Brian Gaynor: Shareholders left out of the boardroom

"The greatest barrier to meaningful independence in the boardroom is insider control of the nomination process," say two corporate governance experts. Photo / 123RF

One of the most frustrating aspects of corporate governance is that shareholders are rarely consulted about the appointment of new directors. Yes, shareholders get to vote on the re-election of current directors but they rarely have the opportunity to approve a director before he or she has been appointed to the board. It is also a long, long time since we have had a contestable election for a board seat in New Zealand.

We would be appalled if Phil Goff, the former MP and new mayor of Auckland, appointed a replacement for his Mt Roskill seat and this replacement was the only candidate in the subsequent by-election.

This is essentially what happens as far as company directors are concerned.

US corporate governance experts Robert Monks and Nell Minow have this to say about the director appointment process in their book Corporate Governance: "The greatest barrier to meaningful independence in the boardroom is insider control of the nomination process. The fact that we speak of directors as 'representing' or being 'elected' by shareholders when the shareholders play no role in the nomination is evidence of the challenge we face in trying to understand corporate governance.

"Almost every public company has a nominating committee responsible for proposing candidates to the board. In many cases, however, the nomination committee receives the names from the CEO. One CEO told the authors of this book, 'My nominating committee is very independent. Sometimes they turn down the names I send them'. However, when challenged to think of a time that the committee came up with its own name, he could not recall a single one."

The main board characteristics of the NZX's 10 largest companies, which have a combined sharemarket value in excess of $49 billion, are:

• Five of the companies have eight board members, four have seven directors and one, Contact Energy, has only six directors.

• These 10 companies have 23 female directors, representing 31 per cent of the 74 directors.

• Joan Withers, at Mercury NZ, is the only chairwoman. Fisher & Paykel Healthcare, with just one woman director, has the lowest female representation. Auckland International Airport, Spark NZ, Contact Energy and Z Energy all have three women directors.

• Only four of the 10 companies - Fletcher Building, Spark NZ, Ryman Healthcare and F&P Healthcare - have appointed the chief executive to the board. It is generally considered, particularly by CEOs themselves, that CEOs have more status and power if they are appointed to the board.

• Thirty-seven of the 74 directors live in Auckland, 23 are based elsewhere in New Zealand and 14 live offshore. Only Meridian Energy, Contact Energy and Vector have no overseas directors. Ryman Healthcare probably has the best overseas representation as it has three Victorian directors, the base of its aggressive Australian expansion strategy. F&P Healthcare has only one overseas director, a low number for a company with substantial offshore operations and revenue.

At this year's annual meetings, 31 of the 74 directors stood for election, with 24 retiring by rotation and seeking re-election. The remaining seven had been appointed since last year's annual meeting and shareholders were asked to approve these appointments.

NZ shareholders are a happy lot as most of these 31 directors received approval from nearly 100 per cent of the votes cast. In addition, three of the 10 companies asked shareholders to approve increases in directors' fees, with two of these resolutions receiving support from more than 99.5 per cent of the votes cast.

It is very important that shareholders initiate board changes before companies are at a terminal stage ...

Ryman Healthcare's motion to raise director fees was also approved but the company does not release voting figures.

Monks and Minow said they believe that shareholders, particularly institutions, should have more engagement with nomination committees and propose their own candidates. However, they write: "The British investment institutions have so far not taken advantage of their ability to play a role in nominating directors, despite the strong recommendation of the Cadbury Report."

NZ companies argue that they must raise directors' fees to attract high-quality candidates. Monks and Minow say fees are only one of the issues considered by individuals when they are offered a board seat.

They write: "Non-executive directorships are prestigious, well- paid, banners of achievement, and unsurpassed networking opportunities. It is understandable that people of achievement covet them and do not want to lose them. It is also understandable that the system makes it difficult for those who want directorships to restrain or focus a CEO who will decide whether they get to stay in that very exclusive club".

There are issues in New Zealand, including: how do shareholders identify new directors for poorly performing companies; and how do independent directors assert their influence when a company is effectively controlled by a large shareholder?

It is extremely difficult to identify new directors for poorly performing companies because highly regarded directors do not want to be associated with entities that could fail. Therefore, it is critical that shareholders initiate board changes before companies are at a terminal stage because then it is too late to make meaningful board changes.

Tower is an example of a company that has not benefited from the influence of a controlling shareholder.

At the beginning of 2012 Tower had a market value of $400 million, 54,500 shareholders and GPG was its largest shareholder with a 34.1 per cent stake. It had four operating divisions: general insurance; life insurance; health insurance; and investment management, including its KiwiSaver default position.

The notice of meeting for the annual meeting to be held on February 8, 2012 showed that Denis Wood, a regarded and strong-minded independent director, was standing for re-election. Tower's post-meeting stock exchange release revealed that Wood "withdrew from standing for re-election and retired by rotation at the conclusion of the meeting".

The clear impression when I was at the meeting was that GPG indicated it would vote against Wood's re-election and he decided to stand down before the vote was taken. This illustrates how a 34 per cent shareholder can control a board of directors and remove a director who may be opposed to its plans.

Tower has had the following developments since its 2012 annual meeting:

• In 2013 the company sold its life insurance, health insurance and investment management businesses for $370m and returned $120m of capital to shareholders.

• GPG sold all its shares in September 2013, just after Tower announced that it intended to make an additional capital return of $70m.

• The company made capital returns of $57.1m in 2014 and $12.2m in 2015.

• Tower reported a net loss of $6.6m for its September 2015 year and a net loss of $21.5m for the 2016 year.

The company now has a sharemarket value of $137m compared with $400m at the beginning of 2012 although it has had capital repayments of $180m in between. Tower's sharemarket value has fallen more than 35 per cent since early 2012, after adjusting for the two capital repayments, while the NZX50 Gross Index has surged more than 100 per cent in the same period.

Tower is not in great shape because the GPG-controlled board sold its profitable and high-cash flow businesses: heath insurance, life insurance and investment management. Tower is now a much smaller company with a high-risk exposure to major insured disasters.

In my view it would have been difficult for Wood, who took his role as an independent director extremely seriously, to successfully oppose these asset sales.

I believe that GPG, which at the time rejected suggestions it had forced Wood to resign, effectively removed him because he questioned Tower's asset sale strategy.

Tower's poor performance since early 2012 demonstrates why shareholders should pay close attention to the appointment and re-election of directors.

Brian Gaynor is an executive director of Milford Asset Management which holds shares in Tower on behalf of clients.