Auditors are supposed to be a key cog in corporate governance. While it is not an auditor’s responsibility to root out fraud or corruption, financial audits are meant to be one line of defence against nefarious accounting. In recent years, however, prominent auditing firms have been named in several high-profile accounting scandals, such as KPMG South Africa’s audit of Gupta-owned Linkway Trading. More recently, Deloitte, which had been auditing Tongaat Hulett for eight decades, signed off financials that included dubious sugar and land valuations. Little wonder the public has lost its faith in the profession.
Executive remuneration is also under fire, as top brass take home impressive pay, whether their stewardship warrants it or not. As the Financial Mail recently reported, Mediclinic’s CEO, Ronnie van der Merwe, received a short-term incentive bonus of £110,000 this year, over and above his package of £447,000, despite the company losing 70% shareholder value over the past three years.
...top brass takes home impressive pay, whether their stewardship warrants it or not.
Shareholders, please stand up
Shareholder activist Theo Botha says for business to work properly, government first needs to function correctly and provide the necessary infrastructure, such as an effective revenue authority and judicial system. “The judicial system lets us down,” he says. “In the USA, [former Steinhoff CEO] Markus Jooste would have been arrested. In South Africa, we don’t hold company boards accountable. We also don’t see many class actions, possibly because they’re not being driven by the few large legal firms operating here, or the Companies Act. If this were Holland, there would be a class action against Steinhoff. There’s also a lack of transparency. When things go wrong, there’s an internal investigation (how can you investigate yourselves?) and you wait months for the findings and then get a sanitised report and a promise to make changes, but nobody is ultimately held responsible.”
As an outsider, and by simply paying attention, Botha has often managed to spot governance breaches that boards and audit committees seem blind to. “You need to appoint the right people to do the right thing,” he says. “There are independent non-executive directors who are not fulfilling their roles and challenging management decisions. It’s often too collegial. People are in it for the prestige and don’t want to ruffle feathers.”
To fix holes in the system, he believes each party needs to play its role more effectively – business, government, shareholders and civil society (including the public and NGOs). While we should question how and why CEOs, CFOs, boards and audit committees are not picking up problems, bodies like the JSE, CIPC and the Institute of Directors also have an important role to play, as do shareholders.
Botha says there are two types of shareholder activism we need to embrace – holding management accountable for poor performance and holding management accountable for good governance. “For example, at Nampak, in my opinion, I’d say management hasn’t been performing over the last few years. It’s then the shareholders’ responsibility to question and to turn up the pressure,” says Botha. “When it comes to corporate governance, shareholders don’t want to spend money on researching and proxy voting, but they should. If a remuneration policy makes no sense, it should be voted down and the remuneration committee should come under fire. We need civil society and NGOs to criticise. It doesn’t have to be adversarial or aggressive, however. It can simply be a case of picking up the phone and asking questions. We need more engagement between all the different stakeholders. There is room for more listening, and for admitting when you’ve been wrong.”
His aim, he says, is to make the theory of good governance practical and to draw attention to real issues, but it’s a thankless job, which is why working as shareholder activists is not very popular.
The 2018, the Deloitte Executive Compensation Report notes that although “trends in shareholder value and company performance have been largely dictated by economic and market conditions, this is not the case in executive pay, which has been resilient over time and has essentially doubled over the six or seven-year period.”
“There should be significant personal loss for executives in the event of failure”
While one could infer out-of-hand executive pay, Leslie Yuill, Reward and Well-being leader at Deloitte Africa, believes it’s not the case. He says while there are documented examples of abuse, on the whole, executive remuneration is under control.
“Personally, I am against more regulation,” he says. “Governance codes have noble objectives, but often have unintended consequences, such as placing additional burdens on firms already doing the right thing – and these are in the majority.”
Yuill says South Africa’s current governance codes, laid out in King IV, are robust, progressive and fair, but there will always be a few companies that look for ways to get around doing what’s right. “King IV places specific emphasis on fairness, with Principle 14 stating, ‘The governing body should ensure that the organisation remunerates fairly, responsibly and transparently, so as to promote the achievement of strategic objectives and positive outcomes in the short, medium and long term’.”
He says due to public scrutiny and improvements to governance protocols, remuneration committees are taking a more proactive approach and are having hard conversations with all stakeholders/ But, he admits it’s tricky to keep all stakeholders satisfied. This is even harder in the South African context where unemployment levels of roughly 28% and a Gini coefficient of 0.63 can make executive pay seem obscene. Deloitte research suggests that there is a weak correlation between the size of company in terms of market cap and CEO pay, with the exception of really large multinationals such as Naspers. This seems to imply that in certain circumstances CEO pay may be structured around the individual rather than the role.
Furthermore, executive compensation arrangements are enormously complex. Yuill believes there’s room for simplification, improved transparency and increased accountability. The latter begins with ensuring executives have “skin in the game”.
“There should be significant personal loss for executives in the event of failure,” Yuill says. One useful shift could be from performance contingent pay (which is semi-guaranteed) towards performance-driven pay (value above a threshold). It’s important to distinguish between poor results caused by poor performance and those caused by structural or sectoral issues.
“Perhaps one alternative could be a system where executives contract on a single-figure, split between guaranteed pay (salary and benefits) and an annual cash bonus (at risk), with no share-based payments,” Yuill suggests. “The split could be negotiated, and the single figure could be higher if the executive is willing to accept higher risk. The executive would then be required to purchase shares with the after-tax proceeds and build up a shareholding, which should be a multiple of the single figure over time and grow with tenure. Careful consideration would need to be given to the design to avoid negative tax consequences that could be triggered by Schedule 8c of the Income Tax Act. The executive would be required to hold the shares for the duration of employment with the company. However, it’s difficult to encourage remuneration committees to do something to their peer group, so we see a lot of copying. Most committees are producing similar policies.”
There are independent non-executive directors who are not fulfilling their roles...
Shareholders can, however, choose to vote against remuneration policies, and this has been happening more in recent years, although in South Africa, unlike the UK, the vote is non-binding.
Principles for managing executive pay
Yuill says King IV lays out good basics for executive pay, which the Remco should build on, including:
· Minimum shareholding: The Remco should enforce minimum shareholding for executives, expressed as a multiple of guaranteed pay. Strict timelines should govern shareholding build-up and no additional awards of shares should be made to encourage or facilitate this. “This would ensure that executives stand to lose a large portion of their personal wealth in the event of failure,” says Yuill.
However, this idea fails without follow-through. For example, Brait has chosen to fork out R1.1 billion to buy back shares from top management after its shareholder value slumped by 84% and its share incentive scheme went down the tubes.
· Malus and clawbacks: “malus” refers to adjusting incentive awards downwards before they become payable, while clawbacks require participants to pay back all or some of an incentive already received. Yuill says these should be applied in both short and long-term incentive schemes and strictly enforced in event of failure. “Malus should also apply to deferred portions of short-term incentives, and there should be no pay-outs in the event of dismissal or any fault termination.”
Yuill notes that had Markus Jooste’s employment contract expressly included malus and clawbacks, it would be much easier to claim the R850 million the company is seeking from him. Jooste has argued that the specific terms of his employment and payment were not clear.
Ensuring auditor efficacy
Bernard Agulhas, CEO of the Independent Regulatory Board for Auditors (IRBA), says the auditing profession must realise it is at a crossroads. “Trust and confidence have been broken by recent business and audit failures,” he says.
The IRBA has compiled a “Restoring Confidence Strategy” comprising several projects to address auditor behaviour, firm structures, changes to standards, and the enhancement of audit committees and the expectation gap. It has also begun publishing the names (where deemed to be in the public interest) of auditors found guilty of misconduct, such as former KPMG partner, Jacques Wessels, who was found guilty on all charges relating to the Linkway Trading saga. Wessels has been struck from the record and his licence to practice as an auditor revoked.
The IRBA is pushing for the regulation of all accounting professions and has produced a paper outlining proposed recommendations to be presented to National Treasury. “These proposals are in line with developments in the UK,” says Agulhas, referring to the Kingman Report, which examines the effectiveness of the regulator; the Brydon Review, examining the nature of the audit product and whether it is fit for purpose; and the Competition and Markets Authority Report, examining the dangers of market concentration, including recommendations to address the concentration of FTSE 350 clients audited by the Big 4.
Unfortunately, IRBA fines remain pitiful. Currently calculated according to the Adjustment of Fines Act, the maximum fine is R200 000 per transgression. “There is no doubt that the current fine structure is not a deterrent,” Agulhas says. “To change auditor behaviour, the disincentive must be more significant, both monetarily and in terms of sanctions, such as striking negligent auditors from the register.”
The Auditing Profession Amendment Bill seeks to de-link IRBA fines from the Adjustment of Fines Act, empowering the Minister of Finance to determine maximum fines. “The bill is on the work schedule for the new Standing Committee on Finance and will hopefully be fast-tracked on the work programme of the new committee,” says Agulhas, who has also been leading the charge for mandatory audit firm rotation. This will come into effect on 1 April 2023 and will be another step towards preventing further accounting scandals.