PRESENTATION TO THE

OECD FORUM 2003

“CORPORATE GOVERNANCE – STRENGTHENING CONDITIONS FOR INVESTMENT”

PARIS

MONDAY, 28 APRIL 2003
2.30PM

Thank you very much, John [Rossant – Moderator, European Editor Business Week].

Can I start off by saying I do not think we need to re-think the concept of

a corporation. And if we did, it would be long outside the political cycle that

any of us are familiar with. I think we know what a corporation is there to

do. It is to give limited liability to people who want to share their capital

for joint economic purpose, for a hope of return. What we may have to do, is,

we may have to educate the public on what a corporation stands for and, in particular,

the word risk. I heard Daniel [O’Keefe – Managing Director, Protiviti] mention

that. As a general rule, the higher the return, the greater the risk. And we

have lived through a bull market which encourages people to believe that high

returns could be obtained without risk. And it is only at the end of that bull

market, that the old laws are proven again that return goes hand in hand with

risk. And you cannot take risk out of investment. The moment you legislate against

risk, you will legislate against the opportunity to return profit. And it is

very important not only that lawmakers understand that point. It is important

that investors understand that point.

Now, from a lawmaker’s point of view, we always have two competing issues

that come at us in this area. On the one hand, we do not want to stifle entrepreneurial

activity, so we want low transactional costs. On the other hand, we want to

protect investors so that we have confidence in our markets. And it is these

two competing issues that come at us every time, from which we need to try and

strike a balance, which can preserve the concept of a corporation and confidence

of investors, which is necessary to make it work.

Now, when theorists look at those two competing issues they say, well how

can you reconcile them? And they always come up with the word transparency.

Transparency means that a legislator does not have to tell a corporation what

to do. They can decide what to do as long as they tell everybody. And an investor

can be protected because they know what is going on.

But I think where this has broken down, is, that as the general public, mass

investors, have developed with privatisation projects and so on, your ordinary

investor does not have the sophistication to be able to assess the kind of information

that is coming out from a company. Prospectuses are too long, analysts use their

own jargon, and during a bull run, who cares anyway because you are always getting

a good return. Nobody is really interested in the information.

And so we have the rise of the professional manager. And it was thought that

the professional manager would understand all of this disclosure. He would protect

the investor, he would get them a good return, they could put their trust either

in terms of the collective investment, or a pension plan, in the professional

manager.

Now, I will put to you, and I am going to make four points here, that professional

managers are a very large part of the problem. They were being rewarded by returns

which gave them incentives to pump the stock. There was not enough transparency

on the managers themselves. And although I would not legislate it, I would certainly

recommend to people, to go to analysts who charge a fee rather than take an

equity position. I am not sure that the managers themselves learned how to distinguish

between their own incentive and that of their clients. I think also the tendency

became very short-term. Quarterly returns, quarterly rating. Nobody was interested

in long-term investment and I think that undermined the idea of the company.

The second thing I am going to suggest is, it is essential to look very carefully

at your tax system. There were biases in the tax system for capital returns,

which again gave incentives to pump stock. Most developed countries now have

a lower rate of tax on capital than they do on income. That is one bias in favour

of a capital return. Those countries that offer a classical taxation system,

tax income twice – both in the hands of the company and the hands of the shareholder.

That gave an incentive to pump stock rather than to earn income – and I welcome

moves in some countries now to move to a system away from the classical taxation

system. We, in our country, operate a full dividend imputation system so that

income is only taxed once, and the incentive is therefore for a corporation

to derive income.

And thirdly, transactional costs on share buying and selling should be kept

low so that people have the opportunity to exit. Stamp duties on share transactions

and so on are bad things if you want to get discipline into markets. Should

you have ease of entry, ease of exit in order to have discipline on the corporations

themselves.

The third thing I am going to suggest that we found very useful in Australia

is continuous disclosure. We do not have quarterly reporting, but for listed

corporations we have continuous disclosure. That is, anything that can materially

affect the share price must be immediately disclosed to a stock exchange. It

does not give you the opportunity to make an announcement early in a quarter

which does not have to be announced for some time. And we are going to back

that up with on-the-spot fines, with a failure to disclose will incur an on

the spot fine from the regulator. You have the right to contest that in court

if you want to, but you run the risk of what we call an on-the-spot infringement

notice, which of course puts enormous pressure on the corporations to get the

information out. By the time it has gone off to court, everybody has lost interest

in the actual information.

The fourth, and the last, point that I want to underscore, and numbers of

people have already made it in this presentation, is peer group pressure. Peer

group pressure was in many respects a force for ill, I think, in the bull market

run of the late ’90s. That is, if you were a company director that did not have

a deal going, you were considered rather indolent or not working as hard as

your shareholders would expect. If you were in the so-called old economy, rather

than the new economy, this would open you up to criticism. And the tendency

became, I think, for chief executives, they had to leave their mark in corporations

by doing a deal somewhere to realise shareholder value. You do not hear too

many people these days adversely contrasting old economy stocks to new economy

stocks. That is a language that seems to have died in the late 1990s for obvious

reasons. So just as peer group pressure could be a force for ill, it can be

a force for good.

The importance of non-government institutions, I would underline the Institute

of Company Directors, stock exchange rules and public pressure. We have had

examples in our country where chairmen of boards that have lost shareholder

value have foregone remuneration. Now, that is a very good signal, I think,

to the investing public, and I think it is a very good arm of peer group pressure

in relation to other company directors.

The other thing I would put in there, that we are thinking very carefully about

in relation to enforcement, is civil enforcement as against criminal enforcement.

We found particularly in western legal systems, the criminal standard beyond

reasonable proof, the rules of evidence, mean that proceedings can take a very

long period of time. Civil proceedings, different standard of proof which is

the balance of probabilities, financial penalty which follows, maybe a disqualification

penalty from being a company director, which for a professional company director

is equivalent to a life sentence to be banned from being a company director,

allows you to much more quickly access the court system and get some kind of

verdict out there. And this is absolutely important for the investors. At the

end of the day, the investors need to know that it is safe to go back into the

water, and a government that can reassure them on that I think is going to get

an economic benefit.

One last point I will just make in closing, John. From an economic point of

view, we have always thought about the importance of fiscal policy, the importance

of monetary policy, the importance of tax policy, structural policy. We see

corporate governance very much as an arm of structural policy. Rather than a

race to the bottom, which you sometimes get in tax policy, a race to the top

in relation to corporate governance can actually give a country and a business

environment a competitive advantage that people who want to invest in your jurisdiction

know that it will be done well. Companies that are competing in your jurisdiction

know that the regulation will be independent so that people will not get advantages,

and of course investors feel free to be able to reinvest. So corporate governance,

as an arm of economic policy, which is why I as a Treasurer got interested in

it, and I think if you think of it in that way, you can actually make it a great

benefit and positive.

Thanks very much.