How Westpac got its governance right

1 June 2004

Today in 2004 Westpac Banking Corporation not only stands tall at the top of the Australian corporate governance league table, but is the only bank worldwide to get into the global top twenty as measured by Governance Metrics International, a corporate governance ratings body.

Six years ago if you had uttered the name Westpac, any Australian lawyer, sharebroker, journalist or any other professional or bank customer within earshot would have winced. It was disliked by customers and shareholders alike, and even its own staff despised the board and management. A series of exposures in the media revealed that Westpac's top management had authorised cash payments to famous radio personalities for making positive comments on air about Westpac.

This 'cash for comment' scandal coincided with the nadir of the bank's fortunes and prefaced the departure of the chairman and chief executive.

Colin Chapman visited Westpac headquarters in Sydney to find out how they transformed the governance.The following story will show how Westpac, created as the Bank of New South Wales in 1817 and as good a pioneer as any in the opening up of the Australian economy, had all but destroyed its reputation. This corporate tale provides a model for companies struggling to create sound corporate governance.

Biting the bullet

Westpac's transformation began when a new board was persuaded that its previous belief that the only thing wrong was the fact that people did not understand the company was totally wrong.

The change activist was Noel Purcell who, as general manager in charge of investor relations, has an overall remit on corporate governance working in tandem with Ilana Atlas, company secretary and corporate counsel.

"It started from the point of view that the mindset was not the right mindset, you can tick the boxes for all you like, but it is not going to change very much. We think box ticking is important but you can't regulate good behaviour. That's the issue", explains Purcell.

When John Uhrig became chairman and David Morgan, a former IMF official, moved to Westpac from his job as senior deputy secretary of the Australian Treasury (Finance Ministry) in 1999. There was a two-day strategy meeting away from Westpac's head office to discuss the bank's sagging reputation.

"I guess the fundamental thing in those discussions were we went through some processes which were facilitated by me", Purcell said.

"We put ourselves through an exercise because everyone at that stage was saying that what we had was a communications problem. Everything would be OK if only they understood our story. In other words 'we are doing the right thing, but they do not understand what we are doing, we just need to change the perception, and get them to understand that we are the good guys'</ p>

"The problem was there was a big gap between the company's aspirations and what we were actually doing. Basically I exposed that and said we have got a substance problem. You can never get the community to accept the perceptions about us while there is a substance problem. They were actually reading our behaviour correctly.

"At that point the board embraced the need for change, to fix those things. We had to find sustainable solutions - not give up on the profit imperative, but find a balance between achieving outstanding results and meeting our broader social responsibilities."

The action taken

Westpac set about nothing less than changing corporate culture right through the company, while admitting its past failures.

CEO David Morgan went on record in the company's annual report to say candidly: "People don't like banks. This is an unarguable fact, which we cannot afford to ignore. What is clear is these are perception s not to be dealt with by a few exercises in public education. They are realities: they go to the heart of what we are doing every day".

The board was tasked with total responsibility for corporate governance, which was officially defined as:

• Monitoring management and financial performance;
• Monitoring financial reporting;
• Ensuring the business is conducted ethically and transparently;
• Reviewing regularly the practices and standards governing the board's composition, independence and effectiveness, the accountability and compensation of directors and senior executives, and the board's responsibility for the stewardship of Westpac;

Compliance with the best practice guidelines of the Australian Stock Exchange was seen as a must. The guidelines allow listed companies not to meet certain guidelines provided that they state why they have done so, but Westpac decided on 100 per cent compliance.

But that, as Purcell says, was only ticking boxes. The Bank decided it had to go beyond the guidelines. It publishes with each annual report a 12-page corporate governance statement, which sets out the Westpac way of doing things.

The fundamentals of this are to be found in the new constitution, which provides there must be a minimum of 7and a maximum of 15 non-executive directors, and that the chairman is selected from the independent directors. At present Westpac runs with only 8 directors, of whom only one, CEO Morgan, is an employee.

The Westpac board meets formally at least ten times a year - last year it met 13 times - but in addition to these formal meetings it undertakes a number of regular and relevant workshops. Over the past year these have included executive and senior management succession planning, corporate governance, Westpac's risk-reward approach, and a number of other subjects.

Attendance has been excellent - a 100 per cent record during last year's regular board meetings. Additionally there are a number of board committees - for audit and compliance, credit and market risk, nominations, remuneration, and social responsibility.

"It is quite normal for board members to attend committee of which they are not a member. They go not because they have to but because they want to. We have been able to build a board which has very relevant and diverse skills, we have individuals who I would say are in the modern school - I think they are all people who are very adaptive.

"I think they are all people who understand how the requirements of companies are very different to what they used to be, and the expectations and requirements of them as a board. There is a culture that if there is something wrong you should deal with it, don't try to avoid it. " says Purcell.

While they are not youthful - with only Carolyn Hew son aged under 50, they do not lack diverse experience, seen as essential in the modern era of the non-executives. All but the chairman has had line experience in finance or accountancy.

The present chairman, Leon Davis, has had extensive experience in resource management and mining in Australia, Papua New Guinea, Singapore and Britain, and is also deputy chairman of mining giant Rio Tinto, having previously been the international mining company's chief executive.

Two are former public servants - Ted Evans and CEO Morgan. Those with accountancy experience include David Crawford, Australian chairman of KPMG for 12 years until 2001, and Peter Wilson, a former partner of Ernst and Young. Carolyn Hewson was an executive director of Schroders, and now sits on the board of AGL, CSR and the South Australian Economic Development Board. Others have had experience at chairman or chief executive level with major industrial companies.

The board committees are seen as especially important in corporate governance. The audit and compliance committee consists solely of independent directors, and it meets regularly with Westpac's external auditors, Pricewaterhouse Coopers, without any executives present.

The audit committee as policeman

Here Westpac has introduced a process aimed at preventing relationship between its officials and its auditors becoming too cosy - one of the major flaws exposed in recent American corporate governance scandals.

"In their mandate the auditors are required to report to this committee any attempt at any time by executives to influence the audit, and the committee will investigate and report on this", says Purcell. "This is controversial, but Westpac has been doing it for a number of years.

"It is not that we do not trust executives - it is simply establishing the fabric of good behaviour".

Under Westpac rules directors must retire after 12 years on the board or at the age of 70, whichever comes sooner. One third of the directors retire each year. New directors are considered by the nomination committee using external consultants to trawl for candidates.

The criteria used includes "background, experience, professional skills, personal qualities, whether their skills and experience will augment the existing board, and their availability to commit themselves to the board's activities".

They also have to consider whether the prospective director is likely to be truly independent.

Assess the directors

Directors are considered to be independent if they are "independent of management and free from any business or other relationship that could materially interfere with (or could reasonably be perceived to materially interfere with) the exercise of their unfettered and independent judgement".

Westpac's corporate governance statement states: " In assessing independence the board considers whether the director has a business or other relationship with Westpac, either directly or as a partner, shareholder or officer of a company, or other entity that has an interest, or a business, or other relationship with Westpac or a Westpac group member".

Any director appointed during the year has to be approved by shareholders at the annual meeting, and when appointed new directors undergo a substantial induction program.

Applied across a broad swathe of business, these criteria alone would rule out many of those gracing existing boardrooms, and provide an excellent model for those wishing to embrace change in board selection.

Give the directors real information - Power

Westpac directors get "unrestricted access" to company records and information, and receive regular detailed financial and operational reports from executive management.

Here there i s another innovation, which has earned the company its high marks for governance. The board collectively and each director individually has the right to seek independent professional advice at Westpac's expense to help them carry out their responsibilities. While the chairman's approval is required for this, it may not be reasonably withheld.

Pay directors well

This kind of director does not come cheap. Independent directors' base fees are $A125, 000 (E 77,480) per director per year. Directors who chair a committee receive an extra $A 20,000 (E 12,400) per committee. The chairman gets remuneration of $A 440,000 (E 272,730) a year, inclusive of committee fees.

Independent directors do not receive share options, but they may choose to receive a percentage of their fees in Westpac shares, which are bought on the market at the market price. Until last year directors also received generous retirement benefits, but for directors appointed after July 2003 these has been abolished.

These fees are likely to rise, but the pot of money allocated to directors' pay has to be approved by shareholders first.

In contrast to the practice in many companies full details of each and every director's pay is published in the annual report. This kind of transparency also applies to the controversial issue of executive pay.

Create a pay structure which does not reward failure

One of the hottest issues in corporate governance worldwide is payment for non-performance. In many of the companies involved in recent scandals or where the share price has collapsed executive directors have continued to receive huge bonuses much to the ire of shareholders, the media and the public.

Westpac claims its reward framework will prevent this happening, based as it is on a firm alignment to shareholder value as well as being sufficient to attract and retain high calibre executives.

The framework provides a mix of fixed and variable pay, and a blend of short and long-term incentives. As executives gain experience the balance of this shifts to a higher proportion of 'at risk' rewards.

At Westpac economic profit is the primary measure of performance. The term 'economic profit' is an important one because it implies that profit earned for profit's sake - for example by increasing market share at high cost - does not work. Profits have to be earned while controlling costs.

To earn a market competitive short-term incentive payment both Westpac and the executive concerned must meet economic profit related performance targets. Running in parallel with this are long-term incentive schemes. These use straightforward and transparent performance hurdles that are expressly aligned to creating shareholder value. If the hurdles are not cleared, than executives forfeit the incentive.

For full details see Westpac Performance Plan click here

Go beyond the codes

Other major planks of corporate governance are a series of codes that go far beyond the ASX codes. Apart from general business behaviour and business ethics they cover areas such as anti money laundering policy, insider trading policy, conflicts of interest policy, and market disclosure policy.

Encourage whistle blowing

Additionally employees are firmly encouraged to blow the whistle whenever they spot or suspect wrongdoing. Westpac has installed a concern raising process, which includes a special intranet site accessed only by the chief executive and the chief financial officer. Concerns can also be raised anonymously by telephone or on line with the company's chief compliance officer. Individuals who, in good faith, report any apparent or actual violation of Westpac codes are fully protected.

Rebuild the DNA

With these and other measures the bank has, as CEO David Morgan put it "rebuilt the Westpac DNA from the base up".

Noel Purcell stresses the transformation, and believes Westpac has truly earned its position as a global corporate governance model.

"Companies tend to fit three groups. The first one is the blind ignorant - in other words they are blinkered to the reality of what today's world is about, the transparency of markets and the transparency of corporate behaviour, and what that actually means. Some companies, in the second group, have moved out of that, got beyond the bunker mentality, a victim mentality, and fall within a compliance mentality. They set up new processes, put numerous systems in, and set up a kind of tick a box mentality. But that can only take you so far.

"The third position is the one where we decided we had to lead, and put good governance at the heart of everything.

"What we have here is an approach based on principle. Everything we do goes well beyond the regulatory requirements, it is based on what we believe is doing the right thing"