Corporate governance and performance an exploration of the connection in a public sector context.doc

Corporate Governance and PerformanceAn Exploration of the Connection in a Public Sector ContextBy Meredith Edwards & Robyn CloughIssues SeriesPaper No. 1January 2005PrefaceThis paper is part of a major project - Corporate Governance in the Public Sector: An evaluation of its Tensions, Gaps and Potential. The project will provide the first comprehensive theoretical and empirical work on corporate governance in the Commonwealth public sector. It has been designed to enhance communication and participation in governance across government, industry, and the community by improving corporate governance literacy and making information publicly available.The project is a collaborative venture between three University of Canberra research centres and key governmental and industry partners including the Australian National Audit Office, the Australian Government Department of Finance and Administration, Deloitte, Touche, Tohmatsu, CPA Australia and MinterEllison Lawyers. This paper is the first in a series that will be produced by researchers and industry partners involved in the project. The aim of the series is to identify and explore key emerging public sector governance issues and encourage wider discussion and activity.The series has been designed for public sector practitioners and corporate governance enthusiasts across the public and private sectors. All papers will be broadly distributed and will be available online - www.canberra.edu.au/corpgov-apsAcknowledgementsThe Authors gratefully acknowledge the assistance of the industry partners and colleagues who contributed to this paper:Dr Russell AyresMr Andrew Bain - University Secretary, Murdoch UniversityMr Patrick GourleyMr Geoff Hine & Ms Anna DAlessandro CPA AustraliaMr John Kalokerinos MinterEllison Lawyers Mr Ian McAuley University of CanberraMr Andrew Morris - Australian National Audit OfficeA/Professor Jenny Stewart University of CanberraProfessor Roger Wettenhall University of CanberraProfessor John Halligan University of CanberraProfessor Bryan Horrigan University of CanberraMr Geoff Nicoll University of CanberraThe public sector corporate governance project is funded by the Australian Research Council, with financial and in-kind assistance from Industry Partners: the Australian National Audit Office, the Australian Government Department of Finance and Administration, Deloitte Touche Tohmatsu, CPA Australia and MinterEllison Lawyers. Sponsorship monies have also been provided to the Project from the Australian Public Service Commission. Corporate Governance in the Public Sector: An Evaluation of its Tensions, Gaps and PotentialUniversity of CanberraFor more information please contact:Roberta Dowd, Project Administrator Ph: 02 6201 5960, e-mail: Roberta.Dowdcanberra.edu.au.www.canberra.edu.au/corpgov-apsContents1. Introduction1.1 About this paper11.2 Governance concepts11.3 Why explore the relationship between governance And organisational performance?42.Private Sector Evidence2.1 Conventional “good” governing boards62.2 Measures of performance62.3 The tenuous relationship102.4 “Soft” governance and performance123.Applicability to the Public Sector3.1 The differences between the private and public sectors153.2 Public sector corporate governance: recent findings164.Measuring Governance Performance4.1 Hard measures of governance194.2 Hard measures of “soft” governance?205.Conclusions5.1 What can the public sector learn from private sectorexperience?255.2 Moving forward26ReferencesGeneral29Codes, guidelines and principles32Attachment A Public sector and private sector differences331. Introduction1.1About this paperThe focus of this paper is on the relationship between governance practices and performance of organisations. It examines what private sector evidence has to tell us about this relationship and explores the extent to which that evidence is relevant to the public sector. It goes inside the black box of the board room.The central issue that emerges is that the relationship between players in the decision-making process is critical for organisational performance. Yet to-date, this aspect of corporate governance has been largely neglected in studies that test the links between governance attributes and organisational performance. Good business relationships, in common with personal relationships, require nurturing, being worked on, and protected. Once the concept of good relationships is brought into the governance-performance equation, our perception of what good governance is and what to look for to enhance performance changes.Structure of paperThe remainder of this section includes a brief discussion of governance concepts and the rationale behind exploring the links between corporate governance and organisational performance. Section 2 of the paper provides a survey of the literature on the extent to which conventional “good” governance factors lead to company performance. Alternative or “soft” factors of governance that current research suggests appear to be important for performance are then introduced. The ways in which private sector findings could be applicable to the public sector are then addressed in section 3. This includes a brief discussion of the differences between the public and private sectors, and the findings of recent research into public sector corporate governance. The paper then turns to the measurement of (good) governance - both conventional and emerging in section 4. The concluding section provides a summary of issues and suggests some next steps for taking the issue of public sector corporate governance and organisational performance forward.1.2Governance conceptsIn its narrowest sense, corporate governance is about how an organisation is directed and controlled. It is about the structures and processes in place to facilitate and monitor effective management of an organisation, including mechanisms to ensure legal compliance and prevent improper or unlawful behaviour. However, as the Organisation for Economic Co-operation and Development (OECD) definition below indicates, the emphasis on relationships is central to broader definitions of corporate governance.The OECD takes a broad view of corporate governance and defines it as the full set of relationships among a companys management, its board, its shareholders and other stakeholders. It provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance determined. (1999a: 10)The term corporate governance finds its genesis in the private sector and conceptions have traditionally focused on the corporation-shareholder relationship. Increasingly, however, definitions of corporate governance place attention on a broader set of relationships to include those involved with, or with an interest in, the organisation (for example, employees, directors, suppliers, shareholders) and stakeholders served or affected by the organisation (for example, customers and local communities). A definition of governance we find most appropriate within the context of this paper is that of the Australian Auditor-General:I generally define corporate governance to encompass how an organisation is managed, its corporate and other structures, its culture, its policies and strategies, and the ways in which it deals with its various stakeholders. Public sector stakeholders include: clients, ministers, local communities, inter-government agencies, other levels of government, business/industry representatives, NGOs, community and private partnership agencies, private contractors and academics. (Barrett 2002: 2, emphasis added) Corporate governance involves the following two dimensions, which are the responsibility of the board (or governing body/individual):§ Performance monitoring the performance of the organisation and CEO. This also includes strategy - setting organisational goals and developing strategies for achieving them, and being responsive to changing environmental demands, including the prediction and management of risk. The objective is to enhance organisational performance; § Conformance - compliance with legal requirements and corporate governance and industry standards, and accountability to relevant stakeholders.(see for example, ANAO, 2003, Vol 1: 6)Increasingly, the concept corporate governance is used in the public sector as well as the private sector. While there are some similarities between the two sectors in governance terms, there are also significant differences that shape the way government departments, authorities, corporations and even government business enterprises are organised and governed (see section 3.1). For this reason public sector governance is, for some, the preferred term. For example, the ANAO has opted for the term public sector governance in its governance better practice guides (2003), and the literature suggests that the term corporate governance is rarely associated with the public sector in the American context. However, for the purposes of this paper, the term corporate governance, or simply governance, is employed. Extensive consideration will be given to terminology and its appropriateness in the public sector context in other project publications.Separation of governance and managementWhile, as noted by the Auditor-General above, governance is concerned with “how an organisation is managed”, it is important to understand that governing is not the same as managing. Broadly, governance involves the systems and processes in place that shape, enable and oversee management of an organisation. Management is concerned with doing with co-ordinating and managing the day-to-day operations of the business.The following table is helpful in understanding the conceptual difference between governing and managing. The BoardManagementThe mindThe handsDirectors directManagers managePolicyAction (Source: AICD, 2003: 20)However, whilst theoretically distinct, in practice an inflexible division between those who govern and those who manage may be impractical and inefficient or simply not relevant. For smaller organisations particularly in the not-for-profit sector with limited staffing and financial resources, board members may be called on to play a more hands on role. In the private sector, the separation of chair and CEO is a contested area and by no means a given in practice (this is discussed in more detail below). Importantly, within the context of this paper, many public sector entity heads are responsible for both governance and management. The majority of Commonwealth public sector entities under the Financial Management and Accountability (FMA) Act do not have legally based decision-making boards and legal responsibility rests with the entity head. Some governance functions may be delegated to other officers and it is common practice to establish an executive committee or board to provide advice and support. Ultimately, however, the entity head will be held to account. For board-based entities, staff and board member clarity about the differences between governing and managing will help to:§ avoid a board that micro-manages interfering with day-to-day operations at the expense of strategically directly§ avoid a passive, rubber-stamping board culture, controlled by the CEO.Even when the two roles directing and managing - are carried out by the same person or people, clarity about the different responsibilities and functions of each role and achieving a balance between the two will contribute to a smoother running organisation.Principles of good governanceThere are some commonly accepted key principles or elements of good governance that are applicable to both the public and private sectors. The three most common are: accountability both internal and external; transparency/openness; and recognition of stakeholder/shareholder rights. Often to these are added: efficiency, integrity, stewardship, leadership, an emphasis on performance as well as compliance, and stakeholder participation or inclusiveness. See for example: The ASX Principles of Good Corporate Governance (2003), The OECD Principles of Corporate Governance (2004) and the ANAO Principles of Public Sector Governance (2003). See also the characteristics of good governance identified by the United Nations, within the context of a broad understanding of governance (1997). At different times and in different organisations, different elements will be given emphasis and it is always a matter of balancing them. Indeed, there are inevitable tensions in attempting to practice good governance principles. Examples of tensions include between external and internal accountability, accountability and transparency, and efficiency and inclusiveness. More generally, tensions are created between those who govern and those who manage and role conflicts will come into play - especially in the public sector, when participants wear more than one hat. As will be discussed later in this paper, a key to success in balancing these tensions is clarity around role, responsibilities and expectations. Essential to managing tensions well is to establish and maintain good relationships.1.3Why explore the relationship between corporate governance and organisational performance?The connection between corporate governance and organisational performance lies in the multi-dimensional nature of (good) governance. Narrowly conceived, corporate governance involves ensuring compliance with legal obligations, and protection for shareholders against fraud or organisational failure. Without governance mechanisms in place in particular, a board to direct and control - managers might run away with the profits. This understanding of corporate governance as, primarily, a protective mechanism stems from agency theory. Agency theory emphasises individual action and specifically the self-interested individual who will seek to maximise her/his personal gain. This creates an inherent tension or conflict between managers and owners. The board is there to safeguard the interests of the owners from managerial opportunism (Smallman, 2004: 80-82 and Donaldson & David, 1991: 50-51) Understood in this way, good governance minimises the possibility of poor organisational performance. As noted earlier, however, more recent definitions of good governance emphasise the contribution good governance can make to improved organisational performance by highlighting the strategic role of the