Governance in group entities still a potential weak spot
Parent boards must be aware of the financial and reputational damage a problem at a subsidiary can cause and take proactive steps.
COMPANIES still have a long way to go to improve corporate governance standards at their subsidiaries, according to governance experts.
Some large multinational corporations have recognised that the governance of group entities or subsidiaries can be a significant problem and have started to take action to improve their internal processes and procedures to address the issues. “But it seems it is still only a minority of companies that accept that theirs is a problem,” said Chris Bennett, director at BPA Australasia, a South-east Asian enterprise that promotes improvements in corporate governance through research, professional education and advocacy in boards and senior management.
Experts note that corporate governance regulation and much of the commentary often focus on the listed entity of a holding company.
But most corporate governance failures occur within group entities other than the ultimate listed parent company.
“In reality, the ultimate parent is almost always financially liable for the ‘sins’ of the group entities and also faces significant reputational damage. Walking away from a group entity is rarely a practical proposition for a holding company,” said Mr Bennett.
The problem is not just confined to individual countries.
In a report entitled “Governance of Company Groups” published by CPA Australia late last year, Mr Bennett and Mak Yuen Teen, associate professor of the NUS Business School, studied 150 of the largest companies listed in Australia, Malaysia and Singapore.
It found that most of the largest listed companies in the three countries consisted of many group entities and these entities held most of the assets and liabilities rather than their parent firms.
In all three countries, group entities contributed significantly to the financial performance and financial position of company groups.
“Clearly, the performance and risks of group entities which are legally separate from, but often managerially integrated with, the listed entity will have a significant impact on the performance and risk of the listed entity,” said Prof Mak, a well-known commentator on corporate governance issues.
One year on from the report, awareness of the importance of the issue to listed organisations and their entities is rising but there is still some way to go.
“Besides financial institutions, where regulators have imposed clear governance responsibilities on subsidiary boards, awareness is still low and change is slow,” observed Prof Mak.
He cites the example of OW Bunker, one of the world’s largest traders of marine fuel oil, which went bankrupt earlier this year. Problems at its Singapore subsidiary essentially brought down the listed parent in Denmark.
“One may ask why no one is looking at the directors of the subsidiary here and whether they discharged their duties adequately,” said Prof Mak.
“Or do the regulators accept that the subsidiary boards are mere ornaments within the group and, therefore, directors on these boards should not be held accountable?” he added.
Observers say more will clearly have to be done to enhance the oversight of companies with group entities.
“The group board must take responsibility for, and be very careful about, what is being reported to them by the boards and management of the subsidiaries,” said Rob Elliott, executive director at the Centre for Governance Excellence and Innovation (CGEI), set up by the Australian Institute of Company Directors.
A big push may need to come from regulators, who can play a major role in changing mindsets and driving behaviours among listed companies with group entities.
“Directors of subsidiary boards often still feel that they are just there rubber-stamping decisions imposed on them by their parent boards, if they are informed or consulted at all,” said Prof Mak.
“As long as regulators are not going after them when things go wrong in the subsidiaries, they may feel comfortable with this state of affairs,” he added.
Meanwhile, parent boards may feel they are sufficiently protected from a legal standpoint if things go wrong in the subsidiaries because, legally in most countries, the duties of directors of parent companies are owed only to the parent organisations.
“There is moral hazard, with things falling between the cracks,” noted Prof Mak.
Experts say the lack of regulatory attention to governance of group entities may sometimes mean that parent companies will not give priority to group governance.
There could be several reasons, such as group entities being separate legal entities with their own boards making their own decisions; parent companies of groups may view governance of group entities as irrelevant; and where the financial investments in group entities are not large, parent firms may view these entities as being insignificant risk to the group.
Observers say the risk of reputational damage if something goes awry should also spur companies and boards into considering the priorities of what they need to do to improve the situation.
A way forward to minimise the risk of governance failures in group entities and causing significant financial and reputational harm to the entire group is to have a proactive approach.
“The best things companies can do are to discuss the implications in a board meeting, review the discussion issues with their company secretary and members of the subsidiary boards, and then come up with a plan of action,” said Mr Bennett.
Appropriate training for directors may also help but the catalyst for change will have to come from all stakeholders – regulators, boards, management and perhaps even investors, experts say.
According to the “Governance of Company Groups” report by Prof Mak and Mr Bennett published by CPA Australia, the following are the recommended steps to boost governance at the subsidiary level.
Regulators should review laws and regulations relating to the fiduciary duty of directors in company groups, and consider the need to clarify it for directors of parent companies, subsidiaries and other group entities.
Regulators should review corporate governance rules and guidelines to ensure that boards of parent companies recognise the importance of providing adequate oversight and guidance for entities throughout the group, while respecting the duties and responsibilities of boards of group entities to safeguard the interests of the group entity.
Regulators should recognise the need for laws and regulations imposing duties and responsibilities on boards of both parent companies and group entities to be accompanied by adequate guidance to assist these boards to interpret these laws and regulations, thereby minimising inter-board conflicts.
Boards of the ultimate parent company should ensure that the issue of governance of group entities is discussed and well-communicated throughout the group.
Company groups should utilise the framework presented in the report for discussing and evaluating the approach and specific measures to be used for governance of group entities.
Company groups should improve their disclosures of key measures they have put in place to ensure good governance of the entire group.