Board and Executive Remuneration Policy and Disclosure
The board must disclose in the company’s annual report its policies on, and the quan-
tum and components of, remuneration for all directors and each of the five highest

73 For a discussion of ‘pre-nuptial’ agreements entered into between the board and a director, see James
McConvill, ‘Removal of Directors in Public Companies Takes Centre Stage: An Exploration of the Contempo-
rary Corporate Law and Governance Issues’ (2005) 1 The Corporate Governance Law Review 1.
 BACKGROUND AND INITIATIVES 151

paid executives. Where consolidated financial statements are required, remuneration

details of each of the five highest paid group executives must be provided. The disclo-
sure should be made in one section of the annual report in tabular form with appropriate
explanatory notes.
Guideline 15 – Company Meetings
– Format of resolutions
Notices of meeting and company resolutions should be in plain English and made
in a manner that permits shareholders to make informed decisions. Notices of
meeting should be posted on the company website or be accessible electronically.
Separate issues should not be combined and presented as a single motion for
shareholder vote.
– Form of proxies
Companies should adopt the Model Proxy Form in APENDIX B (with appropriate
modifications). Additionally, companies should take steps to implement facilities
for the electronic submission and authentication of proxy forms.
– Notification Period for Shareholder Meetings
The annual report, notice of meeting and other documents for all shareholder
meetings should be sent to shareholders at least 28 days prior to the meeting.
– Method of Voting
Voting should generally be conducted by poll only on the conclusion of discussion
of each item of business. Appropriate forms of technology should be utilised to
facilitate the proxy voting process.
– Disclosure of voting results
In announcing to the ASX the decisions made by shareholders at a general meet-
ing, a listed company must report the aggregate proxy votes validly received for
each item of business in the notice of meeting. The report should disclose, in the
case of a resolution passed on a show of hands, the aggregate number of proxy
votes received in each voting category (‘For’, ‘Against’, ‘Left to Proxy’s Discretion’
and ‘Abstain’). In the case of a resolution submitted to a poll, the report should dis-
close both the information specified in the preceding sentence and the aggregate
number of votes cast ‘For’ and ‘Against’ on the poll.
– Access to Minutes
Shareholders should be able to authorise an agent to inspect or obtain copies of
minutes of shareholders’ meetings.
Guideline 16 – Disclosure of Beneficial Shareholder Information
Information about beneficial shareholdings obtained by companies in response to their
inquiries should be disclosed to the market.
Guideline 17 – Major Corporate Changes
Major corporate changes, which in substance or effect may impact shareholder equity or
erode share ownership rights, should be submitted to a vote of shareholders. Sufficient
time and information (including a balanced assessment of relevant issues) should
be provided to shareholders to enable them to make informed judgements on these
resolutions.
Guideline 18 – Company Codes of Ethics and Conduct
Listed companies should have a company Code of Ethics and Conduct that is adopted
by the board and is available to shareholders on request.
152 CORPORATE GOVERNANCE IN AUSTRALIA

5.7 Standards Australia

Standards Australia was founded in 1922, but then called the Australian Com-
monwealth Engineering Standards Association. It is a non-government organ-
isation that aims to ensure high standards of Australian product and business
standards that meet Australia’s need for contemporary, internationally aligned
standards and related services. The work of Standards Australia enhances the
nation’s economic efficiency and international competitiveness, and contributes
towards community demand for a safe and sustainable environment. It is com-
mitted to the following:74
● Work for the Net Benefit of the Australian community;
● Provide national leadership and public access to Standards development;
● Represent Australia’s interests internationally;
● Promote Standardisation;
● Use good regulatory principles and behave legally and ethically;
● Engage with all stakeholders;
● Ensure balance on committees and transparency of interests;
● Adhere to consensus and governance processes;
● Accredit other Standards development organisations; and
● Continuous improvement.
One of its divisions is called Business and Management. This sector develops,
in response to the needs of business, best-practice solutions to assist businesses
to perform more effectively in highly competitive markets. The focus is on a
diversity of areas, including:75
● business governance
● risk management
● knowledge management
● earned value management
● market research
● business continuity management
● personal financial planning
● Quality and Environmental Management Systems (AS/NZS ISO 9001 and
14001)
● conditions of contract.
In 2003, Standards Australia sold its commercial businesses to SAI Global Lim-
ited and this company was floated on ASX.76 It means that if standards devel-
oped by Standards Australia are to be viewed or used, they need to be bought
commercially.

74 Available at <www.standards.org.au/cat.asp?catid=21>.
75 See <www.standards.org.au/cat.asp?catid=36>.
76 See <www.standards.org.au/cat.asp?catid=24> and <www.ncsi.com.au/as8000.html> – this address
leads the user to a site from which a print copy or electronic (pdf) version of the standards may be
purchased.
 BACKGROUND AND INITIATIVES 153

In 2003, Standards Australia launched the AS 8000 Corporate Governance

series of Standards.77 Supporting these standards, two guides were published
in March 2004: a guide to corporate governance; and the other elaborating on
applications of corporate governance principles. The guides were developed in
collaboration with Victoria University. The AS 8000 series of corporate gover-
nance standards provide guidance to businesses in the following areas:78
● good governance principles (AS 8000)
● fraud and corruption control (AS 8001)
● organisational codes of conduct (AS 8002)
● corporate social responsibility (AS 8003)
● whistleblower protection programs for entities (AS 8004).
AS 8000 promotes principles of good corporate governance and is designed
to assist members of boards, chief executive officers and senior managers to
develop, implement and maintain a robust system of governance that fits the
particular circumstances of the entity, provide the mechanisms for an entity to
establish and maintain an ethical culture through a committed, self-regulatory
approach and provide shareholders, or stakeholders, as the case may be, with
benchmarks against which to gauge the entity’s performance. The object of good
corporate governance principles is to:79
● Enhance organisational performance.
● Understand and manage risks to minimise the negative aspects and max-
imise the opportunities.
● Increase investor confidence in the integrity and efficiency of capital mar-
kets and also enhance the competitiveness of the economy.
● Strengthen shareholder and/or community confidence in an entity, partic-
ularly in areas that are not formally regulated.
● Enhance the public reputation of an entity through enhanced transparency
and accountability.
● Allow entities to demonstrate how they are discharging their legal, share-
holder and ethical obligations.
● Provide a mechanism for benchmarking accountability.
● Assist in the prevention and detection of fraudulent, dishonest and/or
unethical behaviour.
AS 8000 consists of four main parts, dealing respectively with the scope, appli-
cation and objectives of the AS 8000 standards; developing and implementing
a system for achieving good governance; good governance principles; and three
appendices. Different to the ASX Principles of Good Corporate Governance and
Best Practice that apply to listed companies, AS 8000s also aims to set appro-
priate good governance standards for private companies, government entities,
trustee companies and not-for-profit organisations. It also covers a wider range

77 Standards Australia, Good Governance Principles, AS 8000–2003 (Incorporating Amendment No 1 –

November 2004), Standards Australia International Ltd, Sydney (2003).
78 See <www.standards.org.au/cat.asp?catid=36>.
79 See <www.ncsi.com.au/as8000.html>.
154 CORPORATE GOVERNANCE IN AUSTRALIA

of elements including structural elements (government policy and continuous

improvement), operational elements (identification of governance issues, oper-
ating procedures for governance and dealing with governance breaches and
complaints) and maintenance elements (education and training, communica-
tion, monitoring and assessment of governance practices).
The part dealing with good governance principles includes guidance on the
role, powers and responsibility of the board, board composition and board
appointment. The concept of board independence is prominent.80 In this part
entities are encouraged to develop codes of conduct; there are also guidelines
dealing with board and shareholder meetings and board committees and their
composition. Part 3.6 captures the important role of stakeholders in corporate
governance.
The three appendices are important in a practical sense: Appendix A deals
with ‘board roles’ and includes summaries of the role of the chairperson, indi-
vidual directors, the CEO and the company secretary. Appendix B spells out the
underlying ethical values that entities should promote, while Appendix C deals
with special issues for consideration in the governance of not-for-profit entities.

5.8 Conclusion

Whereas the ‘excesses of the 80s’ ensured ‘diligent awareness of good corporate
governance practices during the 90s’, none of these factors seems to have stopped
poor corporate governance practices in the 1990s and early 2000s. As mentioned,
many reasons could be given for this, but the complacency that prevailed about
corporate governance after many years of sustained growth in Australia in the
middle to late 1990s and early 2000s was one of the biggest contributing factors
in poor corporate governance practices thriving once again, in an environment
in which there was surely no lack of appreciation of the virtues of good corpo-
rate governance practices. With the 2008–9 global financial crisis, it was again
realised that good corporate governance principles are pivotal in maintaining
financial stability. Thus, the importance of corporate governance grows steadily
as a subject area. We can, however, expect that aspects of total transparency,
risk management and increasing regulations will become even more prominent
over the next decade or so.
The next chapter will illustrate that Australia clearly received a wake-up call.
It was realised, quite late in the day, that poor corporate governance practices
were lurking below the surface in an environment in which a ‘less prescriptive’
approach was chosen. Several other jurisdictions had more drastic measures in
place to ensure corporate governance compliance at least a decade before Aus-
tralia adopted a similar approach. And, as David Knott observed in 2000, ‘[w]e
probably paid a price for that’.81 However, it is remarkable that as far as riding the
80 Ibid, para 3.2.4.
81 Knott, above n 12, 4.
 BACKGROUND AND INITIATIVES 155

storm of the global financial crisis is concerned, Australia did remarkably well. It
is to be hoped that this will not lead to complacency as far as the importance of
good corporate governance principles and practices are concerned. The financial
stimulus, combined with adhering to good corporate governance practices were
probably, in that order, responsible for Australia doing better than most other
developed countries during the global financial crisis.
6
Regulation of corporate governance

The impetus for considering the impact of regulation on law is the

growing importance of regulation. There is a broad and general move
in the community to manage or regulate risk. This focus on regulation and
risk management is, in turn, part of a broader interest in using a range
of governance mechanisms to directly and indirectly ‘influence the flow of
events’.
Angus Corbett and Stephen Bottomley, ‘Regulating Corporate Governance’
in Christine Parker, Colin Scott, Nicola Lacey and John Braithwaite (eds),
Regulating Law, Oxford, Oxford University Press (2004) 60

6.1 Overview

It will be clear from Figure 3.10 in Chapter 3 that we consider regulation of cor-
porate governance to be prominent in a good corporate governance model. This
chapter builds upon that model by focusing on the regulation of corporate gover-
nance in particular. It deals specifically with the various mechanisms, legislative
and non-legislative, which regulate the corporation and which set in place, col-
lectively, a framework by which good governance can be achieved. Overall, this
collective body of mechanisms forms part of what has recently been described as
an emerging ‘law of corporate governance’.
The regulation of corporate governance in Australia is achieved through both
binding and non-binding rules, international recommendations and industry
specific standards, commentaries of scholars and practitioners and the decisions
of judges. The legislature acts to facilitate the fulfillment of good corporate
governance by refining the rules encompassing corporate law, and indirectly
through the entire panoply of rules and regulations enacted, which have an
impact on the corporation and its activities in a variety of ways. But there are
other agencies, apart from the legislature, that assume a role in the regulation of
corporate governance.
Section two of this chapter provides a working definition of ‘regulation’, to
clarify what is meant by references to the ‘regulation’ of corporate governance
throughout this chapter. It also introduces the influential ‘pyramid’ of regula-
tory compliance developed by Ayres and Braithwaite. Section three explores
the common and unifying aims and objectives of regulation, with reference in

156
 REGULATION 157

particular to the Organisation for Economic Co-operation and Development’s

(OECD) Principles of Corporate Governance (2004), and similar statements made
when recent corporate governance reforms were introduced in Australia (namely
the CLERP 9 Act (2004), and the Australian Securities Exchange (ASX) Corporate
Governance Principles and Recommendations (2007)). These sources emphasise
the strong financial objectives underpinning the recent formalisation of corpo-
rate governance regulation. Section four explains the various mechanisms (or
‘sources’), both traditional and more recent, which encompass the regulation of
corporate governance in Australia. These mechanisms are categorised as being
examples of ‘hard law’, ‘hybrids’ or ‘soft law’.
Finally, section five assesses whether, in general terms, there is an effective
corporate governance with reference to the financial markets regulatory frame-
work in Australia. This assessment is based on the guidelines contained in the
OECD’s Principles of Corporate Governance (2004) on what it perceives to be an
effective corporate governance regulatory framework.

6.2 Regulation generally

Regulation is a topic of significant and increasing interest in a wide range of

disciplines, from politics and economics to sociology, psychology and history.
There is, therefore, a variety of different definitions of ‘regulation’ used in the
literature, with some commentators referring to a ‘definitional free-for-all’.1
One of the best and most useful definitions of ‘regulation’ is provided by
Simon Deakin and Jacqueline Cook of the University of Cambridge, in an August
1999 Research Paper prepared by the United Kingdom’s Company Law Review
Steering Group. The paper, ‘Regulation and the Boundaries of the Law’ provides
some general considerations relating to the debate about the appropriate form
of corporate regulation, and usefully explores the present structure of company
law and corporate governance in the UK. Deakin and Cook state:

In the present context the term ‘regulation’ may be taken to refer to the control of
corporate and commercial activities through a system of norms and rules which may
be promulgated either by governmental agencies (including legislatures and courts) or
by private actors, or by a combination of the two. The direct involvement of the state is
not a necessary condition for the existence of regulation in this sense, since rules may
be derived from the activities of industry associations, professional bodies or similarly
independent entities.
This is because the rules of contract, property and tort are seen as empowering com-
mercial actors to enter into and enforce transactions, whereas regulatory interventions

1 See Helen Bird, David Chow, Jarrod Lenne and Ian Ramsay, ASIC Enforcement Patterns, Research Report,
Melbourne, Centre for Corporate Law and Securities Regulation (2004), 5 referring to Julia Black, ‘Decentring
Regulation: Understanding the Role of Regulation and Self Regulation in a “Post-Regulatory” World’ (2001)
54 Current Legal Problems 103, 129. For a general discussion of regulation in a legal context, see Christine
Parker, Colin Scott, Nicola Lacey and John Braithwaite (eds), Regulating Law, Oxford, Oxford University Press
(2004). In this edited work, Angus Corbett and Stephen Bottomley have written a chapter on ‘Regulating
Corporate Governance’ (at 60).
158 CORPORATE GOVERNANCE IN AUSTRALIA

are seen as more often controlling the terms of contracts and imposing obligations of
various kinds regardless of the intentions of the parties.2

A similarly broad working definition of regulation is used in the recent research

report of the Centre for Corporate Law and Securities Regulation at The Uni-
versity of Melbourne, entitled ‘ASIC Enforcement Patterns’. The authors of the
report, state that:

Three broad ‘textbook’ definitions or approaches to regulation are commonly iden-

tified, ranging from the narrowest to widest sense of the term. First, regulation
as (government-determined) legal rules backed by mechanisms for monitoring and
enforcement. Secondly, in a more encompassing variation of the first, regulation
includes any form of deliberate state intervention in the economy or other fields of
social activity. Thirdly, regulation, in its widest reading, includes all mechanisms of
social control or influence, from whatever source and whether intentional or not.3

The report goes on to discuss the ‘pyramid’ of regulatory compliance developed

by Ayres and Braithwaite in their influential book, Responsive Regulation, pub-
lished in 1992. The report’s authors explain that the ‘pyramid’ aligns itself to
a self-regulatory approach to regulation (as opposed to enforced, mandatory
regulation), by highlighting the purpose and limits of self-regulation.
The ASIC Enforcement Patterns report provides a useful explanation of how
Ayres and Braithwaite perceive the pyramid as operating, and the significance
of the pyramid in illustrating their theory of responsive regulation. Bird, Chow,
Lenne and Ramsay describe the operation of the pyramid as follows:

Sanctions are structured in such a way as to combine persuasion in the majority of

cases with direct enforcement in a smaller number. At the base of the pyramid, most
actors are persuaded to comply through indirect intervention; full sanctions, such as
criminal penalties or the withdrawal of a licence to operate, are reserved for the few
cases at the top.4

In terms of the purpose of the pyramid in illustrating Ayres and Braithwaite’s

theory, the authors of the report go on to explain:

The purpose of the pyramid is to provide regulatees with maximum incentives for early
compliance. This is an acknowledgement that, where ‘persuasive’ strategies are used,
the regulator and the regulatee are, in effect, engaged in bargaining over the terms and
timing of compliance, and that without the threat of escalating sanctions, the regulatee
may have incentives to hold out in the expectation of being able to negotiate a better
deal.5

2 Paper prepared by the ERSC Centre for Business Research, University of Cambridge (1999), for the
Department of Trade and Industry’s Review of Company Law.
3 Bird, Chow, Lenne and Ramsay, above n 1, 4.
4 Ibid. In ‘Responsive Regulation’, Ayres and Braithwaite explain that (at 39): ‘Firms that resist initial
compliance will be pushed up the enforcement pyramid. Not only escalating penalties, but also escalating
frequency of inspection and tripartite monitoring by trade unions . . . can then negate the returns to delayed
compliance.’
5 Ibid 5. See also John Braithwaite, Restorative Justice and Responsive Regulation, Oxford, Oxford University
Press (2002).
 REGULATION 159

Another useful explanation of Ayres and Braithwaite’s pyramid of regulatory

compliance is provided by Simon Deakin in the research note, ‘Economic Effects
of Criminal and Civil Sanctions in the Context of Company Law’.6
Ayres and Braithwaite’s model of regulatory compliance and enforcement has
received widespread support, and indeed was endorsed by the authors of ASIC
Enforcement Patterns.7 This research report, published in 2004, details the find-
ings of an empirical study of court-based enforcement activities undertaken by
ASIC during the period 1997–9. One of the key aims of the study was to determine
whether ASIC’s enforcement activities during this time were consistent with the
findings of past sociological studies of legal regulation and enforcement. Accord-
ing to the report, sociological theories contend that the effectiveness of laws as
forms of regulation depends on the process by which those laws are received,
interpreted and responded to by the participants in the regulatory process. ‘Those
participants include ASIC, the Commonwealth Director of Public Prosecutions
(DPP), and the pool of persons and companies influenced and controlled by
company and financial services laws.’8
What we will see below is that Ayres and Braithwaite’s pyramid of regu-
latory compliance provides an important context within which to understand
the extensive and exciting recent developments in the regulation of corporate
governance,9 enabling one to engage in an informed assessment of why corpo-
rate governance regulation has reached the point that it has, and where things
may head in the future.

6.3 Objectives in regulating corporate governance

The impetus for recent corporate governance regulatory reforms both domesti-
cally and internationally (such as Sarbanes-Oxley in the USA, and CLERP 9 and
the ASX Corporate Governance Principles and Recommendations in Australia) has
been spurred on by a series of corporate collapses and the perceived need to
restore confidence in the market. As a result, financial objectives are expressed
to be the driving factor underpinning contemporary corporate governance regu-
lation. Most, if not all, contemporary corporate governance reports, guidelines,
commentaries and legislative packages strongly emphasise the link between
sound corporate governance practices and success within the corporation and
throughout the economy. For example, the OECD Principles of Corporate Gover-
nance states that:

6 Simon Deakin, ‘Economic Effects of Criminal and Civil Sanctions in the Context of Company Law’, Research
Note July 2000, DTI Company Law Review, United Kingdom, 5, available at <www.dti.gov.uk/cld/deakin
z.pdf>.
7 See Bird, Chow, Lenne and Ramsay, above n 1.
8 Ibid xiii.
9 For application of the pyramid in the enforcement of directors’ duties, see Commonwealth of Australia,
Review of Sanctions in Corporate Law (2007), available at <www.treasury.gov.au/documents/1182/PDF/
Review of Sanctions.pdf>.
160 CORPORATE GOVERNANCE IN AUSTRALIA

The presence of an effective corporate governance system, within an individual com-

pany and across an economy as a whole, helps to provide a degree of confidence that
is necessary for the proper functioning of a market economy. As a result, the cost of
capital is lower and firms are encouraged to use resources more efficiently, thereby
underpinning growth . . . 10
The degree to which corporations observe basic principles of good corporate gov-
ernance is an increasingly important factor for investment decisions. Of particular
relevance is the relation between corporate governance practices and the increasingly
international charter of investment. International flows of capital enable companies to
access financing from a much larger pool of investors.11

In discussing the OECD Principles of Corporate Governance, Janis Sarra has use-
fully described the link between effective corporate governance and healthy
global capital markets, as follows:

Corporate governance is only one aspect of the larger framework of macroeconomic

policies, competition and tax policy, global capital, products and labour markets, cul-
tural norms and ethics, and diverse state regulatory systems. The growth of global
capital markets has created the potential for greater access to a larger investor pool.
Key to the attraction of long-term ‘patient capital’, whether it is domestic or interna-
tional, is the ability to offer corporate governance systems that are clearly articulated
and adhered to, within regulatory and legal frameworks that support contractual and
ownership rights.12

At the domestic level, in Australia, important sources of recent corporate gover-

nance regulatory reform – the CLERP 9 amendments to the Corporations Act 2001
(Cth) (the Act), the ASX Corporate Governance Principles and Recommendations
and the recently revised IFSA Blue Book on corporate governance – all empha-
sise the financial objectives underlying contemporary regulation of corporate
governance.
The CLERP 9 amendments to the Act, the majority of which came into effect
from 1 July 2004, contain the bulk of corporate governance-related reforms,
including enhanced mandatory rules dealing with auditor independence, finan-
cial reporting, executive remuneration, continuous disclosure and shareholder
participation.13 CLERP 9 represented the 9th stage of the Howard Government’s
Corporate Law Economic Reform Program, which was strongly driven by eco-
nomic objectives for law reform. In the Second Reading Speech of the CLERP 9
Bill, delivered in the House of Representatives on 3 December 2003, Treasurer
Peter Costello said:
10 OECD Principles of Corporate Governance (April 2004), available at <www.oecd.org/dataoecd/32/18/
31557724.pdf> 11.
11 Ibid 13.
12 See Janis Sarra, ‘Convergence Versus Divergence: Global Corporate Governance at the Crossroads’ (2001)
33 Ottawa Law Review 177, 186–7.
13 See generally James McConvill, An Introduction to CLERP 9, Sydney, LexisNexis (2004); R P Austin, H A
J Ford and I M Ramsay, Company Directors: Principles of Law and Corporate Governance, Sydney, LexisNexis
(2005); John Farrar, Corporate Governance: Theories, Principles and Practice, Melbourne, Oxford University
Press (3rd edn, 2008).
 REGULATION 161

The draft Bill continues the work of the Government’s Corporate Law Economic Reform
Program, to modernise business regulation and foster a strong and vibrant economy,
progressing the principles of market freedom, investor protection and quality disclosure
of relevant information to the market.

Importantly, however, as suggested in the above statement by the then-Treasurer

Costello, the CLERP 9 reforms are not only driven by a narrow financial objec-
tive, but are also seeking to protect and enhance the rights of shareholders, by
confirming their position as the central and most significant stakeholder in the
modern corporation.
The ASX Corporate Governance Principles and Recommendations (2007) are
also expressed to be driven by financial objectives – it notes the importance
of good corporate governance from the perspective of achieving a sound econ-
omy and maintaining market confidence. Two statements in the ASX Corporate
Governance Principles and Recommendations (2007) illustrate this point:
[G]ood governance structures and practices continue to be important in determining
the cost of capital in a global capital market. Australian companies must be equipped
to compete globally and to maintain and promote investor confidence both in Australia
and overseas.14

and
The Recommendations are not prescriptions, they are guidelines, designed to produce
an outcome that is effective and of high quality and integrity. This document does not
require a ‘one size fits all’ approach to corporate governance. Instead, it states sugges-
tions for practices designed to optimise corporate performance and accountability in
the interests of shareholders and the broader economy.15

Finally, the IFSA Blue Book on corporate governance (Corporate Governance:

A Guide for Fund Managers and Corporations),16 providing guidance for IFSA-
member fund managers as to how they may influence companies in which they
invest to achieve and maintain corporate governance best practice standards,
explains that the guidelines and standards in the IFSA Blue Book, if followed,
will provide ‘positive benefits to all shareholders and the economy as a whole’.17

6.4 Sources of regulation in Australia

The key definitions of ‘regulation’, as quoted above, highlight some of the main
sources of regulation. We now apply this background discussion to a specific
context of corporate governance in Australia, and provide an account of the
14 ASX, Corporate Governance Council, Corporate Governance Principles and Recommendations (2nd
edn) (August 2007) at 4, available at <www.asx.com.au/about/corporate governance/revised corporate
governance principles recommendations.htm>.
15 Ibid 5.
16 Guidance Note No. 2.00: Corporate Governance: A Guide for Fund Managers and Corporations (June
2009) (IFSA Blue Book (2009) – available at <www.ifsa.com.au//2009%20Documents/2009 0703 June%
202009%20Blue%20Book%20FINAL.pdf>.
17 Ibid 4.
162 CORPORATE GOVERNANCE IN AUSTRALIA

various mechanisms, both traditional and more recent, which encompass the
regulation of corporate governance in Australia.
John Farrar has engaged in a very useful task of categorising the various
sources of corporate governance regulation in Australia – into ‘hard law’, ‘hybrids’
and ‘soft law’.18 Although Farrar does not provide a working definition of any of
these categories, it could be said that ‘hard law’ means ‘traditional black-letter
law’; ‘soft law’ includes voluntary sources of corporate governance standards
that companies have the freedom to adopt or not; and ‘hybrids’ fall somewhere
between the two: neither mandatory nor purely voluntary. Below we identify the
main sources of corporate governance regulation under the category headings
provided by Farrar. We also detail our perspective on each of these sources and
add to Farrar’s analysis our own viewpoint on corporate governance regulation.

6.4.1 ‘Hard law’

6.4.1.1 Statutory regulation – corporate law
Australia’s primary companies legislation, the Corporations Act 2001 (Cth), con-
tains a number of provisions that influence, both directly and indirectly, all
aspects of a company’s governance arrangements. The provisions range from
director’s duties and liabilities19 and shareholder rights and remedies,20 which
influence the relationship between directors, management and shareholders, to
the financial reporting provisions under Chapter 2M,21 which are intended to
ensure that the financial aspects of a company’s governance practices are charac-
terised by transparency and accountability, and to the comprehensive provisions
under Chapter 2G governing company meetings (both directors’ meetings and
meetings of members). Many of these provisions are mandatory rules, with sanc-
tions imposed for non-compliance.
While there are many important corporate governance ‘mandates’ under the
Act, this does not mean that all of the corporate governance rules that stem
from the Act are prescriptive in nature. Indeed, the opposite is the case. The Act
provides companies with a great deal of say on the internal arrangements and
management of their company. Most of the rules governing a company’s internal
arrangements and management may be contained in the company’s constitution
(if the company has one); this is specifically drafted by each company to meet
its particular needs and therefore in essence may contain whatever rules the
company desires (subject to a special majority of the company’s shareholders
approving the changes). Instead of a constitution, a company’s internal man-
agement may be governed by a set of ‘replaceable rules’ (that is, rules that the
company may abide by or ‘opt out of’ by adopting alternative arrangements in

18 John H Farrar, ‘Corporate Governance and the Judges’ (2003) 15 Bond Law Review 65.
19 For discussion, see Jason Harris, Anil Hargovan and Michael Adams, Australian Corporate Law, Sydney,
LexisNexis (2nd edn, 2009) Chapters 16–19.
20 Ibid, Chapter 20.
21 Ibid, Chapter 21.
 REGULATION 163

its constitution – see discussion below) contained in the Act (see list in section
141 of the Act). A company may also use a combination of constitution and
replaceable rules.
While the constitution (if any) is drafted independently by each company, it
is appropriate to discuss the constitution in the context of regulation under the
Act. This is because the Act contains some important provisions relating to com-
pany constitutions. Most importantly, section 140(1) provides that a company’s
constitution (if any, as well as any replaceable rules that apply to the company)
has effect as a contract between:
(a) the company and each member
(b) the company and each director and company secretary
(c) a member and each other member.

Due to s 140(1), the company’s constitution has the status of a ‘statutory contract’,
which means that it has certain features which depart from ordinary principles of
contract law. With an ordinary contract, only initial parties to the contract are bound
by it. This would typically be the company and the shareholders who purchased shares
in the company when it was first formed. The statutory contract, however, has a reach
beyond the current corporate membership. It extends to, and binds, any person who
acquired membership after the company was formed. An important implication of
the company constitution having the status of a statutory contract is that it offers
remedies beyond damages if the contract is breached. An injunction or declaration is
also available to enforce compliance with the constitution.

Another reason for the constitution ultimately being a creature of the Act, rather
than being an entirely separate initiative of companies, is that the Act sets out
the procedure that companies have to follow in order to adopt or amend a
constitution. Section 136(1) provides that a company may adopt a constitution
in one of three ways:

(a) a new company is considered to adopt a constitution upon registration if those

persons who are named in the company’s registration application as consenting
to become members, agree in writing to the terms of the constitution before the
application is lodged;
(b) by passing a special resolution (defined below) of members if a company is already
registered but does not have a constitution;
(c) if a court order is made under s 233 (finding oppressive conduct under Part 2F.1)
requiring that the company adopt a constitution.

Under section 136(2) of the Act, a special resolution of members is required to

modify or repeal a constitution or a provision of a constitution. Section 9 of the
Act defines ‘special resolution’ as being a resolution passed by at least 75 per cent
of the votes cast by members entitled to vote on the resolution.
Most companies, and probably all larger companies, have a constitution. The
main reason, in practice, for adopting a constitution is to displace one or more
of the so-called ‘replaceable rules’ under the Act that would otherwise apply to
the company. This is implied in section 135(2) of the Act – replaceable rules are
164 CORPORATE GOVERNANCE IN AUSTRALIA

‘replaceable’ because they can be modified or displaced by adopting a constitution

with alternative procedures.
The replaceable rules regime was introduced in 1998. The key objective
behind this move was to provide a simplified procedure for setting up and run-
ning a company. It is explained in the Explanatory Memorandum to the Company
Law Reform Bill 1997, that:

The concept of memorandum of association will be abolished (the memorandum of

existing companies will be treated as part of their constitution). Also, the adoption
of a constitution will be optional. The basic rules that are available to the internal
management of companies (Table A of the Law) will be updated and moved into
the main body of the Law as replaceable rules. Companies will be able to adopt a
constitution displaying some or all of these rules. These reforms will reduce the cost of
registering a company for the approximately 80,000 new companies that are registered
each year.22

With this amendment to the Act, 41 provisions regulating the internal affairs
of the company became replaceable rules. The replaceable rules, listed in sec-
tion 141 of the Act,23 essentially reflect the rules contained in the old Table A
to the Corporations Law, and are divided into provisions dealing with officers
and employees, inspection of books, directors’ meetings, meetings of members,
shares and transfer of shares. The replaceable rules apply only to companies that
were incorporated after the introduction of the replaceable rules regime on 1 July
1998, and to companies incorporated before 1 July 1998, which repeals their
existing constitution.24 As companies are no longer required to have a constitu-
tion, the replaceable rules may entirely govern the internal affairs of a company
if the company so chooses.25
Ford and colleagues explain that it is possible for a company’s internal arrange-
ments and management to be governed entirely according to the replaceable
rules contained in the Act. The authors state, however, that in practice compa-
nies find some or all replaceable rules to be inappropriate or inadequate, and will
therefore adopt a constitution to supplement, or entirely replace, the replaceable
rules. Commonly, therefore, companies will be governed by a constitution, or a
mix of constitutional provisions and replaceable rules.26
The significance of the company constitution in shaping the corporate gov-
ernance practices of companies is recognised in the leading corporate law text-
books: Gower and Davies’ Principles of Modern Company Law in the UK, and Ford’s
Principles of Corporations Law in Australia. Gower and Davies refer to the com-
pany constitution as being the key source of governance arrangements, including

22 Explanatory Memorandum, Company Law Reform Bill 1997, paragraph 10.

23 Section 141 of the Act sets out a list of 41 provisions that apply as replaceable rules, which companies
may use as their internal governance arrangements.
24 See s 135(1) of the Act.
25 See further James McConvill and Mirko Bagaric, ‘Opting Out of Shareholder Governance Rights: A New
Perspective on Corporate Freedom in Australian Corporate Law’ (2005) 3 De Paul Business and Commercial
Law Journal (USA) 401.
26 R P Austin and I M Ramsay, Ford’s Principles of Corporations Law, Sydney, LexisNexis Butterworths (14th
edn, 2010) 188–9 para 6.11.
 REGULATION 165

the division of powers between shareholders and the board, and the composi-
tion, structure and operation of the board.27 Ford’s Principles of Corporations
Law uses ‘corporate governance rules’ and the company’s ‘constitution’ as almost
interchangeable terms, with the authors noting:

The provision of the constitution which deals with the power to manage the company’s
business is obviously of critical importance. The constitution of many companies will
contain a provision that the directors may exercise all the powers of the company
except any powers that the Corporations Act or the company’s constitution requires
the company to exercise in general meeting.28

6.4.1.2 Statutory regulation – other than corporate law

As already explained in Chapter 2, the manner in which the internal arrange-
ments and management of companies is achieved, and the relationship between
the company and its various stakeholders operates, is also influenced by legal
rules operating outside of company law. These rules derive from areas of law
such as industrial relations, tax, environmental law, and banking and finance.

6.4.1.3 ‘Corporate governance and the judges’ – the place of

judge-made law

Regulation encompasses the making of laws, the interpretation of laws to determine

what is required to comply with them and, in turn, the actions taken to enforce these
laws in cases of non-compliance.29

In Australia, ‘company law’ (including the rules of corporate governance) as

a collective body of rules has traditionally been statute-based, unlike in the
UK, where much of company law – including directors’ duties and shareholder
rights – principally has been governed by common law and equitable principles
(although this is progressively changing as a result of company law reform).
Within this statute-based regulatory framework, as the above statement sug-
gests, judges have an important role in developing and applying the principles
of the law through their role as interpreters (particularly when provisions are
vaguely expressed or overly complex). Thus, while the common perception is that
regulation of corporate governance comes in the form of black-letter rules – leg-
islative or quasi-mandatory codes and principles – it is important to understand
the significant role that judges continue to play.30
Probably the best recent account of the important role that judicial determina-
tions have in the context of corporate governance regulation in Australia comes
from Farrar. He states as follows:

27 Paul L Davies, Gower and Davies’ Principles of Modern Company Law, London, Sweet & Maxwell (8th edn,
2008) 62.
28 Austin and Ramsay, above n 26, 223 para 7.091.
29 From Bird, Chow, Lenne and Ramsay, above n 1, 2, citing Robert Baldwin and Martin Cave, Understanding
Regulation, New York, Oxford University Press (1992) 1–2 (emphasis added).
30 See Davies, above n 27, 61. See also Corbett and Bottomley, above n 1, 60.
166 CORPORATE GOVERNANCE IN AUSTRALIA

If we turn to corporate governance consisting of statutory rules and case law rules
and principles [they have] traditionally been regarded as justiciable [that is, capable
of being determined by a court acting judicially]. Indeed, it was left to the courts to
fill in the substantial gaps left by the legislation in terms of director’s fiduciary and
other duties, and shareholder remedies . . . Court proceedings of any sort are expen-
sive and occasion delay. ASIC prefers to avoid them if possible for these reasons and
uses its administrative powers wherever possible and is seeking to impose its own
penalties . . . This needs to be considered as does the question whether the courts have
a role in respect of self-regulation.31

Farrar also discusses in detail three high-profile recent cases in Australia (relating
to the HIH and One.Tel collapses, and the ongoing saga associated with NRMA)
to highlight the importance of the continuing role of the courts in corporate
governance where self-regulation fails. He gives the following explanation of the
important role of Australian courts in relation to the regulation of contemporary
corporate governance:

What these situations demonstrate is that self-regulation sometimes fails and there
is no alternative to court involvement. Self regulation lacks an effective system of
sanctions which can only be provided by the courts. In the case of HIH, retribution has
been swift. There was not time and perhaps inclination for minority shareholders to
seek redress. ASIC took prompt action.32

6.4.2 ‘Hybrids’
‘Hybrid’ mechanisms of corporate governance regulation have been described
in the literature from a broader theoretical context as constituting a strategy
of ‘enforced self-regulation’. According to Ayres and Braithwaite in Responsive
Regulation, enforced self-regulation occurs where the law delegates to private-
sector bodies (such as self-regulatory organisations, which loosely describes
ASX) the task of formulating substantive rules, to which certain legal sanctions
are then attached.

6.4.2.1 ASX Listing Rules

ASX provides a market for trading in securities. ASX engages in market surveil-
lance in relation to securities issued by entities that are accepted onto the official
list of the ASX (‘listed entities’). One way that ASX does this is through setting
the standards of behaviour for listed entities, which are contained in ASX Listing
Rules.
According to ASX, the Listing Rules ‘govern the admission of entities to the
official list, quotation of securities, suspension of securities from quotation and
removal of entities from the official list. They also govern disclosure and some
aspects of a listed entity’s conduct’. Compliance with the Listing Rules is a
requirement for admission to the official list. Non-compliance is a ground for

31 Farrar, above n 13.

32 Ibid 80.
 REGULATION 167

removal from the official list. The corporate governance rules in the Listing Rules
typically require a listed entity to disclose to the market and/or shareholders
certain information, or to obtain shareholder approval for a particular transac-
tion or arrangement. Some of the corporate governance-related Listing Rules
include:
● LR 3.1 (dealing with continuous disclosure of information upon discover-
ing the information’s ‘materiality’)
● LR 7.1 (requiring shareholder approval if a company issues more than 15%
worth of its securities over a 12 month period)
● LR 10.1 (requiring shareholder approval for, among other things, certain
related party transactions)
● LR 11.1 (requiring provision of details to ASX if an entity proposes to make
a significant change, either directly or indirectly, to the nature and scale of
its activities)
● LR 11.2 (requiring shareholder approval if the significant change involves
the entity disposing of its main undertaking).
At first blush, it appears curious that Farrar included the ASX Listing Rules
under the ‘hybrid’ category when they are mandatory rules, given statutory force
under section 793C of the Corporations Act (meaning that an application may be
made by ASIC, ASX or an aggrieved person for a court order that the operating
rules of the market be complied with or enforced).33 However, an explanation for
categorising the Listing Rules as hybrids is that they are different from traditional
legislation – rather than being enacted by Parliament, they are developed and
implemented by ASX, subject only to disallowance by the relevant Minister.34
Another plausible reason for treating the listing rules as hard–soft law (hybrid),
which we accept, can be explained with reference to the approach to enforcement
of corporate governance principles by ASX.
The attitude of ASX towards enforcement of the Listing Rules also offers
support to the categorisation of the Corporate Governance Principles and Recom-
mendations (2007) as soft law – despite the elevation of the Listing Rules to a
statutory importance. The paradoxical position, and difficulty with labelling, is
best explained with reference to the introduction to the ASX Listing Rules and
judicial attitude to its enforcement. The former explicitly rejects a perspective
approach to enforcement:35

ASX has an absolute discretion concerning the admission of an entity to the official list
(and its removal) and quotation of its securities (and their suspension). ASX also has
discretion whether to require compliance with the Listing Rules in a particular case (ie,
apart from waiving the rules). In exercising its discretion, ASX takes into account the
principles on which the Listing Rules are based.

33 Furthermore, s 1101B of the Act provides that the court may make a wide range of orders to ensure
compliance with legislation, operating rules and other requirements which relate to dealing in financial
products, providing financial services or operating a licensed market. An application may be brought by ASIC,
a market licensee or a person aggrieved by a contravention of the operating rules.
34 See s 793E(3) of the Act.
35 See <www.asx.com.au/supervision/rules guidance/listing rules1.htm>.
168 CORPORATE GOVERNANCE IN AUSTRALIA

ASX may also waive compliance with a listing rule, or part of a rule, unless the rule in
question says otherwise. The Listing Rules necessarily cast a wide net. However, ASX
does not want to inhibit legitimate commercial transactions that do not undermine the
principles on which the Listing Rules are based.

There is a line of judicial authority that is sympathetic to the nature and intent
of the listing rules, as envisaged above by ASX.36 In Bateman v Newhaven Park
Stud Ltd, Barrett J rejected counsel’s submission that the views of ASX as to
the construction of its listing rules (reproduced above) ‘are essentially beside
the point’37 and reinforced the explicit power ASX reserves to itself to decide
whether to require compliance.
Herein lies the complication and tension in trying to fit ASX Corporate Gover-
nance Principles and Recommendations (2007) easily into the slots of ‘hybrid law’
and ‘soft law’. The discussion illustrates, at the least, that it is not easy to find a
strict classification that is necessarily decisive.

6.4.2.2 ASX Corporate Governance Principles and Recommendations

Farrar includes the ASX’s Corporate Governance Principles and Recommendations
(2007) under the category of ‘soft law’.38 The rationale for this is that the Best
Practice Recommendations differ from the Listing Rules in that they are not
strictly mandatory rules backed up by statutory force; rather, as was explained in
greater detail in Chapter 5 of this book, ASX Corporate Governance Principles and
Recommendations (2007) operate under a ‘comply or explain’ regime: ASX-listed
companies must either comply with each of the recommendations, or clearly
explain why not in their annual report.
Notwithstanding the caveat expressed above on strict classifications, we
believe that ASX Corporate Governance Principles and Recommendations (2007)
should come under the ‘hybrid’ category for the reasons discussed above. The
‘comply or explain’ regime stems from Listing Rule 4.10.3, which expressly states
that listed entities must comply with the recommendations (constituting bench-
marks for corporate governance best practice in relation to a range of different
matters) or explain why not in their annual report. Hence, while the benchmarks
contained in ASX Corporate Governance Principles and Recommendations (2007)
are not prescriptive rules – as exist in the USA with the Sarbanes-Oxley Act of
2002 and the New York Stock Exchange corporate governance rules – neither
are they purely voluntary – as are the other standards and guidelines express-
ing corporate governance benchmarks, discussed below under ‘soft law’. Listed
companies do not have complete freedom (as they do, say, with the replaceable
rules in the Corporations Act) to decide whether or not to comply with the rec-
ommendations: to depart from any one of the 27 recommendations contained in

36 For example, see Harman v Energy Research Group Australia Ltd (1985) 9 ACLR 897; Fire and All Risk
Insurance Ltd v Pioneer Concrete Services Ltd (1986) 10 ACLR 760; Bateman v Newhaven Park Stud Ltd (2004)
49 ACSR 454.
37 (2004) 49 ACSR 454 at 456.
38 John Farrar, Corporate Governance: Theories, Principles and Practice, Melbourne, Oxford University Press
(3rd edn, 2008) 384 et seq.
 REGULATION 169

ASX Corporate Governance Principles and Recommendations (2007), companies

need to justify their action by clearly explaining why they have done so. Failure
to do this technically constitutes a breach of Listing Rule 4.10.3, and sanctions
(including even removal from the official list of ASX) are available.
The following judicial remarks by Kirby P (as his Honour then was) in FAI
Insurances Ltd v Pioneer Concrete Services Ltd (No 2),39 in support of a wide
construction on the enforceability of ASX Listing Rules are relevant to this
debate:40

[Section 793C of the Corporations Act] permits the protective intervention of the court
to ensure that breaches of listing requirements, which, for whatever reason, are not
pursued by the Commission or a securities exchange, can be brought to notice of the
court by a person aggrieved . . . Making every allowance . . . for the ‘absolute discretion’
reserved to the securities exchanges by the foreword to the official listing requirements
[reproduced above], the overall scheme of [Chapter 7 of the Act], as enacted by the
Parliament, appears to be one which elevates the listing requirements to a statutory
importance which they did not previously have. They are now more than the private
rules of a private body. By [s 793C], as by]s 1101B] of the [Act], they are given statutory
significance . . . (emphasis added)

6.4.2.3 Accounting standards

The importance of having in place proper procedures and policies to ensure
accurate and transparent financial reporting within a company (which involves
complying with standards of accounting and auditing practice) was highlighted
by the accounting scandals in the early part of this decade, which led to the
collapse of Enron and World.Com in the USA and HIH in Australia.
Farrar distinguishes accounting standards from the Corporations Act, cate-
gorising accounting standards as ‘hybrids’ rather than ‘hard law’. For similar
reasons to those given for ASX Listing Rules above, we understand why Far-
rar has done this, but believe that accounting standards are in fact ‘hard law’.
Accounting standards, essentially a collection of generally accepted account-
ing practices, are set by the Australian Accounting Standards Board under the
supervision of the Financial Reporting Council, rather than being enacted by Par-
liament. However, they are given statutory force under the Act (see sections 296
and 304), and therefore failure to prepare a financial report in accordance with
the accounting standards may be enforced under the Act. But, again, nothing
major turns on the accounting standards being characterised as ‘hybrids’ rather
than ‘hard law’.

6.4.2.4 Auditing standards

Since the implementation of the CLERP 9 reforms in 2004, we can now simi-
larly refer to auditing standards (standards of proper auditing practice which,

39 (1986) 10 ACLR 801.

40 Ibid at 812. In this case, Street CJ commented on the enforceability of listing rules and also supported
a wide construction of the relevant statutory provisions. For application of this broad view, see FAI Traders
Insurance Co Ltd v ANZ McCaughan Securities Ltd (1990) 3 ACSR 279.
170 CORPORATE GOVERNANCE IN AUSTRALIA

if adhered to, assist auditors in satisfying their duty to use reasonable care and
skill) as ‘hard law’. Section 307A of the Act, introduced by CLERP 9, provides
that if an individual auditor, audit firm or an audit company conducts:
(a) an audit of the financial report for a financial year; or
(b) an audit or review of the financial report for a half year
the individual auditor or audit company must conduct the audit or review in
accordance with the auditing standards.

6.4.3 ‘Soft law’

Corporate governance objectives are also formulated in voluntary codes and standards
that do not have the status of law or regulation. While such codes play an important
role in improving corporate governance arrangements, they might leave shareholders
and other stakeholders with uncertainty concerning their status and implementation.
When codes and principles are used as a national standard or as an explicit substitute
for legal or regulatory provisions, market credibility requires that their status in terms
of coverage, implementation, compliance and sanctions is clearly specified.41

Soft law involves the purely voluntary (that is, no formal sanctions arise from non-
compliance) codes and guidelines articulating benchmarks for what is considered
best practice in corporate governance, as well as scholarly and trade writings (in
the form of books, reports and articles) that have had some role in influencing
companies to shape their internal arrangements and management to achieve best
practice. Recent examples of these codes/guidelines include the IFSA Blue Book
on corporate governance for fund managers (discussed above, and in Chapter 5)
and Standards Australia’s series of corporate governance standards (released in
2003), which contain similar benchmarks for a number of governance matters
to ASX Best Practice Recommendations (2003) and Revised Principles (2007),
but are used mostly by public sector bodies, non-listed entities and non-profit
organisations.
In terms of reports and other writings, a plethora of such material has been
produced and published in Australia (mainly since the early 1990s) – as in other
jurisdictions – contributing towards a rich and valuable collection of corporate
governance ‘soft law’.
While there were obviously some company law rules and voluntary standards
in Australia prior to the introduction of ASX Best Practice Recommendations
and the rules on corporate governance in CLERP 9, the conception of what best
practice in corporate governance meant was primarily shaped by the contents and
recommendations of a number of well-publicised reports by committees chaired
by prominent directors and business persons. The first of these was the Bosch
Report (officially titled Corporate Practices and Conduct), first released in 1991
(with subsequent editions published in 1993 and 1995), followed closely by Fred
Hilmer’s Strictly Boardroom, first published in 1993 by the Sydney Institute – see
Chapter 5 for further discussion of these reports. In the UK, the first such report
41 OECD Principles, above n 10, 30.
 REGULATION 171

was the Cadbury Report, published in 1992 by the Committee on Financial

Aspects of Corporate Governance. Bob Baxt, Keith Fletcher and Saul Fridman
explain that:

These various committees looked at many aspects of corporate governance such as the
use of committees by boards of directors, the practice of having one individual act as
both chairman of the board as well as chief executive officer, the use of independent
directors and the proper role and working of a good board.42

Since the Bosch Report (1991) – the first attempt in Australia to capture and
express in written form what was considered to be corporate governance best
practice at the time – the focus of corporate governance in Australia was on self-
regulation. However, since CLERP 9, the focus has shifted towards a more formal
regulatory approach. Nonetheless, the various reports and writings (including
books, journal articles etc.) which preceded this shift continue to have an impor-
tant place in the regulation of corporate governance. For example, in the 2003
New South Wales Supreme Court case of ASIC v Rich,43 ASIC presented as evi-
dence three books on corporate governance (including Sir Adrian Cadbury’s
A Company Chairman (2nd edn, 1995), and John Harper’s Chairing the Board
(2000)) to support its argument that a company chairperson has greater respon-
sibilities than an ordinary director, and therefore should be required to exercise
and maintain a higher standard of care. In accepting ASIC’s use of this evidence,
Austin J stated:

Much of the literature of corporate governance is in the form of exhortations and

voluntary codes of conduct, not suitable to constitute legal duties. It is sometimes
vague and less than compelling, and must always be used with caution. Nevertheless,
in my opinion this literature is relevant to the ascertainment of the responsibilities to
which Mr Greaves was subject.44

And later in the judgment:

[Over the last decade] there has been an enormous outpouring of literature concerning
corporate governance, and there has been much debate in the Australian commercial
community as to the effects the new thinking should have in practice. The court must
perform the difficult task of articulating a standard of care by reference to community
expectations, in an area not frequently traversed in litigation. It seems to me preferable
for the court to embark upon this task with a measure of assistance from the kind of evi-
dence the commission proposes to advance, than to choose the only other alternative,
namely to rely on unassisted armchair reflection.45

A fourth category of regulation that Farrar refers to is ‘business ethics’. In this

book, we deal with business ethics separately to regulation in Chapter 14.

42 See Corporations and Associations: Cases and Materials, Sydney, LexisNexis Butterworths (9th edn, 2003)
264.
43 (2003) 44 ASCR 341.
44 Ibid 358.
45 Ibid 359.
172 CORPORATE GOVERNANCE IN AUSTRALIA

6.4.4 The role of market forces

Another important source of influence, and perhaps control, over the internal
arrangements and management of the company, but one that does not sit com-
fortably under any of the categories of regulation above46 is ‘market forces’.
In their 1997 book, Making Boards Work, David S R Leighton and Donald H
Thain interestingly referred to common examples of market forces as ‘alternatives
to self-motivated board improvement’, which lends support to our approach in
this chapter of including market forces as a form of regulation. It is perhaps
difficult for some to envisage how market forces, being the natural forces of an
intangible entity, could actually be said to be a form of regulation; however, the
label ‘alternatives to self-motivated board improvement’ could be useful in easing
in market forces as part of the dialogue on corporate governance regulation.47
The significant role of market forces in contributing towards good corporate
governance and strong corporate performance has for some time been empha-
sised in economic literature on the corporation and corporate law.48 In fact,
many consider the influence of market forces to be an effective substitute for
formal legal regulation.49
Ford’s Principles of Corporations Law gives an excellent summary of how the
significance of market forces as a regulatory mechanism is presented in the
economic literature on corporate law and governance – or ‘law and economics’,
which underlie the ‘contractarian’ view of the corporation (that the corporation is
an abstract entity consisting of a ‘nexus of contracts’, rather than having separate
legal personality).50
In approaching regulation of corporate governance, the focus on contractual
theory would suggest that market forces – probably best fitting into the category

46 In reference to ‘hard law’, ‘hybrids’ and ‘soft law’, it could perhaps be argued that market forces are
‘hybrids’, in that they cannot be described as traditional black-letter law, but neither are they purely
voluntary – market forces exist and have an important influence on governance practices regardless of
the wishes of the company and its management.
47 In their book, Leighton and Thain discuss five such ‘alternatives’ (some of which are often discussed as
market forces, some of which are not): (1) takeovers [ineffective boards leave companies wide open for
takeovers]; (2) proxy contests [use voting powers to remove inefficient directors and appoint more effective
directors]; (3) ‘power investing’ [investment bankers, who pool their money with pension funds and other
institutional investors to take control of major corporations]; (4) shareholder activism [self-explanatory];
and (5) legal action [e.g. class action; oppressive remedy etc.]. See David S R Leighton and Donald H Thain
Making Boards Work, Whitby, Ontario, McGraw-Hill Ryerson (1997), 10–12.
48 See Frank H Easterbrook and Daniel R Fischel, The Economic Structure of Corporate Law, London, Harvard
University Press (1991); more recently, consider, for example, Larry E Ribstein, ‘Market vs Regulatory
Responses to Corporate Fraud: A Critique of the Sarbanes-Oxley Act of 2002’ (2002) 28 Journal of Corporation
Law 1.
49 The classic article on the role of market forces as an alternative regulatory mechanism to traditional legal
regulation is L A Bebchuk, ‘Federalism and the Corporation: The Desirable Limits on State Competition in
Corporate Law’ (1992) 105 Harvard Law Review 1437 (which examines the operation of the various markets
that may affect the decisions of managers); another significant contribution is by J C Coffee, ‘Regulating the
Market for Corporate Control: A Critical Assessment of the Tender Offer’s Role in Corporate Governance’
(1984) 84 Columbia Law Review 1145. Bebchuk’s article ultimately contends that there are limits to the
effectiveness of market forces and that, at least in the USA, there remains a strong place for traditional legal
rules in corporate law, if corporate law is truly to maximise shareholder value.
50 The alternative view of the corporation discussed in Ford is the ‘managerialist’ view. Managerialists place
greater weight on the hard law, hybrids and soft law as regulatory mechanisms by which to achieve positive
outcomes than on the role of market forces. This theory is further discussed in the text above.
 REGULATION 173

of ‘soft law’, due to constituting a form of corporate control, but control aris-
ing without any form of threat of direct legal sanction – are more significant
than legal rules. This is in contrast to an alternative theory discussed in Ford’s
Principles – the managerialist theory, which suggests that strong legal rules are
needed to temper the enormous power that corporate managers wield, and to
ensure that this power is exercised consistently with the interests of shareholders.

According to the contractual theory, competitive markets are more important than
mandatory legal rules in providing managers with appropriate incentives to maximise
shareholder wealth. These markets include the product market, the market for cor-
porate control and the managerial labour market [often described in the USA as the
‘factors market’]. The contractual theory does not imply the absence of legal rules.
Rather, the theory asserts that market forces require managers to act in the interests
of shareholders . . . Clearly the validity of the contractual theory depends upon the
efficiency of the markets.51

Ford’s Principles of Corporations Law valuably deals with each of the market forces
separately, and the impact of each in terms of influence and control:
(i) Products market

With respect to the products market, adherents to contractarian theory argue

that management must ensure that the company competes effectively in the
market for the company’s goods and services. Otherwise the company will lose
business and may be forced into liquidation.

(ii) Market for corporate control

If a company is operating inefficiently this should be reflected in the company’s

share price. This creates an opportunity for a raider to take over the company,
install more efficient managers and therefore profit. Yet there are limits on
the effectiveness of the market for corporate control. If the inefficiency in the
management of the company results in only a minor reduction in the company’s
share price, this means that the likelihood of a takeover is increased to only a
limited degree.

(iii) Labour force market

Another market force which may operate to discipline management is the

managerial labour market. Any reduction in shareholder value because of man-
agement inefficiency may have a detrimental effect on the employment oppor-
tunities of managers.52

51 Austin and Ramsay, above n 26, 25 para 1.380. As an example of the attitude of ‘contractarians’ towards
the role of market forces in corporate governance (and more specifically, the influence of market forces on
board composition), see for example Donald C Langevoort, ‘The Human Nature of Corporate Boards: Law,
Norms, and the Unintended Consequences of Independence and Accountability’ (2001) 89 Georgetown Law
Journal 797, 800: ‘Notwithstanding the longstanding legal interest in board independence, I share the sense
of many commentators that the law has played a relatively minor role in the evolution of board structure and
behaviour; market and other social forces are far more important. Indeed, I suggest leaving the matter of
board independence and accountability largely to these extralegal incentives.’
52 Austin and Ramsay, above n 26, 25–6 para 1.380.
174 CORPORATE GOVERNANCE IN AUSTRALIA

The OECD Principles of Corporate Governance (OECD Principles) also recognises

the role of market forces in influencing the decisions of directors and managers
in relation to the internal arrangements of the company. Its preamble states that:

Corporate governance is affected by the relationships among participants in the gov-

ernance system . . . The role of each of these participants and their interactions vary
widely among OECD countries and among non-OECD countries as well. These relation-
ships are subject, in part, to law and regulation and, in part, to voluntary adaptation and,
most importantly, to market forces.53

The OECD Principles explain that, in order to achieve the most efficient deploy-
ment of resources, policy makers in OECD countries need to undertake analyses
of the impact of key variables that affect the functioning of markets, such as
incentive structures, the efficiency of self-regulatory systems and dealing with
conflicts of interests. According to the OECD Principles:

The corporate governance framework should be developed with a view to its impact
on overall economic performance, market integrity and the incentives it creates for
market participants and the promotion of transparent and efficient markets.54

6.5 Towards an effective supervision of

financial markets regulatory framework
in Australia – analysis

6.5.1 OECD’s guidelines for achieving an effective

governance framework
We have already explained in Chapter 1 and above in this chapter why, in order
to maintain international money market confidence in the domestic economy
and local companies, it is important that Australian companies are perceived to
be operating according to best practice corporate governance standards – ‘good
corporate governance’ is important and it does add value! For our companies to
meet best practice in corporate governance, any corporate governance regulatory
framework that is in place needs to be effective. In this section, we discuss the
criteria for an effective corporate governance regulatory framework set out in the
OECD’s Principles, and assess whether Australia’s regulatory framework meets
the criteria for effectiveness.
As previously mentioned, the OECD Principles are intended to assist OECD
(and non-OECD) governments to evaluate and improve the legal, institutional
and regulatory frameworks for corporate governance in their countries, and to
provide guidance for stock exchanges, investors, corporations and other parties
having a role in developing good corporate governance.55

53 OECD Principles, above n 10, Preamble (emphasis added).

54 Ibid 30.
55 See OECD Principles, above n 10, 11.
 REGULATION 175

One of the key principles contained in the OECD Principles is: ‘Ensuring
the Basis for an Effective Corporate Governance Framework’. For a regulatory
framework to be effective, the OECD Principles states that:
The corporate governance framework should promote transparent and efficient mar-
kets, be consistent with the rule of law and clearly articulate the division of responsi-
bilities among different supervisory, regulatory and enforcement authorities.56

Thus, according to the OECD Principles, whether or not a corporate governance

regulatory framework is effective depends on whether the following three criteria
are satisfied:
– promotion of transparent and efficient markets
– consistency with rule-of-law principles (namely accountability, accessibil-
ity and clarity)57
– clear articulation of the division of responsibilities among the different
supervisory, regulatory and enforcement authorities.
In our view, Australia’s regulatory framework for corporate governance easily
satisfies the first two criteria. Most developed economies with strong democracies
do so as a matter of course. That is why Australia is considered to be an attractive
place for international investment and why it has enjoyed a long period of strong
economic growth, whereas some countries in Asia – with regulatory frameworks
that traditionally have not been consistent with Western democratic principles,
and generally do not allow markets to operate free of unnecessary controls –
have struggled over the past decade.
We believe, however, that the third OECD criterion highlights a weakness
in Australia’s existing regulatory framework with respect to corporate gover-
nance. We believe there are currently some issues to do with the dual roles of
ASIC and ASX in the supervision of Australia’s financial markets framework. The
forthcoming discussion in Chapter 7 on the roles of ASX and ASIC finds that
their respective roles are far from clear, and that there is some friction between
the primary corporate regulator (ASIC) and ASX. As contemporary corporate
governance further matures into a sophisticated area of corporate regulation, it
is crucial that the key regulators have a clear vision as to how they contribute
towards good corporate governance practices in Australian corporations.
Achieving an effective corporate governance regulatory framework by inter-
national standards is not merely an exercise of adding more red tape to an
already burdensome framework of corporate governance regulation; it is also
about ensuring (as already emphasised in this chapter) that Australia maintains
a positive reputation in the international money markets – thereby providing
strong benefits for the economy. In order to ensure that Australia does satisfy the
third criterion, and can be seen to have an effective corporate governance regula-
tory framework, it is essential to address shortcomings in the current regulatory
56 Ibid 29.
57 For a discussion of rule-of-law principles in the context of corporate law, see James McConvill and Mirko
Bagaric, ‘Related Party Transactions under Part 2E of the Corporations Act: Time for Reconsideration’ (2002)
15 Australian Journal of Corporate Law 19.
176 CORPORATE GOVERNANCE IN AUSTRALIA

structures (as the Federal Government has recently done,58 discussed below)
and avoid a general lack of confidence in the market due to perceived conflicts
of interest arising from having a private-sector entity (ASX) with supervisory
powers over brokers.59

6.5.2 Division of responsibilities between ASX and ASIC

There is presently (December 2010) a memorandum of understanding (MOU)
between ASIC and ASX, which seeks to minimise overlap and to increase co-
operation in relation to market supervision.60
Traditionally, the role of the ASX has been limited to market surveillance and
supervision, with ASIC also having some responsibility in this area as part of its
general role of enforcing the Corporations Act. The subsequent privatisation of
the ASX and its retention of supervisory powers over the financial market have
long given rise to accusations of conflicts of interest. In a recent interview, the
Minister for Financial Services (Chris Bowen) made the following concessions
when explaining the reasons for the proposed important structural change to
market supervision:61
. . . we don’t believe it’s appropriate any longer for a private-sector entity (ASX) to have
supervisory powers over brokers. So this is important in terms of the perception of
conflict of interest, to ensure there’s no perception that there’s a conflict of interest . . . I
think it’s more appropriate going forward that [supervision] be done by a single, unified
supervisor. I think there are issues where wherever there’s a perception of a conflict of
interest, I think that’s a real problem . . . there are concerns about things falling through
the cracks; about grey areas.

A common theme in the recent corporate governance reform movement has been
the desire to instill a culture of transparency and accountability in the governance
practices of Australian companies. We believe that the parameters should nat-
urally be extended so that the regulators themselves set in place guidelines for
a transparent and accountable approach to their own regulation of corporate
governance. There is no reason the regulators should operate outside the more
intense regulatory arena – indeed, they should set the lead. The OECD Principles
make this point very strongly, emphasising that a ‘clearly defined’ division of
responsibilities between corporate governance regulators constitutes one of the
three key criteria underpinning an effective corporate governance regulatory
58 The Government announced on 24 August 2009 its intention to install ASIC as the new regulator of market
supervision of brokers. See ASX submission to Treasury Consultation Paper: Reforms to the Supervision of
Australia’s Financial Markets Framework (22 December 2009), available at <www.asx.com.au/about/pdf/
20091222 asx submission on reforms to supervision.pdf>.
59 For example, see Adele Ferguson, ‘Query on ASX’s Supervisory Power’, The Australian (17 September
2007); Danny John, ‘ASX Cited for Conflict of Interest’, Sydney Morning Herald Business Day (5 April 2008).
60 ASIC also has entered into MOUs with a number of other regulators and organisations, including the
Australian Competition and Consumer Commission (ACCC). In December 2004, ASIC and the ACCC revised
their MOU – believing this was necessary due to the closer relationship that has developed of late in their
respective actions in addressing wealth-creation seminars and get-rich-quick schemes, as well as misconduct
in debt collection.
61 Australian Broadcasting Corporation, Interview with Minister for Financial Services on Lateline Business,
Transcript, (24 August 2009), available at <www.abc.net.au/lateline/business/items/200908/s2665567.
htm>.
 REGULATION 177

framework. The OECD Principles express the importance of this clearly defined
division of responsibilities as follows:

Effective enforcement also requires that the allocation of responsibilities for supervi-
sion, implementation and enforcement among different authorities is clearly defined
so that the competencies of complementary bodies and agencies are respected and used
most effectively. Overlapping and perhaps contradictory regulations between national
jurisdictions is also an issue that should be monitored so that no regulatory vacuum is
allowed to develop . . . and to minimise the cost of compliance with multiple systems
by corporations.62

At the time of writing (December 2010), the Federal Government is propos-

ing that ASIC will become responsible by late 2010 for both supervision and
enforcement of Australian market participants, with progress scheduled as
follows:63

Date
September/October 2009
November 2009
December 2009/January 2010
February/April 2010
May/June 2010
July/September 2010
Third quarter 2010
Steps
Drafting of exposure draft legislation
Public consultation on exposure draft
Additional drafting (to take account of public consultation) and
preparation of accompanying document
Amending legislation introduced in 2010 autumn sittings of
Parliament
Amending legislation passed in 2010 winter sittings of Parliament
ASIC prepares systems for supervision and begins customising
SMARTS system (ASIC’s new trade surveillance system)
ASIC begins supervision of Australia’s financial markets

Should the proposed reforms be enacted in its current form, the main
implications64 are that licensed financial market operators, such as ASX, will
no longer self-supervise trading on their own markets. As a result, brokers and
other trading participants in those markets will be subject to the direct supervi-
sion and enforcement powers of ASIC in relation to market misconduct. However,
market operators will retain responsibility for supervising the entities listed on
those markets. We also discuss the proposed changes of the regulatory functions
of ASX further in Chapter 7.
The Federal Government notes that the proposed reforms:65
● will enhance the integrity of Australia’s financial markets
● support other initiatives implemented by the Federal Government that
are aimed at reinforcing Australia as a credible and significant financial
services hub in this region
● bring Australian markets into line with other leading jurisdictions that
have, or are in the process of moving to, centralised or independent
regulation.

62 OECD Principles, above n 10, 31.

63 The timeline and schedules are extracted from Allens Arthur Robinson, ASIC Market Regulation
(24 August 2009), available at <www.aar.com.au/pubs/fsr/cufsraug09.htm>.
64 Ibid.
65 Ibid.
178 CORPORATE GOVERNANCE IN AUSTRALIA

6.6 Conclusion

We have seen in this chapter that there has been a recent formalisation in the
regulation of corporate governance. Increasingly, where companies once had
complete freedom (from a regulatory perspective) to adopt benchmarks of cor-
porate governance best practice, or to choose alternative arrangements, they
now have to abide by formal rules (consider the series of corporate governance
rules introduced under CLERP 9 in Australia) or provide a clear explanation
in their annual report justifying why they are departing from them (consider
the ‘if not, why not?’ regime underpinning the ASX Best Practice Recommen-
dations and now under the revised ASX Corporate Governance Principles and
Recommendations).
The formalisation of corporate governance regulation has been considered
a necessary response to high-profile corporate collapses and poor stock market
performance, which were perceived as being attributable to less-than-desirable
corporate governance practices. While corporate governance practices may have
been a cause of the problems we have recently witnessed, this does not necessarily
mean that formalising the regulation of corporate governance is the appropriate
solution. Indeed, many commentators stress that a focus on conformance rather
than performance will not resolve the recent problems, which were expressly
raised as the impetus for the recent tranche of reforms.
In Chapter 15, we engage in a detailed theoretical and normative analysis of
the recent shift towards a formal corporate governance regulatory framework,
and reflect on the desirable future direction of regulation. In the next chapter we
will focus on the role of ASX and ASIC as two of the main corporate regulators in
Australia.
7
The role of the regulators:
ASIC and ASX

[HIH Insurance Ltd’s collapse] is a tale of scoundrels – crooks even,

who jockey and grasp and concoct the most ingenious ways to pocket
HIH’s cash while they still can. Well-placed mates help well-placed
mates . . . Mortgages are forgiven, bonuses awarded, dodgy invoices are
fast-tracked and cheques are somehow cleared after the banks have closed.
But policy-holders get nothing because that is the new policy, and share-
holders might as well not exist.
The Australian, Wednesday, 15 January 2003
Directors of Australian public companies have a dual challenge in seeking to
navigate their companies through the heavy seas of the global financial ser-
vices. They must set strategies to deliver long-term profitable performance
in a manner that responds to the difficult circumstances. And they must
ensure conformance by their companies and themselves with all applicable
legal and regulatory requirements. Hard economic times are enhancing the
challenge to directors in both their performance and conformance roles.
Robert Austin and Aaron Rathmell, An Introduction to the Conference
Theme, Directors in Troubled Times (R P Austin and A Y Bilski, eds, Ross
Parsons Centre of Commercial, Corporate and Taxation Law Monograph 7,
Sydney, 2009) at 22

7.1 Introduction

This chapter highlights the role and relationship between the twin regulators,
the Australian Securities and Investments Commission (ASIC) and the Australian
Securities Exchange (ASX) in the Australian corporate governance regime. The
exercise of ASIC’s powers are reviewed and enforcement patterns are commented
upon. The chapter sketches the role of ASX in corporate governance and con-
cludes with remarks addressing the broad philosophical debate on the role of
the regulator in light of the carnage (the widespread corporate collapses or near
collapses)1 arising from the global financial crisis and the pressure on ASIC to be
more proactive and to perform to a higher standard.
1 Opes Prime Stockbroking Ltd, Tricom Equities Ltd, Chimaera Capital Ltd, Allco Finance Group Ltd, Babcock
& Brown Ltd, Storm Financial Ltd, ABC Learning Ltd, Timbercorp Ltd, Great Southern Ltd, to name a few.

179
180 CORPORATE GOVERNANCE IN AUSTRALIA

7.2 The Australian Securities and

Investments Commission2

7.2.1 Overview
ASIC was first called the National Companies and Securities Commission (NCSC)
and later the Australian Securities Commission (ASC).3 The Wallis Report
(released in April 1997) recommended several regulatory changes, including
the establishment of ASIC, which occurred on 1 July 1998:

[The Wallis Report] proposed a regulatory system based around three regulatory agen-
cies: the Reserve Bank as central bank, but without the role of bank supervision; APRA
[the Australian Prudential Regulation Authority], as a new prudential regulator; and
ASIC, a new single regulator for conduct and disclosure, responsible for administration
of the Corporations Law, ensuring market integrity and consumer protection.4

In recognition of this new role, ASIC is Australia’s corporate, markets and finan-
cial services regulator. ASIC regulates companies, financial markets, financial
services organisations and professionals who deal and advise in investments,
superannuation, insurance, deposit taking and credit. ASIC’s work covers con-
sumers, investors and creditors of corporations and other businesses, including,
an estimated:5
● 16.9 million people who have a deposit account
● 11.8 million who invest in superannuation or annuities
● 10.8 million who have a major card credit, debit or charge
● 6.7 million who have a loan
● 3.9 million who directly hold shares
● 2 million who have invested (managed investment/superannuation)
through a financial planner/adviser
● 1 million who invest in managed investments.
As the market regulator, ASIC assesses how effectively authorised financial mar-
kets are complying with their legal obligations to operate fair, orderly and trans-
parent markets6 . As the financial services regulator, ASIC licenses and monitors

2 This part is based on part of the following article: Jean J du Plessis, ‘Reverberations after the HIH and other
Recent Australian Corporate Collapses: The Role of ASIC’ (2003) 15 Australian Journal of Corporate Law 225,
230.
3 This chapter focuses on contemporary developments following the rebadging of ASC to ASIC. For an exellent
study on the many complexities (political, legal, social and institutional) that have influenced, motivated and
constrained the development of the present system of Australian companies and securities regulation, see
Bernard Mees and Ian Ramsay, Corporate Regulators in Australia (1961–2000): From Companies’ Registrars
to the Australian Securities and Investments Commission’ Research Report (Melbourne: Centre for Corporate
Law and Securities Regulation, University of Melbourne, 2008); Bernard Mees and Ian Ramsay, ‘Corporate
Regulators in Australia (1961–2000): From Companies’ Registrars to ASIC’ (2008) 22 Australian Journal of
Corporate Law 212.
4 A Cameron, ‘Not Another Regulator!!!’, 1998 Suncorp-Metway Bob Nicol Memorial Lecture, Brisbane,
10 November 1998, available at <http://fido.gov.au/asic/pdflib.nsf/LookupByFileName/not_another_
regulator.pdf/$file/not_another_regulator.pdf> 6–7, 10.
5 ASIC Annual Report 2008–09 at 59, available at <www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/
ASIC_Annual_Report_08-09_pt2.pdf/$file/ASIC_Annual_Report_08-09_pt2.pdf>.
6 ASIC, ‘Our Role’, available at <www.asic.gov.au/asic/ASIC.NSF/byHeadline/Our%20role>.
 ASIC AND ASX 181

financial service businesses to ensure that they operate efficiently, honestly and
fairly.7 As the corporate regulator, ASIC is responsible for ensuring that com-
pany directors and officers carry out their duties honestly, diligently and in the
best interests of the company8 . This chapter focuses on ASIC’s traditional role as
corporate watchdog.9

7.2.2 Statutory powers under the ASIC Act10

ASIC is a Commonwealth Government body, led by five full-time commissioners
who are accountable to the Minister for Financial Services, Superannuation and
Corporate Law and the Parliament under the Australian Securities and Investments
Act 2001 (the ASIC Act).
The objects of the ASIC Act are described in general terms in section 1 of the
Act. Section 1(2) of the ASIC Act provides, in part, that in performing its functions
and exercising its powers, ASIC must take whatever action it can take, and is
necessary, in order to enforce and give effect to the laws of the Commonwealth
that confer functions and powers upon it.11
In order to ensure compliance with the law, ASIC is vested with special powers
of investigation and information gathering. These powers are set out in Part 3
of the ASIC Act. Where ASIC decides to undertake an investigation, it can
require any person to render to it all necessary assistance in connection with the
investigation.
ASIC is authorised to initiate an investigation if it suspects, on reasonable
grounds, that:
● a contravention of the corporations legislation (other than the excluded
provisions)12 may have been committed (ASIC Act section 13(1)(a))
● a contravention of a law of the Commonwealth, state or territory con-
cerning the management of the affairs of a body corporate or man-
aged investment scheme may have been committed (ASIC Act section
13(1)(b)(i))
● a contravention of a law of the Commonwealth, state or territory which
contravention involves fraud or dishonesty in relation to a body corpo-
rate, managed investment scheme or financial products may have been
committed (ASIC Act section 13(1)(b)(ii))

7 Ibid.
8 Ibid.
9 For an interesting perspective of ASIC’s role as a regulator, see F Assaf, ‘What will Trigger ASIC’s Strate-
gies?’ (2002) Law Society Journal (May 2002) 60, 60–1.
10 For fuller discussion, see Jason Harris, Anil Hargovan and Michael Adams, Australian Corporate Law (2nd
edn, LexisNexis, 2009, Chapter 2 ‘ASIC: Role and Powers’).
11 See also George Gilligan, Helen Bird and Ian Ramsay, ‘Civil Penalties and the Enforcement of Directors’
Duties’ (1999) 22 University of New South Wales Law Journal 417, 433–6; George Gilligan, Helen Bird and
Ian Ramsay, ‘The Efficiency of Civil Penalty Sanctions Under the Australian Corporations Law’ (1999) 136
(November) Trends and Issues in Crime and Criminal Justice 1.
12 The excluded provisions are s 12A of ASIC Act, which deals with ASIC’s other functions and powers, and
Div 2 of Pt 2 of the ASIC Act, which deals with unconscionable conduct and consumer protection in relation
to financial products: ASIC Act s 5.
182 CORPORATE GOVERNANCE IN AUSTRALIA

● unacceptable circumstances within the meaning of the provisions of the

Corporations Act dealing with takeovers may have occurred (ASIC Act
section 13(2))
● a contravention of the consumer protection provisions (Division 2 of
Part 2) of ASIC Act may have been committed (ASICA section 13(6)).
Following an investigation or examination conducted, ASIC may, if it is in the
public interest to do so, commence proceedings under section 50 of the ASIC
Act seeking civil remedies from the court. In these proceedings, based on public
interest considerations, ASIC may take legal action in the name of a company
without the need for the company’s consent. In such circumstances, ASIC may
seek damages for fraud, negligence, default, breach of duty, or other misconduct
committed in connection with a matter to which the investigation or examina-
tion related. It may also seek to recover property on behalf of individuals. It is
disappointing to note that Section 50 has not been used to great effect, with only
21 actions being taken since 1991.13
Much of the recent litigation instituted by ASIC, after the most recent spate of
corporate collapses, was instituted in response to ASIC’s obligations associated
with these responsibilities – specifically, and most prominently, its powers under
the Corporations Act 2001 (Cth) (the Act).

7.2.3 The role of ASIC in corporate governance

Jillian Segal (former Deputy Chair of ASIC), in addressing the role of the reg-
ulator, captures the complex and multifaceted role that ASIC plays in Australia
with the following observation: ‘the regulator’s role is a continuum of responses.
It is bounded by enforcement at one end and education at the other, with policy
guidance, industry support and disclosure guidelines in between.’14
ASIC has clearly accepted that it should play an important role in corporate
governance in Australia. In a speech on 27 November 2002 at a Corporate Gov-
ernance Summit, Berna Collier (a former commissioner of ASIC) outlined the
role of ASIC in corporate governance as follows:
So what exactly is our role in corporate governance? What do we do on a daily basis
to improve corporate governance in Australia? Essentially, ASIC’s role in corporate
governance is threefold:
1. monitors, enforces and administers compliance with the broad range of corporate
governance provisions in the Corporations Act;
2. has a public education or advocacy role; and
3. contributes to law reform in relation to corporate governance.15

13 ASIC Media Release 07–291, ‘ASIC to Pursue Compensation for Westpoint investors’ (8 November 2007),
available at <www.asic.gov.au/asic/asic.nsf/byheadline/07–291+ASIC+to+pursue+compensation+for+
Westpoint+investors?openDocument>. For the major reported instances of s 50 actions taken by ASIC, see
Janet Austin, ‘Does the Westpoint Litigation Signal a Revival of the ASIC s 50 Class Action?’ (2008) 22
Australian Journal of Corporate Law 8.
14 Jillian Segal, ‘Corporate Governance: Substance Over Form’ (2002) 25 University of New South Wales Law
Journal 1 at 5.
15 Berna Collier, ‘The Role of ASIC in Corporate Governance’, Corporate Governance Summit (27 Novem-
ber 2002) 5, avalailable at <http://fido.gov.au/asic/pdflib.nsf/LookupByFileName/corporate_governance_
summit.pdf/$file/corporate_governance_summit.pdf>.
 ASIC AND ASX 183

The first of these roles, and in particular enforcing compliance, was prominent
in ASIC’s dealings with the corporate collapses in Australia in 2001 and 200216
and the recent failures of corporate governance.17
There is no doubt that in the aftermath of the massive corporate collapses
in 2001–2, ASIC fulfilled its role as the primary Australian corporate regulator
with assiduousness, and it has remained highly active since then, with several
actions instituted against directors, albeit with a mixed record of success in 2009
(discussed below).
David Knott, former Chair of ASIC, was reported as saying that the orders
against the three HIH directors acted as a warning to company directors and
‘highlighted the serious consequences that could flow from the failure of good
corporate governance’.18 Berna Collier observed that ‘it is important to note that
all [the recent] enforcement action [by ASIC] does more than target individuals
who breached the law. It has an education and market confidence impact’.19 Or,
as Assaf puts it, ‘the above matters [civil proceeding against HIH and One.Tel
directors] sent out a strong signal to directors of public companies – comply with
your statutory obligations or else[!]’.20 Stewart Wilson, executive officer of the
Australian Shareholders Association, made his views on the deterrence value of
possible jail sentences for white-collar crime known in no uncertain terms – ‘the
threat of being locked up is perhaps the most effective deterrent for white-collar
crime’.21
ASIC’s successful civil penalty proceedings in the case of ASIC v Macdonald
and Others (No 11)22 against seven former non-executive directors and three
former executives of James Hardie was hailed by ASIC as a landmark decision
in Australia as far as corporate governance is concerned. The impact-value and
aims of ASIC with this litigation was explained by ASIC’s current Chairperson,
Tony D’Aloisio:

I encourage Boards to carefully consider this decision and assess what improvements
they can make to their decision making processes, the way they convey decisions to the
market and in the way they conduct investor briefings and so called road shows . . . The
decision is another important step in improving corporate governance in Australia and
that improvement will add confidence to the integrity of our markets. This confidence
will be particularly important as we emerge from the financial crisis and companies
come to the market to raise funds for new investments, much needed for the recovery
of the real economy.23

16 For discussion of enforcement actions against officers of GIO Insurance Ltd, HIH Insurance Ltd, One.Tel
Ltd and Water Wheel Holdings Ltd, see Jason Harris, Anil Hargovan and Michael Adams, Australian Corporate
Law (2nd edn, LexisNexis, 2009, Chapters 16–19 on Directors and Officers Duties).
17 For example, see ASIC v Macdonald (No 11) (2009) 256 ALR 199 – discussed in Anil Hargovan, ‘Corporate
Governance Lessons from James Hardie’ (2009) 33 Melbourne University Law Review (forthcoming).
18 The Australian, Friday 31 May 2002.
19 Collier, above n 15 6.
20 Assaf, above n 9, 63.
21 Stuart Wilson, ‘Jail Best Deterrent for Corporate Crims’ The Australian, 22 February 2005, 25.
22 (2009) 256 ALR 199.
23 ASIC Media Release 09–69, ‘James Hardie Proceedings’, 23 April 2009, available at <www.asic.gov.
au/asic/asic.nsf/byheadline/09-69+James+Hardie+proceedings>.
184 CORPORATE GOVERNANCE IN AUSTRALIA

How afraid some greedy corporate cowboys will be after the spate of litigation
against delinquent directors since 2002 is an open question, especially in light of
ASIC’s recent failures in complex litigation (discussed below).24 There was some
speculation that because of the active role ASIC plays in bringing civil penalty
actions against directors, that Australian directors are becoming risk-averse due
to a fear of personal liability. This, in turn, led to Treasury commencing a review
of criminal and civil sanctions, with a view to possibly widening the protection of
directors against civil sanctions and considering whether there are not too many
criminal sanctions that expose directors to criminal liability.25
There have, however, been strong views expressed in the media and by
investor groups that there is no real need to protect directors further because
there is no evidence that directors are over-exposed to liability. Also, there was
no evidence that indicated that directors who were held liable following ASIC’s
enforcement actions since 2000 should in fact not have been held liable. Finally,
it was argued that there are no facts backing the claim that Australian direc-
tors are indeed risk-adverse because of the wide range of legal sanctions in
Australia.
At the end of 2008, Treasury released some interesting results of a survey
undertaken among directors.26 The results of this survey indicated that there
is little substance in the claim that directors are influenced by the high risks of
personal legal liability when taking business decisions. Only 27.7 per cent of 101
respondents said they felt a high degree of risk of being found personally liable
(under any law) for decisions they or their boards have made in good faith. A
further 65.3 per cent of respondents said that they had only ‘occasionally’ taken
an overly cautious approach to business decision making because of the risk of
personal liability (under any law). The areas of law indicated as the areas most
likely to cause an overly cautious approach to business decisions seem to be
‘derivative liability’ laws. This was described as laws under which the director
may be found liable for the misconduct of his or her company due to being a
director. The examples given of such laws were ‘occupational health and safety
laws, environmental laws and/or building laws’. Of the 94 respondents, 35.1 per
cent indicated that these laws caused overly cautious business decisions.
However, it is comforting to know that there are also other strategies in place
to control the financial markets, apart from focusing on director liability and ASIC
attempting to scare directors by instituting actions against high-profile directors
who allegedly did not fulfil their statutory duties under the Corporations Act. The
Financial Services Reform Act 2001 and other reforms in the insurance industry
should be seen as part of a broader strategy to ensure good corporate governance
and to act proactively in the battle to prevent spectacular corporate collapses.

24 Stuart Washington, ‘Academics Question ASIC’s Ability’, The Age Business Day (26 December 2009).
25 See Commonwealth of Australia, The Treasury, Corporate and Financial Services Division, Review
of Sanctions In Corporate Law (2007), available at <www.treasury.gov.au/documents/1182/PDF/
Review_of_Sanctions.pdf> and <www.treasury.gov.au/contentitem.asp?NavId=037&ContentID =1182>.
26 See <www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=1387>.
 ASIC AND ASX 185

The words ‘spectacular corporate collapses’ are used specifically, as it is impos-

sible for any regulator, legislature or the market to prevent corporate collapses
completely. ASIC’s view is that there will always be company failure because of
the simple reality of competitiveness and economic forces.27 The role of the law
and the regulators is rather to manage the problem and to ensure, as diligently
as possible, that signs of financial difficulties are detected as soon as possible
and, where there is still hope, to take struggling companies by the hand through
voluntary or external administration or similar supportive arrangements.28

7.2.4 ASIC enforcement patterns

The Centre for Corporate Law and Securities Regulation at the University of
Melbourne has undertaken some interesting research on ASIC’s enforcement
patterns.29 This research has revealed that ASIC was more likely to pursue court-
based enforcement against individuals (rather than companies), and against men
(rather than women) aged 41–50 years in their capacity as directors of compa-
nies working in the finance and insurance industries. It was also discovered that
more actions are instituted against directors of private companies than against
directors of public companies.30 This is perhaps understandable, as there are far
more private companies than public companies and directors of public compa-
nies will often also be directors of subsidiary private companies of the public
company – see the case study on the HIH Insurance Ltd collapse (ASIC v Adler) in
Chapter 10.
During the period from January 1997 to December 1999, where 1438 court-
based ASIC enforcement actions were examined, the research showed that ASIC
predominantly used penal enforcement actions rather than civil enforcement
action. ASIC was more likely to pursue penal enforcement in relation to laws
that were mandatory (rather than enabling) in nature, and to laws orientated
towards social (rather than economic) regulation. ASIC would predominantly
use settlements – rather than the court processes – as outcomes for civil enforce-
ment. ASIC preferred to focus on laws with an ethical foundation, addressing
conduct that is widely condemned because it exploits and defrauds shareholders
and creditors.31

27 Segal, above n 14; Jillian Segal, ‘Institutional Self-regulation: What Should be the Role of the Regulator?’
Address to the National Institute for Governance Twilight Seminar, Canberra, 8 November 2001, avail-
able at <http://fido.gov.au/asic/pdflib.nsf/LookupByFileName/NIGConf_081101.pdf/$file/NIGConf_
081101.pdf>; Knott, ‘Corporate Governance: The 1980s Revisited?’ Monash Law School Foundation
Lecture, 23 August 2001, 3. Several causes can potentially play a role in any business failure, see J Adams
and N Jones, ‘Distressed Businesses – Preventing Failure’, in Collapse Incorporated: Tales, Safeguards &
Responsibilities of Corporate Australia, Sydney, CCH Australia (2001) 205–10.
28 See Adams and Jones, above n 27, 210–16.
29 Helen Bird, Davin Chow, Jarrod Lenne and Ian Ramsay, ASIC Enforcement Patterns Research Paper
No 71, Melbourne, Centre for Corporate Law and Securities Regulation, University of Melbourne (2003). See
also Helen Bird, Davin Chow, Jarrod Lenne and Ian Ramsay, ‘Strategic Regulation and ASIC Enforcement
Patterrns: Results of an Empirical Study’ (2005) 5 Journal of Corporate Law Studies 191.
30 Ibid xiv.
31 Ibid xiv–xv.
186 CORPORATE GOVERNANCE IN AUSTRALIA

During 2008–9, in collaboration with the Commonwealth Director of Public

Prosecutions, ASIC completed 39 criminal proceedings, with 34 convictions,
including 19 jail terms.32 ASIC, in that period, also completed 35 civil proceedings
and obtained over $14.5 million in recoveries, costs and fines.33
A recent study argues that ASIC’s perceived failure to use criminal sanctions in
cases of serious corporate misconduct (for example against Vizard,34 the direc-
tors and officers of James Hardie Ltd35 and AWB Ltd) threatens to undermine its
reputation as an effective regulator36 – notwithstanding data showing that dur-
ing the period 2001–6 the number of criminal prosecutions commenced by ASIC
outnumbered the civil penalty proceedings issued.37 Vicky Comino, although
supportive of ASIC’s strategic regulation theory, is critical of the implementa-
tion of this approach to enforcement for a variety of reasons, including the
following:38

ASIC . . . should focus its efforts to rigorously enforcing the law rather than continue
to allow itself to be exposed to the criticism that it fails to do so, as happened under
the [previous] chairmanship . . . The view that ASIC fails to adequately enforce the law
is also borne out by the results of the stakeholder survey . . . to help it identify what
it did well and where improvements were needed. One of the ways in which ASIC
can overcome criticisms is to ensure that it uses the criminal law in the enforcement
pyramid underlying Pt 9.4B more, to punish corporate misconduct in serious cases,
especially against high profile wrongdoers, and thus prove that it is a serious regulator
crucially portraying an ‘image of invincibility’.

ASIC’s reputation for law enforcement took a severe blow in 2009, when it lost
three high-profile civil cases against the directors of One.Tel Ltd (Jodee Rich
and Mark Silbermann),39 former AWB Ltd managing director Andrew Linberg40
and Fortescue Metals Group Ltd’s chairman and chief executive officer, Andrew
Forrest.41 Critical comments on ASIC’s litigation strategy by each of the judges,

32 ASIC Annual Report (2008–2009) at 16.

33 Ibid.
34 ASIC successfully launched a civil penalty proceeding against Vizard (director of Telstra Ltd) for breach
of director’s duties, resulting in the defendant being banned for 10 years from managing a corporation and
ordered to pay pecuniary penalties of $390 000. Nothwithstanding the judge in ASIC v Vizard (2005) 219
ALR 714 making critical comments on the director’s dishonesty and ‘gross breach of trust’ and the defendant’s
admission of insider trading to ASIC, a criminal offence was never pursued by ASIC in this case.
35 See ASIC Media Release, ‘James Hardie Group Civil Action’ (5 September 2008).
36 See further, Vicky Comino, ‘The Challenge of Corporate Law Enforcement in Australia’ (2009) 23 Aus-
tralian Journal of Corporate Law 233.
37 Michael Welsh, ‘Civil Penalties and Strategic Regulation Theory: The Gap Between Theory and Practice’
(2009) 33 University of Melbourne Law Review (forthcoming).
38 Vicky Comino, above n 36, at 260.
39 ASIC v Rich [2009] NSWSC 1229: Justice Austin of the NSW Supreme Court held that ASIC failed to prove
any facet of its pleaded case against either defendant.
40 Re AWB Ltd (No 10) [2009] VSC 566. The court found that Mr Lindberg, who was accused of bribery and
breach of director’s duties arising from the delivery of wheat by AWB to the Government of Iraq contrary
to United Nations sanctions, will be unjustifiably vexed and oppressed and manifestly denied a fair trial by
the existence of a pending second proceeding – the latter which would also bring the administration of justice
into disrepute in the minds of right-thinking people. ASIC’s civil action, which followed an initial case in the
courts on a similar issue, which is still continuing (at the time of writing), was therefore held to be an abuse
of process.
41 ASIC v Fortescue Metals Group Ltd [No 5] [2009] FCA 1586. ASIC unsuccessfully alleged, inter alia, that
Andrew Forrest breached his duty as a director to exercise care and diligence as required by s 180(1) of the
Act by failing to ensure that the company both complied with its disclosure obligations and did not engage in
misleading or deceptive conduct and, as a result, he exposed the company to a risk of serious harm.
 ASIC AND ASX 187

made independently in the three different jurisdictions, painted a disturbing

picture of the regulator’s litigation strategy. A hostile media humiliated ASIC,
questioned its ability to carry out complex litigation and commented upon its
flawed sense of judgment.42 Ian Ramsay, director of the Centre for Corporate
Law at The University of Melbourne, commented on the need for a review on
the manner in which ASIC conducts complex litigation.43 It is hoped that ASIC’s
success in the James Hardie litigation (if not overturned on appeal) will provide
the template for future success.

7.3 The Australian Securities Exchange Ltd

7.3.1 Slow to get out of the blocks

ASX was slow in following the examples of other securities exchanges in the
world to develop and promote good corporate governance through a code of good
corporate governance practices and to promote compliance with such a code by
including a provision in its Listing Rules that companies that did not comply
with such provisions should explain non-compliance in their annual reports.
By the early 1990s, both the London Stock Exchange and the Johannesburg
Stock Exchange had already included a Listing Rule to ensure compliance or an
explanation of non-compliance with a code of best practice. Until early 2003,
ASX chose to be ‘less prescriptive’,44 and resisted any change in its approach,
despite being criticised by ASIC for not following the example of several other
securities exchanges.45
Prior to 2003, ASX Listing Rule 4.10 (originally introduced on 1 July 1996 as
Listing Rule 3C(3)(j))46 provided as follows:

4.10 An entity must include the following information in its annual report. The infor-
mation must be current at a date specified by the entity which is no more than 6 weeks
before the report is sent to security holders . . .
4.10.3 A statement of the main corporate governance practices that the entity had in
place during the reporting period. If a practice had been in place for only part of the
period, the entity must state the period during which it had been in place.

In 1997, there was vigorous debate between the Australian Investment Managers’
Association (AIMA) (or IFSA, as it is now known) and ASX as to whether listed

42 For example, see Matthew Stevens, ‘Laughter and Jeers over ASIC Failure’, The Australian (31 December
2009). Jennifer Hewett, ‘Three Strikes Prove Regulator is out of Touch’, The Australian (24 December 2009).
43 Stuart Washington, ‘Academics Question ASIC’s Ability’, The Age Business Day (26 December 2009). For
the complexities involved in litigation concerning civil penalty proceedings, see judgment of Justice Austin
in ASIC v Rich. See further, Tom Middleton, ‘The Privilege Against Self Incrimination, the Penalty Privilege
and Legal Professional Privilege under the Laws Governing ASIC, APRA, the ACCC and the ATO: Suggested
Reforms’ (2008) 30 Australian Bar Review 282.
44 See Paul Redmond, Companies and Securities Law, Sydney, LBC information Services (3rd edn, 2000)
268, and Phillip Lipton, quoted at n 42 in Chapter 5.
45 Phillip Lipton and Abe Herzberg, Understanding Company Law, Sydney, Law Book (11th edn, 2003)
296.
46 Business Council of Australia, Corporate Practices and Conduct, Melbourne, Pitman (3rd edn, 1995) (the
Bosch Report (1995)), 3.
188 CORPORATE GOVERNANCE IN AUSTRALIA

companies were actually complying with the Rule. ASX alleged that every one
of the largest 150 companies listed on the Exchange complied with Listing Rule
4.10.3, while AIMA showed that very few of the listed companies had a clear
understanding of what really should be disclosed.47
Whether ASX or AIMA was right in its claims is to a large extent irrelevant
today, but it required several huge corporate collapses between 2000 and 2003
to cause ASX to realise that its ‘less prescriptive’ approach was probably not
the right one. Under the ‘less prescriptive’ arrangement – in place until March
2003 – listed companies had to rely on the ‘indicative list in Appendix 4A (orig-
inally Appendix 33) to the Listing Rules to guide them in the types of matters
considered to be corporate governance practices upon which they had to report.
Guidance Note 9 of ASX, issued in September 2001, provided guidance on the
disclosure of corporate governance practices under Listing Rule 4.10.3. Guid-
ance Note 9 cited Listing Rule 4.10 and then explained several aspects, such
as the role of ASX; disclosure in annual reports; corporate governance matters
generally; and the way in which the indicative list should be used to comply with
the disclosure required under Listing Rule 4.10.3.48
On 4 August 2009, ASX released its first review of corporate governance dis-
closures since the Principles were updated in 2007. It should be noted that the
statistics were based on only a small sample of 168 companies whose reporting
period ended on 31 December 2008. Only 75 per cent of disclosures were ‘good’
or ‘very good’. In relation to Principle 7 (recognise and manage risk, an issue
that became crucial during the global financial crisis), ASX identified a number
of areas with ‘room for improvement’ including disclosure of risk-management
policies, information about board evaluations and how responsibilities are dele-
gated between the board and management.49
Until March 2003, listed companies were assisted in two other ways (apart
from the indicative list) in complying with Listing Rule 4.10.3. First, the 1996
reprint of the Bosch Report (1995) specifically mentioned the introduction of the
disclosure requirement on corporate governance practices in Listing Rule 4.10.3
and also discussed the corporate governance matters to be reported upon in
Part II.50 Second, listed companies could use the AIMA Guidelines and later the
IFSA Blue Book as a guide for good corporate governance practices to comply
with Listing Rule 4.10.3 – see discussion in Chapter 6.

47 Ian Ramsay and Richard Hoad, Disclosure of Corporate Governance Practices by Australian Companies,
Research Paper, Melbourne, Centre for Corporate Law and Securities Regulation, The University of Melbourne
(1997), available at <http://cclsr.law.unimelb.edu.au/go/centre-activities/research/research-reports-and-
research-papers/> 1–2; also published as Ian M Ramsay and Richard Hoad, ‘Disclosure of Corporate Gover-
nance Practices by Australian Companies’ (1997) 15 Company and Securities Law Journal 454.
48 ASX Guidance Note 9, ‘Disclosure of Corporate Governance Practices: Listing Rule 4.10’, Issued
September 2001, available at <http://www.asx.com.au/ListingRules/guidance/gn09 disclosure corporate
governance practices.pdf>.
49 ASX, ‘Analysis of Corporate Governance Disclosures in Annual Reports for Year ended 31 December 2008’,
available at <www.asx.com.au/about/pdf/mr 040809 corp gov report review.pdf>.
50 Bosch Report (1995), above n 46, 3.
 ASIC AND ASX 189

7.3.2 Rapid change in attitude since the end of 2002

The entire face of corporate governance in Australia changed rapidly with the
collapses of HIH, Harris Scarfe, One.Tel, Pasminco, Centaur and Ansett during
2000–3 and the establishment by ASX of the Corporate Governance Council
(CGC) on 15 August 2002.51 The CGC is composed of representatives of the most
important players in the financial markets.52 Its first task was to produce a set
of consolidated and up-to-date standards of best practice. The CGC developed
these guidelines with great speed, approving the Principles of Good Corporate
Governance and Best Practice Recommendations in March 2003. Even before the
approval of this document by the CGC, Listing Rule 4.10.3 was amended on
1 January 2003 to read as follows:

4.10 An entity must include the following information in its annual report. The infor-
mation must be current at a date specified by the entity which is no more than 6 weeks
before the report is sent to security holders . . .
4.10.3 A statement disclosing the extent to which the entity has followed the best
practice recommendations set by the ASX Corporate Governance Council during the
reporting period. If the entity has not followed all of the recommendations the entity
must identify those recommendations not followed and give reasons for not following
them. If a recommendation had been followed for only part of the period, the entity
must state the period during which it had been followed.
Introduced 1/7/96. Origin: Listing Rule 3C(3)(j). Amended 1/1/2003.
Note: The corporate governance statement may be given to ASX as a separate report but
must be given to ASX at the same time as the annual report and be clearly identified as the
corporate governance report.

In March 2003, a new Guidance Note 9A on ‘Corporate Governance – ASX Cor-

porate Governance Council – Principles of Good Corporate Governance and Best
Practice Recommendations’ was issued.53 Guidance Note 9A was reissued in
December 2007 and that is the current document guiding companies to comply
with Listing Rule 4.10.3.54 It cites the current Listing Rule 4.10.3; explains that
any deviation from the CGC’s Principles of Good Corporate Governance and Best
Practice Recommendations should be explained on the basis of the principle of

51 The CGC had its 5th meeting on 20 February 2003 – Alan Kohler, ‘Directors Face D-day as Old Rules go
by the Board’, The Australian Financial Review, 20 February 2003.
52 The Council consists of representatives of 21 business and investor groups: Association of Superannuation
Funds of Australia Ltd; Australasian Investor Relations Association; Australian Council of Superannuation
Investors; Australian Financial Markets Association; Australian Institute of Company Directors; Australian
Institute of Superannuation Trustees; Australian Securities Exchange; Australian Shareholders’ Association;
Business Council of Australia; Chartered Secretaries Australia; CPA Australia Ltd; Financial Services Institute
of Australasia; Group of 100; Institute of Actuaries of Australia; The Institute of Chartered Accountants in
Australia; Institute of Internal Auditors Australia; Investment and Financial Services Association;Law Council
of Australia; National Institute of Accountants; Property Council of Australia; and Securities & Derivatives
Industry Association.
53 See <www.asx.com.au/ListingRules/guidance/gn09a corporate governance principles.pdf>.
54 See <www.asx.com.au/supervision/rules guidance/changes/pre 20080331/lr/asxlr gn09a corporate
governance principles.pdf>.
190 CORPORATE GOVERNANCE IN AUSTRALIA

‘if not, why not?’; and contains a condensed version of the Principles of Good
Corporate Governance and Best Practice Recommendations.

7.3.3 ASX Corporate Governance Council’s Principles of Good

Corporate Governance and Best Practice Recommendations
7.3.3.1 Changes in 2007
As mentioned in Chapter 1, the 2003 ASX Principles of Good Corporate Governance
and Best Practice Recommendations were amended in 2007. The 2007 ASX Prin-
ciples of Good Corporate Governance and Best Practice Recommendations now only
contains eight principles as a result of the merger of two principles (Principle 8,
‘Encourage enhanced performance’ and Principle 10, ‘Recognise the legitimate
interests of stakeholders’), now incorporated into other principles.55

7.3.3.2 Structure
Apart from the Foreword, the 2007 ASX Principles of Good Corporate Governance
and Best Practice Recommendations consists of the following parts: a description of
corporate governance in Australia; disclosure of corporate governance practices
(following the ‘if not, why not’ approach); a summary of the eight core corporate
governance principles and recommendations; an explanation of the eight core
corporate governance principles and recommendations; and glossary.
The explanatory part of the document is contained under the heading ‘Cor-
porate Governance Principles and Recommendations’. This part consists of the
eight core corporate governance principles, followed typically by the following:
● a short explanation of the principle
● recommendations on the essential principles
● commentary, guidelines and application on the core principle
● boxed paragraphs giving practical guidance on what the content of certain
documents should contain
● suggestions on how the recommendation should be implemented or how
certain aspects should be assessed (for example, assessing the indepen-
dence of directors).
In a speech to launch the revised ASX corporate governance principles, the
Parliamentary Secretary to the Treasurer made the following observations on
the nature and role of these governance principles:56

Initiatives [such as these below] are an integral part of Australia’s corporate governance
framework. This framework consists of a mixture of regulation, co-regulation and
encouragement of industry best practice. It is an approach that has served us well. In
fact, Australia’s corporate law has been recognised as world class . . . The government’s
approach to improving corporate governance in Australian companies is to steer well

55 Principle 8 has been incorporated into current Principles 1 and 2, while Principle 2 has been incorporated
into current Principles 3 and 7. Principle 9 became Principle 8.
56 The Honourable Chris Pearce MP, ‘Speech to Launch the Revised ASX Corporate Governance Principles’
(2 August 2007), available at <www.asx.com.au/supervision/pdf/chris pearce speech 2 aug 07.pdf>.
 ASIC AND ASX 191

away from imposing arbitrary ‘black letter rules’ that prescribe detailed governance
practices that companies must adopt . . . The ASX corporate governance principles are
consistent with this framework. In fact, they are a good example of a flexible market-
based solution.

7.3.3.3 Recommendations
There are 27 specific recommendations in the 2007 ASX Principles of Good Cor-
porate Governance and Best Practice Recommendations:

Principle 1 – Lay solid foundations for management and oversight

Recommendation 1.1: Companies should establish the functions reserved to the board
and those delegated to senior executives and disclose those functions.
Recommendation 1.2: Companies should disclose the process for evaluating the per-
formance of senior executives.
Recommendation 1.3: Companies should provide the information indicated in the
Guide to reporting on Principle 1.
Principle 2 – Structure the board to add value
Recommendation 2.1: A majority of the board should be independent directors.
Recommendation 2.2: The chair should be an independent director.
Recommendation 2.3: The roles of chair and chief executive officer should not be
exercised by the same individual.
Recommendation 2.4: The board should establish a nomination committee.
Recommendation 2.5: Companies should disclose the process for evaluating the per-
formance of the board, its committees and individual directors.
Recommendation 2.6: Companies should provide the information indicated in the
Guide to reporting on Principle 2.
Principle 3 – Promote ethical and responsible decision-making
Recommendation 3.1: Companies should establish a code of conduct and disclose the
code or a summary of the code as to:
● the practices necessary to maintain confidence in the company’s integrity
● the practices necessary to take into account their legal obligations and the rea-
sonable expectations of their stakeholders
● the responsibility and accountability of individuals for reporting and investigat-
ing reports of unethical practices.
Recommendation 3.2: Companies should establish a policy concerning trading in
company securities by directors, senior executives and employees, and disclose the
policy or a summary of that policy.
Recommendation 3.3: Companies should provide the information indicated in the
Guide to reporting on Principle 3.
Principle 4 – Safeguard integrity in financial reporting
Recommendation 4.1: The board should establish an audit committee.
Recommendation 4.2: The audit committee should be structured so that it:
● consists only of non-executive directors
● consists of a majority of independent directors
● is chaired by an independent chair, who is not chair of the board
● has at least three members.
192 CORPORATE GOVERNANCE IN AUSTRALIA

Recommendation 4.3: The audit committee should have a formal charter.

Recommendation 4.4: Companies should provide the information indicated in the
Guide to reporting on Principle 4.
Principle 5 – Make timely and balanced disclosures
Recommendation 5.1: Companies should establish written policies designed to ensure
compliance with ASX Listing Rule disclosure requirements and to ensure account-
ability at a senior executive level for that compliance and disclose those policies or
a summary of those policies.
Recommendation 5.2: Companies should provide the information indicated in the
Guide to reporting on Principle 5.
Principle 6 – Respect the rights of shareholders
Recommendation 6.1: Companies should design a communications policy for promot-
ing effective communication with shareholders and encouraging their participation
at general meetings and disclose their policy or a summary of that policy.
Recommendation 6.2: Companies should provide the information indicated in the
Guide to reporting on Principle 6.
Principle 7 – Recognise and manage risk
Recommendation 7.1: Companies should establish policies for the oversight
and management of material business risks and disclose a summary of those
policies.
Recommendation 7.2: The board should require management to design and imple-
ment the risk management and internal control system to manage the company’s
material business risks and report to it on whether those risks are being man-
aged effectively. The board should disclose that management has reported to
it as to the effectiveness of the company’s management of its material business
risks.
Recommendation 7.3: The board should disclose whether it has received assurance
from the chief executive officer (or equivalent) and the chief financial officer (or
equivalent) that the declaration provided in accordance with section 295A of the
Corporations Act is founded on a sound system of risk management and internal
control and that the system is operating effectively in all material respects in relation
to financial reporting risks.
Recommendation 7.4: Companies should provide the information indicated in the
Guide to reporting on Principle 7.
Principle 8 – Remunerate fairly and responsibly
Recommendation 8.1: The board should establish a remuneration committee.
Recommendation 8.2: Companies should clearly distinguish the structure of non-
executive directors’ remuneration from that of executive directors and senior
executives.
Recommendation 8.3: Companies should provide the information indicated in the
Guide to reporting on Principle 8.

Compared to the UK formulation of ‘comply or explain’ adopted in the UK Cor-

porate Governance Code, ASX–CGC approach to enforcement is based on an ‘if
not, why not?’ precept. It would appear to be an identical approach; however,
 ASIC AND ASX 193

Alan Cameron argues that there is a subtle difference between the two, based on
the following considerations:57
‘Comply or explain’ connotes an assumption, a presumption, that you should be doing
it and you have to explain if you are not doing it.
‘If not, why not?’ . . . is, and ought to be, morally neutral. It simply says, in effect, ‘If you
are not doing this, tell us why you are not doing it’, but there is no presumption. Despite
the use of the word ‘recommendation’ in the Corporate Governance Guidelines, it is
clear that there is not a presumption in favour of compliance in the Australian rules.

In the first review of corporate governance reporting under the revised principles,
conducted by the ASX Markets Supervision, overall reporting levels was 93.4 per
cent for all entities and 98.3 per cent for top-500 entities, including trusts.58

7.3.3.4 The roles and relationship between ASX and ASIC

Currently (December 2010), an MOU59 governs the relationship between ASIC
and ASX, but as will be seen below, changes are envisaged. The MOU aims to
minimise duplication of activity and promote cooperation, effective communi-
cation and mutual assistance between ASIC and ASX. Under the MOU, ASX is
expected to:60
● Monitor and enforce compliance by Participants and listed entities with its
Operating Rules.
● Undertake regular education of Participants and listed entities to promote
compliance with the Rules.
● Maintain a close working relationship with ASIC to avoid unnecessary
duplication of investigation and enforcement work.
● Consult with ASIC before making public any information in relation to a
current or possible future ASIC investigation or enforcement action.
● Maintain ongoing and effective communication in accordance with agreed
procedures.
Under the existing legislative framework (proposed structural changes are dis-
cussed below), as discussed in Chapter 6, ASX is the ‘front line’61 regulator of
participants’ conduct in relation to its market, and both ASX and ASIC have sep-
arate and complementary roles in the supervision of the markets.62 In addition,
ASIC also supervises ASX.
ASIC is obliged, under the Corporations Act, annually to assess the extent to
which ASX group licensees have complied with their obligations to, to the extent
that it is reasonably practicable to do so; do all things necessary to ensure that
57 Alan Cameron, ‘How Do Directors Sleep at Night?’ in Directors in Troubled Times (R P Austin and A Y
Bilski, eds, Ross Parsons Centre of Commercial, Corporate and Taxation Law Monograph 7, Sydney, 2009)
115 at 118.
58 ASX, ‘Analysis of Corporate Governance Disclosures in Annual Reports for Year ended 31 December 2008’
(3 August 2009), above n 49 at 3.
59 See <www.asx.com.au/about/pdf/ASICMOU.pdf>.
60 See <www.asx.com.au/supervision/approach/working with asic.htm>.
61 ASIC Report 168, Market Assessment Report (28 August 2009) at 17.
62 For further information, see ASX, ‘ASX’s Role in Australia’s Financial Regulatory Framework’, (June
2008).
194 CORPORATE GOVERNANCE IN AUSTRALIA

the markets operated by ASX group are fair, orderly and transparent.63 In the 7th
Market Assessment Report released by ASIC, for the period 1 January 2008 to 31
December 2008, the regulator identified the following nine areas in which ASIC
and ASX concluded that changes and improvements were needed by ASX:64
1. increase in resourcing levels within ASX Capital Monitoring Function
2. enhanced focus on the overall internal supervision culture of participants
3. increase in resourcing initiatives relating to the Enforcement and Tribunal
functions
4. improvements in ASX’s real-time surveillance practices and complaint han-
dling procedures in relation to trading activities
5. greater consideration to be given by ASX to requesting on a more reg-
ular basis, insider lists from listed entities, to assist in insider trading
investigations
6. report to ASIC, by 31 March 2010, on the effectiveness of recent changes
to the resourcing and procedures of ASX’s real-time surveillance function
7. during 2008, three entities were admitted to the list without meeting the
spread requirements. ASX was to report to ASIC, by 31 March 2010, on
effectiveness of measures to prevent a repeat occurrence
8. report to ASIC, by 31 March 2010, on a review of effectiveness of ASX
group’s measures to monitor and deal with software capacity issues
following two technology outages during 2008 caused by software error
9. report to ASIC after the Error Resolution Policy is invoked on the basis
of the rationale for the Fair Price Value determination, which is used to
identify trades that are to be cancelled.
The current regulatory regime under which ASX operates does not preclude the
existence of conflicts of interest as operator and watchdog. There is no per se pro-
hibition on ASX having conflicts of interest65 but ASX must manage any conflicts it
does have so as not to allow its commercial interests to prevail over its supervisory
role. ASIC’s view is that whether or not there should be such a per se prohibition
is a policy matter for government66 and continues to discharge its role to assess if
ASX has adequate arrangements in place to manage conflicts of interest. Despite
ASIC’s conclusion in its seven most recent reports that ASX’s arrangements for
managing conflicts were adequate (that is, met the statutory standard),67 ASX
has been continually dogged by allegations of inherent conflicts of interest from
operating a money-making business alongside its regulatory duties.68

Proposed Structural Changes to Supervision of Financial Markets

The MOU will continue to govern the relationship between ASIC and ASX, but
only until the third quarter of 2010. In a joint media release of the Federal

63 Sections 792A, 794C and 821A.

64 ASIC Report n 61, at 9–11.
65 Ibid at 20.
66 Ibid.
67 Ibid.
68 For example, see Adele Ferguson, ‘Query on ASX’s Supervisory Power’, The Australian (17 September
2007); Danny John, ‘ASX Cited for Conflict of Interest’, Sydney Morning Herald Business Day (5 April 2008).
 ASIC AND ASX 195

Treasurer Wayne Swan and The Hon. Chris Bowen,69 it was announced that the
supervisory responsibility of ASX will be transferred to ASIC in the third quarter
of 2010. The main aim is to ‘enhance the integrity of Australia’s financial markets
and take another step towards establishing Australia as a financial services hub
in the region’.70 Transferring this supervisory role will ensure that in future
Australia will have only ‘one whole-of-market supervisor’. The transfer of powers
will be done in stages to ensure that it is done in an orderly fashion. There were
some individuals in ASIC that were vehemently opposed to the regulatory powers
of ASX to be transferred to ASIC.71 Taking away the regulatory powers of ASX
will end a long and sometimes stinging attack on ASX being a regulator and
player on the securities market, which led to obvious conflicts of interests.72
ASX is one of only a few major exchanges with such dual functions.73 It is
submitted that transferring all the regulatory powers to ASIC is a development
that should be welcomed as one that is in line with good regulatory corporate
governance principles. Whether ASIC, however, has the resources and expertise
to discharge these additional duties more effectively than ASX remains to be seen.
ASIC itself has commented upon the pressure and stress on resources put upon
ASX in 2008 when policing real-time surveillance of the market.74 Ian Ramsay
also raised issues that are relevant for the future assessment of ASIC’s new
role:75

The big question now is will ASIC put in sufficient resources? Will it receive sufficient
resources from the Government to do an adequate job? Also, there’s a second major
question, will ASIC have the required expertise? The argument in favour of ASX doing
it is that it’s close to the market, close to the brokers, knows what the brokers are
doing.

7.4 Conclusion

Fundamental questions remain about the scope of ASIC’s prudential supervision,

powers and responsibilities. There are some differences in opinion as to how far
the powers of a regulator should be extended. David Knott touched on some of
these issues in a public address:

69 Treasurer Wayne Swan and Minister for Financial Services, Superannuation and Corporate Law, Chris
Bowen, ‘Reforms to the Supervision of Australia’s Financial Markets, joint media release (24 August
2009), available at <http://mfsscl.treasurer.gov.au/DisplayDocs.aspx?doc=pressreleases/2009/013.htm&
pageID=003&min=ceba&Year=&DocType=>.
70 See <www.treasurer.gov.au/DisplayDocs.aspx?doc=pressreleases/2009/093.htm&pageID=&min=
wms&Year=&DocType=0>.
71 See Henry Davis York Lawyers, <www.hdy.com.au/attachments/FinancialMarketsandDerivatives
Insight_Aug2009.pdf> for a good summary of the intended changes and consequences for the financial
markets.
72 Gill North, ‘The Corporate Disclosure Co-regulatory Model: Dysfunctional and Rules in Limbo’ (2009) 37
Australian Business Law Review 75, 80–1.
73 The Australian, 25 August 2009 – ‘Securities Exchange had Conflicting Roles’.
74 ASIC Report 168, above n 61, at 51.
75 Australian Broadcasting Corporation, ‘ASX Stripped of Key Supervisory Powers’, Lateline Business Tran-
script (24 August 2009). For similar queries, see Allens Arthur Robinson, ASIC Market Regulation, (24 August
2009), available at <www.aar.com.au/pubs/fsr/cufsraug09.htm>.
196 CORPORATE GOVERNANCE IN AUSTRALIA

Is the traditional approach leaving responsibility for corporate governance and com-
pliance with boards, shareholders and auditors still valid? Or should we be thinking
about extending the scope of prudential supervision more pervasively throughout
the business community? Should the corporate regulator, for example, have rights to
enter, inspect and even seize records without cause? Should the regulator have pow-
ers to prescribe and enforce governance standards? These would be radical notions
for a corporate regulator and would represent a major shift in managing governance
responsibilities. I am not necessarily advocating such change, merely making the point
that if you are not in control of governance, you cannot prevent failure.76

One could be forgiven for detecting from this a hint that ‘failure’ may well be
‘prevented’ if ASIC’s powers are extended along the line David Knott alluded to in
2002. That notion may nowadays find favour among the general public,77 who
have suffered greatly from the recent corporate collapses, and among politicians,
who will surely see the political gain in ‘protecting’ and ‘coming to the rescue’ of
the voters.
There are, however, also views that such drastic powers are unwarranted and
that further regulation may just stifle corporate initiative.78
Corporate governance is again high on the corporate law agenda in Aus-
tralia. Challenging economic times, associated with the global financial crisis
during 2008–9 has, however, laid bare the shortcomings of the Australian reg-
ulators (ASIC and ASX) in protecting investors who lost millions of dollars fol-
lowing the collapse of managed investment schemes like Timbercorp Ltd and
Great Southern Ltd, financial planners like Storm Financial Ltd and Opes Prime
Ltd, and other companies like Babcock & Brown Ltd and Allco Finance Group
Ltd.
These events raise the fundamental question as to whether the regulators in
Australia should be acting as an early warning system? ASIC Chairman Tony
D’ Aloisio addressed the regulatory framework in reply to this question posed
by the media and, in turn, posed a number of challenging questions in a lengthy
reply that is worth reproducing:79
. . . as a community, is the regulatory framework one where the role of an ASIC is to actu-
ally prevent collapses of companies, or is it as it’s been traditionally that you really over-
sight the markets and you come in and you deal with issues as they unfold? I think what
you’re seeing is we’re not having clear debate about that. I mean, traditionally a reg-
ulator such as ASIC has had roles of enforcement, compliance . . . investigations . . . it’s
never extended to the fact that an ASIC is the guarantor of last resort, or that it actually
has the resources to be able to go into every boardroom and every chief executive to
make sure that things are being done properly. If that’s where the community wants to
go, then clearly there would be a need for quite substantial resources. Philosophically

76 David Knott, ‘Corporate Governance – Principles, Promotion and Practice’ Inaugural Lecture –
Monash Governance Research Unit (16 July 2002), available at <www.asic.gov.au/asic/pdflib.nsf/
LookupByFileName/Monash_spch_160702.pdf/$file/Monash_spch_160702.pdf> 8.
77 See Jillian Segal, ‘Institutional Self-regulation’, above n 27 at 13.
78 Robert Baxt, ‘The Necessity of Appropriate Reform’ in Collapse Incorporated: Tales, Safeguards & Respon-
sibilities of Corporate Australia, Sydney, CCH Australia (2001) 326.
79 Australian Broadcasting Corporation, ‘ASIC Chairman Defends Role as Corporate Regulator’ (Transcript,
Lateline, 22 May 2008).
 ASIC AND ASX 197

in a free enterprise system, I think the community also has to take into account the
fact that failures in companies are part of the free enterprise system, as well as success.
And I think you need to . . . have a debate on whether ASIC should be preventative or
whether it should remain in its traditional role of really oversighting the market and
coming in and dealing where there’s been excesses that should be dealt with.

The quote raises rich questions on policy settings and whether the time is ripe for a
review of the philosophical considerations currently underpinning the regulatory
system, as identified by the ASIC Chairman. It is reasonable to presume that, given
a choice, the community will prefer the regulatory framework to be amended to
facilitate ASIC’s monitoring rule to become more prominent in future, as a way
of detecting the signs of potential huge corporate collapses as soon as possible,
rather than cleaning up after such collapses.80 It is interesting to note that the
proportion of the adult population of Australia that owns shares is one of the
highest in the world, with approximately 46 per cent (some 7.3 million people)
of adult Australians owning shares.81 Many of these shareholders, as well as
the thousands of creditors and those who lost their insurance cover in the HIH
collapse, are likely to support any suggestion of extending ASIC’s powers that
may prevent future spectacular corporate failures.
If so, the challenge for ASIC will be to play a far more active role in ensuring
that signs of corporate collapses are detected at the earliest possible time. This
will probably mean a much greater focus on monitoring companies, rather than
strictly on its role as regulator and enforcer. Fulfilling this role will likely be a
far greater challenge than that of picking up the leftovers on behalf of affected
corporations and individuals after the corporate cowboys and bold riders have
left the corporations they have ruined financially. Only time will tell whether
ASIC will be allowed to take up this challenge and live up to public expectations
in this regard.
As part of a preventative approach, the education and advocacy roles of ASIC
will also have a prominent role to play. But, as Jillian Segal points out, the
success of this approach will also depend on the willingness and commitment of
the corporate sector to embrace ethical standards.82
80 See generally regarding the role of governments in risk minimisation: Rick Sarre, ‘Risk Management and
Regulatory Weakness’, in Collapse Incorporated: Tales, Safeguards & Responsibilities of Corporate Australia,
Sydney, CCH Australia (2001) 319–21.
81 Speech by Prime Minister of Australia, Kevin Rudd, ‘Australia’s Economic Future’ to Confederation of
British Industry and Australian Business in London (4 April 2008), available at <www.pm.gov.au/node/
5868>.
82 Jillian Segal, ‘Corporate Governance: Substance Over Form’ (2002) 25 University of New South Wales Law
Journal 1 at 21.
8
Accounting governance

The CLERP 9 Act amends a number of Acts, including the Corporations

Act 2001, to give effect to reforms aimed at restoring public confidence in
corporate Australia after a number of significant instances of misconduct
and corporate failure.
The BDW Guide to CLERP 9 (Blake Dawson Waldron, July 2004) 22

8.1 Overview

No matter which corporate code of conduct or corporate governance framework

is used, the issue of ‘transparency’ is referred to either directly or by implication.
The application of ‘transparency’ to the reporting to the public by companies of
their financial and non-financial conduct and performance for a period has come
under increasing scrutiny of corporate stakeholders. The single most significant
reform in this area in Australia came in response to the high-profile corporate
collapses of the early 2000s. On 1 July 2004, the Corporate Law Economic Reform
Program (Audit Reform & Corporate Disclosure) Act 2004 (Cth) came into effect.
This Act is now commonly referred to as the ‘CLERP 9 Act’, or simply ‘CLERP 9’,
since it was the ninth such Act under the Government’s Corporate Law Economic
Reform Program (CLERP).
This Act, together with an Australian Securities Exchange (ASX) Listing Rule
change (2003) with respect to the establishment of audit committees for certain
companies (see Chapter 9) and ASX Best Practice Recommendations of 2003,
and as amended in 2007, together represent one of the most significant packages
of corporate law reform, and by far the most significant effort at regulating the
corporate governance practices of companies in Australian history. Since then,
other important reforms in Australia have been the adoption of International
Financial Reporting Standards and International Standards on Auditing based on
those promulgated by the International Accounting Standards Board (IASB) and
the International Auditing and Assurance Standards Board (IAASB) respectively
(see Chapter 9).
No book on corporate governance in Australia could do justice to its topic
without devoting at least some discussion to accounting governance in terms

198
 ACCOUNTING GOVERNANCE 199

of the CLERP 9 and accounting and auditing standard-setting reforms and their
place in the broader context of corporate governance, and in the regulation of
corporate governance in particular.
The effects of the CLERP 9 reforms have been significant, with considerable
parts of the Corporations Act 2001 (Cth) (the Act) now devoted to mandatory
‘corporate governance rules’ (especially in relation to the financial aspects of
corporate governance, with substantial reforms in the area of audit and financial
reporting). Prior to CLERP 9, many of the best-practice requirements that are now
prescriptive rules forming part of the Act (dealing with, for example, executive
remuneration, shareholder participation and financial reporting) were either
part of a self-regulatory approach to governance and standard setting overseen
by professional bodies (for example, the Australian Auditing and Assurance
Standards Board), or merely aspirational standards. CLERP 9 accelerated the
shift in the way that corporate governance operates and is perceived, as well as
the actual role of the regulators and quasi-regulators such as ASX, in shaping
corporate governance best practice and the behaviour of companies.
The CLERP 9 Act was designed, with some minor exceptions, to be consis-
tent with and to complement ASX Best Practice Recommendations (2003) over
the range of corporate governance matters to which they both applied (from
board structure and auditing to shareholder participation and continuous dis-
closure). The aim was to have these two measures work to promote both good
corporate governance practices within Australian listed companies and achieve
effective regulation. Some of the initiatives introduced under CLERP 9, however,
go further than the 2003 and 2007 ASX Best Practice Recommendations: they
apply also to non-listed companies, and non-compliance with CLERP 9 poten-
tially attracts formal penalties, whereas (as already mentioned in Chapter 7), the
Best Practice Recommendations operate under an ‘if not why not?’ (‘comply or
explain’) regime notwithstanding the Corporations Act requirement to comply.
This chapter draws on the explanation of the background to, and contents of,
each of the key CLERP 9 reforms provided by James McConvill in his 2004 book,
An Introduction to CLERP 9.1

8.2 Background to the Corporate Law Economic

Reform Program and some later developments

The CLERP was announced by then-Federal Treasurer Peter Costello in March

1997, and involved a review of key areas of regulation affecting business and
investment activity. According to the then-Government, the objective of CLERP
was to ensure that business regulation was consistent with promoting a strong
and vibrant economy and provided a framework which assisted business in
adapting to change.

1 James McConvill, An Introduction to CLERP 9, Sydney, LexisNexis (2004).

200 CORPORATE GOVERNANCE IN AUSTRALIA

The establishment of CLERP is said to have been a consequence of the decision

to transfer responsibility for legislation on corporations and securities from the
Office of the Attorney-General to the Department of Treasury. The perception
was that this transfer of responsibility would generate a shift from an emphasis
on legal regulation to economic regulation, and would result in a focus on the
economic impact of corporations law.
Since the election of the Labor Government in 2007, regulatory reform has
continued, particularly in standardising state and Federal requirements in an
effort to reduce the regulatory burden on business2 , but these reforms have
not occurred under the CLERP title3 . As pointed out in Chapter 7, one particu-
larly important, recently proposed reform is the re-balancing of responsibilities
for monitoring of the capital market in favour of the Australian Securities and
Investments Commission (ASIC), at the expense of ASX. ASX is itself a listed com-
pany and, as such, it has been argued that it has an inherent conflict of interest
since it has historically regulated and monitored the exchange upon which it self-
lists. The global financial crisis of 2007, which did not affect the Australian stock
market severely until 2008, highlighted issues associated with margin lending
to directors, share trading by directors during ‘black out’ periods and other mat-
ters, which prompted reform proposals not implemented at the time of writing.4
Another area that has received attention is executive remuneration, particularly
after generous bonuses were paid in the aftermath of the downturn caused by
the global financial crisis.5 Chapter 4 provides detail of activities in relation to
director and executive remuneration.

8.3 The Corporate Law Economic Reform Program

The CLERP reform program was developed with the benefit of consultation
with the Business Regulatory Advisory Group, which was formed in 1997 with
the intention of providing quality feedback to the government on business and
corporate law reform. The Business Regulatory Advisory Group consists of rep-
resentatives from key business groups.
Since 1997, nine policy proposal papers were released as part of CLERP,
comprising:
Paper 1 – Accounting Standards (1997)
Paper 2 – Fundraising (1997)
Paper 3 – Directors’ Duties and Corporate Governance (1997)
Paper 4 – Takeovers (1997)
Paper 5 – Electronic Commerce (1997)
2 See, for example, the Treasury project on Standard Business Reporting, available at <www.sbr.gov.au>.
3 See Corporations and Markets Advisory Committee, Aspects of Market Integrity (June 2009), available
at <www.camac.gov.au/camac/camac.nsf/byHeadline/PDFFinal+Reports+2009/$file/Market_Integrity_
Report_Jun2009.pdf>.
4 Ibid.
5 See Productivity Commission, Executive Remuneration in Australia, Report No. 49, Final Inquiry Report,
Melbourne, Commonwealth of Australia (December 2009), available at <www.pc.gov.au/projects/inquiry/
executive-remuneration/report>.
 ACCOUNTING GOVERNANCE 201

Paper 6 – Financial Markets and Investment Products (1997)

Paper 7 – Simplified Lodgment and Compliance Procedures with ASIC (2000)
Paper 8 – Cross-Border Insolvency (2002)
Paper 9 – Audit Reform and Corporate Disclosure (2002).
The first four papers, and part of the fifth, were reflected in the Corporate Law
Economic Reform Program Act 1999 (Cth). The sixth paper led to the Financial
Services Reform Act 2001 (Cth), which took full effect from March 2004, and
introduced Chapter 7 of the Corporations Act, dealing with financial products,
financial markets and providers of financial services.6
Paper seven was adopted with a series of reforms taking effect from 1 July
2003, and CLERP 9 was largely adopted with reforms taking effect from 1 July
2004. The proposals contained in paper eight were implemented by way of the
Cross-Border Insolvency Act 2008 (Cth), which commenced on 1 July 2008.
In a document titled CLERP – Policy Framework, released in 1997, the Depart-
ment of Treasury indicated that the key factors driving changes to corporate
regulation in Australia were: (1) globalisation and market behaviour; and (2)
that the law had not kept pace with change. This document identified six ‘key
principles’ to be applied under CLERP. Under the heading ‘Economic Approach
to Business Regulation’ these principles are:
3.1 Market Freedom
Competition plays a key role in driving efficiency and enhancing community
welfare. However, free markets do not always operate in a sufficiently com-
petitive, equitable or efficient manner. Business regulation can and should
help markets work by enhancing market integrity and capital market effi-
ciency. At the same time, the regulatory framework needs to be sufficiently
flexible so that it does not impede market evolution (for example, new
products and technologies) and competition.
3.2 Investor Protection
With an increasing number of retail investors participating in the market for
the first time, business regulation should ensure that all investors have rea-
sonable access to information regarding the risks of particular investment
opportunities. Regulation should be cognisant of the differences between
sophisticated and retail investors in access to information and the ability
to analyse it.
3.3 Information Transparency
Disclosure is a key to promoting a more efficient and competitive marketplace.
Disclosure of relevant information enables rational investment decision
making and facilitates the efficient use of resources by companies. Disclo-
sure requirements increase the confidence of individual investors in the
fairness and integrity of financial markets and, by fostering confidence,
encourage investment. Different levels of disclosure may be required for
sophisticated and retail investors.

6 R P Austin and I M Ramsay, Ford’s Principles of Corporations Law, Sydney, LexisNexis, Butterworths
(14th edn, 2010) 52.
202 CORPORATE GOVERNANCE IN AUSTRALIA

3.4 Cost Effectiveness

The benefits of business regulation must outweigh its associated costs. The
regulatory framework should take into account the direct and indirect costs
imposed by regulation on business and the community as a whole. What
Australia must avoid is outmoded business laws which impose unnecessary
costs through reducing the range of products or services, impeding the
development of new products or imposing system-wide costs.
The regulatory framework for business needs to be well targeted to
ensure that the benefits clearly exceed the costs. A flexible and transparent
framework will be more conducive to innovation and risk taking, which
are fundamental elements of a thriving market economy, while providing
necessary investor and consumer protection.
3.5 Regulatory Neutrality and Flexibility
Regulation should be applied consistently and fairly across the marketplace.
Regulatory distinctions or advantages should not be conferred on particu-
lar market structures or products unless there is a clear regulatory justifi-
cation. The regulatory framework should also avoid creating incentives or
opportunities for regulatory arbitrage. The regulatory framework should
be sufficiently flexible to permit market participants to respond to future
changes in an innovative, timely and efficient manner. Regulation should
be designed to facilitate predictability and certainty.
3.6 Business Ethics and Compliance
Clear guidance regarding appropriate corporate behaviour and swift enforce-
ment if breaches occur are key elements in ensuring that markets func-
tion optimally. The Government is committed to the strong and effective
enforcement of corporate law and will continue to provide substantial
resources to the Australian Securities Commission [now the Australian
Securities and Investments Commission (ASIC)] to enforce the law.
Fostering an environment which encourages high standards of business
practice and ethics will remain a central objective of regulation, as will
effective enforcement.
These principles provide a useful tool for developing or critiquing corporate law
and governance reforms. As discussed briefly in the concluding remarks to this
chapter, subjecting the CLERP 9 reforms to the key principles provides another
basis from which to evaluate the efficacy of shifting towards further formalisation
of corporate governance regulation in Australia.

8.4 Impetus for CLERP 9: Responding to

corporate collapses

As is discussed in various parts of this book, renewed international attention

to corporate governance resulted from the collapse of two of America’s largest
 ACCOUNTING GOVERNANCE 203

companies, Enron and WorldCom in 2001. The collapse of HIH Insurance Ltd –
Australia’s largest-ever corporate collapse – followed soon thereafter.
Regulators were quick to focus their attention on any role of those companies’
auditors in contributing to the collapses due to poor audit oversight, lack of
transparency and accountability, or the relevant audit firms being too close to
their audited clients.
In the USA, it was discovered that the global accounting firm Arthur Andersen
& Co (Andersen), which subsequently also collapsed under the weight of the
ensuing scandal, had signed off on Enron financial reports, which overstated
the company’s earnings by US$586 million over five years, and had allegedly
shredded a large volume of Enron’s documents – this was later found on appeal
not to have been the case. It was argued that Andersen’s negligence and, indeed,
dishonest practices, were due to its dependence upon fees paid to the firm by
Enron for non-audit services (such as consultancy and legal services). As other
audit firms similarly depended on non-audit fees, lack of ‘auditor independence’
was considered to be a major problem that required attention.7
Auditor dependence is a problem from a corporate governance perspective,
because if a company involves the same firm in the provision of both audit ser-
vices and non-audit services, such as consulting or legal services, the auditor will
possibly be reluctant to provide an unfavourable audit report to management if
the result is a loss of the audit engagement, and the subsequent loss of substan-
tial fees arising from non-audit services. Despite the limited role that auditors
actually perform and their very narrow obligations under law, the renewed focus
on corporate governance and the importance of the auditor’s role in ensuring
the reliability of a company’s half-year and full-year accounts warranted serious
attention being given to the regulation of auditors.
In Australia, the same problem of potential auditor dependence on audit
clients was found to be rife. This was due mainly to the large accounting and
audit firms establishing multidisciplinary practices (with consulting, legal and
tax practices) in an attempt to offer a ‘one-stop advisory shop’ for their clients,
and thereby to maximise client fees. An important study of Australia’s 100 largest
companies, conducted by ASIC in January 2002, revealed that a large majority of
these companies retained their audit firm to provide non-audit services, and that
non-audit fees accounted for nearly 50 per cent of the total fees paid to the audit
firm.8 Also raising the issue of auditor independence in Australia was the fact
that two board members of the collapsed HIH Insurance group were ex-partners
of Andersen, the firm that had performed HIH’s last audit.9

7 See generally Melissa Fogarty and Alison Lansley, ‘Sleepers Awake! Future Directions for Auditing in
Australia’ (2002) 25 University of New South Wales Law Journal 408.
8 See ASIC, ‘ASIC Announces Findings of Audit Independence Survey’ (Press Release 02/13, 16 January
2002). Not surprisingly, the concept of multidisciplinary practices is now considered to be passé and anachro-
nistic, rather than a real opportunity for fee maximisation.
9 See Michael De Martinis, ‘Do Directors, Regulators, and Auditors Speak, Hear and See No Evil? Evidence
from the Enron, HIH and One.Tel collapses’ (2002) 15 Australian Journal of Corporate Law 66, 67.
204 CORPORATE GOVERNANCE IN AUSTRALIA

It is not difficult to see why the problems that were believed to be behind
these high-profile corporate collapses became the focus of CLERP. Corporate law
reform – particularly in the area of corporate disclosure – was seen as a possible
solution to restoring market confidence, addressing the cause of those collapses
and preventing further collapses from occurring.
Prior to developing proposals for corporate law reform to address corporate
disclosure and corporate governance more generally, the Federal Government
commissioned Ian Ramsay to review audit independence regulation in Australia.
Ramsay was commissioned in August 2001, soon after the collapse of HIH Insur-
ance Ltd, and at a time when auditor independence was a hot topic in the financial
press and among law-makers and regulators. Ramsay handed his report, titled
‘Independence of Australian Company Auditors: Review of Current Australian
Requirements and Proposals for Reform’, to the government in October 2001.
The report contained seven key reform recommendations:
1. Introduction of a general requirement for auditors to be independent under
the Corporations Act.
2. Incorporation in the Corporations Act of the best-practice position regard-
ing the employment of auditors, and the financial relationships between
the audit firm and the firm’s clients to ensure independence.
3. Enhancement of the disclosure requirement for non-audit services (for
example, consulting, legal) performed by the audit firm (so that the type
of service and the monetary amount paid is transparent).
4. Prohibition of audit firm partners who were directly involved in an audit
from becoming directors of the audited client within two years of the
auditor resigning from the audit firm.
5. Introduction of a requirement that all listed companies have an audit
committee.
6. Establishment of an auditor independence ‘supervisory board’.
7. Introduction of measures to improve the operation of the Companies Audi-
tors and Liquidators Disciplinary Board.
Following the HIH collapse, the Australian Government also established a Royal
Commission to investigate the collapse and, among other things, raise proposals
for possible corporate law and governance reforms. Justice Owen of the Western
Australian Supreme Court was appointed as Commissioner.
Following the endorsement of the Ramsay Report by the Federal Govern-
ment, a less-publicised review of audit reform was also conducted by the Fed-
eral Parliament’s Joint Committee of Public Accounts and Audit. In a 144-page
report titled ‘Review of Independent Auditing by Registered Company Auditors’,
released in September 2002, the Joint Committee made 13 recommendations for
reform.10
Also in September 2002, the Federal Government released its discus-
sion paper, ‘Corporate Disclosure: Strengthening the Financial Reporting
10 A pdf version of this report is available at <www.aph.gov.au/house/committee/jpaa/Indepaudit/
contents.htm#contents>.
 ACCOUNTING GOVERNANCE 205

Framework’, which comprehensively explained its proposals for law reform in

relation to audit and financial reporting in particular, but also in other areas
drawn together by a strong objective of ensuring good corporate governance
practices. The discussion paper drew heavily on the Ramsay Report in relation to
auditor independence, and was also influenced by the United States Sarbanes-
Oxley Act of 2002, which had been quickly drafted and implemented to respond
to the large collapses in that country.
In October 2003, the Australian Government released its draft Corporate
Law Economic Reform Program (Audit Reform & Corporate Disclosure) Bill (the
so-called ‘CLERP 9 Bill’), and accompanying commentary, for public consulta-
tion. The CLERP 9 Bill was introduced into Parliament on 4 December 2003,
incorporating some amendments to the draft Bill and immediately sent to the
Joint Parliamentary Committee on Corporations and Financial Services for fur-
ther review. That Committee released its report in June 2004. The Committee
was generally supportive of the initiatives contained in the CLERP 9 Bill; how-
ever, it suggested a number of important reforms, particularly in relation to the
proposed whistleblowing provisions, and shareholder participation (including
a recommendation that all individuals appointed as proxy for company meet-
ings be required to vote as directed, with CLERP 9 otherwise being limited to
reforms pertaining to electronic proxy voting). We return to the Committee’s
report below in this chapter, when we discuss the possibility of further corporate
governance-related law reform, post-CLERP 9.
On 25 June 2004, Parliament approved the CLERP 9 Bill. It came into effect as
the Corporate Law Economic Reform Program (Audit Reform & Corporate Disclo-
sure) Act 2004 (Cth) on 1 July 2004, as intended with most provisions applying
from that date.

8.5 Explanation of key CLERP 9 reforms

In this section, we identify each of the key CLERP 9 reforms implemented. The
explanation is divided into three parts: (a) audit reform, (b) corporate disclo-
sure, and (c) miscellaneous. Note that ASIC has released a number of policy
statements, practice notes and other policy documents indicating its intentions
in administering different aspects of CLERP 9. Where relevant, we include refer-
ence to these policy documents, but readers are encouraged to visit the CLERP 9
section of ASIC’s website: <www.asic.gov.au/clerp9>.

8.5.1 Audit reform

As noted earlier, Chapter 9 of this book is devoted to explaining the role of audi-
tors in corporate governance, and the reforms to auditing and audit regulation
introduced under CLERP 9. This section merely identifies the main initiatives
relating to audit reform that were made as part of CLERP 9.
206 CORPORATE GOVERNANCE IN AUSTRALIA

A key area for reform as part of CLERP 9 was auditor independence. CLERP
9 enhanced auditor-independence requirements through a number of reforms
including general and specific independence rules embedded into the Corpo-
rations Act, new audit–partner rotation rules (requiring listed companies to
essentially replace their external audit partner every five years), the imposition
of ‘cooling off’ periods for ex-auditors before being able to take up a position with
a former audit client, and requirements for disclosure of the dollar value of non-
audit services by category11 provided by auditors (the value of auditor-provided
non-audit services purchased had long been a required disclosure under account-
ing standards) with an explanation in the directors’ report of how the provision
of these services did not compromise independence.
Other changes increased auditor accountability by requiring that auditors
of listed company clients attend the clients’ annual general meeting to answer
shareholder questions; extended the duty of auditors to report unlawful con-
duct occurring within an audited body; gave auditing standards the force of
law similar to accounting standards, which had long enjoyed this requirement;
reconstituted the previous professional body that sponsored the Auditing and
Assurance Standards Board (AUASB) as a statutory authority under the guid-
ance of the Australian Financial Reporting Council (FRC); allowed registration of
audit companies (previously only sole practitioners or partnerships were permit-
ted); formalised auditor competence requirements; and provided jurisdiction to
the FRC to supervise and guide auditors regarding independence requirements.
ASIC set out its policy in relation to audit reform in Policy Statement 180, ‘Audi-
tor Registration’, and Policy Statement 34, ‘Auditors’ Obligations – Reporting to
ASIC’.

8.5.2 Corporate disclosure

8.5.2.1 Remuneration of directors and executives
CLERP 9 introduced enhanced disclosure requirements for listed companies
in relation to the disclosure of informing shareholders regarding the rates of
director and executive remuneration, and in particular of the link between levels
of executive pay and company performance.
The major changes were to section 300A of the Corporations Act, requiring
much greater disclosure by listed companies of director and executive remuner-
ation (both the level of remuneration, and the company’s policy in determining
remuneration) – including the preparation of a specific ‘remuneration report’
to be included as a section in the directors’ report (which is intended to clearly
explain board policy in relation to remuneration and demonstrate to share-
holders that levels of executive pay were based on company performance and
how this was determined), and disclosure of the remuneration of each director
and the five highest-paid key managerial personnel in the company and in the

11 Refer AASB 101 Presentation of Financial Statements para AUS 138.1.

 ACCOUNTING GOVERNANCE 207

group (if applicable)12 . Other CLERP 9 initiatives in relation to remuneration

included:
● a requirement (under section 250R) for listed companies to provide share-
holders with a non-binding ‘advisory’ vote on the designated ‘remuneration
report’ prepared by the directors
● a tightening of the termination payment rules, with shareholder approval
generally being required for all termination payments (including payments
arranged pursuant to pre-employment contracts, and damages for breach
of contract due to early termination of contract), which are the greater
of the relevant person’s average remuneration for the last three years
multiplied by the number of years the person has held an office in relation to
the company (up to a maximum seven years) or the person’s remuneration
for the last 12 months (see section 200F).
Under the Act, a ‘company executive’ is defined to mean a company secretary or
senior manager of the company (see section 300A(1B)). A ‘senior manager’ is
defined under section 9 as a person, other than a director or company secretary,
who makes, or participates in making, decisions that affect the whole, or a
substantial part, of the business of the corporation; or has the capacity to affect
significantly the corporation’s financial standing.

8.5.2.2 Financial reporting

CLERP 9 introduced some significant financial reporting reforms requiring that
further information be provided in the directors’ report or financial report (which
is included in the annual or half-yearly report of the company). Another impor-
tant financial reporting-related initiative introduced under CLERP 9 involved
the establishment of the Financial Reporting Panel, which has jurisdiction to
hear and determine disputes between ASIC and companies (or other entities)
regarding accounting treatments in annual reports.13
In terms of the compliance-based reforms, the three key changes made under
CLERP 9 were:
● that listed companies must include in the directors’ report a declaration
by the directors that they had received a chief executive officer (CEO) and
chief financial officer (CF) joint declaration that the company’s financial
records have been properly maintained, that the financial statements and
accompanying notes have been prepared in accordance with accounting
standards, and that the financial statements and notes for the financial
year provide a ‘true and fair’ view of the company’s position (see sections
295(4)(e) and 295A)
● that the directors’ report for a listed company must include a ‘management
discussion and analysis’ (a so-called ‘MD&A’), which contains sufficient
information that investors would reasonably require to make an informed

12 See also AASB 2 (accounting standard), Share-based Payment for other required disclosures and account-
ing treatments.
13 See Part 13 of the Australian Securities and Investments Commission Act 2001 (Cth) which established the
Panel; also Part 2M.3, Division 9 of the Corporations Act.
208 CORPORATE GOVERNANCE IN AUSTRALIA

assessment of the company’s operations and financial position, as well

as business strategies and prospects for future financial years (see
section 299A)
● that if additional information is included in an entity’s full year or half-year
financial report to ensure a ‘true and fair’ view (of the financial performance
and position of the company – satisfying the existing requirement under
the Act (see sections 297 and 305)), then the directors’ report must set
out the reasons for the directors forming the view that the inclusion of this
information was necessary and the location of this additional information
in the financial report (see section 298(1A)), and the auditor’s report must
include a statement as to whether the auditor believes the inclusion of this
additional information was necessary to provide a ‘true and fair’ view (see
section 306(2)).

8.5.2.3 Continuous disclosure

One of the most controversial areas of reform under CLERP 9 was the changes
made to the continuous disclosure regime. The continuous disclosure regime
(under the Corporations Act and ASX Listing Rules) requires that listed com-
panies (and non-listed ‘disclosing entities’) immediately release to the market
information that could have a material effect on the price or value of affected
companies’ securities.
There were two key changes relating to continuous disclosure under
CLERP 9:
● introduction of personal liability for individuals who are deemed to be
‘involved’ in an entity’s contravention of the continuous disclosure pro-
visions (which essentially ‘pick up’ the continuous disclosure rules under
ASX Listing Rules). This personal liability provision is subject to a ‘due
diligence’ defence14
● providing ASIC with the power to issue so-called ‘infringement notices’
against an entity (but not against an individual ‘involved’ in a contraven-
tion) if ASIC considers that the entity has not met its continuous disclosure
obligations. The infringement notice power was introduced with a view
to enabling ASIC to take action in relation to less serious contraventions
of the continuous disclosure provisions, where court action would not be
justified. An infringement notice may only be issued within 12 months of
an alleged contravention. The size of the monetary penalty contained in
the infringement notice depends on the offending entity’s market capital-
isation and whether it has previously been convicted of contravening the
continuous disclosure provisions. The maximum possible penalty for each
offence (at the time of writing) was $100 000. Complying with an infringe-
ment notice by paying the specified monetary penalty within the specified
time period is not an admission of guilt, and bars ASIC from commencing
civil or criminal proceedings in relation to the alleged contravention.

14 See Corporations Act s 674(2A).

 ACCOUNTING GOVERNANCE 209

Importantly, in relation to publicity, ASIC may not issue any public release relat-
ing to an infringement notice being issued against a company. ASIC may only
publish a statement when an entity complies with an infringement notice, and
this statement must include a note clearly stating that compliance is not an admis-
sion of the entity’s guilt, and that the entity is not regarded as having contravened
the continuous disclosure provisions.15

8.5.2.4 Shareholder participation

CLERP 9 introduced some important amendments to the Act, designed to facil-
itate and promote the exercise by shareholders of important governance rights:
being informed of company activities, as well as participation in and voting at
general meetings of the company.
The key amendments in this area were designed to:
● encourage companies to embrace technology (particularly the internet
and e-mail) and forms of electronic communication (such as web-casting)
to improve communication with shareholders, particularly facilitating the
distribution of notices of meeting and annual reports through electronic
means16
● encourage shorter and more comprehensible notices of company meetings
so that shareholders can fully understand the contents of the notices (see
section 249L(3), which introduced a requirement that notices are worded
and presented in a ‘clear, concise and effective manner’)
● improve shareholder access to general meetings by facilitating proxy voting
(in particular, to facilitate electronic proxy voting (by permitting regula-
tions to prescribe so-called ‘authentication mechanisms’), which authenti-
cate proxy appointments provided electronically)17
● better inform shareholders, by requiring that listed company directors
disclose other directorships held in the three years prior to the end of
the financial year to which the report relates,18 and the qualifications
and experience of the company secretary be included in the directors’
report.19

8.5.2.5 Whistleblowers
Part 9.4AAA of the Act introduces a new regime providing protection from vic-
timisation for ‘whistleblowers’ (officers, employees, contractors and employees
of contractors) who report contraventions (or suspected contraventions) of the
‘Corporations legislation’ (defined to include the Corporations Act, the Australian
Securities and Investments Commission Act, and regulations under either Act) to
ASIC, the company’s auditor, a director or other authorised person. Victimisation

15 See Part 9.4AA of the Act, and ASIC’s policy document, ‘Continuous Disclosure Obligations: Infringement
Notices – An ASIC Guide’ (released in May 2004), which sets out ASIC’s processes for administering the
infringement notice regime, including how hearings are to be conducted and notices issued.
16 See Corporations Act, ss 249J and 314.
17 See Corporations Act, s 250A(1A) and reg 2G.2.01 of the Corporations Regulations.
18 Corporations Act, s 300(11)(e).
19 Corporations Act, s 300(10)(d).
210 CORPORATE GOVERNANCE IN AUSTRALIA

may occur in a number of ways, including actual dismissal, demotion, bullying

or constructive dismissal.
In order for the whistleblower to obtain protection under Part 9.4AAA, there
are three pre-conditions that need to be satisfied:
(i) The person has reasonable grounds to suspect the disclosure highlights
that there has been a contravention of the Corporations legislation.
(ii) The disclosure is made in ‘good faith’.
(iii) Prior to making the disclosure, the person provides their name to the person
to whom they are reporting (for example, ASIC, the company’s auditor, a
director or another authorised person).
Part 9.4AAA contains a number of useful provisions, including section 1317AB,
which states that whistleblowers are not subject to civil or criminal liability,
or the enforcement of contractual rights and remedies, simply on the basis of
the disclosure they made, and sections 1317AC and 1317AD, which prohibit
victimisation (this offence carries a fine of $2750 and/or imprisonment for six
months), and enable whistleblowers to claim compensation where they have
suffered loss as a result of victimisation.
The House of Representatives: Standing Committee on Legal and Constitu-
tional Affairs released a report titled Whistleblower Protection: A Comprehensive
Scheme for the Commonwealth Public Sector on 25 February 2009.20 It contains
wide-ranging discussions on the need for whistleblower protection, including
comparative approaches with respect to other jurisdictions. A key recommenda-
tion of the report was the enactment of a new law, the Public Interest Disclosure
Act, to facilitate public interest disclosures and strengthen legal protection for
whistleblowers in the federal public sector.
Due to concerns that the existing protections for corporate whistleblow-
ers contain ‘fundamental shortcomings’,21 the Federal Government released an
options paper in October 2009, exploring strategies for improving protections
for corporate whistleblowers.22 Issues include:
● who is allowed to qualify for protection as a whistleblower – former employ-
ees currently do not qualify
● whether motive should affect protection – currently an individual with
malicious motives cannot be protected even if the information they disclose
is genuine
● whether anonymity should affect protection
● when a court may order the production of documents that reveal a whistle-
blower’s identity – there is concern that whistleblowers will be discouraged
from coming forward unless there is further guidance on this issue.

20 See Commonwealth of Australia, Whistleblower Protection: A Comprehensive Scheme for the Commonwealth
Public Sector (Report of the House of Representatives: Standing Committee on Legal and Constitutional
Affairs), (25 February 2009).
21 The Minister for Financial Services, Superannuation and Corporate Law, the Hon Chris Bowen, Media
Release No.032 of 22 October 2009.
22 Commonwealth of Australia, Improving Protections for Corporate Whistleblowers: Options Paper, (October
2009), available at <www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=1620>.
 ACCOUNTING GOVERNANCE 211

To date, however, there are no court decisions clarifying the scope of the
provisions23 and there is no evidence of any enforcement activity involving the
provisions by ASIC.24 Janine Pascoe’s research on the literature on business ethics
and compliance suggests that the introduction of whistleblower laws, without
corresponding changes in organisational ethical values, will not work.25 In order
to be effective, Pascoe argues that legal and regulatory initiatives require a shift
in corporate culture and ethical values. Similarly, a significant research project
based on case studies and quantitative and qualitative analyses produced two
key messages:26
(1) organisations can and should adopt a policy of ‘when in doubt report’ to
encourage the reporting of wrongdoing
(2) organisations need to improve their performance in supporting and pro-
tecting persons who come forward with reports of wrongdoing.
The need to provide an environment free from recriminations and victimisation,
as noted by ASIC,27 is essential if senior management and the board are to
adequately manage risk and cultural issues within their company.

8.5.2.6 Disclosure rules

A less-publicised component of CLERP 9 involves the series of important reforms
made in relation to the disclosure requirements for prospectuses (under Chapter
6D of the Act) and product disclosure statements (PDSs) (under Chapter 7 of
the Act). The objective underlying the reforms was to improve the quality of
information provided to investors in securities and financial products. There
were four key reforms in this area, as follows:
● Information in prospectuses and other Chapter 6D disclosure documents
under which securities are offered must be worded and presented in a ‘clear,
concise and effective manner’ under new section 715A. This provision was
based on section 1013C(3) of the Act, introduced in 2002, which con-
tains an equivalent presentation requirement in relation to the content of
PDSs – issued under Part 7.9 of the Act for certain offers of financial prod-
ucts other than securities.
● Introduction of section 1013FA under Chapter 7 (dealing with financial ser-
vices and products), which enabled so-called ‘transaction specific’ PDSs in
relation to ‘continuous quoted securities’. This provision was based on exist-
ing section 713, under Chapter 6D of the Act, which allows for ‘transaction

23 ASIC v Dawson Nominees Pty Ltd (2008) 169 FCR 227 raised issues concerning the availability of public-
interest immunity for the regulator from the need to surrender documents and transcript arising form its
investigation of Multiplex Ltd. In affirming such protection, the court did not directly address the statutory
provisions.
24 Janine Pascoe ‘Corporate Sector Whistleblowing in Australia: Ethics and Corporate Culture’ (2009) 27
Company and Securities Law Journal 524 at 525.
25 Ibid.
26 Peter Roberts, Jane Olsen and A J Brown, Whistling While They Work – Towards Best Practice Whistleblow-
ing Programs in Public Sector Organisations (Draft Report, July 2009), available at <www.griffith.edu.au/
whistleblowing>.
27 ASIC, Whistleblowers: Corporate Culture of Compliance, available at <www.asic.gov.au>.
212 CORPORATE GOVERNANCE IN AUSTRALIA

specific’ prospectuses. A ‘transaction specific’ document is shorter than

usual, as information that investors may require but has recently been
made available to investors through another forum (for example, the com-
pany’s most recent annual or half-yearly report, or a continuous disclosure
notice issued after the company report but before the date of the PDS),
does not need to be included – thus avoiding ‘doubling up’ of disclosure.
With respect to continuous disclosure notices, information contained in the
notice may be only validly excluded if the PDS states that as a disclosing
entity the issuer is subject to regular reporting and disclosure obligations,
and informs people of their right to obtain a copy of the notice. Importantly,
ASIC may determine that section 1013DA does not apply to the offer of
particular continuously quoted securities if the regulator is satisfied that
the issuer has in the previous 12 months contravened: (a) the provisions
of Chapter 2M of the Act dealing with financial reporting; (b) the continu-
ous disclosure provisions; (c) section 1012DA(9), which requires financial
product issuers to correct defective notices; or (d) section 1308 (false and
misleading statements).28
● The introduction of section 708A provides exemptions for some secondary
sales of securities originally issued without a disclosure document under
Chapter 6D of the Act. The basis of this amendment was that no further
disclosure is required if at the time securities are issued investors have the
benefit of information that is comparable to the information that would
otherwise be available in a prospectus. Section 708A is considered to essen-
tially enact the exemptions that ASIC formerly provided under categories
1 and 2 in Schedule C of ASIC Class Order 02/1180. The basic gist of the
provision is it exempts a person offering to sell an entity’s securities, within
12 months of the securities having been issued without disclosure provided
under Chapter 6D of the Act, from having to provide disclosure in the form
of a prospectus or some other disclosure document. The exemption only
applies if the relevant securities are in a class of securities that were ‘quoted
securities’ at all times in the 12 months before they were issued. Further, the
exemption is not available if the company that originally issued the securi-
ties did so with the purpose that the purchaser would then sell or transfer
the securities (or otherwise grant, issue or transfer an interest in, or option
over, the securities). As with section 1013DA, ASIC is able to make a deter-
mination disallowing the exemption in section 708A from applying if the
issuer of the securities has in the previous 12 months contravened certain
disclosure obligations under the Act (for example, continuous disclosure,
financial reporting).
● Section 1012DA was introduced, which is consistent with section 708A
in terms of exempting some secondary sales of financial products from
PDS requirements. The provision also extends the existing relief that was
28 See s 1013FA. ASIC applies Practice Note 66, ‘Transaction Specific Prospectuses’ to transaction-specific
PDSs.
 ACCOUNTING GOVERNANCE 213

available under ASIC Class Order 02/1180 for secondary sales of financial
products so that relief is available for all quoted financial products, not just
managed investment products.29

8.5.3 Miscellaneous
8.5.3.1 Managing conflict by financial services licensees
CLERP 9 introduced section 912A(1)(aa), which provides a condition on the
licence of financial services licensees (‘AFS licensee’), under Chapter 7 of the Act,
that they have in place adequate arrangements to manage conflicts of interest
that may arise, either wholly or partially, from the activities undertaken by an
AFS licensee or their representatives in the context of providing financial services
in a financial services business.
This reform was directed mainly at addressing conflicts of interest faced by
so-called ‘sell-side’ research analysts working for full-service investment dealers
who have not clearly separated research and investment banking businesses.
This potential for conflict became a focus for reform after a series of Wall Street
scandals in 2001 that revealed a very close dependence between research and
other areas of large investment banks.30 This same issue has been raised in the
context of the global financial crisis.31

8.5.3.2 Register of relevant interests

CLERP 9 introduced s 672DA into the Act, requiring listed companies and listed
management schemes to establish a register of ‘relevant interests’, recording
the information that is obtained under Part 6C.2 of the Act (which sets up a
procedure to enable ASIC or a listed public company or scheme to trace the true
beneficial ownership of a company’s shares). Section 608 of the Act provides
that a person has a ‘relevant interest’ in securities if they are the holder of the
securities, or have the power to exercise (or control the exercise of) a right to vote
attached to the securities, or have power to dispose of (or control the exercise of
a power to dispose of) the securities. Section 609 of the Act outlines a number
of situations (including holding of securities by financial services licensees, and
shares covered by buy-backs) which do not give rise to a relevant interest for the
purposes of section 608.
Section 672DA(1) provides that a listed company (or the responsible entity
for a listed managed investment scheme) must keep a register of information
that it receives under Part 6C.2 (whether the information is received pursuant

29 In relation to the operation of ss 708A and 1012DA, see ASIC’s Policy Statement 173, ‘Disclosure for
On-sale of Securities and Other Financial Products’ (revised in December 2004).
30 ASIC set out its policy for dealing with this obligation to manage conflicts in Policy Statement 181,
‘Licensing: Managing Conflicts of Interests’ (August 2004) and ‘Managing Conflicts of Interests: An ASIC
Guide for Research Report Providers’ (November 2004).
31 John Kehoe, ‘ASIC Targets Independence of Auditors, Analysts’, Australian Financial Review (Sydney),
(13 October 2009), 1.
214 CORPORATE GOVERNANCE IN AUSTRALIA

to a direction the company, or responsible entity, itself gives under s 672A, or is

received from ASIC under section 672C).

8.5.3.3 Officers, senior managers and employees

Prior to CLERP 9, the Act contained two different definitions of ‘officer’ – one
in section 82A, which included employees within the definition, and one in
section 9. This anomaly was discussed in detail by Justice Owen in the HIH
Royal Commission Final Report and was eventually addressed in the CLERP
9 Act, which repealed section 82A to leave only one definition of ‘officer’ in
section 9.
CLERP 9 also introduced a new definition of ‘senior manager’ under section
9, being a person (other than a director or company secretary) who (a) makes,
or participates in making, decisions that affect the whole, or a substantial part,
of the business of the corporation, or (b) has the capacity to affect significantly
the corporation’s financial standing. The concept of ‘senior manager’ is mainly
used in sections of the Act introduced by CLERP 9 on executive and director
remuneration and audit services.

8.5.3.4 Enforcement
The CLERP 9 Act introduced a number of important measures to strengthen the
enforcement provisions of the Act, such as increased penalties,32 providing courts
with the power to extend the period of ‘automatic disqualification’ of directors
managing a corporation, upon application by ASIC, for a further 15 years.33

8.5.3.5 Proportionate liability

The CLERP 9 Act introduced a proportionate liability approach in relation to
claims for misleading conduct regarding economic loss or property damage
under three provisions: section 1041H of the Act, section 12DA of the ASIC
Act and section 52 of the Trade Practices Act 1974 (Cth). This change in approach
facilitated apportionment between a plaintiff and a defendant according to their
respective level of blame (similar to the rules of ‘contributory negligence’ in
torts), and between two or more defendants based on their respective levels of
blame.
The change to proportionate liability was principally designed to protect audi-
tors, but applies to all professional advisers. Prior to the CLERP 9 reforms, audit
partners in firms were jointly and severally liable for professional default within
the firm, thus exposing each partner to unlimited liability. Auditors had tra-
ditionally protected themselves from unlimited liability through professional
indemnity insurance, but the cost of insurance premiums had skyrocketed as a
result of the collapse of HIH Insurance.

32 See Corporations Act, s 1308 and s 1309.

33 See Corporations Act s 206BA and s 206B(1).
 ACCOUNTING GOVERNANCE 215

8.6 Accounting standards

The Australian Financial Reporting Council directed the Australian Accounting

Standards Board (AASB) to adopt international financial reporting standards
(IFRS) issued by the International Accounting Standards Board in July 2003.
Previously there had been a policy of harmonisation with IFRS but not outright
adoption. The AASB issued the suite of Australian Equivalents to International
Financial Reporting Standards (AIFRS) by May 2004 for implementation by
all reporting entities for periods beginning on or after 1 January 2005. For 31
December balancers, this gave little time for implementation. Further, since
financial statements had to provide comparative numbers from the previous
year, these numbers needed to be re-worked according to IFRS too, and certain
reconciliations between the previous and new treatments were required. Many
other countries (for example, in Europe) that adopted IFRS did so only for
consolidated financial reports. Hence, the transition was a monumental task and
not without cost.
As justification for the reform, the then-Government argued that ‘in a glob-
alised economy with large and growing cross-border capital movements, high
quality, internationally accepted accounting standards will facilitate cross-
border comparisons by investors and enable Australian companies to access
international capital markets at lower cost’.34 However, the initial policy of
amending the wording of the original IFRS meant there was still uncertainty
internationally over compliance with IFRS, and in 2007 the AASB was given a
strategic direction by the Australian Financial Reporting Council to the effect
that auditors should attest to compliance with IFRS where companies in their
annual reports made this claim.35
One important difference between IFRS and the previous accounting stan-
dards is the emphasis on the use of ‘fair value’ to value assets, particularly invest-
ments in securities. In the illiquid market for many securities in the aftermath
of the global financial crisis, this valuation method has come under enormous
scrutiny and even blame.36 The IASB was forced to compromise on its standard on
financial instruments when European banks found themselves at a disadvantage
with United States banks on recognition of losses on poorly performing loans.
Indeed, the struggle for supremacy between accounting standards issued by the
IASB and the United States standard setter, the American Financial Accounting
Standards Board (FASB), has been highlighted by the financial crisis. The USA
had laid out a roadmap itself to adopt IFRS by 2014 but at the time of writing
this timetable, and even whether there is still appetite for this reform in the USA,
is under a cloud.37

34 CLERP 9 Proposals (2002), 6.2.

35 For detail see C A Jubb and K A Houghton, ‘The Australian Auditing and Assurance Standards Board after
the Implementation of CLERP 9’, (2007) 22 Australian Accounting Review. 688–715.
36 See, for instance, Tim McCollum, ‘Fair Value Under Fire’ (2008) 65(6) The Internal Auditor, 13.
37 See, for instance, Stephen Barlas, Lance Thompson, Dave Topp and Kathy Williams, ‘Slowdown on IFRS’
(2009) 90(9) Strategic Finance 61.
216 CORPORATE GOVERNANCE IN AUSTRALIA

8.7 Conclusion

We have recently witnessed a major change in the mode of corporate governance

regulation: from a ‘disclosure’ based approach, which preferred companies to dis-
close the corporate governance policies and practices they implemented in accor-
dance with their particular needs, to an ‘interventionist’ approach – with CLERP
9 contributing to the formalisation of best-practice governance benchmarks by
introducing (or significantly enhancing) substantive corporate governance man-
dates under the Corporations Act.
Considerable debate still exists as to whether many of the compliance-related
requirements under CLERP 9 (particularly in relation to audit reform, financial
reporting – for example, CEO/CFO declarations and the MD&A discussion in the
directors’ report – and executive remuneration) were necessary to improve the
governance practices and general performance of companies, and therefore to
‘fireproof’ companies from collapse, or whether they merely imposed additional
burdens on the company. We believe that returning to the ‘key principles’ of the
CLERP program, discussed in section two above, is an important project (and one
that has not been carried out to date) to properly assess the efficacy of the post–
CLERP 9 regulatory framework. In particular, we repeat the fourth key principle,
‘cost effectiveness’, supporting a cost–benefit approach to assessing the efficacy
of corporate regulation, which states:

The benefits of business regulation must outweigh its associated costs. The regulatory
framework should take into account the direct and indirect costs imposed by regulation
on business and the community as a whole. What Australia must avoid is outmoded
business laws which impose unnecessary costs through reducing the range of products
or services, impeding the development of new products or imposing system-wide
costs.
The regulatory framework for business needs to be well targeted to ensure that the
benefits clearly exceed the costs. A flexible and transparent framework will be more
conducive to innovation and risk taking, which are fundamental elements of a thriving
market economy, while providing necessary investor and consumer protection.

The costs need to include an evaluation of the adoption of IFRS and of giving
auditing standards the force of law, among other things. Do the benefits of
moving towards more substantive corporate governance mandates outweigh the
additional costs (both time-based and financial) of compliance? Does the post–
CLERP 9 regulatory landscape represent a flexible and transparent framework
that is conducive to innovation and risk taking, or is the overriding objective of
contemporary corporate regulation in Australia now ‘conformance’ rather than
‘performance’? We leave you to come to your own conclusion with the assistance
of the overview of the CLERP 9 and other reforms provided in this chapter.
Both the key principle extracted above, and the remaining five key princi-
ples comprising the CLERP policy framework, provide an excellent source for
 ACCOUNTING GOVERNANCE 217

engaging in a systematic evaluation – importantly, against criteria which the

Government has itself set and continues to endorse (with every CLERP discus-
sion paper it releases) in its attitude to effective corporate regulation – as to the
effectiveness of the increasing shift towards substantive corporate governance
mandates as part of CLERP 9.
Is the general trend towards formalisation of corporate governance, of which
CLERP 9 forms a significant component, in harmony with the Government’s
present framework of corporate regulation as reflected in the key principles?
What are the implications if inconsistencies can be identified? It may be that the
government needs to either reassess the efficacy of the regulatory momentum
it has influenced, or go back and review whether the key principles underlying
CLERP are in fact in line with its contemporary thinking on corporate regulation.
But there may be, and in fact are, many recent reforms (for example, the changes
to the continuous disclosure regime, and the reforms in the area of shareholder
participation and information – both promoting investor protection and infor-
mation transparency) that align with the CLERP key principles. How would these
changes be affected by such a review?
If the package of substantive corporate governance mandates introduced by
CLERP 9 is not considered to be efficacious, one possible option for reform –
which perhaps is more aligned with the CLERP key principles and the economic
philosophy underpinning the government’s approach to corporate regulation –
may be to convert the relevant provisions from mandatory rules to optional
terms or at least to make them differentially applicable (for example, requir-
ing audit–partner rotation for companies in other than Australian Prudential
Regulation Authority (APRA)-regulated industries because of the rigorous expe-
rience requirements for auditors to be accepted by APRA as ‘approved auditors’
in that sector).38 In Australia, this could be achieved by converting many of
the compliance reforms into ‘replaceable rules’ under the Corporations Act (see
section 141), thereby providing companies with greater freedom to tailor their
governance procedures and practices by including an alternative procedure in
the company’s constitution if this is considered to better suit their organisational
needs. Alternatively, ASIC could be given powers of exemption and modification,
to provide relief to companies from one or more of the provisions by establish-
ing to ASIC that such relief would be in the best interests of the company.39
Another option would be to adopt an ‘opt in’ procedure, whereby the corporate
governance rules under the Act would only apply to a company if the company’s
constitution is amended (by special resolution of shareholders) to confirm that

38 This was a recommendation of an extensive study of, among other things, auditors’ perceptions of the
CLERP 9 reforms in the period post their implementation. See chapters 10–12, K C Houghton, C Jubb, M.
Kend and J. Ng, The Future of Audit: Towards a National Strategy in Keeping Markets Efficient, Canberra, ANU
E-Press (2009), available at <http://ancaar.fec.anu.edu.au/documents/FutureOfAuditReport.pdf>.
39 For a discussion of the potential expansion of ASIC’s exemption and modification powers under the
Corporations Act, see James McConvill and Mirko Bagaric, ‘Opting Out of Shareholder Governance Rights:
A New Perspective on Contractual Freedom in Australian Corporate Law’ (2005) 3 De Paul Business and
Commercial Law Journal (USA) 401.
218 CORPORATE GOVERNANCE IN AUSTRALIA

the company ‘opts in’ to the rules, rather than the rules applying to the company
unless it opts out.40
Such a proposal would certainly find favour with advocates of a law and
economics conception of corporate law and the corporation (who perceive
corporate-law rules to be default terms designed to fill ‘gaps’ in the series of
exchanges forming the ‘nexus of contracts’ – see discussion above), and would
be compatible with other key principles underlying the CLERP policy frame-
work (promoting market freedom, innovative decision making and regulatory
neutrality and flexibility).
A similar proposal was raised recently by Yale Law Professor Roberta Romano
in the context of discussing the formalisation of corporate governance in the
USA as a result of the Sarbanes-Oxley Act of 2002. Romano argues that imposing
corporate-governance requirements in relation to independent audit commit-
tees, provision of non-audit services, executive loans and executive certification
of financial statements through prescriptive rules under the Act is misguided
and ineffective. There are alternative means available to achieve the ends sought
by law-makers in the USA in relation to the Sarbanes-Oxley Act. According to
Romano:
The analysis of the empirical literature and political dynamics relating to the [Sarbanes-
Oxley Act] (‘SOX’) corporate governance mandates indicates that those provisions were
poorly conceived, as there is an absence of a factual basis to believe the mandates would
be efficacious. Hence there is a disconnect between means and ends. The straightfor-
ward policy implication of this chasm between Congress’s action and the learning
bearing on it is that the mandates should be rescinded. The easiest mechanism for opera-
tionalizing such a policy change is to make the SOX mandates optional, serving as statutory
default rules that firms choose whether or not to adopt.41 (emphasis added)

In section five of this chapter, we discussed some additional corporate-

governance reform proposals that may form part of the next wave of corporate
law reform in Australia – ‘CLERP 10’. But further into the future, the very mode
of regulating corporate governance – disclosure-based or prescription-based –
may need to be subjected to review by law-makers and regulators.
40 There is a debate, particularly in the USA, where competition exists between states to adopt management-
friendly corporation law (so-called ‘chartermongering’), as to whether default terms in corporate law should
be phrased as ‘opt out’ or ‘opt in’ provisions. The predominant view appears to be that ‘opt out’ provisions
favour management as managers can block the necessary charter (constitutional) amendment to achieve
opting out. See, for example, Lucian Bebchuk and Assuf Hamdani, ‘Optimal Defaults for Corporate Law
Evolution’ (2002) 96 Northwestern University Law Review 489.
41 Roberta Romano, ‘The Sarbanes-Oxley Act and the Making of Quack Corporate Governance’ (2005) 115
Yale Law Journal; also available as Yale Law School Centre for Law, Economics and Public Policy, Research
Paper No. 297, 205–6, available online at <http://papers.ssrn.com/sol3/papers.cfm?abstract id=596101>.
9
Auditors and audits

Audited financial statements are an important part of the financial infor-

mation that is available to the capital markets and an important part of
effective corporate governance.
Ian M Ramsay, Independence of Australian Company Auditors: Review of
Current Australian Requirements and Proposals for Reform, Report to the
Minister for Financial Services and Regulation, Canberra, Department of
Treasury, October 2001 [4.01]

9.1 Introduction: The audit role and where it fits

into corporate governance

9.1.1 Overview of the audit role

Auditing is defined as an assurance service that objectively gathers evidence
and communicates it to third parties.1 Companies that are required to prepare
a financial report for a financial year must have their financial report audited
and obtain an auditor’s report.2 Thus, all large proprietary companies and pub-
lic companies must appoint an auditor. Small proprietary companies in normal
circumstances are not required to prepare a financial report and hence need not
appoint an auditor.3 However, they must do so in a limited range of circum-
stances, namely where shareholders holding at least 5 per cent of voting shares
require preparation of accounts and ask for an auditor.4
Broadly, the function of an auditor is to conduct an audit on the financial
affairs of the company and to ascertain whether the financial report provided by
the company complies with relevant legal requirements and accounting princi-
ples, and gives a true and fair account in all material respects of the company’s
financial affairs. The audit role has several objectives. The main one is to provide

1 C Jubb, S Topple, P Schelluch, L Rittenberg and B Schwieger, Assurance and Auditing: Concepts for a
Changing Environment, Sydney, Thomson,(2nd edn, 2008), 4 of 681.
2 Section 301(1) Corporations Act 2001 (Cth).
3 On 4 December 2009, the Australian Government released the Draft Corporations Amendment Corporate
Reporting Reform Bill 2010. Among other things, the Draft Bill proposed a three-tiered, differential reporting
framework that exempts small companies limited by guarantee from reporting and auditing requirements
(subject to the same current safeguard for small proprietary companies) and providing other companies
limited by guarantee with streamlined assurance requirements (review rather than audit) and simplified
disclosures in the directors’ report.
4 Section 293 of the Act.

219
220 CORPORATE GOVERNANCE IN AUSTRALIA

reasonable assurance that the financial information reported by the company is

free from material misstatement. In the process, auditors provide a barrier of pro-
tection against careless or dishonest company officers. In order to fulfil this role,
the auditor must have suitable skills and expertise, and must be independent of
the company.
The main auditing requirement is to provide an audit report to the members
in the financial report for a financial year.5 This is laid before the annual general
meeting and lodged with the Australian Securities and Investments Commission
(ASIC).6 It is important to note that the auditor’s role is essentially procedural,
not substantive in nature. More particularly, pursuant to sections 307 and 308 of
the Corporations Act 2001 (Cth) (the Act), the auditor’s report to members must
set out a number of matters in relation to the financial report for a financial year.
These include:
● whether the financial report is in accordance with the Act, including com-
pliance with accounting standards, and whether the report provides a true
and fair view of the financial position and performance of the company7
● if the auditor is of the opinion that the financial report does not comply
with an accounting standard, the auditor’s report must, to the extent it
is practicable to do so, quantify the effect that non-compliance has on the
financial report. If it is not practicable to quantify the effect fully, the report
must state why
● whether the auditor has been given all information and assistance for the
conduct of the audit
● any defect or irregularity in the financial report
● whether the company has kept financial records sufficient to enable the
conduct of the audit
● whether the company has kept other records required by the Act.
The Act specifically states that if the auditor is of the opinion that the financial
report does not comply with an accounting standard, the auditor’s report must
indicate the effect that this has on the financial report. In addition to this, the
auditor’s report must describe any defect or irregularity in the financial report
and any other relevant deficiencies or shortcomings regarding the record keeping
of the company.8
The auditor’s role does not extend to commenting or passing judgment on
the soundness of the business and financial decisions of the directors and other
officers.9

5 Disclosing entities may have their half-year financial report audited or reviewed (s 309 of the Act). A review
provides limited rather than reasonable assurance. A review consists of making enquiries, primarily of persons
responsible for financial and accounting matters, and applying analytical and other review procedures.
A review may bring significant matters affecting the financial information to the assurance practitioner’s
attention, but it does not provide all of the evidence that would be required in an audit. Refer to the Auditing
Standard on Review Engagements, ASRE 2410 Review of a Financial Report Performed by the Independent
Auditor of the Entity.
6 Sections 308, 317, 319 of the Act. Other audit report circumstances are detailed in R P Austin and I M
Ramsay, Ford’s Principles of Corporations Law (14th edn, 2010) 663–4 para 10.470.
7 See also ss 296 and 297 of the Act.
8 Section 308 of the Act.
9 BGJ Holdings Pty Ltd v Touche Ross & Co (1987) 12 ACLR 481.
 AUDITORS AND AUDITS 221

9.1.2 The link between the audit role and corporate governance
The audit role in the context of corporate governance needs some explanation,
as the role is largely external to that of company decision makers. Auditors do
not prepare company reports. Their role is one of ‘checking’, or verifying. In this
respect, it has been noted that an auditor is ‘a watch dog, but not a bloodhound’.10
This audit function is, however, integral to the activities and affairs of a company.
Although the audit role can be defined relatively easily, it is a role that at various
junctures has been perceived not to have been fulfilled well. Indeed, doubts about
audit quality in the context of high-profile corporate collapses led to CLERP 9
reforms of the audit function so far as it relates to public companies.
The audit role is now regarded as being so central to the activities of a company
that, despite the fact that it is in essence a monitoring role performed by parties
outside the corporate structure, it is considered by some commentators to be a
definitional and cardinal aspect of corporate governance.
In looking at the nexus between external audit and corporate governance, the
Report of the HIH Royal Commission (Owen Report) notes that:
Auditors play a significant role in corporate governance. This is not surprising given
the emphasis placed on integrity and on the need for financial reporting that is honest
and that presents a balanced picture of the state of the company’s affairs. Again, I refer
to the Cadbury report:
The annual audit is one of the cornerstones of corporate governance . . . the audit
provides an external and objective check on the way in which the financial statements
have been prepared and presented, and it is an essential part of the checks and balances
required. The question is not whether there should be an audit, but how to ensure its
objectivity and effectiveness.

Irrespective of whether the audit function is viewed as being internal or external

to corporate governance, there is no doubt that it is a crucial activity. This, too,
is a point emphasised by Justice Owen in the HIH Report:
The point of an audit is to provide independent assurance of the integrity of the way
in which the company has reported. It follows that shareholders in particular have an
interest in the proper functioning of the audit process as it provides them with comfort
in making investment decisions. This element of assurance is of course also relevant to
the directors themselves, so far as they rely on management in the preparation of the
accounts as well as to others with an interest.11

Similar comments were made by Treasury in its Explanatory Memorandum out-

lining the CLERP 9 proposals:
Audited financial statements are an important part of the financial information that
is available to the capital markets and an essential element of effective corporate
governance. Auditor independence is fundamental to the credibility and reliability
of auditors’ reports and in turn independent audits perform an important function

10 See Lopes LJ in Re Kingston Cotton Mill (No 2) [1896] 2 Ch 270. For a more expansive view of the duty of
an auditor, see, for example, Pacific Acceptance Corporation ν Forsyth (1970) 92 WN (NSW) 29.
11 Report of the HIH Royal Commission (Owen Report), The Failure of HIH Insurance – Volume I: A Corporate
Collapse and its Lessons, Canberra, Commonwealth of Australia (2003), 162 para 7.2.
222 CORPORATE GOVERNANCE IN AUSTRALIA

in terms of capital market efficiency. There has been widespread concern about the
efficacy of the audit function, including the independence of auditors, as a result of
major corporate collapses in Australia and overseas, including HIH.
Over recent years there have been a number of corporate collapses which have called
into question the degree of independence of auditors. These cases have demonstrated
that while a company’s actual financial position may have been poor, the financial
statements and the audit report did not reflect the true condition of the company. This
has impaired the ability of shareholders and the market more generally to adequately
assess the financial health of their investment. Whilst the Global Financial Crisis (GFC)
has not to date resulted in major criticisms of auditors,12 regulatory action against
auditors is underway in connection with several corporate failures including ABC
Learning, Babcock and Brown, Centro Properties and Allco Finance Group. Often there
is a time lag between corporate collapses and actions against the auditing profession.
For instance, the Westpoint collapse in 2006 resulted in ASIC banning three auditors for
up to two years in August 2009.13 Similarly, ASIC accepted enforceable undertakings
not to practice as registered auditors for 12 months from the auditors of the failed
Estate Property Group in January 2010, some three and a half years after the lead
auditor signed an unqualified audit opinion for the company’s financial report for the
year ended June 30, 2006.14 It is also to be expected that here will be ramifications also
for the auditors flowing from ASICs intended litigation against 8 directors and officers
of Centro Properties Group (CNP) and Centro Retail Group (CER).15 ASIC alleges that
the financial reports of the companies did not comply with the relevant accounting
standards and regulations. In addition the contention is that the financial reports did
not give a true and fair view of the financial position and performance of the entities
because they failed to classify, or failed to correctly classify, a significant amount of
interest-bearing liabilities of the relevant entities as current liabilities, as required by
the relevant accounting standard, AASB 101 Presentation of Financial Statements.

9.2 CLERP 9 changes to audit role

The role and regulation of auditors underwent significant changes following the
CLERP 9 reforms. As noted by James McConvill:

The CLERP 9 reform movement emerged principally due to an international debate

on corporate governance, and the role and regulation of auditors more specifically,
as a result of a concentrated period in 2001 and 2002 when a number of very large
companies, in the United States (Enron and World.Com), and Australia (HIH Insurance,
One.Tel principally, as well as Ansett and Pasminco) collapsed.16

12 For further detail, refer to the concluding chapter in K C Houghton, C Jubb, M Kend and J Ng, The Future
of Audit: Towards a National Strategy in Keeping Markets Efficient (2009), ANU E-Press, available at <http://
ancaar.fec.anu.edu.au/documents/FutureOfAuditReport.pdf>.
13 S Washington, ‘Westpoint Collapse: ASIC Imposes Ban on Three Auditors’, The Sydney Morning Herald
(18 August 2009), 21.
14 B Wilmont, ‘Auditors Under ASIC Review’, The Australian Financial Review (6 January 2010), 7.
15 See ASIC Media Release 09–202AD of 21 October 2009, ‘ASIC Commences Proceedings Against Current
and Former Officers of Centro’, available at <www.asic.gov.au/asic/asic.nsf/byheadline/09–202AD+ASIC+
commences+proceedings+against+current+and+former+officers+of+Centro?openDocument>.
16 James McConvill, Introduction to CLERP 9, Chatswood, Lexis Nexis Buttterworths (2004) 1.
 AUDITORS AND AUDITS 223

In the Enron audit it was discovered that the accounting firm Arthur Andersen &
Co (Andersen) had signed off on Enron’s financial reports, which had overstated
the company’s earnings by US$586 million over five years, and had shredded a
large volume of Enron’s documents. Although the finding in relation to shredding
of documents subsequently was overturned, Andersen had already collapsed in
March 2003. It was argued that Andersen’s negligence and dishonest practices
were due to its dependence on fees that Enron had paid the firm for non-audit
services, such as consultancy and legal services. Thus, the absence of ‘auditor
independence’ was seen as a significant factor that had contributed towards the
collapse of Enron.
In Australia, the lack of independence of auditors was also rife. This was due in
large part to the major accounting and audit firms establishing multidisciplinary
practices (with consulting, legal and tax practices) in an attempt to offer a ‘one-
stop advisory shop’ for their clients, and maximise client fees. A study conducted
in January 2002 by ASIC of Australia’s 100 largest companies revealed that a
large majority of these companies retained their audit firms to provide non-audit
services, and that non-audit fees accounted for nearly 50 per cent of the total
fees paid to the audit firm.17
Given the circumstances leading to these high-profile collapses, the principal
CLERP 9 audit reforms related to enhanced auditor oversight and independence.
These included:
1. Introducing a general requirement for auditors to be independent under
the Act.
2. Incorporating in the Act the best-practice position regarding the employ-
ment of auditors and the financial relationships between the audit firm
and the firm’s clients to ensure independence.
3. Enhancing the disclosure requirement for non-audit services (for example,
consulting, legal) performed by the audit firm (so that the type of service
and the monetary amount paid is transparent).
4. Prohibiting audit firm partners who were directly involved in an audit from
becoming directors of the audited client within two years of the auditor
resigning from the audit firm.
5. Establishing an auditor independence ‘supervisory board’.
It had been proposed initially that CLERP 9 introduce a requirement that all
listed companies have an audit committee. This requirement was subsequently
taken up by ASX, which introduced Listing Rule 1.13, effective 1 January 2003,
mandating audit committees for only the top 500 companies on the basis of
disproportionate cost for smaller companies.
In the remainder of the chapter we analyse the audit role in so far as it relates
to companies, and focus particularly on some of the above reforms. As noted in
Chapter 8, the role and operation of auditors was drastically reformed by CLERP

17 See ASIC, ‘ASIC Announces Findings of Audit Independence Survey’ (Press Release 02/13, 16 January
2002), available to <www.asic.gov.au/asic/asic.nsf/byheadline/02%2F13+ASIC+announces+findings+
of+auditor+independence+survey?openDocument>.
224 CORPORATE GOVERNANCE IN AUSTRALIA

9. For a detailed discussion of the background and effect of the changes, readers
are referred to chapters 2, 3, 4 and 5 of McConvill’s An Introduction to CLERP 9.18

9.3 Auditor independence

9.3.1 Overview of rationale behind independence requirement

A central aim of the CLERP 9 audit reforms was to ensure greater auditor inde-
pendence. Prior to the CLERP 9 changes, the Act dealt with auditor independence
in only a piecemeal fashion.
The importance of auditor independence was underlined in the HIH Final
Report, where Justice Owen stated:

Auditor independence is a critical element going to the credibility and reliability of an

auditor’s reports. Audited financial statements play a key role promoting the efficiency
of capital markets and the independent auditor constitutes the principal external check
on the integrity of financial statements. The Ramsay report recognised the following
four functions of an independent audit in relation to capital market efficiency:
• adding value to financial statements
• adding value to the capital markets by enhancing the credibility of financial state-
ments
• enhancing the effectiveness of the capital markets in allocating valuable resources
by improving the decisions of users of financial statements
• assisting to lower the cost of capital to those using audited financial statements by
reducing information risk.

In addition to the above functions noted in the Ramsay Report, an independent

audit contributes to capital market efficiency by enhancing the consistency and
comparability of reported financial information.
It is widely accepted that the auditor must be, and be seen to be, free of any
interest that is incompatible with objectivity. For an audit to fulfil its functions,
there must be public confidence in the auditor.
The responsibility of auditors to maintain independence in the carrying out
of their function was stated by the United States Supreme Court:

The independent public accountant performing this special function owes allegiance
to the corporation’s creditors and stockholders, as well as the investing public. This
public watchdog function demands that the accountant maintain total independence
from the client at all times and requires complete fidelity to the public trust.19

In the absence of a competently and independently performed audit, there is

increased risk to the efficiency of capital markets. There is a danger that the
audit report will lure users into a false sense of security that there has been an
independent scrutiny of the financial report when there has not.20

18 McConvill, above n 16 – much of the foregoing chapter is derived from these chapters.
19 United States ν Arthur Young, 465 US 805, 817–18 (1984).
20 Owen Report, above n 11, 163 para 7.2.1.
 AUDITORS AND AUDITS 225

It seems striking that an ‘independent’ auditor could, in relation to another

aspect of its business, be ‘dependent’ upon the fees paid by the company being
audited. Human nature dictates that an auditor is likely to be less impartial in
assessing a corporation’s financial reporting, such that an unfavourable audit
report may jeopardise substantial fees arising from provision of non-audit
services.
CLERP 9 attempted to address this issue by introducing a range of reforms,
which aimed to improve both actual, and perceived, independence, and led
to greater confidence in the credibility and reliability of audited financial
statements – as noted in discussion of the Ramsay Report in Chapter 8,
part 8.3.

9.3.2 General requirement for auditor independence

The CLERP 9 amendment to include section 324CA of the Corporations Act
established a general requirement for auditor independence. Section 324CA(1)
applies to auditors21 and prohibits an individual auditor or audit company
from engaging in ‘audit activity’22 in relation to an audited body at a particular
time if:
● a ‘conflict of interest situation’ exists in relation to the audited body at that
time
● the individual auditor or the audit company are aware that the conflict of
interest situation exists
● the individual auditor or the audit company does not take all reasonable
steps to ensure that the conflict of interest situation ceases to exist, as soon
as possible after the relevant person (referred to in section 324CA(1)(b))
becomes aware that the conflict of interest situation exists.

9.3.3 Meaning of ‘conflict of interest situation’

The CLERP 9 amendment to section 324CD(1) provided that a ‘conflict of inter-
est situation’ exists in relation to an audited body at a particular time, if circum-
stances exist at the time which:
● impair, or might impair, the ability of the auditor, or a professional member
of the audit team, to exercise objective and impartial judgment in relation
to the conduct of an audit of the audited body (section 324CD(1)(a))
● would give a person, with full knowledge of the facts and circumstances,
reasonable grounds for concern that the ability of the auditor, or a pro-
fessional member of the audit team, to exercise objective and impartial
judgment in relation to the conduct of an audit of the audited body is, or
might be, impaired (section 324D(1)(b)).

21 A general independence requirement for members of audit firms and directors of audit companies,
mirroring s 324CA, is contained in ss 324CB and 324CC of the Act, respectively.
22 See the definition of ‘engage in audit activity’ under s 9 of the Act.
226 CORPORATE GOVERNANCE IN AUSTRALIA

In determining whether a conflict of interest situation exists, section 324CD(2)

goes on to provide that regard is to be had to circumstances arising from any
relationship (that either exists, has existed, or is likely to exist) between:
● the individual auditor
● the audit firm or any current or former member of the firm
● the audit company, any current or former director of the audit company or
any person currently or formerly involved in the management of the audit
company and any of the following persons and bodies:
– a company (including a person currently or formerly involved in the
management of the company)
– a disclosing entity (including a person currently or formerly involved in
the management of the entity)
– a registered scheme (including a person currently or formerly involved
in the management of the responsible entity).

9.3.4 Disclosing and resolving conflicts

Section 324A(1A) provides that if a ‘conflict of interest situation’ exists in relation
to an audited body while an individual auditor or audit company is the auditor
of that audited body, the individual auditor or audit company must notify ASIC
in writing of the conflict of interest within seven days from the day they became
aware of the conflict of interest. If the auditor or audit company does not then
notify ASIC within 21 days subsequent to the notification (or such other period as
ASIC determines) that the conflict has been removed, then the audit appointment
will terminate pursuant to section 327B(2A) if the audit is of a public company.23

9.3.5 Specific independence requirements – minimising conflict

of interest through employment and financial restrictions
Prior to the CLERP 9 reforms, section 324 of the Act included a limited number of
specific restrictions on auditors to ensure independence. There are now specific
independence requirements applying to:
● individual auditors: section 324CE
● audit firms: section 324CF
● audit companies: section 324CG.
For example, section 324CE(1) provides that an individual auditor must not
engage in audit activity at a particular time if a ‘relevant relationship’ outlined in
the table in section 324CH(1) (which applies to each of sections 324CE, 324CF

23 Section 324CA(2) of the Act deals with circumstances in which a ‘conflict of interest situation’ exists in
relation to the audited body but the individual auditor, or the audit company, is not aware that the conflict of
interest exists. An audit in such circumstances is prohibited where the individual auditor or audit company
would have been aware of the existence of the conflict of interest situation if they had in place a quality control
system reasonably capable of making them aware of such a conflict of interest. An individual auditor is not
in breach of s 324CA(6) if they have reasonable grounds to believe that they have in place a quality control
system providing reasonable assurance that the audit company and the company’s employees complied with
the general independence requirements. A similar ‘quality control’ defence is provided for audit companies
under s 324CA(5).
 AUDITORS AND AUDITS 227

and 324CG) applies at that time to a person or entity specified in the table in sec-
tion 324CE(5). This means, as an example, that an individual auditor (subsection
324CE(1) – table item 1) cannot engage in ‘audit activity’ (as defined in section
9) if the individual is an officer of the audited body (subsection 324CH(1) – table
item 1). There are separate but similar tables in the legislation outlining specific
independence requirements for members of audit firms (see section 324CF) and
authorised audit companies (see section 324CG).
If a relevant item of the table in subsection 324CH(1) applies to a person or
entity listed in the table of persons in any of sections 324CE, 324CF or 324CG,
then the individual auditor, audit firm or audit company must notify ASIC of
this specific conflict within seven days: see sections 324CE(1A), 324CF(1A),
or 324CG(1A) (there is also a provision applying to directors of audit compa-
nies under section 324CG(5A)). If this initial notification is not followed up
within 21 days (or in such other period as ASIC decides) by another notice to
ASIC, indicating that the conflict of interest is removed, then pursuant to section
327B(2A) (individual auditors), 2B (audit firms) or 2C (audit companies), the
audit appointment terminates.24
CLERP 9 also introduced a cooling off period concerning the involvement of
auditors with firms they have audited. Under the Act, a person is prohibited from
becoming an officer of an audited body for two years if the person:
● ceases to be a member of an audit firm or director of an audit company and
was a professional member of the audit team25 engaged in an audit of the
audited body (section 324CI)
26
● ceases to be a professional employee of the auditor if the person was a
‘lead auditor’ or ‘review auditor’ for an audit of the audited body (section
324CJ). Under the Act, a ‘lead auditor’ is the registered company auditor
who is primarily responsible to the audit firm or audit company that is
conducting the audit. A ‘review auditor’ is the registered company auditor
(if any) who is primarily responsible to the individual auditor, the audit
firm, or audit company for reviewing the conduct of the audit (section
324AF).
Additionally, CLERP 9 requires that a person who has been a member of an audit
firm or director of an audit company cannot become an officer of an audited body
if another person who is, or was, a member or director of the auditor at a time
when the auditor undertook an audit of the audited body is also an officer of the
audited body: section 324CK.
24 It should also be noted that similar to the general independence provisions discussed above, for each of
ss 324CE, CF and CG there is a ‘quality control’ defence, so that the individual auditor, member of an audit
firm or audit company is not taken to have contravened the relevant section if there are reasonable grounds
to believe that a quality control system was in place to provide reasonable assurance that the auditor, firm or
company was complying with its specific independence requirements.
25 Section 324AE of the Act defines ‘professional members of the audit team’ as any registered company
auditor who participates in the conduct of the audit, any other person who in the course of doing so exer-
cises professional judgment regarding the application of or compliance with accounting or auditing stan-
dards and legal requirements, and any other person who is in a position to directly influence the audit
outcome.
26 Section 9 of the Act provides that a ‘professional employee’ of an auditor participates in the conduct of
audits and in the course of doing so exercises professional judgment regarding the application or compliance
with accounting or auditing standards or legal requirements.
228 CORPORATE GOVERNANCE IN AUSTRALIA

9.3.6 Auditor rotation

Prior to the CLERP 9 changes, there was no legislative requirement for audit
partner rotation. The requirement for audit partner rotation instead formed part
of the self-regulatory Joint Code of Professional Conduct of the ICAA and CPAA27
(which recommended rotation after seven years). While these two professional
bodies encompass most auditors, it was considered necessary to set this rotation
requirement in legislation so that it applied to the entire auditing profession and
was enforceable.
The legislative framework for auditor rotation applies where either an indi-
vidual auditor, an audit firm or authorised audit company has been appointed
as auditor of a listed company or registered scheme. The provisions rely on the
concept of an auditor having ‘played a significant role’, which is defined under
section 9. Where an individual plays a significant role in the audit of a listed com-
pany for five successive financial years, the individual cannot play a significant
role in the audit of that company for at least another two successive financial
years: section 324DA.
Section 324DA(2) goes on to provide that a person may not play a significant
role as auditor for more than five out of any seven successive financial years.
According to the Explanatory Memorandum to the CLERP 9 Bill:

This approach recognises that auditors may not necessarily audit a body in consecutive
years however the relationship between the auditor and the audited body can still give
rise to a threat to independence.

This is also intended to prevent an auditor from avoiding the rotation obligation
in section 324DA:

. . . where an auditor plays a significant role for four successive years, resigns from the
audit for only one year and then resumes a significant role for another four successive
years.28

9.3.7 Disclosure of non-audit services

The HIH Royal Commission Final Report noted that non-audit services by audi-
tors to audited bodies raised two threats to audit independence:
● self-review threats – these situations arise when the auditor may need to
review work performed either by the auditor or the auditor’s firm
● the sacrifice of audit integrity in order to procure more lucrative non-audit
work.
27 These two professional bodies subsequently initiated a more independent body for the setting of ethical
standards, the Accounting Professional Ethical Standards Board (APESB), and were later joined by a third
professional body – the National Institute of Accountants (NIA). APES 110 Code of Ethics for Professional
Accountants superseded the Joint Code of Professional Conduct.
28 There is a range of possible offences for breaching the rotation requirement: see ss 324DC, 324DD of the
Act. It should be noted that pursuant to s 342A, ASIC has been given the power to extend the period before
rotation of an auditor is required, if the general rotation requirements are considered too burdensome for a
particular company.
 AUDITORS AND AUDITS 229

In response to this, following CLERP 9, the board of directors of a listed company

must provide a statement in the company’s annual report identifying non-audit
services29 that have been provided, and a declaration that the provision of these
services does not compromise the auditor’s independence: see section 300(11B).
Where the company has an audit committee, this statement must be made in
accordance with advice provided by that committee: section 300(11D).

9.4 Auditors and the AGM

A good way to look beyond the often superficial nature of audit reports is to ask
questions of the auditors. Shareholders traditionally have had little meaningful
opportunity to probe deeper into audit reports. Since the Company Law Review
Act 1998 (Cth) came into effect, company shareholders have been entitled to ask
questions of the auditor concerning the conduct of the audit and the contents of
the audit report. However, this right was somewhat limited as it depended on
shareholders actually attending the annual general meeting (AGM, which most
do not), and on the company’s auditor attending the meeting.
CLERP 9 introduced section 250PA, which allows a shareholder of a listed
company to submit questions to the auditor about the contents of the audit
report or the conduct of the audit. Importantly, section 250PA(5) allows auditors
to ‘filter’ questions according to their relevance to the audit report or conduct of
the audit. While the filtering exercise is the task of the auditor, the company can
express its opinion to the auditor regarding the relevance of individual questions.
Section 250PA(7) requires the company to make the list of questions provided by
the auditor reasonably available to members attending the AGM. The list could
be provided through distribution of printed copies to shareholders or by other
means.
Section 250RA of the Act requires auditors of a listed company to attend the
company’s AGM at which the audit report is to be considered. Where the auditor
is an individual auditor and is unable to attend the AGM, the auditor can instead
be represented by a member of the audit team who is ‘suitably qualified’, and is
in a position to answer questions regarding the audit: section 250RA(1)(b).30

9.5 Auditors’ duties

Another change introduced by the CLERP 9 package of reforms involved expand-

ing auditors’ reporting obligations to ASIC to include a much wider range of

29 The Act does not include a definition of ‘non-audit services’; however, it is intended that non-audit services
will include any services that are provided by an auditor but not included in the terms of the audit engagement.
30 As auditors of listed companies are now required to attend company AGMs, s 1289(3) makes it clear that
qualified privilege applies to answers to questions asked before or during a company AGM. Section 1289(4)
of the Act also extends qualified privilege to a person representing the auditor at the AGM in cases where the
auditor is not present.
230 CORPORATE GOVERNANCE IN AUSTRALIA

suspected or actual malfeasance. Section 311 requires individual auditors con-

ducting an audit31 to notify ASIC in writing within 28 days after they become
aware of any circumstances that:
● they have reasonable grounds to suspect what amounts to a contravention
(either a significant contravention, or a contravention that the auditor
believes has not been or will not be adequately dealt with by commenting
on it in the auditor’s report or bringing it to the attention of the directors)
of the Act
● amount to an attempt, in relation to the audit, by any person to unduly
influence, coerce, manipulate or mislead a person involved in the conduct
of the audit
● amount to an attempt, by any person, to otherwise interfere with the proper
conduct of the audit: section 311(1).
Section 311(4) provides that in determining whether a contravention of the Act
is a ‘significant’ one, regard is to be had to:
(a) the level of penalty provided for in relation to the contravention
(b) the effect that the contravention has, or may have, on:
(i) the overall financial position of the company, registered scheme or
disclosing entity
(ii) the adequacy of the information available about the overall financial
position of the company, registered scheme or disclosing entity
(iii) any other relevant matter.
Section 311(7) defines ‘a person involved in the conduct of the audit’ to mean
the auditor, the ‘lead auditor’32 for the audit, the ‘review auditor’33 for the audit,
a professional member of the audit team34 for the audit or any other person
involved in the conduct of the audit.
Where an audit firm or audit company is conducting an audit, section 311(2)
imposes an obligation equivalent to that under section 311(1) on the lead auditor.
If there is a failure to comply with section 311(2), the lead auditor of either the
firm or the company will have contravened the section: section 311(3). The audit
company is also taken to have contravened section 311(2) if the lead auditor fails
to adhere to their obligations.
Section 601HG, which contains similar obligations for auditors of managed
investment schemes, was amended to reflect the extended reporting obligations
placed on auditors under section 311. CLERP 9 also amended section 990K(2) of
the Act through the addition of a requirement that an auditor must give a report
to ASIC in relation to any matter that, in the opinion of the auditor, constitutes
an attempt to unduly influence, coerce, manipulate or mislead the auditor in the
conduct of the audit: section 990K(2)(c).

31 Defined under s 9 of the Act to include a review of a half-year financial report.

32 Defined under s 324AF of the Act.
33 Ibid.
34 Defined under s 324AE of the Act.
 AUDITORS AND AUDITS 231

9.6 Reducing the legal exposure of auditors

9.6.1 Overview of auditors’ liability

Like all parties, professional or otherwise, auditors may be legally liable where
they do not properly discharge their legal duties.35 This liability can arise in
three main ways. First, the auditor is engaged to perform an audit pursuant
to a contract (which is normally in writing) by a company. The auditor can be
liable for breach of contract if the audit function is not performed adequately.
Parties to a contract are always free to agree to any express terms in the contract;
however, in relation to audit services, the implied duties of an auditor include
an undertaking by the auditor to use reasonable skill and care in the conduct of
the audit.36 As result of the operation of the ‘privity’ doctrine, only the company
may sue the auditor for breach of contractual promise. Other potentially affected
parties, such as shareholders, are not a party to the contract and hence have no
standing to sue under the contract.
Second, the law on negligence provides that the auditor will be liable to parties
to whom they owe a duty of care, if they do not complete the audit to the standard
required of a professional auditor and the other party suffers loss as a result of
the negligent audit.37 To this end, it is noteworthy that existing case law has
held that not only do auditors owe a duty of care to the company, but in some
cases the duty may also extend to shareholders38 and potentially also to other
third parties, such as financiers of the company, where the financiers made the
auditors aware of the fact that the information received from the auditors will
be used to determine whether or not finance should be provided to the audited
person or entity.39
Finally, auditors can be held liable for breach of statutory duties. Where
an auditor breaches duties imposed on the auditor by statute (such as section
311), the company may sue for damages for breach of this duty.40 In these
circumstances, only the company may sue, given that the statutory duties are

35 For a detailed discussion regarding the legal liability of auditors, see Austin and Ramsay, above n 6, 666–8
paras 10.530–10.540.
36 Frankston & Hastings Corp ν Cohen (1960) 102 CLR 607.
37 For example, see Alexander ν Cambridge Credit Corp Ltd (1987) 9 NSWL 310; Northumberland Insurance
Ltd (in liq) ν Alexander (1988) 13 ACLR 170.
38 Columbia Coffee & Tea Pty Ltd ν Churchill t/as Nelson Parkhill (1992) 29 NSWLR 141; Strategic Minerals
Corp NL ν Basham (1996) 15 ACLC 1155; but cf Esanda Finance Corp Ltd ν Peat Marwick Hungerfords (1997)
188 CLR 241.
39 The circumstances in which an auditor could owe a duty of care to third parties was most recently
examined by the High Court in Esanda Finance Corp Ltd ν Peat Marwick Hungerfords (1997) 188 CLR 241. In
this case, it was held that an auditor did not have a duty of care to a financier of the company. The High Court,
however, did not state that auditors could never be liable to third parties. McHugh J, at 285, stated that: ‘The
position in Australia to date with respect to liability for pure economic loss caused by negligent misstatement
is that, absent a statement to a particular person in response to a particular request for information or advice
or an assumption of responsibility to the plaintiff for the statement, it will be difficult to establish the requisite
duty of care unless there is an intention to induce the recipient of the information or advice, or a class to which
the recipient belongs, to act or refrain from acting on it. Mere knowledge by a defendant that the information
or advice will be communicated to the plaintiff is not enough.’
40 AWA Ltd ν Daniels t/as Deloitte Haskins & Sells (No 2) (1992) 9 ACSR 983.
232 CORPORATE GOVERNANCE IN AUSTRALIA

enacted in order to protect the company.41 There are a range of other statutory
actions that might also be available to a company. The main one is the misleading
and deceptive conduct cause of action pursuant to s 52 of the Trade Practices Act
1974 (Cth).
Often, the causes of action will be overlapping. Thus, it will be open to a
company to pursue all of the causes of above action against an auditor who has
not competently audited the company’s records. The manner in which damages
are assessed will often differ. In relation to proceedings based in contract, the
general rule is that damages are assessed on the basis of one’s ‘expectation loss’.
This means that the successful party may recover the amount that is necessary
to put it in the same position as if the audit was conducted properly. Damages
in the tort of negligence are assessed on the basis of the amount that it takes
to put the plaintiff in the position prior to the negligent conduct. The quantum
of damages for breach of statutory duty is often similar to that for breach of
contractual duty.42
As a result of the operation of normal contract – and, particularly, negligence
principles – auditors potentially might be burdened with a legal liability beyond
their level of fault. A moment of inattention in checking company records can
result in an auditor failing to observe a significant problem or defect with a
company’s finances. If the defect had been detected by the auditor this may have
enabled the company to, say, stave off insolvency and thereby save many millions
of dollars. In order to redress this issue, changes introduced as part of CLERP 9
reduced the potential liability of auditors.
Two key changes that were introduced were (i) to enable audit firms to
incorporate (so that liability is restricted to the auditor(s) actually responsible);
and (ii) to introduce a system of ‘proportionate liability’ in relation to dam-
ages actions involving (but not limited to) auditors concerning economic loss or
property damage stemming from misleading and deceptive conduct.

9.6.2 Registration of audit companies

Prior to the CLERP 9 changes, only natural persons could be registered as an audi-
tor under the Corporations Act 2001; companies could not be registered as audi-
tors. Because of this, partnerships were the main business structure employed
by auditing firms. The consequence of this, given that audit partners were sub-
ject to unlimited joint and several liability for professional default, was that all
partners in an audit firm could be liable for losses caused by another partner in
the firm, even if they had no involvement in the particular conduct causing loss.
Giving audit firms the option to incorporate was considered to be the best way
to overcome this liability issue.
Section 1299A requires companies to apply to ASIC for registration as an
‘authorised audit company’. Section 1299B states that a company may only be
41 Ibid.
42 Ibid.
 AUDITORS AND AUDITS 233

registered as an authorised audit company if all of the following conditions are

met:
● each of the directors of the company is a registered company auditor and
is not disqualified from managing a corporation under Part 2D.6
● each share in the company is held and beneficially owned by a person who
is an individual or the legal representative of an individual
● a majority of the votes that may be cast at a general meeting of the company
attach to shares in the company that are held and beneficially owned by
individuals who are registered company auditors
● ASIC is satisfied that the company has adequate and appropriate profes-
sional indemnity insurance
● the company is not an externally administered body corporate.

9.6.3 Proportionate liability

Prior to the CLERP 9 reforms, audit partners in firms were jointly and severally
liable for professional default within the firm, thus exposing each partner to
unlimited liability. Auditors had traditionally protected themselves from unlim-
ited liability through professional indemnity insurance. However, as a result of
the collapse of HIH, insurers in Australia adopted much tougher risk-selection
protocols, which meant that many auditors found it extremely difficult to obtain
adequate insurance, or were paying much higher premiums to get the level of
professional indemnity insurance they wanted. As a consequence of this, many
auditing firms reduced the scope of the audit and other services provided to their
clients, in order to be able to obtain insurance, or obtain it at a reasonable rate.
In response to these problems, the CLERP 9 legislation implemented a regime
of ‘proportionate’ liability to all professional advisers, including auditors. The
basic thrust of the provisions is that for claims not involving dishonesty or delib-
erate breaches, the liability of financial advisers would be commensurate with
their degree of wrongdoing.
Section 12GP(1) of the ASIC Act provides that Subdivision GA (‘Proportionate
Liability for Misleading and Deceptive Conduct’) applies to a claim for damages if:
43
● the claim is made under section 12GF (action for damages) for eco-
nomic loss or damage to property caused by conduct that contravenes
section 12DA (misleading or deceptive conduct in relation to financial
services)
● the economic loss, or the damage to property, was not caused intentionally
or fraudulently.
43 Section 12GF of the ASIC Act 2001 (‘Action for Damages’) was amended to complement the addition of
Subdivision GA by adding a new subsection (1B), which provides that if a person makes a claim for damages
under s 12GF(1) in relation to economic loss or property damage, caused by a defendant in contravention of
s 12DA, and the claimant suffered loss or damage as a result of the claimant’s failure to take reasonable care,
and the claimant suffered loss (economic loss or property damage) both as a result partly of the claimant’s
own failure to take reasonable care, and as a result of the defendant’s action, which was neither intentional
or fraudulent, the damages are to be reduced to the extent to which the court thinks just and equitable having
regarding to the claimant’s share in the responsibility for the loss or damage.
234 CORPORATE GOVERNANCE IN AUSTRALIA

Section 12GP(3) goes on to provide a definition of ‘concurrent wrongdoer’. For

the purposes of these provisions, a ‘concurrent wrongdoer’ is one of two or more
persons whose acts or omissions, independently of each other or jointly, caused
the damage or loss that is subject to the claim. Then section 12GP(4) provides
that ‘apportionable claims’ are limited to those claims specified in subsection
12GP(1) above.
Section 12GQ(1) provides that the liability of a concurrent wrongdoer
in proceedings involving an apportionable claim (that is, a claim that fits
within section 12GP(1)) is limited to an amount reflecting that person’s
responsibility for the loss or damage in question. It also provides that the
court may give judgment against the defendant for not more than that
amount.
As a matter of clarification, section 12GR(2) states that when a matter involves
an apportionable claim and some other claim, then only the apportionable claim
is to be determined in accordance with Subdivision GA. Existing law continues
to apply to the non-apportionable claim (for example, involving wrongdoers
who intended to cause or fraudulently caused the plaintiff’s loss or damage).
Section 12GR(3) goes on to state that when apportioning responsibility between
defendants:
● the court is to exclude that proportion of the loss attributable to a plaintiff’s
contributory negligence under any relevant law
● the court may have regard to the comparative responsibility of any concur-
rent wrongdoer who is not a party to the proceedings.
Section 12GR(4) provides that the section applies in proceedings involving an
apportionable claim whether or not all concurrent wrongdoers are parties to the
proceedings.
Section 12GS states that when a defendant has reasonable grounds to believe
that a particular person may be also be a concurrent wrongdoer in a claim, and
fails to give the plaintiff written notice about the identity of the person as soon
as practicable, the court may order the defendant to pay all or any of the costs
that the plaintiff has incurred in the proceedings.
A defendant against whom a judgment is given cannot be made to contribute to
any damages or contribution recovered from another wrongdoer in respect of an
apportionable claim and cannot be required to indemnify any such wrongdoer:
section 12GT.
Section 12GT of the ASIC Act states that a plaintiff is entitled to bring an action
against a concurrent wrongdoer even though the plaintiff previously brought an
action against another concurrent wrongdoer relating to the same damage or
loss. Importantly, however, the plaintiff cannot recover damages if this would
mean that the plaintiff receives compensation greater than the loss or damage
actually sustained by the plaintiff.
Section 12GV provides that certain matters are not affected by the changes.
This means, in particular, that:
● a person may still be held vicariously liable for a proportion of any appor-
tionable claim
 AUDITORS AND AUDITS 235

● a partner may still be held severally liable with another partner for the
proportion of an apportionable claim for which the other partner is liable
● any other statutory provisions imposing several liability will not be affected.
Similar provisions to Subdivision GA of the ASIC Act outlined above have been
introduced in the Corporations Act 2001 (Cth) and the Trade Practices Act 1974.

9.7 Qualification of auditors

The audit role can only be fulfilled properly if auditors have high-level skills and
expertise. Prior to the CLERP 9 reforms, the law required prospective auditors to
have completed a three-year degree course in accountancy from an Australian
university, or to have other qualifications and experience which, in the opinion of
ASIC, was equivalent to such a degree. In addition to this, professional accounting
bodies required completion of an advanced training course in auditing; however,
this was not mandatory in order to become an auditor.
CLERP 9 introduced minimum competency, standard-based practical expe-
rience for all auditors in order to enhance public confidence in auditors. The
specific CLERP 9 amendments to the Corporations Act in this regard included:
● providing that the practical experience requirements for registration may
be satisfied by completion of all the components of a competency standard
in auditing44
● revising the education requirements for registration to include completion
of a specialist course in auditing45
● making an auditor’s continued registration subject to compliance with any
conditions that may be imposed by ASIC in accordance with the regulations
(with new Corporations Regulations introduced to deal with this)
● replacing the requirement for auditors to lodge a triennial statement with
a new requirement to lodge an annual statement46
● revising the matters that may be referred to the Companies Auditors and
Liquidators Disciplinary Board (CALDB) in light of the above.47

9.8 Uniform auditing standards

CLERP 9 amended the Corporations Act to give auditing standards the force of
law, a status long enjoyed by accounting standards. All registered company
auditors, not just professional accounting members as had been the case

44 See ss 1280A and 1280(2)(b) of the Act. New Reg 9.2.01 sets out the practical experience that is prescribed
for the purposes of subparagraph 1280(2)(b)(ii). Regulation 9.2.01 provides the applicant will have to have
had at least 3000 hours work in auditing, including at least 750 hours spent supervising the audits of
companies, during the five years immediately before the date of the application. The expression ‘work in
auditing’ means work under the direction of a registered company auditor, which includes appraising the
operations of companies and forming opinions on the matters specified in ss 307 (Audit), 308 (Auditor’s
report on annual financial report) and 309 (Auditor’s report on half-year financial report) of the Act.
45 See ss 1280(2A), 1280(2B) of the Act.
46 Section 1287A of the Act.
47 Section 1292(1) of the Act.
236 CORPORATE GOVERNANCE IN AUSTRALIA

previously, are required to use auditing standards when performing auditing

work to meet the requirements of the Act. Division 2A in Part 12 of the ASIC Act,
inserted into the legislation under CLERP 9 provisions related to:
48
● the interpretation of auditing standards
49
● powers of the AUASB to make auditing standards
● requirements that the AUASB must comply with when making standards
● the giving of directions to the AUASB by the Financial Reporting Council
(FRC, see below for more information on this body) and the Minister.
Section 307A of the Corporations Act requires audits of a financial report for a
financial year and audits or reviews of a financial report for a half-year period
to be conducted in accordance with auditing standards. Sections 308 (Auditor’s
report on annual financial report) and 309 (Auditor’s report on half-year finan-
cial report) have been amended to require auditors to include in their reports
any statements or disclosures required by the auditing standards: see sections
308(3A) and 309(5A).
The pre-CLERP 9 suite of auditing standards were deemed unenforceable
due to their many implied obligations (for example, use of phrases such as
‘the auditor considers . . . ’) and ASIC agreed not to take action on force-of-law
standards before 1 July 2006. By that date, all of the auditing standards relevant
to statutory audits had been revised and rewritten to ensure enforceability.50

9.9 Audit oversight

Prior to CLERP 9, there was little genuine oversight of the auditing profession.
The oversight that existed was largely self-regulatory in nature, undertaken to a
large part by the professional accounting bodies. This obviously carried a serious
risk that professional bodies would champion the interests of their members
rather than broader community interests, thereby potentially undermining the
quality and independence of the audit process.
Following CLERP 9, the role of the FRC, a statutory body created to oversee
the accounting standard-setting process, was expanded to include responsibility
for overseeing auditor-independence requirements and audit-standard setting.
As part of this change in audit oversight, a reconstituted Auditing and Assurance
Standards Board51 came under the auspices of the FRC, with an expanded,

48 See s 234A of the ASIC Act.

49 Section 336 of the Corporations Act provides AUASB with the authority to make auditing standards for
the purposes of the Act. An auditing standard must be in writing and must not be inconsistent with the
Corporations Act or the Corporations Regulations. See also s 1455.
50 Auditing standards are available at <www.auasb.gov.au/Standards-and-Guidance/AUASB-Standards.
aspx>.
51 Sections 227A and 227B of the ASIC Act establish the AUASB as a statutory body, and set out its func-
tions and powers. The AUASB has a number of important functions: these include the power to make an
Australian auditing standard by issuing the text of an international standard with any minimum modification
to ensure that the standard operates effectively, having regard to the existing Australian legislative frame-
work and institutional regulatory arrangements. The AUASB, when performing its functions, must follow the
broad strategic direction determined by the FRC under ss 225(2A)(c), 225(7), 234C. In relation to auditing
standards, see also, especially, s 234D(3).
 AUDITORS AND AUDITS 237

more representative membership and government-appointed chairperson (to

overcome criticisms of the body lacking independence). These arrangements
bring together, under a single oversight body – the FRC – policy advice and
oversight functions for the key elements of the financial reporting framework. It
is assumed that having policy direction coming from a single overarching body
will lead to better oversight, while at the same time protect the independence of
the two technical boards within the structure.
In order to allow it to fulfil its role, the FRC was given sweeping powers.
Section 225 of the Australian Securities and Investments Commission Act 2001
(Cth) was amended to state that the FRC is formally responsible for overseeing
both the AASB and the AUASB.
The FRC’s functions in relation to auditor independence are set out in section
225(2B) of the ASIC Act. These include:
● monitoring and assessing the nature and overall adequacy of:
– the systems and processes used by auditors to ensure compliance with
auditor independence requirements
– professional accounting bodies for planning and performing quality
assurance reviews of audit work
– the investigation and disciplinary procedures of the professional
accounting bodies
● monitoring overall compliance by companies and other entities with audit-
related disclosure requirements
● giving the Minister and professional accounting bodies reports and advice
about the above matters
● promoting the teaching of professional and business ethics by the profes-
sional accounting bodies, universities and other tertiary institutions.
Despite the FRC’s extensive role in ensuring auditor independence, enforce-
ment of auditor-independence requirements is the responsibility of either ASIC
or the professional accounting bodies (depending on whether the indepen-
dence requirement is contained in the Corporations Act or in APES 110 Code
of Ethics for Professional Accountants), rather than of the FRC. ASIC’s audit firm
inspection powers were strengthened in 2007 with passage of the Australian
Securities and Investments Commission Amendment (Audit Inspection) Act 2007
No. 1, 2007.52

9.10 Audit committees

An effective audit committee, a committee of the board of directors, can play

a critical role in financial reporting by overseeing and monitoring the manage-
ment’s and the auditor’s participation in the financial reporting process. They
can increase the credibility of the financial reporting process by monitoring

52 This Act followed release by Treasury on 30 September 2005 of a consultation paper entitled Audit
Inspection Powers of the Australian Securities and Investments Commission. The proposals related to the ability
of ASIC to cooperate with overseas audit regulators and to ASIC’s domestic audit-inspection powers.
238 CORPORATE GOVERNANCE IN AUSTRALIA

the opportunistic selection of financial accounting policies, and meeting regu-

larly with internal and external auditors, at least occasionally in the absence of
management.
Originally proposed to be part of the CLERP 9 reforms was a requirement
for all listed companies to establish an audit committee. However, ASX took
charge of this proposal since it coincided with ASX taking charge of corporate
governance best-practice recommendations, originally also proposed to be part
of CLERP 9. ASX introduced a Listing Rule effective 1 January 2003, mandating
audit committees for the top 500 companies. A subsequent review of ASX gover-
nance guidelines reduced the requirement for compliance with ASX Corporate
Governance Guidelines (2003) on committee composition and other matters to
only the top 300. Prior to this, although many listed companies had audit com-
mittees, their formation was entirely voluntary. Currently, ASX Listing Rule 12.7
requires that an entity included in the S&P All Ordinaries Index at the beginning
of its financial year have an audit committee during that year. If an entity is in
the top 300 of that Index, the composition, operation and responsibilities of the
audit committee must comply with the relevant recommendations found in ASX
Corporate Governance Principles and Recommendations (2007).
For an audit committee to be effective and not merely a cosmetic construct,
research has shown that it should be composed of independent or non-executive
directors entirely, at least some of whom have financial expertise; should have
issued an audit committee charter; and should meet frequently.53 Consistent
with these findings, Recommendation 4.2 of ASX Corporate Governance Prin-
ciples and Recommendations (2007) states that: ‘The audit committee should
be structured so that it consists only of non-executive directors, consists of a
majority of independent directors, is chaired by an independent chair, who is
not chair of the board and has at least three members.’ In terms of expertise, the
Commentary to this recommendation states that: ‘The audit committee should
include members who are all financially literate (that is, be able to read and
understand financial statements); at least one member should have relevant
qualifications and experience (that is, should be a qualified accountant or other
finance professional with experience of financial and accounting matters); and
some members should have an understanding of the industry in which the entity
operates.’
Recommendation 4.3 states that the audit committee should have a formal
charter. The Commentary states that: ‘The charter should clearly set out the
audit committee’s role and responsibilities, composition, structure and member-
ship requirements and the procedures for inviting non-committee members to
attend meetings. The audit committee should be given the necessary power and
resources to meet its charter. This will include rights of access to management,
rights to seek explanations and additional information and access to auditors,

53 For a review of this research see F T DeZoort, D R Hermanson, D Archambeault and S A Reed, ‘Audit Com-
mittee Effectiveness: A Synthesis of the Empirical Audit Committee Literature’,’ (2002) Journal of Accounting
Literature 21 at 38–75.
 AUDITORS AND AUDITS 239

internal and external, without management present.’ In terms of responsibilities

the Commentary states that: ‘The audit committee should review the integrity of
the company’s financial reporting and oversee the independence of the external
auditors.’ In terms of the frequency of meetings, the Commentary states that: ‘The
audit committee should meet often enough to undertake its role effectively.’ One
would expect that to be at least twice a year, in line with the formal reporting
requirements for disclosing entities.
Research has provided evidence consistent with increased financial report-
ing and/or audit quality in association with effective audit committees. For
instance, reduced manipulation of accounting numbers,54 greater willingness
to issue appropriately modified auditor’s reports,55 a lower incidence of fraudu-
lent financial reporting and financial restatements,56 lower incidence of auditor
switching and following an unfavourable auditor’s report,57 lower incidence of
auditor resignation58 and a higher frequency of engagement of industry specialist
auditors.59

9.11 Conclusion

It will be clear from this chapter not only that auditors and audits are nowadays
pivotal to corporate governance, but that the threshold of what is expected of
auditors and audits has been raised considerably in recent times. There is now
an expectation that auditors should be independent, that they should report
breaches of the law and that if they do not do so, action will be taken against
them – either by private suit or by the corporate regulator. The ultimate objective
with the CLERP 9 reforms and the audit committee ASX Listing Rule change,
as is the case with similar reforms in several other countries, is to ensure that
financial statements better reflect the true financial position of corporations. This
will enable investors to make sound investment decisions, based on the financial
statements reflecting the true financial position of corporations. These reforms
will not ensure that corporations do not collapse in future, but they should, it is
hoped, ensure that the signs of a collapse are detected as early as possible.
54 A Klein, ‘Audit Committee, Board of Director Characteristics, and Earnings Management’ (2002), Journal
of Accounting and Economics 33, 375–400.
55 J V Carcello and T L Neal, ‘Audit Committee Composition and Auditor Reporting’ (2000), Accounting
Review 75 at 453–67.
56 L J Abbott, S Parker and GF Peters, ‘Audit Committee Characteristics and Restatements’ (2004), Auditing:
A Journal of Practice and Theory 23 at 69–87.
57 J V Carcello and T L Neal, ‘Audit Committee Characteristics and Auditor Dismissal Following “New” Going
Concern Reports’ (2003), The Accounting Review 78 at 95–117.
58 H Y Lee, V Mande and R Ortman, ‘The Effect of Audit Committee and Board of Director Independence on
Auditor Resignation’ (2004), Auditing: A Journal of Practice and Theory 23 at 131–46.
59 Y M Chen, R Moroney and K Houghton, ‘Audit Committee Composition and the Use of An Industry
Specialist Audit Firm’ (2005), Accounting and Finance 45 at 217–39.
10
Directors’ duties and liability

Typically a director’s working (office) days were short and lunches long,
collegial, and often alcohol fuelled. How things have changed. The mindset
now is meant to be all numbers, regulation by law only, self-interest, ruth-
lessness, over-long hours, and mineral water and sandwiches at your desk.
The levels of client service and comfort are now sufficient, but no more, to
do the deal just within the law.
Bob Garratt, Thin on Top, Nicholas Brealey Publishing, London (2003) 30
Those responsible for the stewardship of HIH ignored the warning signs
at their own, the group’s and the public’s peril. The culture of apparent
indifference or deliberate disregard on the part of those responsible for the
well-being of the company set in train a series of events that culminated in
a calamity of monumental proportions.
Report of the HIH Royal Commission (Owen Report), Volume I,
Department of the Treasury (2003), xiii–xiv

10.1 Introduction

As a general rule, directors owe their duties to the company as a whole, not
to individual shareholders.1 Historically, directors’ duties and liability were dis-
cussed under general law duties (duties at common law or in equity) and, more
recently,2 were supplemented under statutory duties. Under general law duties,
most courts and commentators usually draw a distinction between fiduciary
duties and the duty to act with due care and diligence. The following duties are
generally recognised as directors’ fiduciary duties:
● directors’ duty to act honestly and in the company’s best interests
● directors’ duty not to fetter discretion
● directors’ duty to avoid a conflict of interests
● directors’ duty to exercise powers for their proper purpose.
These duties are considered to be strict duties at common law or in equity, and the
courts have held on numerous occasions that directors can be in breach of these

1 Percival v Wright [1902] 2 Ch 421. For an example of recognised exception, see Brunninghausen v Glavanics
(1999) 46 NSWLR 538.
2 For discussion on the rationale and development of directors’ statutory duties in Australia, see Jason Harris,
Anil Hargovan and Janet Austin, ‘Shareholder Primacy Revisited: Does the Public Interest Have Any Role in
Statutory Duties?’ (2008) 26 Company and Securities Law Journal 355.

240
 DIRECTORS’ DUTIES AND LIABILITY 241

duties irrespective of the fact that they acted without fault, either in the form of
negligence or intent. It has also been held that, as a general rule, the fact that
directors acted in what they believed to be in the best interests of the company
as a whole will not serve as a general defence for a breach of these duties. It also
does not matter whether the company suffered any damages.3 As long as one
of these duties are breached, several remedies are available to the company:4 it
can claim back any profits the directors made as a result of the breach of their
duties;5 it has, as a general rule,6 the option to avoid any transaction (including
contracts) concluded in breach of any of these duties; or it can force directors to
rectify what they had did in breach of any one of these duties.7
In contrast with the judicial approach to directors’ fiduciary duties, in the
case of directors’ duty to act with due care and diligence the courts originally
insisted that directors would only be in breach of this duty if they acted with gross
negligence and only if the company suffered damages because the directors acted
negligently.8 There are, however, some interesting recent decisions that illustrate
that it is not easy to classify directors’ duty of care simply as a common law duty,
an equitable duty, a fiduciary duty or a general duty of care as part of the tort of
negligence.9 In addition, under the statutory duty of care, damages suffered by
the company need not be proven, so long as there is a foreseeable risk or harm
to the company.10
Directors’ duty of care and diligence was, for many years, considered to impose
remarkably low standards on directors as the courts expected gross negligence11
as the yardstick for liability and judged a breach of these duties against subjec-
tive standards – ‘[a] director need not exhibit in the performance of his duties
a greater degree of skill than may reasonably be expected from a person of his
knowledge and experience’.12 The idea that the shareholders were ultimately
responsible for the unwise appointments of directors led to the duty of care,
skill and diligence being characterised as remarkably low.13 Historically, direc-
tors were viewed as country gentlemen and were not expected to realise the

3 Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134; ASIC v Vizard (2005) 145 FCR 57.
4 For a useful discussion on the remedies available for breach of fiduciary duty, see Western Areas Exploration
Pty Ltd v Streeter [No 3] (2009) 73 ACSR 494.
5 Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134; Furs Ltd v Tomkies (1936) 54 CLR 583.
6 The exceptions were if the company affirmed the transaction with knowledge of its right to avoid it;
innocent third parties would be prejudiced by the election to avoid the transaction; the company unduly
delayed acting to exercise its right to avoid the transaction (a form of estoppel); or it became impossible for
the parties’ rights to be restored to the position obtaining before (restitutio in integrum) the transaction was
entered into.
7 In The Australian Metropolitan Life Assurance Co Ltd v Ure (1923) 33 CLR 199 at 215–16 and 220, a
shareholder was unsuccessful in an action to force the directors to register a particular shareholder, as
the court held that in this case they had used a power conferred upon them for a proper or permissible
purpose.
8 ASIC v Rich [2009] NSWSC 1229 [7193].
9 See in particular Daniels v Anderson 16 ACSR 607 at 652 et seq; and ASIC v Rich [2009] NSWSC 1229
[7193].
10 ASIC v Rich [2009] NSWSC 1229 [7193].
11 Lindley MR in Lagunas Nitrate Co v Lagunas Nitrate Syndicate Ltd [1899] 2 Ch 392, 435.
12 Re City Equitable Fire Insurance Co Ltd [1925] Ch 407.
13 For example, see Turquand v Marshall (1869) LR 4 Ch App 376.
242 CORPORATE GOVERNANCE IN AUSTRALIA

significance of certain information in the financial accountants14 or to be aware

of the company’s affairs.15
This laidback approach to directors’ duties changed after the landmark deci-
sion in Daniels v Anderson,16 emphasising that the Australian courts are now
prepared to expect high standards of care and diligence of directors, including
non-executive directors.17
Nowadays, the statutory duties of directors in Australia are far more promi-
nent than their duties at common law or in equity.18 Under contemporary law, the
discussion of directors’ duties and liability can be adequately based on statutory
provisions in the Australian Corporations Act 2001 (Cth) (the Act), notwithstand-
ing the fact that most of the primary statutory duties imposed upon directors ‘have
effect in addition to, and not in derogation of, any rule of law relating to the duty
or liability of a person because of their office or employment in relation to a
corporation’.19 In other words, directors’ statutory duties are most prominent
irrespective of the fact that the legislature did not intend to codify directors’
duties at common law and in equity.
We have adopted the approach of explaining directors’ duties and liability
primarily by way of the statutory provisions. Not only are these provisions com-
prehensive, but in more recent times they form the basis of most of the litigation
in this area due largely to the introduction of the civil penalty provisions since
1993 and the lower standard of proof (balance of probabilities) to establish
breach of directors’ duties under the civil penalty provisions.
The enforcement of directors’ duties is of particular importance. Enforcement
of the civil penalty provisions, with reference to case studies (HIH Insurance
Ltd, James Hardie Ltd and One.Tel Ltd), are discussed below. The first part
of this chapter will demonstrate that enforcement by the Australian Securities
and Investments Commission (ASIC) of civil penalty provisions has been most
prominent in recent years. However, in Chapter 11 we will also touch upon the
enforcement of directors’ duties by the corporation under the statutory derivative
action (Part 2F.1A) and the rights of minority shareholders to apply for various

14 For example, see Re Denham and Co (1883) 25 CH D 752.

15 In Re Cardiff Savings Bank (Marquis of Bute’s case) [1892] 2 Ch 100, in dismissing a claim of negligence
against the Marquis, who had become the president of the board of the bank at the age of 6 months and held
that position for over 40 years (during which time he attended only one board meeting), the court said that
the Marquis was entitled to rely on the bank’s managers to perform their duties properly and could not be
liable for their neglect.
16 (1995) 13 ACLC 614.
17 For discussion on the development of the modern law in this area, see Anil Hargovan, ‘Corporate Law’s
New Love: Section 232(4) and the Director’s Duty of Care’ (1994) Asia Pacific Law Review 20; Sally Sievers,
‘Farewell to the Sleeping Director – The Modern Judicial and Legislative Approach to Directors’ Duties of
Care, Skill and Diligence – Further Developments’ (1993) 21 Australian Business Law Review 111; ‘Directors’
Duty of Care: What is the New Standard?’ (1997) 15 Company and Securities Law Journal 392; Julie Cassidy,
‘An Evaluation of Corporations Law s 232(4) and the Directors’ Duty of Care, Skill and Diligence’ (1995) 23
Australian Business Law Review 184.
18 This was not always the case. Prior to the insolvent trading cases in the late 1980s and early 1990s (such as
Statewide Tobacco Services v Morley (1990) 2 ACSR 405; Commonwealth Bank of Australia v Friedrich (1991) 5
ACSR 115), which articulated higher standards of care, there was a dearth of reported cases on the directors’
statutory duty of care and diligence. See further, Anil Hargovan, ‘Corporate Law’s New Love: Section 232(4)
and the Director’s Duty of Care’ (1994) Asia Pacific Law Review 20.
19 Section 185(a) of the Act.
 DIRECTORS’ DUTIES AND LIABILITY 243

remedies in the case of unfairly prejudicial or unfairly discriminatory or oppres-

sive conduct by the corporation or its directors (Part 2F.1). Finally, we will deal
with injunctions under section 1324 of the Act, allowing ASIC or ‘a person whose
interests have been affected’ by a contravention of the Act to stop such conduct
and to obtain damages suffered because of such conduct.

10.2 Part 9.4B – civil penalty provisions or

pecuniary penalty provisions

10.2.1 Overview
As far as directors’ duties and liabilities are concerned, the Act is based on
the premise that the most important duties of directors are listed under the
‘civil penalty provisions’.20 This basically means that if a breach of any of these
provisions is proven, the court will make a declaration of contravention, which
is then considered to be conclusive evidence of the following matters:21
● the court that made the declaration
● the civil penalty provision that was contravened
● the person who contravened the provision
● the conduct that constituted the contravention
● if the contravention is of a corporation/scheme civil penalty provision –
the corporation or registered scheme to which the conduct related.
Once such an order of contravention is made, there are primarily three further
orders that ASIC may seek: disqualification orders; pecuniary penalty orders
(called civil penalties in the case of corporations/scheme); or compensation
orders. The relevant corporation (or responsible entity of a registered scheme)
may also apply for a compensation order,22 and the corporation/scheme is also
entitled to intervene in any proceedings for a disqualification order or pecuniary
penalty (which may only be initiated by ASIC) and is entitled to be heard on
all matters other than whether the declaration or order should be made.23 It is
important to emphasise that a declaration order must be made before a pecu-
niary penalty or disqualification order can be sought by ASIC. A declaration of
contravention is not, however, a necessary prerequisite to a compensation order
being sought.
We have already dealt with disqualification orders, pecuniary penalty orders
(called civil penalties in the case of corporations/scheme) and compensation
orders in some detail in Chapter 7.

20 This is confirmed in para 5.3 of Part 1.5 (Small Business Guide) of the Act, listing most of the civil penalty
provisions as ‘some of the most important duties’ of directors of proprietary companies.
21 Sections 1317F and 1317E(2) of the Act.
22 See s 1317(2) of the Act.
23 See s 1317(3) of the Act. In relation to ‘financial services civil penalty provisions’ (see s 1317E(1)(ja)
to (jg)); any person who suffers damage in relation to a contravention, or alleged contravention, of such a
provision can also apply for a compensation order (see s 1317(3A)).
244 CORPORATE GOVERNANCE IN AUSTRALIA

As far as pecuniary penalty orders are concerned, a court may order a per-
son to pay the Commonwealth up to $200 000 as a pecuniary penalty or a civil
penalty – except for so-called ‘financial services civil penalty provisions’ (includ-
ing, for example, continuous disclosure, false trading, market manipulation and
insider trading) – where the maximum penalty is $1 million following amend-
ments under CLERP 9 – see section 1317G). It should be noted that civil penalty
orders have nothing to do with orders to cover damages suffered by the company
because of a breach of the civil penalty provisions. Civil penalties are statutory
penalties paid to the Commonwealth simply for a breach of what are considered
to be some of the most important provisions of the Act, namely the civil penalty
provisions mentioned in section 1317E of the Act. The main aim of these so-
called pecuniary penalty or civil penalty provisions is to highlight some of the
core provisions relating to directors’ duties in the Act and to serve as a serious
warning to all directors and officers not to contravene these provisions. This was
explained as follows in ASIC v Adler:24

It is well established that the principal purpose of a pecuniary penalty is to act as a

personal deterrent and a deterrent to the general public against a repetition of like
conduct.25

10.2.2 The civil penalty provisions in particular

10.2.2.1 Section 180: Duty of care and diligence – civil obligation26
Directors’ duty of due care and diligence are captured in section 180 of the Act.
This section provides that a director or other officer of a corporation must exercise
their powers and discharge their duties with the degree of care and diligence that
a reasonable person would exercise if they:
(a) were a director or officer of a corporation in the corporation’s circumstances
and
(b) occupied the office held by, and had the same responsibilities within the
corporation as, the director or officer.
The fact that this duty is judged against objective standards (‘a reasonable per-
son’) means that the standards of this duty have been raised considerably and is
consistent with its common law counterpart established in Daniels v Anderson27 .
No longer can directors escape a breach of this duty by relying on the fact that
subjectively they lacked the knowledge or experience to take a certain decision.
In other words, they would not be able to rely on the fact that in the performance
of their duties they did not exhibit ‘a greater degree of skill than may reasonably

24 [2002] NSWSC 483 (30 May 2002), available at <www.austlii.edu.au/cgi-bin/disp.pl/au/cases/nsw/

supreme%5fct/2002/483.html?query=%7e+asic+v+adler>.
25 ASC v Donovan; Trade Practices Commission v CSR Limited [1991] ATPR 52–135 at 125. Compare George
Gilligan, Helen Bird and Ian Ramsay, ‘Civil Penalties and the Enforcement of Directors’ Duties’ (1999) 22
University of New South Wales Law Journal 417, 438–9.
26 For a fuller discussion, see Jason Harris, Anil Hargovan and Michael Adams, Australian Corporate Law,
Sydney, LexisNexis (2nd edn, 2009), Chapter 18.
27 (1995) 37 NSWLR 438.
 DIRECTORS’ DUTIES AND LIABILITY 245

be expected from a person of [their] knowledge and experience’.28 In order to

ensure consistency in the application of this duty, two provisos were included:
that the duty of care and diligence be judged against the standards expected
of directors or officers in corporations comparable to the corporation in which
the accused director or officer held office; and that they occupied the office and
had the same responsibilities within the corporation as directors in comparable
corporations.
The expression ‘same responsibilities’ in section 180(1)(b) requires a consid-
eration of the work in fact undertaken by the relevant director or officer and
requires a consideration of the whole of the position occupied. If a director or
officer has dual roles as, for example, a company secretary and in-house counsel,
both roles are to be taken into account.29
The courts adopt the following test to determine breach of section 180(1):

In determining whether a director has exercised reasonable care and diligence one
must ask what an ordinary person, with the knowledge and experience of the defendant
might have expected to have done in the circumstances if he or she was acting on their
own behalf.30

The precise degree or standard of care and diligence required is to be determined

with reference to the particular circumstances of the company. These include a
host of circumstances such as:31
● the type of company
● the size and nature of the company’s business
● the composition of the board
● the director’s and officer’s position and responsibilities within the company
● the particular function the director or officer is performing
● the experience or skills of the particular director or officer
● the circumstances of the specific case.
The application of section 180(1) to directors (executive and non-executive)
and officers (company’s general counsel and chief financial officer (CFO)) is
demonstrated in Part 10.3.3 below with reference to the decision in ASIC v
Macdonald (No 11).32 The content of the directors’ duty of care, skill and diligence
is also discussed in Part 10.3.4 below with reference to the collection of the
contemporary case authorities and legal principles in ASIC v Rich.33

Business judgment rule

There is, however, some protection for directors against a breach of duty of care
claim in a safe-haven provision, called the ‘business judgment’ rule34 – ‘business

28 Re City Equitable Fire Insurance Co Ltd [1925] Ch 407.

29 ASIC v Macdonald (No 11) (2009) 256 ALR 199.
30 ASIC v Adler (2002) 41 ACSR 72.
31 ASIC v Maxwell (2006) 59 ACSR 373.
32 (2009) 256 ALR 199.
33 [2009] NSWSC 1229.
34 For discussion on the origins of the business judgment rule and its operation at common law, see Paul
Redmond, ‘Safe Harbours or Sleepy Hollows: Does Australia Need a Statutory Business Judgment Rule? In
246 CORPORATE GOVERNANCE IN AUSTRALIA

judgment’ means any decision to take or not take action in respect of a matter
relevant to the business operations of the corporation.35 It is assumed that direc-
tors and other officers acted with the required degree of care and diligence if, in
exercising a business judgment, they meet four standards (section 180(2)):
(a) they must have made the judgment in good faith for a proper purpose
(b) they must not have had a material personal interest in the subject matter
of the judgment
(c) they must have informed themselves about the subject matter of the judg-
ment to the extent they reasonably believed to be appropriate
(d) they must have rationally believed that the judgment was in the best inter-
ests of the corporation.
As far as the last requirement is concerned, it is provided that the director’s or offi-
cer’s belief that the judgment is in the best interests of the corporation is a rational
one unless the belief is one that no reasonable person in their position would hold.
It should be noted that this provides considerable protection to directors as the
requirement is not the ordinary objective requirement that ‘a reasonable person in
their position will hold’, but that ‘no reasonable person in their position will hold’.
This ensures that only in extreme circumstances, where they blindly believed
something that ‘no other person in their position’ would believe, will a court with-
hold the protection of the business judgment rule based on the fact that it was not
a rational belief that their business judgment was in the best interest of the cor-
poration. The operation of the business judgment rule is discussed further in Part
10.3.4 below with reference to its application in ASIC v Adler36 and to the judicial
views on its meaning expressed by Austin J in ASIC v Rich37 – see Part 10.3.4
below.
It is of considerable importance to note that the business judgment rule will
only provide protection to directors when the courts must consider whether they
acted with the required care and diligence. It does not operate in relation to
duties under any other provision of the Act; for example, the duty to act in good
faith (section 181); the duty not to use their position to gain personally or cause
detriment to the corporation (section 182); the duty not to use information to
gain personally or cause detriment to the corporation (section 183); or the duty
to prevent insolvent trading (section 588G).
To illustrate this with an example: directors will still be liable under the
insolvent trading provision (section 588G) if they incurred a debt when the
company was insolvent or if there were reasonable grounds to suspect that
the company was insolvent, irrespective of the fact that they based that decision
on what could be considered to be a sound business judgment under section
180(2) of the Act. They may well be protected under section 180(2), but since
that protection applies only to their duty of care and diligence, the protection
will not be extended to the insolvent trading provisions as the law stands at
I Ramsay (ed.), Corporate Governance and the Duties of Company Directors, Melbourne, Melbourne University
Centre for Corporate Law and Securities Regulation (1997).
35 Section 180(3) of the Act.
36 [2002] 41 ACSR 72.
37 [2009] NSWSC 1229.
 DIRECTORS’ DUTIES AND LIABILITY 247

the time of writing. The Australian Government in January 2010 has, however
released a set of possible options for law reform that includes the prospect of
a business judgment rule as a safe harbour from directors’ personal liability
for insolvent trading (see further, Treasury, Insolvent Trading: A Safe Harbour
for Reorganisation Attempts Outside of External Administration). Meanwhile, the
director will have to rely on the statutory defences to insolvent trading contained
in section 588(H), which is discussed in Part 10.2.2.7 below.

Delegation and reliance

The ability to delegate responsibilities and rely on subordinates to carry out a
task is an essential part of effective management. The general law (ASIC v Adler
(2002) 41 ACSR 72) and sections 198D and 189 of the Act permit directors to
delegate powers and to reasonably rely on others for information or advice.
In order to obtain the benefit of the reliance defence, the director’s reliance on
others must be reasonable, which is to be determined on the facts of each case.
Justice Santow, in ASIC v Adler,38 collated the judicial authorities on this issue
and offered the following general legal principles in determining reasonableness:
● The function that has been delegated is such that it is proper to leave it to
the delegate.
● The extent to which the director is put on enquiry, or given the facts of a
case, should have been put on enquiry.
● The relationship between the director and the delegate must be such that
the director honestly holds the belief that the delegate is trustworthy, com-
petent and someone upon whom reliance can be placed. Knowledge that
the delegate is dishonest and incompetent will make reliance unreason-
able.
● The risk involved in the transaction and the nature of the transaction.
● The extent of steps taken by the director; for example, inquiries made or
other circumstances engendering trust.
● Whether the position of the director is executive or non-executive
(although, as noted by Justice Santow, the majority judges in Daniels v
Anderson (1995) 37 NSWLR 438 moved away from this distinction).
The reliance defence is unavailable when management specifically brings a mat-
ter before the board for attention and the task for consideration is not an onerous
one, as illustrated in ASIC v Macdonald (No 11),which is discussed further in
Part 10.3.3 below.

10.2.2.2 Section 181: Duty of good faith – civil obligation39

A director or other officer of a corporation is also expected to exercise their
powers and discharge their duties:
(a) in good faith in the best interests of the corporation and
(b) for a proper purpose.

38 (2002) 41 ACSR 72.

39 For a fuller discussion, see Harris, Hargovan and Adams, above n 26, Chapter 16.
248 CORPORATE GOVERNANCE IN AUSTRALIA

This duty is a slight extension of the fiduciary duty of directors that they must
always act bona fide in the best interests of the corporation. The part that has been
added is that they must also act for a ‘proper purpose’. This part was included
because of several court cases in which it was held that if directors based their
decisions primarily or substantially within the purpose for which a particular
power was conferred upon them, a court would not set such decisions aside
irrespective of the fact that partially or incidentally the power might have been
exercised for an improper or impermissible purpose. On the other hand, if the
decision was primarily or substantially taken for an improper or impermissible
purpose (for example, issuing shares with a view to defending a hostile takeover
of the company), a court will set such a decision aside irrespective of the fact
that partially or incidentally the power might have been exercised for a proper
purpose. Once the court has determined that primarily or substantially the power
was misused, it will not help the directors to allege that they had not gained
personally, that the company had benefited from the conduct or that they had
acted honestly – the conduct of the directors under attack will then be set aside
because of the breach of their strict fiduciary duty to exercise their powers for
the purpose for which the power was conferred upon them.40

10.2.2.3 Sections 182 and 183: Duty not to use position or information to
gain personally or cause detriment to the corporation41
These two duties are discussed together because they deal with basically the
same situation. They cover typical conflict of interests situations. Because direc-
tors occupy a unique position and have access to lots of information about the
corporation’s business, they may not use their position or the information they
obtain as directors to gain personally; or to gain an advantage for someone else;
or use their position or the information they obtain as directors to the detri-
ment of the corporation. This duty will also cover situations in which directors
use a corporate opportunity to make a secret profit or to allow someone else to
gain from a corporate opportunity. It originates from the strict fiduciary duty on
directors to act in the best interests of the corporation and to prevent a conflict
between their duty to the corporation and their own self-interest. In the High
Court decision of Hospital Products Ltd v United States Surgical Corporation,42
Dawson J described a fiduciary duty in the following terms:
Inherent in the nature of the fiduciary relationship itself is a position of disadvantage or
vulnerability on the part of one of the parties which causes him to place reliance upon the
other and requires the protection of equity acting upon the conscience of that other. From
that springs the requirement that a person under a fiduciary obligation shall not put
himself in a position where his interest and duty conflict or, if conflict is unavoidable,
shall resolve it in favour of duty and shall not, except by special arrangement, make a
profit out of his position. (emphasis added)

40 See Jean J du Plessis, ‘Directors’ Duty to Use their Powers for Proper or Permissible Purposes’ (2004) 16
South African Mercantile Law Journal 308, 320.
41 For a fuller discussion, see Harris, Hargovan and Adams, above n 26, Chapter 17.
42 (1984) 55 ALR 417 at 488.
 DIRECTORS’ DUTIES AND LIABILITY 249

The following rationale for the no-conflict rule and its codification was offered
by Justice Finkelstein in ASIC v Vizard:43

[Sections 182 and 183] bear the stamp of ‘regulatory offences’. On a daily basis, a
director of a large public company will come across information that is not available
to the public or even to the company’s shareholders. According to the common law a
director is denied the ability to use such information for his or her own purposes. It does
not matter that the director’s action causes no harm to the company or does not rob it of
an opportunity which it might have exercised for its own advantage: Regal (Hastings)
Ltd v Gulliver [1942] UKHL 1; [1967] 2 AC 134. This rule admits of few exceptions.
Parliament realised that the common law was too often ignored. The temptation to
make an improper profit was too great. So Parliament decided to act. The Companies
Acts were amended to create an offence if a director misused information obtained by
reason of his fiduciary position. It is in this sense that the sections are regulatory in
character, directed to avoiding the potential harmful consequences of a particular type
of conduct.
[Section 183 has] another equally important purpose. [It] seek[s] to establish a norm
of behaviour that is necessary for the proper conduct of commercial life and so that
people will have confidence that the running of the marketplace is in safe hands. For
this reason a contravention of . . . s 183 carries with it a significant degree of moral
blameworthiness. There is moral blameworthiness because a contravention involves a
serious breach of trust.

It should be noted that the duties in sections 182 and 183 also apply to the
company’s employees.

10.2.2.4 Part 2E: Duty relating to related party transactions

Part 2E stems from the recommendations made by the Companies and Secu-
rities Advisory Committee (CSAC) in its Report on Reform of the Law Govern-
ing Corporate Financial Transactions in 1991. The Committee’s draft legislation
was intended to introduce ‘detailed procedures to monitor and control those
matters which [are] otherwise vulnerable to abuse by corporate controllers’,
including loans to directors, inter-corporate loans, asset transfers and excessive
remuneration.44
The underlying principle introduced by the legislation was that financial ben-
efits given to persons who are in a position to significantly influence the decision
to give the benefit should be subject to shareholder approval unless they are on
commercial terms. The legislation is based on the notion that ‘uncommercial’
transactions with related parties should be referred to disinterested sharehold-
ers before the transactions take place. These sentiments are currently echoed in
Section 207, which states the object of Part 2E as being to protect the interests
of a public company’s members as a whole, by requiring member approval for
giving financial benefits to related parties that could endanger those interests.

43 (2005) 145 FCR 57 at [28]–[29].

44 CSAC, Report on Reform of the Law Governing Corporate Financial Transaction, Canberra, The Committee
(1991) 11–12.
250 CORPORATE GOVERNANCE IN AUSTRALIA

Part 2E prohibits a company from giving a financial benefit to a related party

of the company, unless:45
(a) the giving of the financial benefit falls within one of several exceptions to
the provision or
(b) prior approval is obtained from shareholders to the giving of the financial
benefit.
For the purposes of Part 2E, each director of a public company is considered to
be a related party of the public company. ‘Financial benefit’ is given a very wide
meaning. In order to determine whether a transaction is a ‘financial benefit’, the
economic and commercial substance of the transaction will be considered, and
it is as a general rule irrelevant whether the related party delivered services or
paid something (consideration given) to receive the financial benefit. ‘Giving
a financial benefit’ includes things like making an informal agreement, oral
agreement or agreement that has no binding force. It can be considered to be
giving a financial benefit even if it does not involve paying money, but only
conferring a financial advantage on the related party. The following examples
are given of financial benefits:46
(a) giving or providing the related party finance or property
(b) buying an asset from or selling an asset to the related party
(c) leasing an asset from or to the related party
(d) supplying services to or receiving services from the related party
(e) issuing securities or granting an option to the related party
(f) taking up or releasing an obligation of the related party.
Two of the main exceptions, where members’ approval is not required when a
financial benefit is given to a related party, are arm’s-length transactions47 and
reasonable remuneration and reimbursement of expenses incurred by directors
and other officers.48
The civil penalty provisions will be contravened if a financial benefit is given
to a related party without prior approval of the general meeting or without it
falling under one of the statutory exceptions.49 The operation of these provisions
is illustrated below in Part 10.3.2 with reference to the decision in ASIC v Adler.50

10.2.2.5 Part 2H: Duty relating to share capital transactions

Part 2H covers several prohibitions regarding share capital transactions. For
instance, a corporation may reduce its share capital only if it is permitted or if it
complies with the specific provisions for such a reduction in the Act.51 A corpora-
tion may only acquire its own shares under the limited circumstances provided
for in the Act.52 Furthermore, a corporation may only give financial assistance to
45 Sections 208–29 of the Act.
46 S 229 of the Act.
47 S 210 of the Act.
48 S 211 of the Act.
49 S 1317(1)(b) of the Act.
50 (2002) 41 ACSR 72.
51 Section 256B of the Act.
52 Sections 259A and 259B of the Act.
 DIRECTORS’ DUTIES AND LIABILITY 251

a person to acquire shares in that corporation under the limited circumstances

provided for in the Act.53 All the prohibitions are listed as civil penalty provi-
sions, and will expose the directors or officers of corporations contravening these
provisions to any of the orders described above.54

10.2.2.6 Part 2M.2 and 2M.3: Duty relating to requirements for

financial reports
Part 2M.2 and 2M.3 contain detailed provisions regarding keeping of finan-
cial records, financial reporting and directors’ reports. As part of the CLERP 9
amendments (2004), discussed in greater detail in Chapter 8 of this book, sev-
eral of these provisions were refined, and new obligations added to ensure that
sound financial and other information is available to the public regarding the cor-
poration’s financial performance and financial practices. These provisions require
directors to take all reasonable steps to comply with or to secure compliance with
Part 2M.2 and 2M.3. This is quite an important civil penalty provision, especially
in light of the corporate collapses in Australia between 2000 and 2003.55

10.2.2.7 Part 5.7B: Duty to prevent insolvent trading56

Section 588G of the Act imposes a positive duty on directors to prevent insolvent
trading by the corporation. The statutory purpose of this section was recently
considered by the New South Wales Court of Appeal in Edwards v ASIC:57
[It] is to discourage and provide a remedy for a particular type of commercial dishon-
esty or irresponsibility . . . [which] occurs when a company that is at or approaching
insolvency obtains a loan, or obtains property or services on credit, and either there is a
director who knows or suspects the insolvency or approaching insolvency, or a reason-
able person in the director’s position would know or suspect it. In that situation, any
director . . . can be made personally liable . . . The section aims to encourage directors
to carry out their duties properly if the company is at or approaching insolvency, and
provides a sanction if they do not.

This section applies to a person who is a director of a company at the time when
the company incurs a debt; and the company is insolvent at that time, or becomes
insolvent by incurring that debt, or by incurring at that time debts including that
debt; and at that time, there are reasonable grounds for suspecting that the
company is insolvent, or would so become insolvent, as the case may be.58 It is
important to note that the extended definition of director under section 9 of the
Act discussed earlier in Chapter 4, which includes de facto and shadow directors,
applies to this provision.

53 Section 260A of the Act.

54 Section 1317(1)(c) of the Act.
55 The duty relating to the requirements for financial reports is made a civil penalty under ss 344(1) and
1317E(1)(d) of the Act.
56 For a fuller discussion, see Harris, Hargovan and Adams, above n 26, Chapter 19.
57 [2009] NSWCA 424 at [3] per Cambell JA.
58 For a list of relevant factors that may be used to determine whether there are reasonable grounds to
suspect insolvency, see ASIC v Plymin (2003) 46 ACSR 126; Re Damilock Pty Ltd (In Liq); Lewis and Carter as
Liquidators of Damilock Pty Ltd (In Liq) v VI SA Australia Pty Ltd (2009) 252 ALR 533.
252 CORPORATE GOVERNANCE IN AUSTRALIA

Section 95A of the Act provides that a company is insolvent if, and only if, the
company is unable to pay all the company’s debts, as and when they become due
and payable. A temporary lack of liquidity does not mean there is insolvency.59
The practical difficulties in assessing insolvent trading, and some of the indicia
of insolvency, is recognised by Justice Palmer in the following passage in Hall v
Poolman:60

The law recognises that there is sometimes no clear dividing line between solvency
and insolvency from the perspective of the directors of a trading company which is
in difficulties. There is a difference between temporary illiquidity and ‘an endemic
shortage of working capital whereby liquidity can only restored by a successful outcome
of business ventures in which the existing working capital has been deployed’ . . . The first
is an embarrassment, the second is a disaster. It is easy enough to tell the difference
in hindsight, when the company has either weathered the storm or foundered with
all hands; sometimes it is not so easy when the company is still contending with the
waves. Lack of liquidity is not conclusive of insolvency, neither is availability of assets
conclusive of solvency. (emphasis added)

Section 588E of the Act assists in proving insolvency under section 588G by
allowing for the following rebuttable presumptions to be made:
● Continuing insolvency – if it can be proved that a company was insolvent
at a particular time during the 12 months ending on the ‘relation-back
day’ (as defined in section 9 of the Act as the date of filing the application
for a compulsory winding up), it is presumed that the company remained
insolvent thereafter
● Absence of accounting records – if the company has contravened either
section 286(1) or (2) by failing to keep or retain adequate financial records
for seven years (except for a minor or technical breach), it is presumed that
the company is insolvent during the period of contravention.
The Act does not contain a definition of ‘debt’. What, then, is a debt for pur-
poses of the insolvent trading provisions? Section 588G captures trading debts61
(including contingent debts such as guarantees)62 and a range of ‘deemed debts’
under section 588G(1A) linked to certain share capital transactions undertaken
by the company. For example, when the directors make a decision to pay divi-
dends, the debt so incurred will be considered to be when the dividend is paid or,
if the company has a constitution that provides for the declaration of dividends,
when the dividend is declared. Another example is that when directors incur
a debt by providing financial assistance to a person, within the circumstances
permitted for such assistance (see discussion above), the debt will be considered

59 Sandell v Porter (1966) 115 CLR 666. The authorities in relation to determining whether a company is
insolvent are exhaustively analysed by Mandie J in ASIC v Plymin (2003) 46 ACSR 126 at [370]-[380].
60 (2007) 65 ACSR 123 [at 266].
61 For consideration of the question ‘when does a company incur a debt?’, see collection of authorities
discussed in Playspace Playground Pty Ltd v Osborn [2009] FCA 1486; Edwards v ASIC [2009] NSWCA 424
held that quantum meruit liabilities are debts for purposes of s 558G.
62 Hawkins v Bank of China (1992) 7 ACSR 349.
 DIRECTORS’ DUTIES AND LIABILITY 253

to be incurred when the agreement to provide the assistance is entered into or,
if there is no agreement, when the assistance is provided.
It is by failing to prevent the company from incurring the debt that the person
contravenes this civil penalty provision. There are certain further requirements
for a contravention, namely that:
(a) the person was aware at that time that there were grounds for suspecting
that the debt would render the company insolvent or
(b) a reasonable person in a like position in a company in the company’s
circumstances would be so aware.
Directors need to be vigilant about this duty as it has the potential to make
them liable for huge amounts.63 A non-executive, honorary, director of a com-
pany limited by guarantee in Commonwealth Bank of Australia v Friedrich64 was
found personally liable (under the predecessor provisions to section 588G) for
a substantial corporate debt of $97 million owed to the bank. Apart from civil
liability, where insolvent trading is accompanied with a dishonest intent, there
is a separate criminal offence that may result in a fine and/or imprisonment (up
to five years).
Section 588H contains a number of defences to insolvent trading and a director
is entitled to rely on any one or more of the following statutory defences.

Reasonable expectation of solvency (s 588H(2))65

The courts require evidence greater than a mere hope or possibility that the
company will be solvent. In explaining the concept of ‘expectation’, Austin J in
Tourprint International Pty Ltd v Bott (1999) 32 ACSR 201 at para. 67 held:

Expectation . . . means a higher degree of certainty than ‘mere hope or possibility’ or

‘suspecting’ . . . The defence requires an actual expectation that the company was and
would continue to be solvent, and that the grounds for so expecting are reasonable. A
director cannot rely on complete ignorance of or neglect of duty . . . and cannot hide
behind ignorance of the company’s affairs which is of their own making of, if not . . . has
been contributed to by their own failure to make further necessary inquiries.

Palmer J in Hall v Poolman66 offers guidance on the approach required to dis-

charge the defence in section 588H(2):

There comes a point where the reasonable director must inform himself or herself
as fully as possible of all relevant facts and then ask himself or herself and the other
directors: ‘How sure are we that this asset can be turned into cash to pay all our debts,
present and to be incurred, within three months? Is that outcome certain, probable,
more likely than not, possible, possible with a bit of luck, possible with a lot of luck,
remote, or is there is no real way of knowing?’ If the honest and reasonable answer is

63 Insolvent trading is made a civil penalty under ss 588G(2) and 1317E(1)(e) of the Act.
64 (1991) 5 ACSR 115.
65 For case examples on the operation of this defence, see Statewide Tobacco Services v Morley (1990) 2 ACSR
405; Metropolitan Fire Systems v Miller (1997) 23 ACSR 699; Tourprint International Pty Ltd v Bott (1999) 32
ACSR 201; Hall v Poolman (2007) 65 ACSR 123; McLellan (in the matter of The Stake Man Pty Ltd) v Carroll
[2009] FCA 1415.
66 Hall v Poolman (2007) 65 ACSR 123 [at 269].
254 CORPORATE GOVERNANCE IN AUSTRALIA

‘certain’ or ‘probable’, the director can have a reasonable expectation of solvency. If the
honest and reasonable answer is anywhere from ‘possible’ to “no way of knowing”, the
director can have no reasonable expectation of solvency.

Reasonable reliance on others providing the information on the solvency of the

company (s 588H(3))67
Directors will not be able to rely on section 588H(3) where they are put on
enquiry as to whether the delegate was fulfilling their responsibilities and they
do not make enquiries and receive reasonable assurances that the duties are
being performed.68 Distrust of the person relied upon for financial information
will also negate the defence.69

Illness or some other good reason resulting in absence from

management (s 588H(4))70
The law’s intolerance of ‘sleeping, or passive, directors or a director who is absent
from management because of their total reliance on their spousal director due
to their love and faith is captured in the following passage by Chief Justice
Spigelman in DCT v Clarke:71
Sections 588G and 588H was based on the assumption that a director would participate
in the management of the company. This assumption strongly suggests that a total
failure to participate, for whatever reason, should not be regarded as a ‘good reason’ for
failing to participate at a particular time . . . it is a basal structural feature of corporations
legislation in Australia that directors are expected to participate in the management of
the corporation.

Reasonable steps to prevent the company from incurring any debts (s 588H(5))
This defence may be established if the director has acted swiftly in their decision to
appoint a voluntary administration to take over the management of the company:
section 588H(6). If the director is unable to persuade the board to pass a written
resolution to appoint a voluntary administrator, the director should either seek
to wind up the company or resign to protect themselves from personal liability.72

10.2.2.8 Part 5C: Duties relating to managed investment schemes

Part 5C of the Act contains provisions regarding the registration of a managed
investment scheme; the corporate form it must use; its constitution; and how
it must be administered. This part contains several duties for directors of these
managed investment schemes. There is also a special requirement that if less
67 For case examples on the operation of this defence, see Manpac Industries Pty Ltd v Ceccattini (2002) 20
ACLC 1304; Williams v Scholz [2007] QSC 266; McLellan (in the matter of The Stake Man Pty Ltd) v Carroll
[2009] FCA 1415. See further, Anil Hargovan, ‘Relevance of Directors’ Unsecured Borrowings, Guarantees
and Honesty in Determining Liability for Insolvent Trading’ (2009) 17 Insolvency Law Journal 36.
68 ASIC v Plymin (No 1) (2003) 175 FLR 124; affirmed Elliot v ASIC (2004) 48 ACSR 621.
69 Williams v Scholz [2007] QSC 266; affirmed [2008] QCA 94.
70 For case examples on the operation of this defence, see DCT v Clarke (2003) 57 NSWLR 113; Williams v
Scholz [2007] QSC 266.
71 [2003] NSWCA 91 at paras. 114 and 116.
72 Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405; affirmed [1993] 1 VR 423.
 DIRECTORS’ DUTIES AND LIABILITY 255

than half of the directors of the responsible entity (a public company) are exter-
nal directors, the responsible entity must establish a compliance committee.73
Section 601 imposes duties, similar to the duties on directors, on the members
of the compliance committee, who are expected:
(a) to act honestly and
(b) to exercise the degree of care and diligence that a reasonable person would
exercise if they were in the member’s position and
(c) not to make use of information acquired through being a member of the
committee in order to:
i. gain an improper advantage for the member or another person or
ii. cause detriment to the members of the scheme and
(d) not make improper use of their position as a member of the committee to
gain, directly or indirectly, an advantage for themselves or for any other
person or to cause detriment to the members of the scheme.
A breach of any of these duties will expose the members of the compliance
committee or the directors to any of the orders a court may make under the civil
penalty provisions.74

10.2.2.9 Chapter 6CA: Duty relating to continuous disclosure

We have already dealt with the introduction of the continuous disclosure pro-
visions: in Chapter 8 as part of the CLERP 9 amendments to the Act and
when discussing the Australian Securities Exchange (ASX) Best Practice Rec-
ommendations and the recommendation that listed companies have in place a
‘trading policy’ to ensure compliance with their continuous disclosure obliga-
tions. Suffice here to point out that non-compliance with the continuous disclo-
sure provisions is considered to be a contravention of a ‘financial services civil
penalty provision’, in which a higher maximum penalty applies (as mentioned
above).75

10.2.2.10 Part 7.10: Duty not to be involved in market misconduct and

other prohibited conduct relating to financial products and
financial services
Market manipulation
A person must not take part in, or carry out (whether directly or indirectly
and whether in this jurisdiction or elsewhere)76 a transaction that has or is
likely to have, or two or more transactions that have, or are likely to have,
the effect of creating an artificial price for trading in financial products on a
financial market operated in this jurisdiction; or maintaining at a level that is
artificial (whether or not it was previously artificial) a price for trading in financial

73 Section 601JA(2) of the Act.

74 The duty relating to managed investment schemes is made a civil penalty under ss 588G(2) and
1317E(1)(e) of the Act.
75 The continuous disclosure provisions are made civil penalty provisions under s 1317E(1)(ja) of the Act.
76 Section 1041A of the Act.
256 CORPORATE GOVERNANCE IN AUSTRALIA

products on a financial market operated in this jurisdiction. All these forms of

market manipulation are considered to be contravention of a ‘financial services
civil penalty provision’.77

False trading and market rigging

A person must not do, or omit to do, an act (whether in this jurisdiction or
elsewhere) if that act or omission has or is likely to have the effect of creating, or
causing the creation of, a false or misleading appearance of: (1) active trading
in financial products on a financial market operated in this jurisdiction; or (2)
the price for trading in financial products on a financial market operated in this
jurisdiction.78
A person is taken to have created a false or misleading appearance of active
trading in particular financial products on a financial market if the person enters
into, or carries out, either directly or indirectly, any transaction of acquisition
or disposal of any of those financial products that does not involve any change
in the beneficial ownership of the products; or makes an offer (the regulated
offer) to acquire or to dispose of any of those financial products in the follow-
ing circumstances: the offer is to acquire or to dispose of at a specified price;
and the person has made or proposes to make, or knows that an associate of
the person has made or proposes to make, if the regulated offer is an offer to
acquire – an offer to dispose of; or if the regulated offer is an offer to dispose of –
an offer to acquire; the same number, or substantially the same number, of those
financial products at a price that is substantially the same as the price referred to
above.
An acquisition or disposal of financial products does not involve a change
in the beneficial ownership if a person who had an interest in the financial
products before the acquisition or disposal, or an associate of such a person, has
an interest in the financial products after the acquisition or disposal. A transaction
of acquisition or disposal of financial products includes a reference to the making
of an offer to acquire or dispose of financial products; and a reference to the
making of an invitation, however expressed, that expressly or impliedly invites
a person to offer to acquire or dispose of financial products.
The Act also prohibits a person (whether in this jurisdiction or elsewhere)
from entering into, or engaging in, a fictitious or artificial transaction or device
if that transaction or device results in the price for trading in financial products
on a financial market operated in this jurisdiction being maintained, inflated
or depressed; or fluctuations in the price for trading in financial products on a
financial market operated in this jurisdiction.79
Any such false trading, market rigging and artificial price maintenance are
contraventions of ‘financial services civil penalty provisions’.80

77 Section 1317E(1)(jb) of the Act.

78 Section 1041B of the Act.
79 Section 1041C of the Act.
80 Section 1317E(1)(jc) and (jd) of the Act.
 DIRECTORS’ DUTIES AND LIABILITY 257

Dissemination of information about illegal transactions

A person must not (whether in this jurisdiction or elsewhere) circulate or dis-
seminate, or be involved in the circulation or dissemination of, any statement
or information to the effect that the price for trading in financial products on a
financial market operated in this jurisdiction will, or is likely to, rise or fall, or be
maintained, because of a transaction, or other act or thing done, in relation to
those financial products, if the transaction, or thing done, constitutes or would
constitute a contravention of inter alia the prohibitions regarding false trading,
market rigging and artificial price maintenance described above; and the person,
or an associate of the person, has entered into such a transaction or done such
an act or thing; or has received, or may receive, directly or indirectly, a consid-
eration or benefit for circulating or disseminating, or authorising the circulation
or dissemination of, the statement or information.81
Any such dissemination of information about illegal transactions is a contra-
vention of a ‘financial services civil penalty provision’.82

Insider trading83
Part 7.10 – Division 3 contains the general prohibition on a person trading
in financial products (defined in Division 3; for instance, securities, deriva-
tives and debentures) when that person is in possession of inside information.
‘Inside information’ is defined as information that is not generally available
or, if the information were generally available, a reasonable person would
expect it to have a material effect on the price or value of a particular financial
product.84
A person with inside information (the insider) may not apply for, acquire,
or dispose of, any of the defined financial products, or enter into an agreement
to apply for, acquire, or dispose of, such financial products or procure another
person to apply for, acquire, or dispose of such financial products, or enter
into an agreement to apply for, acquire, or dispose of such financial products.85
‘Procuring’ is defined as inciting, inducing or encouraging an act or omission of
another person by a person in possession of inside information.86
The insider must also not, directly or indirectly, communicate the inside
information (so-called ‘tipping’), or cause the information to be communicated,
to another person if the insider knows, or ought reasonably to know, that the
other person would or would be likely to apply for, acquire, or dispose of, the
defined financial products, or enter into an agreement to apply for, acquire,
or dispose of, such financial products or procure another person to apply for,

81 Section 1041D of the Act.

82 Section 1317E(1)(je) of the Act.
83 See Gregory Lyon and Jean J du Plessis, The Law of Insider Trading in Australia, Sydney, Federation Press
(2005) for a comprehensive analysis of all legal aspects pertaining to insider trading.
84 Section 1042A of the Act.
85 Section 1043A(1) of the Act.
86 Section 1042A of the Act.
258 CORPORATE GOVERNANCE IN AUSTRALIA

acquire, or dispose of such financial products, or enter into an agreement to

apply for, acquire, or dispose of such financial products.87
Any contravention of the insider trading provisions is a contravention of a
‘financial services civil penalty provision’.88

10.2.2.11 Subclause 29(6) of Schedule 4: Duty relating to disclosure for

proposed demutualisation
Clause 3 of Schedule 4 to the Act provides for some transitional arrangements
for the registration of transferring financial institutions or friendly societies as
companies. Subclause 29(6) of Schedule 4 lays down several rules regarding
modification of the constitution of such unlisted companies. For instance, if such
modification would have the effect of varying or cancelling the rights of members,
or a class of members, to the reserves of the company; or varying or cancelling
the rights of members, or a class of members, to the assets of the company on a
winding up; or varying or cancelling the voting rights of members or a class of
members etc., the following rules will apply:
(a) The notice of the meeting of the company’s members at which the pro-
posed modification is to be considered must be accompanied by certain
documents listed in subclause 29(4) of Schedule 4 (namely a disclosure
document estimating the financial benefits to members if the proposed
modification occurs, and an expert’s report indicating whether the pro-
posed modification is in the best interests of the company as a whole)
and
(b) The notice of the meeting may not be shortened under subsection 249H(2)
of the Act and
(c) The company must lodge with ASIC the notice and the documents referred
to in paragraphs (4)(a) and (c) within seven days after notice of the meeting
is given.
A substantially similar procedure applies if the unlisted entity proposes to issue
shares.
A contravention of any of these rules is considered to be a contravention of a
‘financial services civil penalty provision’ and will expose those involved in such
contraventions to any of the orders discussed above.89

10.2.2.12 Relief from civil liability90

Section 1317S gives the court discretion to relieve from liability persons, either
wholly or partly, held liable to pay compensation if it appears that the person
acted honestly and having regard to all the circumstances of the case ought
fairly to be excused. Section 1318 provides similar relief against breaches of civil
penalty provisions. The purpose of these sections are ‘to excuse company officers
from liability in situations where it would be unjust and oppressive not to do
87 Section 1043A(2) of the Act.
88 Section 1317E(1)(jf) and (jg) of the Act.
89 Section 1317E(1)(k) of the Act.
90 This discussion draws upon Michael Adams, Jason Harris and Anil Hargovan, Chapter 13 ‘Officers’ in
Australian Corporation Practice, LexisNexis Loose-leaf Service.
 DIRECTORS’ DUTIES AND LIABILITY 259

so, recognising that such officers are businessmen and women who act in an
environment involving risk in commercial decision-making’: Daniels v Anderson
(1995) 37 NSWLR 438 at 525. Acting honestly, which underpins both sections,
means to act ‘without moral turpitude’.91 In Hall v Poolman,92 Justice Palmer
considered the following factors as relevant in assessing honesty:
whether the person has acted without deceit or conscious impropriety, without intent
to gain improper benefit or advantage for himself, herself or another, and without
carelessness or imprudence to such a degree as to demonstrate that no genuine attempt
at all has been to carry out the duties and obligations of his or her office imposed by
the Corporations Act or the general law.

There have not been many successful cases in which the directors have benefited
from the operation of these discretionary provisions. The recent decisions in Hall
v Poolman and in McLellan (in the matter of The Stake Man Pty Ltd) v Carroll93
are, however, a notable exception to the trend of judicial reluctance in this
regard. In the former case, a director was partially absolved from liability for
debts incurred during insolvent trading in breach of section 588G, discussed
earlier. Significantly, the latter case is the first in which a director has been fully
exonerated from personal liability through the exercise of judicial discretion.
The court in Hall v Poolman was influenced by the commercial conduct of
the director, who was found to have acted in a reasonable manner, for a limited
time, when attempting to save the business while negotiating over a large debt
with the Australian Taxation Office. In adopting an approach widely regarded
by commentators as commercially realistic, Justice Palmer in Hall v Poolman94
made the following observations:
Experienced company directors . . . would appreciate that, in some cases, it is not com-
mercially sensible to summon the administrators or to abandon a substantial trading
enterprise to the liquidators as soon as any liquidity shortage occurs. In some cases a
reasonable time must be allowed to a director to assess whether the company’s diffi-
culty is temporary and remediable or endemic and fatal. The commercial reality is that
creditors will usually allow some time for payment beyond normal trading terms, if
there are worthwhile prospects of an improvement in the company’s position.

Honesty, by itself, is insufficient to justify relief.95 In Williams v Scholz,96 the Court

of Appeal in Queensland declined to exercise judicial discretion under section
1318 and excuse the directors from liability for insolvent trading on the basis of
their knowledge of deterioration financial conditions, suspicions of mismanage-
ment and their failure to take remedial steps. Under these circumstances, despite
the honest conduct of the directors, it was held that the function of section 1318
is not to subvert the operation of the insolvent trading laws.

91 Commonwealth Bank Ltd v Freidrich (1991) 9 ACLC 946; 5 ACSR 115 at 198; ASIC v Vines (2005) 56 ACSR
528; affirmed Vines v ASIC (2007) 62 ACSR 1, at [568] per Ipp JA and at [797], [800] per Santow JA.
92 (2007) 65 ACSR 123 at [325].
93 [2009] FCA 1415. For commentary, see Anil Hargovan, ‘Director’s Liability for Insolvent Trading, Statu-
tory Forgiveness and Law Reform’ (2010) Insolvency Law Journal (forthcoming).
94 (2007) 65 ACSR 123 at [331].
95 Kenna & Brown Pty Ltd v Kenna (1999) 32 ACSR 430.
96 [2008] QCA 94.
260 CORPORATE GOVERNANCE IN AUSTRALIA

It is an irrelevant consideration, for the exercise of judicial discretion for relief,

that directors do not have directors and officers’ liability insurance to meet any
judgment debt and has to rely on their own resources. In Hall v Poolman,97 Justice
Palmer considered this issue and held:
The fact that a director has no insurance to meet a judgment debt arising from an
insolvent trading claim cannot, without more, play a part in the consideration of dis-
cretionary defences under s.1317S and s.1318. Most creditors are not insured against
the insolvency of their debtors. The Court should not, in the exercise of discretion
under s.1317S or s.1318, hold accountable only a director whose insurer will absorb
the pain of a judgment.

10.3 Case studies regarding civil penalty provisions

or pecuniary penalty provisions

10.3.1 Overview
ASIC v Adler98 remains one of the best cases to illustrate how the civil penalty
provisions or pecuniary penalty provisions are used by ASIC in practice, because
of both the lucid judgment of Justice Santow and the fact that the case involved
multiple breaches of statutory duties and civil penalty provisions. However,
there were several other significant cases that ASIC brought against directors
and officers that either clarified or demonstrated the operation of the statutory
duties of directors. There is only space to provide brief overviews of the key legal
issues in ASIC v Adler,99 ASIC v Macdonald (No 11)100 and ASIC v Rich.101

10.3.2 ASIC v Adler [2002] 41 ACSR 72

10.3.2.1 Summary of the facts
This case deals basically with four different sets of transactions in the lead up
to the collapse of HIH Insurance Ltd. The main defendants were Rodney Adler
(director and shareholder in HIH), Ray Williams (chief executive officer (CEO),
shareholder and founder of HIH) and Dominic Fodera (director and CFO of HIH).
1. Transfer of funds: The first transaction took place on 15 June 2000 when
an amount of $10 million was transferred from one of HIH Insurance
Ltd’s (HIH) subsidiaries, Casualty & General Insurance Company Limited
(HIHC), to a company, Pacific Eagle Equity Pty Limited (PEE), controlled by
Rodney Adler. This payment followed earlier correspondence commencing
9 June 2000 between Rodney Adler and Ray Williams and later steps
involving various officers of HIH and HIHC. This transfer was executed
by Dominic Fodera, the CFO of HIH and HIHC and also a director of both

97 (2007) 65 ACSR 123 at [342].

98 (2002) 41 ACSR 72; [2002] NSWSC 483 (30 May 2002).
99 Ibid.
100 (2009) 256 ALR 199.
101 [2009] NSWSC 1229.
 DIRECTORS’ DUTIES AND LIABILITY 261

companies, after Rodney Adler requested such a transfer and the CEO of
HIH, Ray Williams, concurred with it and also directed the transfer.
2. Purchase of HIH shares: The second set of transactions took place between
16 and 30 June 2000, when PEE began to purchase shares in HIH to
the extent of $3 991 856.21. All these purchases were instigated by Rod-
ney Adler. This was in circumstances in which, according to ASIC, but
disputed, the stock market was led to believe by Rodney Adler that the
purchases were made by Rodney Adler or family interests associated with
Rodney Adler in order to shore up the HIH share price. On 7 July 2000, the
Australian Equities Unit Trust (AEUT) was established, by execution of a
Trust Deed, with PEE as trustee. Units of different classes were issued to
HIHC and Adler Corporation, a company controlled by Adler. The $10 mil-
lion investment by HIHC, including the HIH shares purchased with it, then
became part of this trust (AEUT).102 The HIH shares were subsequently
sold by AEUT at a loss of $2 121 261.11 on 26 September 2000 – barely
three months after they had been purchased.
3. Purchase of unlisted investments: The third set of transactions relates to
AEUT buying three unlisted investments (unlisted technology and inter-
net companies), from Adler Corporation Pty Ltd (Adler Corp). Adler Corp
was a company in which Rodney Adler was the sole director and he and
his wife the only shareholders. AEUT bought dstore Limited (dstore) on
25 August 2000 for $500 002, Planet Soccer International Limited (Planet
Soccer) on 25 August 2000 for $820 748 and Nomad Telecommunica-
tions Limited (Nomad) on 26 September 2000 for $2 539 000 – collec-
tively called ‘the unlisted investments’. These sales were all financed with
the funds still available (after the purchase of the HIH shares) from the
original $10 million payment by HIHC, which became AEUT’s after the
execution of the Trust Deed. AEUT suffered a loss on all three transactions
totalling $3 859 750 (without interest taken into consideration) from these
transactions.
4. Making of unsecured loans: The fourth set of transactions deals with unse-
cured loans. Between 26 July 2000 and 30 November 2000, Rodney Adler
caused three unsecured loans totalling $2 084 345 to be made by AEUT,
without adequate documentation, to companies or funds associated with
him and/or Adler Corp, to the latter’s advantage and allegedly to the dis-
advantage of AEUT.

10.3.2.2 Contraventions of civil penalty provisions103

Related party transactions (Chapter 2E)
It was held that the payment of $10 million by HIHC to PEE on 15 June 2000
amounted to ‘giving of a financial benefit’ to PEE, Adler Corp and Adler within
102 Jason Lang and Giselle McHugh (Mallesons Stephen Jacques) in Corporate Law Electronic Bulletin (Bul-
letin No 55, March 2002), available at <http://cclsr.law.unimelb.edu.au/bulletins/archive/Bulletin0055.
htm>.
103 This part is based on the excellent summary of the findings of Santow J by Lang and McHugh, ibid, and
the headnote to the Australian Corporations and Securities Reports–ASIC v Adler (2002) 41 ACSR 72–7.
262 CORPORATE GOVERNANCE IN AUSTRALIA

the meaning of section 229 of the Act. Thus, HIH and HIHC had contravened
section 208 of the Act. The transaction was not an ‘arms length’ transaction under
section 210. The subsequent entering into of the trust deed was also not held
to fall within the ‘arms length’ exception in section 210 because the trust deed
lacked proper safeguards in circumstances in which Adler had a potential conflict
of interest and was significantly one-sided against HIHC.
It was also held that the transaction was carried out at Adler’s request and
with Williams’ concurrence and direction. Both of them were ‘involved’ in giving
of a financial benefit within the meaning of section 79. Both contravened section
209(2) by being ‘involved’ in the contravention of section 208 by HIH and HIHC.
Fodera was also in breach of section 209(2). He had sufficient knowledge of
the essential elements of the contravention, and his attempts to subsequently
distance himself from the transaction by referring matters to others did not alter
this.

Financial assistance (Part 2J.3)

HIHC suffered material prejudice as a result of financially assisting PEE to acquire
shares in HIH and, in so doing, contravened section 260A of the Act. The material
prejudice arose from the fact that the rights that HIHC obtained from PEE were
of a materially lesser value than the cash handed over. In other words, HIHC was
‘impoverished’ by this transaction. The court relied on Charterhouse Investment
Trust Ltd v Tempest Diesels Ltd [1986] PCLC 1, looking ‘at all interlocking elements
in a commercial transaction as a whole’.
The material prejudice for HIHC resulted from the fact that there was no
security or documentation and no control over the disposition of the funds. The
AEUT Trust Deed was also one-sided and did not include safeguards to protect
against Adler’s potential conflict of interest. A loss on the HIH shares traded by
PEE was inherently likely from the inception, and did in fact occur.
It was held that Rodney Adler and Ray Williams were sufficiently involved in
the contravention of section 260A to have breached section 260D(2). They knew
that HIHC was providing assistance for the purchase of HIH shares, but it was
not necessary for them to have actual knowledge of material prejudice. Dominic
Fodera’s involvement was more remote and, on the facts, Santow J was not able
to conclude that Fodera, while having knowledge that financial assistance was
given, also had knowledge that it would materially prejudice HIHC. However, as
the onus lay on the defendants to prove that giving the financial assistance was
not materially prejudicial, this element of section 260A was essentially a defence,
and proof of knowledge of material prejudice was therefore not necessary for
section 260D(2). Accordingly, Fodera was also found to have breached section
260D(2).104 In making these findings, Santow J stated that ‘a combination of
suspicious circumstances and the failure to make appropriate enquiry when

104 Lang and McHugh, above n 102.

 DIRECTORS’ DUTIES AND LIABILITY 263

confronted with the obvious, makes it possible to infer knowledge of the relevant
essential matters’.105

Duty of care and diligence (s 180)

It was held that a reasonably careful and diligent director or officer in the position
of Adler would not have caused the payment of $10 million by HIHC to PEE to be
applied in part to purchasing HIH shares. Adler failed to follow authorised prac-
tices relating to investments made by HIH/HIHC and to ensure that safeguards
were in place to protect HIH or HIHC. In fact, Adler’s object was to support the
HIH share price (doing so for his own substantial shareholding in HIH), rather
than to enable HIH to obtain, through its interests in AEUT, the benefit of a quick
profit on the resale of the HIH shares.
In the case of Ray Williams, he was aware the $10 million was to be used in
whole or in part to pay for shares in HIH, and permitted that amount to be paid
in advance of any documentation and with no stipulation of any necessary safe-
guards to deal with Adler’s potential conflicts of interest, which is a circumstance
requiring special vigilance. While the primary responsibility will fall on the direc-
tor proposing to enter into the transaction, this does not excuse other directors
or officers who become aware of the transaction. It was only common sense
that a reasonably careful and diligent director would have brought the issue of a
$10 million payment being made to a director, to be used at his discretion, before
the board or at least the HIH Investment Committee. Similarly, Fodera was found
to be in breach of section 180.106
The directors’ attempt to rely on the protection of the business judgment rule
(see section 180(2)) failed. In Adler’s case, there was no ‘business judgment’;
moreover, Adler clearly had a material personal interest in the ‘subject matter
of the judgment’. Williams failed to establish that he had made the decision in
good faith for a proper purpose, and failed to inform himself to the extent that
he could reasonably believe that the decision was a proper business decision.

Duty of good faith (s 181)

Rodney Adler was the only director found to be in breach of section 181. This was
because Adler, quite apart from failing to make proper disclosure, promoted his
personal interest by making or pursuing a gain (of maintaining or supporting the
HIH share price) when there was a substantial possibility of a conflict between
his personal interests and those of the company in pursuing a profit. The interests
of HIH and HIHC were put at risk by illegality under sections 208 and 260A, and
by concealing from the market that HIHC, not Adler or his interests, was funding
the purchase of HIH shares.107

105 ASIC v Adler (2002) 41 ACSR 72, 163.

106 Lang and McHugh, above n 102.
107 Ibid.
264 CORPORATE GOVERNANCE IN AUSTRALIA

Use of position to gain advantage for oneself or another or to cause

detriment to the corporation (s 182)
Santow J concluded that both Adler and Williams were in breach of section 182.
Adler’s conduct evinced his improper purpose in supporting the share price in
HIH. This included passing up an early opportunity for AEUT to make a profit on
the sale of HIH shares, as well as maximising the ultimate loss for AEUT by selling
his own interests in HIH ahead of AEUT’s when the market was falling. Williams
likewise breached section 182 in authorising the $10 million payment without
proper safeguards and without the knowledge or approval of the HIH Investment
Committee. More generally, Adler was also found to have breached his duties
under sections 180 to 182 in relation to PEE’s acquisition of the three unlisted
technology and internet investments from Adler Corp. No reasonable director
in Adler’s position and possessing his knowledge would have committed PEE to
acquiring investments in Nomad, dstore and Planet Soccer at the prices Adler
Corp paid for them. The known radical change in market conditions relating to
technology stocks, the lack of any due diligence and the misleading statements
and omissions made by Adler in relation to the on-sale of these investments
all supported this conclusion. Despite being clearly aware of the financial dire
straits of these investments, Adler and Adler Corp extricated Adler Corp from its
position, at no loss to Adler Corp, but to the disadvantage of PEE, HIH and HIHC.
Adler was in further breach of sections 180 to 182 in relation to the three
unsecured loans from AEUT to entities associated with Adler. These loans were
not adequately documented and not one of them was even within the scope of
the vaguely sketched mandate for AEUT, as discussed by Adler and Williams, to
pursue investment in ‘venture capital’ or ‘share trading’.108

Improper use of information (s 183)

Adler was also found by Santow J to have breached his obligations under section
183, in relation to both the acquisition of the three unlisted investments from
Adler Corp and the loans to Adler-associated entities. Adler had improperly used
information obtained by him to gain an advantage for himself.109 It must be
noted, however, that this part of Santow J’s judgment was overturned on appeal.
The New South Wales Court of Appeal held that neither Adler’s disregard of
HIH’s investment guidelines and procedures, nor his knowledge of Williams’
susceptibility, amounted to an improper ‘use’ of information for the purposes of
section 183.110

10.3.2.3 Court orders

Santow J ordered that Rodney Adler should be disqualified for a period of 20
years and that he and Adler Corp should pay pecuniary penalties of $450 000
each (totalling $900 000). Ray Williams was disqualified for a period of 10 years
108 Ibid.
109 Ibid.
110 See Adler v ASIC; Williams v ASIC (2003) 46 ASCR 504.
 DIRECTORS’ DUTIES AND LIABILITY 265

and was ordered to pay pecuniary penalties of $250 000. Dominic Fodera was not
disqualified, but was ordered to pay pecuniary penalties of $5000. In addition,
Rodney Adler, Ray Williams and Adler Corp were ordered to pay aggregate
compensation of $7 958 112 to HIH Casualty and General Insurance Limited
(subject to verification of the calculation of interest).111
Criminal proceedings were later brought against Rodney Adler and Ray
Williams in relation to their activities prior to the collapse of HIH, and both
pleaded guilty – see discussion later in this chapter.

10.3.3 ASIC v Macdonald (No 11) (2009) 256 ALR 199 – James
Hardie litigation112
10.3.3.1 Background and summary of the facts
This case sheds light on the practical application of the scope and content of direc-
tors’ and officers’ duties in a large, publicly listed company. The case illustrates
the standard of care expected by management and the board when considering
strategic company decisions and market-sensitive information. It offers guid-
ance on the standards expected under section 180(1), with particular reference
to non-executive directors, executive directors, CFOs, company secretaries and
in-house counsel.
In Chapter 2 we have already used the James Hardie litigation as a case study
in context of the importance of stakeholders and how stakeholders and pressure
groups are able to influence corporate behaviour and influence corporate gov-
ernance practices. The irony is that the agreement by James Hardie to establish
a fund to cover future medical claims led to further litigation, resulting in the
reported cases ASIC v Macdonald (No 11)113 and ASIC v Macdonald (No 12).114
As will be recalled, James Hardie Industries Limited (JHIL) faced significant
liability for damages claims for asbestos-related conditions resulting from the
use of its products since 1920. JHIL was the holding company of the James
Hardie group. In order to separate JHIL from this liability, the board decided to
establish the Medical Research and Compensation Foundation (MRCF) which
would manage and pay out asbestos claims against JHIL.
At a board meeting of JHIL held on 15 February 2001, the board decided to
constitute JHIL as trustee of the MRCF. At the same meeting, a draft announce-
ment to ASX was approved. Although this event was disputed by the 10 defen-
dants (directors and officers), the judge rejected the chorus of non-recollection.
This draft announcement explained that MRCF would be ‘fully funded’ (to meet
the outstanding liability). At the same meeting, the board also agreed to execute
the Deed of Covenant and Indemnity (DOCI), which dealt with liability between
111 Lang and McHugh, above n 102; Jillian Segal, ‘Corporate Governance: Substance over Form’ (2002) 25
University of New South Wales Law Journal 320, 328.
112 Parts of this discussion is based on Anil Hargovan, ‘Corporate Governance Lessons from James Hardie’
(2009) 33 Melbourne University Law Review (forthcoming).
113 (2009) 256 ALR 199.
114 (2009) 259 ALR 116; [2009] NSWSC 714.
266 CORPORATE GOVERNANCE IN AUSTRALIA

JHIL and MRCF. The seven non-executive directors attended this meeting (two
by phone from the USA), as did the CEO (Peter Macdonald), the board secretary
and general counsel (Peter Shafron) and the CFO (Phillip Morley).
The minutes of the board meeting contained an entry to the effect that the
company had explained the impact of the resolution passed at the meeting to
approve an ASX announcement and to execute the ASX announcement and
send it to ASX. The minutes of the meeting were signed by the chairman at the
following board meeting, held on 4 April 2001. On 7 April 2001, the minutes
of the meeting of 15 February 2001 were sent to the secretary of the company.
The evidentiary value of the minutes, however, was negated by the company’s
non-compliance with the relevant statutory provisions governing minutes and
thereby precluded the court from reliance on the minutes to establish the events
that transpired at the board meeting.
ASIC alleged that the draft ASX announcement was approved at the board
meeting of 15 February 2001 and that it stated that the MRCF would commence
operations with assets of $284 million. The draft ASX announcement also con-
tained a number of statements to the effect that MRCF would have sufficient
funds to meet all legitimate asbestos claims; that it was fully funded; and pro-
vided certainty for people with legitimate asbestos claims.
The final ASX announcement included, inter alia, the following statements:

The Foundation has sufficient funds to meet all legitimate compensation claims . . . Mr
Peter Macdonald said that the establishment of a fully-funded Foundation provided
certainty for both claimants and shareholders . . . In establishing the Foundation, James
Hardie sought expert advice . . . James Hardie is satisfied that the Foundation has
sufficient funds to meet anticipated future claims . . .

10.3.3.2 Legal issues

Based on the facts discussed above, ASIC alleged in Supreme Court hearings
in September 2008 that JHIL, its officers and the board breached several civil
penalty provisions of the previous Corporations Law and the current Corporations
Act 2001 (Cth), which attracted civil penalties.115 In particular, ASIC argued that:
1. The draft ASX announcement approved at the board meeting on 15 Febru-
ary 2001 was false or misleading. The approval by the non-executive
directors,116 the CEO (Mr Macdonald), the company secretary and general
counsel (Mr Shafron), and CFO (Mr Morley) was in breach of the duty of
care in section 180(1)
2. JHIL’s failure to disclosure information, in relation to the DOCI, to ASX
was in breach of section 1001A(2)117

115 ASIC concluded that there was insufficient evidence to refer any matter to the Commonwealth Director of
Public Prosecution for criminal prosecution of the company’s officers: ASIC, ‘James Hardie Group Civil Action’
(Media Release 08–201, 5 September 2008), available at <www.asic.gov.au/asic/asic.nsf/byheadline/08–
201+James+Hardie+Group+civil+action?openDocument>
116 Mr Brown, Ms Hellicar, Mr Wilcox, Mr O’ Brien, Mr Terry, Messrs Gillfillan and Koffel.
117 Section 1001A(2) of the Corporations Law, carried over into the Corporations Act until its repeal in
2002, dealt with breach of continuous disclosure obligation.
 DIRECTORS’ DUTIES AND LIABILITY 267

3. Failure by the CEO and company secretary and general counsel to advise
the board that the DOCI information should be disclosed to ASX was in
breach of section 180(1)
4. The CEO had breached section 180(1) for failure to advise that the final
ASX announcement on 16 February 2001 should not be released or that it
should be amended to cure the defect
5. Statements made by the CEO at a press conference concerning the ade-
quacy of funding for asbestos claims were false or misleading and involved
a breach of section 180(1)
6. A release to ASX on 23 February 2001 by the CEO, which contained false
or misleading statements, was in breach of section 180(1); the approval of
an announcement released to ASX on 21 March 2001 by the same officer,
which contained false or misleading statements was in breach of section
180(1) and the good faith provisions in 181(1)118
7. The publication of the final ASX announcement, the press conference state-
ments and the further ASX announcements, referred to in (6) above, JHIL
contravened sections 995(2)119 and 999120
8. The representations made by the CEO with respect to JHI NV at road-
shows in Edinburgh and London and in slides for these United Kingdom
presentations, lodged with ASX, were false and misleading and in breach
of sections 180(1) and 181. On the same facts, it was argued that JHI NV
was in breach of s 1041E121 and, in making ASX representations, breached
s 1041H;122 and
9. JHI NV failed to notify ASX of JHIL information in accordance with List-
ing Rule 3.1 and thereby contravened disclosure obligations in section
674(2).123

10.3.3.3 Decision and significance of the decision124

The following discussion centres on the findings made against the directors and
officers of JHIL. We focus on the significance of the case for different types of
directors and officers.

Non-executive directors
The court addressed the question of whether the law differentiated in the stan-
dard of performance expected between executive and non-executive directors.
118 Section 181 requires directors and officers of a corporation to exercise their power and discharge their
duties in good faith in the best interests of the corporation and for a proper purpose.
119 Section 995(2) of the Corporations Law, carried over into the Act until its repeal in 2002, was modelled
on s 52 of the Trade Practices Act 1974 (Cth) and prohibited misleading or deceptive conduct in connection
with securities. A similar provision to s 995 exists in s 1041H (1) of the Corporations Act.
120 Section 999 of the Corporations Law, carried over into the Act until repealed in 2002, prohibited false
or misleading statements in relation to securities.
121 Section 1041E of the Act prohibits false or misleading statements that induce persons to, inter alia, apply
for or dispose of financial products.
122 Section 1041H of the Act prohibits misleading or deceptive conduct in relation to a financial product.
123 Section 674(2) of the Act deals with a listed disclosing entity’s continuous disclosure obligations.
124 This part is based on Hargovan, above n 112; Anil Hargovan, ‘Directors’ and Officers’ Statutory Duty of
Care Following James Hardie’ (2009) 61 Keeping Good Companies 590.
268 CORPORATE GOVERNANCE IN AUSTRALIA

Justice Gzell referred to the divergent judicial views expressed by Rogers CJ in

AWA Ltd v Daniels t/as Deloitte Haskins & Sells,125 who appeared to show readi-
ness to accept a lower standard of care for non-executive directors,126 and the
Court of Appeal in Daniels v Anderson127 wherein Clarke and Sheller JJA held
that the approach of Rogers CJ on this issue did not represent contemporary
company law128 and that all directors are required to take reasonable steps to
guide and monitor the management of the company.129 After reviewing the case
law on this point,130 Gzell J reiterated the analysis of Justice Santow in ASIC v
Adler131 and held that a director should become familiar with the fundamentals
of the company’s business and is under a continuing obligation to keep informed
about the company’s activities.
Satisfied that the same standards of care are imposed on all directors, Justice
Gzell focused on the test to determine breach of section 180(1) and relied on
ASIC v Adler132 to adopt the following test:

In determining whether a director has exercised reasonable care and diligence one
must ask what an ordinary person, with the knowledge and experience of the defendant
might have expected to have done in the circumstances if he or she was acting on their
own behalf.133

Justice Gzell commented on the failure of the non-executive directors to dis-

charge their monitoring role as part of the statutory duty of care and diligence:134

. . . it was part of the function of the directors in monitoring the management of the
company to settle the terms of the draft ASX announcement to ensure that it did not
assert that the foundation had sufficient funds to meet all legitimate compensation
claims.

The court held that the directors’ conduct thereafter, in releasing the defective
ASX announcement, fell short of the standards expected to discharge obligations
under section 180(1) for the following reasons:135

The formation of the foundation and the [restructure of the relevant entities described
earlier] from JHIL were potentially explosive steps. Market reaction to the announcement
of them was critical. This was a matter within the purview of the board’s responsibility:
what should be stated publicly about the way in which asbestos claims would be
handled by the James Hardie group for the future. (emphasis added)

125 (1992) 7 ACSR 759 (AWA).

126 Ibid 867.
127 (1995) 16 ACSR 607.
128 Ibid 668.
129 Ibid 664.
130 Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405; Group Four Industries Pty Ltd v Brosnan
(1992) 8 ACSR 463; Vrisakis v ASC (1993) 11 ACSR 162; Permanent Building Society v Wheeler (1994) 14
ACSR 109; ASIC v Adler (2002) 41 ACSR 72; ASIC v Maxwell (2006) 59 ACSR 373; Vines v ASIC (2007) 62
ACSR 1.
131 (2002) 41 ACSR 72.
132 (2002) 168 FLR 253.
133 Macdonald (2009) 256 ALR 199, 247.
134 ASIC v Macdonald (No 11) (2009) 256 ALR 199 at [332].
135 Ibid at [333].
 DIRECTORS’ DUTIES AND LIABILITY 269

Although two of the non-executive directors attended the relevant board meeting
by telephone, and claimed that the draft ASX announcement was not provided
nor read to them, the court, nonetheless, held that both directors had breached
section 180(1) by voting in favour of the resolution. Gzell J, unimpressed with the
conduct of both directors in such circumstances, found liability on the following
basis:136

Neither [non-executive directors] raised an objection that [they] did not have a copy
of the draft ASX announcement at the . . . meeting. Nor did they ask that a copy be
provided to them. Nor did they abstain from approving the . . . announcement.

The entire board’s reliance upon, and delegation to, management and experts
were held to be inappropriate on the facts of this case for these key reasons:137

This was not a matter in which a director was entitled to rely upon those of his co-
directors more concerned with communications strategy to consider the draft ASX
announcement. This was a key statement in relation to a highly significant restructure of
the James Hardie group. Management having brought the matter to the board, none of
them was entitled to abdicate responsibility by delegating his or her duty to a fellow
director. (emphasis added)

Chief executive officer

The court found that Mr Macdonald, as a director and CEO of JHIL with reporting
duties directly to the board, had ultimate responsibility for planning the sep-
aration proposals and was the driving force. Furthermore, he was appointed to
make public statements on behalf of JHIL on these matters and, in keeping with
his position, was responsible for dealing with the board on this issue.
As a result of these responsibilities, Gzell J concluded that the CEO bore
a high standard of care. In voting in favour of the resolution to approve the
draft ASX announcement, the court applied an objective test and found liability
under section 180(1) based on similar reasons applicable to the non-executive
directors.
The court also found that the negligent conduct of the CEO resulted in multiple
breaches of the statutory duty of care and diligence under section 180(1). These
included the failure of the CEO to:
● advise the board of the limited nature of the reviews on the cash-flow
model undertaken by external consultants. The review was restricted to
issues concerning logical soundness and technical correctness. Accord-
ing to Justice Gzell,138 a reasonable person with the same responsibilities
would have informed the board that the external consultant had been
specifically instructed not to consider the key assumptions adopted by the
cash-flow model – namely, the fixed investment earnings rates, litigation
and management costs and future claim costs

136 Ibid at [233].

137 Ibid at [260].
138 Ibid at [363].
270 CORPORATE GOVERNANCE IN AUSTRALIA

● advise the board that the draft ASX announcement was expressed in too
emphatic terms and, in relation to the adequacy of funding, was misleading
and deceptive
● correct the misleading statements on the adequacy of funding when making
representations during international roadshows in Edinburgh and London
to promote the company and
● advise the board of the company’s continuous disclosure obligations to
release price-sensitive information in a timely manner.
The court, however, rejected ASIC’s allegation that the CEO had breached section
180(1) through failure to enquire of each director as to whether they had formed
an opinion on the adequacy of the quantum expressed to meet all present and
future asbestos claims. The imposition of such a duty, according to Gzell J, was
unwarranted because a director is not obliged to analyse the basis upon which
fellows directors intend to vote before determining his or her own course.139
The CEO failed to offer oral evidence to substantiate all of the statutory
criteria under the business judgment rule in section 180(2) (discussed earlier
in Part 10.2.2.1). This strategic decision proved to be fatal to the successful
discharge of the defence. It is not easy, as recognised by the court, to rely on
documentation alone to discern, for example, if the director had a rational belief
that the business judgment was in the best interests of the company.

General counsel
Mr Shafron, the company secretary and in-house counsel, was held to be a
company officer due to his expansive role in the affairs of JHIL and, significantly,
attracted the stringent statutory duties applicable to officers under sections 180–
183 of the Act, which includes the duty of care and diligence.
Mr Shafron’s failure to advise the board of the limited nature of the reviews
on the cash-flow model undertaken by external consultants also constituted a
breach of section 180(1), for the same reasons discussed earlier with respect to
the conduct of the CEO. Similarly, Mr Shafron’s failure to advise the CEO and
the board of the company’s continuous disclosure obligations, in relation to the
failure to release price-sensitive information to the market in a timely manner,
constituted breach of section 180(1).
The court rejected Mr Shafron’s argument that he had no duty to warn the
board of the emphatic statements in the draft ASX announcement because,
according to the defendant, a reasonable director would be capable of assessing
the statement as false and misleading. On the contrary, according to the court,
there was a compelling duty to speak in such circumstances:140

. . . [general counsel] had a duty to protect JHIL from legal risk and if the directors
were minded to approve the release of the draft ASX announcement in its false and
misleading form, there was the danger that JHIL would be in breach . . . [of the statute].

139 Ibid at [351].

140 Ibid at [402].
 DIRECTORS’ DUTIES AND LIABILITY 271

Against that harm it was [the] duty [of Mr Shafron] to warn the directors that [such
an] announcement should not be released in its too emphatic form.

Chief financial officer

Mr Morley, the CFO of JHIL, was also held to be an officer due to his participation
in far-reaching decisions of the board. The CFO was responsible for all of the
finance, audit, tax and treasury aspects of the James Hardie Group of companies.
Engaging in a similar analysis on this issue with respect to the conduct of the
CEO and general counsel described earlier, it was held that section 180(1) was
breached by Mr Morley for identical reasons concerning the failure to address
the limitations of the cash-flow model and its key assumptions and to commu-
nicate this to the board.141 As CFO, Mr Morley was responsible for verifying the
sufficiency of financial information. The court held that a reasonable CFO would
have known that the range of limited assumptions meant that the press release
could not state with certainty that the Foundation was fully funded.

10.3.3.4 Court orders

In a separate judgment dealing with the civil penalty consequences of breach of
the law, Justice Gzell in ASIC v Macdonald (No 12)142 dismissed the defendants’
claims to be exonerated from their contravention pursuant to section 1317S or
section 1318 of the Act – the latter provisions confer judicial discretion to grant
relief from liability upon the basis that the defendants had acted honestly and,
in the circumstances, ought fairly to be excused for their contravention.
Significantly, the court adopted a rigorous approach to the application of the
duty of care and diligence, and held that the defendants could not be excused
from liability despite the existence of the following circumstances surrounding
the decision making at the key board meeting on 15 February 2001 – namely:
● The board meeting was attended by JHIL management and a number of
external advisers who did not raise concerns.
● JHIL was in receipt of legal advice on issues surrounding the separation
plan, which addressed directors’ duties (but not the resolution to approve
the draft ASX announcement).
● There was contravention of standard practice, which required the approval
of a draft press release by line management and senior executives prior to
its placement before the board.
● It was a busy board meeting and the approval of the draft ASX announce-
ment by the non-executive directors, who had lengthy and accomplished
careers of service on other boards, was an isolated act.
In denying relief under such circumstances, his Honour was influenced by the
following key features of the case:143

141 Ibid at [454].

142 [2009] NSWSC 714.
143 ASIC v Macdonald (No 12) [2009] NSWSC 714 at [104].
272 CORPORATE GOVERNANCE IN AUSTRALIA

This was a serious breach of duty and a flagrant one. The non-executive directors were
endorsing JHIL’s announcement to the market in emphatic terms that the Foundation
had sufficient funds to pay all legitimate present and future asbestos claims, when they
had no sufficient support for that statement and they knew, or ought to have know,
that the announcement would influence the market.

Furthermore, while this event may have been an isolated one, it was nonetheless
held to be a very significant event in the life of the company, which demanded
attention. Justice Gzell was also influenced by the fact that reliance on advisors
was inappropriate on the facts of this case. According to the court, the task before
the board involved ‘no more that an understanding of the English language used
in the document’.144
In light of these findings, Gzell J made the following disqualification orders
under section 206C and imposed the following pecuniary penalties under section
1317G(1) of the Act, payable to the Commonwealth of Australia:
● Mr Macdonald banned from management for a period of 15 years and
liable to pay a pecuniary penalty of $350 000.
● Mr Shafron banned from management for a period of 7 years and liable to
pay a pecuniary penalty of $75 000.
● Mr Morely banned from management for a period of 5 years and liable to
pay a pecuniary penalty of $35 000.
● All of the seven former non-executive directors banned from management
for a period of 5 years each and liable to pay a pecuniary penalty of $30 000
each.
● JHI NV liable to pay a pecuniary penalty of $80 000.
It should be noted that this case is subject to appeal, scheduled for hearing in
2010.

10.3.4 ASIC v Rich [2009] NSWSC 1229

10.3.4.1 Background and basic facts
ASIC launched civil penalty proceedings against some directors and officers of
One.Tel Ltd (One.Tel) for breach of the statutory duty of care and diligence
under section 180(1) of the Act. The proceedings initially brought by ASIC were
against four defendants, arising out of the collapse in May 2001 of One.Tel
and its local subsidiaries, and the collapse or on-sale of overseas subsidiaries.
After a settlement was reached with Bradley Keeling and John Greaves and
disqualification orders made against them, they were not included in the further
litigation against Jodee Rich and Mark Silbermann. ASIC sought relief against
the defendands, Jodee Rich and Mark Silbermann. Jodee Rich was a director
and joint chief executive of One.Tel at all relevant times up to 17 May 2001, and
Mark Silbermann was finance director of One.Tel at all relevant times.

144 Ibid at [77].

 DIRECTORS’ DUTIES AND LIABILITY 273

ASIC alleged that the defendants did not disclose the true financial position
of the company to the board, and that they knew or should have known the true
financial position of their company. The central allegation was that the financial
position of the Group and the Australian and international businesses within
it, in terms of cash, cash flow, creditors, debtors, earnings and liquidity, was
much worse during the months of approximately January to March 2001 than
the information provided to the board of directors revealed. It was also alleged
by ASIC that forecasts of those matters provided to the board, particularly for
the period to June 2001, had no proper basis. In addition, ASIC contended that
the defendants were aware of the poor financial position of the Group, or ought
to have been, and failed to make proper disclosure to the board.

10.3.4.2 Legal issue

In essence, ASIC’s case was based on a breach by Jodee Rich and Mark Silbermann
of their duty of care and diligence under section 180(1) of the Act. In other words,
in not disclosing the true financial position of the company to the board, while
they knew or should have known the true financial position of their company,
they did not act with the required care and diligence expected of directors under
section 180(1).

10.3.4.3 The decision and its significance

On 18 November 2009, in a decision of more than 3000 pages, Justice Austin
held that the defendants were not in breach of their duty of care and diligence
as required under section 180(1). In short, that ASIC failed to prove its pleaded
case against either Jodee Rich or Mark Silbermann.
The case is particularly significant because of the observation Justice Austin
made on directors’ duty of care and diligence and the business judgment rule as
contained in sections 180(2) and (3) of the Act. However, almost as significant
as these aspects is the fact that this is one of very few prominent and high-profile
cases lost by ASIC. Justice Austin’s criticism of the way in which ASIC conducted
its case is particularly interesting and will probably change the way ASIC handles
similar cases in future.

Directors’ duty of care and diligence and the business judgment rule
Since this part of the case alone stretches over 55 pages, it is hardly possible to
discuss it in detail in a book dealing primarily with general principles of corporate
governance, but a few of the most important points made will be highlighted.
Justice Austin confirmed that the statutory duty of care and diligence under
section 180(1) of the Act is essentially the same as the duty of care and diligence
of a director under general law. Directors will only be held in breach of this duty if
the risk or potential harm was reasonably foreseeable. This basically means that
directors will only be in breach of this duty if they did not foresee, but objectively
other directors in a similar situation would have foreseen the risk or harm and
would have taken steps to prevent it. In judging a breach of directors’ duty of
274 CORPORATE GOVERNANCE IN AUSTRALIA

care and diligence, a ‘forward looking’ approach should be adopted by the courts
and that requires the defendants’ conduct to be assessed with close regard to the
circumstances existing at the relevant time, without the benefit of hindsight.145
Justice Austin pointed out that section 180(1) incorporates a minimum stan-
dard of diligence, requiring every director or officer, including a non-executive
director:146
(i) to become familiar with the fundamentals of the business or businesses of
the company
(ii) to keep informed about the company’s activities
(iii) to monitor, generally, the company’s affairs
(iv) to maintain familiarity with the financial status of the company by appro-
priate means, including (in the case of a director) review of the company’s
financial statements and board papers, and to make further inquiries into
matters revealed by those documents where it is appropriate to do so
(v) in the case of a director, and at least some officers, to have a reasonably
informed opinion of the company’s financial capacity.
Although it was pointed out that they have somewhat different consequences
for executive and non-executive directors, Justice Austin accepted the following
submissions of ASIC:
(i) the statutory duty in terms of section 180(1) encompasses a duty of com-
petence, measured objectively
(ii) compliance with the duty is determined by reference to what a reasonable
person of ordinary prudence would do; a duty that is enhanced, where the
directorial appointment is based on special skill, by an objective standard
of skill referable to the circumstances
(iii) the statutory standard of skill includes a standard of competence in read-
ing and understanding financial material, which is not dependent on the
director’s subjective inexperience or lack of skill
(iv) it follows that directors and officers cannot escape liability on the basis
that they did not read financial material made available to them for the
purposes of their office, and at least to that extent, the statutory duty of
care and diligence imports an objective standard of skill irrespective of the
directors’ or officers’ subjective inexperience or lack of skills
(v) the legislative history of section 180 confirms that the provision was
intended to impose an objective standard of skill
(vi) whatever particular skills an individual director or officer actually pos-
sesses, or inexperience the individual may suffer from, the director or
officer is accountable to a core irreducible requirement of skill, measured
objectively.
An interesting, and possibly controversial, point made by Justice Austin is that
there are in actual fact two layers of protection for directors against liability. In
his view, directors are automatically protected against liability for mere errors of
145 ASIC v Rich [2009] NSWSC 1229 [7242].
146 Ibid at [7203].
 DIRECTORS’ DUTIES AND LIABILITY 275

judgment. For mere errors of judgment, they do not need to rely on the protection
provided by the statutory business judgment rule (also called the ‘safe-habour
rule’) contained in section 180(2) and (3) of the Act. However, if it was not a
mere error of judgment, they may still be protected by the statutory business
judgment rule:147

If the impugned conduct is found to be a mere error of judgment, then the statutory
standard under s 180(1) is not contravened and it is unnecessary to advert to the special
business judgment rule in s 180(2). In the view that I have taken of it, explained below,
s 180(2) provides a defence in a case where the impugned conduct goes beyond a mere
error of judgment, and would contravene the statutory standard but for the defence.

The reason the distinction is perhaps controversial is that there is little guidance
for when a matter will be considered to be a mere error of judgment. Can a
director simply aver that whatever went wrong was simply an error of judgment
and would the plaintiff (ASIC, but could also be the shareholders – see discussion
below regarding statutory derivative actions) then have to provide evidence that
it was not merely an error of judgment? Or, is the onus from the beginning
on the plaintiff to make out a prima facie case that the alleged breach of the
duty of care was not a mere error of judgment? Also, there has been a general
understanding that there is a presumption that directors will be protected against
liability if they have made proper business judgments, even if the judgments are
proven, in hindsight, to be wrong. In short, there seems to be confusion between
the protection that Justice Austin describes as mere errors of judgment and the
protection provided by the business judgment rule.
Closely linked to this controversial distinction is Justice Austin’s finding on
who carries the burden of proof to establish that the criteria listed under section
180(2)(a)-(d) of the Act were met. In order to rely on the protection of the statu-
tory business judgment rule, it has to be shown that a ‘business judgment’148
was made and that, in respect of such a ‘business judgment’, a director or
office:
(a) made the judgment in good faith for a proper purpose and
(b) did not have a material personal interest in the subject matter of the judg-
ment and
(c) informed themselves about the subject matter of the judgment to the extent
they reasonably believe to be appropriate and
(d) rationally believed that the judgment was in the best interests of the cor-
poration.
An unresolved issue was whether there is a presumption that directors exercise
business judgment by following the four criteria. Thus, that the plaintiff (usually
ASIC, but could also be the shareholders – see discussion below regarding statu-
tory derivative actions) carries the burden of proof to rebut these presumptions.

147 ASIC v Rich [2009] NSWSC 1229 [7242].

148 Under s 180(3) of the Act a ‘business judgment’ is defined as follows: ‘business judgment means any
decision to take or not take action in respect of a matter relevant to the business operations of the corporation.’
276 CORPORATE GOVERNANCE IN AUSTRALIA

In other words, should a court accept that directors exercised their business deci-
sion in such a manner unless it is proven not to be the case by the plaintiff? The
alternative approach would be that these criteria are not presumptions, but that
the defendants (directors or officers) need to prove each one of these aspects
in order to be protected by the statutory business judgment rule under sections
180(2) and (3) of the Act.
The statutory business judgment rule was supposed to create a presumption
in favour of directors and the way in which the presumption in favour of directors
was supposed to work, was explained as follows in the Explanatory Memorandum
before section 180(2) was introduced:

Provided directors or other officers fulfil the requirements of proposed subsection

180(2) paragraphs (a) to (d):
• such directors have an explicit safe-harbour, being effectively shielded from liability
for any breach of their duty of care and diligence; and
• the merits of directors’ business judgments are not subject to review by the Courts.149
Proposed subsection 180(2) acts as a rebuttable presumption in favour of directors which,
if rebutted by a plaintiff, would mean the plaintiff would then still have to establish
that the officer had breached their duty of care and diligence150 (emphasis added).

Whether this has, in fact, been achieved with the way the statutory business rule is
currently worded in the Act has been questioned by at least one commentator.151
A leading commercial law judge, Justice Santow, has also pointed out that it was
uncertain152 whether or not the directors carried the burden of proof at least
to establish that they have met the standards set out in section 180(2)(a)–(d).
Justice Austin has now determined that the matter will have to be revisited (‘at the
appellate level’) as the language is ‘profoundly ambiguous’, but for the moment,
and as the provision is currently worded, it will be the defendants (directors
and officers) who will carry the burden to proof that they have exercised their
business judgments meeting the criteria set out in section 180(2)(a)–(d) in order
to rely on the protection of the statutory business judgment rule:153

The question whether the plaintiff or the defendant bears the onus of proving the
ingredients of s 180(2) is an important one that will eventually need to be resolved at
the appellate level. With some hesitation in light of the US approach, I have reached
the conclusion that the Australian statute casts the onus of proving the four criteria in s
180(2) on the defendants [director or officers against whom it is alleged that they have
breached their statutory duty of care and diligence under s 180(1)] . . . As revealed in
the Explanatory Memorandum, paras 6.1–6.10, the purpose of the introduction of a

149 The Parliament of the Commonwealth of Australia – House of Representatives, Explanatory Memoran-
dum to the Corporate Law Economic Reform (CLERP) Bill 1998 (ISBN 0642 37879 7) para 6.9.
150 Ibid at para 6.10.
151 See D DeMott, ‘Legislating Business Judgment – A Comment from the United States’ (1998) 16 Company
and Securies Law Journal 575, commented on by R P Austin and I M Ramsay Ford’s Principles of Corporations
Law, Chatswood, LexisNexis Butterworths (14th edn, 2010) 438 para 8.310.
152 G F K Santow, ‘Codification of Directors’ Duties’ (1999) 73 The Australian Law Journal 336 at 348–9 and
350.
153 ASIC v Rich [2009] NSWSC 1229 [7269]–[7270].
 DIRECTORS’ DUTIES AND LIABILITY 277

business judgment rule was (generally speaking) to ensure that directors and officers
are not discouraged from taking advantage of opportunities that involve responsible
risk-taking. Casting the onus of proof of the elements of the defence on the director
or officer is not necessarily incompatible with that purpose, because it may happen in
practice that the evidential burden can be shifted to the plaintiff relatively easily, if the
defendant addresses the statutory elements in his or her affidavit, though the price to
be paid is that the defendant is exposed to cross-examination on those matters.

Judicial criticism of ASIC’s case management

Justice Austin was quite critical about the way in which ASIC had conducted the
case. For instance, he observed that ASICs contentions had ‘a superficial appeal,
but time and again they were shown to be unpersuasive when the underlying
financial detail was investigated’.154 He observed that a very large number of
documents were presented to the court, and that ASIC’s case was primarily based
upon documentary evidence. However, when those documents were scrutinised
in detail, they were found to be, wholly or in part, too unreliable to form the
basis for financial findings. Also, there were ‘unexplained problems’ with the
documents, adding to ‘a serious flaw in ASIC’s case’.155
Perhaps the most serious indication that Justice Austin was not impressed with
the way in which ASIC ran the case, is his serious consideration that in addition
to ordering ASIC to pay the defendants’ costs of the proceedings as agreed or
assessed, he gave close consideration to the question of whether this was not
an appropriate case for ordering costs assessed on the indemnity basis. In other
words, not only the actual legal costs, but also additional costs associated with
a long, drawn-out court case. It was with some hesitation and unassertiveness
that Justice Austin eventually concluded that it was not warranted to impose
indemnity costs.156 ASIC, and other Australian regulators as well, should take
serious note of his observations when running cases in future, especially stark
criticism like this:

According to my observation, ASIC doggedly pursued an extremely large case because

of its conviction, erroneously in my view but not reckless or totally groundless, that the
evidence would support its contentions.157 (emphasis added)

10.4 Conclusion

This chapter confirms the view of Lord Hoffman that it is far from easy to suc-
cinctly extract the duties expected of directors.158 For two reasons we have chosen
to use the statutory duties, and in particular the civil penalty provisions in the

154 Ibid at [7319].

155 ASIC v Rich [2009] NSWSC 1229 [7319].
156 Ibid at [7325]–[7330].
157 Ibid at [7330].
158 Lord Hoffman, ‘Duties of Company Directors’ (1999) 10 European Business Law Review 78.
278 CORPORATE GOVERNANCE IN AUSTRALIA

Australian Corporations Act 2001, as the starting point for explaining directors’
duties and their potential liability. First, the Australian Corporations Act 2001
covers directors’ general law duties (duties at common law and in equity) very
comprehensively, and provides a neat extraction of most of these. Second, the
litigation in recent years, dealing with breaches of directors’ duties, almost exclu-
sively has been based on breaches of the statutory duties and not on breaches of
the duties at common law and in equity.
11
Enforcement of directors’ duties

There are no qualifications for being a company director. Even directors

of listed companies do not have to take any examinations . . . In principle,
anyone can become a director. One might therefore think that the duties
of an office so unexacting in its qualifications would be simple and easy to
ascertain. In fact, this is far from the case. In fact, the duties of directors
can be discovered only by examining at least three different sources which
lie like strata one above the other. The bedrock is the duties which directors
owe at common law, or more precisely in equity, simply because they
are managing other people’s property. Over that layer has been imposed
a number of specific statutory duties intended to reinforce the duties at
common law. And over that layer has been imposed still further duties
under various self-regulatory codes, which are also intended to reinforce
the common law duties in areas not thought suitable for legislation.
Lord Hoffman, ‘Duties of Company Directors’ (1999) 10
European Business Law Review 78
The governance of a public company should be about stewardship. Those
in control have a duty to act in the best interests of the company. They must
use the company’s resources productively. They must understand that those
resources are not personal property. The last years of HIH were marked
by poor leadership and inept management. Indeed, an attitude of appar-
ent indifference to, or deliberate disregard of, the company’s underlying
problems pervades the affairs of the group.
Report of the HIH Royal Commission (Owen Report), Volume I,
Department of the Treasury (2003), xiii–xiv

11.1 Introduction

The Australian Securities and Investments Commission (ASIC), as the primary

corporate regulator, has played such an active role in enforcing the civil penalty
provisions over recent years that it has been questioned whether there is any
real incentive left for corporations themselves to enforce directors’ duties.1 In
fact, nowadays the single most distinctive factor between the Australian and

1 Jean J du Plessis, ‘Reverberations after the HIH and Other Recent Australian Corporate Collapses: The Role
of ASIC’ (2003) 15 Australian Journal of Corporate Law 225, 240–3.

279
280 CORPORATE GOVERNANCE IN AUSTRALIA

United Kingdom corporations law models is the extent to which the primary Aus-
tralian regulator, ASIC, has been prepared to use its extensive powers to enforce
directors’ and officers’ duties under the civil penalty provisions of the Corpora-
tions Act 2001 (Cth) (the Act), albeit with mixed results (as discussed earlier in
Chapter 6). In the UK it is still primarily the shareholders, and not the primary
regulators, that will enforce directors’ duties. The UK Companies Act 2006 now
makes it easier for individual shareholders to bring actions against directors,
based on new and closer-defined statutory duties contained in the UK Compa-
nies Act 2006. However, it will still be the shareholders, not the regulators that
will bring these actions against directors in breach of their statutory duties.2 In
this respect, the fundamental duty of shareholders to enforce these duties did
not change from the traditional common law position in the UK, explained by
Johnstone and Chalk:
[O]wing largely to the fact that [directors’ duties] are owed to the general body
of shareholders taken as a whole, and enforceable against the directors only by the
company acting on their behalf, these duties have not historically played a prominent
role.3 (emphasis added)

In Australia, there is an array of actions available for private parties to institute

actions against directors or to enforce their rights internally,4 but they are not
used very often nowadays, and it is submitted that the reason for this is the active
role that ASIC plays in enforcing civil penalty provisions against directors and
officers.5 As noted by one commentator,6 ASIC has shown a marked reluctance
in recent years to use its power under section 50 of the ASIC Act to bring civil
action in the name of the company, or a class action for shareholders or investors
for the recovery of damages for corporate misconduct. The purpose of section 50
has been captured by Justice Lockhart in Somerville v ASIC:7
An evident function of s 50 is to permit the commission, acting in the public interest,
to cause proceedings to be taken where persons or corporations have suffered loss
or harm arising from fraud, negligence or misconduct, but do not have the resources
to maintain expensive and complicated litigation . . . In the case of a company, the
commission may cause the proceedings to be begun and carried on the company’s
name whether it consents or not.

The focus of this chapter is to provide an overview of the enforcement actions

available to shareholders and some other parties. It deals briefly with the
2 Keith Johnstone and Will Chalk, ‘What Sanctions are Necessary?’ in The Business Case for Corporate Gover-
nance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008) 146 at 151–2 and 163–7.
3 Ibid at 151.
4 See Michael Duffy, ‘Shareholder Representative Proceedings: Remedies for the Mums and the Dads’ (2001)
75 Law Society Journal 54.
5 For some of the literature on the growth of civil penalties and its use, see Robert Baxt, ‘The Expansion
of Civil Penalties under the Corporations Act’ (2002) 30 Australian Business Law Review 61; Michael Welsh,
‘Eleven Years On – An Examination of ASIC’s Use of an Expanding Civil Penalty Regime’ (2004) 17 Australian
Journal of Corporate Law 175; Vicky Comino, ‘The Enforcement Record of ASIC Since the Introduction of the
Civil Penalty Regime’ (2007) 20 Australian Journal of Corporate Law 183.
6 Janet Austin, ‘Does the Westpoint Litigation Signal a Revival of the ASIC s 50 Class Action?’ (2008) 22
Australian Journal of Corporate Law 8 at 8.
7 (1995) 131 ALR 517 at 523.
 ENFORCEMENT OF DIRECTORS’ DUTIES 281

statutory derivative action (Part 2F.1A); actions aimed at unfairly prejudi-

cial, discriminatory or oppressive conduct by the corporation or its directors
(Part 2F.1); and injunctions under section 1324 of the Corporations Act.8 The
chapter also canvasses the criminal liability of directors and selected types of
criminal offences under the Corporations Act 2001.

11.2 The statutory derivative action: Part 2F.1A

11.2.1 The case to introduce a statutory derivative action

These provisions [statutory derivative action] basically make it easier for shareholders
and others to institute proceedings (including proceedings against directors) where the
directors refuse to do so. These provisions obviously increase the exposure of directors,
as there is now greater potential for actions to be brought against directors in the name
of the company.9

In many respects, the derivative action is unique. It allows an individual to bring

an action that belongs to another (it should be remembered that directors owe
their duty to the corporation and that the corporation is thus the proper plaintiff
in the case of any breach of these duties). Furthermore, the benefit of this action,
brought by the shareholder, will not directly advantage that member; rather, it
will accrue to the corporation, which has, for whatever reason, decided not to
pursue the matter. Thus, it allows the shareholder to usurp the authority that the
corporate entity has vested in the board of directors. Significantly, it also allows
the minority shareholders of the corporation to act as some sort of corporate
watchdog over the majority, and to set the company in motion to establish their
rights in situations in which the majority shareholders oppose the company
doing so.10
The main difficulties associated with the common-law derivative action, which
preceded the introduction of the statutory derivative action under Part 2F.1A,
were summarised as follows in the Explanatory Memorandum to the CLERP Bill
1998 (which became the CLERP Act 1999):11
● the effect of ratification of the impugned conduct by the general meeting
of shareholders (if effective, the purported ratification by a majority of
shareholders could deny the company as a whole, and hence minority
shareholders, any right of action against the directors)
● the lack of access to company funds by shareholders to finance the proceed-
ings (where a shareholder seeks to enforce a right on behalf of a company,
they are likely to be disinclined to risk having costs awarded against them

8 For a fuller discussion, see Jason Harris, Anil Hargovan and Michael Adams, Australian Corporate Law,
Sydney, LexisNexis (2009, 2nd edn), Chapter 20.
9 Emilios Kyrou, ‘Directors’ Duties, Defences, Indemnities, Access to Board Papers and D&O Insurance Post
CLERPA’ (2000) 18 Company and Securities Law Journal 555, 561.
10 See Metyor Inc v Queensland Electronic Switching P/L [2002] QCA 269 (30 July 2002).
11 Explanatory Memorandum to the CLERP Bill 1998, para 6.15.
282 CORPORATE GOVERNANCE IN AUSTRALIA

in a case which will ultimately benefit the company as a whole, not just
individual shareholders) and
● the strict criteria that need to be established before a court may grant leave.
The current statutory derivative action allows an eligible applicant, which
includes shareholders and directors, to commence proceedings on behalf of a
company, including for breaches of directors’ duties under sections 180–4, where
the company is unwilling or unable to do so. Proceedings may be commenced
in respect of wrongs done to the company, with the company thereby benefiting
from successful actions.12

11.2.2 Eligible applicant

Section 236(1), outlining who is entitled to apply to bring a statutory derivative
action, provides as follows:
(1) A person may bring proceedings on behalf of a company, or intervene
in any proceedings to which the company is a party for the purpose of
taking responsibility on behalf of the company for those proceedings, or
for a particular step in those proceedings (for example, compromising or
settling them), if:
(a) the person is:
(i) a member, former member, or person entitled to be registered as
a member, of the company or of a related body corporate or
(ii) an officer or former officer of the company and
(b) the person is acting with leave granted under section 237.
Thus, an application for leave can be made by:
● members of the company (including those with a present entitlement to
be registered)
● former members of a company or related body corporate and
● directors and officers, present and former, of the company.
Under the common law, only members may institute derivative proceedings
on behalf of a company. Former members were included under the statutory
provision because they may have been compelled to leave the company in view
of the dispute potentially giving rise to the litigation on behalf of the company.
Members and former members of a related body corporate are also included as
they may be adversely affected by the failure of the company to take action and
therefore may have a legitimate interest in applying to commence a derivative
action. This will be particularly relevant in a corporate group scenario where
subsidiary companies wish to take action against the directors of the holding
company; for example, the New South Wales Supreme Court decision in Goozee
v Graphic World Group Holdings Pty Ltd.13 In this case, however, leave to institute
a derivative action was refused, as the court held that the applicant was not acting
in good faith, and the derivative action would not be in the best interests of each
12 Ibid, para 6.17.
13 [2002] NSWSC 640 (25 July 2002).
 ENFORCEMENT OF DIRECTORS’ DUTIES 283

immediate holding company. The conferral of standing on officers recognises

that they are most likely to be the first to become aware of a right of action that
is not being pursued by the company.14
ASIC is not included as an eligible applicant. The motivation of this rule is
discussed as follows in the Explanatory Memorandum to the CLERP Bill 1998:15

[A]s the basic policy objective of derivative proceedings is to provide an effective

remedy for investors and to overcome the difficulties in Foss v Harbottle – there is
no proper role for ASIC to bring such proceedings. In particular, the statutory action
is not intended to be regulatory in nature, but to facilitate private parties to enforce
existing rights attaching to the company – effectively, the action is designed to be a self
help measure. In this regard, a statutory derivative action has the potential to remove
some of the regulatory burden from ASIC by making it easier for investors themselves
to protect the interests of a company. (There are other means by which ASIC may
commence actions on behalf of investors, for example, under s 50 of the ASIC Act.)

11.2.3 Cause of action

The statutory derivative action may be used in respect of a cause of action that a
company has against either:
● a director of the company for breach of duties owed to the company or
● a third party for a breach of contract or in respect of a tortious act committed
by that third party (it is however presumed that where proceedings involve
a third party, granting leave is not in the best interests of the company unless
the contrary is proved (section 237(3)).16
The provisions allow a person to intervene in proceedings to which a company
is a party, on behalf of the company, for the purpose of taking responsibility on
behalf of the company for those proceedings, or for a particular step in those
proceedings. This includes continuing, defending, discontinuing, compromising
or settling the proceedings on behalf of the company.17

11.2.4 Leave of court required to institute the statutory

derivative action
It was realised that appropriate checks and balances should be provided in the
legislation to prevent abuse of the proceedings and to ensure that company
managements are not undermined by vexatious litigation and that company
funds are not expended unnecessarily. This is done by requiring in section 237
that a court should only grant leave to proceed with the action if:18

14 Explanatory Memorandum to the CLERP Bill 1998, paras 6.26–6.28.

15 Ibid, para 6.30.
16 Ibid, para 6.20.
17 Ibid, para 6.21.
18 For discussion of the legal principles surrounding the operation of s 237, see Swansson v Pratt (2002) 42
ACSR 313; Fiduciary Ltd v Morningstar Research Pty Ltd (2005) 53 ACSR 732; Ragless v IPA Holdings Pty Ltd
(in liq) (2008) 65 ACSR 700; Chahwan v Euphoric Pty Ltd (2008) 65 ACSR 661; Oates v Consolidated Capital
Services Ltd (2009) 72 ACSR 506.
284 CORPORATE GOVERNANCE IN AUSTRALIA

● there is inaction by the company: section 237(2)(a)

● the applicant is acting in good faith: section 237(2)(b)
● the action appears to be in the best interests of the company: section
237(2)(c)
● there is a serious question to be tried: section 237(2)(d) and
● the applicant gave written notice to the company of the intention to apply
for leave, and of the reasons for applying, at least 14 days before making
the application, or circumstances are such that it is appropriate to grant
leave in any case: section 237(2)(e).
Upon the applicant establishing each of the five ingredients of section 237(2) to
the court’s satisfaction, the court is required to grant the application for leave
under section 237(1). There is no residual discretion.19
In one of the first cases to interpret Part 2F.1A, RTP Holdings Pty Ltd v Roberts,20
Lamer J explained why leave of the Court is necessary for a derivative action:

There are good reasons why leave should first be obtained. If any former member or
officer was able to cause the company to commence proceedings before leave was
granted, a multiplicity of suits might arise. Moreover a member or officer could usurp
the proper functions of the company. A company is entitled to decide for itself whether
it wishes to bring, defend or intervene in legal proceedings. Where a company will
not itself bring, defend or intervene in proceedings it is necessary that there be some
filtering system such as the requirement for leave before proceedings are commenced
in the name of the company.21

Empirical evidence suggests that it is a moot point whether the introduction of the
statutory derivative action, as framed in Part 2F.1A,22 has served as an effective
watchdog by empowering shareholders to litigate on behalf of the company to
redress wrongs done to the company.23

11.3 Oppressive conduct of affairs: Part 2F.1

11.3.1 Type of conduct covered by Part 2F.1

Section 232 of the Corporations Act specifies the grounds for a court order
under Part 2F.1. It provides that a court can make any order under section 233
(see discussion below) if certain specified conduct by the corporation is either
contrary to the interests of the members as a whole; or oppressive to, unfairly

19 Chahwan v Euphoric Pty Ltd (2008) 65 ACSR 661.

20 [2000] SASC 386 (8 November 2000).
21 Ibid [14].
22 For criticisms of law reform proposals leading up to the introduction of Part 2F.IA, see Anil Hargovan,
‘Under Judicial and Legislative Attack: The Rule in Foss v Harbottle’ (1996) 113 South African Law Journal
631.
23 See further, I Ramsay and B Saunders, Litigation by Shareholders and Directors: An Empirical Study of the
Statutory Derivative Action, Melbourne, Centre for Corporate Law and Securities Regulation, The University
of Melbourne (2005).
 ENFORCEMENT OF DIRECTORS’ DUTIES 285

prejudicial to, or unfairly discriminatory against, a member or members whether

in that capacity or in any other capacity. Three specified forms of conduct are
listed:
(a) the conduct of a company’s affairs or
(b) an actual or proposed act or omission by or on behalf of a company or
(c) a resolution, or a proposed resolution, of members or a class of members
of a company.
The oppression remedy is frequently relied upon, especially by members in pro-
prietary companies whose commercial interests may be exploited and who may
be unable to sell their shares to exit the company. The Corporations Act does
not define oppression. The courts have defined oppression widely to mean con-
duct that is ‘burdensome, harsh and wrongful’.24 In the leading decision on the
operation of section 232, the High Court in Wayde v NSW Rugby League Ltd25
held that there is no need to establish any irregularity or breach of legal rights
to succeed. Thus, conduct that is legal may still be oppressive.26 Furthermore,
mere prejudice or discrimination is insufficient to establish a breach of section
232, as the wording in that section requires the prejudice or discrimination to be
unfair. Oppression may occur even though all members of a company are treated
equally.27 There is no requirement to prove that the company or its officers
intended to cause harm to the members.28 The broad nature of this provision,
together with the wide nature of relief available (identified below), makes it an
important remedy for minority shareholders.29

11.3.2 Who may apply for relief under Part 2F.1?

Section 234 allows the following parties to bring an application under Part 2F.1:
● a member of the company, even if the application relates to an act or
omission that is against:
(i) the member in a capacity other than as a member or
(ii) another member in their capacity as a member or
● a person who has been removed from the register of members because of
a selective reduction or
● a person who has ceased to be a member of the company if the application
relates to the circumstances in which they ceased to be a member or
● a person to whom a share in the company has been transmitted by will or
by operation of law or

24 Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324.

25 (1985) 180 CLR 459.
26 For recent application of these legal principles, see Dodrill v The Irish Restaurant & Bar Co Pty Ltd [2009]
QSC 317.
27 John J Starr (Real Estate) Pty Ltd v Robert R Andrew (A’asia) Pty Ltd (1991) 6 ACSR 63,
28 Campbell v Backoffice Investments Pty Ltd [2009] HCA 25.
29 See further, Ian Ramsay, ‘An Empirical Study of the Use of the Oppression Remedy’ (1999) 27 Australian
Business Law Review 23.
286 CORPORATE GOVERNANCE IN AUSTRALIA

● a person whom ASIC thinks appropriate having regard to investigations it

is conducting or has conducted into:
(i) the company’s affairs or
(ii) matters connected with the company’s affairs.
The discretion of ASIC under section 234(e) is, however, now wide enough to
allow any person to have standing if ASIC thinks it to be appropriate after the
investigation conducted into the company’s affairs or matters connected with
the company’s affairs. This, obviously, may include a creditor.
‘Member’ was defined in the former section 246AA(5) as including a legal
personal representative of the member and others to whom a share has been
transmitted under a will or by operation of law. It was, however, required that
the shareholder be a ‘registered’ shareholder.30
It will be apparent from the above that this is no longer a requirement. Even a
person removed from the register or who ceased to be a member, if the application
relates to the circumstances in which they ceased to be a member, could bring
the application.

11.3.3 Nature of relief available under Part 2F.1

Section 232(1) confers upon a court a broad discretion to make ‘any order under
this section that it considers appropriate in relation to the company’. Apart from
this very wide discretion, section 232(1) lists 10 specific orders the court could
consider, namely:
● that the company be wound up
● that the company’s existing constitution be modified or repealed
● that conduct of the company’s affairs be regulated in future
● for the purchase of any shares by any member or person to whom a share
in the company has been transmitted by will or by operation of law
● for the purchase of shares with an appropriate reduction of the company’s
share capital
● for the company to institute, prosecute, defend or discontinue specified
proceedings
● authorising a member, or a person to whom a share in the company has
been transmitted by will or by operation of law, to institute, prosecute,
defend or discontinue specified proceedings in the name and on behalf of
the company
● appointing a receiver or a receiver and manager of any or all of the com-
pany’s property
● restraining a person from engaging in specified conduct or from doing a
specified act and
● requiring a person to do a specified act.

30 Niord Pty Ltd v Adelaide Petroleum NL (1990) 8 ACLC 684.

 ENFORCEMENT OF DIRECTORS’ DUTIES 287

It is clear that the judicial discretion afforded under section 233 may be exercised
to mould a remedy appropriate to each particular case. Section 233(2) ensures
that the general law applying to winding up will apply if the court orders that
the company be wound up. Previously, the court’s discretion was limited in that
it could not order that a company be wound up if it would unfairly prejudice the
oppressed member(s): former section 246AA(4). This limitation has now been
removed.
Where a court’s order effects a change to the company’s constitution the
company cannot, without leave of the court, alter the constitution in a manner
that is inconsistent with the order, unless the order states that the company does
have the power to make such a change: section 232(3)(a). The company could,
alternatively, obtain the leave of the court to repeal or modify its constitution if
it was modified by the court in terms of section 233(1)(b).

11.4 Section 1324 injunctions

11.4.1 Introduction
Strangely, the injunctive relief provided for under section 1324 has only rarely
been used. Subsection 1324(1) allows ASIC or a person ‘whose interests have
been, are or would be affected by the conduct’ to apply for an injunction or interim
injunction (section 1324(4)) restraining a person who engages in conduct which,
in essence, directly or indirectly involves a contravention of the Corporations Act
2001 (Cth). Under section 1324(2), the court may require a person who fails or
refuses to do an act required by the Act to do such an act. We emphasise that
section 1324 applies to the entire Act.

11.4.2 Section 1324(1)

In essence, section 1324(1) provides that where a person has engaged, is engag-
ing or is proposing to engage in conduct that constituted, constitutes or would
constitute a contravention of the Act, the court may, on the application of ASIC or
of ‘a person whose interests have been, are or would be affected by the conduct’,
grant an injunction, on such terms as the court thinks appropriate, restraining
the first-mentioned person from engaging in the conduct and, if in the opinion
of the court it is desirable to do so, requiring that person to do any act or thing.
Importantly, the phrase ‘a person whose interests have been, are or would be
affected’, has been interpreted broadly to apply to creditors, employees, share-
holders and other stakeholders31 – even though, as discussed earlier, directors
owe their duties first and foremost to the company. Accordingly, while the gen-
eral duties of directors (for example, due care and diligence, good faith, proper

31 See, for example, Airpeak Pty Ltd v Jetstream Aircraft (1997) 15 ACLC 715; Allen v Atalay (1993) 11 ACSR
753.
288 CORPORATE GOVERNANCE IN AUSTRALIA

purpose) under Chapter 2D of the Act are owed to the company, and only ASIC
or the company (if seeking a compensation order – see section 1317(2)) has
standing to initiate action for breach as the duties are civil penalty provisions, if
a shareholder or a creditor, for example, suffers some loss or damage due to a
breach or potential breach of a Chapter 2D duty, they may utilise section 1324 to
have the particular conduct stopped, and/or to obtain damages (under section
1324(10), discussed below). This also applies, for example, to the insolvent trad-
ing provisions, which is particularly relevant for creditors who may be affected
by a director incurring debts at a time when the company is insolvent or faces
pending insolvency. Without section 1324, stakeholders affected by corporate
misconduct, but without standing, would be dependent on ASIC to take action.
This highlights the power of section 1324 as a remedial tool for stakeholders,
and explains why commentators are frustrated by the fact that it has to date been
under-utilised.32 For example, Baxt has commented:

Section 1324 has, in my view, been rather surprisingly little used in trying to make
directors accountable to a broader range of persons. The section creates a statutory
right in shareholders and others who may establish that they have a relevant interest
in pursuing a claim to have the directors comply with the duties imposed on them by
the Corporations Act.33

With the statutory derivative action under Part 2F.1A now also available to
shareholders and others, and with ASIC’s active role as litigating regulator, the
use of section 1324 may become even rarer in future.

11.4.3 The court’s discretion

Section 1324 provides the court with a broad discretion to make orders on such
terms as it thinks appropriate and to discharge and vary such at any time: section
1324(1), (2) and (5). The court may also order the person to pay damages to any
other person in lieu or in addition to an order under section 1324(1) and (2):
section 1324(10). Moreover, the court may order relief under section 1324(1)
or (2) whether or not it appears that:
● the person will continue to engage, or refuse/fail to engage, in that conduct
● the person has previously engaged, or refused/failed to engage, in that
conduct and
32 See James McConvill, ‘Part 2F.1A of the Corporations Act: Insert a New s 242(2) or Give it the Boot?’
(2002) 30 Australian Business Law Review 309; James McConvill, ‘Australian Securities and Investments
Commission’s Proposed Power to Issue Infringement Notices: Another Slap in the Face to s 1324 of the
Corporations Act or an Undermining of Corporate Civil Liberties?’ (2003) 31 Australian Business Law Review
36; James McConvill, ‘Geneva Finance and the “Duty” of Directors to Creditors: Imperfect Obligations and
other Imperfections’ (2003) 11 Insolvency Law Journal 7; James McConvill, ‘Directors’ Duties to Creditors in
Australia After Spies v The Queen’ (2002) 20 Company and Securities Law Journal 4; James McConvill and
Martin Joy, ‘The Interaction of Directors’ Duties and Sustainable Development in Australia: Setting off on
the Unchartered Road’ (2003) 27 Melbourne University Law Review 116; James McConvill, ‘Ensuring Balance
in Corporate Governance’ (2001) 12 Australian Journal of Corporate Law 293; Robert Baxt, ‘A Body Blow to
Section 1324 of the Corporations Law?’ (1996) 14 Company and Securities Law Journal 312.
33 Bob Baxt, ‘Directors’ Duty of Care and the New Business Judgment Rule’ in Ian Ramsay (ed.), Key
Developments in Corporate Law and Trusts Law, Sydney, LexisNexis Butterworths (2002) 164.
 ENFORCEMENT OF DIRECTORS’ DUTIES 289

● there is an imminent danger of substantial damage to any person if that

person engages, or refuses/fails to engage, in that conduct: section 1324(6)
and (7).
In Australian Securities and Investments Commission v Mauer-Suisse Securities
Ltd,34 Palmer J held that when exercising its discretion under section 1324, a
court is not strictly confined by the considerations that would be applicable if it
were exercising its equitable jurisdiction to grant injunctions (that is, whether
there is a serious question to be tried, where the balance of convenience lies, and
whether damages would be an adequate remedy). Rather, according to Palmer
J, while the approach to determining an application under section 1324 will
be virtually the same as an application for an injunction in equity, the ‘broad’
question the court must consider in an application for a section 1324 injunction
is ‘whether the injunction would have some utility or would serve some purpose
within the contemplation of the Act’.35 This approach accords with the universal
view now held by academics and judges that section 1324 should be accorded
an expansive interpretation.36
Later cases have applied the Mauer-Suisse approach, and in doing so have
emphasised that equitable considerations (in particular the balance of con-
venience) still represent a sound basis for undertaking a preliminary assess-
ment of what factors should be reviewed against ASIC’s statutory role in deter-
mining whether to grant an injunction, and are applied when considering
applications for interim injunctions under section 1324(4) as to whether it
is ‘desirable’ (the wording used in section 1324(4)) for the injunction to be
granted.37

11.4.4 Remedies in particular

The main force of section 1324 is to provide restraining and mandatory injunctive
relief. However, section 1324(9) widens the relief available under section 1324
to include the Mareva-type relief provided for under section 1323 of the Act.
Section 1323 gives power to the court to prohibit payment or transfer of money,
securities, futures contracts or property.
Section 1324(10) provides that where the court has power under this section
to grant an injunction restraining a person from engaging in particular conduct, or
requiring a person to do a particular act or thing, the court may, either in addition
to or in substitution for the grant of the injunction, order that person to pay
damages to any other person. In Vanmarc Holdings Pty Ltd v PW Jess & Associates

34 (2002) 42 ACSR 605.

35 Ibid 609.
36 See discussion in James McConvill and Martin Joy, ‘The Interaction of Directors’ Duties and Sustainable
Development in Australia: Setting off on the Unchartered Road’ (2003) 27 Melbourne University Law Review
116, 135.
37 See ASIC v Triton Understanding Insurance Agency Pty Ltd and Others (2003) 48 ACSR 244, 256; Tekinvest
Pty Ltd v Lazarom [2004] NSWSC 940 (11 October 2004), [21]–[22].
290 CORPORATE GOVERNANCE IN AUSTRALIA

Pty Ltd,38 it was confirmed that damages are available to complainants under
section 1324(10) even if an injunction is not sought under section 1324(1).39

11.5 Criminal liability of directors

11.5.1 The importance of the criminal sanction in the

corporations law
The sanctions explained above could be described as civil sanction based on
statutory provisions. We have chosen not to deal with non-statutory civil sanc-
tion (for example, action against directors or other personnel for common law
negligence or breach of trust in equity) because of limited space and the fact that
the statutory sanctions are so prominent nowadays. The criminal sanction is,
however, also a very prominent one in the Australian corporations law and some
mention should be made of potential offences directors and officers can commit
under the Act. A comprehensive discussion of possible offences for corporations,
directors and other officers falls outside the scope of this work. Appendix G
to the Report of the HIH Royal Commission provides a very useful summary of
the offence provisions of several Acts. This appendix also contains an excellent
explanation of the differences between the corporations law before and after
13 March 2000. The relevance of this date is that significant amendments were
made to the Corporations Act with effect from 13 March 2000.40
We deal here with only some of the most important criminal offences that
directors and officers can commit, and only with those mentioned in the Act.
There are numerous other offences, in particular in the areas of occupational
health and safety and environmental law, and, of course, under general criminal
law (for example, theft, complicity and a range of deception offences)41 that
could be committed by directors and officers, but also that fall outside the scope
of this work.
Subject to the provisions of the Act, the Criminal Code Act 1995 (the Code)
applies to all offences against the Act.42 The Code clarifies the operation of
general principles of criminal liability by setting in place the ‘physical’ element
(what traditionally was the actus reus or physical act of the offence) and the
‘fault’ element of an offence (traditionally the mens rea). To briefly explain, the
Code provides that the physical elements of an offence are:
(a) conduct or
(b) the circumstances in which conduct occurs or
(c) a result of conduct.

38 (2000) 34 ACSR 222 at 227.

39 See also Airpeak Pty Ltd v Jetstream Aircraft (1997) 15 ACLC 715, 720 (Einfeld J).
40 Report of the HIH Royal Commission (Owen Report), Volume I, Department of the Treasury (2003) 321–30.
41 See, for example, James McConvill and Mirko Bagaric, ‘Criminal Responsibility Based on Complicity
Among Corporate Officers’ (2004) 16 Australian Journal of Corporate Law 172. For a general discussion of
these offences, see Mirko Bagaric and Ken Arenson, Criminal Laws of Australia, Melbourne, Oxford University
Press (2004), Chs 9 and 10.
42 Section 1308A of the Act.
 ENFORCEMENT OF DIRECTORS’ DUTIES 291

Under the Code, the prosecution has the onus of proving each physical element
contained in the offence. Along with the physical element(s), the prosecution
is also required to prove the fault element of the offence. The Code sets down
four so-called ‘default’ fault elements: intention, knowledge, recklessness and
negligence. The Code operates such that an offence can have its own fault ele-
ment specific to the physical element of the offence; however, where there is no
specified fault element, the Code expressly states that a default fault element
will apply to determine liability. The Code provides that for the ‘conduct’ part of
an offence (for example, improper use of company information), the default ele-
ment is ‘intention’; for ‘circumstances’ or ‘result’ (for example, causing detriment
to the corporation) the default element is ‘recklessness’.
Part 2.5 of the Criminal Code is particularly significant, in that it expresses
how the Code applies to bodies corporate. It explains how the principles of crim-
inal responsibility in the Code apply to bodies corporate in relation to offences
against Commonwealth laws (including the Corporations Act). Thus, to deter-
mine whether the company will be criminally liable for intentional offences of
directors or other officers under the Act, Part 2.5 needs to be consulted (unless
the relevant provision states that the principles of criminal responsibility under
the Code do not apply). Part 2.5 provides that the physical element of an offence
will be attributed to a body corporate where it is committed by an agent or officer
of the body corporate acting within the actual or apparent scope of their author-
ity. This is, in essence, a codification of the traditional common law principle
attributing criminal liability to the company when a criminal act is committed
by the ‘directing mind’ of the company.43 In relation to the fault element, Divi-
sion 12.3(1) provides that where ‘intention, knowledge or recklessness’ is a fault
element of an offence, that element can be attributed to the company if the com-
pany ‘expressly, tacitly or impliedly authorised or permitted the commission of
the offence’.
Division 12.3(2) of the Code is crucial here, as it provides that ‘authorisation
or permission’ may be established by a number of means including:
(a) proving that a corporate culture existed within the body corporate that
directed, encouraged, tolerated or led to non-compliance with the relevant
provision or
(b) proving that the body corporate failed to create and maintain a corporate
culture that required compliance with the relevant provision.
‘Corporate culture’ is defined under Part 2.5 (section 12.3(6)) of the Code as
an ‘attitude, policy, rule, course of conduct or practice existing within the body
corporate generally or in the part of the body corporate in which the relevant
activities take place’. The effect of Part 2.5, therefore, is that the intention of a
company will be equated with its ‘corporate culture’. It is generally accepted that
Part 2.5 of the Code, by embedding the concept of corporate culture, will have a
significant impact on the approach to determining criminal liability of companies

43 See Tesco Supermarkets v Nattrass [1971] 2 All ER 127.

292 CORPORATE GOVERNANCE IN AUSTRALIA

for the actions of their directors as well as their employees and agents.44 Part
2.5 may, indeed, impose a direct duty on companies to implement a compliance
system to avoid systematic contravention of federal legislation, including the
Act.45
It is pertinent to note that there is often very little, if any, substantive dif-
ference between conduct that is a criminal or a civil wrong. As a result of the
huge expansion over the past few decades in the types of conduct that are now
proscribed by the criminal law, it is not tenable to provide a coherent rationale
to distinguish between criminal and civil wrongs. It is certainly not the case, for
example, that criminal liability is now reserved for the most heinous or harmful
types of conduct. A large amount of very trifling conduct – such as littering and
incorrectly parking a motor vehicle, and in some jurisdictions even flying a kite
to the annoyance of others – is a criminal offence.46 Thus, as a general rule, few
inferences, in terms of the seriousness of the proscribed conduct, can be drawn
merely from whether a director or officer is guilty of a civil or a criminal penalty.
Whether conduct is made a criminal or civil offence often turns on matters
such as the (actual or perceived) public sentiment, at the time the offence was
created, in relation to the relevant conduct. Given the increasing amount of public
disillusionment in recent years regarding corporate behaviour and collapses, it
is not surprising that progressively we are seeing a range of new corporate
criminal offences being enacted. This, however, does not necessarily mean that
the conduct prohibited by these provisions is objectively particularly serious or
damaging.
Despite the fact that there is no coherent distinction between civil and criminal
wrongs, there are significant differences in the manner in which the respective
breaches are treated. Criminal offences tend to result in stigmatisation and sub-
ject the agent to a range of coercive measures, including imprisonment. Civil
wrongs do not generally involve moral censure, and the harshest measure is
generally in the form of a monetary extraction.
Thus, whether conduct is dealt with by means of civil or criminal liability often
seems arbitrary. In addition, the conduct covered by the civil and criminal wrongs
is often very similar, and in fact can often be dealt with under either regime. In
such circumstances, prosecution authorities effectively may elect to pursue the
director or officer in either the civil or the criminal jurisdiction. Faced with such
a choice, it might seem most appropriate to elect to go down the criminal stream
in order that the defendant is held fully accountable for their conduct. However,
there are often compelling reasons for instead pursuing a civil remedy.
First, it is generally easier to establish civil wrongdoing, where the burden of
proof is on the balance of probabilities, instead of the higher standard of beyond

44 See James McConvill and John Bingham, ‘Comply or Comply: The Illusion of Voluntary Corporate Gov-
ernance’ (2004) 22 Company and Securities Law Journal 208, 213–14.
45 See Christine Parker and Olivia Conolly, ‘Is there a Duty to Implement a Corporate Compliance System in
Australian Law?’ (2002) 30 Australian Business Law Review 273, 282–3.
46 For further discussion regarding the convergence between criminal and civil offences, see Mirko Bagaric,
‘The “Civil-isation” of the Criminal Law’ (2001) 25 Criminal Law Journal 197.
 ENFORCEMENT OF DIRECTORS’ DUTIES 293

reasonable doubt. The rules of evidence in relation to civil proceedings are also far
more liberal and hence prosecution authorities (including the Commonwealth
Department of Public Prosecutions in relation to the Act) can normally tender a
greater amount of evidence in support of a civil case.47
Second, people charged with criminal offences are likely to more fiercely
contest such allegations than allegations that have only a civil dimension. This
is because criminal offences carry a greater stigma and often involve a risk of
imprisonment – which is the harshest penalty in our system of law. Thus, the
prospect of reaching an agreed settlement with a director or officer is diminished
if criminal proceedings are pursued.
Prosecution authorities should not be unduly influenced by seeking to finalise
matters as expeditiously as possible. Ultimately, the most important objective
is to ensure that all people are held fully responsible for their transgressions. It
would be remiss of prosecution authorities not to give considerable weight to
the likely cost to the public of a long criminal trial – which can readily blow out
into millions of dollars – in deciding whether they should launch civil or criminal
proceedings against a director or officer.
In some cases, where the evidence is particularly strong, even the most power-
ful and well-resourced directors or officers may plead guilty to criminal offences.
The advantage to them in doing so is that a plea of guilty, which spares the
community significant costs in the form of legal costs and is viewed as evidence
of contrition by the accused person, entitles the accused to a significant penalty
reduction.

11.5.2 Selected criminal offences directors and other officers

can commit under the Corporations Act
11.5.2.1 General
Schedule 3 to the Act contains all the penalties (criminal as well as civil) and
maximum periods of imprisonment for each of the criminal offences created by
the Act. After the amendments effected by CLERP 9 (after 1 July 2004) there
are 590 different offences for which penalties are prescribed in Schedule 3.
These offences can be committed by a wide variety of persons, but they are
primarily offences that can be committed by the company, directors and officers
and employees of the company.
Since we have concentrated on the civil penalty provisions as far as directors’
duties are concerned, we will also only give an overview of the offences directors
can commit in relation to those provisions. Apart from section 180 (duty of care
and diligence) and sections 674(2A) and 675(2A) (continuous disclosure), all
the other civil penalty provisions are also made offences under the Act.

47 For a discussion of evidence law and the different rules that apply in the criminal and civil jurisdiction,
see Ken Arenson and Mirko Bagaric, Understanding Evidence Law, Sydney, LexisNexis Butterworths (2002).
294 CORPORATE GOVERNANCE IN AUSTRALIA

11.5.2.2 Specific offences for breaches of duties

Whereas sections 181–3 reflect directors’ civil obligations, section 184 lays down
the requirements for when directors will commit criminal offences in contra-
vening their duties of good faith, use of position and use of information. Under
section 184(1) a director or other officer of a corporation commits an offence if
they are reckless, or are intentionally dishonest, and fail to exercise their powers
and discharge their duties in good faith in the best interests of the corporation,
or for a proper purpose.
Section 184(2) provides that a director, other officer or employee of a corpo-
ration commits an offence if they use their position dishonestly with the intention
of directly or indirectly gaining an advantage for themselves, or someone else,
or causing detriment to the corporation; or recklessly as to whether the use may
result in themselves or someone else directly or indirectly gaining an advantage,
or in causing detriment to the corporation.
In terms of section 184(3), a person who obtains information because they
are, or have been, a director or other officer or employee of a corporation commits
an offence if they use the information dishonestly with the intention of directly
or indirectly gaining an advantage for themselves, or someone else, or causing
detriment to the corporation; or recklessly as to whether the use may result in
themselves or someone else directly or indirectly gaining an advantage, or in
causing detriment to the corporation.
A director who fails to perform his or her duties under these sections may be
guilty of a criminal offence with a penalty of $200 000 or imprisonment for up
to five years, or both.48
The most common penalty for directors who commit the offences comparable
to the civil penalty provisions is a penalty of $200 000 (or $1 million for financial
services civil penalty provisions) or imprisonment for five years, or both.49 The
offences associated with insider trading are, however, more serious. A person
who commits the insider trading criminal offences faces fines of up to $2 million,
or imprisonment for five years, or both.50

11.6 Conclusion

In this chapter we have shown that there are several ways of enforcing the
provisions of the Corporations Act 2001 (Cth). Although ASIC plays a dominant
role in this regard, shareholders, directors and officers, and creditors are also
given standing to enforce directors’ duties either on behalf of the company or
on their own behalf. The statutory derivative action (Part 2F.1A) and oppressive
remedies (Part 2F.1) are the most important remedies available to shareholders.

48 Item 30 of Schedule 3 to the Act; Para 5.3 of Part 1.5 (Small Business Guide) of the Act.
49 See Items 50, 80, 86, 89–90, 117, 138, 163A–163C, 164A and 309B–310B of Schedule 3 to the Act; and
subclause 29(7) of Schedule 3 to the Act.
50 See Items 311C and 312A of Schedule 3 to the Act.
 ENFORCEMENT OF DIRECTORS’ DUTIES 295

Section 1324 injunctions and damages provide powerful remedies to any person
affected by conduct of the company in contravention of provisions of the Act, but
its use in practice is disappointing.
It will also be apparent that there are numerous criminal sanctions for con-
traventions of the Act. As pointed out in Chapter 7, several criminal charges
have already been brought against several directors of the large corporations
that have collapsed since 2000, leading to the imprisonment of people like Ray
Williams, Rodney Adler, Brad Cooper and others. There are also criminal pro-
ceedings pending against the directors of Chartwell Enterprises (Ian Rau and
Graeme Hoy) and the directors of Opes Prime.51 It is highly likely that further
civil and criminal proceedings will follow the collapses of Westpoint, Centro
Properties, Storm Financial,52 Fincorp and Kleenmaid.
51 See ‘Chartwell Officer Arrested on Criminal Charges’ ASIC Media Release 09–139AD (11 August
2009), available at <www.asic.gov.au/asic/asic.nsf/byheadline/09–139AD+Chartwell+officer+arrested+
on+criminal+charges?openDocument>; ‘ASIC Brings Charges Against Opes Prime Directors’, ASIC Media
Release 10–05AD (11 January 2010), available at <www.asic.gov.au/ASIC/asic.nsf/byHeadline/10-05AD%
20ASIC%20brings%20charges%20against%20Opes%20Prime%20directors?opendocument>; Chris Zap-
pone, ‘Opes Prime Directors Charged by ASIC’, Sydney Morning Herald (11 January 2010), available at
<www.smh.com.au/business/opes-prime-directors-charged-by-asic-20100111-m27h.html>.
52 See ASIC Media Centre, ‘Update for Former Clients of Storm Financial, available at <www.asic.gov.au/
storm>.
 PART THREE
CORPORATE GOVERNANCE IN
INTERNATIONAL AND
GLOBAL CONTEXTS
12
Corporate governance in the USA,
the UK and Canada

Two features can be considered to describe the modern world – globalization

and the free market. It is widely accepted – almost unquestioningly – that
free markets will lead to greater economic growth and that we will all
benefit from this economic growth.
Güler Aras and David Crowther ‘Convergence: A Prognosis’
in Güler Aras and David Crowther (eds), Global Perspectives
on Corporate Governance and CSR, Farnham,
Gower Publishing Ltd (2009) 314–15

12.1 Introduction

In this chapter we give a brief overview of corporate governance in the USA, the
UK and Canada, while we deal with the OECD principles of corporate governance
and corporate governance in Germany, China and Japan in Chapter 13. In the
first edition of this book we dealt with the OECD principles of corporate gover-
nance and corporate governance in the USA, the UK and Germany in one chapter
(Chapter 12). As we decided to add China and Japan as two new and important
jurisdictions, the chapter became too long. The reason for the split is that cor-
porate governance in the USA, the UK and Canada is classified as Anglo-American
models. The OECD principles include traditional Anglo-American corporate gov-
ernance principles, but it also goes wider – spanning across principles applying to
a traditional unitary board structure and principles applying to a typical two-tier
board structure. Germany has always been seen as the prime example of a juris-
diction that adopted a true two-tier board structure for public corporations and
larger proprietary companies, while Japan has been influenced by this. China has
a unique corporate governance model because of the political model adopted in
that country.

299
300 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

12.2 United States

12.2.1 Background to the corporate governance

debate in the USA
Corporate governance has been a topic for discussion in the USA for a very long
time, and the materials on corporate governance in the USA are extensive. In such
a dominant world economy, United States debates on corporate governance will
almost invariably influence corporate governance debates in other jurisdictions.
It is, therefore, important to deal with corporate governance debates in the USA
to lay the basis for understanding corporate governance models in other parts of
the world.
The debate on corporate governance in the USA had started as early as 1932,
when Berle and Means published their book, The Modern Corporation and Private
Property.1 The importance of this debate was emphasised further by Mace’s book,
Directors: Myth and Reality, published in 1971, but the discussion became really
heated in 1982 with the publication by the American Law Institute (ALI) of its
Principles of Corporate Governance and Structure: Restatement and Recommenda-
tions. This project, which had started off quite modestly, resulted in a stream of
publications on the topic of corporate governance in the USA. The Proposed Final
Draft (later termed Principles of Corporate Governance and Structure: Analysis and
Recommendations) was only approved in May 1992. However, publications on
this topic did not stop there. In 1993 alone, 73 articles published in American
law review journals dealt directly with the topic of corporate governance. One
commentator justly alluded to ‘The Emergence of Corporate Governance as a
New Legal Discipline’;2 while another remarked that between 1990 and 1993
‘events have moved at lightning speed for the world of corporate governance’.3
That speed has accelerated considerably since the huge corporate collapses of
Enron,4 WorldCom, Global Crossing, Tyco, Adelphia and others.
Studying corporate governance developments in the USA is important, since
some people apparently became aware of the corporate governance debate only
when the Cadbury Report was published in 1992 in the UK, and, there are still
some who wrongly believe that corporate governance was an invention of the
Cadbury Report.5 It is also noteworthy that the Cadbury Report dealt only with
a limited area of corporate governance, namely ‘Financial Aspects of Corporate
Governance’.

1 Klaus J Hopt, ‘Preface’ in Institutional Investors and Corporate Governance, New York, W. de Gruyter
(1994) i.
2 E Norman Veasey, ‘The Emergence of Corporate Governance as a New Legal Discipline’ (1993) 48 The
Business Lawyer 1267.
3 Irna M Millstein, ‘The Evolution of the Certifying Board’ (1993) 48 The Business Lawyer 1485, 1489.
4 For a summary of the circumstances that led to the collapse of Enron, see K Fred Skousen, Steven M Glover
and Douglas F Prawitt, An Introduction to Corporate Governance and the SEC, Mason, Thomson South-West,
(2005) 3–5.
5 See generally Nigel Kendall and Arthur Kendall, Real-World Corporate Governance, London, Pitman (1998)
22; Bob Garratt, The Fish Rots from the Head, London, P Profile Books (2003) 140.
 THE USA, THE UK AND CANADA 301

In the USA, the theories of shareholder primacy and profit maximisation are
still dominant in expressing ‘the objective and conduct of the corporation’. This
is clearly set out in the ALI’s Principles of Corporate Governance:
The objective and conduct of the corporation
§ 2.01(a) Subject to the provisions of Subsection (b) . . . a corporation should
have as its objective the conduct of business activities with a view to enhance
corporate profit and shareholder gain.
(b) Even if corporate profit and shareholder gain are not thereby enhanced,
the corporation, in the conduct of its business:
1. Is obliged, to the same extent as a natural person, to act within the bound-
aries set by law;
2. May take into account ethical considerations that are reasonably regarded
as appropriate to the responsible conduct of business; and
3. May devote a reasonable amount of resources to public welfare, humani-
tarian, educational, and philanthropic purposes.
The only qualifications to shareholder primacy and profit maximisation are that
these aims should be achieved within the boundaries of the law; taking into
account ethical considerations; ensuring responsible conduct of business; and
that a reasonable amount of resources should be given to public welfare, human-
itarian, educational, and philanthropic purposes.

12.2.2 The American Law Institute’s involvement in the

corporate governance debate
12.2.2.1 Basic aims of the project
In its project, Principles of Corporate Governance and Structure: Restatement and
Recommendations, the ALI aspired to extract from the corpus of United States law
of corporations a set of generalised propositions that would instruct managers
and directors about their duties, and to provide criteria for judgment by courts in
cases involving allegations of improper conduct by managements and directors.6
It was hoped to extract the basic corporate governance principles applicable in
the USA from court cases and other sources and to restate the law.7

12.2.2.2 Impact and importance of the project

The project was supposed to be finished within two years, but eventually took
15 years because of the sensitivities involved in the topics discussed and the
huge vested business interests involved in the discussion.8 One commentator
observes that ‘it is fair to say that the successive drafts of the Principles received
more intensive review, by a greater number and wider variety of persons and over

6 Bayless Manning, ‘Principles of Corporate Governance: One Viewer’s Perspective on the ALI Project’ (1993)
48 The Business Lawyer 1319, 1320.
7 Ibid 1319, 1324.
8 Ibid 1319, 1325.
302 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

a longer period of time, than any other project in the history of corporate law’,9
while another states that ‘the Project’s work . . . has occupied the time and effort
of leaders of the corporate bar and respected academicians for over a decade of
intense work, debate, and drafting.’10 One thing is certain, and that is that the
ALI project on corporate governance shaped views on corporate governance and
laid the foundations for many of the current discussions and debates regarding
corporate governance in the rest of the world. This area is of great complexity and
many issues discussed by the ALI are still considered to be quite controversial.11

12.2.2.3 Some of the key aspects addressed

The key topics addressed by the ALI were:
● the objectives and conduct of the corporation
● the structure of the corporation
● the duty of care
● the duty of fair dealing
● tender offers
● remedies.
The topic of the objectives and conduct of the corporation has already been dealt
with above. It is, however, necessary to emphasise that the stakeholder debate
was to a large extent ignored by the ALI. The reason for this is that the theories
of shareholder primacy and profit maximisation were adopted by the ALI as its
point of departure. There are certain statutes in some states of the USA that allow
corporations specifically to consider the interests of other stakeholders such as
employees, suppliers and customers, but the exact nature and scope of these
provisions are still uncertain.12
It is very interesting to study the part of the ALI report dealing with the
structure of the corporation, as it illustrates clearly how the corporate governance
debate in the USA has shaped corporate governance debates in several other
jurisdictions.
§ 3.01 covers ‘Management of the corporation’s business’. It provides that ‘the
management of the business of a publicly held corporation should be conducted
by or under the supervision of such principal senior executives as are designated
by the board of directors, and by those other officers and employees to whom the
management function is delegated by the board or those executives, subject to
the functions and powers of the board in § 3.02 [see below]’.13 This description
clearly provides for a differentiation between the ‘governance circle’ and the
‘managerial pyramid’ we described in Chapter 3 of this book. In fact, it provides for

9 Melvin Aron Eisenberg, ‘An Overview of the Principles of Corporate Governance’ (1993) 48 The Business
Lawyer 1271, 1295.
10 Veasey, above n 2, 1267.
11 See in particular Stephen M Bainbridge, Corporation Law and Economics, New York, Foundation Press
(2002) at 218; Eisenberg, above n 9, 1273–4; and Manning, above n 6, 1319, 1321, 1328–9.
12 Manning, above n 6, 1278.
13 § 8.01(b) of the Model Business Corporations Act (1984 and Supplement) reads as follows: ‘All corporate
powers shall be exercised by or under the authority of, and the business affairs of the corporation managed
by or under the direction of, its board of directors . . . ’
 THE USA, THE UK AND CANADA 303

dual ‘managerial circles’, namely ‘principal senior executives’ and ‘other officers
and employees’. The last-mentioned group receives its managerial powers either
from the board or from the principal senior executives.
This description also clearly recognises the ‘supervisory role’ of the board
and is in accordance with the principle explained in Chapter 3 that the board’s
function is primarily to ‘direct, govern, guide, monitor, oversee, supervise and
comply’. It differs from the traditional formulation of the board’s function, namely
that the business of the corporation ‘shall be managed by [its] board . . . ’14 The
new description of the board’s functions provides another indication that it is
impossible for the board of a large corporation to manage the day-to-day business
of the corporation. That task must of necessity be left to senior executives and
other employees of the corporation.
§ 3.02 deals with ‘Functions and powers of the board of directors’. § 3.02(a)
allocates five primary functions to the board:
(1) select, regularly evaluate, fix the compensation of, and, where appropriate,
replace the senior executives
(2) oversee the conduct of the corporation’s business to evaluate whether the
business is being properly managed
(3) review and, where appropriate, approve the corporation’s financial objec-
tives and major corporate plans and actions
(4) review and, where appropriate, approve major changes in, and determina-
tions of other major questions of choice respecting, the appropriate audit-
ing and accounting principles and practices to be used in the preparation
of the corporation’s financial statements
(5) perform such other functions as are prescribed by law, or assigned to the
board under a standard of the corporation.
It is once again clear that the board’s functions of ‘directing, governing, guiding,
monitoring, overseeing, supervising and complying’ are foremost.

12.2.3 The Securities Exchange Commission

The Securities Exchange Commission (SEC) is the primary securities markets
regulator in the USA. It was formed in 1934 after the passing of Federal legislation
in the form of the Securities Exchange Act of 1934. This legislation followed the
passing of the Securities Act of 1933. The intent of Congress in establishing the
SEC is summarised in the following SEC statement:

Congress, in establishing the securities laws, created a continuous disclosure system

designed to protect investors and to assure the maintenance of fair and honest securities
markets. The Commission, in administering and implementing these laws, has sought
to coordinate and integrate this disclosure . . . 15

14 Bainbridge, above n 11, 195.

15 As quoted by Skousen, Glover and Prawitt, above n 4, 48.
304 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

This Securities Act of 1933 and the Securities Exchange Act of 1934 aimed to
restore the integrity and reliability of information provided to investors. The
stock market crash of 1929 and the fraud, deceit and excesses of the 1920s
were arguably major factors leading to the Great Depression.16 The Securities
Exchange Act of 1934 gave the SEC extensive powers to police, oversee and
regulate the financial markets and also gave it considerable power to investigate
contraventions of the law and civil as well as criminal sanctions to enforce the law.
The SEC experienced slow growth until 1945, but the there were rapid expansions
of powers after almost every market crash or market break, in particular in 1962
and 1977.17
As will be seen in the next part, the expansion of powers and overseeing role
of the SEC were not enough to prevent several abuses, as became apparent in the
early 2000s with the scandals associated with Enron and other scandals involving
corporate giants (Tyco, WorldCom, Xerox, Adelphia, Ahold etc.), brokage firms
(for example, Merrill Lynch), stock exchanges (for example, the New York Stock
Exchange), the large public accounting firms (like Arthur Anderson and others)
and managers of mutual funds (for example, Piper Jaffray). The reaction to
this was another piece of draconian legislation, the Sarbanes-Oxley Act of 2002
(SOX).18
The organisational structure of the SEC is impressive. It consists of five
commissioners and five different divisions (Corporation Finance; Enforcement;
Investment Management; Marker Regulation and Compliance Inspections &
Examinations), an executive director and general counsel. The principal Acts
defining the SEC’s mandate and legal framework are the Securities Act of 1933,
the Securities Exchange Act of 1934 and SOX.19

12.2.4 The Sarbanes-Oxley Act of 2002 – the US response to

collapses such as Enron and WorldCom
12.2.4.1 Backdrop
The passing of SOX should be seen against the backdrop of several huge cor-
porate failures in the USA. These collapses, in particular Enron and WorldCom,
caused serious concern and became such a political issue that the United States
government of the day (at that stage the Bush Administration) saw no option
but to act quickly and radically. It was thought by the Bush Administration to be
the best way to deal with the issue, but there are those who saw it as a politi-
cal knee-jerk reaction to an immediate crisis rather than a carefully considered
and integrated set of responses to wider and underlying corporate governance
problems.20 As was explained by Commissioner Paul Atkins of the SEC:

16 Ibid 2–3 and 31–2.

17 Ibid 35–6.
18 Ibid 5.
19 Ibid 39 and 40–4 and 49 et seq.
20 Bob Garratt, Thin on Top, London, Nicholas Brealey Publishing (2003) 20.
 THE USA, THE UK AND CANADA 305

Last year, in fact, the market decline and large corporate failures led to just such a
general sense that politicians should ‘do something’. The impending November 2002
congressional elections, which had been said to be very close, gave added urgency
to legislative action. Because these corporate failures stemmed from lax accounting
and corporate governance practices, ‘Corporate Responsibility’ became an important
political issue in the United States, for the first time in perhaps 70 years. In late July
of 2002, Congress passed the Sarbanes-Oxley Act, with only 3 members voting ‘no’.
Corporate responsibility is still a critically important political issue in America. Just last
week in his State of the Union address, the President, referring to Sarbanes-Oxley, said
that ‘tough reforms’ were passed to ‘insist on integrity in American business’.21

12.2.4.2 Aims and objectives

The SEC’s summary of SOX22 very clearly set out the aims and objectives of the
Act soon after it became law:
● restoring confidence in the accounting profession
● improving the ‘tone at the top’
● improving disclosure and financial reporting
● improving the performance of ‘gatekeepers’ and
● enhancing enforcement tools.
SOX is indeed a blunt statutory instrument, with heavy civil and criminal
sanctions for contraventions. The passing the SOX Act has been described as
‘enormously consequential’.23 A look at some of its provisions illustrates these
points:

Section 3(b)(1): A violation by any person of this Act, any rules or regulation of the
Commission issued under this Act or any rule of the Board shall be treated for all
purposes in the same manner as a violation of the Securities Exchange Act of 1934 or
the rules and regulations issued thereunder . . .
Section 102: Beginning 180 days after the determination by the Commission it shall
be unlawful for any person that is not a registered public accountant firm to prepare,
or issue, or participate in the preparation or issuance of, any audit report with respect
to any issuer.
Section 105(4): If the Board finds, based on all of the facts and circumstances, that a
registered public accounting firm or associated person thereof has engaged in any act or
practice, or omitted to act, in violation of this Act [or any other relevant rule or regula-
tion] . . . the Board may impose such disciplinary or remedial sanctions as it determines
appropriate, subject to applicable limitations under paragraph (5), including–
(D) A civil money penalty for each violation, in an amount equal to not more than
$100,000 for a natural person or $2,000,000 for any other person; and
in any case to which paragraph (5) applies, not more than $750,000 for a natural
person or $15,000,000 for any other persons.

21 The Sarbanes-Oxley Act of 2002: Goals, Content and Status of Implementation, address delivered at the
University of Cologne (5 February 2003), available at <www.sec.gov/news/speech/spch020503psa.htm>.
22 See <www.sec.gov/news/press/2003-89a.htm>.
23 Skousen, Glover and Prawitt, above n 4, 5.
306 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

Under section 101 a five-member Public Company Accounting Oversight Board,

with extensive powers, was established. This Board has regulatory and enforce-
ment powers comparable to the SEC itself.
The tentacles of SOX stretch all over the world, as no distinction is made
between United States and non-United States ‘Issuers’ (§ 106). Foreign compa-
nies issuing securities on United States markets are brought under the umbrella
of SOX through the definition of ‘Issuer’ in § 2 – basically meaning companies
that issue securities on United States markets. As was explained by Commissioner
Paul Atkins:
Of course, Sarbanes-Oxley generally makes no distinction between U.S. and non-U.S.
issuers. The Act does not provide any specific authority to exempt non-U.S. issuers
from its reach. The Act leaves it to the SEC to determine where and how to apply its
provisions to foreign companies. The SEC is well aware that new U.S. requirements
may come into conflict with home-country requirements on non-U.S. issuers. As we
move forward to implement Sarbanes-Oxley, we have tried and we will continue to try
to balance our responsibility to comply with the Act’s mandate with the need to make
reasonable accommodations to our non-U.S. issuers.24

Paul von Nessen explains as follows:

The passage of the Sarbanes-Oxley Act itself would have had minimal impact upon cor-
porations outside the United States were it not for the fact that a number of Australian
and other foreign corporations have sought to raise capital on the stock exchanges
of the United States. As a result of this, the US legislation and the rules for corpo-
rate governance implemented by the US exchanges in response to the requirement of
Sarbanes-Oxley Act necessitate that Australian corporations which are listed on US
exchanges comply with the listing rules requirements, including requirements relat-
ing both to corporate governance generally and to accounting and auditing standards
specifically.25

The wide application and consequences of SOX were also explained thus by
Commissioner Paul Atkins:
Over 1,300 non-U.S. corporations from 59 countries file reports with the SEC, as
compared with approximately 400 issuers from less than 30 countries in 1990. Most
of our non-U.S. issuers are from Canada. The second largest number are from the U.K.
Currently, approximately 30 German corporations report to the SEC – the largest ones
being DaimlerChrysler AG, E.ON AG, Deutsche Bank, and SAP. In our efforts to create
a global marketplace, we want to encourage more German corporations to participate
in the U.S. securities markets, and we always welcome your comments and advice as
to how we might improve the situation.26

Given this wide application of SOX, at the time of completing this book, the
Australian Securities and Investments Commission (ASIC) was in negotiations
24 The Sarbanes-Oxley Act of 2002: Goals, Content and Status of Implementation, address delivered to the
International Financial Review (25 March 2003), available at <www.sec.gov/news/speech/spch032503psa.
htm>.
25 Paul von Nessen, ‘Corporate Governance in Australia: Converging with International Developments’
(2003) 15 Australian Journal of Corporate Law 189 at 194–5.
26 The Sarbanes-Oxley Act of 2002: Goals, Content and Status of Implementation, above n 21.
 THE USA, THE UK AND CANADA 307

with the SEC and the Public Company Accounting Oversight Board in the USA
to confirm arrangements for overseeing compliance of Australian ‘issuers’ (and
auditors of Australian issuers) with the SOX rules.27
Title II of SOX attempts to ensure ‘auditor independence’ by prohibiting audi-
tors from delivering certain non-audit activities to entities they audit, including
(§201(a)):
● legal services and expert services unrelated to the audit
● management functions or human resources
● book-keeping or other services related to the accounting records or finan-
cial statements of the audit client.
Section 303 of SOX aims to prevent improper influence on the audit process by
making it ‘unlawful . . . to fraudulently influence, coerce, manipulate, or mislead
any auditor engaged in the performance of an audit for the purpose of rendering
the financial statements materially misleading’.
This overview provides more than enough evidence of the evils SOX aims
to prevent28 or, to put it differently, the misuses and abuses related to audits
that occurred in the past. These misuses and abuses of the audit process were
the main reasons many of the recent corporate collapses occurred and why the
actual (poor!) financial position of these corporations could not be detected by
investors.

12.2.4.3 Some perspectives on SOX and its effect

In the first edition of this work it was pointed out that whether SOX was an
overreaction or not, was open to debate and depended on one’s personal political
views on how far a regulatory system of corporate governance should go or
whether one favoured a self-regulatory corporate governance model or not.29 In
fact, as Bob Tricker observed, SOX will go down in history as an important turning
point, as SOX made it clear that United States and UK corporate governance
no longer share similar foundations – that they were, from the passing of SOX,
based on fundamentally different foundations. The United States’ approach was,
from the passing of SOX, based on a prescriptive, rule-based legal approach to
governance, while the UK approach is still based on a non-prescriptive, principles-
based, self-regulatory approach.30
Since 2002, several additional perspectives began to emerge regarding the
regulatory or hard-law approach adopted with SOX. The principle underlying
SOX is ‘comply or else’. In other words, as seen above, there are legal sanctions

27 See, for example, Fiona Buffini, ‘ASIC May Help US Regulator’, The Australian Financial Review
(17 February 2005), 9.
28 See also Robert A G Monks and Nell Minow, Corporate Governance, Oxford, Blackwell (3rd edn, 2004)
248–9; Richard Smerdon, A Practical Guide to Corporate Governance, London, Sweet & Maxwell (2nd edn,
2004) 364–6.
29 For a similar view expressed later, see Sir Bryan Nicholson, ‘The Role of the Regulator’ in The Business Case
for Corporate Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008) 100 at 103–6
and 118; Keith Johnstone and Will Chalk, ‘What Sanctions are Necessary?’ in The Business Case for Corporate
Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008) 146 at 154.
30 Bob Tricker, Corporate Governance: Principles, Policies and Practices, Oxford, Oxford University Press
(2008) 19. See also Nicholson, above n 29, 100 and 107–8.
308 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

for non-compliance that could lead to people being convicted of crimes and
being sent to jail for long periods or huge fines imposed for non-compliance. The
irony of SOX is that despite such a draconian piece of legislation already being
in place, several poor corporate governance practices related to risk manage-
ment and excessive executive remuneration were lurking beneath the surface.
As far as executive remuneration is concerned, it is somewhat perplexing that the
abuses were well-known and commented upon within the United States before
the global financial crisis.31 However, it seems as though greed and a highly com-
petitive corporate environment ensured that these poor corporate governance
practices could be perpetuated, and even flourished, amid severe criticism of
excessive executive remuneration. These poor corporate governance practices
were, to a large extent, if not exclusively, responsible for the global financial
crisis – sparked-off by a melt-down of the United States economy in 2008 and
early 2009, especially in the banking and financial sectors.
The ripple effect this caused is well-known and was well covered in the media.
It was, therefore, to be expected that the proponents of a self-regulatory corporate
governance model, who criticised the regulatory hard-law approach of SOX,
would say that the global financial crisis illustrates that such an approach does
not work.32 Some have also used the global financial crisis to challenge the
contention that the European, relationship-based corporate governance systems
are inherently less efficient than the Anglo-American, market-based systems.33
In addition, it has been pointed out that the compliance or agency cost of SOX
far outweighs its efficiency. It has, for instance, been said that the ‘total cost
to the American economy of complying with SOX is considered to amount to
more than the total write-off of Enron, WorldCom and Tyco combined’.34 On the
other hand, some United States companies report benefits from SOX compliance,
including better accountability of individuals, reduced risk of financial fraud and
improved accuracy in financial reports.35
The causes of the global financial crisis are complex and wide-ranging, and it
would be preposterous to state that it was caused by SOX or even that it proves
that SOX did not ensure better corporate governance practices, or that SOX was
ineffective in preventing corporate collapses – it should be remembered that if
several banks were not bailed-out by the United States Government, they would
surely have collapsed in a similar fashion to Enron, WorldCom and Tyco. What is,
however, reasonably safe to conclude is that the one-size-fits-all corporate gover-
nance does not work. Also, the most sensible approach to corporate governance
is still to tackle corporate governance problems along a broad front and in a

31 Commentators like Skousen, Glover and Prawitt, above n 4, 6 provide a very clear picture of unacceptable
compensation practices in the USA, especially as far as compensation by way of overvalued stock was
concerned.
32 King Report on Governance for South Africa 2009 (King Report (2009)), Institute of Directors (2009) 9,
available at <http://african.ipapercms.dk/IOD/KINGIII/kingiiireport/> at 6 and 9.
33 Thomas Clarke and Jean-Francois Chanlat, ‘Introduction: A New World Wisorder?’ in European Corporate
Governance, London, Routledge (2009) 1.
34 KingReport (2009)), above n 32, at 6.
35 Tricker, above n 30, 158.
 THE USA, THE UK AND CANADA 309

flexible way. In fact, aspiring to strike a balance between sensible self-regulatory

arrangements and a rigid regulatory corporate governance model is still the best
approach to corporate governance. As was pointed out by Duncan Niederauer,
chief executive officer (CEO) of the New York Stock Exchange on 15 June 2009,
the regulatory framework in the USA is under strain and requires reform.36 He
identifies four core principles that should guide modern and proactive regulatory
reform:
● Financial regulatory reform must protect investors and restore investor
confidence.
● Financial oversight must be rationalised and harmonised.
● New systems must bring complex financial instruments out of the shadows.
● A new regulatory system must stress smarter regulation, not over-
regulation.
These guiding principles, and corporate law and corporate governance regula-
tion generally, will be high on the agenda for the United States’ Government and
regulators in the USA.

12.2.5 NYSE: Sections 303 and 303A – corporate

governance rules
12.2.5.1 Background
The SEC approved the New York Stock Exchange (NYSE) rules on corporate gov-
ernance on 4 November 2003. Some amendments were made on 3 November
2004, primarily dealing with the definition of independence. All listed companies
(with a few exceptions) must comply with certain standards regarding corporate
governance as codified in section 303A.37 The most important exception is that
foreign private issuers (defined in Rule 3b-4 under the Exchange Act) are per-
mitted to follow home country practice in lieu of the provisions of section 303A,
except that such companies must comply with the following rules:
● They must have an audit committee that satisfies the requirements of Rule
10A-3 under the Exchange Act.38
● They must disclose any significant ways in which their corporate gov-
ernance practices differ from those followed by United States companies
under the NYSE listing standards.39 The following commentary is included
in section 303A.11 as far as this requirement is concerned: Foreign pri-
vate issuers must make their United States investors aware of the signifi-
cant ways in which their corporate governance practices differ from those
required of domestic companies under NYSE listing standards. However,

36 ‘Principles that Must Guide Financial Regulation’ (15 June), Financial Times, available at <www.nyse.
com/about/nyseviewpoint/1245147557416.html>.
37 NYSE Section 303A: Corporate Governance Standards (31 December 2009), available at <http://
nysemanual.nyse.com/LCMTools/PlatformViewer.asp?selectednode=chp%5F1%5F4%5F3&manual=%
2Flcm%2Fsections%2Flcm%2Dsections%2F>.
38 Ibid s 303A.06.
39 Ibid s 303A.11.
310 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

foreign private issuers are not required to present a detailed, item-by-

item analysis of these differences. Such a disclosure would be long and
unnecessarily complicated. Moreover, this requirement is not intended to
suggest that one country’s corporate governance practices are better or
more effective than another. The NYSE believes that United States share-
holders should be aware of the significant ways that the governance of
a listed foreign private issuer differs from that of a United States listed
company. The NYSE underscores that what is required is a brief, general
summary of the significant differences, not a cumbersome analysis.
● Each listed company CEO must promptly notify the NYSE in writing after
any executive officer of the listed company becomes aware of any material
non-compliance with any applicable provisions of this section 303A.40
● Each such company must submit an executed Written Affirmation annu-
ally to the NYSE. In addition, each listed company must submit an interim
Written Affirmation each time a change occurs to the board or any of
the committees subject to Section 303A.41 The annual and interim Writ-
ten Affirmations must be in the form specified by the NYSE. This form
was updated on 25 November 2009 and became effective from 1 January
2010.42

12.2.5.2 Summary of the most important NYSE corporate

governance rules43
● Listed companies must have a majority of independent directors, and ‘inde-
pendence’ is defined in detail in section 303A.02 of the NYSE Listed Com-
pany Manual.44
● In order to empower non-management directors to serve as a more effec-
tive check on management, the non-management directors of each listed
company must meet at regularly scheduled executive sessions without
management.
● Listed companies must have a nominating/corporate governance commit-
tee composed entirely of independent directors.
● Listed companies must have a compensation committee, with a minimum
of three members, composed entirely of independent directors (as defined
in section 303A.02).
● Each listed company must have an internal audit function.
● Listed companies must adopt and disclose corporate governance guide-
lines, addressing the following subjects:
– director qualification standards
– director responsibilities
40 Ibid s 303A.12(b).
41 Ibid s 303A.12(c).
42 See <www.nyse.com/pdfs/FINAL FPI Exhibit B 1 4 08.pdf> for the ‘Foreign Private Issuer Annual
Written Affirmation Form’. The form is available at <www.nyse.com/regulation/nyse/1101074752859.
html>.
43 See <http://nysemanual.nyse.com/lcm/help/lcm-rules-map.html> for the full text to the NYSE Listed
Company Manual.
44 Ibid.
 THE USA, THE UK AND CANADA 311

– director access to management and, as necessary and appropriate, inde-

pendent advisers
– director compensation
– director orientation and continuing education
– management succession
– annual performance evaluation of the board.
● Listed companies must adopt and disclose a code of business conduct and
ethics for directors, officers and employees, and promptly disclose any
waivers of the code for directors or executive officers. Each listed company
may determine its own policies, but all listed companies should address
the most important topics, including the following:
– conflicts of interest
– corporate opportunities
– confidentiality
– fair dealing
– protection and proper use of company assets
– compliance with laws, rules and regulations (including insider trading
laws)
– encouraging the reporting of any illegal or unethical behaviour.
● Listed foreign private issuers must disclose any significant ways in which
their corporate governance practices differ from those followed by domes-
tic companies under NYSE listing standards.
● Each listed company CEO must certify to the NYSE each year that he or she
is not aware of any violation by the company of NYSE corporate governance
listing standards, qualifying the certification to the extent necessary.
● Each listed company CEO must promptly notify the NYSE in writing after
any executive officer of the listed company becomes aware of any material
non-compliance with any applicable provisions of section 303A.
● Each listed company must submit an executed Written Affirmation annu-
ally to the NYSE. In addition, each listed company must submit an interim
Written Affirmation each time a change occurs to the board or any of
the committees subject to section 303A. The annual and interim Written
Affirmations must be in the form specified by the NYSE.
● The NYSE may issue a public reprimand letter to any listed company that
violates a NYSE listing standard.
NASDAQ and the American Stock Exchange (AMEX) have also amended
their corporate governance listing requirements by including, inter alia, the
following:45
● Require that a majority of the members of the board of directors of most
listed companies must be independent of management.
● Define independence using very strict bright-line rules.
● Expand the duties and powers of the independent directors.

45 Stephen M Bainbridge, The New Corporate Governance in Theory and in Practice, Oxford, Oxford University
Press (2008) 177.
312 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

● Expand the duties and powers of the audit committee of the board of
directors.

12.3 United Kingdom

12.3.1 Background to the corporate governance

debate in the UK
Corporate governance in the UK became a prominent issue after the release of the
Cadbury Report in 1992. The report was a response to the Maxwell and Polly Peck
scandals of that period.46 As mentioned above, the Cadbury Report had a rather
narrow focus on the financial aspects of corporate governance. The Cadbury
Report was followed by several other corporate governance reports, such as
the Greenbury Report (1995), the Hampel Report (1998), the Smith Report
(2003) and the Higgs Report (2003). It is interesting to note that, unlike the
ALI’s comprehensive investigation of corporate governance within the context
of corporate law generally, all the UK reports dealt only with specific aspects
of corporate governance – including the disclosure of remuneration of directors
and executive officers, audit committees and the role and effectiveness of non-
executive directors.

12.3.2 The Cadbury Report and the unfolding of the concept of

‘corporate governance’ in the UK
12.3.2.1 Context of the Cadbury Report
The Cadbury Committee was set up by the Financial Reporting Council, the Lon-
don Stock Exchange (LSE) and the accountancy profession in May 1991 in order
to address the financial aspects of corporate governance.47 The main reason for
conducting such an inquiry was to take action in respect of the perception that
the UK was slipping down the league table of international business competi-
tiveness. The second reason was to show the financial community that some of
the major parties involved in the financial markets were greatly concerned about
unexpected company failures and cases of fraud in England, particularly after
the Maxwell and BCCI scandals.48
The draft report was issued for public comment on 27 May 1992, and the final
report49 was released on 1 December 1992.

46 Peter Montagnon, ‘The Role of the Shareholder’ in The Business Case for Corporate Governance (Ken
Rushton, ed.), Cambridge, Cambridge University Press (2008) 81.
47 The Financial Aspects of Corporate Governance: Draft Report (hereafter Cadbury Report (Draft)), Committee
on the Financial Aspects of Corporate Governance, UK (1992) 7 para 2.1; Charlotte Villiers, ‘Draft Report by
the Cadbury Committee on the Financial Aspects of Corporate Governance’ (1992) 13 Company Lawyer 214.
48 John C Shaw, ‘The Cadbury Report, Two Years Later’ in K J Hopt, K Kanda, M J Roe, E Wymeersch
and S Priggle (eds) Comparative Corporate Governance: The State of the Art and Emerging Research, Oxford,
Clarendon Press (1998) 21, 23; Stanley Christopher, ‘Corporate Accountability: Cadbury Committee: Part 1’
(1993) 11 International Banking and Financial Law 104.
49 Report of the Committee on the Financial Aspects of Corporate Governance (hereafter Cadbury Report
(1992)) Committee on the Financial Aspects of Corporate Governance, UK (1992).
 THE USA, THE UK AND CANADA 313

The essence of a system of good corporate governance was explained as

follows:

The country’s economy depends on the drive and efficiency of its companies. Thus
the effectiveness with which their boards discharge their responsibilities determines
Britain’s competitive position. They must be free to drive their companies forward,
but exercise that freedom within a framework of effective accountability. This is the
essence of any system of good corporate governance.50

These objectives are not unique to the UK. They are, indeed, essential for any
country seriously striving to be competitive in international business.

12.3.2.2 Code of Best Practice

At the heart of the committee’s recommendations was a Code of Best Practice,
designed to achieve high standards of corporate behaviour.51 While the Code sets
out the general principles,52 the committee also made various recommendations
on specific aspects: the composition of the board of directors,53 the establishment
of auditing committees54 and the role of a company’s shareholders.55
The committee believed that had a Code of Best Practice been in existence, a
number of unexpected company failures and frauds, which had occurred in the
UK, could have been avoided.56 The principles upon which the Code is based are
those of openness, integrity and accountability.57 It is basically aimed at all listed
companies,58 with compliance to be ensured by the LSE, thus making acceptance
of the Code one of its listing requirements.59 However, the committee specifically
encouraged as many other companies as possible to aim at meeting the Code’s
requirements.60
The Code of Best Practice was published as a separate document accom-
panying the final report. It deals with general aspects concerning the board of
directors, non-executive directors, executive directors and financial reporting. It
is clear that the basic aim is to promote useful checks and balances within the
corporate structure.
According to the Code of Best Practice, there should be a clearly accepted
division of responsibilities at the head of a company, which will ensure a balance
of power and authority, such that no single individual has unfettered powers
of decision. The role of the non-executive director is to bring an ‘independent
judgment’ on issues of strategy, performance, resources, key appointments and
standards of conduct. Concerning executive directors, the Code makes it clear
that they should, in principle, not be protected against removal by long-term

50 Cadbury Report (Draft), above n 47, 5 para 1.1.

51 Cadbury Report (1992), above n 49, 11 para 1.3.
52 Ibid 58 et seq.
53 Ibid 20 et seq.
54 Ibid 36 et seq.
55 Ibid 48 et seq.
56 Ibid 12 para 1.9.
57 Ibid 16 para 3.2.
58 Ibid 16 para 3.1.
59 Ibid 17 paras 3.7–3.9.
60 Ibid 16 para 3.1.
314 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

service contracts. Their contracts of service should not exceed three years with-
out shareholders’ approval. Disclosure of the emolument of executive directors
constitutes an important part of the Code, which also provides that executive
directors’ pay should be subject to the recommendations of a remuneration
committee made up wholly or mainly of non-executive directors.
The Code also contains various reporting controls. It notes that it is the
responsibility of the board of directors to present a balanced and understandable
assessment of the company’s position, to maintain an objective and professional
relationship with the auditors and to establish an audit committee, consisting of
at least three non-executive directors, with written terms of reference dealing
clearly with its authority and duties.
A set of ‘Notes’ accompanied the Code of Best Practice; it was explicitly stated
that these notes did not form part of the Code, but only ‘included further rec-
ommendations on good practice’. Note 5, aiming to ensure the independence
of non-executive directors, is of particular interest: ‘The Committee regards it
as good practice for non-executive directors not to participate in share option
schemes and their services as non-executive directors not to be pensionable
by the company, in order to safeguard their independent position.’ The pre-
sumption of the Committee was clearly that share-option schemes and pension
schemes for non-executive directors may tend to make the non-executive direc-
tor dependent on the company and this will jeopardise the basic role of the
non-executive director; that is, to bring an ‘independent judgment’ on issues of
strategy, performance, resources, including key appointments, and standards of
conduct.
The four primary principles promoted by the Cadbury Report were sum-
marised as follows by John C Shaw:61
1. A clear division of responsibilities at the head of a company to ensure a bal-
ance of power and authority, such that no single individual has unfettered
powers of decision.
2. Every board should include non-executive directors of sufficient calibre
and number for their views to carry significant weight in decisions.
3. Institutional investors should take a positive interest in the composition
of boards of directors, with particular reference to avoiding unrestrained
concentration of decision making.
4. The board structure should clearly recognise the importance and signifi-
cance of the financial function.

12.3.2.3 Further developments

The Financial Reporting Council (FRC) is the UK’s independent regulator for
corporate reporting and governance. It has ultimate responsibility for maintain-
ing and updating the so-called ‘UK Combined Code’,62 which will in future be

61 Shaw, above n 48, 24.

62 See <www.frc.org.uk/about/>.
 THE USA, THE UK AND CANADA 315

called the UK Corporate Governance Code.63 In June 2004, the FRC committed to
conducting a regular review of the Combined Code,64 and has since established
several operating bodies to achieve its goals.65 In November 2006, the FRC issued
an important policy statement, ‘The UK Approach to Corporate Governance’.66
In December 2006, the FRC also released a ‘Draft Updated Regulatory Strategy
and Plan & Budget 2007/08’.67 The FRC has set six objectives to achieve its pri-
mary aim of promoting confidence in corporate reporting and governance. The
six objectives are:
1. high-quality corporate reporting
2. high-quality auditing
3. high-quality actuarial practice
4. high standards of corporate governance
5. the integrity, competence and transparency of the accountancy and actu-
arial professions
6. its effectiveness as a unified independent regulator.68
The functions that the FRC exercises, in pursuit of its six objectives, are sum-
marised as follows:
● promoting high standards of corporate governance
● setting, monitoring and enforcing accounting and auditing standard
● setting actuarial standards
● statutory oversight and regulation of auditors
● operating an independent investigation and discipline scheme for public
interest cases
● overseeing the regulatory activities of the professional accountancy and
actuarial bodies.69
The basis upon which the Government reached its decisions about the role of the
FRC was set out in two reports, that from the Consultative Group on Audit and
Accounting (CGAA)70 and the Government ‘Review of the Regulatory Regime of
the Accountancy Profession’.71
In the past, the FRC amended the UK Combined Code after investigations and
reports by specialised committees. The Greenbury Report (1995), the Hampel
Report (1998), the Smith Report (2003) and the Higgs Report (2003) are exam-
ples of such reports that led to some amendments to the UK Combined Code. The
FRC is still considered to be a better form of self-regulation and market-driven

63 See <www.frc.org.uk/corporate/reviewCombined.cfm>.
64 See <www.frc.org.uk/press/pub0583.html>.
65 See <www.frc.org.uk/about/organisation.cfm>.
66 See <www.frc.org.uk/documents/pagemanager/frc/FRC%20The%20UK%20Approach%20to%
20Corporate%20Governance%20final.pdf>.
67 See <www.frc.org.uk/images/uploaded/documents/Draft%20FRC%20Reg%20Strat%20-%20Plan%
20and%20Budget07-08%20FINAL.pdf>.
68 These objectives are set out in the FRC Regulatory Strategy, May 2006, Version 2.1 at p. 2, avail-
able online at <www.frc.org.uk/images/uploaded/documents/FRC%20Regulatory%20Strategy%202.1%
20May%20061.pdf>.
69 Ibid.
70 See <www.dti.gov.uk/cld/cgaai-final.pdf>.
71 See <www.dti.gov.uk/cld/accountancy-review.pdf>.
316 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

regulation of corporate governance than a full-on regulatory regime following

SOX in the USA.72

12.3.3 The Greenbury, Hampel, Smith and Higgs reports

12.3.3.1 The Greenbury Report (1995)
Richard Smerdon points out that no subject in recent years has aroused more
controversy than the question of remuneration, and that commentators some-
times portray it as the only issue of concern in governance.73 The Greenbury
Report (1995) had a very specific focus on executive remuneration: its rec-
ommendations dealt primarily with the establishment of remuneration com-
mittees for listed companies and the role and function of the remuneration
committee.74 It also made several recommendations regarding the disclosure
of executive remuneration75 and the remuneration policy that listed companies
should adopt.76 The final part of the Greenbury recommendations dealt with
service contracts and what entitlements directors would have in the event of
early termination.77 This investigation was considered to be necessary because
of concerns that executive remuneration was excessive and that shareholders
should know exactly what executives earned and what a company’s liability
would be if executive directors were removed or if an executive contract were to
be terminated prematurely.

12.3.3.2 The Hampel Report (1998)

This report was to a large extent a continuation of the work already done by the
Cadbury and Greenbury reports. The Hampel Report is probably one of the most
balanced UK reports on corporate governance, in the sense that it concentrated
on broad trends and commented on some incorrect perceptions on corporate
governance. One of its main aims was, as Kendall and Kendall point out, ‘to
calm the situation down’.78 A few examples will illustrate the point. It was one
of the main aims of the Hampel Committee ‘to restrict the regulatory burden
on companies’, and to ‘substitute principles for detail wherever possible’.79 This
particular focus was possible because the Hampel Committee was established
to focus not on poor corporate governance practices, but rather on the positive
contribution that good corporate governance could make.80 The focus was thus
on corporate governance guidelines and principles, rather than ‘box-ticking’ to
determine whether or not good corporate governance practices identified in

72 Nicholson, above n 29, 108–9.

73 Smerdon, above n 28, 115.
74 Code Recommendations – Para A.
75 Code Recommendations – Para B.
76 Code Recommendations – Para C.
77 Code Recommendations – Para D.
78 Kendall and Kendall, above n 5, 23.
79 Committee on Corporate Governance, Committee on Corporate Governance: Final Report (Hampel Report
(1998)) London, Gee (1998), para 1.6.
80 Ibid para 1.7.
 THE USA, THE UK AND CANADA 317

Cadbury and Greenbury were being followed.81 The Hampel Report is also one
of the few UK corporate governance reports to recognise the importance of the
stakeholder debate.82
Perhaps one of the most controversial aspects of the Hampel Report was its
contention that the monitoring role of the board had become ‘over-emphasised’
because of the focus on the role of non-executive directors and in particular
the role of ‘independent non-executive directors’. Hampel saw the role of non-
executive directors as clearly linked to ‘a strategic and monitoring function’ and
as ‘mentors to relatively inexperienced executives’.83

12.3.3.4 The Higgs Report (2003) and the Smith Report (2003)
The Higgs Report (2003) had a primary focus on the role and effectiveness of
non-executive directors. The most significant aspects of this report were the
recommendations that at least half of the board of directors (excluding the
chairman) should be independent non-executive directors, and the very detailed
definition of the term ‘independence’. At the same time as the Higgs Commit-
tee was conducting its work, the Smith Committee (2003) was investigating
accounting standards.
Both the Higgs Report and the Smith Report were to some extent a result of
collapses such as Enron and WorldCom, and of the USA’s reaction to these col-
lapses – the Sarbanes-Oxley Act of 2002. The factor that most clearly distinguishes
the UK and United States approaches, however, is that the SOX Act is a statutory
instrument that makes several accounting standards and practices compulsory.
In the UK, good corporate governance practices are still primarily self-enforced
arrangements that are promoted through the listing rules for listed public com-
panies. In particular, the Code Provisions contained in the UK Combined Code
set the standards for good corporate practices.

12.3.4 The 2008 UK Combined Code and the 2010 UK Corporate

Governance Code
Since 2003 the UK Combined Code was revised and refined on several occasions,
with the last refinements, before proposals to rename it to the UK Corporate
Governance Code in December 2009,84 done in June 2008 (2008 UK Combined
Code).85 As pointed out above, the UK Combined Code is ultimately the respon-
sibility of the FRC. The Combined Code represents the combined wisdom of the
reports discussed above and currently serves as the norm for good corporate gov-
ernance practices for listed public companies in the UK. Voluntary compliance

81 Hampel Report (1998), above n 79, paras 1.12–1.14. See also Smerdon, above n 28, 17–18.
82 Hampel Report (1998), above n 79, para 1.16.
83 Ibid paras 3.7–3.8.
84 FRC, 2009 Review of the Combined Code: Final Report (December 2009) <http://www.frc.org.
uk/corporate/reviewCombined.cfm>.
85 See <www.frc.org.uk/corporate/combinedcode.cfm>.
318 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

with the Combined Code is ensured through the Listing Rules of the LSE, which
require that as a general rule listed public companies must comply with the Code
or explain why they are not complying – the so-called principle of ‘comply or
explain’.86 The effect of this approach, although classified as ‘soft-law’, is not
insignificant as there are powerful market forces at work to ensure compliance
rather than allowing listed public companies to explain why they are not comply-
ing. It is, therefore, not uncommon still to find strong support for a market-based
or self-regulatory approach to promoting good corporate governance practices in
the UK.87 Apart from the Listing Rules, additional requirements have been added
through the Directors’ Remuneration Report Regulation 2002 and a requirement
to introduce a business review, following the implementation of the EU Accounts
Modernisation Directive.88
On 1 December 2009 the FRC published a final report on the findings of its
review of the impact and effectiveness of the Combined Code.89 At the same time
the FRC released a report explaining the consultation processes that preceded
the recommendations to change the 2008 UK Combined Code.90 The final report
also sets out the actions that the FRC propose to take as a result of the review.
The main findings and actions are explained in the ‘Executive Summary’ section
of the report.91 It is proposed that the UK Combined Code should be called the
UK’s Corporate Governance Code in future. The Code has been revised regularly
since 2003 to ensure it reflects changing governance concerns and practices and
economic circumstances. The latest proposals take into account those lessons
of the 2008–2009 global financial crisis that are relevant to all companies. The
FRC expected to announce its final decision and publish the revised Code in May
2010. In December 2009 it was anticipated that the revised Code would apply to
reporting periods beginning on or after 29 June 2010.92
Some of the main changes proposed to the 2008 UK Combined Code by the
FRC in December 2009 were explained as follows by the FRC in its final report:93
● Proposed new Code principles on: the roles of the chairman and non-
executive directors; the need for the board to have an appropriate mix of
skills, experience and independence; the commitment levels expected of
directors; and the board’s responsibility for defining the company’s risk
appetite and tolerance.

86 This is ensured through the LSE Listing Rule 12.43A – see generally Smerdon, above n 28, 19–20.
87 Sir Nicholson, above n 29, 103–6; Keith Johnstone and Will Chalk, ‘What Sanctions are Necessary?’ in The
Business Case for Corporate Governance (Ken Rushton, ed.), Cambridge, Cambridge University Press (2008)
146 at 168–70; Simon Low, ‘Is the UK Model Working?’ in The Business Case for Corporate Governance (Ken
Rushton, ed.), Cambridge, Cambridge University Press (2008) 222 at 240–1.
88 Nicholson, above n 29, 100 at 107.
89 FRC, above n 84.
90 See FRC, Consultation on the Revised UK Corporate Governance Code (December 2009) <www.
frc.org.uk/images/uploaded/documents/Consultation%20on%20the%20Revised%20Corporate%
20Governance%20Code1.pdf>.
91 See <http://www.frc.org.uk/corporate/reviewCombined.cfm>.
92 See <www.frc.org.uk/press/pub2175.html>.
93 FRC, above n 84 at 3.
 THE USA, THE UK AND CANADA 319

● Proposed new ‘comply or explain’ provisions including: board evaluation

reviews to be externally facilitated at least every three years; the chairman
to hold regular development reviews with all directors; and companies to
report on their business model and overall financial strategy.
● Changes to the section of the Code dealing with remuneration to emphasise
the need for performance-related pay to be aligned with the long-term
interest of the company and to the company’s risk policies and systems and
to enable variable components to be reclaimed in certain circumstances.
It was proposed by the FRC that the 2010 UK Corporate Governance Code consists
of five different parts, dealing with leadership, effectiveness, accountability,
remuneration and communication.
Some of the main provisions of the 2010 UK Corporate Governance Code
regarding board composition can be summarised as follows:
● The chairman should be an independent non-executive director (Code
Provision A.3.1).
● The board and its committees should consist of directors with the appro-
priate balance of skills, experience, independence and knowledge of the
company to enable it to discharge its duties and responsibilities effectively
(New Principle B.1).
● The board should include a strong presence of executive and non-executive
directors (and in particular independent non-executive directors) such that
no individual or small group of individuals can dominate the board’s deci-
sion taking (Supporting Principle to B.1). It is of considerable importance
to note that there is no longer a requirement that at least half of the board
(excluding the chairman) should be independent non-executive directors
(2008 UK Combined Code Provision A.3.2). However, the board should
identify in the annual report each non-executive director it considers to be
independent (Code Provision B1.1).
● The board should appoint one of the independent non-executive directors
to be the senior independent director to provide a sounding board for the
chairman and to serve as an intermediary for the other directors when
necessary. The senior independent director should be available to share-
holders if they have concerns which contact through the normal channels of
chairman, chief executive or other executive directors has failed to resolve
or for which such contact is inappropriate (Code Provision A.4.1).
● The annual report should identify the chairman, the deputy chairman
(where there is one), the chief executive, the senior independent director
and the chairmen and members of the board committees. It should also
set out the number of meetings of the board and those committees and
individual attendance by directors (Code Provision A.1.2).
● There should be at least three committees of the board, namely an audit
committee (Code Provision C.3.1), a nomination committee (Code Provi-
sion B.2.1); and a remuneration committee (Code Provision D.2.1).
320 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

● No one other than the committee chairman and members is entitled

to be present at a meeting of the nomination, audit or remuneration
committee, but others may attend at the invitation of the committee
(Supporting Principle to B.1).
The average board size for FTSE 100 companies in 2002 was just under 12;
for FTSE 250 companies, 8.5; and for other listed companies, six directors.94 It
is possible to appoint two types of non-executive directors: ‘independent non-
executive directors’, who meet the criteria laid down for independence; and
non-executive directors, who do not meet these criteria, called connected non-
executive directors in Chapter 4 (CNEDs). The executive directors serving on
the board will typically include the managing director or CEO and the chief
financial officer (CFO). We have stated in Chapter 4 our opinion that the role
and effectiveness of independent non-executive directors are over-emphasised,
and that requiring a majority of the board to consist of independent non-executive
directors may have a detrimental impact on the performance of the corporation.

12.4 Canada

12.4.1 Overview
In an increasingly globalised world economy, competition is intense and good corpo-
rate governance can make a difference to how Canadian companies are viewed. There
are benefits to being recognised as a country where excellence in corporate gover-
nance receives a high priority; these benefits accrue to individual Canadian companies
when operating abroad, as well as to the entire Canadian capital market as viewed by
international investors.95

Broadly speaking, in common with the general approach to corporate governance

in the UK and Australia, Canada also places great emphasis on guidelines rather
than prescriptive rules.96 There is, to some degree, a basic level of congruence in
the principles governing the corporate governance framework in international
jurisdictions. In particular, there are similar themes in Canada, Australia and
the UK on the guidelines relating to, inter alia, board composition, the establish-
ment of independent audit, nominating and compensation committees and the
operation of the disclosure regime of corporate governance practices (‘comply
or explain’ system).

94 Review of the Role and Effectiveness of Non-Executive Directors (Higgs Report (2003)), (January 2003),
available at <www.berr.gov.uk/files/file23012.pdf> 18.
95 Beyond Compliance: Building a Governance Culture – Final Report Joint Committee on Corporate Governance
(November 2001) at 7 (Sponsored by the Canadian Institute of Chartered Accountants, the Canadian Venture
Exchange, Toronto Stock Exchange and chaired by Guylaine Saucier).
96 Exceptions to this general categorisation arise, however, when the influential impact of the rules-based
approach under SOX on Canadian corporate governance is considered. The Canadian response to SOX is
dealt with later in this chapter.
 THE USA, THE UK AND CANADA 321

12.4.2 Regulatory environment

In focusing on the Canadian securities regulatory framework, it is worth noting
that Canada is the only developed country that does not have a national securities
regulator.97 Each Canadian province (of which there are 10) and territory (of
which there are three) has its own securities regulator responsible for admin-
istering the province’s or territory’s securities act and formulating its own set
of rules and regulations. The difficulties and concerns arising from the current
patchwork approach to securities regulation are captured in the recent report
issued to the Canadian Government by the Expert Panel on Securities Regulation
in Canada:98
The Expert Panel heard repeated . . . concerns about the cost and confusion caused by
our fragmented system of thirteen separate securities regulators . . . While the termi-
nology has differed over the years – single, common, Canadian, national, or federal –
the conclusion of virtually every study [over the years] has been the same: Canadians
are ill-served by such a balkanized system . . . The lack of a national Canadian securities
regulator also raises wider concerns about systemic risk, as there is no national entity
accountable for the stability of our national capital markets.

The Expert Panel viewed Canada’s fragmented system of 13 regulators as a seri-

ous shortcoming in Canada’s system of financial regulation, and recommended
the establishment of a single securities regulator administering a single secu-
rities act for Canada.99 The report and draft Securities Act make a number
of recommendations to improve securities regulation and investor protection.
These include:
● establishing a single, comprehensive system to measure the performance
of securities regulation in Canada to promote greater accountability
● establishing the Canadian Securities Commission to administer a single
securities act for Canada
● advancing a principles-based approach to securities regulation
● promoting fairness in the adjudication of regulatory matters by establishing
an independent adjudicative tribunal
● establishing an investor panel and an investor-compensation fund to better
serve the needs of investors.
The philosophical approach adopted by the Expert Panel to securities regulation
is captured in the following extract from the report:100
97 Chair’s Foreword to Final Report and Recommendations: Creating an Advantage in Global Capital Markets
(12 January 2009), available at <www.expertpanel.ca>.
98 Ibid. For earlier reports warning of similar dangers and advocating a single national securities regulator
in Canada, see Wise Person’s Committee to Review the Structure of Securities Regulation in Canada, It’s Time
(December 2003), available at <www.wise-averties.ca/reports/WPC%20Final.pdf>; Crawford Panel on a
Single Canadian Securities Regulator, Blueprint for a Canadian Securities Commission (June 2006), available
at <www.crawfordpanel.ca/Crawford Panel final paper.pdf>.
99 This criticism was made despite the existence of passport, which is a regulatory system designed to
aid harmonised laws and provides market participants with streamlined access to Canada’s capital markets.
Although a major step forward, the passport system has been criticised as being limited in application and
too slow, cumbersome and expensive. See further, Chair’s Foreword to Final Report and Recommendations:
Creating an Advantage in Global Capital Markets (12 January 2009), available at <www.expertpanel.ca>.
100 Ibid.
322 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

We recommend Canadian securities regulators should focus less on process and more
on outcomes; relying more on articulating principles than on multiplying rules. We
believe that regulation should be grounded in guidance and rules on a bedrock of well-
formulated principles. This will help reduce unnecessary compliance costs, improve
regulatory outcomes, and give Canada a competitive edge.

Only seven provinces and three territories agreed to support these law reform
proposals, with Quebec threatening to launch a constitutional challenge on the
federal legislation, which is seen as an encroachment on Quebec’s jurisdiction
over property and civil rights.101 The situation remains fluid (at the time of writ-
ing). In October 2009, the federal Minister of Justice announced the Canadian
Government’s next step – its plan to submit in 2010 a draft bill for a Federal
Securities Act, to the Supreme Court of Canada for an advisory opinion on its
constitutionality.102 Although the recent financial crisis has added impetus to the
latest push for securities law reform, it remains to be seen if these latest initiatives
will also succumb to political forces and jurisdictional competition among the
provinces.
Currently, the Canadian Securities Administrators (CSA) is working to achieve
harmonisation of the 13 separate securities regime. The CSA is an umbrella
organisation representing all 13 Canadian securities regulators and provides a
coordinating function.103
In the wake of the passage of SOX in 2002 in the USA, the Canadian secu-
rities and corporate governance landscape has changed. Similar to the USA’s
experience with the collapse of Enron and WorldCom, Canada was not immune
to failures in corporate governance and also had its share of financial scandals
such as Nortel, Livent and Cinar Corporation.104 The combination of internal
failures and pressure from the USA to implement reforms, due to the existence
of the Multi-Jurisdiction Disclosure System that allows Canadian issuers to list
in United States markets, resulted in significant debate and eventual action on
the part of Canadian securities regulators to implement corporate governance
reforms.105 The CSA adopted and modified certain aspects of SOX, which has the
effect of ensuring that the Canadian securities regulatory environment remains
closely aligned in principle with that in the USA.106

101 Existing provincial regulatory regimes are based on their ‘property and civil rights’ jurisdiction conferred
under s 92(13) of the Constitution Act 1867.
102 Ken Dickerson, ‘Reference Case to Confirm Constitutionality of Federal Securities Regulation’, Centre
for Constitutional Studies, University of Alberta (16 October 2009), available at <www.law.ualberta.ca/
centres/ccs/news>.
103 For an examination of Canadian securities regulation, see Task Force to Modernise Securities Regulation
in Canada, Canada Steps Up (2006), available at <www.tfmsl.ca>.
104 Stephanie Ben-Ishai, ‘Sarbanes-Oxley Five Years Later: A Canadian Perspective’ (2008) 39 Loyola Uni-
versity Chicago Law Journal 469 at 476.
105 Ibid.
106 Susan Jenah, ‘Commentary on a Blueprint for Cross-Border Access to U.S. Investors: A New International
Framework’ (2007) 48 Harvard International Law Journal 69 at 78. For a critique on the Canadian approach
to regulatory policy initiatives, see Ronald Davis, ‘Fox in S-Ox North, A Question of Fit: The Adoption of
United States Market Solutions in Canada’ (2004) 33 Stetson Law Review 955. For a brief comparison of the
Canadian and United States regulatory schemes, see Ben-Ishai, above n 104, 481.
 THE USA, THE UK AND CANADA 323

The key instruments and policies, covering a broad range of subjects, impact-
ing on Canadian corporate governance practices are:
● National Instrument 58–101: Disclosure of Corporate Governance
Practices
● National Instrument 51–102: Continuous Disclosure Obligations
● National Instrument 52–109: Certification of Disclosure in Issuers’ Annual
and Interim Filings (CEO and CFO Certifications)107
108
● National Instrument 52–110: Audit Committees
● Companion Policy 52–110CP: Audit Committees
109
● National Instrument 52–108: Auditor Oversight
● National Policy 51–201: Disclosure Standards
● National Policy 58–201: Corporate Governance Guidelines.
On 30 June 2005, the CSA introduced a key policy document, National Policy
58–201: Corporate Governance Guidelines, which is recommended as a guide to
best practice for issuers to follow. At the time of writing, it was envisaged that the
current National Policy 58–201 would be replaced with the proposed National
Policy 58–201, discussed below. These recent initiatives aimed to review and
improve the current corporate governance regime;110 however, they have been
shelved until the 2011 proxy season, at the earliest.111 The proposed reforms,
which the CSA is now reconsidering due to the concern that ‘issuers are currently
focused on business sustainability issues in a challenging economic climate’,112
contemplated significant changes to Canada’s corporate governance regime.
Despite this setback to law reform, the chapter focuses on the law reform
proposals given the similarities to the current guidelines, except where indicated
below.

12.4.3 Proposed National Policy 58–201: Corporate

governance principles
The proposed National Policy 58–201 articulates nine core principles address-
ing corporate governance issues (similar to the current guidelines), discussed
107 This instrument covers the certification requirements of section 302 of SOX. It requires each CEO and
CFO of an issuer company to file a separate annual certificate stating that he or she has reviewed annual filing,
has no knowledge of any material misrepresentation and that he or she is responsible for establishing and
maintaining disclosure controls and procedures and internal control over financial reporting for the issuer.
108 This instrument covers, with some modification, the independent audit committee requirements of
section 302 of SOX. Unlike the United States position, Canadian audit committees are not required to have a
financial expert – however, similar to the position in the USA, each member must be financially literate.
109 This instrument is influenced by sections 101 to 105 of SOX, which deals with the audit requirements of
public companies.
110 See CSA Staff Notice 58–304 Review of NI 58–1–1 Disclosure of Corporate Governance Prac-
tices and NP 58–201 Corporate Governance Guidelines, available at <www.osc.gov.on.ca/documents/
en/Securities-Category5/csa 20070928 58-304 review-58-101.pdf>.
111 See CSA Staff Notice 58–305 Status Report on the Proposed Changes to the Corporate Governance
Regime (13 November 2009), available at <www.osc.gov.on.ca/documents/en/Securities-Category5/csa
20091113 58-305-gov-regime.pdf>. In December 2008, the CSA published for comment proposed changes
to the corporate governance regime entitled Proposed Repeal and Replacement of National Policy 58–21–
Corporate Governance Guidelines, National Instrument 58–1–1 Disclosure of Corporate Governance Practices,
and National Instrument 52–110 and Companion Policy 52–110CP Audit Committees.
112 Ibid CSA Staff Notice 58–305.
324 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

below, that are not fully covered in other corporate governance instruments.
Each principle below is accompanied by commentary explaining those princi-
ples. In addition, it includes examples of corporate governance practices that
can be used to achieve the objectives in the principles. In supplying examples,
an innovative feature compared to the current National Policy 58–201, the CSA
aims to assist issuers in crafting their own corporate governance regime that is
appropriate in the circumstances.113 As stated by the CSA, they are not meant to
create obligatory practices or minimum requirements.114
In adopting a flexible, principles-based approach, the purpose of the CSA’s
policy is designed to:115
(a) provide protection to investors and foster fair and efficient capital markets
and confidence in those markets
(b) reflect the realities of the large number of small issuers and controlled
issuers in the Canadian market and
(c) take into account corporate governance developments around the world.
The nine core corporate governance principles are:
Principle 1: Create a framework for oversight and accountability
An issuer should establish the respective roles and responsibilities of the board and
executive officers.
The commentary under Principle 1 identifies the following tasks as being the
usual responsibilities of the board:
(a) developing the issuer’s approach to corporate governance, including a set
of corporate governance practices that are specific to the issuer
(b) recruiting and appointing the CEO and evaluating his or her performance,
based on clear objectives
(c) satisfying itself that the executive officers have integrity
(d) empowering the CEO, and other executive officers, to create a culture of
integrity throughout the organisation, and satisfying itself they have done
so
(e) adopting a strategic planning process and approving, at least annually, a
strategic plan
(f) identifying the principal risks of the issuer’s business and ensuring that
appropriate systems are in place to manage these risks
(g) ensuring that a system for succession planning is in place
(h) adopting a communications policy for the issuer and
(i) adopting measures for receiving feedback from stakeholders.
The national policy document recognises that the objectives of this principle can
be achieved in a number of ways, including by:

113 Request for Comment: Proposed Repeal and Replacement of National Policy 58–201 Corporate Gov-
ernance Guidelines, National Instrument 58–101 Disclosure of Corporate Governance Practices and National
Instrument 52–110 and Companion Policy 52–110CP Audit Committees (19 December 2008), Appendix B,
National Policy 58–201 Corporate Governance Principles, available at <www.securities-administrators.ca>.
114 Ibid.
115 Ibid.
 THE USA, THE UK AND CANADA 325

(a) adopting a written mandate or formal board charter that details the board’s
roles and responsibilities and that of each standing committee of the board,
if any
(b) having the board develop clear position descriptions for the chair of the
board and the chair of each board committee
(c) having the board together with the CEO, develop a clear position descrip-
tion for the CEO, which may include delineating management’s responsi-
bilities and
(d) providing directors with the terms and conditions of their appointment.
Principle 2: Structure the board to add value
The board should be comprised of directors that will contribute to its effectiveness.
The commentary under Principle 2 recognises that the board’s role is to pro-
vide strategic leadership and to supervise the performance of executive officers.
It recommends that an effective board is to be structured in a way that allows
directors to (a) fully and effectively carry out their fiduciary duties; and (b) add
value to the issuer with a view to its best interests. To this end, each director
should:
● have skills that will contribute towards the effective functioning of the
board
● competencies appropriate to the issuer’s business
● demonstrate integrity and high ethical standards
● exercise independent judgment when making decisions and carrying out
their other duties. This includes reviewing and challenging how executive
officers discharge their duties and achieve their goals, where appropriate
● be able to provide sufficient time and commitment to their role
● be able to act collectively and interact in a manner that facilitates effective
decision making. No individual or small group should dominate the board’s
decision making.
The national policy document recognises that the objectives of this principle can
be achieved in a number of ways, including by having the board (or a committee
of the board) regularly review its size and composition, and by encouraging
directors to limit other external board commitments so as not to affect their
ability to fulfil their duties to the board.
The national policy document identifies the following related principles deal-
ing with board composition:
(a) having a majority of independent directors on the board116
(b) having an independent director chair the board or act as a lead director117
116 This recommendation is the same as Part 3.1 of the current National Policy 58–201. A director is
independent if he or she has no direct or indirect material relationship with the issuer. A ‘material relationship’
is a relationship that could, in the view of the issuer’s board of directors, be reasonably expected to interfere
with the exercise of a member’s independent judgment. This definition, located in the current Audit Committee
Instrument, is subject to proposed amendment. Such law reform proposals are discussed later in the chapter.
The current law reform process has, however, been temporarily suspended. See further, CSA Staff Notice
58–305 Status Report on the Proposed Changes to the Corporate Governance Regime (13 November 2009),
available at <www.securities-administrators.ca>.
117 This recommendation is the same as Part 3.2 of the current National Policy 58–201.
326 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

(c) having an appropriate number of independent directors who are unrelated

to any control person or significant shareholder
(d) separating the roles of chair and CEO
(e) creating committees with an appropriate number of independent directors
for specific purposes
(f) giving independent directors an opportunity, both at the board and com-
mittee level, to hold regularly scheduled meetings at which other directors
and the executive officer are not present118 and
(g) giving the board the authority to engage and compensate any internal
and external advisor that it determines necessary to carry out its duties,
including advice from outside advisors.
Principle 3: Attract and retain effective directors
A board should have processes to examine its membership to ensure that directors,
individually and collectively, have the necessary competencies and other attributes.
The commentary under Principle 3 recognises that while the shareholders
elect directors, the board plays an important role in selecting candidates for
the shareholders’ consideration. The board should be satisfied that appropriate
procedures are in place for selecting candidates so that it can maintain a balance
of competencies and other attributes.
The national policy document recognises that the objectives of this principle
can be achieved in a number of ways, including by:
(a) having procedures for:
(i) evaluating the competencies of directors
(ii) identifying any gaps that exists on the board
(iii) nominating directors to fulfil the needs of the board and
(iv) developing and reviewing board succession plans
(b) establishing a nomination committee to carry out, or make recommenda-
tions with respect to, some or all of these procedures.
The national policy document identifies the following design principles dealing
with the nomination committee:
(a) having a majority of independent directors119
(b) having directors with the necessary competencies to fulfil the committee’s
mandate
(c) being chaired by an independent director
(d) adopting a charter that sets out its roles and responsibilities, composition,
structure and membership requirements and
(e) having authority to engage and compensate any advisor that it determines
necessary to permit it to carry out its duties.
Principle 4: Continuously strive to improve the board’s performance
A board should have processes to improve its performance and that of its committees,
if any, and individual directors.

118 Ibid, Part 3.3.

119 This recommendation is a departure from Part 3.10 of the current National Policy 58–201, which states
that the board of the nomination committee should be composed entirely of independent directors.
 THE USA, THE UK AND CANADA 327

The commentary under Principle 4 recognises that a board’s performance

is dependent upon directors having the requisite knowledge, information and
abilities to fulfil their obligations. It recommends that the board should provide
its new directors with a comprehensive introduction to the company’s business
and culture, and that continuing education should be provided for all directors.
The subject matter to be covered should include the roles and responsibilities
of the board, committees, directors and officers. On a broader level, it should
also cover the issuer and its business, including its financial condition, strategy
operations and risk management practices, the industry within which the issuer
operates and its competitive position.120
The national policy document recognises that the objectives of this principle
can be achieved in a number of ways, including by:
(a) having appropriate orientation procedures in place for new directors121
(b) ensuring that all directors are provided with continuing education oppor-
tunities relevant to their duties on the board122
(c) having procedures in place regarding the timely provision of relevant infor-
mation to the board by executive officers
(d) allowing directors to request additional information or independent advise
at the issuer’s expense, if the directors consider it necessary to fulfil their
duties
(e) creating opportunities for directors to interact with executive officers and
(f) assessing the board, any board committees and each individual director
on a regular basis regarding his, her or its contribution against established
criteria and acting upon results.123
Principle 5: Promote integrity
An issuer should actively promote ethical and responsible behaviour and decision-
making.
The commentary under Principle 5 recognises that the board has a responsibil-
ity to set the ethical standards applicable to the issuer’s directors, executive offi-
cers and employees. It acknowledges that investor confidence can be enhanced
if the board clearly articulates ethical practices that are acceptable to the issuer.
Executive officers are given the responsibility to implement and enforce those
standards for behaviour and decision making.
The national policy document recognises that the objectives of this principle
can be achieved in a number of ways, including by:
(a) supporting the issuer’s standards of ethical behaviour with appropriate
training, monitoring, reporting, investigating and addressing unethical
behaviour and
(b) adopting a code of conduct.

120 This recommendation is similar to Part 3.6 of the current National Policy 58–201.
121 Ibid.
122 Ibid, Part 3.7.
123 Ibid, Part 3.18.
328 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

The commentary under Principle 5 identifies the following matters as being the
usual content addressed by a code of conduct:124
(a) conflicts of interest, including transactions where a director or executive
officer has a significant interest
(b) protection and proper use of corporate assets and opportunities
(c) confidentially of corporate information
(d) the issuer’s responsibilities to security holders, employees, those with
whom it has a contractual relationship and the broader community
(e) compliance with laws, rules and regulations
(f) reporting of any illegal or unethical behaviour and
(g) monitoring and ensuring compliance with the code.
Principle 6: Recognise and manage conflicts of interest
An issuer should establish a sound system of oversight and management of actual
and potential conflicts of interest.
The commentary under Principle 6 recognises that conflicts of interest may
arise in various situations (apart from those identified above under Principle 5),
for example, when there is a significant divergence of interests among share-
holders or their interests are not completely aligned or when a director cannot
be considered impartial in connection with a proposed decision to be made by
the board.
The national policy document recognises that the objectives of this principle
can be achieved in a number of ways, including by:
(a) having practices for:
(i) identifying, reviewing and assessing situations, decisions, contracts,
arrangements or transactions where an actual or potential conflict of
interest could arise
(ii) submitting to the board the prior declaration by directors of their
conflicts of interest
(iii) keeping records of conflicts of interests and
(b) establishing an ad hoc or standing committee made up of independent
directors to carry out these practices and
(c) obtaining paid independent advice on conflict of interest situations.
Principle 7: Recognise and manage risk
An issuer should establish a sound framework of risk oversight and manage-
ment.125
The commentary under Principle 7 recognises that risk oversight and man-
agement include the culture, processes and structures that are directed towards
taking advantage of potential opportunities while managing potential adverse
effects. It acknowledges that risk oversight and management is most effective if
it is embedded into the issuer’s practices and business processes rather than if it
is viewed or practised as a separate activity. While a risk management committee

124 Ibid, Part 3.8.

125 Compare the guidance herein with the more specific recommendation contained in Principle 7 in
Australia’s Corporate Governance Principles and Recommendations.
 THE USA, THE UK AND CANADA 329

can assist in identifying and managing risks, the responsibility for risk oversight
and management rests with the full board.
The national policy document recognises that the objectives of this principle
can be achieved in a number of ways, including by:
(a) developing, approving and implementing policies and procedures for the
oversight and management of principal risks that:
(i) reflects the issuer’s risk profile
(ii) take into account its legal obligations and
(iii) clearly describe the roles and accountabilities of the board, audit
committee, or other appropriate board committee, management and
any internal audit function.
(b) regularly reviewing and evaluating the effectiveness of these policies and
procedures and requiring the CEO and other executive officers to regularly
report to the board on these matters.
Principle 8: Compensate appropriately
An issuer should ensure that compensation policies align with the best practices of
the issuer.
The commentary under Principle 8 recognises that compensation should be set
and structured to attract and retain executive officers and directors and motivate
them to act in the best interests of the issuer. This includes a balance pursuit of the
issuer’s short-term and long-term objectives. It acknowledges that transparency
of compensation can promote investor understanding and confidence in the
process.
The national policy document recognises that the objectives of this principle
can be achieved in a number of ways, including by:
(a) having procedures for:
(i) establishing and maintaining goals related to executive officers’ com-
pensation
(ii) regularly evaluating executive officers’ performance in light of these
goals
(iii) determining the compensation of executive directors and directors
and
(iv) having the board review executive compensation disclosure before
the issuer publicly discloses it and
(b) establishing a compensation committee to carry out, or make recommen-
dations to some or all these procedures.
The national policy document identifies the following design principles dealing
with the compensation committee:
(a) have all independent directors126
(b) have directors with the requisite competencies to fulfil the mandate of the
committee
(c) have a charter that clearly sets out its roles and responsibilities, composi-
tion, structure and membership requirements
126 This recommendation is the same as Part 3.15 of the current National Policy 58–201.
330 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

(d) have the authority to engage and compensate any advisor

(e) have procedures to ensure that no individual is directly involved in deciding
his or her own compensation.
Principle 9: Engage effectively with stakeholders
The board should endeavour to stay informed of shareholders’ views through the
shareholder meeting process as well as through ongoing dialogue.
The commentary under Principle 9 recognises that an issuer’s relationship
with its shareholders is an important aspect of corporate governance. To this
end, within the parameters of corporate and securities law, it recommends that
the board should promote a voting process that is understandable, transparent
and robust, and that facilitates the board obtaining meaningful information on
shareholder views.
The national policy document recognises that the objectives of this principle
can be achieved in a number of ways, including by:
(a) posting on the issuer’s website a clear description of the voting process for
registered and beneficial shareholders
(b) giving shareholders the option of voting electronically, for example,
through telephone or internet voting and
(c) giving shareholders or proxy holders the option of attending meetings
through electronic means.

12.4.4 Current National Policy 58–201: Corporate

Governance Guidelines
The current governance policy also sets out corporate governance guidelines,
grouped under nine main topics. Similar to the proposed National Policy 58–201,
these guidelines are not mandatory. The proposed governance policy is, however,
broader in scope since the current governance policy does not expressly address
the subject matter of principles 6 (Recognise and manage conflicts of interest),
7 (Recognise and manage risk) and 9 (Engage effectively with stakeholders)
discussed above.127 Furthermore, the proposed governance policy will have a
wider application and extends to all issuers. The current governance policy
applies to all reporting issuers (both corporate and non-corporate entities), other
than investment funds.

12.4.5 National Instrument 58–101: Disclosure of Corporate

Governance Practices
Currently, this instrument requires a reporting issuer (other than an invest-
ment fund) to include in its information circular, annual information form or

127 For criticisms directed to principles 7 and 8, see submission by the Institute of Corporate Directors to
CSA based on the report developed by the Independent Task Force on the Canadian Securities Administrators’
Proposed National Governance Policy Regarding Revisions to NP 58–201 and NI 58–101 (17April 2009).
 THE USA, THE UK AND CANADA 331

equivalent document disclosure regarding its corporate governance practices.

Issuers must disclose whether their practices are consistent with those recom-
mended under current National Policy 58–201 Corporate Governance Guidelines.
This approach is consistent with the ‘comply or explain’ disclosure regime in
other jurisdictions, such as Australia and the UK.128
The proposed National Instrument 58–101129 will significantly revise disclo-
sure requirements to comport with the contents of the proposed National Policy
58–201 Corporate Governance Principles. In particular, the disclosure require-
ments will no longer be based on a model of ‘comply or explain’ against gover-
nance guidelines. Instead, issuers will be required to disclose their governance
practices that achieve the objectives espoused in the nine core governance prin-
ciples. The proposed adoption of an ‘explain’ model has been criticised for taking
Canada in a different direction from other jurisdictions and, more significantly,
running the risk that unsophisticated investors in governance practices will be
reading and evaluating the issuer’s disclosures in a vacuum due to the absence
of a common benchmark.130

12.4.6 National Instrument 52–110 and Companion Policy

52–110CP Audit Committees
As a response to major corporate fraud and misconduct in the USA, Canada
reformed the audit function to enhance the quality of the audit process by adopt-
ing the following measures:
● establishing the Canadian Public Accountability Board (CPAB), which par-
allels the creation of the Public Company Accounting Oversight Board
(PCAOB), seen as the centerpiece of SOX131
● creating an Auditing and Assurance Standards Oversight Council
(AASOC)
● promulgating new auditor independence standards
● passing a national instrument on auditor oversight.
In line with international trends, which has concentrated attention on audit com-
mittees in fulfilling their oversight responsibilities with respect to the integrity of
financial statements and reporting,132 Canada has also focused on the expanded

128 Since 1995, companies listed on the Toronto Stock Exchange (TSX) have been required to disclose on
an annual basis a ‘Statement of Corporate Governance Practices’. Although the TSX guidelines (set out in the
TSX Company Manual) were not prescriptive, it was predicated on the ‘comply or explain’ disclosure regime.
For examples of disclosure of Canadian corporate governance practices, see disclosure documents of public
companies, which are available at <www.sedar.com>.
129 See earlier discussion on the status of this law reform measure.
130 See submission by the Institute of Corporate Directors to CSA based on the report developed by the
Independent Task Force on the Canadian Securities Administrators’ Proposed National Governance Policy
Regarding Revisions to NP 58–201 and NI 58–101 (17April 2009).
131 For a useful discussion on the role of the audit profession in corporate governance and an account of
developments in the regulation of the audit function in both Canada and the USA, see Paul Paton, ‘Rethinking
the Role of the Auditor: Resolving the Audit/Tax Services Debate’ (2006) 32 Queen’s Law Journal 135.
132 See, for example, Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness
of Corporate Audit Committees, published by the New York Stock Exchange and The National Association of
Securities Dealers (1999).
332 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

role of audit committees. Similar to section 301 of SOX, this national instrument
requires every reporting issuer to have an audit committee composed of indepen-
dent directors, unless otherwise exempted, which is responsible for the oversight
of the external auditor and for reviewing the company’s financial statements.
The national instrument establishes requirements for the responsibilities, com-
position and authority of audit committees.133 The companion policy provides
information regarding the interpretation and application of the instrument.
In the case of a non-venture issuer, an audit committee must be composed
of a minimum of three directors who must be, subject to limited exceptions,
independent and financially literate.134 For purposes of the instrument, a director
is financially literate if he or she has the ability to read and understand a set of
financial statements that present a breadth and level of complexity of accounting
issues that are reasonably comparable to the breadth and complexity of the
issues that can reasonably be expected to be raised by the issuer’s financial
statements.135 Furthermore, issuers disclose the education and experience of
each audit committee member that is relevant to the performance of his or her
responsibilities as an audit committee member.136
The definition of ‘independent director’, which is also applicable to the corpo-
rate governance guidelines discussed earlier, is contained in National Instrument
52–110 and is determined with reference to the following specific ‘bright-line’
tests:
● an individual who is, or with the prior three-year period has been, an
employee or executive officer of the issuer
● an individual whose immediate family member is, or within the prior three-
year period has been, an executive officer of the issuer
● an individual who is, or has been, or has an immediate family member who
is, or has been, a partner or employee of a current or former internal or
external auditor of the issuer, or personally worked on the issuer’s audit
within the past three years as a partner or employee of that audit firm
● an individual who is, or has been, or whose immediate family member is,
or has been within the past three years, an executive officer of an entity
if any of the issuer’s current executive officers serve or served at the same
time on that entity’s compensation committee
● an individual who received, or whose immediate family member who is
employed as an executive officer of the issuer received, more than $75 000
in direct compensation from the issuer during any 12-month period within
the past three years and
● for purposes of this definition, an ‘issuer’ includes any parent or subsidiary
entity.
The definition above is extended for audit committee composition purposes. In
addition, an individual will not be treated as independent if he or she:
133 The instrument applies to a reporting issuer other than an investment fund, an issuer of asset-backed
securities, a designated foreign issuer and an SEC foreign issuer.
134 Part 3.2 of National Instrument 52–110.
135 Part 4.1 of Companion Policy 52–110CP to National Instrument 52–110 Audit Committees.
136 Ibid.
 THE USA, THE UK AND CANADA 333

● Accepts, directly or indirectly, any consulting, advisory or compensatory

fee from the issuer, other than as remuneration for acting as a board
member or as a part-time chair or vice-chair of the board or
● Is an ‘affiliated entity’ of the issuer or any of its subsidiary entities.
Proposed law reform to National Instrument 52–110, which is currently stalled
for reasons discussed earlier, contemplates redefining when a director can be
considered independent of the company. The ‘bright-line’ tests, identified above,
may no longer apply if the proposed reforms are implanted in 2011 (at the
earliest).137 Instead, the proposed redefinition states than an independent direc-
tor is a director of an issuer who:
(a) is not an employee or executive officer of the issuer and
(b) does not have, or has not had, any business or other relationship with the
issuer or its executive officers which could, in the view of the issuer’s board
having regard to all relevant circumstances, be reasonably perceived to
interfere with the exercise of his or her independent judgment.
The CSA has proposed a ‘perceptions’ test because it believes that the concept
of perception is broader and more appropriate in view of the proposed removal
of the ‘bright-line’ tests. The revised definition has been attacked by the Alberta
Securities Commission (ASC) over concerns the clause (b) above may remove
the discretion of the board to determine whether or not a director who is not
an employee or executive offer is independent.138 The ASC has queried whether
the reasonable person litmus test to judge independence is appropriate and
whether it is desirable for issuers to identify directors as being ‘not independent’
and to offer an explanation for such a label.139 The concern for the ASC is that
the best available directors may not become members of the boards because
of the application of the revised definition of independence.140 Another con-
cern expressed is that the primacy of independence has caused many boards
to operate with directors who are entirely independent but who lack the skills,
attributes and industry knowledge that would be most valuable to the issuer’s
business.141
The responsibilities of the audit committee are set out in Part 2.3 of the
National Instrument 52–110, which states:
(1) An audit committee must have a written charter that sets out its mandate
and responsibilities.
(2) An audit committee must recommend to the board of directors
(a) the external auditor to be nominated and
(b) the compensation of the external auditor.

137 See CSA Staff Notice 58–305 Status Report on the Proposed Changes to the Corporate Governance Regime
(13 November 2009), available at <www.securities-administrators.ca>.
138 Request for Comment: Proposed Repeal and Replacement of National Policy 58–201 Corporate Gov-
ernance Guidelines, National Instrument 58–101 Disclosure of Corporate Governance Practices and National
Instrument 52–110 and Companion Policy 52–110CP Audit Committees (19 December 2008), Appendix A,
National Policy 58–201 Corporate Governance Principles – available at <www.securities-administrators.ca>.
139 Ibid.
140 Ibid.
141 See submission by the Institute of Corporate Directors to CSA based on the report developed by the
Independent Task Force on the Canadian Securities Administrators’ Proposed National Governance Policy
Regarding Revisions to NP 58–201 and NI 58–101 (17 April 2009).
334 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

(3) An audit committee must oversee the work of the external auditor engaged
for the purpose of preparing or issuing an auditor’s report or performing
another audit, or attest services for the issuer, including the resolution of
disagreements between management and the external auditor regarding
financial reporting.
(4) An issuer or any of its subsidiary entities must not obtain a non-audit
service from its external auditor unless the service has been approved by
the issuer’s audit committee.
(5) An issuer must not publicly disclose information contained in or derived
from its financial statements, Management Discussion and Analysis
(MD&A) or annual or interim earnings news releases, unless the docu-
ment has been reviewed by the audit committee.
(6) An audit committee must be satisfied that adequate procedures are in place
for the review of the issuer’s public disclosure of financial information
extracted or derived from the issuer’s financial statements and must, on a
reasonably frequent basis, assess the adequacy of those procedures.
(7) An audit committee must establish procedures for:
(a) the receipt and retention of and reasonable attempts to resolve com-
plaints received by the issuer regarding accounting, internal account-
ing controls, or auditing matters and
(b) the confidential, anonymous submission by employees of the issuer of
concerns regarding questionable accounting or auditing matters.
(8) An audit committee must review and approve the issuer’s hiring policies
regarding partners, employees and former partners or employees of the
present or former external auditor of the issuer.

12.4.7 Future direction

The following section highlights some of the key concerns expressed on the
future direction of corporate governance in Canada. A common concern, echoed
by various commentators,142 deals with the tendency for Canadian corporate
and securities law reform to move lockstep with the USA despite considerable
differences in the Canadian capital markets from those in the USA. The key major
difference between the USA and Canada lies in the fact that most United States
companies are widely held, unlike the Canadian position where half of the top
firms have controlling shareholders (wealthy families, other firms, or large finan-
cial institutions).143 Those controlling shareholders usually dominate the board,
giving rise to governance problems whereby controlling shareholders are either

142 See, for example, Sukanya Pillay, ‘Forcing Canada’s Hand? The Effect of the Sarbanes-Oxley Act on
Canadian Corporate Governance Reform’ (2004) 30 Manitoba Law Journal 285; Davis, above n 106, 990;
Paton, above n 131, 135; Edward Waitzer, ‘Paradigm Flaws: An Agenda for Corporate Governance Reform’
(2007) Banking & Finance Law Review 405.
143 Randall Morck and Bernard Yeung, ‘Research Study: Some Obstacles to Good Corporate Governance in
Canada and How to Overcome Them’, commissioned by the Task Force to Modernise Securities Legislation
in Canada, Canada Steps Up (18 August 2006) at 293–300.
 THE USA, THE UK AND CANADA 335

unsophisticated or wield control without owning very many shares through

control-magnifying devices such as super-voting shares and pyramiding.144
Morck and Yeung note that much empirical research links these problems to
weak performance.145 In their view, current corporate governance reforms in
Canada are ill-suited for the following reasons:146

Canadian corporate governance laws, regulations and best practices must attend to
controlling – versus public-shareholder disputes in firms with controlling shareholders,
and to shareholder-manager disputes in firms without them. This requires a fundamen-
tally broader focus that in the United States and the United Kingdom, where controlling
shareholders are relatively rare and good governance is mainly about preventing or
solving shareholder-manager disputes.

The following questions posited by a Canadian commentator illustrate the fierce

debate about the future direction of Canadian corporate governance reform:147
● Should Canada harmonise its securities laws with SOX?
● Since Canada has traditionally employed a principles-based model of cor-
porate governance, is it necessary for Canada now to shift its corporate
governance culture to adopt a rules-based model in order to harmonise
with SOX?
● Given that Canada does not have a federal securities regulator like the
USA’s SEC, can Canada even achieve domestic harmonisation let alone
external harmonisation with SOX?
An unanswered question, posed by Ronald Davis,148 is whether the importation
of the SOX regulatory requirements will adversely affect the culture of Canada’s
corporations by encouraging the abandonment of a ‘culture of compliance’ for a
loop-hole conscious, rules-based culture. Answering this question merits schol-
arly research and empirical evidence into corporate governance practices. It
is noted with some irony by one commentator149 that the current calls to roll
back section 404 of SOX (dealing with internal controls) due to the high cost of
compliance (in particular for smaller public companies) and the United States
reforms150 suggests that the USA may be moving in the Canadian direction.
The contemplated change in philosophy, from a set of recommended gov-
ernance practices to a principles-based approach to corporate governance in

144 Ibid.
145 Ibid at 295.
146 Ibid at 296. For similar concerns, see Janis Sarra, ‘The Corporation as Symphony: Are Shareholders First
Violin or Second Fiddle?’ (2003) 36 University of British Columbia Law Review 403, who notes that corporate
law reforms shift oversight power to large investors and their ability to influence corporate governance.
147 Pillay, above n 142, 285;
148 Davis, above n 106, 990.
149 Ben-Ishai, above n 104, 490.
150 SEC Press Release (13 December 2006), ‘SEC Votes to Propose Interpretive Guidance for Management
to Improve Sarbanes-Oxley 404 Implementation’, available at <www.sec.gov/news/press/2006/2006-206.
htm>; SEC Press Release (23 May 2007), ‘SEC Approves New Guidance for Compliance with Section 404
of Sarbanes-Oxley’, available at <www.sec.gov/news/press/2007/2007-101.htm>; and see John W. White,
SEC’s Proposed Interpretive Guidance to Management for Section 404 of Sarbanes-Oxley Act (23 May 2007),
Washington, DC.
336 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

National Policy 58–201, will bring with it opportunities and risks151 for those
at the coal-face who are familiar with the current governance culture. The pro-
posed replacement of the current system of corporate governance with nine
broad principles designed better to protect investors and make Canadian busi-
ness more competitive is yet to be tested, and therefore its workability is yet to be
judged.152 In an effort to be less prescriptive by removing the ‘bright-line’ tests to
determine director independence, the proposed amendment of the definition of
independence to a more principles-based definition brings with it a range of con-
cerns discussed earlier. It remains to be seen, as forewarned,153 if on the path to
transition Canada loses the generally accepted baseline of governance practices
that currently exists should the principles-based approach be implemented.

12.5 Conclusion

There were considerable developments in the area of corporate governance in

all three jurisdictions discussed in this chapter. Although signs of convergence of
corporate governance models were identified and still exist, it is far from certain
that all corporate governance systems will converge. Cultural differences and
other factors listed in this chapter will almost certainly ensure that there will
always be differences in the corporate governance systems adopted by different
countries, irrespective of globalisasion generally. An interesting illustration of
this is the strong divergence that occurred between the USA and UK corporate
governance models with the adoption of SOX – it has put the two jurisdictions
on different corporate governance paths, with a self-regulatory aspiration still
dominant in the UK, while the United States model is far more prescriptive
and regulatory in nature. Also, the differences between models relying on the
principle of ‘comply and explain’ or ‘comply or else’ or ‘apply or explain’, also
commented on in Chapter 3, illustrate that variety will probably remain the spice
of ‘corporate governance’ (‘life’)!
151 For a comprehensive discussion on the costs and benefits of rules and principle-based regulatory systems,
see Cristie Ford, Principles-Based Securities Regulation: A Research Study Prepared for the Expert Panel on
Securities Regulation (12 January 2009), available at <www.expertpanel.ca>. For critique on the use of such
labels, see Lawrence Cunningham, ‘A Prescription to Retire the Rhetoric of “Principle-Based Systems” in
Corporate Law, Securities Regulation, and Accounting’ (2007) 60 Vanderbilt Law Review 1411.
152 British Columbia introduced a bill to create an innovative principles-based Securities Act (Bill 38), which
was assented to in May 2004 but is yet to come into force.
153 See submission by the Institute of Corporate Directors to CSA based on the report developed by the
Independent Task Force on the Canadian Securities Administrators’ Proposed National Governance Policy
Regarding Revisions to NP 58–201 and NI 58–101 (17 April 2009). Cf Erinn Broshko and Kai Li, ‘Playing
by the Rules: Comparing Principles-based and Rules-based Corporate Governance in Canada and the U.S.’
(2006) Canadian Investment Review 18.
13
OECD Principles of Corporate
Governance, and corporate
governance in Germany,
Japan and China

Nothing so concentrates the mind as an urgent and complex problem.

Frederick G Hilmer, Strictly Boardroom: Improving Governance to Enhance
Company Performance (Hilmer Report (1993)) 1

13.1 Introduction

In Chapter 12 we discussed corporate governance in the USA, the UK and Canada.

We have mentioned that although they are considered to be the major traditional
Anglo-American corporate governance jurisdictions, there are among them some
fundamental differences in approach.
In this chapter the focus is on the OECD principles of corporate governance,
and corporate governance in Germany, Japan and China. The OECD principles
cover board structures. Germany adheres to a two-tier board structure with
employee representatives forming part of the supervisory board. Elements of
the German corporate governance model influenced the original Japanese cor-
porate governance model, but Anglo-American influence emerged after World
War II. China has a unique corporate governance model because Chinese cor-
porations were traditionallyare state-owned and many major corporations are
still either state-owned or state-controlled. Nevertheless, elements of both the
German model and the Anglo-American model, especially as far as independent,
non-executive directors for listed companies are concerned, have influenced the
Chinese corporate governance model.

337
338 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

13.2 OECD Principles of Corporate Governance

13.2.1 Background
The Organisation for Economic Co-operation and Development (OECD) consists
of a group of 30 member countries who share a commitment to democratic
government and a market economy. It shares expertise and exchanges views
with more than 100 other countries, non-government organisations and civil
societies. The OECD brings together the governments of countries committed to
democracy and the market economy from around the world to:1
● support sustainable economic growth
● boost employment
● raise living standards
● maintain financial stability
● assist other countries’ economic development
● contribute towards growth in world trade.
One of the OECD’s early projects was to develop a set of principles of corporate
governance. The first such set was completed in 1999 under the title OECD Princi-
ples of Corporate Governance.2 These principles provided minimum requirements
for best practice and were not aimed at promoting a single corporate governance
model for all OECD countries, but rather at promulgating principles that could
be applied in all OECD and non-OECD countries. On 22 April 2004, the 30 OECD
countries approved the 2004 OECD Principles of Corporate Governance.3 These
principles confirm several sound corporate governance practices already identi-
fied and explained in the 1999 Principles, but they also contain some refinement
in light of the corporate scandals of the late 1990s and early 2000s:
The OECD Principles of Corporate Governance were originally developed in response
to a call by the OECD Council Meeting at Ministerial level on 27–28 April 1998,
to develop, in conjunction with national governments, other relevant international
organisations and the private sector, a set of corporate governance standards and
guidelines. Since the Principles were agreed in 1999, they have formed the basis
for corporate governance initiatives in both OECD and non-OECD countries alike.
Moreover, they have been adopted as one of the Twelve Key Standards for Sound
Financial Systems by the Financial Stability Forum. Accordingly, they form the basis
of the corporate governance component of the World Bank/IMF Reports on the
Observance of Standards and Codes (ROSC).4

13.2.2 Broad aims and application

The OECD Principles aimed to assist governments in their efforts to evaluate
and improve the legal, institutional and regulatory framework for corporate
1 See ‘About OECD’, at <www.oecd.org/pages/0,3417,en_36734052_36734103_1_1_1_1_1,00.html>.
2 OECD Principles of Corporate Governance (1999).
3 OECD Principles of Corporate Governance (2004), available at <www.oecd.org/document/49/
0,3343,en_2649_34813_31530865_1_1_1_1,00.html>.
4 Ibid 9.
 GERMANY, JAPAN AND CHINA 339

governance, and to provide guidance and suggestions for stock exchanges,

investors, corporations and other parties that have a role in the process of devel-
oping good corporate governance.5 One of the unique aspects of the OECD
Principles is that they operate across borders and without preference for any par-
ticular corporate law system or board structure6 – they focus, in the true sense
of the word, on ‘the principles of corporate governance’. Thus, an open-minded
approach to corporate governance is adopted:

Corporate governance is one key element in improving economic efficiency and growth
as well as enhancing investor confidence. Corporate governance involves a set of rela-
tionships between a company’s management, its board, its shareholders and other
stakeholders. Corporate governance also provides the structure through which the
objectives of the company are set, and the means of attaining those objectives and moni-
toring performance are determined. Good corporate governance should provide proper
incentives for the board and management to pursue objectives that are in the interests
of the company and its shareholders and should facilitate effective monitoring.7

13.2.3 Structure
The document containing the OECD Principles is divided into two parts: the first
comprises the core principles, while the second part presents the principles with
annotations and are intended to help readers understand their rationale. The
annotations also provide descriptions of dominant trends and offer alternative
implementation methods and examples that may be useful in making the princi-
ples operational. The principles presented in the first part of the document cover
the following areas: I) Ensuring the basis for an effective corporate governance
framework; II) The rights of shareholders and key ownership functions; III) The
equitable treatment of shareholders; IV) The role of stakeholders; V) Disclosure
and transparency; and VI) The responsibilities of the board. Each of the sections
is headed by a single principle that appears in bold italics and is followed by a
number of supporting sub-principles.8
In this discussion we focus only on the principles not dealt with specifically in
any other chapter of this book, namely those in Part I and Part V.

13.2.4 Ensuring the basis for an effective corporate

governance framework
The basic principle is expressed as follows:9

The corporate governance framework should promote transparent and efficient mar-
kets, be consistent with the rule of law and clearly articulate the division of responsi-
bilities among different supervisory, regulatory and enforcement authorities.

5 Ibid 11.
6 Ibid 13.
7 Ibid 11.
8 Ibid 14.
9 Ibid 17.
340 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

Four specific aspects are mentioned to ensure the implementation of this

principle:10
A. The corporate governance framework should be developed with a view
to its impact on overall economic performance, market integrity and the
incentives it creates for market participants and the promotion of trans-
parent and efficient markets.
B. The legal and regulatory requirements that affect corporate governance
practices in a jurisdiction should be consistent with the rule of law, trans-
parent and enforceable.
C. The division of responsibilities among different authorities in a jurisdiction
should be clearly articulated and ensure that the public interest is served.
D. Supervisory, regulatory and enforcement authorities should have the
authority, integrity and resources to fulfil their duties in a professional
and objective manner. Moreover, their rulings should be timely, transpar-
ent and fully explained.
Many of the aspects discussed in this part of the OECD Principles of Corporate
Governance have already been mentioned in Chapter 3 under the heading ‘3.5
Board structures in the broader context of a good corporate governance model’.
As was discussed in Chapter 5, the OECD Principles emphasise the point that
a corporate governance framework typically comprises elements of legislation,
regulation, self-regulatory arrangements, voluntary commitments and business
practices that are the result of a country’s specific circumstances, history and
tradition. One of the specific dangers warned against is over-regulation. The
costs and benefits of laws and regulations should be considered carefully before
they are implemented, otherwise the result will be over-regulation, or even the
creation of unenforceable laws. Any corporate governance model should support
the exercise of entrepreneurship.11
It is stressed that the regulatory and legal environment within which cor-
porations operate is of key importance to overall economic outcomes. A cor-
porate governance model is typically influenced by several legal arrangements
such as company law, securities regulation, accounting and auditing standards,
insolvency law, contract law, labour law and tax law. However, these laws will
require effective enforcement. The allocation of responsibilities for supervision,
implementation and enforcement among different authorities should be clearly
defined so that the competencies of complementary bodies and agencies are
respected and used most effectively. If this is not done, overlaps can occur or,
even worse, ‘regulatory vacuums’ can be created.12 We have argued in Chapter 6
that this is one of the aspects where the Australian corporate governance model
lags behind, especially as far as the respective roles of the Australian Securi-
ties Exchange (ASX) and the Australian Securities and Investments Commission
(ASIC) are concerned.

10 Ibid.
11 Ibid 29.
12 Ibid 29–31.
 GERMANY, JAPAN AND CHINA 341

13.2.5 Disclosure and transparency

The basic principle is expressed as follows:13

The corporate governance framework should ensure that timely and accurate disclo-
sure is made on all material matters regarding the corporation, including the financial
situation, performance, ownership, and governance of the company.

Four specific aspects are mentioned to ensure the implementation of this

principle:14
A. Disclosure should include, but not be limited to, material information on:
1. the financial and operating results of the company
2. company objectives
3. major share ownership and voting rights
4. remuneration policy for members of the board and key executives, and
information about board members, including their qualifications, the
selection process, other company directorships and whether the board
regards them as independent
5. related party transactions
6. foreseeable risk factors
7. issues regarding employees and other stakeholders
8. governance structures and policies, in particular, the content of any
corporate governance code or policy and the process by which it is
implemented.
B. Information should be prepared and disclosed in accordance with high-
quality standards of accounting and financial and non-financial disclosure.
C. An annual audit should be conducted by an independent, competent and
qualified auditor in order to provide an external and objective assurance to
the board and shareholders that the financial statements fairly represent
the financial position and performance of the company in all material
respects.
D. External auditors should be accountable to the shareholders, and owe a
duty to the company to exercise due professional care in the conduct of the
audit.
The OECD Principles note that most OECD countries already have in place both
mandatory and voluntary disclosure arrangements. The main advantage of a
strong disclosure regime is that it promotes transparency, ensures effective mon-
itoring of companies and is central to shareholders’ ability to exercise their own-
ership rights on an informed basis. Disclosure is also a powerful tool with which
to influence the behaviour of companies and protect investors.15 The advantages
of an effective disclosure regime versus the disadvantages of a poorly developed
disclosure regime are summarised neatly as follows:

13 Ibid 22.
14 Ibid.
15 Ibid 49.
342 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

A strong disclosure regime can help to attract capital and maintain confidence in
the capital markets. By contrast, weak disclosure and non-transparent practices can
contribute to unethical behaviour and to a loss of market integrity at great cost, not just
to the company and its shareholders but also to the economy as a whole . . . Insufficient
or unclear information may hamper the ability of the markets to function, increase the
cost of capital and result in a poor allocation of resources.16

It is, however, important that disclosure requirements should not place unrea-
sonable administrative or cost burdens on enterprises or require of companies to
disclose information that may endanger their competitive position. The principle
adopted in most OECD countries to ensure that the right kind of information is
disclosed is the principle of ‘materiality’: ‘material information can be defined
as information whose omission or misstatement could influence the economic
decisions taken by users of information’.17

13.2.6 Conclusions on OECD corporate governance principles

As was pointed out, one of the unique aspects of the OECD Principles is that
they operate across borders and without preference for any particular corporate
law system or board structure– they focus, in the true sense of the word, on
‘the principles of corporate governance’. It is, therefore, of particular importance
to take note of these principles and to adopt the ones most appropriate for a
specific country. It also provides some of the most convincing arguments for why
good corporate governance is important and why adhering to good corporate
governance adds value to a corporation.

13.3 Germany18

13.3.1 Background to the corporate governance

debate in Germany
The German corporate governance debate is particularly interesting and rele-
vant, since the German corporations law makes a two-tier board system (super-
visory board and management board) compulsory for all public corporations.
This system, and in particular the role and effectiveness of the supervisory board
as institutional supervisor or overseer of the management of the business of the
corporation, has been highly prominent in Germany since the middle 1990s.
In the past, the German two-tier system has been criticised for: the ineffective-
ness of supervisory boards generally; the practical difficulty in distinguishing
between the managerial and supervisory functions of the management board

16 Ibid.
17 Ibid 49–50.
18 For a more comprehensive discussion of the German corporate law and governance models, see J J du
Plessis, B Großfeld, C Luttermann, I Saenger and O Sandrock, German Corporate Governance in International
and European Context, Heidelberg, Springer Verlag (2007).
 GERMANY, JAPAN AND CHINA 343

and supervisory board respectively; the practical difficulties associated with the
relationship between the supervisory and management boards; the defects in the
composition of supervisory boards; and, in particular, employee participation at
supervisory board level.19 Many of the original criticisms against the German
board system have been addressed pertinently since the middle of the 1990s.
These aspects are refreshing and can hardly be ignored as far as the worldwide
debate on corporate governance is concerned.
The German corporate governance debate, and in particular the debate on
the functions of the supervisory board, has for many years been considered to
be of academic interest only.20 This perception has changed significantly over
recent years. The supervisory board has been a focus of attention for the German
government; it formed the central theme of discussion of several seminars and
symposiums; German industry committed itself to finding solutions; trade unions
made recommendations; and eminent German academics participated keenly in
this debate.21
The debate on corporate governance in Germany was closely linked with the
relatively difficult economic conditions experienced there during the middle and
late 1990s,22 and in particular with the difficulties experienced in the German
iron and steel industry.23 Difficulties in some of the large German industries
were blamed upon failure and neglect of management and those overseeing the
business of large corporations, particularly the supervisory boards.24 The recent
global financial crisis took a particular toll on the German economy, which
has always been heavily dependent on export of expensive and sophisticated
commodities such as luxury cars; during a financial crisis, naturally purchases of
luxurious items are cut first.25
The official reaction to the corporate governance debate of the middle 1990s
came in November 1996, with a Ministerial Draft Bill dealing with issues relating
to more transparency in corporations and the powers of control of the various
organs of public corporations26 – generally known as the Aktienrechtsreform
19 See Detlev F Vagts, ‘Reforming the “Modern” Corporation: Perspectives from the German’ (1966) 80
Harvard Law Review 23, 76–8 and 87–9; Mark J Roe, ‘Some Differences in Corporate Structure in Germany,
Japan, and the United States’ (1993) 102 Yale Law Journal 1927, 1995–1997; Jean J du Plessis, ‘Corporate
Governance: Reflections on the German Two-tier System’ (1996) Journal of South African Law 20, 41–4; Jean
J du Plessis, ‘Corporate Governance: Some Reflections on the South African Law and the German Two-tier
Board System’ in Fiona Macmillan Patfield (ed.), Perspectives on Company Law: 2, London, Kluwer Law (1997)
131, 139–43.
20 Marcus Lutter, ‘Defizite für eine effiziente Aufsichtsratstätigkeit und gesetzliche Möglichkeiten der
Verbesserung’ (1995) 159 Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht 287, 288–9.
21 See Jean J du Plessis, ‘Reflections on Some Recent Corporate Governance Reforms in Germany: A Trans-
formation of the German Aktienrecht?’ (2003) 8 Deakin Law Review 381, 384–5 and references in footnotes
19–23.
22 This fact has been mentioned by quite a few chairmen of management boards in their yearly reports – see
Klein-Gunnewyk (Chairman’s Statement: PWA AG) 1994.06.24. See also Carsten P Claussen, ‘Aktienrechts-
reform 1997’ (1996) 41 Die Aktiengesellschaft (Zeitschrift) 481.
23 Marcus Lutter, ‘Deutsche Corporate Governance Kodex’ in Reform des Aktienrechts, der Rechnungslegung
und der Prüfung, Stuttgart, Schäffer-Poeschel Verlag (2003) 68, 69.
24 Claussen, above n 22, 481.
25 See generally Anatole Kaletsky, ‘Europe Needs Rescue Act from Germany’, The Australian (19 May 2009)
at 21; and ‘Thomas Cook Up for Grabs After Retailer Folds’, The Australian (11 June 2009) at 20.
26 Referentenentwurf eines Gesetzes für Kontrolle und Transparenz im Unternehmensbereich (KonTraG) –
Dokumentation, 1997 (Special Edition) Die Aktiengesellschaft (AG) 7.
344 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

1997.27 The 1997 Draft Bill dealt with several fundamental aspects pertaining
to the duties, responsibilities and liability of members of supervisory boards;
proxies; financial statements and disclosure; votes by the banks on behalf of
shareholders; and financial instruments and capital markets.28 This Draft Bill
was widely discussed in 1997,29 and several amendments were made before it
became law in May 1998.30
The proposed changes were described by some as comprehensive and akin
to the reform of the German corporations law in the 1960s.31 Others were more
skeptical and described the changes as no more than cosmetic,32 or done piece-
meal instead of by way of a comprehensive review of the German corporations
law.33 Some of the more fundamental questions asked during the reform pro-
cess were how the German corporations law could be modified to ensure the
improvement of the state of businesses in Germany and how to create more
jobs.34 Nowadays several items, such as the role and functions of the manage-
ment board and general meeting, and removing some unnecessary bureaucratic
provisions from the corporations law, are mentioned as items on the long-term
reform agenda of the German corporations law.35
It was realised at an early stage of the German corporate governance debate
that most of the changes in the Draft Bill could be achieved without the need for
statutory changes36 – in other words, through voluntary or self-imposed good
corporate governance practices. Some commentators warned specifically against
the dangers of over-regulation by the legislature, and that such regulation often
causes more damage than advantages.37
Following the changes in 1998, a government commission, chaired by
Theodor Baums, was appointed by the German Chancellor on 29 May 2000.38
The Baums Commission made 150 recommendations in its report, released on
10 July 2001.39

27 Heinz-Dieter Assmann, ‘AG-Sonderheft: Die Aktienrechtsreform 1997’, Die Aktiengesellschaft (Zeitschrift)

(Special Edition, 1997) 3.
28 See Michael Adams, Die Aktiengesellschaft (Zeitschrift) (Special Edition,1997) 9 ff for a most comprehen-
sive discussion of the issues dealt with in the Draft Bill.
29 See Adams, above n 28, 9 ff for detailed commentary by some of the most eminent corporate law academics
in Germany.
30 Gesetz zur Kontrolle und Transparenz im Unternehmensbereich (KonTraG) – Bundesgesetzblatt Teil I
(BGBI. I. 1998 786 ff).
31 See Claussen, above n 22, 494.
32 Ekkehard Wenger, Die Aktiengesellschaft (Zeitschrift) (Special Edition, 1997) 57.
33 Ulrich Seibert, ‘Aktienrechtsreform in Permanenz?’ (2002) 45 Die Aktiengesellschaft (Zeitschrift) 417.
However, at 419–20 the author explains that such piecemeal reform was necessary as comprehensive corpo-
rate law reforms take a long time and there was simply not enough time to wait for comprehensive corporate
law reform in Germany.
34 Claussen, above n 22, 481.
35 Seibert, above n 33, 419.
36 Conrad Berger, Die Kosten der Aufsichtsratstätigkeit in der Aktiengesellschaft, Frankfurt, Peter Lang (2000)
10.
37 Claussen, above n 22, 481, 487.
38 Until about 2007 available at ‘Corporate Governance – Unternehmensführung – Unternehmenskon-
trolle – Modernisierung des Aktienrechts’. Press Release 3 August 2001 <http://www.bundesregierung.de/
Nachrichten/-,433/Pressemitteilungen.htm> at 3 – for a copy of the press release, contact first author Jean
du Plessis.
39 Ibid.
 GERMANY, JAPAN AND CHINA 345

The work of the Commission was described as follows by the State Minister to
the Chancellery, Hans Martin Bury, when the report was delivered to the German
Chancellor:

The work of the Government Panel on Corporate Governance has laid the foundation
for a comprehensive reform of German company law. The Panel’s recommendations
aim to improve corporate management and supervision, transparency and competi-
tion. They improve the protection of stockholders and strengthen Germany’s financial
market. The Government Panel not only has accomplished its mission of formulating
recommendations to correct undesirable past trends, but has also developed proposals
with well-reasoned future orientation to strengthen the German system of Corporate
Governance and eliminate potential shortcomings.40

The recommendations dealt with the introduction of a corporate governance

code for listed German corporations; intensifying the control over directing the
business of the corporation and increasing the powers of supervisory boards;
improving the rights of shareholders; improving protection for investors; improv-
ing provisions for the disclosure of information; improving accounting standards
and financial reporting; and the use of modern information and communication
technology.41 For current purposes the focus will be on the first two aspects.42

13.3.2 The German Corporate Governance Code43

13.3.2.1 Background to its adoption
In Germany, the introduction of a code of good corporate governance practices
was always seen in the context of the broader definition of corporate gover-
nance. The approach to such a definition was a realistic one, with two aspects
being highlighted: first, that corporate governance cannot ignore the stakeholder
debate; and second, that the concept of corporate governance encompasses more
than just the creation of legal structures for decision making and supervising the
corporation. It was, furthermore, realised that because of the peculiarities of the
German corporations law, in particular the prescriptive nature of the German
Corporations Act (Aktiengesetz (AktG)) regarding a two-tier board, no inter-
national code would fit the German situation perfectly. Even in the European

40 Translation by Shearman and Sterling, ‘German Government Panel on Corporate Governance’, Summary
of Recommendations (Translation) (2001) 1 – translation kindly provided by Professor Theodor Baums. Also
see <www.ecgi.org/codes/documents/baums report.pdf>.
41 Press Release, above n 38, 3–8.
42 As far as the supervisory board in particular is concerned, see the comprehensive and excellent article by
Jan Lieder, ‘The German Supervisory Board on Its Way to Professionalism’ (2010) 11 German Law Journal
115 et seq. For some of the more general issues dealing with the German corporate governance model,
see Christel Lane, ‘Changes in Corporate Governance of German Corporations: Convergence to the Anglo-
American Model?’ in European Corporate Governance (Thomas Clarke and Jean-Francois Chanlat, eds),
London, Routledge (2009) 157.
43 This part is partly based on extracts from the following two articles – Du Plessis, above n 21, 381 et seq;
and Jean J du Plessis, ‘The German Two-tier Board and the German Corporate Governance Code’ (2004) 15
European Business Law Review 1139 et seq.
346 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

Union context, the vast differences between the OECD Principles of Good Corpo-
rate Governance and the UK Combined Code served as a clear illustration that no
international code could really serve as an example for Germany.
Soon after the release of the Baums Report it was made known that a group
of experts would be appointed to draft a code of best practice for Germany that
would apply to all listed German corporations, and that the code should follow
the ‘comply or explain’ principle adopted in the UK. This task was given to the
German Corporate Governance Commission under the chairmanship of Gerhard
Cromme (the Cromme Commission), who was appointed in September 2001.
Although there were some private initiatives to introduce a code of best prac-
tice for Germany in 2000, the official German code was only adopted on 26
February 2002. Since 2005, the code has been amended and adjusted slightly
on an annual basis in June of each year.44 Several of the amendments have been
influenced by international developments and after the publication of several
corporate governance reports based on conferences held under the auspices of
the Cromme Committee. The papers of these conferences were published in Ger-
man and in English.45 The current code is one dated 18 June 2009.46 One of the
main aims of the code was to improve corporate governance practices relating to
managing, directing and overseeing listed corporations. The code adopted the
two basic principles referred to above, namely that in essence it would apply only
to listed corporations and that it would not be mandatory, but that listed cor-
porations must disclose if they did not follow certain specific recommendations
of the code (the ‘comply or disclose’ principle).
What is, however, different from most other systems with which voluntary
corporate governance codes were adopted is that the obligation to comply with
the German code or to explain non-compliance was introduced into the German
law through a statutory provision, section 161 of the Aktiengesetz (AktG). Section
161 basically puts a statutory duty on supervisory boards and management
boards of all listed German corporations, either to state that they ‘comply’ with the
German code as published electronically by the Standing Corporate Governance
Commission, or to ‘disclose’ if they do not comply with the code. The ‘comply
or disclose’ statement must be done on an annual basis and must also be made
available to the shareholders at all times.
Such a voluntary corporate governance model provides the advantage of being
able to respond quickly and effectively to the continuously changing needs of
business – something that cannot be achieved if corporate governance practices
are formalised through legislation, especially because of the tediousness involved
in amending legislation. Klaus J Hopt describes the basic aims of a first-class
44 See <www.ecgi.org/codes/all codes.php>.
45 See for instance Gerhard Cromme (ed.), Corporate Governance Report 2006: Vorträge und Diskussionen
der 5. Konferenz Deutscher Corporate Governance Kodex, Stuttgart, Schäffer-Poeschel Verlag (2006); Gerhard
Cromme (ed.), Corporate Governance Report 2007: Vorträge und Diskussionen der 6. Konferenz Deutscher
Corporate Governance Kodex, Stuttgart, Schäffer-Poeschel Verlag (2007); Gerhard Cromme (ed.), Corporate
Governance Report 2008: Vorträge und Diskussionen der 8. Konferenz Deutscher Corporate Governance Kodex,
Stuttgart, Schäffer-Poeschel Verlag (2008).
46 See <www.corporate-governance-code.de/eng/kodex/index.html>.
 GERMANY, JAPAN AND CHINA 347

corporate governance code as brevity, certainty, allowance for individualisation

and flexibility,47 and it seems that most of these aims are achieved by the German
code.

13.3.2.2 Structure and explanatory nature of the German code

The Code consists of seven distinct parts. The first part, the foreword, explains
the purpose of the Code and how its provisions should be interpreted. Part 2 deals
with shareholders and the general meeting; Part 3 with the cooperation between
the management board and the supervisory board; Part 4 with the management
board; Part 5 with the supervisory board; Part 6 with information that should be
disclosed to ensure transparency; and Part 7 deals with aspects such as financial
reporting, audits and financial statements.
The foreword explains that there are basically three types of provision in the
Code. The first group is identifiable by the use of the word ‘shall’ (soll). These
provisions contain the core recommendations of the Code and are the ones
to which the principle of ‘comply or disclose’ will apply – if a company does not
comply, the nature of non-compliance needs to be disclosed annually. The second
set of provisions is identifiable by the words ‘should’ (sollte) or ‘can’ (kann).
These provisions are considered to be good corporate governance principles,
although not really the core ones. Corporations are encouraged to follow them,
but no explanation is required if they do not. All remaining provisions of the
Code, not identifiable by any one of the words used above, are considered to be
provisions confirming the requirements under the current German law relating
to public corporations. In other words, they simply serve as a general and user-
friendly way of explaining the most basic existing corporate law and corporate
governance rules under the German corporations law. This serves a so-called
communications function. These provisions are quite useful, as it is one of the
most basic explanations of the German two-tier board system and the relationship
among the various corporate organs that exist in the German literature. Almost
half of the provisions of the Code are of an explanatory nature.
At the heart of the Code is the improvement of the supervisory and overseeing
functions of the supervisory board. Thus, the Code explains in some detail the
relationship between the supervisory board and the management board, as well
as the respective roles and functions of the supervisory and management boards.
It is interesting to note that the first two parts of the Code primarily serve the
purpose of explaining the current law. These parts consist of three pages, but
there are only six ‘comply or explain’ provisions in them. There is also a good
deal of explanation of the existing law in Part 4, dealing with the management
board. In contrast, there are only a few articles in Parts 5–7 that do not contain
‘comply or explain’ provisions.

47 Klaus J Hopt, ‘Unternehmensführung, Unternehmenskontrolle, Modernisierung des Aktienrechts – Zum

Bericht der Regierungskommission Corporate Governance’ in Corporate Governance: Gemeinschaftssymposion
der Zeitschriften (ZHR/ZGR) Verlag Recht und Wirtschaft GmbH Heidelberg (2002) 27, 49–51.
348 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

Most of the amendments affected in June 2009 deal with the remuneration
or compensation of members of the management board and the disclosure of
their remuneration and compensation. Also, it is now specifically provided that
performance incentives should be included as part of the remuneration of man-
agement board members. In this regard, Provision 4.2.3 (second paragraph) of
the 2009 German Corporate Governance Code provides as follows:
The compensation structure [of Management Board Members] must be oriented
toward sustainable growth of the enterprise. The monetary compensation elements
shall comprise fixed and variable elements. The Supervisory Board must make sure
that the variable compensation elements are in general based on a multi-year assess-
ment. Both positive and negative developments shall be taken into account when
determining variable compensation components. All compensation components must
be appropriate, both individually and in total, and in particular must not encourage to
take unreasonable risks.
For instance, share or index-based compensation elements related to the enterprise
may come into consideration as variable components. These elements shall be related
to demanding, relevant comparison parameters. Changing such performance targets or
the comparison parameters retroactively shall be excluded. For extraordinary develop-
ments a possibility of limitation (cap) must in general be agreed upon by the Supervisory
Board.

13.3.3 Employee participation at supervisory board level –

co-determination48
Any discussion of the German corporate governance system would be incom-
plete without at least a brief discussion of one of its outstanding features, which
has captured the imagination of those who view the German corporate gover-
nance model from abroad.49 This is, of course, the German system of employee
participation at supervisory board level – or co-determination, as it is more com-
monly known. This is also a theme that regularly pops up in the European Union
context, often with direct or indirect reference to the German corporations law
and corporate governance model. It was, indeed, because of conflicting views on
the two-tier board and employee participation in the supervisory board that the
Draft Fifth Directive has had such a stormy history and has little chance of ever
being implemented.50 Rose explains the opposing approaches succinctly:
The German co-determination system and the UK shareholder primacy model repre-
sent contrasting poles on an EU governance continuum. Given the deep structural and
cultural differences that exist between EU Member States, convergence will entail
significant expense. Convergence costs may include not only regulatory structure

48 For a more comprehensive discussion of employee participation at supervisory board level, see J J du
Plessis, B Großfeld, C Luttermann, I Saenger and O Sandrock, German Corporate Governance in International
and European Context, Heidelberg, Springer Verlag (2007) 111–144.
49 See Margaret M Blair and Mark J Roe (eds), Employees and Corporate Governance, Washington, DC,
Brookings Institution (1999); and sources quoted in Du Plessis, above n 21, 381–2.
50 See J J du Plessis and J Dine, ‘The Fate of the Draft Fifth Directive on Company Law: Accommodation
Instead of Harmonisation’ [1997] The Journal of Business Law 23, 25–7.
 GERMANY, JAPAN AND CHINA 349

costs – the costs required to develop a new regulatory regime or alter an existing
regime – but also cultural costs.51

Co-determination by employees at supervisory board level has recently also

been the focus of renewed attention in Germany, after a relatively long period
during which such co-determination was simply accepted as part of the German
corporate governance model without any serious challenge to the real attributes
of such co-determination as a good corporate governance practice. This reflection
on co-determination was triggered in particular because of several cases in the
European Court of Justice.52
Germany has a long legislative history of support for industrial democracy.
While this was initially reflected in the creation of elected worker committees
and worker councils, which gave employees a voice on the shop floor, later
legislation introduced employee representation at supervisory board level. The
main impetus for supervisory co-determination by employees actually came from
the determination of British occupation authorities and German trade unionists
to ensure that the nation would never again fall into the dictatorial pattern of
the Third Reich.53 The specific method invented was to make it compulsory
for labour and management to work together at the level of the supervisory
board (co-determination!). This was supposed to ensure that the very strict
class distinction that had existed in Germany would not emerge again.54 The
government of the day campaigned for a one-third employee representative
regime, but the trade unions got their way after a strike in the mining, iron, coal
and steel industries.55
The system of electing the employee representatives is a very complicated one.
Furthermore, the number of employees who are appointed to the supervisory
board varies from industry to industry, but also depends on the size of the cor-
poration. However, there are basically only two systems: on certain supervisory
boards one-third of the board is made up of employees, and in other supervisory
boards half of the membership consists of employees. This is sometimes called
parity co-determination by employees, in that shareholders and employees can
appoint an equal number of representatives to the supervisory board. There is
also mention of quasi-parity co-determination in certain industries. This refers
to the arrangement whereby shareholders and employees can appoint an equal
number of representatives on the supervisory board, but the right to appoint

51 Paul Rose, ‘EU Company Law Convergence Possibilities after CENTROS’ (2001) 11 Transnational Law
and Contemporary Problems 121, 133. See also Jonathan Charkham, Keeping Better Company, Oxford, Oxford
University Press (2nd edn, 2005) 28–9.
52 See Otto Sandrock and Jean J du Plessis, ‘The German Corporate Governance Model in the Wake of
Company Law Harmonisation in the European Union’ (2005) 26 Company Lawyer 88; Jean J du Plessis and
Otto Sandrock, ‘The Rise and the Fall of Supervisory Codetermination in Germany?’ (2005) 16 International
and Commercial Law Review 67.
53 Brian Robinson, ‘Worker Participation: Trends in West Germany’ in Mark Anstey (ed.), Worker Participa-
tion (1990) 49.
54 Hellmut Wißmann, ‘Das Montan-Mitbestimmungsänderungsgesetz: Neuer Schritt zur Sicherung der
Montan-Mitbestimmung’ (1982) Neue Juristische Wochenschrift (Zeitschrift) 423.
55 Ibid.
350 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

the chair belongs to the shareholders – thus tilting the power balance slightly in
favour of the shareholder representatives.56
Recently, employee participation at supervisory board level has come under
severe criticism, as illustrated by several articles in leading law review journals –
including an editorial by an eminent academic, Peter Ulmer, in one of the leading
academic commercial and business law journals57 and two articles in perhaps
the leading corporate law journal in Germany.58 Moreover, other legal scholars
and managers experienced in co-determination matters have published many
comments during the past few years that point to several shortcomings of parity
co-determination.59
Despite these shortcomings, members of management and shareholder repre-
sentatives generally have been reluctant to openly challenge the legitimacy and
usefulness of parity co-determination during recent decades, seeking to avoid
confrontations with the powerful German trade unions – confrontations that
could also have provoked strikes. Further, for fear of losing general elections at
the level either of federal German unions or of the important federal industrial
states, most of the political parties have not lent any support to modifications,
not even the most moderate ones. The German system of co-determination was
therefore characterised as a matter of taboo60 or as a ‘dinosaur model’.61 It is
only during the past few years that some voices from management and political
parties have been willing, in this respect, to call a ‘spade a spade’.
Although it is far too soon to draw any definite conclusions from these devel-
opments, it is clear that the topic of co-determination has once again become a
subject for lively political debate, and it will be difficult to keep co-determination
off the political agenda for much longer.62
It is interesting to note that the German Corporate Governance Code rein-
forced and modernised the two-tier board system, and will probably ensure that
it will remain the board system for public corporations in Germany for the fore-
seeable future.63 The most controversial aspect of the German two-tier board
56 Du Plessis and Sandrock, above n 52, 67 at 70.
57 Peter Ulmer, ‘Editorial: Paritätische Arbeitnehmermitbestimmung im Aufsichtsrat von Großunternehmen
– noch zeitgemäß?’ (2002) 166 Zeitschrift für das gesamte Handels-und Wirtschaftsrecht 271. See also Peter
Ulmer, ‘Der Deutsche Corporate Governance Kodex – ein neues Regulierungsinstrument für börsennotierte
Aktiengesellschaften’ (2002) 166 Zeitschrift für das gesamte Handels-und Wirtschaftsrecht 150, 180–1.
58 Martin Veit and Joachim Wichert, ‘Unternehmerische Mitbestimmung bei europäischen Kapital-
gesellschaften mit Verwaltungssitz in Deutschland nach “Überseering” und “Inspire Art”’ (2004) 49 Die
Aktiengesellschaft (Zeitschrift) 14, 17–18; and Otto Sandrock, ‘Gehören die deutschen Regelungen über
die Mitbestimmung auf Unternehmensebene wirklich zum deutschen ordre public?’ (2004) 49 Die Aktien-
gesellschaft (Zeitschrift) 57 et seq. See also Sandrock and Du Plessis, above n 52, 88 et seq; Du Plessis and
Sandrock, above n 52, 67 et seq.
59 Otto Sandrock, ‘Die Schrumpfung der Überlagerungstheorie’ (2003) 102 Zeitschrift für Vergleichende
Rechtswissenschaft 447, 490–3; Sandrock and Du Plessis, above n 52, 88 et seq; Du Plessis and Sandrock,
above n 52, 67 et seq.
60 Expression used by Maximilian Schiessl, ‘Leitungs- und Kontrollstrukturen im internationalen Wettbe-
werb – Dualistisches System und Mitbestimmung auf dem Prüfstand’ (2003) 167 Zeitschrift für das gesamte
Handels-und Wirtschaftsrecht 235, 237.
61 Expression used by Theodor Baums, an eminent German company law expert, according to a note in the
Frankfurter Allgemeine Zeitung (nation-wide German daily newspaper) of 27 June 2003.
62 See in particular Ulmer, above n 57, 272; and Hopt, above n 47, 42–6 and 66–7.
63 See in particular Lieder, above n 42, 115 et seq, but also K Pohle and A v. Werder ‘Die Einschätzung
der Kernthesen des German Code of Corporate Governance (GCCG) durch die Praxis’ (2001) 54 DB 1101,
 GERMANY, JAPAN AND CHINA 351

system is still employee participation at supervisory board level. This is some-

thing that will have to be debated in Germany, especially after several recent
decisions of the European Court, and the skepticism that exists about employee
participation in practice. Employee participation at supervisory board level has
the potential, once again, to become one of the most challenging political issues
in Germany in the near future.64

13.3.4 The German board structure

If we use Tricker’s ‘governance circle’ and ‘managerial pyramid’, as explained in
Chapter 3, the typical German two-tier board structure will look as follows.

Employees Shareholders

13.3.5 Conclusions on Germany

There have been considerable developments in the areas of corporate law and
corporate governance in Germany over recent years. The first wave of devel-
opments focused on the role and effectiveness of supervisory boards. Since the
adoption of the German Corporate Governance Code in February 2001, the focus
has been on promoting good corporate governance practices through the Code.
This has enabled the German corporate governance model to remain relevant
and to reflect international best corporate governance practices.
Co-determination or employee participation at supervisory board level is still
one of the most controversial and most debated issues in Germany. There are
not only increasingly critical views expressed by German commentators on co-
determination, but there are powerful market forces that put strain on the system
of co-determination. It is not difficult to predict that, with globalisation and
internationalisation, where the financial markets of all countries become more
and more accessible, it will lead to further pressure on the German system of co-
determination. With the global financial crisis of 2008–9 still fresh in the minds
of all entrepreneurs, it will be difficult for German entrepreneurs to continue
1103 ff, 1107 for an interesting survey demonstrating that the majority of German public corporations are
largely satisfied with the two-tier board system and co-determination, but that modernisation of the system
was considered to be imperative.
64 See Sandrock and Du Plessis, above n 52, 88 et seq; Du Plessis and Sandrock, above n 52, 67 et seq.
352 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

to cling to a governance model that is viewed with skepticism by many other

entrepreneurs from other countries. The more options investors have to move
their money around internationally, the more pressure there will be on the
German corporate law and corporate governance models to become as flexible
as possible if they want to remain competitive and to ensure that the German
economy attracts more international investments.

13.4 Japan

13.4.1 Introduction
Corporate law and practice in Japan have long attracted considerable atten-
tion among foreign commentators, and an extensive literature in Western
languages.65 Much of the commentary increasingly refers to ‘corporate gov-
ernance’, reflecting the emergence of this broader term world-wide since the
1980s (outlined in Chapter 1) and indeed generating another neologism in the
Japanese language: ‘kopureto gabanansu’.66 But contemporary corporate law
analyses and discussions focused on Japan have long tended to adopt a broader
perspective. This reflects an awareness of the pervasive but typically informal
role in firms of stakeholders other than shareholders, especially core ‘lifelong’
employees, ‘main banks’ and ‘keiretsu’ corporate groups.
Before examining such stakeholders in more detail (especially in Parts 13.4.4–
13.4.6), alongside an account of corporate law topics conventionally covered in
accounts of Japanese law, this chapter locates Japan within the broader context of
debates about comparative capitalism and corporate governance (Part 13.4.2).
It also presents a brief historical introduction to the development of modern
corporate law, initially based mainly on German law when Japan reopened to
the world in the late 19th century (Part 13.4.3).67 Corporate and securities law
elements derived from the USA were superimposed during the Allied Occupation
(1945–51). Arguably, broader Anglo-American as well as European Union law

65 Harald Baum and Luke Nottage, Japanese Business Law in Western Languages: An Annotated Selective
Bibliography, Littleton, F B Rothman (1998); Harald Baum and Luke Nottage ‘Auswahlbibliographie [Selected
Bibliography]’, in Harald Baum (ed.), Handbuch des japanischen Handels- und Wirtschaftsrechts [Japanese
Business Law Handbook], Cologne, Carl Heymanns Verlag, (2010). Much of the commentary has been in
German, reflecting the German influences on developments in this field of Japanese law that are sketched
below. But a growing literature is in English, both practitioner-oriented (parallelling the emergence of English
as the main language of international financial markets) and academic (reflecting a longstanding tradition
within the USA of focusing on business law topics when studying Japan, as well as the particular popularity
of corporate governance as a field of study in the USA).
66 A search of the NACSIS Webcat database aggregating most university library catalogues in Japan gave
266 books in Japanese containing this neologism in the title, available at <http://webcat.nii.ac.jp/webcat.
html>. See also, for example, TSE-Listed Companies White Paper on Corporate Governance 2009 (and its
Japanese-language original), available at <www.tse.or.jp/english/rules/cg/index.html>.
67 For a succinct overview of Japanese legal history and institutions, see Masaki Abe and Luke Nottage,
‘Japanese Law’, in Jan Smits (ed.), Encyclopedia of Comparative Law, Cheltenham, Edward Elgar, (2006),
p. 357, updated under the reference M Abe and L Nottage, ‘Japanese Law: An Overview’ [2008] JPLRes 1,
available online at <www.asianlii.org/jp/other/JPLRes/2008/1.html>.
 GERMANY, JAPAN AND CHINA 353

developments have influenced a ‘third wave’ of corporate law reforms underway

since the 1990s, in conjunction with that ‘lost decade’ of economic stagnation.
This part therefore takes seriously the ‘five ways forward’ proposed for nav-
igating through and assessing often diverse interpretations of contemporary
corporate governance in Japan (and indeed elsewhere).68 Particularly when
considering the ‘convergence’ debate (outlined in Chapter 1), we need always to
be attentive to:
1. timing or the historical periods selected for analysis (with longer time-
spans often suggesting that major transformations are underway)
2. both ‘black-letter law’ or the ‘law in books’ (which also tends to empha-
sise change) and socioeconomic context or the ‘law in action’ (tending to
emphasise continuities)
3. multiple points of comparison (comparing just two legal systems being
risky, as this often results in assessments of either great differences or
great commonalities and hence convergence)
4. normative preferences (even when commentators – inevitably influenced
by their own backgrounds or eras – profess to have none) and
5. processes of law creation and enforcement, not just outcomes (even when
legal rules or their impact in practice appear to display limited change,
the processes by which this occurred may have been very different from
past experience – in turn creating a greater possibility of more far-reaching
changes in outcomes from future iterations).

13.4.2 Japan and debates on comparative capitalism and

corporate governance
A longstanding tradition of comparing Japanese corporate governance in full
socioeconomic context connects to a wider debate about the nature of Japanese
capitalism itself. One issue has been whether it was and remains another ‘coor-
dinated market economy’ (CME, similar to Germany, for example), rather than
a more arm’s-length ‘liberal market economy’ (LME, epitomised by the USA).69
Political scientists have also tried to combine that distinction, developed pri-
marily by economists and organisational theorists, with the extent of ‘minority
shareholder protections’ (MSPs) offered by various national corporate law sys-
tems in order to explain the extent of diffuse shareholdings. In this model, Japan’s
CME plus weaker MSPs help to explain a significant blockholding tradition and
hence a stakeholder system of corporate governance. Perhaps to a somewhat

68 Luke Nottage, ‘Perspectives and Approaches: A Framework for Comparing Japanese Corporate Gover-
nance’ in Luke Nottage, Leon Wolff and Kent Anderson (eds), Corporate Governance in the 21st Century:
Japan’s Gradual Transformation, Cheltenham, Edward Elgar (2008) 41–51.
69 See generally Peter A Hall and David W Soskice, Varieties of Capitalism: The Institutional Foundations
of Comparative Advantage, Oxford, Oxford University Press, (2001). For some longstanding difficulties in
locating Japan at the ‘coordinated’ end of this spectrum, let alone more recently, see Luke Nottage, ‘Japanese
Corporate Governance at a Crossroads: Variation in “Varieties of Capitalism”’ (2001) 27 The North Carolina
Journal of International Law & Commercial Regulation 255.
354 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

lesser extent than Germany nowadays, Gourevitch and Shinn argue that this sys-
tem is underpinned by a political system that has tended to favour compromise
rather than majoritarian approaches, and preferences of management and work-
ers that have dominated those of shareholders.70 Again, however, Japan is hard
to fit within this analysis. It could be argued that they have underestimated the
extent of blockholding in Japan. A more far-reaching critique of their analysis is
that Japan has developed significantly more pervasive LME elements and MSPs,
certainly since its ‘lost decade’ and concomitant waves of corporate law reforms
since the 1990s. This would explain or predict (widely observed) decreases
in blockholdings. Yet, the model would therefore demand a different explana-
tion for the political backdrop in Japan than that provided by Gourevitch and
Shinn.71
A major problem with their approach is its considerable reliance on aggre-
gate quantitative data. They compare many countries’ shareholding diffusion
indices (often difficult to assess) against the extent of LME and MSP policies
(also hard to quantify, especially over time). This then frames their more quali-
tative analyses of specific countries like Japan. That risks over-simplification and
the possibility that the country of interest may not quite fit the overall model –
even though the model itself is robust enough to survive because it fits other
countries better. An alternative methodology is to begin with more qualitative
comparative research, connecting up with (possibly looser) quantitative studies
and overarching theory.72
This is indeed the approach taken in an important recent book by Milhaupt
and Pistor on law and capitalism.73 They begin with empirically based skepticism
about theories that effective property rights – especially MSPs, often also linked
to ‘common law’ rather than ‘civil law’ tradition countries – contribute towards
shareholder diffusion, and hence active share markets and improved economic
growth.74 The dichotomy between ‘common law’ and ‘civil law’ arguably under-
states differences within countries within the same ‘legal family’ and how they

70 See Peter Alexis Gourevitch and James Shinn, Political Power and Corporate Control: The New Global
Politics of Corporate Governance, Princeton, Princeton University Press (2005).
71 Nottage, above n 68, at 47–8. For example, rather than the ‘corporatist compromise’ characteristic of
Germany and especially Japan, according to Gourevitch and Shinn (above n 70), Japanese politics may
be generating more of an ‘investor’ coalition, where owners and managers prevail over employees. They
give Korea as an example of that political configuration, which predicts pressures towards more diffuse
shareholdings and a decline in blockholders.
72 As an example of a small-scale empirical analysis that nonetheless confirms some very significant trans-
formations, see the comparison of key features of Japan’s top 40 listed companies in 1988 compared to
2008: Souichirou Kozuka, ‘Conclusions: Japan’s Largest Companies, Then and Now’, in Luke Nottage, Leon
Wolff and Kent Anderson (eds), Corporate Governance in the 21st Century: Japan’s Gradual Transformation,
Cheltenham, Edward Elgar (2008) 228.
73 Curtis J Milhaupt and Katharina Pistor, Law and Capitalism: What Corporate Crises Reveal About Legal
Systems and Economic Development around the World, Chicago, University of Chicago Press (2008).
74 Compare especially Rafael La Porta, Florencia Lopez-de-Silanes et al., ‘Law and Finance’, (1998) Journal
of Political Economy 106, 1113. For a tongue-in-cheek, empirical critique of the ‘corporate law matters’ thesis,
see also one the most popular papers downloadable via SSRN.com: Mark D West, ‘Legal Determinants of
World Cup Success’, Michigan Law and Economics Research Paper, 02–009 (2002), available at <http://ssrn.
com/abstract=318940>. More seriously, see Dan W Puchniak, ‘In the Company We Trust: Japanese Lifetime
Employment Redefines Why Law Matters’ (manuscript available on request from Assistant Professor Dan
Puchniak at the National University of Singapore, Faculty of Law), Part II.
 GERMANY, JAPAN AND CHINA 355

develop over time. Conventional theories also run up against the fact that market-
supportive legal systems do not reveal a strongly uniform set of characteristics,
and crises in corporate governance do not appear to stem from some obvious
legal ‘defect’ (such as lack of MSPs). Their detailed case studies of contemporary
crises across seven major economies show instead that:

the problems typically stemmed from deep-seated conflicts over the allocation of con-
trol and decision-making rights in society and from often equally deep-seated contro-
versy about the very role that law should play in the country’s economic governance
system. Conversely, [they] often saw importation of new legal rules patterned after
law in more advanced legal economies (typically the United States) had ambiguous,
unintended, or delayed consequences.
These findings defy attempts to fix governance problems according to the simple algo-
rithm of importing legal rules from more advanced economies to plug holes in the
legal systems of less advanced economies. More generally, they defy attempts to asso-
ciate a particular type of legal system with higher economic growth or other attractive
economic outcomes such as larger capital markets.75

Accordingly, Milhaupt and Pistor develop an alternative classification depending

primarily on whether or not (a) an economy’s legal system is decentralised
regarding the involvement in actors in both the making and enforcement of law,
and (b) the main function of the law is protection of individual rights (as in the
USA) rather than the coordination of socioeconomic relationships and activity.
From this perspective, they roughly locate Japan as follows.76

Coordinative Protective
Centralised Russia

China Singapore
Korea

Japan
Germany

United States
Decentralised

Thus, there is no single way to organise an effective corporate governance regime,

and each exhibits considerable static tendencies. However, they argue, for exam-
ple, that ‘a legal regime that protects individual investors’ interests will be pro-
duced in response to growing demand, provided that the system is sufficiently

75 Milhaupt and Pistor, above n 73, 175.

76 Reproduced from ibid 183 (Figure 9.1). See also 28–37. That gives, as a major example of an emphasis on
coordination over rights protection, Germany’s requirement for employee representation on the supervisory
boards of large corporations (see also discussion above in this chapter). Milhaupt and Pistor (above n 73)
also mention, but unfortunately do not explore so much, two other functions of law: signalling and credibility
enhancement.
356 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

decentralised at that point to foster contestation of governance structures’.77

Such contestation may involve widespread political participation in produc-
ing and enforcing law as a device for governance, but can also include access
to politicians, courts or bureaucrats or even business elites. Focusing on this
aspect, determining the demand for legal governance helps explain how the
overall governance structure may change despite no formal legal change, as new
constituencies can make use of existing but dormant rules. Conversely, simply
transplanting new legal rules is unlikely to change the governance structure.78
Indeed, Milhaupt and Pistor anticipate that ‘internally developed’ legal sys-
tems will support markets better than those developed through transplantation,
as law should be broadly responsive to local demands (good ‘micro-fit’) and polit-
ical economy (good ‘macro-fit’). Similarly, legal transplants are more likely to
work if local (legal and other) communities adapt the law to local circumstances.
This depends largely on the motivation for the transplant (practical utility – that
is, ready availability at low cost – being more powerful than colonial neces-
sity or a broader ‘signaling’ effect), the legal community’s familiarity with the
transplant, and consistency with the wider political economy and other existent
governance mechanisms.79 A good example is the belated activation of directors’
duty of loyalty imposed on directors (now Article 355 of the Companies Act),
independently from the more venerable duty of care, from the late 1980s.80
Overall, therefore, Milhaupt and Pistor caution against both evolutionary
accounts of strong-form convergence on shareholder primacy in corporate gov-
ernance, and path dependency underpinned by efficiencies or rent-seeking. For-
eign institutional investors, developments in information technology and efforts
abroad by reform advisors from international and domestic bodies promote
greater formal convergence (in the ‘law in books’). But that may have only limited
functions even in signalling potential broader shifts or credibility enhancement,
depending for example on the country’s track record in actually using and enforc-
ing new legislative provisions. A key element for actual convergence (changes in
the ‘law in action’) is likely to lie in broader developments such as the structure
and education of the legal profession around the world.81
In Japan, for example, since the 1970s in-house corporate counsel have
steadily gained influence both within firms and as a lobby group promoting
broader judicial system reforms.82 And a package of reforms unveiled in 2001
has added significant flexibility into the profession and legal education, as well
as another round of changes to criminal justice and the civil dispute resolution

77 Milhaupt and Pistor, above n 73, 175.

78 Ibid, 203–4.
79 Ibid, 211.
80 Hideki Kanda and Curtis Milhaupt, ‘Re-Examining Legal Transplants: The Director’s Fiduciary Duty in
Japanese Corporate Law’ (2003) 51 American Journal of Comparative Law 887. See further part 13.4.4
(Japanese corporate forms and internal governance mechanisms) below.
81 Milhaupt and Pistor, above n 73, 214–5.
82 Toshimitsu Kitagawa and Luke Nottage, ‘Globalization of Japanese Corporations and the Development of
Corporate Legal Departments: Problems and Prospects’ in William Alford (ed.), Raising the Bar, Cambridge,
Massachusetts, Harvard East Asian Legal Studies Program, Harvard University Press, (2007) 201.
 GERMANY, JAPAN AND CHINA 357

system. Yet results remain very mixed, with the jury mostly still out (quite
literally).83 Adaptable but embedded communities continue to reassert them-
selves vis-à-vis the formal legal system.84 Thus, applying the analytical insights
of Milhaupt and Pistor – but assessing shifts in the legal profession to be somewhat
more limited – suggests that we are likely to find more of a ‘gradual transforma-
tion’ in contemporary Japanese corporate governance.85 Even their ‘institutional
autopsy’ of a mini-crisis has been occasioned by novel hostile takeovers in Japan
this century, described further in Part 13.4.3.
Thus, Milhaupt and Pistor join a growing group of analysts comparing cor-
porate governance and capitalism more generally in Japan who perceive signif-
icant but gradual changes especially since the 1990s, reflecting some broader
socio-economic developments. Specifically, as in other advanced industrial
democracies such as Germany, we perceive incremental change yet some clear
discontinuities (the shaded category [3] below):86

Result of change
Continuity Discontinuity
Process of Incremental [1] Reproduction by adaptation [3] Gradual transformation
change
Abrupt Survival and return [2] Breakdown and replacement

Japan’s system has only partly adapted to new ‘macro-fit’ and ‘micro-fit’ in many
respects, so reproduction does not mean continuity (cf category [1]). This dif-
fers from the view of a few theorists who perceive almost no change in allegedly
fundamental features of institutional organisation and, therefore, corporate gov-
ernance in Japan.87 Yet, nor has there been an abrupt breakdown resulting in
83 On civil and criminal justice reforms, see respectively, for example, Luke Nottage, ‘Civil Procedure Reforms
in Japan: The Latest Round’ (2005) 22 Ritsumeikan University Law Review 81–86; and Kent Anderson and
Mark Nolan, ‘Lay Participation in the Japanese Justice System’ (2004) 37 Vanderbilt Journal of Transnational
Law 935. On legal education reforms, see for example, Luke Nottage, ‘Build Postgraduate Law Schools in
Kyoto, and Will They Come – Sooner and Later?’ (2005) 7 Australian Journal of Asian Law 241 (with a parallel
Special Issue [No 20] of the Journal of Japanese Law partly reproduced at <www.law.usyd.edu.au/anjel/
content/anjel research pap.html>). Japan retains a much stronger ‘gatekeeper’ role for the state: see Luke
Nottage’s ‘Japanese Law and the Asia-Pacific’ blog at <http://blogs.usyd.edu.au/japaneselaw/2009/10/
legal education.html>. But the market for legal services in Tokyo has certainly begun to change extensively
this century: Bruce Aronson, ‘The Brave New World of Lawyers in Japan’ (2008) 21 Columbia Journal of Asian
Law 45.
84 Takao Tanase (Luke Nottage and Leon Wolff, trans and eds), Law and the Community: A Critical Assessment
of American Liberalism and Japanese Modernity, Cheltenham, Edward Elgar (2010).
85 Luke Nottage, Leon Wolff and Kent Anderson (eds), Corporate Governance in the 21st Century: Japan’s
Gradual Transformation, Cheltenham, Edward Elgar (2008).
86 Reproduced from Nottage, above n 68, 39 (Table 2.1). That in turn derives primarily from Wolfgang
Streeck and Kathleen Ann Thelen, ‘Introduction’ in Wolfgang Streeck and Kathleen Ann Thelen (eds), Beyond
Continuity: Institutional Change in Advanced Political Economies, New York, Oxford University Press (2005) 9.
87 John Haley, ‘Japanese Perspectives, Autonomous Firms, and the Aesthetic Function of Law’ in Klaus
Hopt et al. (eds), Corporate Governance in Context: Corporations, State, and Markets in Europe, Japan, and
the US, Oxford, Oxford University Press (2005) 205. Sanford M Jacoby, The Embedded Corporation: Corpo-
rate Governance and Employment Relations in Japan and the United States, Princeton, Princeton University
(2005) – drawing primarily on research around 2001; and even Ronald Dore, Stock Market Capitalism, Wel-
fare Capitalism: Japan and Germany Versus the Anglo-Saxons, New York, Oxford University Press, (2000)
(but backtracking quite considerably for example, in Ronald Dore, ‘Shareholder Capitalism Comes to Japan’
(2007) 23 Journal of Japanese Law 207). Others also suggest that there has been no change in Japanese
(corporate) governance: Yoshiro Miwa and J. Mark Ramseyer, The Fable of the Keiretsu: Urban Legends of the
358 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

C
on
su
rs

m
lie

er
pp

s
Su
Managers

Shareholders Employees

Creditors
nt
rn me
ve
Go

N on
- g o v er ons
n m e n t o r g a n i s a ti

= Changing influence

Figure 13.1

replacement of stakeholder governance by a system based on shareholder pri-

macy and market forces, as proclaimed (and often acclaimed) by some com-
mentators within the financial press.88 The picture is instead more complex.
Shareholders have become more central in corporate governance, especially
since the mid-1990s; banks certainly less so (while still remaining important);
employees probably less so (but with some major fissures emerging), and with
more complex shifts underway regarding the impact of suppliers and consumers
or the state and non-government organisations (see Figure 13.1).89
Japanese Economy, Chicago, University of Chicago Press (2006). But this involves the radical assertion that
everyone else has overlooked that Japan already operates on free-market principles, thus rendering gover-
nance mechanisms like ‘main banks’ and keiretsu groups an unnecessary ‘myth’. For critiques of that revisionist
account, see, for example, Craig Freedman and Luke Nottage, ‘You Say Tomato, I Say Tomahto, Let’s Call
the Whole Thing Off: The Chicago School of Law and Economics Comes to Japan’ in Centre for Japanese
Economic Studies Research Papers (2006), available at <www.econ.mq.edu.au/docs/research papers/2006–
4 Freedman Nottage.pdf>. Dan W. Puchniak, ‘A Skeptic’s Guide to Miwa and Ramseyer’s: “The Fable of the
Keiretsu”’ (2007) 12 Journal of Japanese Law 273 and Takeo Hoshi, ‘The Fable of the Keiretsu [Book Review]’
(2008) 11 Social Science Japan Research 344.
88 Cf for example, Gillian Tett, Saving the Sun: A Wall Street Gamble to Rescue Japan from Its Trillion-
Dollar Meltdown, London, Random House Business (2004). After the global financial crisis of 2008–9, she
confesses to ‘eating humble pie’ (quoted in Luke Nottage, ‘Economics, Politics, Public Policy and Law in
Japan, Australasia and the Pacific: Corporate Governance, Financial Crisis, and Consumer Product Safety
in 2008’ (2009) 26 Ritsumeikan Law Review, 49 at 67). Indeed, her recent enthnological account critically
assesses ‘innovation, perversion and disaster’ linked to Wall Street financial institutions and weak regulatory
oversight: Gillian Tett, Fool’s Gold: How Unrestrained Greed Corrupted a Dream, Shattered Global Markets and
Unleashed a Catastrophe, London, Little Brown (2009).
89 Reproduced from Nottage, above n 68, 29 Figure 2.2, in turn adapted from Luke Nottage and Leon Wolff,
‘Corporate Governance and Law Reform in Japan: From the Lost Decade to the End of History?’ in Rene Haak
and Markus Pudelko (eds), Japanese Management: In Search of a New Balance between Continuity and Change,
New York, Palgrave Macmillan (2005) 133.
 GERMANY, JAPAN AND CHINA 359

Such disparate results pose challenges for theories of convergence on share-

holder primacy, and also (perhaps to lesser extent) of path dependency. But the
phenomenon of different aspects of corporate governance pulling in seemingly
different directions has been observed elsewhere.90 It is much less surprising
from the perspective of Milhaupt and Pistor because of the weight they give to
politics (in a broad sense), in addition to economics.

13.4.3 Historical transformations in Japanese corporate

law and practice
The importance of politics to corporate law and practice has long been evident
in modern Japan. When Japan reopened fully to the world in 1868, after two-
and-a-half centuries of almost complete isolation under Tokugawa rule, it had
to agree to ‘unequal treaties’ with the USA and European imperial powers. A
precondition to renegotiation was the establishment of a modern legal system,
and the Meiji government decided to enact comprehensive codes along Euro-
pean lines, including a commercial code containing corporate law provisions to
support both smaller enterprises and large-scale industrialisation.91
Company law provisions drafted in 1875 were rejected as excessively based on
English law, so a German advisor (Roesler, central also to the Meiji Constitution
of 1889) led a wide-ranging, comparative study to generate a draft Commercial
Code over 1881–4. The first part came into effect in 1893, regulating company
law, insolvency and commercial bills; the rest came into effect in 1898. This
was quite French in form, but in substance more German (drawing especially on
1861 legislation). It inaugurated the kabushiki kaisha (KK) form, the joint stock
company or company limited by shares, with limited liability for shareholders.
The KK was governed especially by its general meeting (sokai), with unlimited
competence and powers to appoint directors (torishimariyaku). The third gover-
nance body comprised statutory auditors (kansayaku). They were charged with
checking whether directors’ activities were not only lawful (as nowadays), but
also in the interests of shareholders. However, they could not dismiss directors
(unlike the Aufsichtsrat in contemporary German law) and initially could even
act as directors.

90 For example, comparing Australia, see Luke Nottage, Corporate Governance and M&A in Australia: An
Overview for Assessing Japan and the ‘Americanisation’ (2008) – 08/28 Sydney Law School Research Paper,
available at <http://ssrn.com/abstract=1105639>. See also a recently published overview of a joint research
project noting continuing managerial control coupled with growing shareholder influence, and ‘the appear-
ance of new forms of corporate governance which are hybrids in the sense of combining institutional mech-
anisms with different origins and/or functions’: Simon Deakin and D Hugh Whittaker, ‘On a Different Path?
The Managerial Reshaping of Japanese Corporate Governance’ in Simon Deakin and D Hugh Whittaker (eds)
Corporate Governance and Managerial Reform in Japan, Oxford, Oxford University Press (2009) 1 at 23. They
conclude (at 21) that while the Japanese corporate governance ‘system’s reaction could be described as one
of resistance to external change, we think that it is better characterised as one of adjustment and adaptation
to a changing institutional environment, with legal reforms acting as a trigger or stimulus’ along with the
changing competitive environment.
91 The following summary, through to the early 1990s, is based on the detailed analysis of corporate law
reforms in full economic and political context provided by Harald Baum and Eiji Takahashi, ‘Commercial and
Corporate Law in Japan: Legal and Economic Developments after 1868’ in Wilhelm Röhl (ed.), History of Law
in Japan since 1868, Leiden, Brill (2005) 330.
360 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

This legislation was replaced by the Commercial Code of 1899, which fol-
lowed German law more closely (including 1884 legislation on stock compa-
nies), except for the insolvency law provisions, which remained in effect until
separate legislation was enacted in 1922. Auditors were no longer allowed to
serve simultaneously as directors, and the licensing scheme for promoters and
subscribers was abolished in favour of a registration system for new companies.
After another wave of corporate scandals, amendments in 1911 added strict lia-
bility for promoters. They also clarified that the relationship between directors
and the company was an agency contract (implicating a high duty of care: see
Part 13.4.4.3 below) and established personal liability in damages. Reform to
the Code in 1938 was more comprehensive, again largely based on Germany’s
Stock Corporation Act of 1937, with both countries attempting to address the
emerging separation from ownership and control. Non-shareholders became
entitled to serve as directors or auditors, for example, and minority shareholders
gained better rights to enforce liability and obtain corporate information. Unlike
Germany, however, the Japanese reform also enlarged the competence of the
sokai but expanded transactions requiring prior consent of shareholders. The
reform also introduced some English concepts for corporate reorganisation (seiri)
and special liquidation (tokubetsu seisan).
Also in 1938, Japan belatedly enacted separate legislation for a private limited
liability company (yugen kaisha or YK), similar to the GmbH already found in
the German Code of 1897. This legislation (containing many cross-references to
the Japanese Code) also included some elements from the English law designed
for closely held companies, such as a limit of 50 shareholders. Japanese policy
makers, initially through academic studies, were also aware that France had
addressed such issues through legislation in 1925. By the end of World War II,
there were nearly half as many YKs as KKs, although many closely held companies
persisted in incorporating as KKs (see Part 13.4.4 below).
The United States-led occupation (1946–51) not only inaugurated securities
regulation and anti-monopoly law, but also significant reforms to the Commercial
Code, all based this time on United States law. The Code amendments first aimed
to redistribute corporate powers. The sokai’s jurisdiction was limited to matters
set in law or articles of incorporation, ushering in the institution of the board
of directors to collectively hold and exercise powers and managerial functions.
Corporate auditors were restricted to auditing financial statements and reporting
to the sokai. Counterbalancing this shift, a second set of reforms strengthened
individual or minority shareholder rights. Voting restrictions in the articles of
association were abolished, cumulative voting was introduced, inspection rights
were enhanced, a new ‘director’s duty of loyalty’ and derivative shareholder
actions were added.
However, many of these changes had little effect in practice until the 1990s
(see Part 13.4.5.3), or were expressly rolled back. For example, 1966 amend-
ments reinstated the capacity for companies to restrict share transferability
through articles of association, and in 1974 the auditors were once again allowed
 GERMANY, JAPAN AND CHINA 361

to supervise the legality (but not, expressly, the appropriateness) of directors’

business activities. (In 1993, auditors were provided an extended term and the
statutory minimum number was raised to three in large companies required to
have a supervisory board – kansa yakkai.) Reforms in 1981 also addressed the
deterioration of sokai into a mere formality due to the Occupation amendment
shifting power to the board of directors, as well as the emergence of sokaiya
(criminals extorting money from companies by threatening to disrupt meetings
or reveal negative information). On the one hand, the revised Code prohibited
the granting of benefits to anyone related to (non-)use of shareholder’s rights –
although sokaiya practices did not die out quickly. On the other hand, it required
directors and auditors to explain sokai agenda items, and gave shareholders
rights to propose matters for discussion. Minority shareholders also gained more
rights to call meetings or propose resolutions.
The four decades from the Occupation through to the collapse of Japan’s
asset ‘bubble economy’ in 1990 thus witnessed the emergence of a new hybrid
corporate governance regime, intertwined with other economic institutions of
the era. One central pillar was the ‘main bank, the largest lender as well as a
principal shareholder (although each bank’s holding was subject to a statutory
5 per cent cap). Main banks provided diverse financing, monitoring (usually ex
ante but ex post if borrowers get into difficulty, through organising acquisitions
or the creditors’ committee), and information and management support (see
Part 13.4.5.4). Cross-shareholding was a second feature, with about two-thirds
of listed company shares held by ‘stable’ shareholders in the early 1990s. The
epitome were the keiretsu, ‘historically derived clusters of affiliated firms held
together by stable cross-share ownership, interlocking directorates, extensive
product market exchanges, and other linkages that enhance group identity and
facilitate information exchange’.92 Six major post-war ‘horizontal’ keiretsu were
centered on main banks (for example, Mitsubishi); ‘vertical’ keiretsu brought
together groups of production and investment chains (for example, Hitachi).
A third significant practice in larger firms (and an ideal for many others) was
‘lifetime employment’, whereby workers implicitly traded initially below-market
wages for continuous employment and above-market wages in the second half of
his or (to lesser extent) her career (Part 13.4.6). Fourth, government–business
relations involved considerable ‘administrative guidance’ (informal enforce-
ment of regulatory objectives), with bureaucrats – and the long-reigning Liberal
Democratic Party (LDP) – promoting consensus-based, private ordering through
repeated informal contacts with firms and industry associations. The first three
features, in particular, reduced the need for the active board monitoring func-
tion promoted by Occupation reformers and, indeed, for the disciplinary effect
of hostile takeovers.

92 Curtis J Milhaupt and Mark D West, Economic Organizations and Corporate Governance in Japan, Oxford,
Oxford University Press (2004) 14 (also outlining this system of main banks, employment relations and
government–business relations).
362 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

This system was never universal or completely stable, of course, and began
to fray when larger firms turned increasingly from bank to shareholder finance
from the 1980s. Bigger challenges came from the collapse of asset prices in 1990
and Japan’s consequent ‘lost decade’ of economic stagnation, including failures of
major financial institutions and ‘Big Bang’ deregulation of financial markets from
1997. Almost in desperation, domestic policy-making elites embarked on major
reforms to commercial regulation generally, and corporate law in particular.
Main objectives, long sought also by Anglo-American investors and governments,
included greater flexibility in corporate law rules – moving away from the German
tradition of detailed mandatory provisions – and greater focus on the interests
of shareholders vis-à-vis other stakeholders such as core employees, trading
partners and main banks. Space precludes detailed analysis here concerning all
the corporate (and related securities) law reforms undertaken from the early
1990s.93 In short, by the time the consolidated Companies Act was enacted in
2005, in rough chronological order the legislator had:
● strengthened supervision by shareholders and statutory auditors (includ-
ing derivative suits) and liberalised corporate bond financing
● relaxed restrictions on share buy-backs, and introduced stock options
● introduced measures to facilitate creation of holding companies (the year
after the Anti-Monopoly Act restriction was lifted in 1998) and for splitting
up companies
● diversified types of shares and voting rights
● allowed companies a new governance form aimed at large companies,
without statutory auditors, and
● allowed paperless shares and electronic announcements.
Overall, therefore, Japan has experienced three major waves in developing cor-
porate law, linked to similar shifts in other fields of legislation, at roughly half-
century intervals. The Meiji-era Code around the turn of the 20th century was
followed by United States-inspired (even ‘United States-imposed’) reforms dur-
ing the post-war Occupation, then the much more wide-ranging reforms from
around the turn of the 21st century. Even in terms of formal legislative changes,
the trajectory has not been one of straightforward ‘Americanisation’, and the
overall position now reached is also very different from United States law, as
evidenced by the persistence of the statutory auditor governance form.94 Also
evident are some influences from – or at least parallels with – aspects of English

93 See further, for example, the summary Appendix in Luke Nottage, Leon Wolff and Kent Anderson (eds),
Corporate Governance in the 21st Century: Japan’s Gradual Transformation, Cheltenham, Edward Elgar (2008)
13–20, based on the detailed descriptions in Tomotaka Fujita, ‘Modernising Japanese Corporate Law: Ongoing
Corporate Law Reform in Japan’ (2004) 16 Singapore Academy of Law Journal 321; the summary Table 11.1
(and accompanying text) in Hiroshi Oda, Japanese Law, Oxford, Oxford University Press (3rd edn, 2009)
219; and more theoretically Curtis J. Milhaupt, ‘A Lost Decade for Japanese Corporate Governance Reform?:
What’s Changed, What Hasn’t, and Why’, in Magnus Blomstrom and Sumner LaCroix (eds), Institutional
Change in Japan, Abingdon, Routledge (2006) 97.
94 Cf R Daniel Kelemen and Eric C Sibbitt, ‘The Americanization of Japanese Law’ (2002) 23 University of
Pennsylvania Journal of International Economic Law 269 (focusing, however, on securities law and product
liability in Japan).
 GERMANY, JAPAN AND CHINA 363

law, epitomised recently in listing requirements (Part 13.4.4.2 below) but also
a tendency in takeover regulation to give priority to decisions of shareholders
rather than directors (Part 13.4.5.3). The impact of German law, filtered some-
times nowadays through European Union law, also remains important. Japan’s
complex corporate law landscape is also matched by persistently distinctive fea-
tures of contemporary corporate governance practice, even though this, too is
undergoing a gradual transformation.

13.4.4 Japanese corporate forms and internal

governance mechanisms
13.4.4.1 Overview
The regime prior to the Companies Act of 2005 provided for four types of corpo-
ration: (i) the KK, (ii) the YK, (iii) the limited partnership company (goshi kaisha)
and (iv) the partnership company (goshi kaisha). The last-mentioned made all
partners jointly and severally liable, and gave them the obligation and right to
manage the company’s affairs as well as the right to represent the company.
Admitting a new member required unanimous consent to modify the articles of
incorporation. The goshi kaisha applied similar provisions, but some partners
could have limited liability with different provisions regarding management and
representation of the company, and there were also differences regarding trans-
fers of equity interests. However, even the goshi kaisha form was infrequently
used.
The YK form proved much more popular and was intended for smaller, closely
held businesses. It involved limited liability for 50 or less shareholders who
had to provide less paid-in capital than the KK form. Differences in governance
structures included no statutorily recognised board of directors, with significant
business decisions instead requiring a shareholders’ resolution. Yet many small
businesses chose the KK form, often for its prestige, despite the latter being
designed for large public companies raising funds through securities markets.
By 2005, there were about 1.5 million YK companies and 2.5 million KK com-
panies, but of the latter 86.7 percent had capital of less than 20 million yen.
Most of these small companies were not among the less than 4000 listed compa-
nies, and instead restricted share transferability through articles of association.95
This growing gap between the ‘law in books’ and the ‘law in action’ had led to
problems, such as minority shareholder ‘squeeze-outs’ and other oppressions
characteristic of family run businesses that lacked directly applicable relief pro-
visions. Yet legislation drafted by a study group in 1990 was not adopted.96

95 Oda, above n 93, 221–3 (comparing also the numbers of differently capitalised companies in the forms
provided now under the Companies Act).
96 Zenichi Shishido, ‘Problems of the Closely Held Corporation: A Comparative Study of the Japanese and
American Legal Systems and a Critique of the Japanese Tentative Draft on Close Corporations’ (1990) 38
American Journal of Comparative Law 337.
364 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

Instead, regulators enacted more general legislation in 1974 and 1993 that
imposed stricter auditing requirements for ‘large’ companies (with capital of 500
million yen or more, or debts of 20 billion yen or more). In 1990, they also
increased the differential in paid-in capital required for YK as opposed to KK
forms. However, following the credit crunch of the 1990s, from 2003 the capital
was allowed to be paid in over five years following incorporation. And in 2005,
the new Companies Act abolished minimal paid-in capital requirements alto-
gether. Indeed, the law abolished YK companies altogether, subsuming them
into the KK form, instead of forcing the smaller KK companies to adopt pro-
visions like those that existed for smaller companies. The Companies Act also
provided multiple options within the KK rubric, including simplified governance
structures very suitable for smaller companies, as part of a broader shift away
from narrow mandatory rules and towards greater choice for businesspeople.
This leaves the risk of large companies also selecting a simplified structure that
may be dangerous for corporate governance, but that was thought to be justified
given other governance rules and practices. These range from potential liability
of directors to third parties in certain situations through to a doctrine of ‘pierc-
ing the corporate veil’ (albeit quite limited97 ) and the monitoring mechanisms
provided by core employees or main banks (described further from Part 13.4.5.4
below).
Furthermore, the Companies Act of 2005 does restrict governance options
depending on whether or not the company is ‘large’ and/or ‘public’ (meaning
that transferability of any class of shares is unrestricted – to be a listed public
company, by contrast, exchanges require that all shares be fully transferable).
The law’s somewhat complex rules can be interpreted to provide for these four
KK subcategories:98
(i) For non-public and non-large companies: there exist nine possible struc-
tures, of which the most practicable is likely to involve just one or several
directors (but no requirement for a board). Shareholders seeking to add a
governance mechanism likely to appeal to banks might also add a statutory
auditor (but who may be restricted through the articles of association to
assessing accounting matters, not the legality of directors’ actions).
(ii) For non-public but large companies: there are four possible structures.
All require accounting auditors. Three involve statutory auditors (with
full powers), with the two not requiring a board of auditors likely to be
most popular; the other structure involves a ‘company with committees’
(explained in Part 13.4.4.2 below).
(iii) For public but not large companies: there are five structures, all involving
a board of directors, with four also involving statutory auditors (two with
boards) and the other a ‘company with committees’. The most practicable
97 See for example the judgments translated in Yukio Yanagida, Daniel H Foote, Edward Stokes Johnson Jr,
J Mark Ramseyer and Hugh T. Scogin Jr (eds), Law and Investment in Japan: Cases and Material, Cambridge,
Massachusetts, Harvard University Press, (2000) 336–41.
98 Keiko Hashimoto, Katsuya Natori and John C Roebuck, ‘Corporations’ in Gerald McAlinn (ed.), Japanese
Business Law, The Hague, Kluwer (2007) 102–5.
 GERMANY, JAPAN AND CHINA 365

is likely to involve a board of directors plus one statutory auditor (but no

board).
(iv) For public and large companies: there are only two options. One is the
‘company with committees’ (iinkai setchi kaisha), which always requires
one or more accounting auditors. The other is ‘a company with a board
of statutory auditors’ (kansayakukai setchi kaisha), including a board of
directors and one or more accounting auditors.
It remains to be seen whether this much-expanded menu of options that busi-
nesspeople can select for smaller companies will lead courts to become even
more reluctant to police oppression of shareholders, on the theory that they
or legal advisors should have chosen a more sophisticated form to improve
governance from the outset. This issue is complicated because some forms of
oppression, such as share issuance, raise issues covered by provisions that are
also creating problems and court precedents in takeover disputes involving large
listed companies (reviewed in Part 13.4.5.3 below). Yet Japanese courts may
make allowance for the fact that the government has enacted the new Com-
panies Act with a considerable element of ‘policy push’ – trying to channel
behaviour, rather than the more usual ‘demand-pull’ approach, whereby leg-
islation tends instead to reflect already emergent practices. They may also take
into account that smaller businesses still lack access to sophisticated legal advice,
despite the parallel effort to reform the legal profession and justice system more
generally.99

13.4.4.2 Companies with committees versus companies with

boards of auditors
Much of the discussion about this new menu of corporate governance structures
has instead focused on the two provided for public and large companies. In fact,
the option of substituting a (more Anglo-American) ‘company with committees’
for the (German) statutory auditor board form was created through legisla-
tive amendment in 2002.100 This ‘elective corporate governance reform’ partly
reflects a compromise among Japan’s major corporate law reform institutions.101

99 Tomoyo Matsui, ‘Open to Being Closed? Foreign Control and Adaptive Efficiency in Japanese Corporate
Governance in Luke Nottage, Leon Wolff and Kent Anderson (eds), Corporate Governance in the 21st Century:
Japan’s Gradual Transformation, Cheltenham, Edward Elgar (2008) 197, applying the distinction between
the two approaches developed by Zenichi Shishido, ‘The Turnaround of 1997: Changes in Japanese Corporate
Law and Governance’ in Masahiko Aoki, Gregory Jackson and Hideaki Miyajima (eds), Corporate Governance
in Japan: Institutional Change and Organizational Diversity, Oxford, Oxford University Press (2007) 310.
In other areas such as contract law, moreover, Japanese case law has developed a more flexible (German
rather than French) approach to protecting the weaker party in a long-term relationship: Luke Nottage, ‘Form
and Substance in US, English, New Zealand and Japanese Law: A Framework for Better Comparisons of
Developments in the Law of Unfair Contracts’ (1996) 26 Victoria University of Wellington Law Review 247.
100 Dan W Puchniak, ‘The 2002 Reform of the Management of Large Corporations in Japan: A Race to
Somewhere?’ (2003) 5 Australian Journal of Asian Law 42.
101 Ronald Gilson and Curtis Milhaupt, ‘Choice as Regulatory Reform: The Case of Japanese Corporate
Governance’ (2005) 53 American Journal of Comparative Law 343 at 353–4; Luke Nottage and Leon Wolff,
‘Corporate Governance and Law Reform in Japan: From the Lost Decade to the End of History?’ in Rene Haak
and Markus Pudelko (eds) Japanese Management: In Search of a New Balance between Continuity and Change,
New York, Palgrave Macmillan (2005) 133.
366 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

The Ministry of Justice (MoJ) – traditionally charged with reform through

its Hosei Shingikai deliberative council, chaired by leading professors – had ini-
tially favoured the imposition of a United States-style, committee-based form.
Yet the MoJ’s leadership in this field had been challenged by private members’
bills since 1997 (beginning with one liberalising stock options). Such bills and
other corporate law initiatives (like the guidelines on takeovers introduced in
Part 13.4.5.4 below) were also supported by the Ministry of Economy, Trade
and Industry (METI). Its responsibility for industrial policy has involved a sig-
nificant shift since the 1990s away from outright interventionism and towards
pragmatic market liberalisation in many respects. METI and big business lob-
bies objected to forcing companies to adopt United States-style committees. So
did the Ministry of Finance (MoF), against the backdrop of its responsibility for
stock exchanges – with the Tokyo Stock Exchange (TSE) subsequently emerg-
ing as another ‘competing’ regulator in Japan’s broader corporate governance
universe.102
Such mixed messages from various constituencies help explain both limited
uptake of the committee-based form in the first round (2003 general meetings,
mostly in June) as well as statistically insignificant share-price effects among the
subset of listed companies that did adopt that form. Only 71 firms (45 listed), or
three per cent, took this option, including the Nomura financial holding company
together with 13 privately held subsidiaries, plus Hitachi with 21 affiliates. These
two major corporate groups are not traditional bank-centred keiretsu, and many
of the other adopting firms diverge from conventional patterns of Japanese
industrial organisation (such as Orix) and have high foreign ownership (such as
Sony).
In fact, existing and budding corporate groups seem to be using the ‘United
States-style’ form in a quite a German way – to entrench control over the group
rather than (directly) advancing interests of shareholders in individual firms.
They can do this because the 2002 amendment requires a majority of directors
on the committees to be ‘outside’ directors, defined not to encompass employees
of parent companies or of sibling firms with a common parent. A large majority
of Nomura and Hitachi firms in fact fell into the latter categories of ‘grey’ out-
side directors. Gilson and Milhaupt acknowledge that these patterns may reflect
and promote efficiency gains, with appointment of outside directors driven by
industrial organisation needs of particular industries or firms. However, they are
concerned that the capacity to appoint directors from other group members may
end up encouraging ‘stakeholder tunnelling’ (firms advancing interests of core
employees and other stakeholders, over dispersed shareholders) and managerial
entrenchment, especially if Japanese courts cannot or do not scrutinise directors’
decisions carefully in takeover contests.103
102 See further Hideki Kanda, ‘What Shapes Corporate Law in Japan?’ in Hideki Kanda, Kon-sik Kim and
Curtis J Milhaupt (eds), Transforming Corporate Governance in East Asia, Abingdon, Routledge (2008) 60 and
Part 13.4.5 below in this chapter.
103 Ronald Gilson and Curtis Milhaupt, ‘Choice as Regulatory Reform: The Case of Japanese Corporate
Governance’ (2005) 53 American Journal of Comparative Law 343.
 GERMANY, JAPAN AND CHINA 367

A subsequent qualitative study shows that lawyers and statutory auditor

respondents, in particular, were worried about the loss of monitoring poten-
tial from appointment of ‘grey outside directors’ to the parent’s subsidiaries.
Respondents focused on the possibility of monitoring improvements only in the
parent company if that itself adopted the committee form, because then the
outside directors would tend also to be independent, and there was relatively
little appreciation of the group cohesion and flexibility benefits of appointments
to subsidiaries. Respondents were also unimpressed by the new form’s creation
of an executive officer system, designed to encourage managerial flexibility in
conjunction with stronger mechanisms for monitoring. The problem here was
that legislation still allowed directors to serve concurrently as executive officers,
allowing for the perpetuation of a tradition of executive directors. A sharper
distinction between monitoring and management can therefore be maintained
through the statutory auditor board corporate form. Unsurprisingly, therefore,
only a further 39 companies had adopted the committee-based form in October
2006, after three more rounds.
Lawley concludes that the new system has the potential to generate stronger
and more transparent corporate governance, and has been perceived in this way,
but the empirical reality so far does not meet these expectations. Nonetheless,
rather than tightening legislative requirements, he suggests that:104
the committee system’s monitoring mechanisms might be improved by encouraging
companies with the committee system to appoint truly independent outside directors
in greater numbers, and to create environments in which grey outside directors will
monitor effectively. The adverse effect this strengthened monitoring would have on
managerial freedom might also indirectly encourage companies with the committee
system to separate officers from directors more strictly.

In fact, the Japan Pension Fund Association did try to encourage such devel-
opments by publishing principles calling for greater independence, and other
calls came from individual investors in Japan and especially from abroad. The
Financial System Council (advising the FSA) established a ‘Study Group on the
Internationalization of Japanese Financial and Capital Markets’, which met eight
times from October 2008, presenting on 17 June 2009 a report entitled ‘Toward
Stronger Corporate Governance of Publicly Listed Companies’. The report urged
stock exchanges to promote a corporate governance model that would include
greater independence of statutory auditors and directors within companies with
committees, and would require listed companies to disclose details of their cor-
porate governance systems and reasons for selecting them. The report hoped
that this would improve uptake of such companies, comprising only 2.3 per cent
of firms listed on the TSE as of August 2008.105
104 Peter Lawley, ‘Panacea or Placebo? An Empirical Analysis of the Effect of the Japanese Committee
System Corporate Governance Law Reform’ in Luke Nottage, Leon Wolff and Kent Anderson (eds), Corporate
Governance in the 21st Century: Japan’s Gradual Transformation, Cheltenham, Edward Elgar (2008) 129 at
154.
105 Available at <www.fsa.go.jp/en/news/2009/20090618-1/01.pdf> 11–12. The chair of this FSA Study
Group was Keio University Professor of Economics Kazuhito Ikeo. For more statistics on companies with
368 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

Another hope was for improvement of governance in statutory auditor com-

panies, which must have outside auditors but not necessarily outside directors –
and with 55 per cent of TSE-listed companies currently lacking such directors.
The report noted that some companies had already appointed highly indepen-
dent outside directors who then collaborated closely with the statutory auditors
(who must include outsiders) as well as officers in charge of internal audits and
control now required by legislation, thereby addressing two problems remaining
with the statutory auditor model. Responsibility for internal audits and internal
control lies with directors, and systems are therefore not directly reportable to
the auditors; the auditors lack voting rights at directors’ meetings (including
regarding election of officers) and their audits are generally confined to whether
the directors acted legally (as opposed to appropriately).
A report of the ‘Corporate Governance Study Group’ established by METI in
December 2008, also released on 17 June 2009, concluded more specifically
that a listed company should have at least one truly independent director or
auditor, as well as improve disclosure about its corporate governance system,
through listing rules rather than legislative reform.106 This Group’s members
considered that this would provide a better trade-off between minimising the risk
of conflicts of interests and maximising effectiveness in corporate governance
and performance. The report also recommended either (a) at least one outside
director and disclosure about the company’s corporate governance system, or
(b) disclosure of the system ‘using the company’s own original method’.107
By 29 September 2009, the TSE had released a ‘Listing System Improvement
Action Plan’. ‘Matters for prompt implementation’ included a requirement for
independent directors/auditors unlikely to give rise to conflicts of interest vis-
à-vis general shareholders. Progress reports released on 29 October clarified
that these were to be selected from among the outside directors or auditors. The
requirement was included, along with disclosure as to the independent directors’
or auditors’ names and reasons for being so designated, as ‘Items to be observed’
in the TSE’s Code of Corporate Conduct (which must be complied with in order
to avoid delisting) with effect from 30 December.108
In addition, following the FSA Study Group’s recommendations, the action
plan proposed new ‘Items desired to be observed’ for the TSE’s Principles of
Corporate Governance for Listed Companies to support statutory auditors. Com-
panies are encouraged to provide them with sufficient human resources, includ-
ing for cooperation with internal audit and control divisions; to appoint highly

committees (and many other corporate governance matters, compared to 2007) see TSE-Listed Companies
White Paper on Corporate Governance 2009, above n 66).
106 See <www.meti.go.jp/english/report/downloadfiles/200906cgst.pdf> 4. The chair was University of
Tokyo Professor of Law Hideki Kanda.
107 Ibid, 5. The report noted other existing innovations within statutory auditor companies, such as executive
directors (who by definition can never be ‘outside’ directors) who had nonetheless been engaged from outside
the company and had never previously worked for it, or looser ‘advisory boards’ comprised of outside experts
providing input into management decision making.
108 The agreed changes can be found at <www.tse.or.jp/english/rules/ls-improvements/index.html>. The
Code is available at <www.tse.or.jp/english/rules/kouhyou/index.html>.
 GERMANY, JAPAN AND CHINA 369

independent outside auditors; and appoint auditors with in-depth knowledge of

finance or accounting. The Principles were unveiled in 2004 as purely voluntary,
‘not to require companies to adopt minimum standard policies or models for cor-
porate governance, nor to demand companies that do not adopt the best policies
or models to explain why’.109 But the TSE has now revised listing rules and its
‘Guidelines for descriptions in corporate governance reports’ to require firms to
describe measures taken to enhance statutory auditor functions. Likewise, the
TSE has presented corporate governance models deemed suitable for most listed
companies, namely in the ‘remarks’ column following its Principles of Corporate
Governance. Each firm must now disclose its current governance system and
reasons for it, referring to the models added to the principles.
In other words, Japan has recently moved to a significantly more prescriptive
approach, at least for companies listed on the main stock exchange. The TSE
demands a stricter standard than the Companies Act in one respect: at least one
independent (not just outside) director or statutory auditor. This adopts one
major recommendation of the METI Study Group’s Report, but not directly the
other regarding outside directors. In addition, following the FSA Study Group
the TSE also encourages further independence and other corporate governance
enhancements through a regime not too dissimilar to the ‘comply or explain’
approach found in the UK and (arguably more loosely) in Australia.110

13.4.4.3 Directors’ duties and derivative actions

Minimum numbers and qualifications as an ‘outside’ or ‘independent’ director (or
auditor) provide ex ante protection for shareholders and even other stakeholders.
Once appointed, directors also owe specified duties that can operate as ex ante
or ex post controls. From a comparative and historical perspective, another
intriguing development in Japan has been the superimposition of a duty of loyalty
(chujitsu gimu) providing relief if directors turn out to have acted dishonestly or
unfairly.111
The Commercial Code added Article 254–3 (now Article 355 of the Compa-
nies Act) during the Occupation in 1950, reflecting the central role played by the
duty of loyalty in (Anglo-)American corporate law. It sat uneasily alongside the
duty of care provided in Article 254(3) (now Article 330), which incorporated –
following German law – the high standard set out in the Civil Code (Article 644:
zen kan chui gimu). In 1970 the Supreme Court of Japan held that it clarifies
and restates the duty of care. Article 254–3 also played no practical independent
role for other important reasons, too. Unlike in common law systems, breach of
the duty of loyalty provided for the same relief: damages, not disgorgement of
profits or other often flexible remedies originally derived from courts of equity.
Developing a new, independent form of ex post relief would have put additional

109 Preface to the 2004 edition, 4, available at <www.tse.or.jp/english/rules/cg/index.html>.

110 Nottage, above n 90. See also Chapter 1 of this book.
111 Kanda and Milhaupt, above n 80.
370 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

strain on a judiciary used to working within a corporate law containing many nar-
rower mandatory provisions. Relatedly, the Commercial Code contained specific
ex ante procedural rules governing many situations. In particular, Article 264
(now Article 356(1)(1)) restricts transactions by a director on his or her behalf or
for another that competes with the company’s business. Article 265 (now Article
356(1)(2) and (3)) regulates self-dealing, also requiring prior board approval.
However, in 1989, the Tokyo High Court awarded damages against a director
solely under Article 254–3. Poaching key employees for his new firm may have
been seen as beyond the scope of Article 264.112 But a few subsequent judgments
have also applied Article 254–3 (and Article 355) independently of the duty of
care in other contexts. Kanda and Milhaupt argue that this reflects new patterns
of ‘micro-fit’ and ‘macro-fit’, reflecting broader shifts in Japanese economic insti-
tutions, sharp reductions in cost barriers to shareholder derivative suits from
1993, and growing familiarity with the duty of loyalty.113 As in Anglo-American
law, it may even yet come to play a role in contests for corporate control (out-
lined in Part 13.4.5.3 below) or more generally in underpinning independence
of directors.
Article 355 of the Companies Act also requires directors to obey all laws,
articles of association and resolutions of general shareholders’ meetings. The
Supreme Court (7 July 2000) has ruled that ‘laws’ should be interpreted broadly.
The Daiwa Bank judgment (Osaka District Court, 20 February 2000) held it
extended to relevant foreign law, namely United States law, which had been
breached by a locally hired New York employee causing huge losses to the Bank
and its shareholders. The judgment also held that the board must establish a
system for internal control, with non-executive directors obliged to monitor its
effectiveness. Generally, the latter must also monitor activities of the other direc-
tors, and creditors of small to medium-sized companies have quite often success-
fully claimed damages against non-executive directors. The board of directors
also must supervise executive directors and the appointment or dismissal of rep-
resentative directors (Article 362); and must supervise executive officers within
companies with committees (Article 416(1)(2)). Directors are also liable if they
negligently allow dividends and the company becomes insolvent by year-end
(Article 465), or the dividends exceed a statutory formula (Article 462).
The emergence of derivative suits in Japan since the 1990s has been even more
striking, enlivening and interacting with these directors’ duties. The issue was
highlighted by the 80 billion yen awarded at first instance in the Daiwa Bank case,
although a 250-million yen settlement was reached during the appeal.114 Under
the German-inspired Commercial Code of 1899, shareholders holding at least
10 per cent of the company’s capital could require the auditors to sue directors,

112 See also the Tokyo High Court judgment of 24 June 2004, cited in Souichirou Kozuka and Leon Wolff,
‘Commercial Law’ in Luke Nottage (ed.), CCH Japan Business Law Guide: Looseleaf, Singapore, CCH Asia
(2007), para. 16–320. See also their paras 16–300 through 16–380 and 15–360 for further key details about
all directors’ duties, including non-competition duties and others described in the ensuing text above.
113 See also Part 13.4.2 (Japan and debates on comparative capitalism and corporate governance), above.
114 See generally Bruce Aronson, ‘Reconsidering the Importance of Law in Japanese Corporate Governance:
Evidence from the Daiwa Bank Shareholder Derivative Case’ (2003) 36 Cornell International Law Journal 11.
 GERMANY, JAPAN AND CHINA 371

but this was little used.115 Occupation reforms in 1950 included a United States-
style, derivative suit mechanism, but it, too, generated only a few dozen cases.
Shareholder plaintiffs typically had to pay attorneys an up-front fee, and even if
successful remained liable for further ‘success fees’ beyond what the court might
find ‘reasonable’. Regarding court costs, they also faced the ‘loser pays’ rule
standard in civil litigation in Japan and, most importantly, had to pay significant
amounts upon filing, which were based on the amount claimed. Courts liberally
construed a provision, modelled on Californian law, allowing defendants to seek
security for costs if it was credible that the suit was brought in bad faith; and
could also invoke the ‘abuse of rights’ doctrine. Only plaintiffs holding at least
10 per cent of shares (3 per cent after 1993) could access company financial
information through rights to examine its books or (only upon showing cause)
to appoint an inspector.
Suits burgeoned after the Code was amended from mid-1993, primarily to fix
the court filing fee at the flat rate of 8200 yen, by deeming derivative actions to
be non-property claims (Article 267(4)). This followed the new interpretation
given by the Tokyo High Court (30 May 1993).116 Yet, statistical analysis of suits
filed between 1993 and 1999 found very low success rates and quite limited set-
tlements for plaintiffs, as well as negligeable indirect benefits reflected in share
price ‘event studies’ – not unlike findings from the United States. Milhaupt and
West therefore conclude that suits persist primarily because of various financial
advantages to Japanese attorneys. But they also acknowledge some influence
from (a) non-monetary motives for some plaintiffs, (b) piggybacking on infor-
mation disclosure ensuing from white collar crime prosecutions, (c) proliferating
professional indemnity insurance (although settlements remained few and low),
and (d) new-generation sokaiya.117
Fujita identifies other empirical work suggesting that the 1993 reform
nonetheless may have enhanced monitoring over misbehaving managers, but
ultimately finds the evidence to be ambiguous, particularly as other major
changes ensued for the management liability regime overall.118 One set of proce-
dural law changes focused on procedural rules in derivative actions themselves.
Japanese law had no express provisions to limit litigation that might be ‘abusive’
vis-à-vis non-plaintiff shareholders, as opposed to directors themselves. Thus,
for example, courts could not dismiss suits likely to succeed even if shareholders

115 Milhaupt and West, above n 92, 18, speculate that this was because such large shareholders could enforce
rights informally anyway, or were deterred by strict rules on security for costs and liability for damages to the
company if the shareholders failed.
116 The Supreme Court (10 October 2002) eventually upheld this interpretation of the old Code provision.
Derivative suits pending in District and High Courts rose to 86 by the end of 1993 to around 200 from 1997:
Tomotaka Fujita, ‘Transformation of the Management Liability Regime in Japan in the Wake of the 1993
Revision’ in Hideki Kanda, Kon-sik Kim and Curtis J. Milhaupt (eds), Transforming Corporate Governance in
East Asia, Abingdon, Routledge (2008) 15 at 17.
117 Milhaupt and West, above n 92, 22–37. For more on the (arguably diminishing) roles of sokaiya as
well as Japanese organised crime more generally see ibid, 109–78. However, subsequent empirical analysis
presents persuasive evidence against their ‘rational attorney’ explanation, and instead emphasises non-
monetary motives and various heuristics as driving burgeoning lawsuits. See Dan Puchniak, ‘Japan’s Love for
Derivative Actions: Revisiting Irrationality as a Rational Explanation for Shareholder Litigation’, 2nd Annual
NUS–Sydney Law School Symposium, Singapore, 15–16 July 2010.
118 Fujita, above n 116.
372 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

as a whole might suffer (for example, due to the directors having insufficient
assets). Article 847(1) of the draft Companies Act of 2005 added a provision
clearly extending court powers in this respect, creating a version of the United
States law requirement that plaintiffs ‘fairly and adequately’ represent share-
holder interests, but this was not enacted due to fears of undermining moni-
toring incentives. However, the Act did clarify that the company has standing
to intervene or participate in the derivative action – indeed, it does away with
certain conditions imposed by a Supreme Court judgment (30 January 2001).
Reforms to the Commercial Code in 2001 had already provided a detailed pro-
cedure by which the company could intervene and assist director defendants. In
particular, the statutory auditor(s) must decide within 60 days of a request from
shareholders whether or not to sue, and provide written reasons for not suing
(see now Articles 386(2) and 847(3) of the Companies Act).
Procedural rules for exonerating management were also amended from 2001.
Liability may be exempted beyond specified limits (for example, two years’
remuneration for outside directors) if a director has acted in good faith and
without gross negligence. This requires approval by the shareholders’ meeting
(Article 425), or by the board of directors if provided in the articles of associa-
tion and 3 per cent of shareholders (or less if so provided in the articles) do not
subsequently override the board’s decision (Article 426). Statutory auditors (or
members of the audit committee in a Company with Committees) also approve
the exemption.
Fujita suggests that partial exemptions may have some psychological effect
on judges considering judgment against directors. However, he suggests that
relatively few companies have amended their articles of association because
exemption by means of the board is further limited to where exemption is ‘par-
ticularly necessary taking into account the relevant circumstances including, but
not limited to, the details of the facts that caused the liability and the status of
execution of duties’ (Article 426(1)). Further, even if exemption is by means of
a shareholders’ meeting, there must be disclosure of ‘the facts giving rise to the
liability and its amount’ (Article 425(1)) – normally after the first-instance judg-
ment. Lastly, there are also few cases in which courts impose liability without
evidence of ‘gross negligence’, anyway.
This last point ties into a third set of developments: transformations in the
substantive law on directors’ duties. In particular, a Japanese version of the ‘busi-
ness judgment rule’ has become more prominent since the late 1980s. Japanese
courts do check that the substance of directors’ decisions was not markedly
inappropriate or not based on detailed fact findings, even if they find no prob-
lems with decision-making or information-gathering processes in general. But
increasingly, judgments begin by expressly referring to the rule and proclaiming
limited scope for reviewing substantive business judgments, before examining
and ruling on the facts. In addition, the Companies Act now applies negligence-
based rather than strict liability regarding illegal distributions or self-dealing,
extending 2002 revisions to the Commercial Code, which had restricted liability
only for companies with committees.
 GERMANY, JAPAN AND CHINA 373

Fujita concludes that the 1993 change to the filing fee issue and rapid growth
of derivative suits pose problems for path-dependence theory (including his own
earlier work with Kanda), which had predicted change only where complemen-
tarities with other rules had been weak, or where strong complementarities
could be overturned through comprehensive reforms in extraordinary political
circumstances. He now suggests that where strong complementaries do exist and
persist, the narrow reform will lead to further changes to the overall system –
like the more recent sets of changes to Japan’s management liability regime.
Alternatively, the perspective of Milhaupt with West or Pistor may provide a bet-
ter explanation for the emergence of the 1993 change itself – namely, broader
transformations in Japanese economic institutions and hence corporate gover-
nance as a whole – but their views then sit rather uneasily with the evidence of
‘backlash’ tentatively identified by Fujita. Japan’s gradual transformation may
be considerably more gradual than they believe.

13.4.5 Shareholder versus bank finance

13.4.5.1 Overview
Greater choice of governance form and enhanced MSPs such as derivative suit
mechanisms were aimed at expanding capital-raising from shareholders. This
consolidated a trend that had accelerated since the 1980s, as companies turned
to bond and share markets. It also acknowledged the growing role of foreign
investors, holding around 20 per cent of TSE-listed shares by the early 2000s,
compared to just 4 per cent in 1990. Shareholder finance also became cru-
cial as banks accumulated huge, non-performing loan portfolios and a credit
crunch persisted throughout Japan’s ‘lost decade’ and into the early 2000s.
Relatedly, corporate law was liberalised to allow companies to offer many new
types of shares. This has moved Japan away from a system of limited options
that left uncertainty about the legality of other possibilities, even though cross-
border joint ventures and some bolder companies in Japan sometimes used
those other options anyway. Since 2001, Japanese corporate law has expressly
made available a much more diverse menu of share type offerings to investors
(Part 13.4.5.2).
Yet, this has highlighted more possibilities for abuse by incumbent managers
and other stakeholders in the face of actual or potential hostile takeovers, result-
ing in complex and ongoing developments in takeovers regulation. Japan has
been influenced by United States law in allowing certain defensive measures
such as ‘poison pills’ – shares or warrants (‘rights’ to subscribe to shares, in
Anglo-Australian parlance) that dilute the hostile bid. But there are echoes of
Anglo-Australian law in the greater role accorded to approval by target share-
holders rather than directors (Part 13.4.5.3). This may further undermine the
‘main bank’ system over the long term, but that did survive the lost decade, and
indeed cross-shareholdings have been increasing more generally in recent years
(Part 13.4.5.4).
374 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

13.4.5.2 Share-class diversification

One striking liberalisation regarding shares relates to new types of shares avail-
able since the 2001 amendments to the Commercial Code. Previously, other than
ordinary shares there could only be preference shares in respect of dividends or
interest or distribution of assets upon insolvency, with the possibility of limiting
voting rights. Now, under Articles 107 and 108 of the Company Law, there may
be classes of shares with different rights regarding:
● distribution of surplus or residual assets (including now ‘tracking stocks’
linked to performance of subsidiaries, for example)
● restrictions on assignment (even now for a specific class of shares)
● no or limited voting rights (for example, voting restricted to profit distri-
butions – with the maximum for such shares with limited rights raised, for
public companies, from one third to one half of issued shares: Article 115)
● rights of shareholder to require companies to acquire the shares (‘shares
with a put option’)
● rights of the company to acquire the shares (‘shares with a call option’, with
the acquisition price payable in other classes of shares, bonds etc.) or an
entire class of shares (now by qualified majority, subject to the squeezed
out shareholders being able to get the court to determine the price:
Article 172(1))
● a veto for the class regarding certain corporate actions (‘golden shares’)
● rights of a class to appoint directors or auditors (except for public compa-
nies and ‘Companies with Committees’: Article 347).
These provisions allow management additional flexibility to raise capital from
shareholders with different investment needs. However, many may also be used
as defensive measures against actual or potential hostile takeovers and thus
entrench incumbent management for its own interest rather than maximising
benefits for all shareholders and the company as a whole.119 In addition, even
without shareholder approval directors may now issue share purchase warrants
with a call option (share options or shinkabu yoyaku-ken) exercisable if a cer-
tain proportion of shares is acquired (Article 236(1)(7)). A company can also

119 See Oda above n 93, 232–7, including a summary of the UFJ Trust Bank case. In 2004 it issued preferred
shares to Mitsubishi Tokyo Bank as the preferred suitor, with rights of veto and to appoint a certain number of
directors, and with no voting rights unless for example the merger was approved by UFJ. Since 2006, however,
the TSE has indicated that issuing shares requiring class approval for director appointment or dismissal can
lead to delisting. (In another remarkable development for Japan, the disappointed Mitsui Sumitomo Banking
Corporation pursued a contract law claim against UFJ all the way to the Supreme Court: see Koji Takahashi,
‘Walford v Miles in Japan: Lock-in and Lock-out Agreements in Sumitomo v UFJ’ (2009) 2009 Journal of
Business Law 166. The issue of ‘golden shares’ can become acute where the government retains them in partly
privatised public utilities and foreign investors are involved, although Japan has not yet witnessed litigation
as in the European Union. Compare Souichirou Kozuka, ‘Foreign Direct Investment, Public Interest and
Corporate Governance: Japan’s Recent Experience’ (2009), Paper presented at the 6th Asian Law Institute
Conference, Hong Kong, 29–30 May 2009 (analysing cases in which foreign investors – TCI from the UK, and
Macquarie from Australia – faced difficulties instead from Japan’s FDI regulation framework) and Kenichi
Osugi, ‘Transplanting Poison Pills in Foreign Soil: Japan’s Experiment’ in Hideki Kanda, Kon-Sik Kim and
Curtis J Milhaupt (eds), Transforming Corporate Governance in East Asia, Abingdon, Routledge (2008) 36
at 40 (discussing the float of Inpex Corporation with a golden share for the government, but in 2004 and
without controversy so far for foreign investors). More generally, see Christopher Pokarier, ‘Open to Being
Closed? Foreign Control and Adaptive Efficiency in Japanese Corporate Governance’ in Luke Nottage, Leon
Wolff and Kent Anderson (eds), Corporate Governance in the 21st Century: Japan’s Gradual Transformation,
Cheltenham, Edward Elgar (2008) 197.
 GERMANY, JAPAN AND CHINA 375

discourage takeovers by increasing the voting requirements, pursuant to the

articles of association, for resolutions of all shareholders to approve dismissal of
directors or M&A transactions (Article 309).120 Since the Companies Act took
effect from 2006, the TSE has developed momentum to impose additional restric-
tions on defensive measures – thereby not only transforming corporate gover-
nance outcomes, but also complicating the process by which law and practice
are being transformed in Japan.121

13.4.5.3 Takeovers regulation

Hostile takeovers had been very rare in post-war Japan due to substitute means
for monitoring incumbent managers: keiretsu or broader cross-shareholding rela-
tionships, main banks, stable core employees and informal relationships with the
economic ministries. However, Milhaupt and Pistor argue that these and other
economic institutions had come under prolonged stress since the 1990s, leading
to great controversy surrounding the February 2005 bid aimed at a Fuji Televi-
sion subsidiary by internet firm Livedoor. Led by maverick entrepreneur Horie,
the bid pitted the new against the old. It also arose in the context of growing con-
cern about increased foreign investment into Japan, facilitated by new entrants
to deregulated financial markets – illustrated by Lehman Brothers’ financing of
Horie’s bid.
In addition, Livedoor aggressively used the legal framework. It found a secu-
rities law loophole (closed in 2006) to accumulate a 38 per cent shareholding
off-market but after-hours, thus circumventing tender-offer rules that required
purchases beyond one-third to be open to all shareholders. (Drawing again on
United States law, tender-offer provisions were added in 1971 to the Securi-
ties Exchange Law – broadened into the Financial Instruments Exchange Act
in 2007.122 ) When the target’s board issued shinkabu yoyaku-ken warrants to
Fuji that would dilute this stake, Livedoor invoked a provision in the 2001 Code
amendments that allowed injunctions if such warrants were ‘substantially unfair’.
All three levels of the courts enjoined Fuji in March 2005, extending earlier case
law that had interpreted the issuance of actual shares (to white knights or the
like) as not unfair if its ‘primary purpose’ was to raise capital rather than entrench
the management against hostile bidders.123 But the courts recognised exceptions

120 Keiko Hashimoto, Katsuya Natori and John C Roebuck, ‘Corporations’ in Gerald McAlinn (ed.), Japanese
Business Law, The Hague, Kluwer (2007) 91 at 139–41 (including useful diagrams).
121 See generally Hideki Kanda, ‘What Shapes Corporate Law in Japan?’ in Hideki Kanda, Kon-sik Kim and
Curtis J Milhaupt (eds), Transforming Corporate Governance in East Asia, Abingdon, Routledge (2008) 60 at
63–6; and the introduction and Part 13.4.4.2 (Companies with committees versus companies with boards of
auditors), above.
122 For a detailed analysis, see Hiroshi Oda et al., ‘Securities Law (the Financial Instruments and Exchange
Law)’ in Luke Nottage (ed.), CCH Japan Business Law Guide: Looseleaf, Singapore, CCH Asia (2009).
123 For details on that case law, based on Code Article 280–10 (effectively restated in Article 210 of
the Companies Act), see Souichirou Kozuka, ‘Recent Developments in Takeover Law: Changes in Business
Practices Meet Decade-Old Rule’ (2006) 22 Journal of Japanese Law 5. Injunction in that context is also
possible where the share issuance breaches other statutory provisions (respectively Article 280–2(2), now
Articles 199(2) and 201(2)). Courts and a 2003 amendment interpreted that aspect to require a price linked
to the market price – typically reflecting the bid offered by the acquirer. To that extent, namely incumbent
management having to re-evaluate their firm’s value in response to bidders, Kozuka believes that the market
for corporate control was operative.
376 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

for specified ‘abusive motives’ (such as greenmail or scorched earth policies) by

the bidder that would clearly harm other shareholder interests, provided the
measures then were proportionate.124
Milhaupt and Pistor join other commentators in highlighting strong parallels
with Delaware case law on similar ‘poison pills’ decided in the 1980s. The influ-
ence of United States law is even more apparent in the first report of METI’s
Corporate Value Study Group, established in September 2004 to clarify whether
and how Japan’s new legislative provisions could be used to provide defensive
measures against takeovers. The report was released on 27 May 2005, with sig-
nificant additions to the Summary Outline (published on 7 March, shortly before
the first Livedoor judgment). But one professor who served on that Group instead
points out that (non-binding but influential) guidelines agreed between METI
and MoJ also on 27 May:125

‘had virtually no trace of Delaware rules and developed native legal thoughts instead.
In the beginning, the Guidelines indicated three fundamental principles:
1. adoption, activation, and abolition of the defensive plan shall be made for maintain-
ing or improving corporate value and eventually shareholders’ collective interests;
2. a defensive plan shall disclose its purpose, contents, etc. when it is adopted and be
dependent on the rational will of shareholders; and
3. a defensive plan shall be allowed only when it is necessary and proper to prevent
[inadequate] takeovers.
Subsequently, the Guidelines issued various legal structures for rights plans and the
legal procedures for adopting them. The Guidelines did not mention what constituted
an appropriate standard that would help adjudicate a target board’s activation of
a defensive plan during a control contest. This was probably because the authority
to interpret statutes was vested only with the judiciary. Compared to the Delaware
rules, the METI Report and to a larger extent the Guidelines laid greater emphasis on
shareholders’ power to adopt and/or abolish a defensive plan.

Subsequent case law in Japan, beginning with the Nireco and Yumeshin-JEC
judgments in 2005 (involving instead pre-bid or ‘peace-time’ measures, unlike
the Livedoor case) and including the Supreme Court’s ruling in the 2007 Bulldog
Sauce case, has developed in conjunction with two subsequent Group reports (in
March 2006 and June 2008) to further emphasise the importance of shareholder
approval.126 The TSE, continuing its emergence as a major policy setter, has
recently reiterated this, too.127

124 Milhaupt and Pistor, above n 73, 90–8.

125 Osugi above n 119, 39. Oda above n 93, 265 also notes parallels to German law’s ‘balance of powers
doctrine’ in the context of the primary purpose rule.
126 See also Mitsuhiro Kamiya and Tokutaka Ito, ‘Corporate Governance at the Coalface: Comparing
Japan’s Complex Case Law on Hostile Takeovers and Defensive Measures’ in Luke Nottage, Leon Wolff
and Kent Anderson (eds), Corporate Governance in the 21st Century: Japan’s Gradual Transformation,
Cheltenham, Edward Elgar (2008) 178; Luke Nottage, Leon Wolff and Kent Anderson, ‘Introduction’
in ibid; and Nottage above n 93 (especially the Appendix comparing the subtly changing membership
of the Group, chaired also by Professor Kanda, from 2004–8: see also Luke Nottage, ‘The Politics of
Japan’s New Takeover Guidelines’ (31 August 2008), available at <www.eastasiaforum.org/2008/08/31/
the-politics-of-japans-new-takeovers-guidelines>.
127 TSE Report of 17 June 2009 above n 66, 4 (and 6 on squeeze-outs). Recall also Kanda above n 121.
 GERMANY, JAPAN AND CHINA 377

However, there remains diversity even within the most popular ‘advance
warning’ poison pills – loosely inspired by the Yumeshin-JEC case – that over
500 companies had implemented by June 2009.128 These generally require the
bidder to present an acquisition plan and other information, and to give the
target shareholders time to assess the bid and decide to have directors seek
out white knights. They usually also provide for directors to deploy defensive
tactics such share warranty issuance, discriminating against a non-compliant
bidder. Such schemes were often set up without shareholder approval. But this
was usually obtained if the schemes also provided for tactics triggered more
broadly, such as judgments that the bidder is abusive or even that the bid will be
detrimental to the company. (Most schemes also had some type of independent
committee to advise the directors, although the final say was reserved for the
board.) In addition, reflecting concern about heightened conflict of interests
with the incumbent directors, a minority of schemes envisaged that only the
shareholders could approve deployment on the broader grounds such as abusive
motive.129
The relative emphasis on shareholder interests is also consistent with devel-
opments at several levels regarding Management Buyouts (MBOs), where the
managers seeking to take their company private (often with private equity financ-
ing, at least before the global financial crisis) have an incentive to take actions
diminishing the market price. Already on 13 December 2006, amendments to the
securities law required bidders to disclose any written evaluation from third par-
ties that had influenced the tender offer price, for example. METI ‘Guidelines on
Increasing Corporate Value and Ensuring Regulatory Compliance in the Context
of MBOs’, released in September 2007 under the chairmanship of the ubiquitous
Professor Kanda, also emphasise the need for an appropriate price (for example,
through longer tender-offer periods or avoiding ‘no shop’ agreements between
the bidders and the company). They further recommend means to promoting
fairness within the target company’s processes for evaluating the offer, including
obtaining independent advice about the process and reports from third parties
about price.130 The Guidelines appear to have influenced the concurring deci-
sion of Justice Tahara in the Supreme Court’s judgment in the Rex Holdings
minority squeeze-out case (29 May 2009), as both emphasise transparency and
appropriate valuation.131

128 See Oda, above n 93, 266. (He notes that this represents less than 20 per cent of listed companies
but suggests that this ‘demonstrates the perception of the companies of the uncertainties involving the
permissibility of such measures’.)
129 Osugi, above n 119, at 42–3.
130 Soichiro Fujiwara and Masanori Tsujikawa, ‘New Procedures for Fair MBOs’ (2008) Supplement: The
2008 Guide to Japan International Financial Law Review, available at <www.iflr.com/Article/1984140/
News>.
131 Squeeze-outs for cash became possible under the new Company Law, but subject to court appraisal if the
price is unfair. The Court upheld the Tokyo High Court’s judgment (of 12 September 2008) that the offer price
should be around 120 per cent of the six-month average market price before the tender offer. See Wataru
Kamoto et al., ‘Rex Holdings – Supreme Court of Japan Requires “Fair Price” to be Paid to Minority Sharehold-
ers’, Allen and Overy Knowledge (19 June 2009), available at <www.allenovery.com/AOWEB/Knowledge/
Editorial.aspx?contentTypeID=1&contentSubTypeID=7944&itemID=51906&prefLangID=410>. For
378 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

Already in 2007, Kanda had observed that regarding defensive measures

against takeovers, ‘the scope of permitted discretion of a target board seems
much narrower in Japan than in the US’.132 Indeed, this seems more consistent
with many substantive rules under Anglo-Australian law. There are even some
parallels between the emergence of Guidelines and the way Takeovers Panels in
the UK and Australia issue guidance notes for market participants and observers.
But one difference from Japan is that these panels (more informal in the UK
than Australia) also issue the binding rulings in takeover disputes, in lieu of
regular courts. Another is that poison pills per se – as opposed to other measures
that can also impede takeovers – are effectively outlawed altogether through a
combination of panel decisions, listing rules and directors’ fiduciary duties.133
Thus, Japan continues to develop its own hybrid regime. As Milhaupt and
Pistor point out, taking Delaware law as a major starting point, rather than the
UK’s City Code requirements for ‘strict neutrality’ from target managers and
hence shareholder approval of defensive measures, promised a system more
protective of those managers and thus more politically acceptable. It also offered
a new business opportunity to United States law firms and financial advisors,
as well as elite Japanese lawyers increasingly found with United States law
training.134
Accordingly, they concede that one outcome may be reinforcement rather
than transformation of management entrenchment, substituting for now-lower
mutual or stable shareholdings. But they also consider the possibility of adap-
tive responses including more use of proxy fights to remove directors (still rarely
used) and the legal profession’s growing familiarity with corporate control issues,
resulting in much stronger convergence on the United States experience, par-
ticularly over the 1980s. Overall, they suggest that Japan will fall somewhere
in between, however, as the METI Takeover Guidelines derive from a compara-
tively ‘rapid, top-down process of law reform’ and Delaware law generates very
‘unpredictable ex post decision making’ even in its native environment. Milhaupt

another example where an MBO failed, after a whistleblower suggested the founding family had maneou-
vered to lower the market price, involving appraisals that were not sufficiently independent: see ‘Charle
MBO Bid Collapses on Opaque Share Pricing’, NikkeiNet Interactive (20 January 2009).
132 Hideki Kanda, ‘Hostile Takeovers, Defenses and the Role of Law: A Japanese Perspective’ (10 July 2007),
available at <www.kipa.re.kr> 9.
133 Nottage, above n 68 (referring especially to the respective studies of Emma Armston and Jennifer Hill).
Another Australian urges Japan to establish a takeovers panel: Geread Dooley, ‘Streamlining the Market
for Corporate Control: A Takeovers Panel for Japan?’ in Luke Nottage, Leon Wolff and Kent Anderson
(eds), Corporate Governance in the 21st Century: Japan’s Gradual Transformation, Cheltenham, Edward Elgar
(2008) 155. But this might create the worst of both worlds: an informal body struggling to apply a still-flexible,
substantive test (rather than the more bright-line Anglo-Australian rules): Nottage et al., above n 93, 8.
134 Milhaupt and Pistor, above n 73, 99–100. They also remark that at least one-third of the (original)
Corporate Value Study Group’s members had extensive exposure to Delaware corporate law. Less convincing,
however, is their argument that the City Code alternative would have required introducing a UK-style
mandatory bid rule, ‘which would require major changes to the tender offer provisions of the securities
law, which may have been politically problematic given the lack of cooperation between METI and the
financial services agencies’. In fact, amendments in 2006 anyway introduced a requirement for bidders to bid
for all outstanding shares if seeking two-thirds of more of the shares: Kanda, above n 132, 5. Nonetheless,
that threshold is comparatively high and anyway ‘the acquirer always has the option of going to the market
and exempting themselves from the obligations of a tender offer’.
 GERMANY, JAPAN AND CHINA 379

and Pistor still view Japanese courts as ‘inclined to stake out a key role for them-
selves as arbiters of contests for control, not unlike the Delaware courts’, with
‘the Livedoor case and its aftermath [being] symptomatic of a broad shift in the
use of law to support market activity in Japan’.135 That may be putting it too
strongly, but another gradual transformation does seem evident already in this
field. Mergers and acquisitions burgeoned after the late 1990s, including now
a considerable proportion involving foreign acquirers.136 And the possibility of
hostile takeovers is no longer a negligeable part of the corporate governance
landscape.
Puchniak justifiably objects to those who have proclaimed already a more
drastic reconfiguration, but tends to overstate his case when arguing for de
minimus change and impact.137 For example, he takes a conventional but quite
narrow view of what constitutes a hostile takeover. Even if a target board does
not directly object to a bid, it can indicate a preference for another. Things have
also changed compared to the 1980s, in that the blue-chip companies are now
launching hostile bids too, turning bids into a recognised business tactic.138 A
major firm admittedly has not yet succeeded in such a bid, but upward share
valuations are occurring and so in that sense the market for corporate control
is operating in Japan. The growing numbers of companies issuing poison pills
should also be counted beyond 2006, alongside survey evidence that many man-
agers nowadays continue at least to feel threatened by the possibility of a hostile
takeover. The numbers may still be proportionately fewer than in the USA, but
that could be due to some ongoing (or even new) uncertainties.139 It is also the
explanation for the persistence of greater stable shareholdings still in Japan;
indeed, companies continued to sign up to more poison pills despite a recent rise
again in cross-shareholdings noted by Puchniak and others.

13.4.5.4 Main banks

Japan’s M&A market remains quite distinctive because of the continuing impor-
tance of bank finance for listed firms, although that peaked during the high-
growth 1960s and 1970s. As the yen appreciated and the stock market boomed
over the 1980s, companies expanded overseas and diversified corporate finance,
especially bond and new share issuance. The collapse of the ‘bubble economy’
from 1990 drastically reduced the raising of capital through shares, with pub-
lic offerings in 2007 constituting less than a tenth of the amount in 1989.
But third-party issuance has grown steadily since 1991, and in 2000 overall

135 Milhaupt and Pistor, above n 73, 104.

136 Milhaupt and West, above n 92, 179–206; Robert Grondine and Brian Strawn, ‘Corporate and Project
Finance’ in Gerald McAlinn (ed.), Japanese Business Law, The Hague: Kluwer (2007) 515 at 535–45.
137 Dan W Puchniak, ‘Delusions of Hostility: The Marginal Role of Hostile Takeovers in Japanese Corporate
Governance Remains Unchanged’ (2009) 28 Journal of Japanese Law 89.
138 As in the case of Oji Paper: cf Oda, above n 93, 262.
139 See respectively, Kozuka, above n 123; Osugi, above n 119; Milhaupt and Pistor, above n 73, 92; Oda,
above n 93. The takeovers story also needs to be read in the context of other evidence that managers are
placing greater weight on shareholder interests: see even the recent work by Ronald Dore and more cited in
Nottage, above n 68.
380 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

equity finance (shares plus bonds – mostly now convertible warrant bonds)
surpassed borrowing from banks. They struggled throughout the 1990s with
non-performing loans and the capital adequacy ratios required by the Bank of
International Settlements, and a banking crisis from late 1997 through to 1998.
On the other hand, equity finance has declined from 2006, including issues of
bonds with pre-emption rights for new shares, with some commentators pointing
to concerns about exposing companies to hostile takeovers.140
Central to post-war bank finance in Japan has been the ‘main bank’, the
primary lender and provider of many other services to the firm. The firm would
disclose information extensively to its main bank, usually assisted by the bank
becoming a major shareholder (albeit subject to a 5 per cent statutory limit),
and with retiring bank officials often becoming its senior finance officers. If
the borrower nonetheless got into difficulties, the main bank would try to tide
it over or restructure it through new loans or refinancing, guaranteeing other
firm debts or sending officials to assist as managers or directors. However, this
constituted an implicit promise to attempt a rescue instead of relying on often
higher-priority security interests. It depended on main banks being able to take
a long-term view of the relationship, which would include possibilities for more
extensive profits on other business provided to the firm compared to the other
banks. Main bank rescue ex post, and its role as an important ex ante and interim
monitoring mechanism for corporate governance of firms in Japan, also relied
on borrowers retaining quite extensive intangible value. Another premise was
informal relationship with the government, promising long-term advantages (for
example, more approvals for new branches) if main banks supported economic
stability by informally supporting firms with desirable long-term prospects.
Logically, the system is challenged by deregulation of financial markets par-
ticularly since the 1990s and a general shift towards more arms-length relation-
ships, including the government now occasionally allowing banks to fail and
a more accessible formal bankruptcy law regime.141 But there is still scope to
debate the precise impact, now and in the foreseeable future, on main banks.
Experienced Tokyo practitioners have argued, for example, that:142

In the last 10 years this main bank system has seriously declined, especially as the 20
major Japanese city and long-term credit banks have consolidated into basically only
four main banking conglomerate groups that are now competing more actively for
good new customers . . .
In the past if a company sough financing from a bank which was not its main bank, the
first impression at this new bank would very likely have been that the company must be
in severe trouble because its main bank would not lend for the particular project. Now
this occurrence has become relatively common and the new bank will often welcome
this opportunity to develop a new customer at the expense of its rivals.

140 Oda above n 93, 270–2 (citing Egashira and Moden).

141 See generally Kent Anderson, Stacey Steele and Shoichi Tageshira, ‘Insolvency Law’ in Luke Nottage
(ed.) CCH Japan Business Law Guide: Looseleaf, Singapore, CCH Asia (2009).
142 Grondine and Strawn, above n 136, 519.
 GERMANY, JAPAN AND CHINA 381

For Kozuka, one of the most striking transformations among Japan’s 40 largest
companies in 2008 compared to 1998 is that banks have virtually disappeared as
major shareholders, with a corresponding rise in institutional investors (includ-
ing many foreign investors). Further, although equity ratios have remained
almost unchanged on average, there is now much greater variance.143
On the other hand, although large firms continued to lessen ties with banks in
favour of bond issuance over the 1990s, smaller listed firms continued borrowing
and firms already carrying high levels of bank debt relied on main banks for a
growing proportion. Empirical studies suggest that the banking crisis did not
result in a credit crunch at least among firms with strong growth opportunities,
while:144

debt did play a disciplinary role in the 1990s, but a high concentration of loans with
the main bank tended to delay the corporate restructuring. This suggests that banks
facing financial distress engaged in soft-budgeting and followed an ‘evergreen’ policy
of rolling over loans. This situation made the threat of bank intervention in poorly
performing firms less credible. Thus, close ties with a main bank no longer the positive
disciplinary role of ‘contingent governance’ in Aoki’s sense.
Relationship banking in Japan is not likely to disappear, but it will play a more limited
role. Roughly, one-third of all listed firms now depend on capital markets for external
finance, but these mostly large firms constitute approximately 70% of total firm value
and over 50% of total employees among all firms on the First Section of the Tokyo
Stock Exchange in 2002. For these firms, bank loans are now based on an explicit
and arms-length contract (eg credit line or loan syndication). For these firms, market
pressure through institutional investors and bond ratings are now playing a major
role in corporate governance and banks are unlikely to regain their monitoring role.
Meanwhile, the majority of smaller firms continue to depend on bank borrowing.
Here banks have continued advantages through private information, which can help
overcome difficulties in raising finance. Whether banks can once again effectively
monitor these firms depends very much on their financial health.

Puchniak therefore seems to overstate the position in suggesting that ‘the main
bank system dramatically increased its influence over the Japanese economy
throughout the lost decade’.145 But he convincingly shows how evergreening

143 Kozuka, above n 72, 234–5.

144 Gregory Jackson and Hideaki Miyajima, ‘Introduction: The Diversity and Change of Corporate Gover-
nance in Japan’ in Masahiko Aoki, Gregory Jackson and Hideaki Miyajima (eds), Corporate Governance in
Japan: Institutional Change and Organizational Diversity, Oxford, Oxford University Press (2007) 1, 18–19,
summarising Yasuhiro Arikawa and Hideaki Miyajima, ‘Relationship Banking in Post-Bubble Japan: Coexis-
tence of Soft- and Hard-Budget Constraints’ in Masahiko Aoki, Gregory Jackson and Hideaki Miyajima (eds),
Corporate Governance in Japan: Institutional Change and Organizational Diversity, Oxford, Oxford University
Press (2007) 51 and referring to Masahiko Aoki, Towards a Comparative Institutional Analysis, Cambridge,
MIT Press (2001). They also note research showing how Japanese banks have increasingly used private equity
funds to strengthen their role in corporate restructuring: Noriyuki Yanagawa, ‘The Rise of Bank-Related Cor-
porate Revival Funds’ in Masahiko Aoki, Gregory Jackson and Hideaki Miyajima (eds), Corporate Governance
in Japan: Institutional Change and Organizational Diversity, Oxford, Oxford University Press (2007) 205.
However, greater formalisation through lines of credit and such like does not automatically mean that main
banks will shelter behind them when the going gets tough for borrowers, who can still appeal to an implicit
promise for assistance in restructuring.
145 Dan W Puchniak, ‘Perverse Rescue in the Lost Decade: Main Banks in the Post-Bubble Era’ in Luke
Nottage, Leon Wolff and Kent Anderson (eds), Corporate Governance in the 21st Century: Japan’s Gradual
Transformation, Cheltenham, Edward Elgar (2008) 81 at 106.
382 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

and perverse lending (to more poorly performing borrowers, usually with no
interest-rate premium) were facilitated particularly through main banks and
thanks to a new informal government policy regime aimed at supporting the
banking system overall. That analysis certainly undercuts Miwa and Ramseyer,
who assert that market forces and arms-length enforceable rules are all that
matter in the Japanese economy, thus rendering the main bank system another
pernicious ‘myth’ about Japanese corporate governance.146
The continued but arguably diminished existence of the main bank system
is also consistent with a broader revival of cross-shareholding and stable share-
holding in recent years, also involving banks. But that has also now attracted
concern from the TSE, including the possibility of mandating disclosure of such
shareholdings and related agreements, which some companies are now doing
voluntarily.147 Overall, therefore, it does seem that:148
corporate finance in Japan is increasingly characterized by the co-existence of two
different, and in ways competing logics – a pattern rather similar to Germany or
Italy . . . While the main bank system has not disappeared, it has been institutionally
displaced and its scope limited to a more specific niche segment of firms than in the
past.

13.4.6 Core employees

Significant ‘displacement’ is also evident in Japan’s lifelong employment system,
although the transformation is arguably even more gradual. The implicit promise
of a job for life – combined with related practices such as seniority based wages
and promotions, cooperative industrial relations, entry level hiring followed
by job rotations (and hence generalist or firm-specific skills training), and a
relatively weak external labour market – have long been identified as a further
key monitoring mechanism distinguishing post-war corporate governance in
Japan. Indeed, Puchniak argues that career management incentivised by lifelong
employment was essential to efficient main bank monitoring, making the system
the most important element for trust in the market and hence the expansion (and
dispersion) of shareholdings in post-war Japan.149 Yet, a range of new strategies
since the 1990s aimed at:150
promoting ‘shareholder value’ may provoke a number of conflicts with employees
around the issues of corporate disclosure, business portfolios, equity-oriented per-
formance targets and the use of performance-oriented pay, such as stock options.
Shareholder value creates pressure for more market responsiveness in employment
through reducing excess employment, divesting from less profitable businesses and
decentralizing bargaining to match wages with productivity.
146 See for example Miwa and Ramseyer, above n 87; cf also Curtis J. Milhaupt, ‘On the (Fleeting) Existence
of the Main Bank System and Other Japanese Economic Institutions’ (2002) 27 Law and Social Inquiry 425
and the further critiques by Puchniak above n 87 and Nottage and Freedman above n 87.
147 Financial System Study Group, above n 105, 8.
148 Jackson and Miyajima, above n 144, 19.
149 Puchniak manuscript, above n 74.
150 Jackson and Miyajima, above n 144, 24–5.
 GERMANY, JAPAN AND CHINA 383

Nonetheless, the ideal of the lifelong employment system has always been more
important than its reality. Already by the 1990s, lifelong employment applied:151

to less than 10 percent of all corporate entities, barely 20 percent of all workers, and
only 8 percent of working women. Even if lifelong employment were dying, this is
hardly a strong basis to project major shifts in Japan’s corporate governance system
or capitalist configuration. Nor, given the enormous powers management have to
command labour even for core workers, is lifelong employment the radical departure
from at-will employment that are said to define more liberal market economies.

In predicting the system’s present and likely future influence, moreover, Wolff
stresses the importance of determining its main causes. A cultural theory seems
implausible in light of the limited reach of lifelong employment in practice,
for example. The neo-classical market theory sketched by Miwa and Ramseyer
asserts that the system survives only due to strict restraints on dismissals devel-
oped quite creatively by Japanese courts, but that development occurred after the
system emerged soon after the War. The ‘institutional complementarities’ theory
emphasised by Aoki and others struggle to explain how those institutions arose,
why they become associated with (seemingly endogenous) economic stagnation
over the 1990s, and other dark sides to the lifelong employment system (for
example, for women).152
For example, data from the late 1990s mostly show only small or statistically
insignificant shifts towards more market-oriented human resource management
(HRM) practices, as predicted by a model emphasising complementarities with
more readily observed transformations in corporate finance.153 Data from 2003
indicate that such practices – especially major shifts towards completely or partly
merit-based pay – are not significantly impacted by foreign ownership, but they
are by more outside board executives or by managerial stock options as an
emergent form of remuneration.154 Overall, ‘changes in corporate governance
have affected the role of employees but, in fact, some elements of Japanese-style
HRM may be compatible with a wider range of corporate governance institutions
than suggested by some theories of complementarity’.155
The best explanation for the lifelong employment system therefore appears
to be a political account, acknowledging the post-war agreement among at
least some major interest groups that established a ‘flexicurity’ mode of reg-
ulation – balancing security of tenure with extensive flexibility in the work-
ing conditions that managers can impose. Tensions are apparent within this

151 Leon Wolff, ‘The Death of Lifelong Employment in Japan?’ in Luke Nottage, Leon Wolff and Kent
Anderson (eds), Corporate Governance in the 21st Century: Japan’s Gradual Transformation, Cheltenham,
Edward Elgar (2008) 53 at 60.
152 Ibid, 61–4.
153 Masahiro Abe and Takeo Hoshi, ‘Corporate Finance and Human Resource Management in Japan’ in
Masahiko Aoki, Gregory Jackson and Hideaki Miyajima (eds), Corporate Governance in Japan: Institutional
Change and Organizational Diversity, Oxford, Oxford University Press (2007) 257.
154 Gregory Jackson, ‘Employment Adjustment and Distributional Conflict in Japanese Firms’ in Masahiko
Aoki, Gregory Jackson and Hideaki Miyajima (eds), Corporate Governance in Japan: Institutional Change and
Organizational Diversity, Oxford, Oxford University Press (2007) 282.
155 Jackson and Miyajima, above n 144, 26.
384 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

mode of regulation, but until it becomes subject to a new political settlement,

the main trend is an intensification of flexicurity for a diminishing core group,
culminating in:156

(i) preserving job security for incumbent core workers, (ii) squeezing out older and
younger workers from the benefits of permanent tenure (they now join women on the
‘outside’ of the system), (iii) disproportionately burdening the SME sector with the
fixed cost of surplus labour, and (iv) encouraging greater casualisation of the Japanese
workforce. A crisis in Japanese industrial relations is now in train.

Intensification has nonetheless been underpinned by a continuation or expansion

of legal rules. A judgment of the Tokyo District Court (2 January 2000) only
slightly relaxed unfair dismissals requirements even for larger companies, and
in 2003 the legislature confirmed the overarching ‘abuse of rights’ doctrine.
Employment security for women has been promoted through amendments to
the Equal Employment Opportunity Law (1997 and 2006) and the Child Care
and Family Care Leave Law (2004), while whistleblowers gained protection
through a new statute in 2004. In exchange, since the late 1990s flexibility has
been enhanced to allow managers to (re)direct labour even more efficiently,
including lifting of the holding companies prohibition and Commercial Code
amendments facilitating for spin-offs and such like, and to outsource labour
more easily.157
It remains to be seen how the new government led by the Democratic Party
of Japan (DPJ) will respond to the present tensions within the lifelong employ-
ment system, following its August 2009 election victory, which displaced the
conservative Liberal Democratic Party (LDP) from power for only the second
time since 1955. The DPJ may be more sensitive to the challenges faced by disad-
vantaged groups such as women and at least some SMEs (although the LDP has
also traditionally sought out votes from small business). It may therefore intro-
duce measures resulting in further displacement (or even ‘exhaustion’158 ) of the
system in favour of HRM practices more focused on the external labour market,
albeit with a more generous social safety net than under the LDP. But others are
likely to call instead for the security promised by the system – even at the cost
of managerial flexibility, especially nowadays – to be extended to increasingly
marginalised groups. Much will depend on the economic constraints placed on

156 Wolff, above n 151, 74.

157 Wolff above n 151, 75–8. See also Nottage and Wolff above n 89. However, whistleblower protection
can serve to promote broader shareholder interests, for example (see the Charle case cited above n 131),
or the interests of consumers – more prominent outside stakeholders these days – rather than conventional
insiders.
158 Wolff (above n 151, 79) agrees with Nottage, (above n 68, 41) that ‘exhaustion’ (the slow withering away
of lifelong employment) may be the closest description from among the five modes of ‘gradual transformation’
proposed by Wolfgang Streeck and Kathleen Ann Thelen, ‘Introduction’ in Wolfgang Streeck and Kathleen
Ann Thelen (eds), Beyond Continuity: Institutional Change in Advanced Political Economies, New York, Oxford
University Press (2005) 1 although ‘displacement’ (emergence of hitherto subordinate institutions and norms)
is also a possible description given the declining core of lifelong employees. But Wolff (above n 151) observes
that within this core, the system’s core feature of flexicurity is in fact intensifying. This pattern may represent
a sixth mode of gradual transformation, which may also be found outside Japan.
 GERMANY, JAPAN AND CHINA 385

the new government by the global financial crisis, in addition to those built up
over the ‘lost decade’, as well as the performance and potential of Japanese
firms – large and small.159

13.4.7 Conclusions on Japan

This brief introduction to two still-important and quite distinctive monitoring
mechanisms in Japanese corporate governance – the lifelong employment system
and main banks – reminds us that government policy and the vicissitudes of
politics are as important as economics and broader social or cultural context in
explaining and predicting trajectories. Nonetheless, a gradual transformation
seems to be underway even along these two dimensions, in parallel with more
significant changes in the relationship between shareholders and directors or
managers.
Among those who examined Japanese corporate governance from the 1970s,
some (like Haley) still emphasise continuities – especially in relation to employ-
ment relationships – and indeed tend to acclaim such features of Japan’s more
coordinated market economy. A very few revisionists (notably Ramseyer) instead
now proclaim Japan to be already a liberal market economy, just like the USA –
and that it has been so already for many decades. A much younger generation
of foreign commentators who have tracked developments since the late 1990s
(such as Kelemen and Sibbitt) tend to perceive drastic shifts towards ‘American-
isation’ and LMEs. But some now (especially Puchniak) see very little significant
change, impressed for example by the renewed economic growth enjoyed by
Japan over 2002–7 – albeit belatedly, at low rates, and thanks to considerably
pump-priming.
A third group (including Nottage, Wolff and Anderson as well as Deakin, Whit-
taker and their co-researchers, and Milhaupt especially over recent years) have
tracked aspects of Japanese corporate governance from the 1980s and tend to see
significant but gradual transformations. A key feature has been growing diversifi-
cation – of processes generating law and policy (especially over the last decade),
of comparative law borrowings or adaptations, and of corporate practices and
norms. This growing and admittedly sometimes messy diversity,160 especially

159 In particular, Japanese firms and governments may become more generally skeptical about the benefits
of deregulation following the global financial crisis debacle, yet both quite desperately need capital, at least in
the short-term, and renewed scepticism may not be as widely shared abroad. In other respects, for example in
its declared intention to pursue FTAs, the DPJ does not seem particularly ‘anti-market’; a very rough analogy
might be ‘New Labour’ in the UK. On the DPJ and possible policy developments more generally, see Luke
Nottage, ‘The New DPJ Government in Japan: Implications for Law Reform’ (1 September 2009), available
at <http://blogs.usyd.edu.au/japaneselaw/2009/09/the new dpj government.html>.
160 See the critique of Japan’s current diversity in generating rules for ‘Cross-Border M&A’, by Ken’ichi Osugi
and Yoshihisa Hayakawa in their Keynote Report for Toshiyuki Kono et al., ‘Koko ga Hen da yo – Nihon-Ho
[Is Japanese Law a Strange Law?]’ (2009) 28 Journal of Japanese Law 229 at 242–3. For a more positive
appraisal of hybridisation more generally in contemporary Japanese corporate governance, see Deakin and
Whittaker, above n 90.
386 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

in organisational forms, itself may be evidence of a move from CME-type insti-

tutions (demanding high levels of mutual investment in relationship-specific
assets) towards LME-type institutions.161 But Japan’s experience confirms some
indications from other jurisdictions that such changes do not necessarily occur at
the same rates along all dimensions – and the political aspects reinforce the possi-
bility of such complexity or even some ‘reverse course’. Evidence from two surveys
(in 2003) indicate considerable support even among managers for employees
being as important as shareholders and for a stakeholder model of corporate
governance more generally.162 Japan, therefore, continues to offer a fascinating
reference point in comparative corporate governance debates, in addition to its
continued practical importance within the world economy.

13.5 China

13.5.1 Introduction
Corporate law and corporate governance in China have been influenced by a
variety of factors: the traditional dominance of the state-owned sector and the
continuing ideological commitment by policy makers to the ‘socialist market
economy’; the decision by the government to attract foreign capital by encourag-
ing the establishment of foreign-invested companies in China and subsequently
to encourage the development of a corporatised private sector in order to develop
the Chinese economy and the use of the stock markets, in China and overseas;
and the decision to capitalise upon and expand first state-owned and then private
Chinese companies. Chinese decision makers have adopted selected concepts and
ideas from a wide range of legal systems in attempting to construct a corporate
and securities legal system that will be appropriate and effective in China.
Corporate governance is of concern to Chinese companies of all kinds –
state-owned, foreign-invested and private, domestically owned corporations.
It became an issue of concern for foreign and domestic investors because of
government-backed efforts by state-owned enterprises from the early 1990s to
raise money first on Chinese and then on international markets from foreign and
domestic investors while maintaining control over the listed vehicle. Indeed,
the issue of the controlling shareholder (generally the state) and its activities in
diverting assets and business advantages from its listed subsidiary continues to
be a major problem in Chinese corporate governance. Corporate governance is
also concerned with providing adequate protection for investors in other listed

161 Mari Sako, ‘Organizational Diversity and Institutional Change: Evidence from Financial and Labor
Markets in Japan’, in Masahiko Aoki, Gregory Jackson and Hideaki Miyajima (eds), Corporate Governance
in Japan: Institutional Change and Organizational Diversity, Oxford, Oxford University Press (2007) 399;
and more generally Jackson and Miyajima, above n 144. Cf for example Jacoby above n 87 (suggesting,
from mostly earlier data, that Japanese companies have shown little or no expansion in HRM and corporate
governance diversity between 1980 and 2004, only a shift on average – smaller than in the USA – towards
market-based forms over that period).
162 Wolff above n 151, 70.
 GERMANY, JAPAN AND CHINA 387

companies and in the fast-growing private sector in China. It is also of interest to

the wholly state-owned sector: the Chinese government has stated its commit-
ment to the principle of corporate social responsibility and better standards of
enterprise internal controls for state-owned enterprises.163
A variegated system of controls and controllers has been developed in China
to deal with these different types of entities and issues. Although principles of
corporate governance imposed on listed companies have attracted much of the
scholarly attention devoted to corporate governance in China and are obviously
important indicators of how Chinese regulators approach the various issues, it
is important not to overlook other Chinese companies and corporate entities,
the regulation of which is also clearly causing concerns for investors, other
stakeholders and regulators.
This part of the chapter begins by examining the legislative structure in China,
particularly as it relates to corporate governance. It looks briefly at the different
kinds of corporate entity in China and the different issues these varied types
of entities present, and examines the regulatory structure relating to corporate
governance. It then considers the main problems for corporate governance in
China, the varying methods that have been used to resolve these issues and
the consequent development of corporate governance principles and rules, and
concludes with a brief discussion of the efficacy of these methods and likely
future developments.

13.5.2 Government and legislation in China

The National People’s Congress (NPC) is the premier law-making authority in
China. Only the NPC (and its Standing Committee when the NPC itself is not in
session) is able to make laws (falü).164 The Constitution, as implemented by the
Law on Legislation,165 makes it clear that the right to legislate on important issues
such as criminal law, deprivation of a citizen’s right to liberty, civil institutions
and fundamental economic systems (including tax, customs, finance and trade)
belongs solely to the NPC or its Standing Committee. Thus, the principal items
of legislation in the corporate area, the Company Law, the Securities Law,166

163 National People’s Congress, 2005, Company Law of the People’s Republic of China (29 December 1993;
subsequently amended on 28 August 2003 and 27 October 2005, effective 1 January 2006), (‘Company
Law’), Article 5: ‘When engaging in business activities, a company must abide by laws and administrative
regulations, observe social morals and business ethics, act in good faith, accept supervision by the government
and the public, and bear social responsibilities.’ Ministry of Finance, China Securities Regulatory Commis-
sion, National Audit Office and China Insurance Regulatory Commission, Basic Internal Control Norms for
Enterprises (2008); State-Owned Assets Supervision and Administration Commission of the State Council,
Guiding Opinions Concerning Fulfillment of Social Responsibility by Central Enterprises (29 December 2007).
164 NPC, Constitution of the People’s Republic of China (adopted 4 December 4, 1982; amended 12 April
1988, 29 March 1993, 15 March 1999 and 14 March 2004), Art 62.
165 Standing Committee of the NPC, Law on Legislation of the People’s Republic of China (15 March 2000,
effective 1 July 2000), Art 8.
166 NPC, Securities Law of the People’s Republic of China (29 December 1998, amended 27 October 2005,
effective 1 January 2006).
388 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

the Securities Investment Fund Law167 and the Criminal Law168 were all passed
by the NPC or its Standing Committee. The State Council, the highest level
of executive authority in China, under the Premier, may issue administrative
regulations (xingzheng guiding) on important matters.169 These often include
detailed implementing regulations that clarify areas in the laws that are vague
or are felt to need further elaboration.
China is not a federal system. Thus, although provincial, municipal and other
lower-level governments have the power to issue rules and decrees, the provinces
and other governments do not have distinct areas of responsibility that belong
specifically to them. They do, however, have the power to issue implementing
legislation and legislation on ‘local matters’.170 The central government has
maintained strict control over companies and securities law, and regulation in
China and local legislation have been permitted only limited impact.171 Thus,
although Shenzhen and Shanghai had introduced experimental corporate law
regimes in the early 1990s in order to underpin their budding stock markets,172
these rules were replaced in their entirety by the Company Law and the national
corporate law regime.
The various ministries, administrations and other bodies under the State
Council may issue rules, decrees and other instruments with legislative impact.173
The State Administration for Industry and Commerce (SAIC) is the company reg-
istration body174 and its rules and activities have some impact on corporate issues
such as governance. The State-owned Assets Supervision and Administration
Commission of the State Council (SASAC) is responsible for centrally adminis-
tered, state-owned enterprises and plays a regulatory, legislative and supervisory
role in relation to those enterprises.175 Similar, state-owned assets administra-
tions play a role in relation to locally administered, state-owned enterprises. The
Ministry of Commerce, which is responsible for internal and external trade, is the
authority primarily responsible for foreign-owned enterprises.176 The primary
regulator for listed companies is the China Securities Regulatory Commission

167 Standing Committee of the NPC, Law on Securities Investment Funds (28 October, 2003, effective 1 June,
2004).
168 NPC, Criminal Law of the People’s Republic of China (adopted 14 March 1997, amended 25 December
1990, 31 August 2001, 29 December 2001, 28 December 2002, 28 February 2005, 29 June 2006 and
28 February 2009).
169 Law on Legislation, note 165, Chapter 3.
170 Law on Legislation, Chapter 4.
171 Standing Committee of the NPC, Law on Administrative Licensing of the People’s Republic of China (27
August, 2003, effective 1 July 2004), Art 15, for example, makes very clear that local authorities may not
impose pre-qualification or other requirements upon entities seeking to incorporate under the Company Law.
172 Standing Committee of the Shenzhen Municipal People’s Congress, Regulations on the Shenzhen Spe-
cial Economic Zone on Companies Limited by Shares (26 April 1993); Standing Committee of the Shenzhen
Municipal People’s Congress, Regulations of the Shenzhen Special Economic Zone on Limited Liability Companies
(26 April 1993); Shanghai People’s Municipal Congress, Shanghai Municipality Tentative Provisions on Com-
panies Limited by Shares (18 May 1992); see also Bath, ‘Introducing the Limited Company’, China Business
Review (1993) 1–2, 50–54.
173 Law on Legislation, Art 71.
174 See website at <www.saic.gov.cn>.
175 See website at <www.sasac.gov.cn>.
176 See website at <www.mofcom.gov.cn>.
 GERMANY, JAPAN AND CHINA 389

(CSRC), another body under the State Council.177 The CSRC is a prolific issuer
of rules and documents in the securities area. In the corporate governance area,
a significant step recognising the importance of corporate governance standards
was taken with the issuance of the Code of Corporate Governance for Listed Com-
panies in China in 2001,178 which was followed by the Guidelines on Introducing
the Independent Director System in Listed Companies.179 The importance of cor-
porate governance was again emphasised by the CSRC in 2005180 and in 2007
with the issuance of the Notice on Matters concerning Carrying out a Special Cam-
paign to Strengthen the Corporate Governance of Listed Companies,181 followed
in 2008 by the jointly issued Basic Internal Control Norms for Enterprises.182 The
CSRC has also issued a number of regulations on important corporate governance
issues such as rights of shareholders of public companies183 and requirements
for public disclosure of information.184
The China Insurance Regulatory Commission, however, has primary respon-
sibility for insurance companies, and the China Banking Regulatory Com-
mission has primary responsibility for banks and financial institutions. These
two commissions thus have overlapping responsibilities with the CSRC to the
extent that insurance and financial companies are listed or engage in securities
transactions.185 The Supreme People’s Court and the Supreme People’s Procura-
torate also issue opinions, interpretations and regulations on the application of
particular laws or the handling of particular matters. Opinions of the Supreme
People’s Court restricting the ability of shareholders to bring actions in securities
cases, for example, have been an important reason for the relatively slow growth
of shareholder litigation.186 The Listing Rules and other regulations of stock
exchanges upon which the securities of Chinese companies are listed and traded,
both inside and outside China, also have an impact on corporate governance and
behaviour of listed companies.
Although the Communist Party plays a ‘leadership’ role under the Preamble
to the Constitution and is given no formal legislative role, it has a continuing
and highly significant role in administration, implementation of policies and

177 See website at <www.csrc.gov.cn>. The primary activities of the CSRC are described in China Securities
Regulatory Commission, CSRC Annual Report (2008), English version available at: <www.csrc.gov.cn/pub/
csrc en/about/annual/200907/P020090701496625000834.pdf>.
178 CSRC, Code of Corporate Governance for Listed Companies in China (7 January 2001).
179 CSRC, Guidelines on Introducing the Independent Director System in Listed Companies (16 August 2001).
180 State Council, Circular of the State Council on Approving and Forwarding the Opinions of the China
Securities Regulatory Commission on Improving the Quality of Listed Companies (19 October 2005).
181 CSRC, Notice on Matters Concerning Carrying out a Special Campaign to Strengthen the Corporate Gover-
nance of Listed Companies (9 March 2007).
182 Ministry of Finance, China Securities Regulatory Commission, National Audit Office and China Insurance
Regulatory Commission, Basic Internal Control Norms for Enterprises (issued 22 May 2008, effective 1 July
2008).
183 For example, CSRC, Several Regulations concerning Reinforcement of Protection of Public Shareholders’
Rights and Interests (7 December 2004); CSRC, Rules on Shareholders’ Meetings of Listed Companies (16 March
2006).
184 CSRC, Measures on Administration of Information Disclosure of Listed Company (30 January 2007).
185 See websites at <www.circ.gov.cn>; <www.cbrc.gov.cn>.
186 See Wallace Wen-Yeu Wang and Jian-Lin Chan, ‘Reforming China’s Securities Civil Actions: Lessons
from PSLRA Reform in the U.S. and Government-Sanctioned Non-Profit Enforcement in Taiwan’ (2008) 21
Columbia Journal of Asian Law 21 at 115–60.
390 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

policy making itself. Indeed, Article 19 of the Company Law provides for the
establishment of a party organisation in each company set up under the law.187
This influence may extend to the issuance of influential policy documents but
also operates through less obvious and formal means. Senior officials of govern-
ment derive power from their positions in the Communist Party, and power may
be in the hands of persons who have a relatively insignificant role in the gov-
ernment hierarchy. This flows through to state-owned enterprises, universities,
courts and other entities, where the Communist Party structure effectively takes
priority over the formal structure and where senior officials may be appointed
by sources outside the organisation.188 In the corporate governance context, the
fact that there may be a dual organisation within the entity, or that important
decisions about managers and management may be taken by sources outside the
organisation, has a potential impact on the effectiveness of measures taken to
improve the internal management structures and activities.

13.5.3 Corporate entities in China

There are three main categories of companies and corporate entities in China,
including foreign-investment enterprises, state-owned enterprises and compa-
nies, and privately owned companies.

13.5.3.1 State-owned enterprises

Until the introduction of foreign-investment enterprises in 1979, the Chinese
economy was dominated by state-owned enterprises, which were under the
control of various parts of government and administered as a part of govern-
ment rather than as autonomous corporate entities.189 The dominance of the
state-owned enterprise in the economy was not, however, accompanied by an
equivalent level of efficiency or productivity.190 The 1980s and 1990s saw a con-
certed effort by government to reform state-owned enterprises by a combination
of means, including reorganisation, mergers and takeovers, privatisation and
mergers.
An important step forward in terms of the formalisation of the structure of
state-owned enterprises was the promulgation of the 1988 Law on Industrial
Enterprises owned by the Whole People.191 This law gave substantial power to

187 See also Sonja Opper and Sylvia Schwaag-Serger,‘Institutional Analysis of Legal Change: The Case of
Corporate Governance in China’ (2008) 26 Washington University Journal of Law & Policy 245 at 253 and 261.
188 For a more detailed discussion, see Nicholas Howson, ‘China’s Restructured Commercial Banks: Nomen-
klatura Accountability Serving Corporate Governance Reform?’ in Cai Zhu and Avery (eds), China’s Emerging
Financial Markets: Challenges and Global Impact, Singapore, John Wiley & Sons, (2009); Fang Hu and Sid-
ney Leung, Appointment of Political Top Executives and Subsequent Performance and Corporate Governance:
Evidence from China’s Listed SOEs (March 17, 2009), available at <ssrn.com/abstract=1361617>.
189 Chao Xi, Corporate Governance and Legal Reform in China, London, Wildy, Simmonds and Hill Publishing
(2009) 6 et seq.
190 Wallace Wen-Yeu Wang, ‘Reforming State Enterprises in China: The Case for Redefining Enterprise
Operating Rights’ (1992) 6 Journal of Chinese Law 89, 92.
191 NPC, 1988, Law of the People’s Republic of China on Industrial Enterprises Owned by the Whole People
(13 April 1988, effective 1 October 1988, amended 27 August 2009). See also Xi, above n 189, 6–35, for a
description of the historical development of management and structure of state-owned enterprises.
 GERMANY, JAPAN AND CHINA 391

the factory director, who was appointed by the relevant level of government or
elected by the workers,192 acted as the legal representative of the enterprise193
and assumed overall responsibility for the work of the enterprise.194 He (or she)
acted as the chief executive officer (CEO) of the enterprise, assisted by a man-
agement committee that was chaired by the factory manager and comprised
employee representatives and ‘leading persons’ in charge of parts of the enter-
prise (Article 47). A board of directors or shareholder structure was not required
in the Law on Industrial Enterprises Owned by the Whole People, even though the
Chinese-foreign Equity Joint Venture Law,195 which required a board of direc-
tors and a chairman, had been in effect since 1979. The role of the relevant local
government in relation to the enterprise was to formulate policies, coordinate
relationships with other enterprises, provide information, protect state assets
and improve public facilities (Article 56). The Communist Party was guaranteed
a role in the enterprise, supervising the implementation of the guiding principles
of the Party.196
This was succeeded by a policy requiring the corporatisation of state-owned
enterprises.197 Thus, the Company Law contains a chapter198 that deals specif-
ically with wholly state-owned companies. In addition, many listed companies
have substantial amounts of state ownership. There are still, however, a number
of different kinds of state-owned enterprises in existence, the corporate organisa-
tion of which varies depending on the history of the entity. An examination of the
list of centrally controlled, state-owned enterprises administered by the SASAC,
for example, shows that many of these state-owned enterprises, although cor-
porations, have not been converted into corporations under the Company Law
and do not have corporate structures including a board of directors or board of
supervisors as required under the Company Law.199 For example, the website of
China National Offshore Oil Company (CNOOC) sets out a list of management,
which does not mention a board of directors; instead, the chief officer of the
company (Fu Chengyu) is both President of CNOOC and Party Leadership Group
Secretary.200
The fundamental principles relating to the management and governance of
state-owned enterprises are reflected in the recently promulgated Enterprise
State Assets Law, which states that the relevant entity of the State should act as the
192 Article 44.
193 Article 45.
194 Article 7.
195 NPC, Law of the People’s Republic of China on Chinese-Foreign Equity Joint Ventures (1 July 1979; amended
4 April 1990 and 15 March 2001).
196 Article 8.
197 Cindy Schipani and Junhai Liu,‘Corporate Governance in China: Then and Now’, (2002) 1(1) Columbia
Business Law Review 1, 22–8.
198 Company Law, Articles 65–71.
199 See list of central enterprises on SASAC website at <www.sasac.gov.cn/n2963340/n2971121/
n4956567/4956583.html>.
200 CNOOC website <www.cnooc.com.cn/data/html/chinese/channel 111.html>. The continuing role
of the Communist Party in state-owned enterprises should not be forgotten. An example of the relative
importance attached to these positions can be seen in the contrast between the English and Chinese websites –
on the English site, the positions held by the President are listed as ‘President: Party Leadership Group
Secretary’. On the Chinese site, the position of Party Secretary is listed first.
392 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

investor in state-owned enterprises ‘in accordance with the separation of govern-

ment from enterprises, the separation of public administrative functions from the
functions of state-owned asset investors and respecting the lawful and indepen-
dent operation of enterprises’.201 The Enterprise State Assets Law also requires
that state-owned enterprises accept social responsibilities and establish corpo-
rate governance systems.202 Although the number of state-owned enterprises
in China has been reduced since 1979 by a concerted policy of privatisations,
planned bankruptcies and consolidations, the state-owned sector continues to
be strong. Government policy is to continue state dominance of ownership and
control in certain sectors203 and to protect ‘state assets’ generally. The challenge
for regulators and companies alike is to maintain the separation of the roles of
managers, investors and regulators in entities that are essentially guaranteed a
dominant place in the market and to improve the corporate governance regimes
within companies that do not have a diverse group of shareholders monitoring
the performance of the company and the behaviour of its executives.

13.5.3.2 Foreign-investment enterprises

Modern corporate law in China can be said to date from 1979, with the pro-
mulgation of the Chinese–Foreign Equity Joint Venture Law. This was followed
in 1986 by the Wholly Foreign Owned Enterprise Law204 and subsequently by
the Cooperative (or Contractual) Joint Venture Law.205 These three laws and
their associated implementing regulations, notices, decrees and other subordi-
nate legislation still define the shape of foreign-investment enterprises, which
generally take the form of Chinese legal persons with limited liability, issuing
registered capital rather than shares. It was not until the promulgation of the
General Principles of Civil Law in 1986,206 however, that there was a serious
attempt to provide a definition for the concept of legal personality. The Com-
pany Law applied to foreign-investment enterprises in a limited fashion. After
the promulgation of the amendments to the Company Law in 2005, a concerted
attempt was made by the government department in charge of company regis-
tration, the SAIC, to bring foreign-investment enterprises into line with wholly

201 NPC, Enterprise State-owned Assets Law of the People’s Republic of China (2008, effective 1 May 2009),
Article 6.
202 Art 17: ‘State-invested enterprises that engage in operating activities shall abide by laws and regulations,
strengthen their operating management practices, enhance their profitability, accept the administration
and supervision of the government and relevant departments and organs, as well as the supervision of the
general public, and shall assume responsibilities to both society and investors. State-invested enterprises shall
establish and improve sound legal entity corporate governance practices, in addition to internal supervision
and risk control systems, in accordance with the law.’
203 General Office of the State Council, State-Owned Assets Supervision and Administration Commission
of the State Council, Circular of the General Office of the State Council Concerning Transfer of the Opinions of
the SASAC on Guidance for Promotion of Adjustment of State-owned Assets and Restructuring of State-owned
Enterprise, (5 December 2006).
204 NPC, Law of the People’s Republic on Foreign Capital Enterprises (adopted 12 April 1986, amended
31 October 2000).
205 NPC, Law of the People’s Republic of China on Chinese-foreign Cooperative Joint Ventures (adopted 13 April
1988, amended 31 October 2000).
206 NPC, General Principles of Civil Law (12 April 1986, effective 1 January 1987, amended 27 August 2009),
Chapter 3.
 GERMANY, JAPAN AND CHINA 393

Chinese-owned companies and to apply the corporate structure rules (such as

the requirement to have a supervisory board) set out in the Company Law to
foreign investment enterprises.207 The foreign-investment laws and regulations
set out only basic rules relating to corporate management structures, but do not
contain detailed provisions relating to corporate governance. The investors may,
however, impose corporate governance standards themselves through their con-
stituent documents or company policies and codes. The structure of joint-venture
companies, in particular, does not fit neatly into the management structure con-
templated by the Company Law, since joint ventures are not required to have
meetings of shareholders. Instead, directors are appointed by the parties and
may be removed only by the party that appointed them.208 An advantage offered
by the joint-venture structure, however, is that the joint-venture contract sets out
in considerable detail what the relationship between the investors is and how it
should operate. The minority party in a joint venture therefore has considerable
scope when it negotiates the joint-venture contract to incorporate the protections
it considers necessary and acceptable.

13.5.3.3 Companies under the Company Law

Companies set up under the Company Law may be privately owned, partly pri-
vately owned or wholly state-owned, and are able to take the form of either
limited liability companies or companies listed on a Chinese stock exchange or
outside China. The number and value of both private and listed companies have
grown considerably. On 5 November 2009, for example, there were 868 listed
companies on the Shanghai Stock Exchange, with a total market capitalisation
of 17.3 trillion RMB (AUD 2.7 trillion).209 Xinhua attributes a 15.8 per cent
increase in the number of privately owned enterprises in 2006 to the amend-
ments to the Company Law, which facilitated the establishment of small private
companies.210
The Company Law was followed by the Securities Law in 1998. Both laws
were significantly amended in 2005 in order to provide additional protection
to shareholders and to provide a higher degree of protection to shareholders,
particularly minority shareholders. In addition, a substantial number of regula-
tions, notices, decrees and codes of conduct have also been issued largely by the
State Council and the CSRC in order to improve the system and the standards of
corporate governance in Chinese companies. These apply mainly in relation to
listed companies, although the Basic Internal Control Norms for Enterprises,211

207 See Vivienne Bath, ‘The Company Law and Foreign Investment Enterprises in China – Parallel Systems
of Chinese-Foreign Regulation’ (2007) 30 UNSW Law Journal 774.
208 Equity Joint Venture Law, Art 6.
209 Shanghai Stock Exchange website <http://static.sse.com.cn/sseportal/en/home/home.shtml>. By
way of contrast, on 10 November 2009, there were 2198 companies listed on the Australian Stock Exchange,
with a market value of AUD 1.09 trillion – see the ASX website at <http://www.asx.com.au/about/asx/
index.htm>.
210 Xinhua, New Corporate Law Drives Growth of China’s Private Sector in 2006 (24 April 2007), available at
<http://english.peopledaily.com.cn/200704/24/print20070424 369117.html>.
211 Basic Internal Control Norms for Enterprises (issued 22 May 2008, effective 1 July 2008).
394 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

which were issued in 2008, are also aimed at large and medium-sized unlisted
enterprises.
The Company Law provides for a three-tier structure of management: a share-
holders meeting, a board of directors and a supervisory board. The roles and
functions of these different levels of management are prescribed in some detail
in the Company Law itself. Each company must have articles of association, and
some leeway is provided in the Company Law for the shareholders to modify the
relationship between them through the medium of the Articles. The main differ-
ence between a limited liability company and a joint stock company (or company
limited by shares) is that a limited liability company has registered capital (that
is, a specified sum of capital that may be paid in cash and/or in kind) and a joint
stock company has shares. Only joint stock companies may be listed – a limited
liability company or other entity must be converted into a joint stock company
if the shareholders wish to conduct a public offering.212 Most features of the
management and corporate governance regime for the two types of companies
as set out in the Company Law are, however, identical.
The vast majority of foreign-investment enterprises with legal personality
are limited liability companies. Corporatised state-owned companies will be
either limited liability companies or, if listed, joint stock companies. There are,
however, some differences between the form of these companies and a standard
limited liability company under the Company Law. A joint venture, as noted
above, does not have a shareholders’ meeting; a private company with only one
shareholder does not hold a shareholders’ meeting but makes decisions by written
memorandum (Article 62). A wholly state-owned company with one investor
effectively does not hold shareholders’ meetings either, and may delegate a
large amount of its authority to the board of directors, although the consent
of the relevant government authority acting as investor is required for certain
actions.213
Generally, however, the shareholders’ meeting is the organ of authority of a
company (Articles 37 and 99) and has, at least in theory, power over most of
the major management decisions of a company, including the ability to approve
business plans and budgets, elect and remove directors and supervisors, approve
dividend distribution plans, review and approve reports of directors and supervi-
sors, changes to the company’s corporate plan and so on (Articles 38 and 100).214
Decisions of the shareholders are generally taken by a majority vote, with the
exception of decisions on amendments to the articles of association, changes to
the registered capital and decisions on merger, division, dissolution or change
of the corporate form of the company, for which a two-thirds vote of the share-
holders is required (Articles 44 and 104). In theory, Chinese companies issue

212 Company Law, Arts 9, 96.

213 Company Law, Art 67.
214 See Charles Qu, ‘The Representative Power of the Shareholders’ General Meeting under Chinese Law’
(2008) 17 Pacific Rim Law & Policy Journal 295 at 300–2; Xi, above n 189, 36–42. See also Sandra Kister,
‘China’s Share-structure Reform: An Opportunity to Move Beyond Practical Solutions to Practical Problems’
(2007) 45 Columbia Journal of Transnational Law 312.
 GERMANY, JAPAN AND CHINA 395

only one class of shares. In practice, there have been many different types of
shares, ranging from state shares (held by the state); legal person shares (often
held by legal persons in which the state had a controlling interest); employee
shares; ‘A’ shares (listed on Chinese exchanges and available only for sale to
Chinese investors, with some exceptions); ‘B’ shares (listed on Chinese exchanges
and traded in foreign exchange); ‘H’ shares (traded on the Hong Kong Stock
Exchange) and so on.215 Voting rights of shareholders are, in principle, equal
(Articles 49 and 104).
The board of directors is elected by the shareholders and acts as the exec-
utive of the company. It is responsible for developing the budget and plans
presented to the shareholders, establishing management structure and appoint-
ing and dismissing the managers, convening shareholders’ meetings and so on
(Articles 47 and 109).
The supervisory board (or supervisor, in the case of a small company) has
essentially a monitoring role. It should include employee representatives as
well as supervisors elected by the shareholders (Articles 52 and 118), and is
responsible for examining the financial affairs of the company, supervising the
activities of the directors and requiring them to rectify wrongful actions and, if
necessary, instituting litigation to protect the shareholders (Articles 54 and 119).
In addition to these three tiers, a limited-liability company, a wholly state-
owned company and a joint-stock company should each have a manager whose
powers are also specified in the Company Law (although subject to the provi-
sions of the articles of association), including responsibility for operations and
production and internal management (Articles 50, 69 and 149).
The two main Chinese stock markets are the Shanghai Stock Exchange and
the Shenzhen Stock Exchange.216 Shares of Chinese companies are listed outside
China, principally on The Stock Exchange of Hong Kong.

13.5.4 Corporate governance – issues and resolutions

The main problem relating to Chinese listed companies arises from the number
of companies that are listed, but have one principal or controlling shareholder –
often the Chinese state in one form or another. Chinese government policy orig-
inally promoted the idea of listing on the basis that it would be a useful way to
raise additional capital from outside shareholders without giving away signifi-
cant amounts of control. Companies could not initially list at all without obtaining
government approval, and this approval was given to state-owned enterprises

215 Chenxia Shi,‘Protecting Investors in China Through Multiple Regulatory Mechanisms and Effective
Enforcement’ (2007) 24 Arizona Journal of International and Comparative Law 451 at 455–6.
216 There is a number of other securities exchanges, however, namely the Dalian Commodity Exchange, the
Shanghai Futures Exchange, the Zhengzhou Commodity Exchange and the China Financial Futures Exchange.
The CSRC’s policy is to develop a three-tiered market, involving the main board, a Growth Development Board
and an over-the-counter share transfer system. CSRC Annual Report (2008), above n 177, 17.
396 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

that were in need of new capital, rather than companies with a strong com-
mercial track record that could attract enthusiastic investors.217 In the Chinese
market, which initially had very few companies in which potential shareholders
could invest, there seemed to be (and still seems to be) no difficulty in attract-
ing shareholders to buy shares in initial public offerings.218 This enthusiasm for
shares, however, has been accompanied by a series of major scandals, in China
and in Hong Kong, relating primarily to the major problem of ‘tunnelling’ – that
is, the use by the controlling shareholder of its position to divert cash, assets and
business advantages from the listed company to itself – but also to such issues as
fraud, false accounts, faulty disclosure, insider trading and other forms of market
manipulation.219
Chao Xi220 comments that the two major problems in corporate governance
can be summarised as the conflicts between the owners of a company and the
managers, who may misuse their power to disadvantage the shareholders, and
the conflict between the majority shareholders, who may misuse their position to
disadvantage the minority shareholders. In China, it is the second of these prob-
lems; that is, the domination of listed companies by state-owned enterprises, that
has been the main problem. China is not, however, free from problems related
to management capture. A recent report on corporate governance in China led
by the China Academy of Social Science,221 for example, reported that corporate
remuneration in the top 100 listed companies in China increased substantially
in 2008, notwithstanding the global financial crisis and the loss of profitability of
many of these companies. Insider trading and market manipulation were specif-
ically addressed in the 2006 amendments to the Criminal Law, and the 2005
revisions to the Securities Law provided for the establishment of a special fund
to protect investors.222
The Chinese legislature and regulators (including the stock exchanges) have
attempted to deal with the issues of corporate governance by a variety of means,
including mandating and encouraging the adoption of internal management and
governance mechanisms, direct intervention in relation to particular corporate

217 Xi, above n 189, 42–51.

218 For example, Ran Zhang ‘Overseas Fever of Tsingtao Beer, 8 September 2008’, available at <www.
chinadaily.com.cn/bizchina/2008–09/08/content 7007294.htm> regarding over-subscription of Tsingtao
Beer shares in 1993; Trippon, ‘Shanghai Stock Exchange – World’s Hottest Stock Market Scores Another
Hit’ (29 July 2009), available at <www.stockmarketsreview.com/news/shanghai stock exchange worlds
hottest stock market scores another hit 20090729/> regarding 30 times over-subscription for Sichuan
Expressway.
219 Examples include Guangdong Kelon Electrical Holdings Co (executives accused of fraud and inflating
profits, a scandal in which Deloitte also became the subject of an investigation), see Zhang Ran, ‘Deloitte
Faces Double Trouble in China’, China Daily (31 March 2006), available at <http://www.chinadaily.com.
cn/bizchina/2006–03/31/content 556998.htm>. See also Hongming Cheng,‘Insider Trading in China: The
Case for the Chinese Securities Regulatory Commission’, (2008) 15 Journal of Financial Crime 165.
220 Xi, above n 189, 51–2.
221 Centre for Corporate Governance, Chinese Academy of Social Sciences, Centre for Research on Assess-
ment of Leaders, China National School of Administration & Protiviti Consulting, Corporate Governance
Assessment; Summary Report on the Top 100 Chinese Listed Companies for 2009, Beijing (2009), avail-
able at <http://en.iwep.org.cn/download/upload files/pradum55fq503c550lrjjnjy20090703142649.pdf>
16–17.
222 China Securities Regulatory Commission, 2006, Circular Concerning Deepening Study of Criminal Law
Amendment (6) by Listed Companies (12 July, 2006); Securities Law, Art 116.
 GERMANY, JAPAN AND CHINA 397

governance issues, public sanctions, education and administrative and criminal

penalties. Although the focus has been on listed companies, private (including
foreign) and state-owned companies are also included in this comprehensive
effort to establish a functional corporate governance regime in China.

13.5.5 Controlling the board of directors and the

managers – the supervisory board
As discussed above, Chinese companies under the Company Law have three
organisational bodies, with roles and responsibilities allocated under the Com-
pany Law. Legislators and regulators have looked at all three, the shareholders,
the directors and the supervisors, with a view to adjusting their powers in order
to improve standards of corporate governance.
The Company Law envisaged that the board of supervisors would play a
monitoring and supervisory role in a Chinese company. The supervisory board,
a body composed of representatives elected by the shareholders and employee
representatives,223 should investigate the financial affairs of the company, super-
vise acts of the directors and managers that breached laws, regulations or the
articles of association and order rectification of any acts that were harmful to
the company. The Company Law as passed in 1993, did not, however, give the
supervisors any power to obtain information or to enforce their decisions. It
became clear that the supervisory board had very little impact on the activities of
the board of directors or in improving the corporate governance of companies.
Indeed, given that the majority of the supervisors were appointed by the same
shareholders who appointed the directors, it seemed unlikely from the outset
that the supervisors would have a real effect on the operations of the board.224
Under Articles 52 and 53 of the amended Company Law, supervisors were
given more power – they may investigate the company’s financial affairs, super-
vise the directors and officers and recommend their removal, require a misbehav-
ing officer or director to ‘rectify’ their misbehaviour, propose that shareholders’
meetings be convened and convene a meeting themselves if the directors fail to
do so, and initiate litigation against directors for breach of duty if so requested
to do so by at least 1 per cent of the shareholders. They do not have the power,
however, to institute litigation at their own volition. In order to back up these
obligations, supervisors may attend board meetings as non-voting members and
conduct investigations (including by hiring outside accounting firms) into the
affairs of the company (Article 55), with all costs and expenses to be paid by the
company (Article 57).
Supervisors are subject to the same requirements as directors and officers of
the company in relation to qualification to act as a director (discussed below in
relation to the duties of directors), and are also required to comply with the law,

223 Company Law 1993, Arts 52 and 54.

224 Xi, above n 189, 151–6.
398 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

administrative regulations and the articles of association and to compensate the

company for any losses due to their failure to do so (Articles 148 and 150); may
not take bribes or otherwise take advantage of their position and are subject to
duties of fidelity to the company and diligence (Article 148), on the same basis
as the directors and officers.
The 2005 amendments did not, however, change the basic method by which
supervisors are selected nor did they impose any obligation that supervisors be
independent of the company or, in particular, of the controlling shareholder
(if there is one).225 There is, however, a requirement in Article 52 that at least
one-third of the supervisors be democratically elected representatives of the
workers.226 In addition, supervisors of joint stock companies, like directors, may
be elected on a cumulative voting system (Article 106) if the company’s articles
of association so provide. If implemented, this provision would give minority
shareholders the opportunity to elect supervisors in a number proportionate
to their total voting power.227 Nevertheless, the lack of any requirement that
the supervisors be independent is likely to mean that the supervisory board
will continue to be a relatively ineffective check upon the powers of the board.
Indeed, in relation to listed companies, although the role of the supervisory
board continues to be included by regulators as an essential part of a coherent
corporate governance regime,228 more emphasis has been put on improving the
board of directors itself than in turning the supervisory board into an effective
mechanism for monitoring and control.
Unlisted companies, however, are not required to have independent direc-
tors under the Company Law. Monitoring of these companies, therefore, still
relies on the supervisory structure, which is required for foreign-investment
enterprises established from the beginning of 2006,229 and wholly state-owned
companies.230

13.5.6 Increasing the duties of directors

The 2005 amendments to the Company Law significantly expanded the duties
of directors, supervisors and officers of the company and, for the first time,
gave shareholders a direct remedy in relation to breaches of duties by these
various officers. The Company Law allowed for the confiscation of unlawful

225 See comments in Xi, above n 189, 175–8 on issues of independence of the supervisory board.
226 See Chao Xi, ‘In Search of an Effective Monitoring Board Model: Board Reforms and the Political Economy
of Corporate Law in China’ (2006) 22 Connecticut Journal of International Law 1 at 21–2.
227 It appears that at least some listed companies do elect supervisors by this means. See China COSCO
Holdings Company Limited, Announcement of the Resolutions Passed at the Annual General Meeting: Amend-
ments to Articles of Association (2009); Payment of 2008 Final Dividends; Appointment of supervisors (9 June
2008), available at <www.jsda.or.jp/html/foreign/fminfo/info3/kobetsu/9197(20090615)1.pdf>, which
refers to the election of supervisors by cumulative voting.
228 For example, see CSRC, Notice on Matters concerning Carrying out a Special Campaign to Strengthen the
Corporate Governance of Listed Companies, Annex (2007).
229 State Administration for Industry and Commerce, Ministry of Commerce, General Administration of
Customs, State Administration of Foreign Exchange, Opinion on Several Issues on the Application of Laws
on the Administration of the Examination and Approval and the Registration of Foreign-Funded Companies
(26 April 2006), Art 18, see also, Bath, above n 207.
230 Company Law, Art 71.
 GERMANY, JAPAN AND CHINA 399

proceeds, punishment of the guilty director or officer by the company or, in

extreme cases, criminal prosecution (Articles 214 and 215). It also provided
that a director, supervisor or manager who caused loss to the company as a
result of breaching the Company Law or the company’s articles of association
should compensate the company (Article 63). The significant weakness in these
provisions, however, was that there was no mechanism clarifying the way in
which the ‘company’ as an entity should impose punishment on its erring officers,
or enforce its claim for compensation. In a case in which the director or manager
involving in defrauding the company was not acting alone, or was collaborating
with a majority shareholder, the minority shareholders did not have adequate
remedies through the medium of the Company Law to take the appropriate
action.
The Company Law now, through Part 6, sets out much more concrete provi-
sions relating to the duty of directors, supervisors and officers, and to the ways
in which action can be taken against infringing parties. Article 147 follows the
previous law in setting out the qualifications for directors, supervisors and offi-
cers. Generally, a person may not serve in such a position, and his election to
such a position is invalid, if he has no or limited capacity for civil acts;231 he
has a criminal conviction for a crime of dishonesty such as corruption and no
more than five years has elapsed since his sentence ended; he held a position
within the past three years as director, factory director or manager of an enter-
prise liquidated in a bankruptcy for which he was personally responsible, or of
an enterprise that has had its business licence revoked for a violation of law for
which he was responsible, or he is a person with a comparatively large amount
of personal debts which are due and unsettled.232
The Company Law does not otherwise provide for the concept of a person
being disqualified to serve as a director. It does, however, provide that directors,
supervisors and senior officers all have duties to the company in which they
serve. These duties are the same for both limited-liability companies and for
joint-stock companies. Article 148 requires that directors, supervisors and senior
officers comply with the provision of laws, administrative regulations and the
articles of association of the company, and that they have in addition duties of
fidelity and diligence to the company (Article 148).233 Although the concept of
the duties of fidelity and diligence (zhongshi yiwu he qinmian yiwu) are often
construed as fiduciary duties, the Chinese system is a civil law system and it is
not at all clear that equitable concepts relating to fiduciaries can to be imported
into these expressions.234 The law does not attempt to define the exact scope

231 General Principles of Civil Law, Chapter 2.

232 The Enterprise Bankruptcy Law does not deal with personal bankruptcies – only with the bankruptcy
of enterprises. NPC, Enterprise Bankruptcy Law of the People’s Republic of China (adopted 27 August 2006,
effective 1 June 2007).
233 By contrast, Article 33 of the Code of Corporate Governance provides that directors shall ‘faithfully,
honestly and diligently perform their duties in the best interests of the company and all the shareholders’.
234 See comments on the borrowed concept of ‘fiduciary’ duties by Donald C Clarke, ‘Lost in Translation?
Corporate Legal Transplants in China’ (2006) GWU Law School Public Law Research Paper No. 213, available
at <www.ssrn.com/abstract=913784> and in Xi, above n 189, 77–86 in the context of takeover legislation
in China.
400 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

of these duties, although Article 149 sets out a list of actions in which directors
may not engage, which ends with the expression ‘other acts in breach of his
duty of fidelity to the company’ and may therefore be construed to constitute
a list of actions that are in breach of the duty of fidelity. These acts focus on
financial misbehaviour and revealing business secrets, and include encroaching
on the property of the company (Article 148) or misappropriating funds of the
company; depositing company funds in a personal account; lending the funds
of the company or providing security over company property for the benefit of
a third person without the consent of the shareholders or directors;235 entering
into a contract with the company in violation of the articles of association of
the company or without the consent of the shareholders; taking for himself
commercial opportunities that belong to the company; taking secret commissions
or disclosing the secrets of the company without authorisation.
As a result, it is not clear whether the scope of the duty extends beyond
financial misfeasance to, for example, such acts as causing the company to trade
while insolvent, or whether the duty extends beyond the company to the share-
holders themselves. Article 153 gives the shareholders the right to bring action
against directors, supervisors or officers who harm the interests of shareholders
in violation of the law, administrative regulations or the provisions of articles
of association. It is not, however, clear how and to what extent this concept of
harm to the shareholders extends beyond the more clearly spelled out concept
of harm to the company itself.
A major development in the 2005 amendments was the creation of a regime
whereby direct action can be taken against infringing officers by the supervisors
(at the behest of the shareholders) or by the shareholders themselves. Article
150 provides that a director, supervisor or member of senior management who
violates ‘provisions of laws, administrative regulations or the articles of associ-
ation of the company in the execution of company duties and thereby causes
losses to the company’ will be liable to pay compensation. Under Article 152,
in such a case, shareholders holding at least 1 per cent of the voting rights in
the company may require the supervisors or, if the action complained of was an
act of the supervisors, the directors, to take action; and if they fail to do so, the
shareholders may take court action themselves ‘for the interests of the company’.
The Supreme People’s Court, in its Second Interpretation on the Company Law,
has extended the right of the shareholders to bring a suit under Article 152 to
the right to institute an action against members of the liquidation group when
the company is in liquidation (Article 23).236 This provision, not surprisingly,
has attracted a considerable amount of attention, due to its similarity to the
Western concept of a derivative action,237 although the sparse content of the

235 Article 16 of the Company Law provides that the grant of security for a third-party debt must be authorised
by either the board or the shareholders as set out in the articles of association.
236 Supreme People’s Court, Provisions of the Supreme People’s Court on Some Issues about the Application of
the Company Law of the People’s Republic of China (II) (12 May 2008, effective 19 May 2008), Art 23.
237 Hui Huang, ‘The Statutory Derivative Action in China: Critical Analysis and Recommendations for
Reform’ (2007) 4 Berkeley Business Law Journal at 227–50, available at <http://papers.ssrn.com/sol3/
papers.cfm?abstract id=1398606>.
 GERMANY, JAPAN AND CHINA 401

provision has raised a number of significant issues about its practical implica-
tions. It should be noted that this provision applies to limited-liability companies
as well as to joint-stock companies and may well prove to be a valuable tool for
oppressed minorities in private companies, as well as for shareholders in listed
companies.238 The issues relating to this provision are discussed in greater detail
below.

13.5.7 Independent directors

The Code of Governance for Listed Companies in China, issued by the CSRC in
2001,239 provided that listed companies should introduce independent directors
to the board (Article 49). This was followed by the Guidelines for Introducing
the Independent Director System in Listed Companies later that year,240 which
required that by 2003 at least one-third of the directors on the board of a listed
company should be independent (Article 1). More than half of the membership
of remuneration, audit, nomination and other committees should also be inde-
pendent, if the listed company has such committees (Article 5(4)). Under the
Guidelines, an independent director must have substantial professional work
experience (Article 2) and must not be related to officers of the company or its
subsidiaries, shareholders holding 1 per cent or more of the shares of the com-
pany and certain shareholders of subsidiaries or persons providing professional
services to or holding office in organisations providing services. An indepen-
dent director cannot be removed without cause unless he or she ceases to be
independent (Article 4(5)), and if he or she resigns must provide an expla-
nation for such resignation to the shareholders and creditors of the company
(Article 4(6)). Independent directors are given specific rights and functions,
including the right to engage an agency to provide an independent consulting
report on major transactions submitted to the director, and to propose that meet-
ings of the shareholders or directors be convened. The importance of ensuring
that the independent directors are able to carry out their functions of indepen-
dent review was reiterated by the CSRC in 2007,241 when it made clear that a
company should review whether an independent director had played a role in
overseeing the operations of the company and, in particular, if the performance
of his functions had been affected by the actions of the principal shareholder or
if he had been improperly removed from office (Annex 2(1)).

238 Interestingly, one reported case under Article 152 involves the Chinese party of a Chinese–foreign joint
venture taking action against the manager appointed by the foreign party. See sino-Link Consulting, ‘The
First Case on Foreign Shareholder Representative Litigation in China’, available at <www.hg.org/article.asp?
id=6626> (no date). Huang notes that it is easier for shareholders in a limited liability company to obtain
standing to sue under the Company Law (above n 237, 236).
239 This followed provisions in Art 112 of the 1997 CSRC, Guidelines on the Articles of Incorporation of Public
Listing Companies (issued 16 December 1997), which provided that a company could have independent
directors and the State Economic & Trade Commission, China Securities Regulatory Commission, Proposal
on Accelerating Standardized Operation of Companies Listed Overseas and Deepening their Reforms (29 March
1999), Arts 5 and 6, which required at least two independent directors on the board of a company listed
outside China. See also Xi, above n 189, 373–6.
240 CSRC, Guidelines on Introducing the Independent Director System in Listed Companies (16 August 2001).
241 CSRC, Notice on the Matters Concerning Carrying out a Special Campaign to Strengthen the Corporate
Governance of Listed Companies (9 March 2007).
402 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

There are a number of stated purposes in requiring a company to have inde-

pendent directors,242 including the need for independent directors to represent
smaller shareholders, to monitor related party transactions, to act as an inde-
pendent consultant and advisor and to serve the public interest on the board.
Both the desirability of these functions and the extent to which the independent
directors serve these purposes can be disputed. (A related question is the overlap
between the functions of the supervisory board and the role to be played by
the independent directors.) Questions have been raised as to the competence
and experience of the persons selected as independent directors, as well as their
ability to act effectively and independently, and the willingness of the board
and its managers to incorporate and utilise independent directors effectively.
The selection of independent directors appears to be dominated by the major-
ity shareholders through their control of the board of directors and supervisory
board.243 Studies suggest that the majority of independent directors have tended
to be academics and government officials rather than experienced businessmen
and women. In addition, with some exceptions, the independent directors have
not fulfilled the expectation that they would be active and if necessary contro-
versial members of the board of directors. As a result, some commentators have
concluded that the effect of independent directors on the performance of listed
companies is minimal.244

13.5.8 Committees
The Code of Corporate Governance (Articles 52 to 58) provides that the board of
directors of a listed company may establish a number of specialist board commit-
tees – a corporate strategy committee, an audit committee, a nomination commit-
tee, a remuneration and appraisal committee and other special committees.245
Pursuant to the Guidelines on Independent Directors (Article 5(4)), if such com-
mittees are established, independent directors must form more than half of the
members. The 2005 Opinions of the China Securities Regulatory Commission
on Improving the Quality of Listed Companies246 provided that a listed com-
pany should establish an audit committee and a remuneration and assessment
committee, and this was further reiterated in the 2007 CSRC Notice on Mat-
ters concerning Carrying out a Special Campaign to Strengthen the Corporate

242 See discussion in Donald C Clarke,‘The Independent Director in Chinese Corporate Governance’ (2006)
31 Delaware Journal of Corporate Law 125 at 169 et seq.
243 Xi, above n 189, 168–75; see also Jie Yuan, ‘Formal Convergence or Substantial Divergence? Evidence
from Adoption of the Independent Director System in China’ (2007) 9 Asian-Pacific Law and Policy Journal at
71–104, available at <www.hawaii.edu/aplpj/articles/APLPJ 09.1 yuan.pdf>. Clarke, above n 242.
244 Ibid.
245 This chapter does not discuss the requirements of stock exchanges outside China that may require
Chinese companies listed there to establish audit and other committees.
246 See State Council, Circular of the State Council on Approving and Forwarding the Opinions of the China
Securities Regulatory Commission on Improving the Quality of Listed Companies (19 October 2005), Annex,
Item 3.
 GERMANY, JAPAN AND CHINA 403

Governance of Listed Companies.247 Article 13 of the Basic Internal Norms for

Enterprises,248 requires companies subject to the standard to set up an audit
committee as part of the requirement for companies to establish a sound system
of corporate governance.
The question, of course, is the extent to which listed companies have adopted
the committee system. A recent study by the Centre for Corporate Governance,
Chinese Academy of Social Sciences, on the top 100 listed companies, shows
that major listed companies in China have made substantial improvements in
the establishment of board committees, particularly audit committees.249

13.5.9 The issue of the controlling shareholder – protection for

minority shareholders under the Company Law
The major issue for Chinese listed companies has been the role of the major
shareholder, which is generally, although not always, a Chinese state-owned
enterprise.250 As a consequence, the regulatory authorities, the stock exchanges
and the legislature have all focused on the role of the controlling or majority
shareholder in Chinese companies. The issue of abuse of power by the majority
shareholder is not, however, confined to listed companies, and the 2005 amend-
ments to the Company Law therefore placed considerable emphasis on protecting
the position of minority shareholders in limited liability companies as well. Thus,
the Company Law sets out not only provisions of general application but pro-
visions that are specifically designed to provide protection for shareholders in
limited liability companies.
Article 21 of the Company Law applies to all companies and forbids controlling
shareholders, de facto controlling persons, directors and senior management of
a company from using ‘their affiliation’ with another enterprise that they con-
trol in order to harm the interests of the company. The concept of affiliation

247 CSRC, Notice on Matters Concerning Carrying out a Special Campaign to Strengthen the Corporate Gover-
nance of Listed Companies (9 March, 2007).
248 Note 163. On 26 April, 2010, the Ministry of Finance, SCRC, National Audit Office, China Bank-
ing Regulatory Commission and China Insurance Regulatory Commission issued the Application Guide-
lines for Enterprise Internal Control, Guidelines for Assessment of Enterprise Internal Control and Guidelines
for Audit of Enterprise Internal Control, which will be implemented in stages from 1 January 2011. For a
summary, see KPMG, China Boardroom Update: Internal control regulatory developments advisory (2010)
issue 2, available at <www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Newsletters/China-
boardroom-update/Documents/China-boardroom-update-1004-02.pdf>.
249 Centre for Corporate Governance, Chinese Academy of Social Sciences, Centre for Research on Assess-
ment of Leaders, China National School of Administration & Protiviti Consulting, Corporate Governance
Assessment; Summary Report on the Top 100 Chinese Listed Companies for 2009, Beijing (2009), avail-
able at <http://en.iwep.org.cn/download/upload files/pradum55fq503c550lrjjnjy20090703142649.pdf>
13–16.
250 The continued dominance of the state-owned sector in China should not be under-estimated. See Xiao
Geng, Xiuke Yang and Anna Janus, ‘State-owned Enterprises in China, Reform Dynamics and Impacts’, in
Ross Garnaut, Ligang Song and Wing Thye Woo (eds), China’s New Place in a World in Crisis, Chapter 9,
(2009) published ANU e-press, available at <http://epress.anu.edu.au/china new place/pdf/ch09.pdf>,
noting that in 2007 state-owned enterprises comprised 70 per cent of the top 500 Chinese enterprises,
owning 94 per cent of the assets, p. 158; Standard & Poors, S&P Transparency and Disclosure Survey by Chinese
Companies 2008 (2009), available at <www2.standardandpoors.com/spf/pdf/equity/SP_TD_Study.pdf>,
including 237 SOEs (central and local) in the top 300 Chinese companies in 2007; Chinese Academy of Social
Science survey, above n 221, counting 31 out of the 100 top listed Chinese companies in 2008 as state-owned.
404 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

includes a relationship that may lead to the transfer of shares in the company
(Article 217).251 If they do use their affiliation in such a manner, they are liable
to compensate the company. The Second Interpretation of the Company Law252
(Article 23) places obligations on controlling shareholders or de facto controllers
of listed companies in relation to failures to act properly in the liquidation
process.
A ‘controlling shareholder’ is generally a person with 50 per cent of the voting
rights, but also includes a person with a substantial interest (Article 217). A
‘de facto controlling person’ is defined quite broadly as a person capable of
controlling the company through agreements or some other means (Article 217).
Under Article 20, any shareholder of the company who abuses ‘shareholder
rights’ to ‘harm the interests of the company or other shareholders’ is liable
to pay compensation to the company or the other shareholders. If it ‘abuses
the independent status of the company legal person and the limited liability of
shareholders’ to evade debts and seriously harm the interests of the creditors
of the company, it may also be jointly liable with the company to the creditors.
Although this provision is not restricted to controlling shareholders, it seems
likely that a majority or controlling shareholder would be the most likely to be
in a position to abuse its shareholder rights. Although it can be assumed that
the purpose of this provision is to provide a legal basis for the piercing of the
corporate veil on a suitable occasion, the basis upon which a court might make
such a decision is not at all clear from the language of the section.253 It seems,
however, that together with Article 64, which provides creditors with a remedy
in circumstances in which the shareholder of a single shareholder company
intermingles his or her assets with company assets, an important purpose of
this provision is the protection of creditors, not just other shareholders or the
company itself.
The Company Law also provides two further protections for shareholders.
The first of these applies only to limited liability companies. Article 75 gives a
dissenting shareholder the right to require the company to buy it out in certain
limited circumstances: when there has been no distribution of dividends for
five years, the company is about to merge or transfer major property, or the
other shareholders vote to extend the term of a limited operation company. The
Article is vague on the mechanism and procedures for the buy-out, which is a
concept that sits uncomfortably with the limited liability company, an entity
having only registered capital. Presumably, the shareholders of the company
must vote to reduce the registered capital of the dissenting shareholder and to
pay the shareholder an agreed amount, which may be greater or lesser than the
paid-in amount of registered capital. It does, however, provide an enforcement
mechanism, since if the company and the dissenting shareholder do not agree

251 It should, however, be noted that Art 217(4) provides that there is no affiliation between two state-owned
enterprises merely by virtue of the fact that the state controls both enterprises.
252 Supreme People’s Court, Provisions of the Supreme People’s Court on Some Issues about the Application of
the Company Law of the People’s Republic of China (II) (12 May 2008, effective 19 May 2008).
253 Mark Wu,‘Piercing China’s Corporate Veil; Open Questions from the New Company Law’ (2007) 117
Yale Law Journal 329.
 GERMANY, JAPAN AND CHINA 405

upon a price within 60 days of the date of the shareholders’ resolution, the
shareholder has a 30-day period within which it may institute proceedings in a
people’s court. It is not clear what the court will do to resolve the dispute.
Article 183 applies to both limited-liability companies and joint-stock compa-
nies. It gives shareholders holding 10 per cent of the voting rights of a company
the right to petition the court for dissolution of the company where ‘there are
serious difficulties in the operation and management of the company and the
continued existence will cause major losses to the rights and interests of the
shareholders, and they cannot be resolved through other means’. The Second
Interpretation of the Company Law fleshes out this provision and clarifies that it
will apply in circumstances in which operation or management of the company is
dysfunctional; that is, when the company has been unable to hold a shareholders’
meeting for two years, it has not been possible to form a quorum for two years,
there is a longstanding dispute between the directors, which the shareholders
cannot resolve, or there are other major difficulties in the company’s opera-
tion or management causing material losses to the interests of the shareholders
(Article 1).
In addition to these specific provisions, it should be noted that the institution
of the supervisory board, as well as the requirement for a listed company to
have independent directors, is intended to have some impact on the controlling
shareholder issue. The requirement in the Code of Corporate Governance that
a company with a controlling shareholder holding more than 30 per cent of the
equity should institute a system of cumulative voting,254 as well as the provision
in Article 106 of the Company Law that a listed company may institute cumu-
lative voting for directors and supervisors, is designed to ensure that minority
shareholders have representation on the board of the company.
The major issue has, however, been the listing of companies that were con-
verted or created from state-owned enterprises and in which the majority share-
holder is the state. The Code of Corporate Governance sets out the basic require-
ment that the corporate governance structure of a listed company ‘shall ensure
equal treatment toward all shareholders, especially minority shareholders’
(Article 2). Chapter 2 of the Code deals with the question of restructuring com-
panies that propose to list, and was clearly directed at the issue of state-owned
enterprises being restructured into listed companies. Thus, it requires the strip-
ping out of social functions and non-operational assets (Articles 15 and 16) and
the conversion of other units into specialised companies that may provide ser-
vices to the listed company (Article 17). Separation of the listed company from
the controlling shareholder is mandated by Articles 22 to 24. Article 21 provides
that the controlling shareholder must not interfere with the company’s decisions
or business activities, or impair the interests of the company or the other share-
holders. Article 27 provides that a controlling shareholder must not engage in the
same or similar business to the listed company and that a controlling shareholder
must adopt measures to avoid competition with the listed company.

254 Article 31.

406 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

The stock exchanges have also included provisions in their listing rules to deal
with the conflicts of interest that arise when a listed company has a controlling
shareholder or de facto controller.255 For example, the Shanghai Stock Exchange
Rules require a lock-up for shares of a controlling shareholder for a set period after
listing.256 They also control transfers of shares by the controlling shareholder or
de facto controller of the company.257 Other detailed requirements deal with
the disclosure and handling of related party transactions, including preventing a
related director from voting on the transaction in a board meeting and preventing
related shareholders from voting in a shareholders’ meeting. Similarly, disclosure
must be made of guarantees granted to related parties.258
A more comprehensive solution to the controlling shareholder issue, at least
in relation to state-owned shares, would be for the state to cease holding majority
interests in major listed companies.259 In this respect, the decision by the State
Council260 to end the distortions in the market caused by the distinction between
tradable and non-tradable shares provides a possible answer by allowing for the
reduction of the stakes held by controlling shareholders. In practice, however,
it is unlikely that this will be the effect. Under the key pillars policy,261 the
government intends to maintain state control over certain sectors of the economy,
such as oil, gas and telecommunications, and in many of these sectors there are
listed companies in which shares have been sold to the public.262 The effect of
the key pillars policy will be that the public will continue to hold a minority of
shares.

13.5.10 Improved disclosure requirements

Chinese legislators and regulators have recognised that access to current and
reliable information is essential for shareholders of all kinds. Thus, the Company

255 The definition of these terms follows the Company Law, although ‘control’ is defined in more detail.
Shanghai Stock Exchange Listing Rules, Art 18.1, English version available at <www.sse.com.cn/sseportal/
en us/ps/support/en sserule20090408.pdf>.
256 Shanghai Stock Exchange Listing Rules, Art 5.1.5 (36-month lock up).
257 Shanghai Stock Exchange Listing Rules, Chapter 9.
258 Shanghai Stock Exchange Listing Rules, Chapter 10. ‘Related party’ is defined widely, but it should be
noted that two parties are not considered to be related merely because they are under the same state assets
administration, unless the chairperson, general manager or more than half of the directors serve as directors,
supervisors or senior officers of the listed company (Chapter 10.1.4).
259 See, for example, recommendation by Geng et al., above n 250, recommending the reduction of state
ownership to less than 30 per cent, p169.
260 State Council, 9 Opinions on Expediting Reform and Development of Capital Markets (4 February 2004).
See Kister, above n 214.
261 State Council, Circular of the General Office of the State Council Concerning Transfer of the Opinions of
the SASAC on Guidance for Promotion of Adjustment of State-owned Assets and Restructuring of State-owned
Enterprises (5 December 2006).
262 These include such companies as CNOOC Ltd (Zhongguo Haiyang Shiyou Youxian Gongsi), listed on The
Stock Exchange of Hong Kong and the New York Stock Exchange, indirectly 64.41 per cent owned by CNOOC
as of May 2009 (see CNOOC Ltd, Explanatory Statement relating to General Mandates to Issue Securities and
Repurchase Shares and Re-election of Directors and Amendment to the Articles of Association, available at
<www.cnoocltd.com/encnoocltd/tzzgx/gonggao/2009/images/2009410583.pdf>); China Telecom Cor-
poration Ltd (China Telecom, Zhongguo Dianxin), listed on The Stock Exchange of Hong Kong and the New
York Stock Exchange, 70.89 per cent owned by China Telecommunication Corporation (see <http://www.
chinatelecom-h.com/eng/company/structure.htm>).
 GERMANY, JAPAN AND CHINA 407

Law and the Securities Law provide for the disclosure of information – to share-
holders in the case of the Company Law and to the public and hence investors in
the case of the Securities Law.
The 2005 amendments to the Company Law expanded the ability of the share-
holders to obtain access to information. Article 34 gives shareholders in limited
liability companies rights to see the articles of association, minutes of share-
holder meetings and supervisors’ meetings, resolutions of the directors and the
financial and accounting reports of the company, as well as the right to see the
account books (under some conditions). Article 98 gives shareholders in joint
stock companies the right to examine the articles of association of the company,
the register of shareholders, counterfoils of corporate bonds, minutes of share-
holders’ general meetings, minutes of the meetings of the board of directors,
minutes of the meetings of the supervisory board, and financial and accounting
reports, as well as the right to offer suggestions in relation to or inquire about
the operation of the company. Under Article 125, the secretary of a joint stock
company is required to handle the provision of information as required under
the Company Law.
The Securities Law not only provides for specific disclosures of information,
but also requires continuing disclosure of information (Chapter 3). All such
information must be authentic, accurate and complete (Article 63). Chapter
3 also requires annual reports, interim half-yearly reports and the disclosure
of major events that may affect the trading price of a listed company’s shares
(Article 67), including changes in business scope, major investments or assets
purchases, major contracts, the incurrence of or failure to pay major debts, major
losses, major changes in circumstances, changes in directors or one-third of
the supervisors or managers, major changes in shareholdings (by shareholders
holding 5 per cent or more of the company’s shares), changes in capital or
an application for bankruptcy, major litigation, criminal investigation of the
company or its officers and so on. Failure to disclose information, or to disclose
it accurately, may result in the imposition by the CSRC of a fine and an order
to correct the information, on the issuer, a person responsible for disclosure
and a controlling shareholder or de facto controller who is responsible for the
omission or provision of incorrect information (Article 193). These requirements
are further fleshed out in the 2007 Measures on Administration of Information
Disclosure of Listed Companies263 and the stock exchange rules.
A 2009 survey on transparency and disclosure in 2008 by the top 300 Chinese
companies264 criticises disclosure by these companies, particularly in the areas
of business operations, director nominations (which continue to be controlled
by the majority shareholder) and information on remuneration, although dis-
closure on ownership concentration was considered to be relatively good. Inter-
estingly, disclosure by state-owned enterprises, particularly centrally controlled

263 CSRC, Measures on Administration of Information Disclosure of Listed Companies (30 January 2007).
264 S&P Survey, above n 250.
408 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

state-owned enterprises, was of a higher standard than that of private companies

(other than joint ventures or university owned companies).265

13.5.11 Imposing additional requirements on the sponsors of

public offerings
Another way in which the CSRC has attempted to deal with the question of corpo-
rate governance is to impose additional obligations on the sponsors of a listing.
The 2008 Measures for the Administration of the Sponsorship of the Offering
and Listing of Securities266 replace and strengthen the previous legislation.267
The Measures require issuers to engage a qualified securities company to act as
its sponsor for a public offering or offering of new shares or bonds (Article 2).
A securities company proposing to act as a sponsor must be approved by the
CSRC (Article 3). In order to qualify, the company must submit, among other
things, evidence of its own corporate governance and internal control systems
(Article 10). The sponsor’s duties include conducting a full investigation of the
issuer (Article 24); providing guidance and training to the issuer and its directors,
supervisors, senior managers and shareholders holding more than 5 per cent of
the shares (Article 25) and satisfying itself that the issuer complies with laws,
administrative regulations and CSRC provisions before it sponsors the offering
(Article 28).
The sponsor is also responsible for post-initial public offering guidance for a
period of at least two years (Articles 35 and 36), during which its responsibilities
include the implementation of internal control systems in the issuer, including
a system guarding against the controlling shareholder, de facto shareholder or
other affiliated persons from appropriating the issuer’s resources. If the spon-
sor subsequently believes that the issuer may have violated laws or committed
another ‘improper act’, it must procure an explanation and a rectification and,
if the matter is serious, report it to the CSRC and stock exchange (Article 57).
The sponsor and its officers may be subject to penalties ranging from an order
to rectify, warnings, being declared ‘persona non grata’, administrative penal-
ties or criminal penalties, and suspension from qualification to act as a sponsor
(Articles 66 and 67 et seq).

13.5.12 Higher standards of accounting

Efforts have also been made to improve the accounting standards of listed com-
panies, by requiring independent audits and by moving towards the adoption
of standards that are closer to international standards from the beginning of
265 Ibid.
266 CSRC, Measures for the Administration of the Sponsorship of the Offering and listing of Securities (17
October 2008, effective 1 December 2008, amended 13 May 2009, effective 14 June 2009).
267 CSRC, Tentative Measures for the Sponsorship System for Issue and Listing of Securities (28 December
2003); CSRC, Measures for the Provision of Guidance for Initial Public Offerings of Shares (16 October 2001).
 GERMANY, JAPAN AND CHINA 409

2007.268 The CSRC has been engaged in a process of supervising the annual
reports of listed companies to review compliance with the new accounting
standards.269

13.5.13 Direct intervention – the case of dividends

The multifaceted approach to regulation outlined above focuses on general prin-
ciples of corporate governance, with a strong emphasis on the implementation
of adequate internal control and corporate governance systems. The question
of how best to enforce these requirements, however, continues to present dif-
ficulties. An interesting example of the issues presented by the many methods
of regulation and enforcement is presented by the issue of the declaration of
dividends, which has proved to be a longstanding issue for shareholders, and
which has apparently not been resolved by compelling Chinese companies to
adopt better internal systems of management or corporate governance.
Many Chinese companies historically have been reluctant to pay dividends.
The division of functions between the board of directors and the shareholders’
meeting set out in the Company Law does not address this issue, since although
the shareholders have the power to approve the plan for distribution of profits,
it is the responsibility of the directors to formulate the plan in the first place
(Articles 38 and 47). The Company Law recognises that this can be a problem
in the case of a limited-liability company by giving the dissenting shareholder
a right to be bought out where a profitable company has not distributed profits
for five years (Article 75). Shareholders in a joint-stock company do not have a
similar right under the Company Law.
The Chinese Academy of Social Science report on corporate governance in
the top 100 Chinese listed companies in 2008270 notes that only about 10 per
cent of Chinese listed companies pay dividends regularly. In 2008, only 13 of
the top 100 listed companies paid dividends at all, and of those only two paid
more than 10 per cent of their profits in the form of dividends – well below
world-market norms. In response, the CSRC has imposed a number of additional
requirements on listed companies to compel them to declare and pay dividends.
These include requiring listed firms that apply to make a new share issue to have
paid out dividends in cash equal to not less than 30 per cent of distributable
profits over the previous three years and requiring companies to disclose in their
annual report their profit distribution plan, with an explanation for any decision

268 For reasons of space, these requirements are not discussed in detail here. See, however, Noelle Trifiro
‘China’s Financial Reporting Standards: Will Corporate Governance Induce Compliance in Listed Companies?’
(2007) 16 Tulane Journal of International and Comparative Law 271. See also CSRC Report 2008, 78 et seq.
269 See, for example, CSRC, ‘Answers by Principal of CSRC Accounting Department to Questions by Corre-
spondent on Supervision over Listed Companies’ Annual Reports of 2008’ (22 August 2009), English version
available at <www.csrc.gov.cn/pub/csrc en/newsfacts/release/200908/t20090822 121162.htm>.
270 Above n 221, 12.
410 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

not to distribute dividends.271 A similar issue in relation to unlisted state-owned

enterprises was dealt with in 2007 by the Implementing Regulations on the
Management of Income and Receipts from the State-owned Assets of Central
Enterprises,272 which required the centrally controlled, state-owned enterprises
to pay a specified percentage of their profits as dividends. The need to address
this issue directly strongly suggests that the efforts made in the Company Law
and by the CSRC and the stock exchanges to promote corporate governance
through a variety of efforts is having only mixed success.

13.5.14 Enforcement
A major issue in relation to corporate governance in China is the question of
enforcement – whose responsibility it is and should be, how effective it is and
how enthusiastically breaches of relevant legislation are pursued. As noted above,
there are a variety of different remedies for breaches of corporate governance
requirements and a variety of entities that have responsibility for enforcement.
Penalties may include warnings, reprimands, public criticisms, bannings, the
imposition of fines and administrative penalties and criminal prosecution. Civil
remedies may be sought by aggrieved shareholders through the courts under
the Company Law and the Securities Law. Cases involving state-owned and
other enterprises may involve action by the SASAC or an equivalent state-owned
asset administration and, where they involve Communist Party members and
government interests, it can be expected that the Communist Party and other
parts of government will become involved in investigation and the ultimate
determination of cases.273

13.5.15 Consequences of breach

The Chinese system has traditionally not relied on shareholders or the courts
to enforce systems of corporate governance. Indeed, historically the legislature
and the courts generally have been reluctant to encourage shareholder litigation
against listed companies in particular.274 The amendments to the Company Law
in 2005 opened up various possibilities in relation to shareholder litigation,
although as discussed above, the preference is clearly for action to be taken by
the directors or supervisors of a company rather than by the shareholders.
The shareholders are, however, empowered to sue directors or officers for
actions contrary to law or the articles of association that harm the interests of

271 CSRC, The Decisions on Amending Some Provisions on Cash Dividends by Listed Companies (7 October,
2008, effective 9 October 2008); see also Bi Xiaoning, ‘State Firms Urged to do More Dividend Spread’ (2 July
2009), China Daily, available at <www.chinadaily.com.cn/bizchina/2009–07/02/content 8345700.htm>.
272 Ministry of Finance and State-owned Assets Supervision and Administration Commission of the State
Council, Implementing Regulations on the Management of Income and Receipts from the State-owned Assets of
Central Enterprises (21 December 2007).
273 See Cheng, above n 219.
274 Wang, above n 186. See also Marlon Layton, ‘Is Private Securities Litigation Essential for the Development
of China’s Stock Markets?’ (2008) 83 New York University Law Review 1948.
 GERMANY, JAPAN AND CHINA 411

shareholders under Article 153. Under Article 22, a shareholder may institute
litigation to have declared void a resolution or action of the company where the
procedure or method of voting contravenes laws, regulations or the Articles of the
company, although the court may require the shareholder to provide security for
the action. For shareholders in limited-liability companies, in fact, few remedies
other than litigation are available in the absence of a regulator with overall
responsibility for shareholders in companies of this kind.
The concept of enforcing shareholder rights through litigation by shareholders
in listed companies is often attractive to Western commentators, who see in the
provisions of Articles 152 and 153 of the Company Law275 an opportunity for
the development of shareholder activism.276 There is, however, little evidence
that these provisions have been effective in encouraging shareholder actions.
In the period 2001 to 2003, the Supreme People’s Court severely restricted the
ability of shareholders to bring actions (limiting the types of cases that could be
brought and requiring that the CSRC should first have made a determination on
corporate wrongdoing before the shareholders could seek compensation).277 A
circular issued by the Supreme People’s Court and other regulatory and judicial
bodies in 2008 acknowledges the right of shareholders to seek compensation
from the courts, but focuses on investigation and punishment of illegal securities
action by regulatory authorities rather than on the question of compensation of
victims.278
At this stage, therefore, it does not seem likely that court action will become a
major method of enforcement of shareholder rights, at least in the near future.279
A major way in which China deals with cases of corporate malfeasance of
various kinds is through the criminal system, although it is questionable whether
the emphasis on criminal prosecutions rather than civil actions provides an ade-
quate remedy to the shareholders. The use of criminal law is, however, a basic
tool in dealing with securities and companies in China. In particular, the Criminal
Law (as amended in 2006 and 2009)280 includes detailed provisions imposing

275 See also the Securities Law. Article 47 gives shareholders the right to institute suit in their own name
in the interests of the company if a director, officer or major shareholder breaches the six-month lock up
on the sale of shares and the directors fail to take action to confiscate the proceeds. Article 235 gives a
concerned party the right to appeal against a decision of the CSRC or other administrative body, either by
way of administrative review or litigation.
276 See Jiong Deng, ‘Building an Investor-Friendly Shareholder Derivative Lawsuit System in China’ (2005)
46 Harvard International Law Journal 347; Wang, 2008, above n 186.
277 Layton, 2008, above n 274. For an interesting illustration of a Chinese securities case, see Chao Xi, ‘Case
Note: Private Enforcement of Securities Law in China: Daqing Lianyi Co v ZHONG Weida and Others (2004),
Heilongjiang High Court’ (2006) 1 Journal of Comparative Law 492.
278 Supreme People’s Court, Supreme People’s Procuratorate, Ministry of Public Security and China Secu-
rities Regulatory Commission, Circular on the Relevant Issues on the Suppression of Illegal Securities Activities
(2 January 2008). Article 6 provides that victims of securities crimes should seek compensation through
criminal procedures for recovery; victims of general legal violations may seek compensation as set out in the
Civil Procedure Law.
279 See Randall Peerenboom, ‘Between Global Norms and Domestic Realities: Judicial Reforms in China’,
available at <http://papers.ssrn.com/sol3/papers.cfm?abstract id=1401232> for a thoughtful discussion
of the development of the judicial system in China.
280 Standing Committee of the NPC, Criminal Law of the People’s Republic of China, Amendment No. 6
(19 June 2006); Standing Committee of the NPC, Criminal Law of the People’s Republic of China, Amendment
No. 7 (28 February 2009).
412 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

penalties of up to 10 years’ imprisoment for serious cases of insider trading (Arti-

cle 180), three years for false or misleading disclosure of financial information
(Article 161) and three to seven years for market manipulation by a director,
supervisor, officer or controlling supervisor causing serious harm to a listed com-
pany (Article 169), as well as other crimes of management malfeasance by such a
person, and up to five to 10 years for serious cases of market manipulation (Arti-
cle 182). The 2008 Supreme People’s Court Circular referred to above focuses on
the transfer of shares to the public without approval; issuing securities without
approval and unlawful operation of securities business as matters of the greatest
concern.
The CSRC is primarily responsible for pursuing these cases, in conjunction
with other bodies such as the procuratorate and the public security bureau,
although its ability to do so effectively is arguably limited not only by resources
but the difficulty for Chinese regulators in pursuing government officials and
businesspeople with strong connections to government.281 The CSRC is able
to investigate and issue administrative sanctions282 (including orders for rec-
tification, confiscation of illegal proceeds and fines) and to impose a ban on
persons or organisations from entering the securities market. According to its
2008 report,283 107 new cases were registered in 2008 involving insider trading
(34 cases), market manipulation (12 cases), fraudulent disclosure (15), illegal
investment advice (19 cases) and other misconduct (27 cases). In the course of
the year, the CSRC closed 130 cases, placed 157 under informal investigation,
transferred 210 to public security authorities and imposed 77 administrative
penalties or market entry bans. RMB 320 million was confiscated (of which
RMB 250 million was actually collected or frozen).284 The courts pronounced
judgments in approximately 20 cases of illegal securities activities. The stock
exchanges also have powers in relation to listed companies, including the ability
to suspend trading and issue other sanctions in the form of suspension, delisting
and other warnings or sanctions. However, the stock exchanges are essentially
still subordinate to the CSRC, even though they are notionally independent.285
It is, of course, difficult to make an accurate assessment from these statistics of
how effective securities enforcement is in China, and opinions vary widely.286 It
has been argued that reputational sanctions such as public criticisms issued by the
281 See Cheng, above n 219.
282 Securities Law, Art 179.
283 CSRC Annual Report 2008, 34–6.
284 By way of comparison, the Australian Securities and Investments Commission 2008–2009 reports the
completion of 39 criminal cases, 35 civil proceedings, the recovery of AUD 14.5 million and the freezing of
AUD 13.8 million in assets (a total of approximately RMB 176 million). See ASIC Annual Report 08-09 on the
ASIC website at <www.asic.gov.au>, 16 et seq.
285 See Shi, above n 215 on the relationship between the CSRC and the stock exchanges in China. See also
Benjamin Liebman‘Reputational Sanctions in China’s Securities Market’ (2008) 108 Columbia Law Review
929 at 945.
286 See Peng Sun and Yi Zhang, ‘Is There Penalty for Crime: Corporate Scandal and Management Turnover
in China’, available at <http://papers.ssrn.com/sol3/papers.cfm?abstract id=891096>, casting doubt on
the effectiveness on punishment of managers in Chinese companies; Gong-meng Chen, Michael Firth, Ning
Daniel Gao and Oliver M Rui, ‘Is China’s Securities Regulatory Agency a Toothless Tiger? Evidence from
Enforcement Actions’, available at <http://papers.ssrn.com/sol3/papers.cfm?abstract id=711107> con-
cluding that CSRC enforcement is effective.
 GERMANY, JAPAN AND CHINA 413

stock exchanges are effective in encouraging listed companies to improve their

standards of corporate governance, due to the impact on the share price and on
such matters as access to financing.287 It is also important not to under-estimate
the greatly increased availability of information on the internet in China, through
government websites and blogs, and the reporting of business and economic
issues as a result of which information on the stock markets and the behaviour
of companies and their executives is published more rapidly and read more
widely.288
Finally, the role of publicity, education and training should also not be under-
estimated. The existence of regular studies and surveys on corporate governance
of Chinese companies puts pressure on listed companies to implement corpo-
rate governance systems. Websites of listed companies include information on
corporate governance and corporate social responsibility systems.289 Continued
emphasis on corporate governance in the form of regulations and notices from
all relevant regulatory authorities also impose continuing pressure on companies
to improve their systems of internal management and control.

13.5.16 Conclusions on China

Legislative and regulatory authorities in China have made extensive efforts to
formulate and implement an adequate system of corporate governance. There
continue to be a number of pervasive issues, however, in relation to corporate
governance in China. These include the questions of clarity and internal con-
sistency in the corporate governance system (of which the conflicting role of
the supervisory board and the independent directors is a good example), the
involvement of multiple enforcement authorities, primarily the CSRC, the stock
exchanges, the public security bureau, police and procuratorate (in relation to
criminal prosecutions) and the courts (in relation to private enforcement actions)
and inconsistent enforcement. In particular, the close relationship between the
state and its instrumentalities and corporate entities in China continues to cause
difficulties in establishing a functioning system of corporate governance and in
enforcing the system that has been established.
Suggestions as to the best way in which to resolve these various issues and cre-
ate a workable and comprehensible system range from privatisation,290 encour-
aging private enforcement,291 following the Taiwanese example by establish-
ing a government-sanctioned non-profit organisation to support shareholder
litigation292 and providing additional resources to the CSRC to strengthen its

287 See Liebman, above n 285.

288 See also comments in Colon Hawes and Thomas Chiu, ‘Flogging a Dead Horse? Why Western-style
Corporate Governance Reform Will Fail in China and What Should be Done Instead’ (2006) 20 Australian
Journal of Corporate Law 20 at 25–54.
289 Although note that the S&P survey suggested that information from regulatory sources and annual
reports is considerably more comprehensive than information on company websites. Above n 250, 2.
290 Geng et al., above n 250.
291 Huang, above n 237.
292 Wang, above n 186.
414 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

enforcement efforts,293 to changing the entire approach to corporate governance

and focusing instead on increasing public scrutiny, executive qualifications and
business ethics.294
The Chinese government will not, it is clear, resolve the issue of state con-
trol of major companies by simply engaging in massive privatisation programs.
Government policy is that state-owned enterprises will continue to be a partic-
ipant in the marketplace for some time to come, despite the structural reforms
that have resulted in state shares becoming tradable and therefore theoreti-
cally disposable.295 It also seems doubtful at this stage that private enforcement
through the court system will become an important method of enforcing account-
ability on major enterprises. For shareholders in small, privately held companies,
however, in the absence of a regulator with an interest in minority rights within
small companies, stronger and more active courts, willing and able to enforce
the rights granted to shareholders under the Company Law, are vital and the
Supreme People’s Court has shown some willingness to expand the activities of
the court in order to assist smaller companies with claims under the Company
Law.296 However, until the courts are prepared to accept and deal with major
and complex securities cases in ways that may be generally unpopular with major
companies, private litigation is unlikely to have a major impact on the wider mar-
ket for tradable shares. It is also questionable whether reputational sanctions and
a focus on business ethics alone, without the strong threat of investigation, sanc-
tion or prosecution, would be more effective than the current system, which
combines all of these different methods of dealing with corporate governance
issues.
Overall, it must be a major element in corporate governance implementation
and reform to convince company management that good corporate governance is
good for the company and for their own future. Improving the resources available
to the CSRC, allowing CSRC regulators greater independence in aggressively
and publicly297 enforcing securities laws against offenders and giving the stock
exchanges more power to deal with offences and offenders is, in our opinion,
essential in dealing with egregious offenders.
The experience of securities and financial markets world-wide in the course
of the global financial crisis has made abundantly clear that there are no simple
answers to the issue of corporate governance. Despite the recurring problems in
the system and the shortcomings in such corporate structures as the supervisory
board and the independent director system, the multifaceted approach taken
by legislators, regulators and company management in China has resulted in

293 Cheng, above n 219.

294 Hawes, above n 288. Hua Cai, ‘Bonding, Law Enforcement and Corporate Governance in China’ (2007)
13 Stanford Journal of Law, Business and Finance 82.
295 See Kister, above n 214, on the share reform program pursuant to which government-owned shares
have been converted into shares that are tradable (at least in theory).
296 See, for example, Supreme People’s Court, Provisions of the Supreme People’s Court on Some Issues about
the Application of the Company Law of the People’s Republic of China (II) (2008), which expands the ability of
the court to order a winding up in situations of management breakdown or deadlock.
297 See Liebman, above n 285, on the significance of public sanctions.
 GERMANY, JAPAN AND CHINA 415

considerable progress in persuading Chinese companies of the importance of a

stronger corporate governance regime.298 The continuing stresses in the system
due to the continuing role of state-owned enterprises in the economy and the
market, the influence of government and Party in the judicial and enforcement
system and the competitiveness of the markets, however, mean that the imple-
mentation of a strong corporate governance system will continue to present
challenges for the future.

13.6 Conclusion

In this chapter we have dealt with the OECD principles of corporate governance
as guiding principles spanning across unitary and two-tier board structures, and
also across various jurisdictions. In short, these principles apply internationally
and they are based on international best practices in corporate governance,
irrespective of which particular company law model is followed.
The German corporate governance system is unique because of the very spe-
cific and rather rigid requirements for public companies and large proprietary
companies. They must have a two-tier-board system (management board and
supervisory board) and there must be employee representatives on the super-
visory board, although the number varies from industry to industry and also
depends on what type of company is involved. The introduction of the German
Corporate Governance Code in 2001 added a new dimension to German law by
expecting listed companies to comply or disclose if they do not comply. It ensures
that contemporary and international best practices in corporate governance have
been able to be identified and promoted for listed companies through the German
Corporate Governance code that has been updated and refined annually since
2005. There is little doubt that the issue of employee participation at supervi-
sory board level, or co-determination, is still one of the most controversial issues
facing German corporate law and corporate governance.
As far as Japan is concerned, we have pointed out that corporate law and prac-
tice have long attracted considerable attention among foreign commentators.
Much of the commentary increasingly refers to ‘corporate governance’, reflect-
ing the emergence of this broader term world-wide since the 1980s (outlined in
Chapter 1). Contemporary corporate law analyses and discussions focused on
Japan have long tended to adopt a broader perspective. This reflects an aware-
ness of the pervasive but typically informal role of stakeholders in firms other
than shareholders, especially core ‘lifelong’ employees, ‘main banks’ and ‘keiretsu’
corporate groups. The two still-important and quite distinctive monitoring mech-
anisms in Japanese corporate governance also remind us that government policy
and the vicissitudes of politics are as important as economics and broader social or
cultural context in explaining and predicting trajectories. Nonetheless, a gradual

298 As indicated by the Academy of Social Sciences Report, above n 221.

416 CORPORATE GOVERNANCE IN GLOBAL CONTEXTS

transformation seems to be under way even along these two dimensions, in par-
allel with more significant changes in the relationship between shareholders and
directors or managers.
We have seen that corporate law and corporate governance in China have
been influenced by a variety of factors: the traditional dominance of the state-
owned sector and the continuing ideological commitment by policy makers to
the ‘socialist market economy’; the decision by the government to attract foreign
capital by encouraging the establishment of foreign-invested companies in China.
The adoption of the Companies Law 1993 can be seen as a highlight in the
corporate law and corporate governance developments in China. In 2005, there
were considerable amendments to the Companies Law 1993, in particular as
far as the duties of directors were concerned and also the role and function
of independent directors. Elements of the German two-tier board system and
outside or independent directors from the Anglo-American corporate governance
model can be identified for certain types of Chinese companies.
It has been pointed out that legislative and regulatory authorities in China
have made extensive efforts to formulate and implement an adequate system
of corporate governance. There continues to be a number of pervasive issues,
however, in relation to corporate governance in China. These include the ques-
tions of clarity and internal consistency in the corporate governance system (of
which the conflicting role of the supervisory board and the independent direc-
tors is a good example), the involvement of multiple enforcement authorities,
primarily the CSRC, the stock exchanges, the public security bureau, police and
procuratorate (in relation to criminal prosecutions) and the courts (in relation
to private enforcement actions), and inconsistent enforcement. In particular, the
close relationship between the state and its instrumentalities and corporate enti-
ties in China continues to cause difficulties in establishing a functioning system
of corporate governance and in enforcing the system that has been established.
Overall, it remains a major element in corporate governance implementation and
reform in China to convince company management that good corporate gover-
nance is good for the company and for their own future. It was also observed that
the continuing stresses in the Chinese corporate system, due to the continuing
role of state-owned enterprises in the economy and the market, the influence
of government and Party in the judicial and enforcement system and the com-
petitiveness of the markets, mean that the implementation of a strong corporate
governance system in China will continue to present challenges for the future.
 PART FOUR
BUSINESS ETHICS AND
FUTURE DIRECTION
14
The ethical obligations
of corporations

The social responsibility of business is to increase profits.

Milton Friedman, The New York Times, 13 September 1970
Ethics deals with values, with good and bad, with right and wrong. We
cannot avoid involvement in ethics for what we do – and what we don’t
do – is always a possible subject of ethical evaluation. Anyone who thinks
about what he or she ought to do is, consciously or unconsciously, involved
in ethics.
Peter Singer, A Companion to Ethics, Oxford, Blackwell (1991), v

14.1 Introduction – the nature of morality

Until now, this book has focused on the legal rights and duties of those involved in
the governance of companies. This chapter examines not what the law stipulates
as expected of those involved in corporate governance, but the ethical responsi-
bilities of company officers.1 These levels of inquiry, though often overlapping,
are quite different. The ultimate aim of the law is to guide and coordinate human
behaviour, normally through the threat of coercive measures for violations of
legal norms. In order to be effective at shaping human conduct, legal norms
must be clear and knowable.
Morality is less prescriptive than the law – there is no official sanction or
censure involved with breach of moral norms. It is also generally more open-
ended and less clear. This, however, should not stifle the search for moral truths
or consensual moral norms. Despite the high level of disagreement about the
precise content of moral norms, an important paradigm of moral judgments is
that they are (apparently) used in the same manner as factual judgments. We

1 The terms ‘ethics’ and ‘morals’ are normally used interchangeably to mean ‘what people ought to do’. Some
writers distinguish between the two terms. In making this distinction, some maintain that morality has a
religious connotation, whereas ethics does not, Further, morality is sometimes used to refer to the particular,
subjective preferences of people and groups, as opposed to an objective field of inquiry. These distinctions are
misguided. Morality, like ethics, is not a localised custom or etiquette. Its rules and principle apply equally to
all people. Hence, the distinction between ethics and morality is illusory and is not adopted in this book. The
terms are used interchangeably. See further, Peter Singer, Ethics (1994) Chapter 1.

419
420 BUSINESS ETHICS AND FUTURE DIRECTION

engage in moral reflection, correction and argument and, as with other areas of
human knowledge, there appears to be a slow but evident convergence in our
moral judgments. We engage in moral dialogue and thinking in order to evaluate
and improve on our own behaviour, and in an endeavour to persuade others to
behave in an appropriate manner. Moral norms are also the cornerstone of our
legal rules and principles.
In this chapter we examine the moral norms that apply to corporations. If it
is established that corporations are morally bound by certain norms, this will
not, of course, compel company officers to adhere to those norms. They may yet
choose to flout morality and be guided solely by their legal rights and duties.
However, the law is often driven by moral considerations and, hence, if it is
established that certain moral norms clearly apply to corporations, these norms
may form the basis for future law reform. While not all laws have a moral
foundation (some are purely for coordination purposes, such as driving on the
left or right-hand side of the road), it is not easy to provide examples of laws
in developed nations that are clearly immoral. Prior to considering the role of
ethics in business, we provide a brief overview of the nature of morality.
At its most basic level, morality consists of the principles that dictate how
serious conflict should be resolved.2 Not every aspect of our lives is governed
by morality. As an empirical fact, morality does not dictate what colour shirt we
should wear, who gets to watch a television show, or what career we should
choose. Morality is not concerned with trivialities. Further, it relates only to
situations in which there is an actual or potential conflict of interest between
two or more parties – it assesses and weighs the respective interests. In a perfect
world, consisting of unlimited resources and no possibility of clashes of interests,
morality would be redundant.
In a book of this nature it is not possible to provide a systematic or detailed
analysis of moral theory. More ink has been spilt on moral theory – perhaps
because of its cardinal status in evaluating human conduct – than probably any
other social issue. However, it is necessary to make some broad observations
regarding the meaning and nature of moral discourse and imperatives.
There has been a proliferation of normative moral theories that have been
advanced over the past four or five decades. These theories can be divided
into two broad groups. Consequentialist moral theories claim that an act is
right or wrong depending on its capacity to maximise a particular virtue, such
as happiness. Non-consequentialist (or de-ontological) theories claim that the
appropriateness of an action is not contingent upon its instrumental ability to
produce particular ends, but follows from the intrinsic features of the act.3
The leading contemporary non-consequentialist theories are those that are
framed in the language of rights. Following the World War II, there has been

2 Mirko Bagaric, ‘A Utilitarian Argument: Laying the Foundation for a Coherent System of Law’ (2002) 10
Otago Law Review 163.
3 Another normative theory, termed ‘virtue ethics’ focuses on moral character or promoting certain ideals as
opposed to duties and obligations.
 ETHICAL OBLIGATIONS OF CORPORATIONS 421

an immense increase in ‘rights talk’,4 both in number of supposed rights and

in total volume. Rights doctrine has progressed considerably since its original
aim of providing ‘a legitimisation of . . . claims against tyrannical or exploiting
regimes’.5
There is now, more than ever, a strong tendency to advance moral claims
and arguments in terms of rights.6 Despite the dazzling veneer of de-ontological
rights-based theories, when examined closely such theories do not provide con-
vincing answers to central questions such as: what is the justification for rights?
How can we distinguish real from fanciful rights? Which right takes priority
in the event of conflicting rights? Arguably, such intractable difficulties stem from
the fact that contemporary rights theories lack a coherent foundation. Attempts
to ground rights in ideals such as dignity, concern or respect are unsound and fail
to provide a mechanism for moving from abstract ideals to concrete rights.7 A
non-consequentialist ethic provides no method for distinguishing between gen-
uine and fanciful rights claims, and is incapable of providing guidance regarding
the ranking of rights in the event of a clash.
Due to the great expansion in rights talk, rights are now in danger of being
labelled as mere rhetoric, and are losing their cogent moral force. Or, as Sumner
points out, rights become an ‘argumentative device capable of justifying anything
[which means they are] capable of justifying nothing’.8
Therefore, in attempting to uncover the scope and content of corporate ethics
it is unhelpful to consider it purely from the perspective of a de-ontological,
rights-based normative theory. Against the background of such a theory, con-
sumers coherently are able to declare that their right to essential goods (such as
medicines) should be subsidised by companies; shareholders are able to assert
that their right to maximise the return on their shares should trump other inter-
ests, while directors are able to assert that their right to high salaries for their
labour should prevail over other competing interests. Unfortunately, there is
no underlying ideal that can be invoked to provide guidance on the issue. As
with many rights, the victor may unfortunately be the side that simply yells the
loudest.
This may seem to be unduly dismissive of rights-based theories and pays inad-
equate regard to the considerable moral reforms that have occurred against the
backdrop of rights talk over the past half-century. There is no doubt that rights
claims have proved to be an effective lever in bringing about social change. As
Campbell correctly notes, rights have provided ‘a constant source of inspiration

4 See Tom Campbell, The Legal Theory of Ethical Positivism, Brookfield Vermoth, Darmouth Publishing
Company (1996) 161–88, who discusses the near-universal trend towards bills of rights and constitutional
rights as a focus for political choice.
5 S I Benn, ‘Human Rights – For Whom and For What?’ in E Kamenka and A E Tay (eds), Human Rights,
London, Edward Arnold (1978) 59, 61.
6 Almost to the point at which it is not unthinkable to propose that the ‘escalation of rights rhetoric is out of
control’: see L W Sumner, The Moral Foundation of Rights, Oxford, Clarendon Press (1987) 1.
7 See Mirko Bagaric, ‘In Defence of a Utilitarian Theory of Punishment: Punishing the Innocent the Compat-
ibility of Utilitarianism and Rights’ (1999) 24 Australian Journal of Legal Philosophy 95, 121–43.
8 Sumner, above n 6, 8–9.
422 BUSINESS ETHICS AND FUTURE DIRECTION

for the protection of individual liberty’.9 For example, recognition of the (uni-
versal) right to liberty resulted in the abolition of slavery; more recently, the
right of equality has been used as an effective weapon by women and other
disenfranchised groups.
For this reason, it is accepted that there is a continuing need for moral dis-
course in the form of rights. This is so even if de-ontological, rights-based moral
theories (with their absolutist overtones) are incapable of providing answers to
questions regarding, for example, the existence and content of proposed rights,
and even if rights are difficult to defend intellectually or are seen to be culturally
biased. There is a need for rights-talk, at least at the ‘edges of civilisation and in
the tangle of international politics’.10 Still, the significant changes to the moral
landscape for which non-consequentialist rights have provided the catalyst must
be accounted for.
There are several responses to this. Firstly, the fact that a belief or judgment
is capable of moving and guiding human conduct says little about its truth –
the widespread practice of burning ‘witches’ being a case in point. Secondly,
at the descriptive level, the intuitive appeal of rights claims, and the absolutist
and forceful manner in which they are expressed, has heretofore been sufficient
to mask fundamental logical deficiencies associated with the concept of rights.
Finally, and perhaps most importantly, we do not believe that there is no role in
moral discourse for rights claims. Simply, that the only manner in which rights
can be substantiated is in the context of a consequentialist ethic.11
A more promising tack for providing concrete guidance regarding competing
rights and interests in constructing and justifying a ladder of human rights is to
ground the analysis in a consequentialist ethic. The most popular consequential-
ist moral theory is utilitarianism. Several different forms of utilitarianism have
been advanced. In our view, the most cogent (and certainly the most influential
in moral and political discourse) is hedonistic act utilitarianism, which provides
that the morally right action is that which produces the greatest amount of hap-
piness or pleasure and the least amount of pain or unhappiness. This theory
selects the avoidance of pain, and the corollary, the attainment of happiness, as
the ultimate goals of moral principle.
We are aware that utilitarianism has received a lot of bad press over the past
few decades, resulting in its demise as the leading normative theory. Consider-
ations of space and focus do not permit us to fully discuss these matters. This
has been done elsewhere.12 The key point to note for the purpose of the present
discussion is that for those with a leaning towards rights-based ethical discourse,
utilitarianism is well able to accommodate interests in the form of rights.13 Rights
9 Campbell, above n 4, 165.
10 Ibid.
11 See also John Stuart Mill, who claimed that rights reconcile justice with utility. Justice, which he claims
consists of certain fundamental rights, is merely a part of utility. And ‘to have a right is . . . to have something
which society ought to defend . . . [if asked why] . . . I can give no other reason than general utility’: J S Mill,
‘Utilitarianism’ in M Warnock (ed.), Utilitarianism, Fontana Press (1986, first published 1981) 251, 309.
12 Bagaric, above n 7.
13 Mill, above n 11.
 ETHICAL OBLIGATIONS OF CORPORATIONS 423

not only have a utilitarian ethic, but in fact it is only against this background that
rights can be explained and their source justified. Utilitarianism provides a more
sound foundation for rights than any other competing theory. For the utilitarian,
the answer to why rights exist is simple: recognition of rights best promotes
general utility. Their origin accordingly lies in the pursuit of happiness. Their
content is discovered through empirical observations regarding the patterns of
behaviour that best advance the utilitarian cause. The long association of utili-
tarianism and rights appears to have been forgotten by most. However, over a
century ago it was John Stuart Mill who proclaimed the right of free speech, on
the basis that truth is important to the attainment of general happiness, and this
is best discovered by its competition with falsehood.14
Difficulties in performing the utilitarian calculus regarding each decision
make it desirable that we ascribe certain rights and interests to people – interests
that evidence shows tend to maximise happiness, even more happiness than if we
made all of our decisions without such guidelines. Rights save time and energy by
serving as shortcuts to assist us in attaining desirable consequences. By labelling
certain interests as rights, we are spared the tedious task of establishing the
importance of a particular interest as a first premise in practical arguments.15
There are also other reasons that performing the utilitarian calculus on each
occasion may be counter productive to the ultimate aim. Our capacity to gather
and process information and our foresight are restricted by a large number of
factors, including lack of time, indifference to the matter at hand, defects in
reasoning, and so on. We are quite often not in a good position to assess all the
possible alternatives and to determine the likely impact upon general happiness
stemming from each alternative. Our ability to make the correct decision will be
greatly assisted if we can narrow down the range of relevant factors in light of
pre-determined guidelines. History has shown that certain patterns of conduct
and norms of behaviour, if observed, are most conducive to promoting happi-
ness. These observations are given expression in the form of rights that can be
asserted in the absence of evidence that adherence to them in the particular case
would not maximise net happiness.
Thus, utilitarianism is well able to explain the existence and importance of
rights. It is just that rights do not have a life of their own (they are derivative not
foundational), as is the case with de-ontological theories. Due to the derivative
character of utilitarian rights, they do not carry the same degree of absolutism
or ‘must be doneness’ as those based on de-ontological theories. However, this is
not a criticism of utilitarianism; rather, it is a strength since it is farcical to claim
that any right is absolute.
The broader matter to note for the purposes of this book is that as far as
implications for corporate ethics are concerned, similar conclusions are reached

14 Ibid.
15 See Joseph Raz, Morality of Freedom, New York, Oxford University Press (1986) 191. Raz also provides
that rights are useful because they enable us to settle on shared intermediary conclusions, despite considerable
disputes regarding the grounds for the conclusions.
424 BUSINESS ETHICS AND FUTURE DIRECTION

irrespective of which ethical theory one chooses. While at the foundational level
ethical theories often diverge enormously, they often share similar premises
concerning the nature of morality and key moral principles. As we shall see below,
the view that moral principles are universalisable transcends most moral theories.
So, too, does the existence of some core moral principles. Consequentialist and
non-consequentialist theories alike place considerable importance on values such
as life, liberty and property – although they differ in terms of the absoluteness
with which such principles apply. However, the exact points of departure in this
regard are not critical for the purposes of the present discussion. The discussion
below emphasises a number of moral principles, and in particular ‘the maxim of
positive duty’.
Thus, we argue that the conclusions we reach concerning the moral obligations
of companies follow irrespective of which moral theory is adopted.
This chapter is about discovering which, if any, moral duties apply to corpora-
tions. Corporate ethics concerns the intersection between corporate activity and
normative ethics. This, of course, assumes that ethics and corporate activities do
in fact overlap. A tenable argument can be mounted that ethics and corporate
activities are parallel areas of human endeavour, which do not intersect. In the
next part of this chapter, following a brief history of business ethics, we consider
whether the fusion between business and ethics belongs in the realm of reality,
as opposed to wishful or ‘virtual’ thinking.
In section three we examine the moral rules that govern business in general.
The ultimate aim of most corporations is to make money, and hence there would
not seem to be a relevant distinction between the ethical constraints that bind
the business world in general and the corporate world in particular. Thus, in
considering the ethical duties that bind those involved in corporate decision
making, we examine the ethical constraints that bind businesses in general.
However, in section four we shall see that very successful businesses, which
normally operate under a corporate structure, have additional moral duties.

14.2 The threshold issue: Is there a role for ethical

considerations in business?

14.2.1 A brief look at the short history of business ethics

The notion that businesses have moral duties is becoming increasingly
widespread. This has been partly as a result of what appears to be an increasing
number of corporate scandals. As noted by Scott Mann:

The scandals of Enron, WorldCom, Xerox and Merck are in the headlines: massive
accounting frauds involving many billions of dollars of fabricated and inflated profits,
assets and revenues through which these corporations with the help of their accoun-
tants, have maintained share prices far above those justified by their true financial
status, to increase the wealth of existing shareholders (including company executives)
 ETHICAL OBLIGATIONS OF CORPORATIONS 425

and to attract new investors. These companies have responded to the public revelations
of such practices by sacking thousands of workers to ‘reduce their costs’ (17,000 in the
case of WorldCom alone).16

In a similar vein, Gordon Clark and Elizabeth Jonson note that during the past
two decades there has been a considerable degree of interest, at least at the
theoretical level, in the concept of business ethics. The topic of business ethics
has been elevated to the front pages of the mainstream media as a result of events
going back to the 1980s, including the 1987 stock market crash (as a result of
which billions of dollars were wiped from the resource base of investors); the
recession of the early 1990s; the apparent corruption in business, leading to the
collapse of personal leveraged empires in Australia, the UK and Canada; 17 and
the ruin of once-iconic symbols of the free market such as Lehman Brothers and
Bear Stearns during the 2007–9 global financial crisis. Springboarding from this
are concepts such as ‘corporate social responsibility’18 (which is discussed further
below) and ‘obligations to stakeholders’.19
Laura Nash correctly notes that ‘the topic of business ethics is acknowledged
to pervade every area of the corporation just as it is a recurrent theme in media.
Corporate codes of conduct are now the norm rather than the exception’.20
However, the link between business and ethics has a very short history. It
has been recognised as a genuine form of applied ethics for little more than the
past few decades. According to Aristotle, the practice of chrematisike, or trading
for profit, was devoid of virtue and engaged in only by ‘parasites’. As is noted
by Robert Solomon, this view prevailed until the 17th century.21 Thereafter the
attitude towards business quickly changed:

John Calvin and then the English Puritans taught the virtues of thrift and enterprise,
and Adam Smith canonized the new faith in 1776 in his masterwork, The Wealth of
Nations . . . The general acceptance of business and the recognition of economics as
a central structure of society depended on a very new way of thinking about society
that required not only a change in religious and philosophical sensibilities but, under-
lying them, a new sense of society and even of human nature. This transformation
can be partly explained in terms of urbanization, larger more centralized societies,
the privatization of family groups as consumers, rapidly advancing technology, the
growth of industry and the accompanying development of social structures, needs and
desires.22

16 Scott Mann, Economics, Business Ethics and Law, Sydney, Lawbook (2003) 13.
17 See Gordon Clark and Elizabeth Jonson, ‘Introduction’ in Clark and Jonson (eds), Management Ethics,
Sydney, Harper Educational (1995), 11.
18 See for example, Simon Longstaff, ‘About Corporate Social Responsibility’ (2000) 40 City Ethics 1. See
more generally list of articles by St James Ethics Centre at <www.ethics.org.au>.
19 See, for example, Otieno Mbare, ‘The Role of Corporate Social Responsibility (CSR) in the New Economy’
(2004) Electronic Journal of Business Ethics and Organization Studies, available at <http://ejbo.jyu.fi/articles/
0901 5.html>.
20 Laura Nash, ‘Why Business Ethics Now’ in Clark and Jonson (eds), above n 17, 25.
21 Robert C Solomon, ‘Business Ethics’ in Peter Singer (ed.), A Companion to Ethics, Oxford, Blackwell (1991)
354, 355.
22 Ibid.
426 BUSINESS ETHICS AND FUTURE DIRECTION

While business has became an acceptable activity it is only recently that a ‘more
moral and more honourable way of viewing business has begun to dominate busi-
ness talk’.23 Although business ethics has a very short and patchy history, Laura
Nash notes that some trends have apparently emerged regarding the changing
focus of business ethics. In the 1950s, the two major concerns were price-fixing
and dehumanisation in the workforce. In the 1960s, constraints were placed
on environmentally and socially destructive activities. The 1970s witnessed
concerns about bribery following the shift to internationalism, in particular to
markets in Asia and the Middle East.24 In the 1980s, the focus shifted from
institutional responsibility to the moral capacity of individuals. Thus, there was
considerable concern over activities such as insider trading and hostile takeovers,
which were marked by a high degree of greed and dishonesty.25
In the early 21st century, greed, sprinkled with an unhealthy dose of dis-
honesty, is still the major constant that underpins public disillusionment with
the corporate governance of many large public companies. This disillusionment
has been fuelled by a string of corporate collapses, wiping out billions of dol-
lars of shareholder investment – notable instances being that of Enron, HIH and
One.Tel; 26 and a suite of financial institutions that either folded or were sub-
ject to government takeover or bail out, including Fannie Mae, Merrill Lynch,
Ford, General Motors Chrysler, Freddie Mac, Washington Mutual and AIG dur-
ing the global financial crisis of the late 2000s. This is nothing new. It seems to
be a cyclical event. In the Australian context, about a decade ago even middle
Australia was taken aback by the collapses of the Quintex group and the Pyramid
Building Society. Company managers continue to be criticised for their apparent
inability to look beyond the bottom line of the profit-and-loss statement and, in
particular, how this impacts on their personal fortunes. There is also increasing
disquiet regarding the huge sums paid to corporate directors, in the form of both
salary and wages and severance payments. This reached its peak at the height
of the global financial crisis. The USA alone injected nearly $1 trillion in 2008
and 2009 in two stimulus packages designed to improve liquity and confidence
in the market. A large portion of these funds were used to prop up crumbling
private financial institutions. The community and many world leaders, includ-
ing United States President Barack Obama and Australian Prime Minister Kevin
Rudd, tapped into widely held community sentiment that it is indecent for offi-
cers of these failing institutions to be receiving massive sums of public money for
(anti-) managing instutions to the brink of financial ruin. Despite the anger and
dismay at burgeoning corporate salaries, governments have yet to put in place
effective mechanisms to rein in these excesses.27

23 Ibid, 356.
24 For a discussion of the similarities between bribery and networking, see Mirko Bagaric and Leigh Johns,
‘Bribery and Networking: Is There a Difference?’ (2002) 7 Deakin Law Review 159.
25 Nash, above n 20.
26 See, for example, Henry Bosch, ‘The Changing Face of Corporate Governance’ (2002) 25 University of
New South Wales Law Journal 270.
27 In January 2010, the Productivity Commission in Australia recommended that directors should be required
to stand for re-election if a majority of shareholders reject remuneration reports. The report can be found at
<www.pc.gov.au/ data/assets/pdf file/0008/93590/executive-remuneration-report.pdf>.
 ETHICAL OBLIGATIONS OF CORPORATIONS 427

14.2.2 The disunity between business and ethics argument

Despite the emerging popularity of the notion of business ethics, there is little
convergence in opinion regarding the precise moral duties owed by company
managers.28 In light of this, and the infancy of the concept of business ethics,
many commentators continue to maintain that ethics does not have a role in the
corporate world. The duty of a company director, so the argument runs, is to
maximise corporate profits within the bounds of the law – no more, no less.
The most famous exponent of this argument is Nobel Prize-winning economist
Milton Friedman who, in an article in the New York Times over three decades
ago titled ‘The Social Responsibility of Business is to Maximise Profits’, stated
that company directors are the employees of shareholders and therefore have
a fiduciary duty to maximise profits. Directing resources to charities or other
social causes is akin to stealing from shareholders. He called business people
who defended the notion of corporate responsibility ‘unwitting puppets of the
intellectual forces that have been undermining the basis of a free society’. He
also accused them of ‘pure and unadulterated socialism’.29
The notion that there may be a contradiction between commercial realities
and moral norms has been noted (though not endorsed) more recently in the
context of legal practice by Justice Kirby, who ‘has speculated about whether it
is possible to maintain noble ideas while practising in the world of commercial
realities’.30
Thus, before launching into a discussion of business ethics, the threshold issue
that must be addressed is this: does ethics have any role in guiding the decision
making of company managers?

14.2.3 Morality applies to business because moral judgments

are universalisable
A counter to the separateness of business and ethics argument is that it violates
a fundamental paradigm of morality. The surface nature of moral language
suggests that moral principle is applicable to all forms of human conduct, whether
public or private,31 and provides the ultimate evaluative framework by which our
behaviour is judged. The notion of contracting out of morality seems untenable.
A key feature of moral judgments is that they are universalisable.
A judgment is universalisable if the acceptance of it in a particular situation
entails that one is logically committed to accepting the same judgment in all other
similar situations. Accordingly, whenever one judges a certain action or thing
(situation) as having a particular moral status then one is logically committed to

28 For an overview of some of the different theories so far as they apply to business, see Mann, above n 16.
29 As cited in Solomon, above n 21, 360.
30 As cited in J Cain and K Hammond, ‘Tending the Bar: Lawyers are Expected to Act Ethically. Whose Job
is it to Ensure They Do?’, The Age (Melbourne), 18 August 2002, 16.
31 For the difference between particular and public reasons, see Stephen Freeman, ‘Contractualism, Moral
Motivation & Practical Reason’ (1987) 88 Journal of Philosophy 281.
428 BUSINESS ETHICS AND FUTURE DIRECTION

the same judgment about any relevantly similar action or situation.32 If an action
is morally good or bad, then it is so in all relevantly similar situations in which
that action is performed. The context in which an action is performed does not
appear to constitute a relevant difference. Deliberately lying to another person
is wrong irrespective of whether it is done in private or in the context of sport,
politics or other fields of human endeavour. So too, it would seem, in the case of
(corporate) business activities. In order to justify the independence thesis, it is
necessary to identify a relevant difference between business activities and other
activities that are subject to moral evaluation.

14.2.4 Exception to universalisation – activities with

internal settled rules?
A possible basis for distinguishing business from most other human endeavours –
which are clearly subject to moral evaluation – is that business is a ‘self-contained’
activity. That is, it is already governed by relatively settled and clear principles
and standards. Moral rules appear to apply most acutely to govern conduct
between private individuals, which is largely unregulated by other norms. Thus,
it is morally reprehensible to lie, break promises or cheat on our partners, and
so on.
Business, on the other hand, has its own settled rules and, hence, so the
argument goes, there is no scope to evaluate the morality of activities conducted
within the scope of business. The boxer who intentionally injures an opponent
is immune from moral blame, even though his or her conduct would be clearly
reprehensible if performed in a different setting. Corporate and business activities
are regulated by extensive and complex legal rules and principles. Hence, just
like boxing, the activities performed by corporations should be immune from
moral evaluation.
This attempt to excise corporations and business from the sphere of moral
evaluation fails because it places too much weight on the importance of the
existence of established rules. The level of sophistication, organisation or sys-
tem that underlies an area of human endeavour is generally irrelevant to its
amenability to moral evaluation. This is shown by the fact that activities that
produce undesirable outcomes – such as drug trafficking, people smuggling and
child pornography – do not attract moral immunity irrespective of their level of
internal regulation and organisation.
There certainly may be instances in which following the rules of an exist-
ing rule-governed practice may provide a general immunity from moral blame.
Tackling another player in conformity with the rules of soccer, refusing to pass
a weak student, serving the first person in a queue are all perfectly justifiable
32 It has been suggested that numerical differences are irrelevant. This refers to specific descriptions of the
person, relation or situation. Thus, the fact that the judgment relates to a particular person (such as John
Smith), place (such as Melbourne), relation (John’s mother) is irrelevant. Also irrelevant are generic differ-
ences: tastes, preferences and desires: see John L Mackie, Ethics: Inventing Right and Wrong, Harmondsworth,
UK, Penguin (1977) 83–102.
 ETHICAL OBLIGATIONS OF CORPORATIONS 429

actions. However, this has nothing to do with the fact that forms of conduct are
regulated by rules (of sport, academia or etiquette), but rather occurs because
the rules have been designed in light of pre-existing moral norms, or at least are
not morally objectionable in themselves. Similarly, the only reason that boxing
is morally acceptable is because the good consequences from it outweigh the
bad – the need to respect the autonomy of the boxers weighs more heavily in the
moral calculus than the possible harm that might occur as a result of condoning
fighting in a controlled environment.
Further, those involved in generally non-offensive, rule-governed activities
never acquire an absolute indemnity from moral censure. For example, it is rep-
rehensible for organisers of a boxing context to pit a skilled professional fighter
against a rank amateur, or for a referee to permit a fight to continue after one
boxer clearly has been rendered defenceless. Hence, even in relation to rule-
governed practices that are generally regarded as being morally acceptable,
moral norms continue to play a supervisory role. This role is so cardinal that
morality remains a constant catalyst for rule changes to the practices – to ensure
that they continue to conform to changing, increasingly enlightened, moral
standards.
It follows that the mere fact that corporations have well-settled rules, proce-
dures and protocols for all aspects of their activities does not provide them with
immunity from moral norms. The important question is whether corporations
conform to minimal moral standards.

14.2.5 Are moral norms too vague to apply to business?

A further rationale that has been advanced in support of the separateness of
business and ethics is that morality has no role in business because it is too
subjective and, given its indeterminate nature, is incapable of providing guidance
concerning business practice.33 To this, there are three counters. First, as one of
the authors has previously argued, moral principles are in fact objective, capable
of logical proof.34 The mere fact that it is sometimes difficult to find moral answers
does not derogate from this – in the same way that difficulties in finding cures for
many physical illnesses do not mean that there are not necessarily better forms
of treatment.
Second, for sceptics who are unconvinced about the objectivity of moral judg-
ments, even if we accept that moral judgments are by their very nature imprecise
and often indeterminate, this has not limited their application to other human
endeavours and activities, such as politics, law, or even sport. Why then should
the situation be any different in the case of corporate business activities?
Third, the fact that the moral status of an activity has not been resolved,
and the application of moral principles to it has not produced clear standards of

33 Milton Friedman, as cited in Solomon, above n 21, 361.

34 Bagaric, above n 2, 163; Mirko Bagaric ‘Internalism and the Part-time Moralist: An Essay about the
Objectivity of Moral Judgments’ (2001) 2 Journal of Consciousness and Emotion 255.
430 BUSINESS ETHICS AND FUTURE DIRECTION

conduct pertaining to that activity, generally results in increased moral reflection

and assessment upon the matter, rather than an abandonment of such discourse.
For example, the fact that activities such as abortion and cloning are morally
equivocal has proved a catalyst for further moral dialogue and debate on such
issues – not less, or none at all.
Accordingly, since there is no relevant difference between corporate and
business activities and other activities that are regulated by moral principles, the
business world is not outside the sphere of morality.

14.2.6 Promise to shareholders to maximise profits as a basis

for rejecting application of moral principles to business?
A third possible justification for excluding the operation of moral principles
to business is the argument that businesses ‘owe’ it to their shareholders and
investors to make profit maximisation the cardinal objective.35 ‘Owe’ in this
context is used in a normative sense, implying that investors and shareholders
invest in businesses in the reasonable expectation that they will be profit-focused
and hence it would be morally reprehensible for businesses to act contrary to
this – it would violate the moral prescription that one should keep one’s promises.
This argument fails for several reasons.
First, few investors who put their finances into a business receive an express
promise that their funds will be used only to maximise profit.36 It could be claimed
that although investors do not receive an express promise as to the manner in
which their funds will be used, there is widespread knowledge in the community
that the sole aim of business is to maximise profit and hence there is at least a
tacit promise to this end. However, even if businesses did promise to investors to
use the funds solely to advance profit, this does not justify the harmony thesis.
Promise-keeping is not the highest-order moral requirement. It is undoubtedly
morally permissible and necessary to break a promise in circumstances in which
keeping it would result in significant harm to another person. For example,
there is no question that it is appropriate to break a promise to meet a friend or
colleague in order to attend to an emergency. Business, too, would be justified
in breaking a ‘profit promise’ to shareholders where keeping the promise would
violate higher-order moral ideals.
In order to get at least some mileage out of the promise to shareholders
argument, it could be contended that while the existence of a promise does
not absolutely justify the harmony thesis, it goes at least part way to doing so

35 Milton Friedman, as cited in Solomon, above n 21, 354.

36 Christopher Stone, Where the Law Ends: The Social Control of Corporate Behaviour, New York, Harper &
Row (1975). Moreover, an increasing number of people want corporations to focus on matters beyond profit
making. Mbare, above n 19, notes that: ‘The Millennium Poll on Corporate Social Responsibility, September
1999 conducted by Mitsubishi Corporation found “two in three citizens want companies to go beyond their
historical role of making profit, paying taxes, employing people and obeying all laws; they want companies
to contribute to broader societal goals”.’
 ETHICAL OBLIGATIONS OF CORPORATIONS 431

by providing a prima facie reason that profit maximisation should be the main
business goal.
However, even this less-ambitious form of the argument fails. It is not true
that one always has even a prima facie obligation to uphold a promise. The
content of a promise often can affect the reason for keeping it.37 Implicit in the
term ‘prima facie’ is the notion that the act it relates to should be done unless
there are other more compelling considerations. If even in the absence of other
more compelling considerations, the act still should not be performed, due to its
abhorrent nature, then the use of the term ‘prima facie’ is not only redundant, but
also incorrect. Thus, a corporate officer would not have an obligation to approve
the sale of dangerous goods, no matter how profitable the arrangement was to
the corporation.

14.2.7 Summary of the general link between business and ethics

In all other areas of life, moral principles are the ultimate standards by which we
evaluate and assess activities and actions. Business is a label describing one of
many types of human activities. Irrespective of how desirable an activity is felt
to be, the universalisability and pervasiveness of morality is such that it applies
to properly regulate the actions performed within the relevant activity. This is so
even in relation to practices such as medicine, law and charitable services.
The fact that corporate activities are not different in any relevant sense from
the range of activities to which moral principles are applicable means that they
too are caught within the sphere of moral evaluation. As such, moral principles
are the ultimate evaluative standard of business conduct and should prevail
where there is tension between them and business principles.
Having dispelled the argument that there is no role for ethics in business,
we now turn our attention to the content of the ethical norms that apply in
the business setting. Before we discuss business ethics, it is important to note
that business ethics is not a stand-alone moral construct, but that it forms part of
normal ethics. Fundamental moral principles and major moral theories – already
discussed by Bagaric38 – should always be kept in mind when business ethics are
considered. As a reminder, there is general consensus that, irrespective of which
of the mainstream normative theories one adopts, the following list represents
the core moral principles:
1. Do not kill or otherwise violate the physical integrity of others.
2. Do not steal the property of others.
3. Do not lie (this includes keeping promises).
4. Assist others who are in serious trouble, when assistance would immensely
help them at no or little inconvenience to oneself (the maxim of positive
duty).

37 Chin Liew Ten, ‘Moral Rights & Duties in a Wicked Legal System’ (1989) 1 Utilitas 139.
38 Bagaric, above n 2, 163.
432 BUSINESS ETHICS AND FUTURE DIRECTION

14.3 Application of moral principles to

a business setting

14.3.1 Types of duties imposed on corporations – proscriptions

against causing harm, lying and environmental damage
already legally enforced
According to some commentators, the managers of corporations have extensive
moral obligations to all those affected by corporate activities. Robert Solomon
believes that ‘managers of corporations have obligations to their sharehold-
ers and all other stakeholders as well. In particular, they have obligations to
consumers and the surrounding community as well as to their employees’.39
More elaborately, he defines the stakeholders in a company ‘as all those who
are affected and have legitimate expectations and rights regarding the actions
of the company, including employees, consumers and suppliers as well as the
surrounding community and society at large’ – see further our discussions in
Chapter 2.40
The content of this obligation to all stakeholders is unclear. Nevertheless,
the view that corporations have wide-ranging ethical obligations is shared by a
growing number of commentators and members of the public. It is an increasingly
popular conception that institutions should be ‘good corporate citizens’ and that
they have widespread ‘social responsibilities’. While the exact meaning of such
phrases has not been defined, the connotation is clear. Corporations should be
managed in such a way that they are socially responsible and do not engage in
activities that adversely impact on the interests of others.
There are a myriad ways in which companies can damage the interests of
others. The most obvious is where a corporation sells or otherwise distributes
unsafe products or engages in unsafe practices that place at risk the lives and
physical safety of employees. Less extreme, but potentially just as damaging, are
practices that are not conducted in a sustainable manner; for example, where
corporations exhaust finite resources or destroy culturally or environmentally
valuable assets. It has also been suggested that corporations have a duty of
candour to all people who may be inclined to invest in them. Finally, it has been
suggested that corporations should not only avoid committing harmful acts, but
that they have a positive duty to engage in activities that promote desirable social
ends.
Thus, there are broadly four levels of expectations or duties that can be
imposed on corporations:

39 Solomon, above n 21, 361.

40 Ibid, 360. See also Kenneth Goodpaster, who defines a stakeholder in an organisation as (by definition)
‘any group or individual who can affect or is affected by the achievement of the organization’s objectives’.
As examples of such stakeholder groups Goodpaster mentions employees, suppliers, customers, competitors,
governments and communities: as cited in Marjaana Kopperi, ‘Business Ethics in a Global Economy’ (1999) 4
Electronic Journal of Business Ethics and Organization Studies, available at <http://ejbo.jyu.fi/articles/0401
1.html>.
 ETHICAL OBLIGATIONS OF CORPORATIONS 433

(i) not to directly harm people

(ii) not to engage in activities that are socially or environmentally unsustain-
able
(iii) not to lie or otherwise misrepresent the activities of the corporation and
(iv) to engage in activities that are socially desirable – for brevity, we shall call
this the duty of benevolence.
In determining the nature and scope of moral duties that apply to corporations,
the starting point, as we have seen, is that all agents are subject to moral norms
and evaluation. Corporations are ultimately a group of people acting towards a
common goal. There is no doubt that moral liability applies not only to individ-
ual, but also to group actions. Individuals cannot opt out of moral liability by
engaging in activities with others. Thus, we see that each individual in a group or
‘gang’ of people that harms others is morally liable for the conduct. This applies
irrespective of the size of the group – in some cases even entire nation states
can be held to account for the conduct of individuals or groups within the state.
The best example of this is the censure that is typically cast upon nations that
engage in unjustified war against other states, such as Germany during both
world wars, Japan during World War II, Iraq during its occupation of Kuwait and
most recently the USA for its ‘coalition of the willing’ invasion of Iraq in 2003.
Thus, the collective decision-making and action-taking nature underpinning cor-
porate activities do not provide a relevant basis for limiting the scope of moral
duties that apply to corporate agents.
Against this background, we see that the first three duties are not highly con-
troversial. All agents have a moral duty not to engage in activities that physically
harm others, and not to lie to others. There is also a widespread consensus that
we have a moral duty not to damage the environment.41 These duties apply uni-
versally and there is no tenable argument for carving out a business exemption
in relation to them.
In relation to each of these areas, Australia and all developed economies have
wide-ranging and settled laws. Developed economies have highly developed
and comprehensive product liability laws (to protect consumers) and labour
laws (to protect employees), and in most circumstances these operate effectively
to discourage corporations from distributing goods that place at risk the physical
safety of consumers or from engaging in work practices that imperil the safety of
their workers. As we have seen in earlier chapters, there are also strict duties on
directors to accurately report on the activities of the corporation and to flag any
material changes to the activities of the corporation. In addition, there are wider-
ranging laws, often imposing criminal sanctions (which are often strict liability
in nature), that proscribe or limit activities that damage the environment or risk
exhausting finite resources.
Underpinning and justifying these laws are the moral principles adverted to
above. While the overlap between moral and legal duties that apply to companies
41 Although the precise content of this duty is less well developed, see Mirko Bagaric, ‘Environmental Ethics
and the Fallacy of Kyoto’ (2005) 12 Buffalo Environmental Law Journal 195.
434 BUSINESS ETHICS AND FUTURE DIRECTION

relating to dishonesty and activities that cause direct harm to others or that
damage the environment is probably not complete, it is certainly extensive. It may
be the case that there are some moral gaps in laws proscribing; for example, the
sale of dangerous goods; however, these gaps are not evident. If commentators
wish to impose a moral duty above and beyond the legal duties that already exist
in these areas it is important to note that these must be established by reference to
the above theories and principles, and not merely asserted as abstract and stand-
alone claims. Given that there is already extensive legal regulation prohibiting the
first three forms of harm listed above42 against all agents, including corporations,
the focus of the rest of this chapter is on moral norms that are not legally enforced.

14.3.2 Additional duties imposed on corporations – a duty

of benevolence?
14.3.2.1 Acts and omissions doctrine serves to minimise obligations
on corporations
The fourth and most controversial duty that potentially applies to corporations
is a positive duty to be a ‘good corporate citizen’. This imposes on corporations a
duty to do more than to simply obey the law. It seeks to impose on corporations
an obligation to engage in activities that promote the welfare of the community,
including company stakeholders, beyond providing high-quality and safe goods
and services. The content of such a duty can vary enormously.
A modest expression of the duty would require corporations to treat all their
employees with concern and respect; for example, by paying performance-based
and end-of-year bonuses. A far more extravagant requirement is in the form that
corporations have a positive duty to enhance community and social capital by
either directly engaging in benevolent activities or indirectly doing so – by, for
example, donating to worthy charities or social causes.43 A duty of benevolence

42 This is obviously not the case in all countries, thus there is a need to carefully consider the moral
obligations of businesses in these areas. Such considerations also arise where Australian companies operate
internationally. For a discussion about business ethics in the global environment, see Kopperi, above n 40. A
particularly important issue in global business ethics concerns the so-called ‘race to the bottom’. This is the
view that corporations are forced to compete with lower salaries, taxation, safety regulations and standards
for environmental protection. In this kind of system, it has been argued that it is very difficult or even
impossible to act in a way that would benefit not only the shareholders but all the stakeholders and the society
on the whole. Given the highly regulated trading and labour market in Australia, this is not a problem at the
domestic level.
43 The uncertainty relating to the meaning of corporate social responsibility is also noted by Mbare, above
n 19, who states: ‘[C]orporate social responsibility is an issue that has dominated many executive discussions
in recent times. Indeed, there are differing perspectives on CSR. At one extreme it is argued that CSR is
achieved as long as an organization does not disobey the law. At the other extreme it is argued that an
organization has a duty to ensure a “good society”.’ He also notes the lack of convergence that exists in
relation to this concept: ‘[C]oncepts of the business-society relationship have evolved and expanded over the
past five decades – from social obligation and stewardship, to social responsibility and social responsiveness
and finally, as Frederick (1994, 1998) suggests, to social consciousness. The literature is replete with theories
and models which seek to describe, to explain, and to institutionalize the relationship (Preston and Post,
1975; Frederick, 1984; Steiner, 1997). Brennan suggest that this scholarship has resulted in less business
defensiveness, more emphasis on managerial techniques for responding to social issues, and more empirical
research on corporate social roles, responsibilities and constraints (see also, Frederick, 1994; Clarkson, 1995).
As pointed out earlier, the efforts to adequately define and circumscribe corporate social responsibility have
been characterized, at times, by acrimonious and frustrating debate and disagreement (Friedman, 1970;
Chamberlain, 1973; Perrow, 1972; Preston & Post, 1975; Frederick, 1994, 1998).’
 ETHICAL OBLIGATIONS OF CORPORATIONS 435

is perhaps the most extreme form of a positive duty that can be imposed on
corporations.
Thus, a duty to be a good corporate citizen can obviously be framed in many
different ways. It is not feasible to consider each such manifestation of this duty.
For the purposes of this chapter we consider the most extreme expression of this
duty – that of benevolence.44
Recognition of such a duty is not in keeping with contemporary corporate
practice. While many corporations are certainly in the business of making dona-
tions, often this is clearly grounded in self-interest (the clearest example of this
being donations to political parties); otherwise it is considered to be an expres-
sion of extreme generosity, rather than the fulfilment of a pre-existing obligation.
Additionally, given the mountain of legal rules that now apply to corporations,
it may seem pragmatically unrealistic and theoretically untenable to expect cor-
porations in a highly regulated environment (where the regulation is already
driven by basic moral norms, such as proscriptions against lying – hence, duties
of disclosure and the like – and harming others) to do more than pursue profits
and comply with the law.
As a general observation, this is correct. At the individual level, as we have
seen, there are very few positive moral obligations imposed upon us. This is also
the case as far as the law is concerned. Thus, it is rare that individuals are required
to positively do an act (as opposed to refraining from engaging in conduct) to
assist another.
This stems from a fundamental distinction that is entrenched in most common
law jurisdictions: the acts and omissions doctrine, which is the view that one is
only responsible and liable for one’s positive acts, as opposed to events that one
fails to prevent (omissions).
The acts and omissions doctrine maintains that there is a relevant distinction
between performing an act that has a certain consequence and omitting to do
something that has exactly the same outcome. Essentially, it is the view that
provided we do not do anything contrary to accepted norms or rules we cannot be
legally culpable. The widespread recognition of this doctrine does not, however,
necessarily entail that there are sound normative reasons supporting it. It may
be that the distinction is grounded in pragmatism as opposed to principle.
Distinguishing between acts and omissions provides a simple method for
demarcating lawful and unlawful conduct. This makes it easier to adhere to the
rule-of-law virtues of consistency, uniformity and certainty.45 Adhering to these
virtues is important if laws are to be effective in guiding conduct. Laws are framed

44 The duty described this way accords with the meaning of corporate social responsibility adopted by the
European Commission. A useful summary of the Commission paper on the topic is provided by Mbare, above
n 19: ‘According to the European Commission’s Green Paper entitled “Promoting a European Framework for
Corporate Social Responsibility” (July 2001), CSR is defined as a “concept whereby companies integrate social
and environmental concerns in their business operations and in their interactions with their stakeholders on
a voluntary basis”. On a simpler note, CSR are actions, which are above and beyond that required by the
law. Frederick (1986: 4) summed up the position as follows: “The fundamental idea of ‘corporate social
responsibility’ is that business corporations have an obligation to work for social betterment”.’
45 For a discussion of the rule-of-law virtues, see John Finnis, Natural Law and Natural Rights, Oxford,
Clarendon Press (1980) 270–6; Joseph Raz, The Authority of Law, New York, Oxford University Press (1979)
Ch 11.
436 BUSINESS ETHICS AND FUTURE DIRECTION

in terms of rules (which are precise guides to certain actions, and apply conclu-
sively to resolve an issue) rather than in terms of principles (which are general
considerations that carry a degree of persuasion and form the underpinnings of
the rules).46
In light of the need for certainty the common law has shown a bias towards
individual liberty. Hence we may do as we wish unless it is clearly wrong. The
acts and omissions doctrine is simple and readily comprehensible and, accord-
ingly, provides a basis for guiding conduct. As a general rule, omissions are not
unlawful, even if motivated by harmful intent, if no pre-established duty is owed
to the other person. Adherence to the acts and omissions doctrine no doubt
allows some reprehensible behaviour to go unpunished. However, it is felt that
the ground lost here is more than made up in terms of the certainty that the
doctrine provides and the harm that would arise if criminal sanctions were to be
imposed on the basis of rules formed retrospectively.
Despite this, there are some circumstances in which people are legally liable
for their omissions. Thus, parents have a duty towards their children, and a
positive duty to act has also been imposed upon those employed in areas having
implications for public safety,47 such as police officers.48
The acts and omissions doctrine has also attracted widespread appeal because
it supposedly prevents our lives being intolerably burdened by demarcating the
extent to which we must help others. It is the reason, so the argument runs,
that we do not feel obliged to devote more resources to assisting people who are
worse off than us, and why we feel less responsible for the deaths and tragedies
we fail to prevent than for those we directly cause. The doctrine is one source of
justification for why failing to feed the starving people in other nations is not
on a par with shooting our neighbour.49 Given the deep roots of the acts and
omissions doctrine, there seems little scope to assert that corporations do in fact
have a positive duty to engage in social and community building activities.
This view is supported by the observations of Solomon, who states that ‘the
purpose of a corporation, after all, is to serve the public, both by way of pro-
viding desired products and services and by not harming the community and
its citizens’.50 While Solomon proposes that corporations should serve the pub-
lic, this duty is supposedly discharged merely by providing quality goods and
services and not harming people. But cannot we ask more from corporations?

14.3.2.2 Principal duty is for corporations to comply with

law – business is morally neutral
From the above, it follows that the starting point so far as the moral obligations
of corporations are concerned is that corporations must abide by the law in

46 For a fuller discussion on the distinction between rules and principles, see Ronald Dworkin, Taking Rights
Seriously, London, Duckworth (1984).
47 For example, see R v Pittwood (1902) 19 TLR 37.
48 For example, see R v Dytham [1979] QB 722.
49 See Helga Kuhse, ‘Euthanasia’ in Peter Singer (ed.), A Companion to Ethics, Oxford, Blackwell (1991) 297.
50 Solomon, above n 21, 361.
 ETHICAL OBLIGATIONS OF CORPORATIONS 437

their pursuit of profit. It is necessary to emphasise that engaging in business

and seeking to make profits is a legitimate form of conduct, and that people –
acting individually or collectively – should be given the opportunity to pursue
such activities. Corporate managers in the pursuit of profits do not, at least prima
facie, need to keep one eye on the bigger moral picture in their pursuit of profits.
They may without any moral embarrassment or guilt go about seeking to make
as much money as is legally possible.
While we might hope that people would engage in somewhat more virtuous
activities than chasing the next dollar, it is not easy to identify a concrete basis
from which to impose such a duty. A good Samaritan duty has not been justi-
fied. The pursuit of profits – like watching television, writing books, walking in
the park, dining with friends, playing or watching sport and driving a car – is
ultimately a break-even or neutral moral activity. It does not harm the agent or
the wider community, nor does it necessarily either promote or diminish any
person’s relevant interests. Moreover, profit chasing will never be able to fully
exhaust the ambit of one’s morally relevant behaviour.
Each person engages in an infinite range of activities. Some are purely for
pleasure, such as watching television and playing tennis; others are functional,
such as working and cleaning the house and buying shares; some are spiritual,
such as attending church or meditating; others are sourced in kindness, such as
babysitting the neighbours’ children and engaging in volunteerism. The point
to note is that even if engaging in business is a morally neutral activity, moral
worthiness (if in fact we should be looking to more than breaking even morally)
can yet be readily acquired through the myriad of other activities in which a
person engages.
So far as business (and other non-inherently harmful activities) is concerned,
people should be given as much space and freedom as possible in terms of how
they go about their activities and projects. This means that corporate managers
should at every point in the process be permitted to keep their eye firmly fixed
on the bottom line of the profit-and-loss statement in making their business
decisions.
Business decisions can thus be made along business lines. Corporate managers
are entitled to pay employees and directors market wages, they can pursue
efficiency at the expense of ‘propping up’ an inefficient workforce, and when they
close down unsound branches they do not need to pay above-market severance
packages.

14.3.2.3 A more elaborate duty – extreme wealth and a maxim

of positive duty
Despite this, there are two (related) reasons that can be advanced to assert that
corporations have a positive duty of benevolence. The first is that the acts and
omissions doctrine is, in fact, unsound.
Despite its intuitive appeal, it is unclear whether the doctrine withstands close
scrutiny. The first criticism of the doctrine is that, as a general rule, there is no
438 BUSINESS ETHICS AND FUTURE DIRECTION

morally relevant difference between acts and omissions – sometimes morality

requires us to perform a positive act.
Morality makes very few positive demands of us. It is essentially a set of neg-
atively framed rules proscribing certain behaviour. However, it is premature to
conclude that so long as we do not violate these negative rules we have discharged
our moral obligations. There are occasions when acting morally requires us to
do more than merely refraining from certain behaviour; when we must actually
do something. Morality defined exhaustively as a set of negative proscriptions
fails to explain why it is morally repugnant for a techno-billionaire to refuse to
give his loose change to the starving peasant whose path he crosses, or why it is
wrong to decline to save the child drowning in a puddle in order to avoid getting
our shoes wet, or to refuse to throw a life rope to the person drowning beside the
pier.
While the situations in which morality demands performance of a positive
action are infrequent, when they do arise the obligations can be so clear, pro-
nounced and unwavering that it would be implausible to postulate an account
of morality that is not consistent with and explicable of such observations. As is
discussed below, in addition to the negative postulates of morality, is one very
important positive one: we must assist others in serious trouble, when assistance
would immensely help them at little or no inconvenience to ourselves51 – the maxim
of positive duty.52
The acts and omissions doctrine is incapable of explaining why we are under-
standably appalled on becoming aware of clear breaches of this maxim. The
public loathing directed at the witnesses of the Kitty Genovese murder is a prac-
tical illustration of the operation of the maxim.53 Whether harm ensues as a result
of an act or omission is in itself irrelevant to the moral appraisal of an action. The
critical issue is whether one is responsible for the harm, where responsibility is
assessed from the perspective of all of the norms and rules of morality including
the maxim of positive duty.
Arguably, the principle of positive duty provides a far more accurate and
coherent basis upon which we can reject intolerable demands on our time and
resources than does the acts and omissions doctrine. The doctrine is not necessary
to explain why we should not work solely to assist others, since there is simply
no pre-existing moral obligation to help everyone we possibly can. As is adverted
to above, morality is essentially a set of negative constraints plus the maxim of
positive duty. The proviso to the maxim, when there is little or no inconvenience
to oneself, readily explains why our duty to assist others is extremely limited.

51 There are some who would deny that any such duty exists (for example, see Edward Mark, ‘Bad Samaritans
and the Causation of Harm’ (1980) Philosophy and Public Affairs 1). However we agree with John Harris, who
in The Value of Life, London, Routledge & Kegan Paul (1987) 31 labels the denial of such a duty as ‘very odd’.
52 A similar principle is articulated by Peter Singer, in Practical Ethics, Cambridge, Cambridge University
Press (2nd edn, 2002), 229–30.
53 Kitty was beaten and stabbed by her assailant in Kew Gardens, Queens, New York City, over a 35-minute
period in front of 38 ‘normal’, law-abiding citizens who did nothing to assist her; not even call the police, or
yell at the offender. When finally a 70-year-old woman called the police it took them only two minutes to
arrive, but by this time Kitty was already dead: Louis P Pojman, Ethics: Discovering Right and Wrong, Belmont,
CA, Wadsworth (1990) 1–2.
 ETHICAL OBLIGATIONS OF CORPORATIONS 439

The second reason that the acts and omissions doctrine may not provide
corporations with a shield to defend themselves against a positive duty to con-
tribute to socially worthy enterprises stems from a relatively rare trait that is
disproportionately enjoyed by corporations.
Corporations are often funded by thousands, and in some cases millions, of
individuals. As a result they have an enormous resource base. This allows them
to compete very effectively in the market place as the preferred provider of
goods and services. This often leads to the generation of enormous profits. Thus,
a distinction between many corporations and individuals is that corporations
control more wealth. This raises for consideration the issue of whether extreme
wealth generates additional or special moral duties.
Generally speaking, wealth is not regarded as being morally relevant in demar-
cating the scope of an agent’s moral rights and responsibilities. Gifts to charity
and other altruistic forms of behaviour are regarded as virtuous conduct, but
there is no expectation on individuals to donate a portion of their resources to
the more needy. While altruism can elevate the moral status of an individual it
is not a necessary requirement for an individual to be a morally fit and complete
agent. This is so, arguably, irrespective of the capacity of the agent to donate
money and other resources.
On this view, a strong argument can be made that corporations, no matter
how large and wealthy, do not have an obligation to promote the betterment
of the community. Corporations are, ultimately, a collection of individuals and
the profits belong to the shareholders. Their duty to assist others should not be
elevated merely because their wealth derives, at least in part, from shareholding –
as opposed to, say, income derived from personal services.

14.3.2.4 Requirement to pay social dividend

However, there are perhaps two fallacies associated with the view that corporate
wealth does not attract a benevolence duty. First, it is not the case that money
derived by collections of individuals is necessarily disaggregated when assessing
whether there is a duty to assist others in need. The ultimate group enterprise
involved in the accumulation of wealth is the nation state. Each nation has a
bottom-line profit-and loss-statement, which is largely measured by its gross
national income (GNI). There is a well-established international custom that
wealthier nations will donate a portion of their wealth (currently the United
Nations has set a target of 0.7 per cent of GNI) to developing countries. This was
pledged nearly 40 years ago in a resolution to the General Assembly. To date,
only five countries have met or surpassed this target: Luxembourg, Denmark,
Norway, Sweden and the Netherlands.54 Australia commits about 25 per cent of
its GDP; the USA 22 per cent and the UK 48 per cent.
This money could, of course, be distributed to the citizens of the donating
countries, but the argument that the money actually belongs to the individuals
does not seem to overcome the strong expectations on rich countries to donate

54 See <www.unmillenniumproject.org/press/07.htm>.
440 BUSINESS ETHICS AND FUTURE DIRECTION

their wealth. Thus, at least in relation to very large institutions, there seems to
be a relatively well-settled moral expectation that very rich institutions should
donate part of their wealth to the more needy.
Second, even at the individual level it can be argued that there is an obli-
gation on the extremely rich to redistribute a portion of their wealth. It is not
necessarily accurate to assert that the parameters of our moral obligations are cir-
cumscribed by an obligation not to engage in activities that harm others.55 This is
an obligation that Australians increasingly seem prepared to fulfil. A study by the
Australian Council of Social Service (ACOSS), published in December 2004, into
the level of donations made by Australians revealed a growth in the collective
sympathy gland of the community. The key findings were:
● $867.7 million was claimed in tax deductible donations in 2001–2, up by
3.5 per cent from the previous year. This builds on a 16.2 per cent increase
in the year before that.
● 3 595 391 taxpayers – 34.8 per cent of all taxpayers – made and claimed tax
deductible donations in 2001–2; 148 828 more people than the previous
year.
● Since 1996, the amount donated by individual Australians as a proportion
of total income has been rising and is at an average of 0.25 per cent. It is
now at its highest level since 1992–3.
● The average tax-deductible donation in 2002 was $241.35.
● The average tax deductible donation made and claimed by Australian males
in 2002 was $280.38 compared to $197.23 for Australian females.56
Thus, a strong argument can be made that corporations do in fact have a moral
responsibility to contribute towards the improvement of the communities in
which they operate. This obligation only crystallises when a corporation is highly
successful in achieving its wealth-generating objective. In dollar terms it is not
feasible to draw a bright line indicating at what point this is reached. Any figure
will be challenged as being arbitrary; however, we suggest that the threshold is
reached once a company (or group of companies) makes a billion-dollar annual
profit. It should then pay a ‘social dividend’ of 5 per cent for each profit dollar
exceeding this amount. A billion dollars is so large a sum that it is unlikely that
anyone could seriously argue that ‘it is not enough’. Five per cent is sufficiently
large to be meaningful, yet small enough to not discourage innovation and merit.
The obvious counter to this proposal is that it is the government’s role to
fund such matters and programs. However, as Peter Singer has commented (in
the context of international aid), there is no evidence that an increase in private
donations will diminish the amount of government support to such areas – in fact

55 According to Peter Singer, people in the developed nations who are on average or above-average incomes
should be donating about 10 per cent of their income to reducing poverty: Practical Ethics, Cambridge,
Cambridge University Press (2nd edn, 2002) 246. For an argument in favour of an even more egalitarian
system, see Kai Nielson, ‘Radical Egalitarianism’ in James Sterba (ed.), Morality in Practice, Belmont, CA,
Wadsworth (3rd edn, 1991) 37.
56 ACOSS, ‘Facts Reveal Record Generosity of Australians at Xmas’, Media Release 13 December 2004,
available at <www.acoss.org.au/News.aspx?displayID=99&articleID=28>.
 ETHICAL OBLIGATIONS OF CORPORATIONS 441

it might even result in an increase.57 Additionally, the two processes of giving

and society building are not mutually exclusive.
In terms of how this social dividend is delivered, there are obviously a mul-
titude of causes and projects that could be described as ‘worthy’. To remove
doubt the money should be applied to basic human needs, such as health and
shelter. Thus, we propose that the social dividend should be paid directly to
public hospitals and other non-profit health providers or institutions involved
in providing housing to destitute members of the community. Food is obviously
another fundamental human need, but the absence of people dying of malnutri-
tion in developed countries indicates that the provision of this important service
is already satisfied.
It should be noted that the duty cast in this manner can be reconciled with the
non-interventionist approach to corporate management set out earlier. As noted
above, corporations are not required at every step to do more than is legally
necessary in their pursuit of profits. However, if they are spectacularly successful
in achieving this goal, they must then donate a portion of their profits. The
proposal being advanced here is analogous to the duties imposed on individuals.
Tiger Woods does not have to break into his golf round to visit the elderly or
staff a soup kitchen, but if he keeps producing outstanding golf rounds and in
the process derives millions of dollars, some of the proceeds should be (and
may well be) donated to worthwhile social causes. Framing the duty in this
manner allows corporate managers and individuals to focus on what they do best,
without constantly being required to have their routine and processes disrupted
by pursuing socially desirable aims, which they may not have appropriate skills
and judgment to identify and implement. At the same time, the community
benefits if they are successful at achieving their prior orientated objectives.

14.3.3 Extreme wealth and duty to not frustrate access to justice

Wealth also confers other advantages upon agents in our legal system. At the
substantive level, there is widespread consensus that the principles underpinning
the legal systems of most developed nations are relatively just and fair – as noted
earlier, certainly it is not easy to identify laws that are demonstrably unjust.
However, this is largely meaningless if parties cannot obtain access to the law
in order to assert and enforce their legal rights. The rights to be free from assault
or to own property would be largely vacuous if muggers and thieves were never
charged and prosecuted. As far as the civil law is concerned, laws of contract
and negligence would be empty if people could not sue when their economic or
physical interests were harmed by others.
In any legal system – such as that in Australia – where the losing party is nor-
mally liable for the other party’s costs, the relative wealth of the potential litigants
plays a crucial role in a rational assessment of whether a party should pursue

57 Singer, above n 55, 241–2.

442 BUSINESS ETHICS AND FUTURE DIRECTION

their legal rights. Corporations often have an invisible barrier of protection from
legal accountability for their unlawful acts because it is not economically viable
for consumers to seek legal redress against them. It is not financially viable to
issue proceedings for a $50 over-charging for a phone, electricity or health-care
bill. Even a ‘win’ in court will result in a net loss. While this is the situation even
in cases in which the defendant is another individual, the problem is even more
acute where the defendant is a wealthy corporation, which has the capacity to
financially exhaust the resources of the plaintiff through interlocutory proceed-
ings even before the substantive claim is determined, or to engage an army of
lawyers to fend off a relatively modest claim.
Thus, corporations have an obligation not to frustrate access of others to the
courts. This obligation can be discharged in a number of different ways. The first
is to have an efficient and open internal complaints system, whereby customer
complaints are handled promptly, courteously and fairly, and which involves pro-
viding written reasons to customers regarding the company’s response to com-
plaints. This complaints-resolution process should be publicised to customers.
For matters that cannot be resolved at this level, and which end up in the courts,
corporations should undertake not to initiate unnecessary interlocutory steps or
engage legal counsel beyond that which is commensurate with the complexity of
the matter and the monetary sum involved. To do otherwise is to use their size
and wealth to achieve unjustified outcomes.

14.3.4 Is corporate social responsibility the answer?

An alternative to these clear and defined (albeit modest) corporate reforms is to
adopt a more wide-ranging mode of corporate regulation that aims to encourage
corporations to become more responsible institutions. The past two decades have
seen a distinct move towards this end.
This has manifested most acutely in the notion of ‘corporate social respon-
sibility’ (CSR), which has gained traction – at least at the conversational and
theoretical levels – in recent times. There is no settled meaning of CSR; however,
in essence it is a concept that corporations and businesses should look beyond the
interest of their immediate stakeholders and give weight to the public interest as
a whole in their policies and practices.
CSR encourages corporations to inject into their decision making important
social and moral objectives and principles. These include the interests of the
immediate community in which a corporation operates as well as more distant
and wider objectives such as environmental concerns.
There are no legal rules compelling CSR. Instead, it is a form of self-regulation,
which despite its vagueness has become synonymous with what is termed the
‘triple bottom line’ of people, planet and profit.
Despite the open-ended nature of CSR, there have been some attempts to more
precisely define its mandates. A number of reporting guidelines or standards
 ETHICAL OBLIGATIONS OF CORPORATIONS 443

have been developed by which to measure and encourage corporations in a

CSR-compliant manner.
For example, the United Nations Global Compact has set out 10 standards that
corporations should observe. The Global Compact is the world’s largest corporate
citizenship and sustainability program. Its participants include more than 5200
businesses in more than 130 countries. Participating corporations are expected
to make the relevant CSR principles part of the organisation’s business and set out
in their annual reports the manner in which these principles are implemented,
and encourage others to advance the Global Impact.
The core requirements of the Global Impact are:

Human rights
● Principle 1: Businesses should support and respect the protection of inter-
nationally proclaimed human rights.
● Principle 2: Businesses should make sure that they are not complicit in
abuses of human rights.

Labour standards
● Principle 3: Businesses should uphold the freedom of association and the
effective recognition of the right to collective bargaining.
● Principle 4: Businesses should uphold the elimination of all forms of forced
and compulsory labour.
● Principle 5: Businesses should uphold the effective abolition of child labour.
● Principle 6: Businesses should uphold the elimination of discrimination in
respect of employment and occupation.

Environment
● Principle 7: Businesses should support a precautionary approach to envi-
ronmental challenges.
● Principle 8: Businesses should undertake initiatives to promote greater
environmental responsibility.
● Principle 9: Businesses should encourage the development and diffusion of
environmentally friendly technologies.

Anti-corruption
● Principle 10: Businesses should work against corruption in all its forms,
including extortion and bribery.58
The FTSE4Good Index Series measures the performance of companies against
CSR standards, to enable investors to make more informed choices about their
investment decisions.59
The aspiration driving the move towards CSR is commendable. However,
there are two deep problems with the concept. First, the principles are vague and
58 See <www.unglobalcompact.org/AboutTheGC/TheTenPrinciples/index.html>.
59 See <www.ftse.com/Indices/FTSE4Good Index Series/index.jsp>.
444 BUSINESS ETHICS AND FUTURE DIRECTION

often not apposite to corporations operating within developed nations. Principles

1 to 6 and 10 of the Global Compact are legal requirements in any event in most
developed countries – compliance with these adds nothing to existing corporate
duties.
Principles 7 to 9 are drafted in aspirational language and contain no objective
measures or defined targets or processes. Moreover, degradation of the envi-
ronment has become a universal problem and ownership of this problem has
effectively been assumed at the government level.
There is a recognition that the only way to improve and deal with pressing
environmental problems is through collective global action, driven initially by
international agreement and then prescribed by government action that forces
corporations to implement specific and concrete environmental measures.
The United Nations Climate Change Conference, held in Copenhagen, Den-
mark in 2009, reached an understanding that climate change needs to be
addressed and that nations need to ensure that any temperature increase does
not exceed 2◦ C. The Copenhagen Accord is not, however, legally binding. There
is some prospect that legally binding targets and measures may be set at the next
climate change conference, scheduled for Mexico in late 2010. In any event, it
seems that there is widespread acceptance of the fact that corporations acting
unilaterally and voluntarily will not achieve meaningful improvement to the
environment.
The second main disadvantage of CSR is that the principles are voluntary. No
country has passed laws mandating compliance with CSR. Denmark requires cor-
porations to include CSR information in their annual reports, such as setting out
the corporation’s policies for CSR; however, it is not mandatory for corporations
to have CSR policies or practices.60
Thus, while CSR is a desirable ideal, its utility in terms of driving more respon-
sible and ethical corporate conduct and outcomes will continue to be limited until
clearer objectives are set and these objectives are mandated by legal require-
ments. Certainly, there is no evidence to show that corporations in the current
CSR environment are behaving more responsibly than at any other time.

14.4 Conclusion

Corporations, like all agents, have moral duties and responsibilities. The content
of the moral obligations of corporations, however, must be established, not
asserted. It is empty merely to claim that corporations must be good citizens,
without defining the source of such a duty.
We have seen that the moral duty owed by corporations must be grounded in
a verifiable, normative ethic. Business ethics is the application of normal ethical
principles to the business setting. An application of moral theory to a business
60 New Danish Law Requires CSR Disclosure: <www.globalreporting.org/NewsEventsPress/LatestNews/
2009/NewsJanuary09DanishLaw.htm>.
 ETHICAL OBLIGATIONS OF CORPORATIONS 445

setting in which there is extensive legal regulation broadly based on enforcing

basic moral proscriptions, such as the duty not to harm others or lie, reveals that
company managers have relatively few moral duties over and above those to
obey the law.
Corporate managers are free to base their business decisions on business
criteria without having to add moral considerations into the decision-making
calculus. However, when they are spectacularly successful in achieving their
profit-making goal, the maxim of positive duty mandates that they pay a social
dividend. At what profit level this duty crystallises is unclear. We suggest that the
threshold is an annual profit of one billion dollars, in which case corporations
should be required to donate 5 per cent of each profit dollar exceeding this
amount to worthwhile social causes. In addition to this, corporations should not
use their wealth to effectively prevent or discourage individuals from pursuing
and enforcing their legal rights. If companies observe these two duties (and do
not breach any laws) they can then claim to be good corporate citizens.
15
Reflections on contemporary
corporate governance and its
future direction

If society is to improve itself and make good on its democratic promises,

large corporations must be reformed so that they better fit and square with
democratic theory and vision. The undertaking is immense, but it is entirely
worthy of our collective energies. Accordingly, if we are to work towards
good corporate governance, we must implement a sea change in how we
think about corporations, how we constitute them, how we regulate them,
and what we expect of them.
Allan C Hutchinson, The Companies We Keep, Toronto,
Irwin Law (2005) 316
The [global] financial crisis has reminded the world of the extreme dangers
of unregulated markets and institutions, and of the eternal importance
of transparency, disclosure, risk management, effective regulation, and
robust governance.
Thomas Clarke, ‘Recurring Crisis in Anglo-American Corporate Governance’
(2010) Contributions to Political Economy (Oxford University Press) 1,3
. . . ethics and norms are not only more potent means to achieve compliance
with the law than deterrence is, but in fact also delimit the relevance of
deterrence.
Michael Wenzel, ‘The Social Side of Sanctions: Personal and Social Norms
as Moderators of Deterrence’ (2004) 28 Law and Human Behavior 547, 549

15.1 Introduction

This chapter builds on the discussion in Chapters 5 and 6 of this book, which
dealt with how corporate governance is regulated in Australia (both the sources
of regulation and the regulatory bodies), and introduced the so-called ‘pyramid’
of regulation developed by Ian Ayres and John Braithwaite in their 1992 book,
Responsive Regulation. Reflecting on this material, in this chapter we make ref-
erence to a variety of sources of research (both in law and management), many

446
 CONTEMPORARY CORPORATE GOVERNANCE 447

of which are at the cutting edge, to identify recent and historical trends in the
context of corporate governance regulation, and determine where regulation of
corporate governance should be directed in the future.1 In this chapter, when
discussing the ‘regulation of corporate governance’, in the Australian context we
mean the Australian Securities Index (ASX) Principles of Good Corporate Gov-
ernance and Best Practice Recommendations and the various formal corporate
governance benchmarks now contained in the Corporations Act 2001 – mainly as
a result of CLERP 9. We do not include other areas of law, such as taxation law,
which may impact on the governance practices of companies.

15.2 Regulatory pyramid and the cycles of

regulation: A perspective on contemporary
corporate governance regulation

We believe that Ayres’ and Braithwaite’s pyramid of regulatory compliance is

very useful and relevant to the discussion in this chapter. Analysing develop-
ments in corporate governance regulation (the shift towards a formalisation of
benchmarks of best practice in corporate governance, often accompanied by
prescriptive rules) with reference to the regulatory pyramid displays an histor-
ical logic and rationale that underlies what on the surface appears to be (using
a phrase adopted by Yale Law Professor Roberta Romano) ‘quack’ regulation
enacted amidst a free-falling stock market (particularly in the USA) and media
frenzy over corporate scandals in the early 2000s.2
Although Ayres’ and Braithwaite’s ‘pyramid’ of regulatory compliance (under-
pinning their theory of responsive regulation) has already been discussed in some
detail in Chapter 5, the following summary of their thesis, derived from the Centre
of Corporate Law and Securities Regulation’s research report, ASIC Enforcement
Patterns, is useful in providing some context for the following discussion.

The key elements of Ayres’ and Braithwaite’s model of regulation . . . relates to their
prescriptions for twin pyramids of enforcement strategies and sanctions. In these hier-
archies, the least intrusive interventions (such as promoting voluntary compliance
through education and persuasion) constitute the base level approach, but the regu-
lator’s actions will respond ‘up’ the relevant pyramid to more intrusive and punitive
approaches . . . depending on the regulatee’s behaviour.3

1 See James McConvill, ‘Of Surfboards, Stewards and Homo Sapiens: Reflections on the Regulation of
Contemporary Corporate Governance’ (1 February 1, 2005), available at <http://papers.ssrn.com/sol3/
papers.cfm?abstract id=660762>.
2 See Roberta Romano, ‘The Sarbanes-Oxley Act and the Making of Quack Corporate Governance’,
NYU Law and Economics Research Paper 04–032 (September 2004), available at <http://preprodpapers.
ssrn.com/sol3/papers.cfm?abstract_id=596101&rec=1&srcabs=192170>. An abridged version of this arti-
cle was published in (May 2005) 114 Yale Law Journal 1521.
3 See Helen Bird, David Chow, Jarrod Lenne and Ian Ramsay, ASIC Enforcement Patterns, Research Report,
Melbourne, Centre for Corporate Law and Securities Regulation, The University of Melbourne (2004), 29.
As Ayres’ and Braithwaite’s ‘strategic’/‘responsive’ approach to regulation provides the basis for the analysis
of corporate governance regulation that follows in the rest of this chapter, we should at least recognise
that there has been some criticism levelled at this approach. For example, in the ASIC Enforcement Patterns
448 BUSINESS ETHICS AND FUTURE DIRECTION

The Ayres and Braithwaite pyramid of regulation is useful in showing that we

have experienced neither the beginning of the regulation of corporate gover-
nance, nor an ‘explosion’ in corporate governance regulation (as some commen-
tators have suggested), since the Enron and WorldCom collapses in the USA,
the HIH collapse in Australia and the raft of other failings that occurred dur-
ing the global financial crisis in the late 2000s, discussed earlier in this book.
Rather, with the increasing formalisation of benchmarks for corporate gover-
nance best practice (often through prescriptive rules – see CLERP 9 in Australia
and the Sarbanes-Oxley Act in the USA), what we have witnessed is a shift up the
‘pyramid’ of corporate governance regulation. Indeed, the reason for the shift
fundamentally accords with Ayres’ and Braithwaite’s explanation of the need
for a hypothetical shift to respond to a perceived abuse of a more voluntary,
disclosure-based approach to corporate governance regulation. It was perceived
that the series of recent corporate collapses reflected an abuse of the voluntary
regime, and emphasised the need for formal rules.
Indeed, complementing this approach of applying Ayres’ and Braithwaite’s
‘pyramid’ to corporate governance regulation, a number of commentators have
recently written that the formalisation of best-practice benchmarks and enact-
ment of corporate governance ‘mandates’ in the post-Enron regulatory envi-
ronment simply constitutes the most recent wave in a longstanding and easily
identifiable ‘cycle of regulation’.
The general consensus is that, to a large extent, the cycles of regulation roughly
follow cycles in the stock market. When the bubble of the stock market bursts
as a result of corporate collapses and a general lack of confidence in the market,
statutory intervention invariably occurs, to restore confidence in the market.
When confidence is restored and the market is characterised by exuberance,
the focus shifts from conformance to performance – companies are allowed
to do essentially whatever they want, so long as the strength in the market is
maintained.
United States law professor Larry E Ribstein has described this phenomenon
in corporate governance regulation as the ‘boom–bust–regulate’ cycle. Ribstein
has explained that:
A boom encourages unwarranted trust in markets, leading to the speculative frenzy of
a bubble and then to the inevitable bust. The bust, in turn, leads first to the disclosure
of fraud and then to the mirror image of the bubble – a kind of speculative frenzy in
regulation.4

report mentioned above, it is noted of Ayres’ and Braithwaite’s thesis that (at 30): ‘[T]his approach has
been critiqued on the basis that by focusing primarily on the use of punishment in enforcement it remains
trapped in the compliance/deterrence dialectic [citing Julia Black, ‘Managing Discretion’, Conference Paper
to ALRC Conference, ‘Penalties: Policy, Principles and Practice in Government Regulation’ (June 2001)
21)] . . . Indeed, it has been argued that the continued examination of general regulatory strategies with
punish/persuade as the basic elements of analysis has distracted academics’ and policy-makers’ attention from
the development of particular, post-regulatory strategies for enforcement (such as education, consultation,
capacity-building and meta-evaluation) [citing Black, above, 22].’ In our view, this critique can be dismissed
as irrelevant to our analysis, given that we are in fact supporting a move away from strict formal regulation
of corporate governance, rather than focusing on punishment and ‘command and control’.
4 See Larry E Ribstein, ‘Bubble Laws’ (2003) 40 Houston Law Review 77, 78.
 CONTEMPORARY CORPORATE GOVERNANCE 449

According to Ribstein, this boom–bust–regulate cycle can be traced as far back

as the 17th century, but has been particularly noticeable since the Wall Street
stock market crash of 1929, which led to the introduction of two major pieces
of corporate legislation in the USA in the early 1930s – the Securities Act 1933
and the Securities and Exchange Act 1934. While this is undoubtedly important
legislation, many have argued (and carried out a variety of empirical studies to
support their opinion) that this legislation was not in fact necessary to achieve
its stated objectives: in other words, that the regulatory heavy hand was not the
appropriate response to corporate collapse. As Ribstein explains:

Lawmakers rushing to regulate following the 1929 crash focused on the supposed
defects of markets while failing realistically to assess the costs and benefits of regu-
lation. Accordingly, they reduced the opportunity of precisely the sort of innovative
firms that were needed to fuel the next boom.5

In an exciting piece (published in 2005) titled, ‘The Inevitable Instability of

American Corporate Governance’, Mark J Roe adopts a similar perspective to
Ribstein’s boom–bust–regulate approach to understanding the recent spate of
corporate collapses and the subsequent emphasis on formal regulation. Accord-
ing to Roe:

The recent business crisis seems new and different from what has gone on before.
But at their core, they are not. The core fissure in American corporate governance
is the separation of ownership from control – distant and diffuse stockholders, with
concentrated management – a separation that creates both great efficiencies and recur-
ring breakdowns. True, some of the Enron-class scandals’ specific problems are new,
or exaggerated forms of what’s come before – special purpose vehicles with complex
funding arrangements, unusually high executive compensation with stock options a
dominating component, failure at a venerable accounting firm, some inattentive boards
of directors – but the specifics still derive from the core structure of American corpo-
rate governance. We will solve the current issues – or, more plausibly, reduce them to
manageable proportions – but then sometime later, somewhere else, another piece of
the corporate apparatus will fail. We’ll have another corporate governance crisis and
it will emanate from the same basic source: that ownership has separated from control
in large firms. We’ll patch it up, we’ll move on, we’ll muddle through. That’s what will
happen this time, and that’s what will happen next time.6

Thomas Clarke, of the UTS Centre for Corporate Governance, has also stressed
the importance of approaching corporate governance regulation with a sound
understanding of history and an appreciation of the cycle of regulation and the
natural inclination towards prescriptive rules following on from a major corpo-
rate collapse. In an article titled ‘Cycles of Crisis and Regulation: The Enduring
Agency and Stewardship Problems of Corporate Governance’, Clarke recognises
the operation of the cycle thus:

5 Ibid.
6 Mark J Roe, ‘The Inevitable Instability of American Corporate Governance’ in Jay W Lorsch, Leslie Berlowitz
and Andy Zelleck (eds), Restoring Trust in American Business, Cambridge, Mass, MIT Press (2005) Chapter 1
at 9.
450 BUSINESS ETHICS AND FUTURE DIRECTION

Corporate governance crisis and reform is essentially cyclical. Waves of corporate gov-
ernance reform and increased regulation occur during periods of recession, corporate
collapse and re-examination of the viability of regulatory systems. During long periods
of expansion, active interest in the conformance aspects of governance diminishes,
as companies and shareholders become again more concerned with the generation of
wealth, rather than in ensuring governance mechanisms are working appropriately for
the retention of wealth, and its use for agreed purposes . . . Complacency concerning
corporate governance during confident times compounds enduring crises.7

Clarke also makes the important statement that:

. . . the historical development of corporate capitalism has been punctuated by periodic

crises and it is at these points of critical inflexion that minds are concentrated on the
need for regulation.8

This historical context suggests that, over time, it is possible that we may see
a shift back down the ‘pyramid’ of corporate governance regulation. This may
be particularly so if, once a formal corporate governance regulatory regime
has been operating over some time, corporate collapses and lack of market
confidence occur to the same or a similar extent as when corporate governance
regulation consisted primarily of voluntary principles and guidelines. Indeed,
over the coming decade what is likely (indeed inevitable, based on past trends)
is that we will experience another wave of high-profile corporate collapses. At
this point, the inevitable question will then be asked: why continue with a high-
cost system of compliance when there is the same or similar risk of corporate
collapse?
Why not revert to a voluntary, self-regulatory approach to corporate gover-
nance? The recent spate of corporate collapses led to calls for the formalisation
of corporate governance regulation. The next spate of corporate collapses may
be the impetus for a gradual process of de-formalisation – based on the acknow-
ledgement that formal rules are not effective in achieving their stated corporate
governance objectives. In other words, to again use the phraseology of Roberta
Romano, we may come to realise the disconnect between means and ends.9
Thus, rather than corporate regulation representing a reaction to corporate col-
lapses, efforts should be directed towards considering what is the best approach
to the regulation of corporate governance for the greater majority of businesses
in operation.
Painting this picture of corporate governance regulation as being similar to
other areas of legal regulation – its direction being influenced by similar factors
to traditional regulation, rather than being a unique and recent intervention and
sui generis in nature, as popular commentary would suggest – is very useful.
With this understanding of corporate governance regulation we can engage in

7 See Thomas Clarke, ‘Cycles of Crisis and Regulation: The Enduring Agency and Stewardship Problems of
Corporate Governance’ (2004) 12 Corporate Governance: An International Review 153–4.
8 Ibid 153. On this point, see also Stuart Banner, ‘What Causes New Securities Regulation?’ (1997) 75
Washington University Law Quarterly 849, 850.
9 Romano, above n 2, 209.
 CONTEMPORARY CORPORATE GOVERNANCE 451

a far more reflective analysis of factors that may influence the development and
direction of regulation over the long term, and engage in an informed, normative
analysis of where corporate governance regulation should be heading. Relying
on the bulk of recent commentary on corporate governance – which is heavily
focused on accounting scandals, collapses and regulatory interventions – would
make this endeavour much more difficult, if not impossible.
Accordingly, rather than regulation theory and the ‘cycle of regulation’ as it
applies to corporate governance being discussed in isolation, it in fact has an
important role in this chapter in providing the basis upon which we can engage
in a fresh, open-minded analysis of the regulation of corporate governance and
its future direction.

15.3 Interaction of cycles of regulation and

‘law and norms’ discourse

As mentioned above, over time it is possible that the trend towards greater for-
malisation of corporate governance regulation will place its legitimacy at risk.
Due to the corporate collapses, corporate misconduct and falling stock market
prices, which inevitably will occur in the future, we believe the attention of main-
stream corporate governance commentary will naturally turn to dealing with the
following question: if the post-Enron formalisation of corporate governance reg-
ulation is not as effective as thought in really improving governance practices and
preventing collapse and associated problems, why not let the forces of the market
have greater influence? That is, should not attention turn to the performance of
companies, as opposed to conformance by companies?
In dealing with this question, we believe it is useful to draw upon commentary
that has entered into corporate law discourse, in relation to ‘law and norms’ and
behavioural law and economics, to mount an argument that having a formal
approach to corporate governance regulation is not necessary to achieve and
maintain sound corporate governance practices, and indeed is not the appropri-
ate regulatory approach. Rather than approach regulation with the focus being
on ‘form’, we should instead turn our attention to the intended ‘function’ of
regulation, and consider how best this function can be performed.10

15.3.1 The significance of norms

Richard Posner, a prominent commentator on law and economics in the USA,
defines a ‘norm’ as:

10 For a discussion of the distinction between ‘form’ and ‘function’ and the relevance of this discussion to
corporate law and governance, see David A Skeel, ‘Corporate Anatomy Lessons’ (2004) 113 Yale Law Journal
1519. Of relevance to the discussion that follows in this chapter, Skeel explains that according to legal realists,
a ‘functional analysis’ of a particular matter or area of law ‘encompasses not only legal rules, but also norms,
history and social context’ (at 1522).
452 BUSINESS ETHICS AND FUTURE DIRECTION

. . . a rule that is neither promulgated by an official source, such as a court or a

legislature, nor enforced by the threat of legal sanctions, yet is regularly complied
with . . . 11

Another useful definition comes from The New Palgrave Dictionary of Economics
and the Law, where the distinction between ‘law’ and ‘norms’ is emphasised:

[L]aws can be adopted through acts of parliament, even if (at times) only to codify
what is already accepted by custom. Social norms, on the other hand, almost always
emerge gradually. Repeated patterns of behaviour gradually ossify into custom and
then into a social norm, the violation of which causes eyebrows to be raised and is seen
as an aberration.12

It is explained in the literature on ‘law and norms’ that what distinguishes a

norm from a regulation is that non-legal sanctions attach to the contravention
of a norm. Nazer refers to there being three types of sanctions: first, second
and third-party sanctions. First-party sanctions are administered by the primary
actor; second-party sanctions are administered by the person acted upon; and
third-party sanctions are administered by other individuals or groups.13
Corporate law scholars, particularly in the USA, have turned their attention
to identifying norms operating inside the corporation, and exploring the impli-
cations of cataloguing and understanding these norms from the perspective of
corporate regulation.14 While it is recognised that there are differences from firm
to firm and between cultures and jurisdictions as to the norms that shape the
internal arrangements and management of corporations, collectively a common
theme that emerges is that the norms are naturally oriented towards what we
would now consider corporate governance best practice (subject to the needs of
each individual company), with participants in the corporation focused on the
continued adherence to, and satisfaction of, these norms.
At a Symposium on Norms and Corporate Law, held at the University of
Pennsylvania Law School in 2000, Edward B Rock and Michael L Wachter had
the following to say about ‘norms’ in the context of corporate law (and, by
implication, the regulation of corporate governance):

Norms are an essential element of human conduct. We have always known that they
guide behavior and that they are important in this role. They represent those behav-
ioral rules and standards that are primarily, if not exclusively, enforced by the parties

11 R A Posner, ‘Social Norms and the Law: An Economics Approach’ (1997) 87 American Economic Review
365–9. Norms are divided into ‘organisational norms’; that is, norms in and between organisations, and
‘societal norms’. In relation to corporate governance regulation, we are more concerned with the former than
with the latter.
12 See Kaashik Basu, ‘Social Norms and the Law’ in Peter Newman (ed.), The New Palgrave Dictionary of
Economics and the Law, London, Macmillan (1998), available at <http://papers.ssrn.com/sol3/papers.cfm?
abstract id=42840>.
13 Daniel Nazer, ‘The Tragicomedy of the Surfers’ Commons’ (2004) 9 Deakin Law Review 655, 663.
14 See, for example, the comments of Robert C Ellickson, ‘Law and Economics Discovers Social Norms’ (1998)
27 Journal of Legal Studies 537, who suggests that founders of classical law and economics exaggerated the
role of law in the overall system of social control (which encompasses corporate regulation), and in doing so
under-estimated the importance of socialisation and the informal enforcement of social norms.
 CONTEMPORARY CORPORATE GOVERNANCE 453

themselves. But until recently, writing about legal rules and standards was of much
greater interest to the legal academy.
In recent years, the legal academy’s interest in norms has reawakened . . . Much of
[the] literature deals with societal norms, the norms of atomistic actors interacting
with other individual actors, or with the non-legal behavioral norms of parties who are
contracting with each other.
The interest in norms is now being felt in corporate law. Changing the context to a
corporate setting changes the role that norms play . . . Corporate norms are distinctive
because they do not deal with third parties colliding with each other in a societal
context or second parties interacting with each other in a contracting context.
Thinking about the role of norms in a corporate setting is critical for several rea-
sons. Inside the corporation second-party relationships reign, but the relationships
are importantly, indeed primarily, non-contractual. For example, behavioural rules
and standards for corporate actors are provided by corporate culture and are essen-
tially norm-based. Much of what goes on in the corporate boardroom varies among
companies and follows corporate-specific practice.
. . . With great latitude, corporations can still follow their own norms and still do it
‘right’.15

Based on one particular perspective or ‘theory’ of the corporation – the so-called

‘transaction cost’ theory – rather than norms existing alongside the panoply of
other sources of corporate regulation, it can be said that ‘corporate norms’ are in
fact central to the operation of the corporation, providing the basis/rationale for
the corporation as a business form existing in the first place.
Transaction cost theorists view the corporation as principally being a mech-
anism to save the costs involved in engaging in sequential specific contracts:
the participants to these continuing contracts (employers and employees being
the best example) use the corporation as the basis for their relationship, with
a view to replacing the formal rules that would otherwise apply (for example,
the law of contract and so on), with informal governance arrangements inside
the corporation – namely, the norms by which the corporation is structured and
organised, and the relationship with participants is managed.16 Transaction-cost
theory derives from Ronald Coase’s seminal 1937 paper, ‘The Nature of the Firm’,
in which he characterised the ‘bounds of the firm’ (a different specimen to the
market) as the range of exchanges over which the market system was suppressed,
and resource allocation was accomplished instead by authority and direction.

15 Edward B Rock and Michael L Wachter, ‘Norms & Corporate Law: Introduction’ (2001) 149 University of
Pennsylvania Law Review 1607, 1608.
16 Consider the following explanation by Edward B Rock and Michael L Wachter in ‘Islands of Conscious
Power: Law, Norms and the Self-Governing’ (2001) 149 University of Pennsylvania Law Review 1619, 1632:
‘When transaction costs are low, the parties can write contingent state contracts to protect the integrity of
their transactions. Transactions can thus be left in the market, with the market providing the parties with
unequaled high-powered incentives for joint maximizing behavior . . . When transaction costs are high, the
relationships are brought inside the firm where they are governed by the intrafirm, hierarchical governance
structure. From the perspective of the transaction cost theorists, the decision to bring relationships within
the firm is just the decision to opt for the intrafirm governance structure over market governance.’ Available
at <www.law.upenn.edu/cf/faculty/mwachter/workingpapers/149%20U%20Pa%20L%20Rev%201619%
20%282001%29.pdf>.
454 BUSINESS ETHICS AND FUTURE DIRECTION

According to Edward Rock and Michael L Wachter in their article, ‘Islands of

Conscious Power: Law, Norms and the Self-Governing’:
according to an emerging consensus among theorists of the firm, the raison d’etre of
firms is to replace legal governance of relations with non-legally enforceable gover-
nance mechanisms.17

Transaction-cost theorists would accordingly support the preservation and

elevation of norms as part of the regulation of corporate governance – a
favourable alternative to the continued shift towards more formal rules and thus
a greater compliance burden for companies. This is because the trend towards
formalisation of corporate governance regulation, with benchmarks of corporate
governance best practice increasingly influenced through mandatory or quasi-
mandatory rules rather than through voluntary principles and commentaries,
works against the underlying rationale for the corporation (to avoid formal
rules), rather than being a measure to protect the corporation and improve
performance. If transaction costs become too high pro rata due to an added
compliance burden, contracting within the market – without the protection and
benefits that the corporation provides – may become more feasible. As Rock and
Wachter explain:
The high transaction costs that bring certain transaction costs inside the boundary of
firms also create the ideal grounds for developing governance arrangements that are
self-enforcing, encouraging good play and discouraging opportunistic play. For them
to function properly, the ability to punish opportunistic play is important, and the high-
frequency/long-duration interactions among the parties operating together inside the
firm allow ample opportunity to sanction bad play and encourage good play.18

In the specific context of corporate governance regulation, the percolation of

norms inside the corporation is important. If we can identify a systematic body
of norms operating inside the corporation, and also between the corporation
and its stakeholders, backed by non-legal sanctions, then in areas where norms
are operating effectively it can be argued that formal rules are not necessary. It
could be asked, applying a simple cost–benefit analysis, why formal regulation
in relation to a particular matter should be introduced, whether it be board
structures, executive compensation, the responsibilities of auditors or whatever
else. Why should these matters be regulated if substantially the same, or exactly
the same, outcome can be achieved through enabling norms of best practice to
operate independently? Regulating these matters and ensuring compliance with
it is, after all, costly and time-consuming.
Norms began as the predominant form by which internal arrangements and
management in companies developed, and over time a commonality in the norms
operating from company to company could be discovered, setting in place an
early standard of corporate governance best practice. Naturally, it is the case
that before everything else must be the norms, as the norms have provided
17 Ibid 1622.
18 Ibid 1649.
 CONTEMPORARY CORPORATE GOVERNANCE 455

the foundation upon which the guidelines and reports subsequently have been
developed and revised, and by which mandatory rules setting in place formal
benchmarks for corporate governance best practice could be enacted. Indeed,
in the 1993 version of the Bosch Report, the importance of corporate norms in
influencing and shaping governance practices was expressly acknowledged:

The corporate sector is making a significant effort to create its own framework of
acceptable standards of behaviour irrespective of existing or prospective legislation.19

The natural development of best practice governance arrangements within cor-

porations over time by way of norms, independently (or with little involvement)
of formal legal rules, is supported by the concept of ‘firm routine’, discussed by
Timothy F Malloy in his piece, ‘Regulation, Compliance and the Firm’.20 Malloy
notes:

Organizational theory teaches us that in many instances, firm behaviour is driven more
by the firm’s routines than by economic rationality or normative values . . . The term
‘firm routine’ is used broadly here, referring to a wide range of formal and informal
regular patterns of behaviour that coordinate the activities of the firm members. This
includes communication routines that channel information through the firm, standard
operating procedures that control production activities, budgeting and resource allo-
cation procedures, and a multitude of other procedures. Because they coordinate the
actions of individuals within the firm and allocate resources to them, firm routines are
basic components of organizational activity.21

Further support for the view that corporate governance was predominantly and
effectively regulated by informal norms, which later influenced the development
of corporate governance reports and guidelines and subsequently mandatory
rules, comes in an article by E Norman Veasey, Chief Justice of the Delaware
Supreme Court, which was written and published prior to the post-Enron for-
malisation of corporate governance regulation. In that article, Justice Veasey
identified seven ‘aspirational ideals of good corporate governance practices’,
operating outside the requirements of the law, which he suggested boards
of directors should implement. According to Veasey, those aspirational ideals
‘reflect some developing norms of corporate behavior’ and constitute ‘the rea-
sonable expectations of stakeholders’.22 The seven ‘aspirational ideals’ were:
(a) There should be a heavy majority of purely independent directors on every
board.
(b) The board should be engaged in actual governance, and not merely act
as advisers to the chief executive officer (CEO). It means directors are in
control of the policy of the firm, and the managers work for them.

19 Business Council of Australia, Corporate Practices and Conduct, Melbourne, Information Australia (2nd
edn, 1993) 2.
20 (2003) 76 Temple Law Review 451.
21 Ibid 458 (emphasis added).
22 E Norman Veasey, ‘Should Corporation Law Inform Aspirations for Good Corporate Governance
Practices – Or Vice Versa?’ (2001) 149 University of Pennsylvania Law Review 2179, 2189.
456 BUSINESS ETHICS AND FUTURE DIRECTION

(c) Directors should meet face-to-face frequently throughout the year and
spend a minimum of at least 100 hours per year attending to routine
matters on each board.
(d) Directors should limit to a reasonable number the major boards upon which
they serve. What is a reasonable number depends on the extent to which
each director is able to carry out his or her responsibilities to each board in
a professional manner.
(e) The board should have audit, compensation and nominating committees
consisting solely of independent directors. Moreover, independent direc-
tors should regularly evaluate the CEO, and they should meet with each
other alone on a regular basis.
(f) The board should establish and monitor reasonable law-compliance
programs.
(g) The board should carefully review disclosure documents for which it has
direct responsibility, to ensure that all material information reasonably
available is disclosed to the relevant audience.23
Most, if not all, of these ‘aspirational ideals’, based on developing norms inside
the corporation, have since been transformed into formal benchmarking ‘rules’
in Australia and the USA (included in the ASX Best Practice Recommendations or
CLERP 9 reforms in Australia, the Sarbanes-Oxley Act and NYSE corporate gov-
ernance rules in the USA), even though these ideals reflected standard practice
inside most corporations at the time of the Enron and WorldCom collapses in the
USA, and the HIH and One.Tel collapses in Australia.
The fact that corporate governance best practice has traditionally been the
product of norms operating within the corporation has also been recognised by
John Farrar. In his article, ‘Corporate Governance and the Judges’, Farrar states:

In its narrower, and most useful, sense [corporate governance] refers to control of
corporations and to systems of accountability by those in control. It refers to the
companies legislation but it also transcends the law because we are looking not only at
legal control but also de facto control of corporations. We are looking at accountability,
not only in terms of legal restraints but also in terms of systems of self-regulation and
the norms of so-called ‘best practice’.24

The overriding objective guiding contemporary corporate governance regula-

tion, and more specifically the shift towards more formal rules, is a desire to
restore confidence in the market by ensuring that corporations and their partici-
pants adhere to good governance practices. In other words, the rationale for the
reforms is that without prescriptive regulation in this area, directors and man-
agers would naturally depart from standards of corporate governance best prac-
tice, due to a preference for more self-interested transactions and arrangements.
Presumptions that traditionally underpinned agency theory and the rational

23 Ibid 2190–1.
24 John Farrar, ‘Corporate Governance and the Judges’ (2003) 15 Bond Law Review 65, 66 (emphasis added).
 CONTEMPORARY CORPORATE GOVERNANCE 457

choice model of the corporation – that directors and managers are self-interested
actors who need to be controlled – have a very strong role here. A reliance on
norms and voluntary principles is considered to be undesirable in the post-Enron
environment – the common assumption is that Enron and other high-profile cor-
porate collapses across the world have shown us that enforced self-regulation
is not sufficient; it has been ‘abused’ and hence (so the argument goes) tougher
regulation is required. In other words, recent events have required us to take
the next step up the ‘pyramid’ of regulatory compliance as a means to ensuring
effective corporate governance.

15.3.2 Norms, corporate governance and the utility of

behavioural analysis
Relatively recent literature on so-called ‘behavioural law and economics’ and
associated theories in management has, however, again cast doubt on the effi-
cacy and appropriateness of formalising the regulation of corporate governance
to ensure directors and executives act consistently in the best interests of the
corporation rather than their own self-interest. Literature shows that the self-
interested actor does not present an entirely accurate view of how corporate par-
ticipants behave. These studies and theories present corporate actors as being
individuals with very human desires, with ‘other-regarding preferences’ and
wanting to behave not only in the best interests of the corporation, but also to be
perceived as trustworthy.
‘Behavioural law and economics’ leads on from the ‘law and economics’ move-
ment, which was particularly prominent between the 1970s and 1990s. Law and
economics scholars embraced a neo-classical, economic conception of human
behaviour, with humans perceived as rational actors in search of the most effi-
cient outcomes.25 Efficiency was generally equated with wealth maximisation.26
Based on this rational-actor model of human behaviour (also referred to as
‘homo economicus’), law and economics scholars believed that legal rules and
legal institutions could be understood from an efficiency rationale; that is, a rule
or institution can be said to maintain its legitimacy only if it enhances efficiency
in the way rights and obligations are dealt with.27

25 According to Becker, the standard economic principles, which were adopted by law and economics
scholars as providing an accurate representation of human behaviour and decision-making processes, were
that human beings are participants who: (1) maximise their utility; (2) form a stable set of preferences; and
(3) accumulate an optimal amount of information and other inputs in a variety of models. See Gary Becker,
The Economic Approach to Human Behavior, Chicago, University of Chicago Press (1976) 14.
26 See in particular Richard A Posner, Economic Analysis of Law, Boston, Mass, Little, Brown (5th edn, 1998).
27 As an example, in Frontiers of Legal Theory, Cambridge, Mass, Harvard University Press (2001), Richard
Posner explains how the ‘fair use’ doctrine in copyright law, which allows anyone to make ‘fair use’ of a
copyrighted work without having to make payment to the holder of copyright, can be justified by applying
economic analysis. According to Posner, the fair use doctrine is an example of the law allocating legal rights
efficiently where large transaction costs (which are ordinarily assumed not to exist in neo-classical analysis)
prevent the market from doing so naturally. Posner’s thesis is best explained by Robert T Miller, ‘Posner’s Laws
of Pragmatism’ (2001) 118 First Things 54–6. See also Richard A Posner, Law, Pragmatism and Democracy,
Cambridge, Mass, Harvard University Press (2003).
458 BUSINESS ETHICS AND FUTURE DIRECTION

While the economic analysis of law dominated legal scholarship in the USA
for many years, it was obvious that there were some limitations to the ‘rational
actor model’ of human behaviour, which provided the basis for strict law and
economics analysis. Even though human beings cannot accurately be described
as irrational creatures, nor are we machines programmed to pursue the most
efficient outcome in every possible situation.28
Accordingly, in the second half of the 1990s, a trend gradually emerged of
legal scholars seeking information from outside neo-classical economics to better
understand how human beings really behave.29 Studies in other fields, primarily
behavioural economics, had shown that rather than being rational self-actors
at all times, people frequently are unselfish. So began the ‘behavioural law and
economics movement’, or what is often referred as the ‘second synthesis’ of law
and economics.30
Behavioural analysis of the law is increasingly standing on its own as a field of
inquiry outside law and economics scholarship. Legal scholars now feel confident
enough to apply findings on human, social cognitive and emotional biases, which
are central to behavioural analysis, without framing the analysis in economic
terms. Corporate law scholars have applied understandings about real, personal
human traits such as trust and sensitivity to dismantle the self-interested actor
model of the individual.31
Further supporting the view that norms are just as capable as formal rules
of satisfying the objectives of contemporary corporate governance regulation,
and capable of operating as a self-contained source of regulation independent
of external legal rules encouraging compliance through the threat of sanctions,
is the stewardship theory of the corporation. While there are many similarities
between the findings and policies of members of the behavioural law and eco-
nomics school and stewardship theorists,32 ‘stewardship theory’ as a discrete
area of study has yet to attract the attention of legal commentators.33
To date, discussion of the stewardship theory of corporate governance has
primarily been confined to the pages of management journals and books – with

28 See, for example, the collection of papers in Daniel Kahneman and Amos Tversky, Choices, Values and
Frames, New York, Russell Sage Foundation (2000).
29 See Christine Jollis, Cass R Sunstein and Richard Thaler, ‘A Behavioral Approach to Law and Economics’
(1998) 50 Stanford Law Review 1471.
30 See generally Cass R Sunstein (ed.), Behavioral Law & Economics, New York, Cambridge University Press
(2000).
31 See Margaret Blair and Lynn Stout, ‘Trust, Trustworthiness and the Behavioral Foundations of Corporate
Law’ (2001) 149 University of Pennsylvania Law Review 1735.
32 Indeed, leading legal scholars in the field of corporate governance Lucian Bebchuk, Jesse Fried and David
Walker have come to similar conclusions as stewardship theorists through their studies on ‘internalised incen-
tives’. See Bebchuk and Walker’s Working Paper, ‘Executive Compensation in America: Optimal Contracting
or Extracting Rents?’, available at <http://papers.ssrn.com/sol3/papers.cfm?abstract id=297005>. This
research is also included in Lucian Bebchuk and Jesse Fried’s recently released book, Pay Without Per-
formance: The Unfulfilled Promise of Executive Compensation, Cambridge, Mass., Harvard University Press
(2004).
33 A study by the authors of law review articles on Westlaw, LexisNexis, AGIS and CaseBase in 2004 found
that reference was made to ‘stewardship theory’, in the context of corporate law and governance, in only
one article, and that article only dealt with stewardship theory in passing. The article is Shann Turnbull,
‘Corporate Charters with Competitive Advantages’ (2000) 74 St John’s Law Review 89.
 CONTEMPORARY CORPORATE GOVERNANCE 459

a handful of commentators being particularly prolific in the early 1990s in explor-

ing the potential implications of the theory. Stewardship theorists have utilised
psychological studies (as well as studies in sociology) into human motivation
to dispel the mainstream view that the company’s directors and executives are
driven purely by self-interest and personal economic gain (that is, agency the-
ory). According to Thomas Clarke, in a commentary on theories of corporate
governance published in 2004:

Stewardship theory acknowledges a larger range of human motives including orienta-

tions towards achievement, altruism and the commitment to meaningful work.34

At the core of stewardship theory is a ‘model of man’ directed towards self-

actualising behaviour rather than purely economic behaviour (which was
the model of ‘man’ presented and accepted by agency theorists), with the
motivation (drawn from psychology and psychological mechanisms) being
‘higher order’ needs (growth, achievement, self-actualisation) rather than lower
order/economic needs. This more humanistic model of ‘man’ has been explained
by stewardship theorists as representing the instinctive desire of humans to ‘grow
beyond their current state and reach higher levels of achievement’.
Deeply rooted in psychological studies and theory relating to motivation and
choice, stewardship theory suggests that managers can be organisational, as well
as individualistic. That is, managers who are ‘stewards’ are just as (if not more)
motivated to make decisions that are in the best interests of the organisation as
to act for their own self-interest, as that will provide them with pure economic
benefits. To use the jargon, their ‘utility functions’ are maximised through a coop-
erative relationship with the shareholders, rather than a relationship of control,
in which shareholders are distanced from the corporation so that management
can rationally pursue what is in their own self-interest. According to Australian
Lex Donaldson, one of the main commentators on stewardship theory since its
emergence into mainstream commentary on corporate governance at the end of
the 1980s,35 studies into human behaviour support this deeper understanding
of managerial motivation:

Students of human behaviour have identified a much larger range of human motives,
including needs for achievement, responsibility, and recognition, as well as altruism,

34 Thomas Clarke, ‘Introduction to Part Four’ in Thomas Clarke (ed.), Theories of Corporate Governance: The
Philosophical Foundations of Corporate Governance, London, Routledge (2004) 117.
35 One of the first major contributions exploring the potential significance of stewardship theory as a
perspective on corporate governance was in 1989 by Lex Donaldson with James Davis, ‘CEO Governance and
Shareholder Returns: Agency Theory or Stewardship Theory’, a paper presented at the annual meeting of the
Academy of Management in Washington, DC. While it can be said that stewardship theory has entered into
mainstream literature on management and received significant support, it is probably incorrect to describe
this theory as a dominant perspective of corporate governance. Obviously, the relatively short time in which
the theory has been discussed is a reason for this, but many commentators also point to a limitation of the
theory, which prevents overwhelming support – it rests on shareholders being prepared to take the risk
(through accepting the ‘relaxed’ governance structures that stewardship theorists support) that management
will act as ‘stewards’ as opposed to being purely opportunistic. See James H Davis, F David Schoorman and Lex
Donaldson, ‘Towards a Stewardship Theory of Management’ in Thomas Clarke (ed.), Theories of Corporate
Governance: The Philosophical Foundations of Corporate Governance, London, Routledge (2004) 118, 121.
460 BUSINESS ETHICS AND FUTURE DIRECTION

belief, respect for authority, and the intrinsic motivation of an inherently satisfying
task.36

A consequence of stewardship theory is the argument that there is not the same
imperative to separate the roles of chairman and chief executive in the corpora-
tion; rather it is considered favourable that boards have a majority of specialist
executive directors rather than a majority of independent directors, as managers
who are entrenched in the corporation (and ‘identify’ with the corporation,
according to stewardship theorists) are naturally drawn to pursue what is best
for the corporation. This view stands in contrast with that held by law and eco-
nomics proponents, who argue for a separation of the roles of chairman and
chief executive, and for a majority of independent directors on the board, as this
is considered necessary in order vigilantly to monitor management and to limit
their individualistic opportunism.37
The point about ‘stewards’ coming to ‘identify’ with the corporation(s) they
are managing is again important in supporting the view that norms shaping
the internal arrangements and management of the corporation can be allowed
to operate on their own without the interference of formal legal rules. If the
directors/executives ‘identify’ themselves with the corporation, any adverse
consequences for the corporation and its general performance as a result of
departing from the norms of good governance would actually impose a form
of ‘sanction’ on the individual personally. This form of sanction is described in
literature on norms as a ‘first-party sanction’, and – at least in relation to social
norms (which are not considered to be different to organisational or corporate
norms) – is considered to be the most effective of the sanctions in ensuring com-
pliance with norms. Even without accepting this form of sanction to be truly
effective, commentators on law and norms also refer to the ability of a person
or group to ‘internalise’ norms and choose to abide by them even when external
sanctions are unlikely.38 Director and manager behaviour that is consistent with
the best interests of the company is therefore likely to continue as a predominant
‘corporate norm’, without any need for formal rules, because disservice to the
corporation from departing from ‘good governance’ is likely to be considered a
sanction in itself.
Overall, the stewardship theory has important implications for the future reg-
ulation of corporate governance, particularly if one is to take a step back and
reflect on why it is considered necessary for corporations to be the subject of for-
mal regulation. It can be said that the primary reason that regulation of corporate
governance is considered necessary is the existence of a ‘separation of ownership

36 Lex Donaldson, ‘The Ethereal Hand: Organizational Economics and Management Theory’ (1990) 15
Academy of Management Review 369, 372.
37 See Lex Donaldson and James H Davis, ‘Stewardship Theory or Agency Theory: CEO Governance and
Shareholder Returns’ (1991) 16 Australian Journal of Management 49, 50–2.
38 See, for example, Amitai Etzioni, ‘Social Norms: Internalization, Persuasion and History’ (2000) 34 Law
and Society Review 157 (arguing that most of the power of social norms comes from internalisation and
first-party based incentives); also Mark West, ‘Legal Rules and Social Norms in Japan’s Secret World of Sumo’
(1997) 26 Journal of Legal Studies 165.
 CONTEMPORARY CORPORATE GOVERNANCE 461

and control’39 in the contemporary public corporation.40 Directors and managers

are given overwhelming power with little accountability to the dispersed group
of shareholders, and regulation of a corporation’s internal arrangements thus
has been considered vital to ensuring that directors and executives do not abuse
this power for personal gain.41
Economists refer to the divergence between ownership and control in the cor-
poration as the ‘agency problem’, and similarly suggest that external incentives
be implemented in order to confine this divergence.42 Kahan provides a useful
explanation from a legal perspective:

The effective management of a public corporation requires the separation of ownership

and control. Multiple, dispersed share-holders cannot themselves make the many day-
to-day management decisions that it takes to run a public company. The corporate
form solves this problem by delegating the power to manage the company to the board
of directors, which further delegates the power to the corporate officers.
The resulting separation of ownership and control, however, creates an agency prob-
lem: since managers do not own all of the corporation’s equity – indeed, they often own
only a trivial portion – their interests diverge from those of the shareholders as a group.
The main issue in corporate governance is therefore to create incentives for managers to
run the company in the interest of shareholders.43

Lipton and Herzberg also make it quite clear that regulation of corporate gov-
ernance is based entirely on the presumption that directors and managers of
modern public corporations need to be kept accountable:

Corporate governance best practice seeks to provide the mechanisms which align the
interests of management with those of shareholders. The development of increased
interest in corporate governance reflects higher expectations by the public and
investment community that greater efforts be made by listed public companies to
develop structures and procedures so as to ensure management is effective and

39 See Adolph Berle and Gardiner Means, The Modern Corporation and Private Property, New York, Macmillan
(1932, rev. 1967). The classic statement in this text regarding the ‘separation of ownership and control’ is as
follows (at 116): ‘In examining the break up of the old concept that was property and the old unity that was
private enterprise, it is therefore evident that we are dealing not only with distinct but often with opposing
groups, ownership on the one side, control on the other – a control which tends to move further and further
away from ownership and ultimately lie in the hands of the management itself, a management ultimately
capable of perpetuating its own position. The concentration of economic power separate from ownership
has, in fact, created economic empires, and has delivered these empires into the hands of a new form of
absolutism, relegating “owners” to the position of those who supply the means whereby the new princes may
exercise their power.’
40 For a recent reflection of the significance of the separation of ownership and control in the history of
corporate USA and corporate governance, see Roe, above n 6 : ‘Technology changes, crises arise, and the
problems in one decade differ from those of another decade. But the principal problems arise from ownership
separation, and ownership separation is with us to stay . . . To say that our problems derive from separation
isn’t to say that we can do better by giving up separation. It just says that we have to deal repeatedly with
separation’s derivative problems. Thus we fix up each current problem, and we muddle through.’
41 See Robert Baxt, Keith Fletcher and Saul Fridman, Corporations and Associations: Cases and Materials,
Sydney, LexisNexis Butterworths (9th edn, 2003) 264.
42 See the classic article, Michael C Jensen and William H Meckling, ‘Theory of the Firm: Managerial
Behavior, Agency Costs and Ownership Structure’ (1976) 3 Journal of Financial Economics 305.
43 Marcel Kahan, ‘The Limited Significance of Norms for Corporate Governance’ (2001) 149 University of
Pennsylvania Law Review 1869, 1877–8 (emphasis added).
462 BUSINESS ETHICS AND FUTURE DIRECTION

acts in the interests of shareholders and adopts appropriate standards of corporate

behaviour.44

In a paper written by seven leading corporate law and governance scholars –

Reiner Kraakman, Henry Hansmann and Ed Rock of the USA; Paul Davies of
the UK; Gerhard Hertig of Switzerland; Klaus Hopt of Germany and Hideki
Kanda of Japan – titled ‘The Anatomy of Corporate Law: A Comparative and
Functional Approach’,45 the same point about the rationale for corporate law is
made, although the authors contend that agency costs go beyond management
and shareholders. They argue that the centre issue for corporate law, in every
jurisdiction, is how to mediate three different kinds of ‘agency conflicts’: between
managers and shareholders; between majority and minority shareholders; and
between the firm and third parties.
The research presented by stewardship theorists shows, however, that in the
great majority of cases, directors, managers and others in positions of power
within the corporation will have personal incentives to do what is best by the
corporation and its stakeholders, without the need for additional incentives in
the nature of formal rules and principles. Accordingly, the longstanding foun-
dation upon which the regulation of corporate governance rests is questionable.
Directors and managers will naturally operate the corporation, including its
relationship with stakeholders, in a manner that is consistent with best practice
standards due to their role as stewards in the corporation, with a comprehensive
body of ‘corporate governance’ norms developing as a result. It is submitted that
these norms, in setting in place a routine by which directors and managers are
focused on the best interests of the corporation, provide (and should be accepted
as) an effective substitute for formal legal rules.
An alternative argument that could be made to justify a role for formal
rules in the regulation of corporate governance is that even if there are
behavioural/psychological factors guiding directors and executives towards nat-
urally doing what is best for the corporation, formal rules are still necessary
so that participants take into account interests other than purely those of the
corporation (such as the environment, local communities and employees – see
further the discussion in Chapter 2 on stakeholders). However, two responses
can be given to this argument.
First, it can be said that this represents an overly narrow view of the cor-
poration, failing to embrace the more ‘enlightened’ view, which sees the cor-
poration as an entity dependent on its stakeholders in order to create wealth
and achieve long-term, sustainable growth. Second, there is empirical evidence,

44 See Phillip Lipton and Abe Herzberg, Understanding Company Law, Sydney, Law Book (11th edn, 2003)
295. Indeed, this view on the significance of agency costs to corporate regulation derives from (or at least
is commonly attributed to) F L Easterbrook and D R Fischel’s classic treatise on the law and economics of
corporate law, The Economic Structure of Corporate Law, Cambridge, Mass., Harvard University Press (1991).
Easterbrook and Fischel argued in this work that corporate law (at least in the USA) is designed to limit
agency costs by providing a menu of default rules that parties can alter by contract if they so choose.
45 Reiner Kraakman et al., The Anatomy of Corporate Law: A Comparative and Functional Approach, Oxford,
Oxford University Press (2004).
 CONTEMPORARY CORPORATE GOVERNANCE 463

utilised in some of the material on behavioural law and economics, showing

that experiments involving so-called ‘prisoner’s dilemmas’46 (one of the key
tools used in game theory47 ) demonstrate that ‘other-regarding preferences’ is
a strong and common characteristic in human beings. Furthermore, it could be
said that the value we place on trust, and our desire to be perceived as trust-
worthy, extends to corporate participants’ relationships with non-shareholder
stakeholders.
The first point is dealt with in Chapter 2 of this book, which is devoted to
the topic of stakeholders. Some discussion here is, however, warranted for the
second point.
Lynn Stout, together with Margaret Blair, has been particularly prominent in
exploring the implications of research into trust and trustworthiness for corpo-
rate law and governance. Both have explored and analysed important empirical
evidence derived from social dilemma games, which lend support to the propo-
sition that there are many ways in which we – as homo sapiens – act as though
we care about the costs borne and the benefits enjoyed by others, as opposed
to being driven purely by economic self-interest. Consider, for example, the
following statement by Stout:

Extrinsic empirical evidence supports the claim that most people shift freely between
self-regarding and other-regarding models of behaviour, depending on their percep-
tions of social context and relative personal cost. This phenomenon is neither rare
nor capricious. To the contrary, it is endemic and predictable. And as a result, it will
often be of vital importance to a sound understanding of many phenomena, including
norms.48

The existence of other-regarding preferences, as well as the importance of the

phenomenon of ‘trust’ and ‘trustworthiness’ (and the related concept of ‘altru-
ism’) to corporate law and governance have been emphasised by Stout and Blair

46 The prisoner’s dilemma is defined as a ‘situation in which the non-cooperative pursuit of self-interest by
two parties makes them both worse off’ (see – A W Tucker, Contributions to the Theories of Games (2001),
Princeton, NJ, Princeton University Press; William Poundstone, Prisoner’s Dilemma, Oxford, Oxford University
Press (1993). In the prisoner’s dilemma, in each game the prisoner has to decide whether to ‘cooperate’ with
an opponent, or otherwise defect. The prisoner and the opponent must make a choice, and then their decisions
are revealed. The prisoner’s dilemma demonstrates that the ‘rational’ choice in each instance is not the one
that maximises personal self-interest as neo-classical economists suggest, but rather the one that maximises
the collective good of the two or more persons who are each making the decision. In other words, the most
rational decision or strategy is the one that promotes competition between the participants in the game. Thus,
the prisoner’s dilemma is studied in a range of different contexts to try to find, and understand, strategies
that promote cooperation.
47 Game theory encompasses an interdisciplinary approach (covering, for example, mathematics, eco-
nomics, sociology and information technology) to the study of the behaviour of humans. A ‘game’ in this
context is a scientific metaphor for a wide range of human interactions between two, or more than two,
persons, such persons possessing opposing (or at least mixed) motives. In constructing these games, game
theorists contend that the rational choice of game participants involves maximising the rewards of the group
of decision makers involved in the game. See Morton Davis, Game Theory: A Non-Technical Introduction,
London, Constable (1997); Oskar Morgenstern and John von Neumann, The Theory of Games and Economic
Behavior, Princeton, NJ, Princeton University Press (1944).
48 See Lynn A Stout, ‘Other-regarding Preferences and Social Norms’, Georgetown Law and Economics
Research Paper No. 265902 (March 2001), available at <http://papers.ssrn.com/sol3/papers.cfm?abstract
id=265902>.
464 BUSINESS ETHICS AND FUTURE DIRECTION

in a number of articles.49 For example, in a collaborative piece, Stout and Blair

note:
Economic theory has yielded great insights into the nature of the business form and
the role the law plays in shaping it. At the same time, conventional economic analysis
has proven inadequate to resolve a number of important debates and questions in
corporate law . . . Our approach does not reject economic reasoning. It does, however,
re-examine one of its standard assumptions: the assumption that people always behave
like homo economicus. We argue to the contrary that people often behave as if they
care about costs and benefits to others. In support of this claim, we review the extensive
empirical evidence that has been developed on human behaviour in social dilemma
experiments. This evidence demonstrates that most people shift readily from purely
self-interested to other-regarding modes of behaviour depending on past experience
and social context.50

Stout has also noted in an individual piece:

[I]f we want to understand the business judgment rule, we must begin by recognizing
that the social institution of the board of directors is premised on the belief that directors
are motivated, at least in part, by altruism, in the form of a sense of obligation to the
firm and its shareholders.51

This literature on other-regarding preferences, and on the concepts of ‘trust’ and

‘altruism’, importantly emphasises that one consequence of moving away from
the strict ‘homo economicus’ model of human towards a more realistic model of
behaviour is that there is a reduced role for formal rules.52 According to Blair
and Stout:
Mistaken assumptions about the role and importance of external incentives in fur-
thering cooperative behavior can lead not only to mistaken descriptions but also to
mistaken prescriptions. In particular, the experimental evidence warns that attempts
to provide external motivations for cooperative behavior can instead reduce coopera-
tion by undermining corporate participants’ internal motivations.53

Our discussion above, particularly in relation to ‘law and norms’ suggests that
over time (as advocated above) the ‘cycle of regulation’ in corporate governance
may settle at voluntary principles and guidelines as ultimately the most effective
49 In fact, these concepts (trust, in particular) are integrated into Stout and Blair’s widely disseminated and
accepted ‘team production’ theory of the corporation. Margaret Blair and Lynn Stout, ‘A Team Production
Theory of Corporate Law’ (1999) 85 Virginia Law Review 247. Blair and Stout’s team-production theory has
generated a great deal of interest in academic circles as it challenges the dominant view of shareholder
primacy, by suggesting that the role of the corporation is not limited to maximising economic returns for
shareholders, but rather is intended to resolve team production problems. As a result, neither shareholders nor
other stakeholders are the primary concern; rather, the corporation and the legal rules regulating corporations
treat shareholders and stakeholders as a ‘team’, each contributing to the corporation in different ways.
50 Blair and Stout, above n 31, 1807.
51 Lynn A Stout, ‘In Praise of Procedure: An Economic and Behavioral Defence of Smith v Van Gorkom and
the Business Judgment Rule’ (2002) 96 Northwestern University Law Review 675, 677.
52 It must be remembered that adherence to principles and standards of behaviour consistent with good
corporate governance practices has also been considered to be achievable through various market forces
(product, labour, corporate control), as a substitute for formal regulation – although the role of markets in
contributing to corporate practices and behaviour is strongly associated with law and economics analysis and
the conception of corporate participants as self-interested actors, which loses some contemporary relevance
due to the growing role of behaviouralism in legal analysis.
53 Blair and Stout, above n 31, 1808–9.
 CONTEMPORARY CORPORATE GOVERNANCE 465

method of ‘regulating’ corporate governance practices.54 This is because the

principal reason for introducing formal legal rules – to impose sanctions in the
form of penalties for non-compliance and hence encouraging compliance ‘by
stealth’ – is unwarranted: sanctions are inherent in norms, and adherence to
these norms is achieved through mechanisms other than legal rules. Indeed, as
Stout explains:

[T]here are a variety of tools available to internalize externalities. These include the
legal sanctions imposed by a coercive state; voluntary exchanges in the market; the
threat of retaliation in repeated dealings . . . 55

15.4 Conclusion: The future of corporate

governance regulation

It is plausible to predict that corporate norms, as an evolutionary source of cor-

porate governance practices, will be the ultimate driver of the ways in which
corporate governance develops and changes over the long term.56 That said,
there is still a role for voluntary principles and codes in emphasising and ‘rein-
forcing’ the norms so that they are adhered to (through an educational, pressure
or incentive function), and so that formal regulation of corporate governance
can be avoided.57 Further, as we discussed in Chapter 8, a range of areas of law
(such as banking law, employment law and environmental law) will still impact
on company activities and encourage good governance.
Thus, what may be required is a different approach to the increasing formali-
sation of corporate governance regulation that we have witnessed over the past
decade. Best-practice benchmarks in corporate governance may be achieved
by allowing corporate norms to operate independently; minimising the need
to turn these benchmarks into mandates. Corporate collapses and downward

54 See David Charny, ‘Norms and Corporate Governance’ in Jeffrey Gordon and Mark Roe (eds), Convergence
and Persistence in Corporate Governance, Cambridge, Cambridge University Press (2004) Ch 8. See also Roberta
Romano’s recent working paper, in which she argues for a return to a voluntary regulatory framework for
corporate governance in the USA, arguing that there is no justification for prescriptive rules (with the principal
focus of the paper being on the federal Sarbanes-Oxley Act) mandating corporate governance practices. See
Romano, above n 2.
55 Stout, above n 48, 6.
56 For a contrary position, see Kahan, above n 43, who suggests (at 1899) that norms only have a limited
significance for corporate governance, and really only have a role when more ‘high-powered incentive devices’
are absent. This causes Kahan, at 1900, to disagree with the prediction of Robert Ellickson that ‘the newly
found appreciation of norms is likely to cause the significant redirection of law and economics’.
57 We should acknowledge at this point that there is a debate in ‘law and norms’ discourse about
whether there remains a role for formal regulation if a particular matter or area is or can be effec-
tively regulated by norms. That is, if norms can be said to embody an ‘informal contract’ between the
participants, what is the justification for supplanting this with ‘formal contracts’ in the form of legisla-
tion and other rules? In a Working Paper prepared for Harvard University (Harvard Institute of Eco-
nomics Research Paper no. 1923), entitled ‘Norms and the Theory of the Firm’, May 2001, Oliver Hart
suggests that ‘it is hard to draw clear-cut conclusions about whether formal contracts will make it eas-
ier to sustain self-enforcing contracts (ie formal and informal contracts are complements), or more dif-
ficult (ie formal and informal contracts are substitutes)’ A copy of the Hart paper is available online
at <http://preprodpapers.ssrn.com/sol3/papers.cfm?abstract_id=269234&rec=1&srcabs=355860>. See
also Rock and Wachter, above n 16.
466 BUSINESS ETHICS AND FUTURE DIRECTION

trends in the market will occur over the course of time, as we have discussed
above, regardless of whether regulation of corporate governance predominantly
consists of formal rules or voluntary principles. The collapses and misconduct
we witness in the corporate world from time to time can be said to be the work
of a few ‘rotten apples’,58 and that therefore there is no benefit in imposing
an increasing compliance burden on companies, which comes from further for-
malising corporate governance regulation, when the overwhelming majority of
companies have sound internal governance arrangements in place. This compli-
ance burden can distract companies from concentrating on performance, and
places in jeopardy the flow-on effects for our society and economy that come
from having companies perform strongly.
While for the immediate, and perhaps medium, term following the global
financial crisis, we must deal with a heavy handed regulatory approach to corpo-
rate governance, in the future advisers, law-makers and general commentators
may experience a natural shift back towards a voluntary regulatory framework
for corporate governance, once an informed historical perspective can be drawn
on whether a formal or voluntary approach to corporate governance regulation
is ultimately more effective. Empirical studies, and the natural course of events
(with collapses continuing to occur, corporate misconduct still arising, and mar-
kets continuing to rise and fall), is likely to demonstrate that a voluntary approach
to corporate governance regulation is desirable. On this point, the comments of
Thomas Clarke are again useful:
Despite the strenuous efforts at reform, the cyclical pattern of stock market booms
encouraging and concealing corporate excesses is likely to continue. When reces-
sion highlights corporate collapses, statutory intervention invariably occurs. To avoid
mandatory restrictive over-regulation, active voluntary self-regulation – particularly
in terms of confidence and growth – is necessary.59

The view that self-enforced regulation is the most desirable approach in rela-
tion to corporate governance finds support in the writings of John Braithwaite
on responsive regulation. In a book chapter titled ‘Responsive Regulation in
Australia’,60 Braithwaite identifies three key obstacles (‘myopias’) to a more con-
structive regulatory culture in Australia. These are ‘regulatory legalism’, deregu-
latory rationalism and knee-jerk opposition to self-regulation. ‘Regulatory legal-
ism’, which essentially describes support for the enactment and enforcement of
black-letter law, aptly characterises the present mindset of regulators and law-
makers enacting specific corporate governance rules, beyond the series of other
legal obligations imposed on companies, to influence good governance practices
and restore and maintain confidence in the market.61 Furthermore, in ‘Respon-
sive Regulation’ (co-authored with Ayres and discussed earlier in this chapter),
58 Frederick G Hilmer, Strictly Boardroom: Improving Governance to Enhance Company Performance (Hilmer
Report (1993)), Melbourne, Business Library (1993) Preface.
59 Clarke, above n 7, 160.
60 In Peter Grabosky and John Braithwaite (eds), Business Regulation and Australia’s Future, Canberra,
Australian Institute of Criminology (1993).
61 Ibid 81–4.
 CONTEMPORARY CORPORATE GOVERNANCE 467

Braithwaite contends that the most effective system of regulation provides a

framework that facilitates a high proportion of willing compliance in response
to persuasion, supported by high expectations of appropriate but inevitable
enforcement.
The relatively recent movement towards the formalisation of corporate gov-
ernance regulation (at least since SOX in 2002) over time may become seen
as misguided. This position, is supported by the present shift (at least in aca-
demic commentary) away from – or at the very least the slowdown in the move
towards – a United States-style ‘outsider’ model of corporate governance (char-
acterised by diffuse shareholdings, the separation of ownership and control,
and a shareholder-value based objective) following the collapses of Enron and
WorldCom. In the mid-to-late 1990s, there was growing momentum for juris-
dictions such as Germany and France – along with other European and Asian
countries (including Japan) – who, for reasons of tradition, culture and per-
ceived effectiveness adhered to an ‘insider’ style of governance, to model their
systems more along United States lines, thereby causing an international ‘con-
vergence’ in corporate governance.62 This was due to the enormous growth, and
strong corporate performance, that the USA was experiencing relative to other
countries. However, over the course of time, as we have experienced large-scale
collapses and a general slowdown in economic performance in the USA, the
‘conventional wisdom’ of convergence is now being questioned.63 Post-Enron,
commentators are focusing on what is wrong with United States corporate gover-
nance, and are reviewing the role and direction of convergence in contemporary
corporate governance, rather than continuing to advocate a convergence strictly
in accordance with the United States system of governance.64 The global finan-
cial crisis has provided added impetus to the questioning of the United States
model. Clarke has observed that ‘the apparent ascendancy of the Anglo-American
markets and governance institutions was profoundly questioned by the scale and
contagion of the 2008 global financial crisis.’65

62 On convergence generally, see Mark J Roe, Political Determinants of Corporate Governance, Oxford, Oxford
University Press (2003).
63 See, for example, Douglas Branson, ‘The Very Uncertain Prospects of “Global” Convergence in Corpo-
rate Governance’ (2001) 34 Cornell International Law Journal 321; and Güler Manisali Darman, Corporate
Governance Worldwide: A Guide to Best Practices and Managers, Paris, ICC Publishing (2004) 137–40. See
also Paul MacAvoy and Ira Millstan, The Recurrent Crisis in Corporate Governance, Basingstoke, UK, Palgrave
Macmillan (2004), in which the authors examine the implications of the Enron scandal and the bursting
of the ‘dot.com bubble’, which has required commentators to re-examine the effectiveness of United States
corporate governance. Indeed, a recent work by Harvard law professor Reiner Kraakman and six other lead-
ing commentators, The Anatomy of Corporate Law: A Comparative and Functional Approach, Oxford, Oxford
University Press (2004), looks beyond path dependence and convergence as the emerging trend, and instead
approaches company law from a globally integrated perspective. The authors frame company law as a body
of rules designed to address three ‘agency problems’ – managerial opportunism, controlling shareholder
opportunism, and the opportunism of shareholders vis-à-vis other stakeholders.
64 See in particular Gordon and Roe, above n 54, which contains a series of essays considering, among
other things, the very point of whether the Enron scandal, and the subsequent corporate governance reform
movement (with the extra compliance costs now involved in properly maintaining a compliant ‘outsider’
public corporation) will halt the trend towards convergence.
65 Thomas Clarke, ‘Recurring Crisis in Anglo-American Corporate Governance’ (2010) Contributions to
Political Economy (OUP) 1, 3.
468 BUSINESS ETHICS AND FUTURE DIRECTION

Meanwhile, in the context of the global financial crisis, the next wave of cor-
porate governance commentary could very much relate to regulators insisting
upon a more formal and prescriptive approach to corporate governance regula-
tion. President Nicolas Sarkozy of France recently proclaimed, in the context of
the global financial crisis, that ‘self-regulation as a way of solving all problems is
finished’.66 Such sentiments only serve to guarantee that the cycle of regulation
in this boom–bust period, prefaced in the opening remarks of this chapter, will
continue into the future. This will remain the case, notwithstanding the findings
of one study, which refutes the popular belief that corporate governance ‘failed’
during the global financial crisis and that justification exists for sweeping corpo-
rate governance reforms.67 Cheffins concluded, after analysing the removal of 37
firms from the S&P 500 index during the market meltdown in 2008, that corpo-
rate governance functioned tolerably well in those companies, implying that the
case has not yet been made for fundamental reform of current arrangements in
corporate governance. However, the next chapter in the evolution of corporate
governance reform is yet to be written. The wait is unlikely to be long, following
the urge of lawmakers around the world to shine the law-reform spotlight upon
corporate governance issues, yet again. The challenge of regulating unethical
corporate behaviour will remain, however.
66 Quoted in Clarke, ibid 1, 2.
67 Brian Cheffins, ‘Did Corporate Governance “Fail” During the 2008 Stock Market Meltdown? The
Case of the S&P 500’ ECGI Law Working Paper No: 124/2009 (July 2009), available at http://ssrn.
com/abstract=1396126.
Index

accountability principle 11–12, 81–82, judicial criticism of ASIC’s case

144, 176–7, 206, 324–5, 461–2 management 277
accounting governance 198–218 legal issue 273
accounting standards 57, 152–4, 169, ‘asset lock’ requirement (of CICs) 48
215 Assets Supervision and Administration
acts and omissions doctrine 434–6, Commission of the State Council
437–8 (SASAC) 388, 391
AIOD see Australian Institute of Directors ASX see Australian Securities Exchange
Alberta Securities Commission (ASC) ATO see Australian Taxation Office
333 auditing/auditors
American Law Institute (ALI) audit committees 237–9, 333–4
involvement in corporate governance audit oversight 236–7
debate 301–3 audit reform 205–6
Principles of Corporate Governance and audit role 219–22
Structure 78, 300–1 auditing standards 169–70,
aims 301 235–6
impact and importance 301–2 auditor dependence 203
key topics 302–3 auditor independence 206, 223,
American Model Business Corporations Act 224–9, 307, 367–8
78 auditor rotation 228
Anatomy of Corporate Law: A Comparative disclosure of non-audit services
and Functional Approach, The 36 228–9
APRA see Australian Prudential Regulation general requirement 225
Authority auditors and the AGM 229
‘arms length’ transaction 262 CLERP 9 changes 222–4
ASC see Alberta Securities Commission Companion Policy 52—110CP Audit
ASIC see Australian Securities and Committees 331–4
Investment Commission and conflict 225–7
ASIC v Adler [2002] 41 ACSR 72 260–5 cooling off period 227
contraventions of civil penalty provisions duties 229–30, 231–2
261–4 Enron audit 223
court orders 264–5 Hilmer Report (1993) 144–5
summary 260–1 liability of auditors 231–2
ASIC v Macdonald (No 11) (2009) 256 ALR qualification of auditors 235
199 (James Hardie litigation) Ramsey Report—reform
265–72 recommendations 204, 224
court orders 271–2 reducing legal exposure of auditors
decision and significance 267–71 231–5
legal issues 266–7 role in corporate collapses 203–5
summary and background 265–6 Australian Institute of Directors (AIOD)
ASIC v Rich [2009] NSWSC 1229 272–7 128
background and facts 272–3 Australian Prudential Regulation Authority
decision and significance 273–7 (APRA) 128–9

469
470 INDEX
Australian Securities and Investments Act
2001 (ASIC Act) 181–2, 280
Australian Securities and Investments
Commission (ASIC) 75, 95,
180–7, 229–30, 232–3
ASIC Enforcement Patterns158–9,
185–7, 447
approach 186
litigation strategy comments
186–7
use of penal enforcement actions 185
Australian Securities and Investments
Commission Act 2001 (ASIC Act)
181–2, 220
civil penalty enforcement 279–80
corporate governance role 182–5
disclosing and resolving conflict 226
enforcement of civil penalty provisions
243–60
financial markets framework role 175,
176–7
FRC’s functions 237
infringement notice power 208–9
injunctive relief 287–8
notification of conflict 227
orders ASIC may seek 243–4
and proportionate liability 233–5
relationship between ASIC and ASX–MOU
193–5
role of 179–95, 197
and SOX 306
transfer of ASX’s supervisory role to ASIC
194–5, 200
Australian Securities Exchange (ASX)
187–95
areas of required improvement
194
ASX Listing Rules 142, 166–8, 187–8,
198, 223
Best Practice Recommendations (2003)
36–40, 65, 170, 198, 199, 456
changes since 2002 189–90
conflicts of interest 194–5, 200
Corporate Governance Council 92, 142,
189
corporate governance definition 4
Corporate Governance Principles and
Recommendations (2007)
and audit committees 238–9
financial objectives in regulating
corporate governance 161
‘soft’ law category 168–9
financial markets framework role 175,
176–7
Principles of Good Corporate Governance
and Best Practice (Recommendations)
96–8, 106, 110, 118, 142, 147,
189, 190–5
2007 changes 190
assessment of independence
112–13
board responsibilities 80
CGC approach versus Combined Code
approach 192–3
ethical behaviour by directors 125
recommendations 191–3
structure 190–1
privatisation and conflicts of interest
accusations 176
Revised Corporate Governance Principles
and Recommendations 26–7, 170
codes of conduct 30, 36–40
Principle 3 37–9
Principle 7 39
roles 179–95, 197
transfer of supervisory role to ASIC
194–5, 200
Australian Taxation Office (ATO) 95
best practice 36–40, 65, 76, 96–8,
313–14
boards (of directors) 395, 397–8,
455–6
accountability 81–2
ASX definition 76
board committees 149–50
company meetings 151
the company secretary 93, 120–1
competency 149
and continuous improvement 326–7
effectiveness of 81–2
employee participation at supervisory
board level 348–51
functions 77–83, 86–7, 93, 303
German two-tiered board 85, 87, 92,
342–5
Hilmer Report (1993) 144–5
integrity 327–8
legislation 93–4
organs of governance 75–7
performance of 81, 144–6, 150
responsibilities 80, 150
structures 83–99, 136, 325–6
supervisory role 303
UK Institute of Directors (purpose and
roles of board) 80, 82
see also independence principle;
shareholders

boardtorial revolution 6, 78
body corporate 291, 292
Bosch Reports 136–41, 170–1, 455
background 136
Bosch Report (1991) (original)
137–8
Bosch Report (1993) 139, 140
Bosch Report (1995) 141, 188
core differences between 1991 and 1993
reports 139–40
Working Group 136, 137, 139, 141
British Columbia Centre for Social Enterprise
49
burden of proof 275–7
business ethics concept 424–31
business judgement rule 245–7, 263,
270, 273–7, 372
Business Regulatory Advisory Group 200
Cadbury Report (UK) 88, 96, 110,
120–1, 122, 137, 170–1
and ALI principles 300
code of best practice 313–14
context 312–13
and corporate governance 312–16
influence on Bosch Reports 139, 140
call options 374
CAMAC see Corporations and Markets
Advisory Committee
Canadian Securities Administrators (CSA)
322–3
capitalism 353–9
CGC see Corporate Governance Council
Chartwell Enterprise Group 95
chief executive officers (CEOs) 34, 79–80,
113, 117–19, 269–70
chief financial officer (CFO) 271
China Securities Regulatory Commission
(CSRC) 388–9, 401–3, 408,
412
CIC see community interest company
citizenship see corporate citizenship
civil liability 258–60
climate change 31–2, 34–5, 444
codes of conduct 30, 33, 36–9, 40,
96–8
co-determination concept 89, 348–51
Combined Code (UK) 92, 96, 111,
124–5, 192–3
common-law derivative action 281–2
communication 148–9, 347
Communist Party 389–90, 391, 410
community 31, 35–6, 45, 47–9,
71–5
INDEX 471
community interest company (CIC) 45,
47–9
Companies (Audit, Investigations and
Community Enterprise) Act 2004 (UK)
47
Companies Act 1993 (NZ) 49–51
Companies Act 2006 (UK) 46, 67, 68–9,
280
company law see corporate law
comparative capitalism 353–9
compliance
ASX Listing Rules 166–7, 187–8
and the auditor’s report 220
and the Bosch Report 139
compliance with law—corporations
436–7
compliance-based reforms of CLERP
207–8
‘comply or disclose’ principle 346,
347
‘comply or else’ principle 307–8
‘comply or explain’ regime 168–9,
346
corporate governance 37–9
regulatory compliance ‘pyramid’ 158–9,
447–51
conduct 284–7, 291, 292–3
conflict 213, 225–6, 248–9, 264, 396,
420
conflicts of interest 104–5, 176,
194–5, 200, 226–7, 328, 406
consequentialist moral theories
420
contracts 231, 283
corporate citizenship 8, 12, 443
‘corporate constituency’ concept 43–5
corporate disclosure 206–13
Corporate Disclosure: Strengthening the
Financial Reporting Framework 204
corporate governance
accounting governance 198–218
Anglo-American models 300–12
aspirational ideals (of good corporate
governance practices) 455–6
ASX Revised Corporate Governance
Principles and Recommendations 4,
26–7, 30, 36–40
audit role – corporate governance link
221–2
in Australia 131–55
1991–1998 146
background 133–6
Bosch Reports 136, 137–8, 139–40,
141, 170–1
472 INDEX
corporate governance (cont.)
divergence from UK practice
(1995–2003) 142
Hilmer Report 142–5, 146,
170–1
IFSA Blue Book 146–51
Standards Australia 152–4
and board structures 90–9
in Canada 320–36
future direction 334–6
National Instrument 52 –110
331–4
National Instrument 58 –101
330–1
National Policy 58 –201 323–30
regulatory environment 321–3
charters, policies and codes of best practice
and conduct 96–8
in China 386–415
committees 402–3
Communist Party 389–90, 391,
410
Company Law 1993 391, 392–5,
397–401, 403–8, 409
and conflict 396
consequences of breach 410–13
controlling shareholder issue
403–6
corporate entities 390–5
direct intervention—dividends
409–10
enforcement 410
foreign-investment enterprises
392–3
government and legislation 387–90
improved disclosure requirements
406–8
increasing duties of directors
398–401
independent directors 401–2
issues and resolutions 395–7
key pillars policy 406
Law on Industrial Enterprises owned by
the Whole People 390–1
National People’s Congress (NPC)
387–8
requirements of sponsors of public
offerings 408
Securities Law 393–4, 406–8
standards of accounting 408
state-owned enterprises 390–2,
410
supervisory boards 395, 397–8,
405
compliance 37–9
contestation of governance structures
356
convergence of corporate governance
models 18–19, 353, 356, 357,
359
Corporate Governance Code 97, 111,
115–16, 117, 345–8, 402–3, 405
cultural differences 18–19
debate origins 5–10
definitions 3–11
employee participation 27–9
framework 339–40
in Germany 342–52
background 342–5
Baums Commission 344–5
Draft Bill (Aktienrechtsreform 1997)
343–4
German Code – structure and nature
347–8
IFSA Blue Book definition 147
implications of trustworthiness research
463–4
in Japan 352–86
Commercial Code 359–60,
369–70
companies – committees versus boards
of auditors 365–9
comparative capitalism and corporate
governance debates 353–9
core employees 382–5
corporate law and practice
transformations 359–63
Daiwa Bank judgement 370
derivative suits 370–2, 373
directors’ duties and derivative actions
369–73
economic stagflation 362
‘five ways forward’ proposal
353
German influence 359, 360
‘grey’ outside directors 366–7
human resource management (HRM)
practices 383, 384
Japanese corporate forms and internal
governance mechanisms 363–73
kabushiki kaisha (KK) company
363–5
lifetime employment practice 361,
382–5
main banks 361, 379–82
Meiji-era Code 359
‘micro-fit’ and ‘macro-fit’ of law 356,
370

Occupation period 360–1, 371
partnership company (goshi kaisha)
363
share-class diversification 374–5
shareholder versus bank finance
373–82
yugen kaisha (YK) company 360,
363–4
and the judges 165–6
managerial pyramid/governance circle
distinction 91–3, 447–51
‘managing the corporation’ concept 7
and market forces 172–4
norms and behavioural analysis
457–65
OECD Principles of Corporate Governance
9, 17, 21, 27, 29–30, 40–1, 65,
66, 338–42
OECD-recognised stakeholders 22–35,
36
community 31, 35–6
creditors 29–30, 35–6
customers 30–1, 35–6
employees 25–9, 35–6
environment 31–6
government 35–6
shareholders 25, 35–6
organs of governance 25, 27, 75–7
paradigms 21
and performance 16
policy guidelines 148
principles 11–14
public disillusionment 426
rating systems for companies 98–9
regulation of 94–6, 156–61, 178,
465–8
role of ASIC 182–5
and share-price (or share-price returns)
17
significance 14–18
solutions to ‘bad corporate governance’
135–6
stakeholders 24, 53–65
statutory provisions 93–4
‘stewardship theory’ 458–61
systems 27
in the United Kingdom 312
in the United States 300–12
background 300–1
Securities Exchange Commission
303–4
and the wealth creation concept 28
Corporate Governance Council (CGC) 92,
142, 189
INDEX 473
corporate law 36, 52, 162–5, 198, 199,
359–63
Corporate Law Economic Reform Program
(Audit Reform and Corporate
Disclosure) Act 2004 (CLERP 9 Act)
94, 108–9, 128, 135–6, 198–9,
202, 448
auditing standards 169–70
auditor rotation obligation 228
auditors’ duties 229–30, 231–2
CLERP reform program 200–2,
456
audit reform explanation 205–6
background 199–200
changes to audit role 222–4
disclosure of remuneration and
emoluments in Australia 206–7
impetus – responding to corporate
collapses 202–5
initiatives 207
key principles 201–2
miscellaneous 213–14
policy proposal papers 200–1
common-law derivative action difficulties
281–2
see also statutory derivative action
Corporations Act 2001 amendments and
IFSA Blue Book 147, 160–1
design 199
effects of CLERP 9 reforms 199
enforcement 214
independence requirements 226–7
self-regulation to formal regulatory
approach shift 171
corporate social responsibility (CSR) 8, 24,
39, 41–2, 442–4
and directors’ duties 65–9
European Alliance for CSR 42
relevance during hard economic times
70
corporations
acts and omissions doctrine 434–6,
437–8
‘agency problem’ 461–2
application of moral principles to business
432–44
application of the Code to bodies corporate
291
codes of conduct 151
company constitution 50–1,
162–5
company dissolution 405
company secretary 93, 120–1
complaints-resolution process 442
474 INDEX
corporations (cont.)
corporate collapses 95, 126, 134–6,
169, 183, 185, 426, 450
as CLERP 9 impetus 202–5
investigations into 146
corporate culture 291–2
corporate entities in China 390–5
corporate social responsibility 8, 24, 39,
41–2, 442–4
duties
benevolence duty 434–41
compliance with law 436–7
extreme wealth and duty not to frustrate
access to justice 441–2
extreme wealth and maxim of positive
duty 437–9
levels 432–3
proscriptions against causing harm,
lying and environmental damage
432–4
ethical obligations 419–45
Japanese corporate forms 363–73
judgment in the best interest of the
corporation (directors) 246
‘managing the corporation’ concept
7 Part 2H – shares 250–1
managing versus directing 78–9
regulator – ASIC 180–7
replaceable rules 162–5, 217
requirement to pay social dividend
439–41
size and socioeconomic power 54–5
and stakeholders 22–3, 36–52,
53–65
sustainability of 35–6
‘transaction cost’ theory 453–4
see also corporate citizenship; corporate
governance; corporate social
responsibility
Corporations Act 2001 (Cth) 26–7, 30, 51,
67, 76, 77, 94, 102, 163
amendments and the IFSA Blue Book
147, 160–1
and the auditor’s report 220
Case Studies – civil/pecuniary penalty
provisions 260–77
Chapter 2D 287–8
Chapter 6CA – continuous disclosure
255
civil liability relief 258–60
CLERP 9 reforms – mandatory corporate
governance rules 199
corporate governance – excesses of the 80s
134–5
corporate law 162–5
criminal liability of directors
290–4
criminal offences – directors and officers
293–5
disclosure of remuneration and
emoluments in Australia 128
duties of directors 109, 242
general requirement for auditor
independence 225
and managing directors 117–18
Part 2E – related party transactions
249–50, 261–2
Part 2F.1 – oppressive conduct of affairs
284–7
applicants for relief 285–6
nature of relief 286–7
type of conduct covered 284–5
Part 2F.1A – statutory derivative action
281–4
case to introduce 281–2
cause of action 283
eligible applicant 282–3
leave of court required to institute
283–4
Part 2J.3 – financial assistance
262–3
Part 2M.2, 2M.3 – financial records and
reporting 251
Part 5.7B – insolvent trading 251–4
Part 5C – managed investment schemes
254–5
Part 7.10 – market misconduct
255–8
Part 9.4B 243–60
s 180: Duty of care and diligence
244–7, 263, 272–7
s 181: Duty of good faith 247–8,
263
s 182, s 183: Duty not to use position or
information to gain personally or
cause detriment 248–9, 264
Schedule 4, Subclause 29(6) – disclosure
for proposed demutualisation 258
Section 188(2) 121
Section 201K – replaceable rule 120
Section 1324 – injunctions 287–90
court’s discretion 288–9
remedies 289–90
Section 1324(1) 287–8
Corporations and Markets Advisory
Committee (CAMAC) 65, 66–9,
108–9

crassa negligentia (gross negligence)
71–3
creditors 29–30, 35–6
categories 29
creditor interests and insolvency law
29–30
Criminal Code Act 1995 290–2
application to bodies corporate
291
corporate culture 291–2
‘default’ fault elements 291
establishing ‘authorisation/permission’
(offence) 291–2
criminal liability 290–4
and the Code 290–2
criminal offences – directors and officers
293–5
importance of criminal sanction in
corporations law 290–3
CSA see Canadian Securities Administrators
CSR see corporate social responsibility
CSRC see China Securities Regulatory
Commission
customers 30–1, 35–6
debt 251–4
Delaware General Corporation Act
78
demutualisation 258
derivative action see statutory derivative
action
director primacy model 9, 78
directorial revolution 78
directors 124–5, 367–8, 455–6
alternate directors 120, 140
chairperson 113, 118–20, 149
chief executive officers 34, 79–80, 113,
117–19, 269–70
competency 326
connected non-executive directors
(CNEDs) 116
and ‘corporate constituency’ laws
43–5
criminal offences under the Act
293–5
definition 102–3, 106
de jure and de facto directors
102–6
nominee directors 104–6, 140
shadow directors 103–4
duties 45–6, 49–51, 67, 68–9,
240–78, 369–73
ASIC enforcement 279–80
breach of duties 245–7, 283
INDEX 475
business judgement rule 245–7, 263,
270, 273–7, 372
continuous disclosure duty 255
corporate governance and the Hilmer
Report 142–4
and CSR 65–9
delegation and reliance 247,
271–2
disclosure for proposed demutualisation
258
due care and diligence 241–2,
244–7, 263, 272–7
duty not to be involved in market
misconduct 255–8
duty of good faith 247–8, 263
duty to prevent insolvent trading
251–4
enforcement 281–94
fiduciary duties 240–1, 248, 399
financial records and reporting duties
251
increasing duties of directors
398–401
managed investment schemes duties
254–5
no-conflict rule 248, 249, 264
related party transaction duties
249–50, 261–2
share capital transactions duty
250–1
statutory duties 242
election and appointment 150
equity participation 150
ethical behaviour by directors 125–7
executive and non-executive directors
109–10, 139, 140, 267–9
‘grey’ outside directors (Japan)
366–7
higher community expectations of
directors 71–5
Hilmer Report (1993) 144–5
independent non-executive directors
110–16, 140, 145, 149, 314,
319–20, 332–3, 401–2
judgement- and decision-making
guidelines 82–3
lead/senior independent directors
117
liability 39–40, 184, 240–78, 290–4
managing versus directing 78–9
and mere errors of judgement 274–5
permissible directorships 149
remuneration 127–9, 206–7,
307–8
476 INDEX
directors (cont.)
trading 150
training of 122–3
types of company directors and officers
101–30
see also boards (of directors); shareholders
discipline principle 11–12
disclosure 39, 52, 94, 127–8, 140, 149,
151, 206, 272–7
and ASX Listing Rules 166–7,
187–8
Australian Accounting Standards 57
and CLERP 201, 211–13
‘comply or disclose’ principle 346,
347
continuous disclosure 208–9, 255
corporate disclosure 206–13
disclosing and resolving conflict 226
National Instrument 58 –101 (Canada)
330–1
of non-audit services 228–9
for proposed demutualisation 258
of remuneration and emoluments in
Australia 128
and transparency 341–2
dividends 409–10, 439–41
duty of benevolence 434–41
duty of care 73–4, 263
development – relevant cases 73–4
director protection – business judgement
rule 245–7, 263, 270, 273–7,
372
directors and the Act: Section 180
244–7, 272–7
247–8, 263
duty of good faith
EEIG see European Economic Interest
Grouping
employees 35–6, 248–9
and CLERP 9 amendments 108–9
employee participation 27–9,
348–51
Japan’s lifetime employment practice
361, 382–5
legislation and regulations protecting
26–7
Mallin’s theories 25–6
nature and corporate governance role
25–9
powers within corporations 76–7
and the wealth creation concept 28
‘whistleblower’ employees 26–7
‘enlightened shareholder value’ 45–6, 67,
68–9
Enron collapse 203, 223, 317, 448
US response – Sarbanes-Oxley Act (2002)
304–9
Enterprise State Assets Law (China)
391–2
environment 31–6, 148–9
Environment Protection Act 1970 (Vic)
32
Environment Protection and Biodiversity
Conservation Act 1999 (Cth) 32
equal opportunity legislation 26
Equator Principle, the 34
ethics
business ethics and compliance principle
(CLERP) 202
business ethics concept 424–31
application of moral norms to business
429–30
business–ethics link 431
business/ethics argument disunity
427
history 424–6
internal settled rules 428–9
justification for excluding moral
principles 430–1
universalisability of moral judgements
427–9
codes of conduct 30, 33, 36–9, 40,
151
ethical behaviour by directors 125–7
ethical obligations of corporations
419–45
and justice 441–2
European Economic Interest Grouping
(EEIG) 47
European Union (EU) 41–2
inclusive approach to protecting
stakeholders’ interests 42
Expert Panel on Securities Regulation
321–2
Fair Work Act 2009 (Cth) 26
fairness principle 11–12, 215
false trading 256
financial markets framework 174–7
financial ratings systems 98–9
financial reporting 207–8, 251
Financial Reporting Council (FRC) 236–7,
314–16
financial services 184, 213, 255–8
first-party sanction 460
‘for-benefit’ companies 69
Ford’s Principles of Corporations Law
[publication] 172–3

general counsel 270–1
global economic crisis 69
10–11, 49,
global financial crisis (GFC)
69–70, 95, 127–8, 154, 308,
343
Global Impact program (UN) 443
governance see corporate governance
government 35–6, 387–90
Greenbury Report (1995) 316
greenhouse gas emissions 31–2
gross negligence (crassa negligentia)
71–3
Hampel Committee (1998) 111
Hampel Report (1998) 316–17
Higgs Report (2003) 88, 111, 124–5,
317
HIH Royal Commission
203, 204,
HIH Insurance Ltd collapse
260–5, 448
Owen Report 4, 14–16, 25, 27, 88, 91,
95
importance of auditor independence
221, 224
observations of middle management
108
offence provisions in Acts 290
and organs of governance
75–7
Hilmer Report 142–6, 170–1
background – AWA Ltd v Daniels; Daniels v
Anderson 142–4
Hilmer Report (1993) 144–5
summary of recommendations aspects
144–5
Hilmer Report (1998) 145–6
Appendix 1 – ‘The Fallacy of
Independence’ 145
IAASB see International Auditing and
Assurance Standards Board
IASB see International Accounting Standards
Board
IFRS see International Financial Reporting
Standards
IFSA see Investment and Financial Services
Association Ltd
IFSA Guidance Note No. 2.00: Corporate
Governance: A Guide for Fund
Managers and Corporations (IFSA
Blue Book) 146–51
indemnity 58, 233
independence principle 11–12, 112–13,
140, 145, 149, 314
INDEX 477
auditor independence 206, 223,
224–5, 228–9, 307, 367–8
insider trading 257–8, 396
insolvency 29–30, 251–4, 288
defences to insolvent trading 253–4
rebuttal presumptions (the Act) 252
intention (‘default’ fault element) 291
International Accounting Standards Board
(IASB) 198
International Auditing and Assurance
Standards Board (IAASB) 198
International Financial Reporting Standards
(IFRS) 198, 215
‘fair value’ emphasis 215
International Standards on Auditing 198
Investment and Financial Services
Association Ltd (IFSA)
and ASX Listing Rules 187
IFSA Blue Book 146–51, 161, 170,
188
James Hardie asbestos scandal 39–40,
53
ASIC’s proceedings 183
Case Study – James Hardie’s asbestos
compensation settlement 56–5
aftermath 62–5
background 56–7
impetus for corporate restructure
57–8
Jackson Report and its significance
60–2
key features of the separation plan
58–9
public announcement of the separation
59
scheme of arrangement and relocation
to The Netherlands 59–60
judicial discretion 288–9
Mauer-Suisse approach 289
key performance indicators (KPIs) 33
King Reports, the (1994, 2002, 2009)
11–12, 16, 88, 90–1, 92, 96–7
291
knowledge (‘default’ fault element)
Kyoto Protocol 31–2
L3C see ‘low-profit limited liability company’
law
behavioural analysis 457–65
compliance with law – corporations
436–7
corporate law 36, 52, 162–5, 290–3,
359–63, 391
478 INDEX
law (cont.)
criminal law (China) 411–12
framing of laws in terms of rules 435
‘hard’ law 162–6
‘hybrid’ regulation mechanisms
166–70
accounting standards 169
auditing standards 169–70
implications of trustworthiness research
463–4
insolvency law 29–30
judge-made law 165–6
law and norms discourse 451–65
legal recognition of expectations of
directors 73–5
‘soft’ law 168–9, 170–1
takeover laws 43–5, 373, 375–9
see also legislation
law of negligence 71–4, 231
development – relevant cases 73–4
negligence as ‘default’ fault element
291
leadership 12
legislation
corporate governance and statutory
provisions 93–4
equal opportunity legislation 26
Fair Work Act 2009 (Cth) 26
government and legislation (China)
387–90
interpretation (excesses of the 80s
context) 134–5
occupational health and safety legislation
26
protecting employees’ interests 26–7
statutory regulation 162–5
see also Corporations Act 2001 (Cth) (the
Act); law
liability 44–5, 47–9, 83, 208, 404
of auditors 231–2
breach of statutory duties 231–2
and contract 231
law of negligence 231
civil liability 258–60
concurrent wrongdoer 234
criminal liability 290–4
of directors 39–40, 71–5, 184,
240–78
disclosure of liabilities 57
and insolvency 253
limited liability companies 394,
404–5
for mere errors of judgement 274–5
moral liability 433
proportionate liability 214, 232,
233–5
see also James Hardie asbestos scandal
litigation 283–4, 410–13
‘low-profit limited liability company’ (L3C)
44–5
Making Boards Work [publication] 172
managed investment schemes 254–5
management
of the corporation’s business – ALI
302–3
IFSA corporate governance definition
147
Management Buyouts 377
management discussion and analysis
(MD&A) 207–8
managerial pyramid/governance circle
distinction 84–6, 91–3, 447–51
middle management as ‘officers’
108–9
register of ‘relevant interests’ 213–14
stakeholder management 8–10, 23,
54–5
strategic management 54–5
supervision of management – boards
81
three-tier structure of management
(China) 394
Management Buyouts (MBOs) 377
managerialist theory 172–3
market rigging 256
markets
Corporations and Markets Advisory
Committee (CAMAC) 65, 66–9,
108–9
financial markets framework 174–7
market forces 172–4
market freedom principle (CLERP) 201
market misconduct 255–8
dissemination of illegal transactions
information 257
false trading and market rigging 256
insider trading 257–8, 396
market manipulation 255–6
regulator – ASIC 180–7
material prejudice 262–3
MBOs see Management Buyouts
Ministry of Commerce (China) 388
Ministry of Economy, Trade and Industry
(METI) 366, 368, 369, 376, 377
Ministry of Justice (MoJ) 366
minority shareholder protections (MSPs)
353–5, 373
 INDEX 479

morality 419–24, 437–8 connected non-executive directors

application to business 429–30, (CNEDs) 116
432–44 executive and non-executive directors
core moral principles 431, 109–10
433–4 independent non-executive directors
moral liability 433 110–16
moral neutrality of business 436–7 lead/senior independent directors
promise-keeping and the harmony thesis 117
430–1 managing director(s), chief executive
universalisability of moral judgements officers and executive directors
427–9 117–18
utilitarianism 422–3 operational participation 29
see also ethics oppressive conduct (of affairs) 283–7
MSPs see minority shareholder protections Organisation for Economic Cooperation and
Development (OECD)
nation state 439–40 OECD effective governance framework
National Australia Bank (NAB) 34–5 guidelines 174–6
National People’s Congress (NPC) OECD Principles of Corporate Governance
387–8 9, 17, 21, 27, 29–30, 40–1, 65,
negligence see law of negligence 66, 338–42
New York Stock Exchange (NYSE) aims and application 338–9
309–12 background 338
background 309–10 board responsibilities 80
corporate governance rules 310–12, corporate governance framework
456 339–40
no-conflict rule (the Act) 213–14, 248, disclosure and transparency
264 341–2
non-consequentialist moral theories division of responsibilities (ASX and
420–2 ASIC) 176–7
norms 451–65 financial objectives in regulating
development 454–5 corporate governance 159–60
significance 451–7 recognition of market forces role 174
NPC see National People’s Congress structure 339
NYSE see New York Stock Exchange OECD-recognised stakeholders 25–35
recognition of stakeholders in corporate
occupational health and safety legislation governance 21, 40–1
26 Owen Report 4, 14–16, 75–7, 88, 91,
OECD see Organisation for Economic 95
Cooperation and Development Appendix G – offence provisions 290
officers (company) audit role – corporate governance link
chief executive officers 34, 79–80, 113, 221, 224
117–18, 269–70 observations of middle management
definitions 108
CLERP definition of ‘senior ‘organs of governance’ discussion 25,
management’ 214 27
middle management as ‘officers’
108–9 Parliamentary Joint Committee on
senior employees and senior executives Corporations and Financial Services
as ‘officers’ 107–8 (PJC) 67
statutory definition 106–7 participatory management philosophy
types 101–21, 130 28–9
alternate directors 120 pluralist approach (to shareholders’ interest)
chairperson 113, 118–20 43–5, 68
company secretary 93, 120–1 ‘poison pills’376, 377, 378, 379
480 INDEX
policy 406
compensation policy 329–30
corporate governance policy 96–8,
148
‘prima facie’ 430–1
Productivity Commission 129
profit(s) 57, 436–7
‘low-profit limited liability company’ (L3C)
44–5
maximisation of 6, 427, 430–1
Program-Related Investment (PRI) 44
Project Green 58
proportionate liability 214, 232,
233–5
recklessness (‘default’ fault element)
291
Redefining the Corporation: Stakeholder
Management and Organizational
Wealth [publication] 23, 54–5
regulation
Australian sources 161–74
‘hard’ law 162–6
‘hybrid’ regulation mechanisms
166–70
role of market forces 172–4
‘soft’ law 168–9, 170–1
Australia’s regulatory framework
36–40
‘boom–bust–regulate’ cycle 448–50
of corporate governance 94–6,
156–61, 178, 465–8
cost effectiveness principle (CLERP)
202, 216
‘cycle of regulation’ 448–50
definitions 157–8
financial markets regulatory framework –
analysis 174–7
division of responsibilities (ASX and
ASIC) 176–7
OECD guidelines 174–6
neutrality and flexibility principle (CLERP)
202
protecting employees’ interests 26–7
regulatory compliance ‘pyramid’ 158–9,
447–51
role of regulators 179–97
self-regulation 166, 171, 442–4
enforced self-regulation 166–70
pivotal role of corporate governance
139
Working Group – Bosch Report 136,
137, 139, 141
see also law; legislation
related party transaction 249–50, 261–2
reliance defence 247, 271–2
remuneration 127–9, 150, 206–7,
307–8, 316, 348
disclosure of remuneration and
emoluments in Australia 128
excessive remuneration debate 127–9,
135–6
replaceable rules 162–5, 217
reporting 148–9, 207–8, 251
resources 32–3, 54–5, 174,
439
responsibility principle 11–12
rights doctrine 420–3
risk 39, 328–9
governance risks 81–2
investor protection principle (CLERP)
201
risk-aversion and directors 184
Royal Commission into the Tricontinental
Group of Companies 143
‘safe-harbour rule’ see business judgement
rule
SAIC see State Administration for Industry
and Commerce
Sarbanes-Oxley Act (2002) (SOX) 94, 97,
456
aims and objectives 305–7
and collapse 304–9, 317, 448
and formalisation of corporate governance
218
perspectives 307–9
SASAC see Assets Supervision and
Administration Commission of the
State Council
Securities Act 1933 449
Securities and Exchange Act 1934 449
Securities Exchange Commission (SEC)
303–4
shadow directors 103–4
share capital transactions 250–1
shareholder primacy model 78
shareholders/shares 35–6, 432
actions against directors 280, 281–94,
400–1
auditors and the AGM 229
call options 374
controlling shareholder issue
403–6
and dividends 409–10
and the Dodge theory 6
‘enlightened shareholder value’ 45–6,
67, 68–9

IFSA corporate governance definition
147
Mallin’s theories 25
and ‘members’ 286
minority shareholder protections (MSPs)
353–5, 403–6
models 78
nature and corporate governance role
25
and ‘ownership’ model inaccuracies
54–5
powers conferred upon by the Act
76
share-class diversification 374–5
shareholder participation 205, 209
shareholder versus bank finance (Japan)
373–82
shareholders’ meeting 394–5
shareholders versus stakeholders 21
share-price (or share-price returns) 17
‘tunnelling’ problem 396
and the wealth creation concept 28
see also boards (of directors); stakeholders
Smith Report (2003) 317
social dividend 439–41
social responsibility principle 11–12, 24,
432
corporate social responsibility 8, 24, 39,
41–2, 442–4
stakeholder management 8–10, 23, 54–5
‘instrumental stakeholder theory’ 55
stakeholders 5, 147–8, 302, 330, 432,
462
corporate governance role 24
definitions 22–4
‘external’ and ‘internal’ stakeholders 24
importance of 8–10
models 23, 53–65, 78
OECD recognition 21, 25–35
shareholders versus stakeholders 21
stakeholder debate origins 5–10
stakeholders’ interests – role of the law
36–52, 65
Australian position 36–40
Canadian position 49
EU position 41–2
New Zealand position 49–51
OECD position 40–1
overseas position 40–52
South African position 51–2
UK position 45–9
USA position 43–5
and sustainability of corporations 35–6,
52
INDEX 481
see also shareholders
Standard and Poor (rating agency) 99
Standards Australia 152–4, 170
AS 800 Corporate Governance series
152–4
parts and appendices 153–4
State Administration for Industry and
Commerce (SAIC) 388, 392
statutory derivative action 281–4
‘stewardship theory’ (of corporate
governance) 458–61
implications 460
stock market 448–50
strategic participation 29
Strictly Boardroom: Improving Governance to
Enhance Company Performance
(Hilmer Report) 142–6, 170–1
supervisory boards 395, 397–8,
405
actions against directors 400–1
see also boards (of directors)
sustainability 12, 32–3
of corporations 35–6, 52
Global Impact program (UN) 443
Suzuki Report (Japan) 90
‘tipping’ 257
Tokyo Stock Exchange (TSE) 366, 368–9,
373
tort of negligence 73–4
Trade Practices Act 1974 (Cth) 30,
232
‘transaction cost’ theory (corporations)
453–4
transparency principle 11–12, 176–7,
201, 341–2
‘triple bottom line’ concept 52
TSE see Tokyo Stock Exchange
‘tunnelling’ problem 396
two-tier board structure 83–90, 136
UK Combined Code 314–16, 317–20
unitary board structure 83–90, 136
United Nations Environment Programme
Statement for Financial Institutions
on the Environment and Sustainable
Development 34
universalisation (of moral judgements)
427–8
exception 428–9
utilitarianism 422–3
victimisation 209–11
voting 148–9, 209, 394–5, 398
482 INDEX

wealth creation 28, 32–3, 437–9 ‘whistleblowers’ 26–7, 115, 205,

extreme wealth and duty not to 209–11
frustrate access to justice Working Group (Bosch Report) 136, 137,
441–2 139, 141
nation state 439–40 WorldCom collapse 203, 304–9, 317,
redistribution of wealth 440 448