Skin in the game may be new trend

Suncorp's surprise announcement last month that directors would need to own more than $200,000 of the company's stock is likely to spark a trend as new data reveals directors with "skin in the game" generally outperform - by a lot.

Suncorp's surprise announcement last month that directors would need to own more than $200,000 of the company's stock is likely to spark a trend as new data reveals directors with "skin in the game" generally outperform - by a lot.

A new report by Macquarie Equities, Board Matters, found that companies that had directors holding stock had better shareholder returns and return on equity. Using a long-short back-test analysis, it found that return on equity was 13.7 percentage points higher and relative share price outperformance was 8 per cent.

It is a fascinating concept and if it gains traction could prompt investors to push for more boards to put their money where their mouths are and better align themselves. The percentage of ownership for the independent directors is less than 1 per cent, on average.

There has been a lot of discussion about executive pay, but as one corporate governance expert said: "What about getting directors motivated to get out of bed in the morning?" He makes a good point because boards are the guardians of shareholder interests. To this end they act on behalf of shareholders to supervise the company. This means having oversight of overall strategy, the use of capital, appointing the chief executive and signing off the financial accounts.

The Macquarie Equities report examines the boards of the top 100 companies over five years, from 2008 to 2013, and tests various board characteristics, including age, tenure, diversity, number of board seats and ownership of shares.

The report comes as the annual reporting season draws to a close. This season has been relatively quiet compared with previous years, with only a few companies attracting controversy, including David Jones, Aurizon, CSL and Southern Cross Media, which incurred a strike on its remuneration report. At a time when Southern Cross chairman Max Moore-Wilton and chief executive Rhys Holleran told the market they were focusing on "cost control", Holleran received a 38 per cent increase in his base pay.

But the most controversial was David Jones, with almost 40 per cent of shareholders voting against the remuneration report to send a message to the board that they were not happy with a string of recent events, including its handling of the announced resignation of the chief executive and the purchase of shares by two directors just three days before the company told the market its first-quarter sales results were better than expected.

The shares soared 6 per cent when the sales results were released, which attracted a lot of anger about the director trades. The corporate regulator is now looking into the trades. While directors of David Jones were putting some skin in the company, their timing attracted criticism.

In Suncorp's case, it has given directors four years to comply with the new policy, which involves directors being asked to buy a minimum number of shares that equate to their base director fees.

Besides the positive correlation between skin in the game and performance, the Macquarie Equities report made some interesting observations about Australian boardrooms post-2008. "The typical ASX100 boardroom in Australia is comprised of eight individuals that have served on the board for 5.3 years. The percentage of independent directors is slightly higher at 75 per cent and the average age of those directors is now just over 59," the report says.

It also finds a positive relationship between board tenure and return on equity and a negative relationship with the "busyness" of directors and return on equity.

Board tenure is expected to become a hot topic following recent proposed amendments to the ASX Corporate Governance Principles and Recommendations, which included adding tenure as a marker for a director's independence. In a set of draft proposals released in August it suggested being on the board for more than nine years should be an indicator a director may not be "independent".

If it comes into practice ASX companies will have to explain why they are not conforming. Macquarie estimates that almost a third of the ASX 100 companies have two or more directors that have served on the board more than nine years.

Interestingly, the Macquarie analysis shows the average tenure of a board member serving in 2012 was 5.3 years for the ASX100. This is down from 5.9 years in 2009.

"In our analysis, companies that have independent directors that have served for a longer period on the board had a superior ROE compared to those boards with shorter tenure using the five-year test period. This could indicate that corporate memory and experience can enhance returns." But at the end of the day statistics are useful but it boils down to the individual and how effective they are.

Twitter: @Adele_ferguson

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