Corporate Governance and the Australian Oil Industry - Case Study Example

Corporate Governance and Australian Oil Industry Table of Contents Table of Contents 2 Executive Summary 3 Introduction to Australian Oil Industry 3 Corporate Governance 4 Good Corporate Governance & Corporate Performance 4 Current Practice of Corporate Governance in Oil Companies of Australia 5 Role and Size of the Board Composition in Corporate Governance 6 Corporate Governance & Sustainability Accounting 7 Summary & Conclusion 10 References 11 Executive Summary Australia is one of the few countries of the world to have large natural oil and gas reserves. The petroleum sector in Australia is one of the most profitable sectors and also a significant contributor to the economy. It is believed by most of the Australian petroleum companies that accurate environmental reporting can accelerate the progress and improve the image of the company. The study focuses on the current situation of the Australian oil industry. It will also focus on the effects of good corporate governance system on the corporate performance of a company. The study will also lay emphasis on the current practice of corporate governance system and the benefits of sustainability accounting practices in the Australian oil companies. Finally, the study will conclude by summarizing the essential components. Introduction to Australian Oil Industry Australia has substantial amount of petroleum, coal and natural gas reserves and is one of the few countries having a membership of Organization for Economic Cooperation and Development (OECD) (DRET, 2012). Australia is one of the main net importers of refined petroleum products and crude oil (AED, 2011). The dependence on oil import will increase as domestic consumption of oil would increase. As per the latest reports, Australia has 3.3 billion barrels of oil reserves (AED, 2011). The Australian crude oil is usually light, low in sulphur, wax and is of higher value than the heavy crude oil. Majority of the reserves are located near Victoria and Western, Northern coast of Australia. The management of Australian oil and production is equally divided among the Federal government and the states. The Australian government manages the application for onshore oil exploration and production projects. The department of resources, tourism is a regulatory body which looks after the Australian oil sector. The valuation of the total output of petroleum and minerals was AUD 92.5 billion; out of which petroleum accounted for AUD 22.8 billion (GOWA, 2010). Around 100 Australian petroleum companies are listed on the Australian stock exchange (ASX, 2013). The average amount of capital raised by the leading oil companies is more than AUD 24.1 million. Corporate Governance Corporate governance lays emphasis on the relationship of the management of the company with the shareholders, stakeholders, debtors, creditors, suppliers, community organizations and the board of directors (Paton, Juleff and Schachler, 2007). Corporate governance framework depends upon the institutional, legal and regulatory environment. There are multitude of factors that affect the corporate governance and decision making of the company. Corporate governance is affected largely by the relationship among the above mentioned participants of the company. The owners of the company including institutional and equity investors have the right on corporate governance. However, the individual shareholders do not usually seek corporate governance rights but are more concerned about getting fair treatment from the management of the company (OECD, 2004a). Creditors play an important role in the governance systems and serve as an external monitor in the corporate performance (OECD, 2004b). The role of each and every participant is very crucial for the corporate performance of the company. The extent to which a company adheres to the basic principles of corporate governance is crucial for investment decisions. Good Corporate Governance & Corporate Performance There is not a single model framework for a good corporate governance system but there are certain elements that fall under the category of good corporate governance system. Good corporate governance has been associated with a successful company. The economic situation of the country may depend largely on the efficiency of the companies however, the effective decision making ability of the board of the company also is a major contributing factor to the success of the company. The essence of a good corporate governance system depends upon the ability of the board of directors exercising their freedom within a framework of effective accountability. Corporate governance increases the corporate performance of the company the management of the companies are focused on introducing sophisticated methodologies which help in improving the social and environmental performance of the company. Good corporate governance is an important element which enhances the investors’ confidence and the efficiency of the markets (Heinrich, 2005). Good corporate governances provide a certain structure through which the company goals and objectives can be met (Paton, Juleff and Schachler, 2007). However, shareholders should regularly monitor the performance of the company because they can provide significant input which can accelerate the company’s progress. The presence of a good corporate governance system within a company helps in providing a certain degree of confidence that helps in smooth functioning of the entire economy. The corporate governance system focuses on the relationship between the shareholders and the management. This is because conflicts related to governance may arise out of the power vested upon the controlling majority shareholders over minority shareholders. To increase the corporate efficiency a corporate governance framework should be maintained which promotes transparent and efficient accounting. A good corporate governance system promotes fairness, transparency and disclosure of accounting standards. It helps in promoting confidentiality of information and prevents the improper use of the information. Thus, we can see that the a good corporate governance system helps in adding structural value to the company, laying solid foundation for creating an independent decision making, promoting responsible and ethical decision making, timely and balanced environmental and accounting disclosure, safe guarding the interest of financial accounting, reporting and promoting fair and equitable remuneration (OSL, 2013). Current Practice of Corporate Governance in Oil Companies of Australia The Australian Stock Exchange (ASX) has established a Corporate Governance Council (CGC) in the year 2002 with the objective to develop agreed corporate governance methods and develop recommendations for the Australian company. The main objective of establishing these principles is to increase the corporate performance of the company and the accountability in the shareholders and stakeholders interests. The principles of the corporate governance may not be mandatory to follow but justification is required for not adhering to these corporate governance principles. Even though corporate governance has surfaced as a potential solution for agency problems but most of the Australian companies focus on protecting the interest of the stakeholders. It promotes transparency in accounting and fairness and accountability in their business activities. The Australian oil companies are required to publish a review report which provides information related to environmental reporting, rights of shareholders and methods used for accounting (Rao, Tilt and Lester, 2012). Further, the Australian oil companies are required to remove the material information related to the stakeholders of the company (Rao, Tilt and Lester, 2012). As per the principles of ASX the Australian companies the oil companies are required to maintain a structured and well numbered board which can add value to the decision making by exercising independent judgment. Role and Size of the Board Composition in Corporate Governance Apart from the shareholders interests, the composition of the board and the duration of the board members also play a significant role for a good corporate governance system. A board of suitable size helps in efficient and independent decision making (NAB, 2011). A well composed board size is directly related to the proper controlling and monitoring of managers and executives. However, some theorists agree that a board of large size helps in effective control and monitoring of managers (Zhang, 2012). As per these theorists the size of the board increases the sources of funds (Kim, 2011). The board also helps in risk management (NAB, 2010). They are pivotal in guiding the management of the company with a view of long term return for shareholder’s and having regard for stakeholders (Kim, 2011). The agency problem faced by the company can be reduced by enhancing the role and importance of the board. The board has the power to control and monitor decision making of the managers (NAB, 2011).The board has sufficient authority to evaluate the performance of the management, employees of the company and decide the reward for the performance. Thus, the board has the power to control the managerial and employee activities including decision making. The constitution of most of the Australian oil companies suggests that the number of board of directors should not be less than three members (EOG, 2013). There is no particular requirement for any shareholder qualifications for these companies. A review meeting is conducted periodically to monitor the size, nature and scope of the board. The board of directors is required to monitor and supervise the activities of the managers and executives periodically. The criteria which determine the application for a suitable post for the board shall include the background, qualification and experience etc. The directors are usually appointed by the shareholder’s at an election conducted in the annual general meeting. The managers or the Chief Executive Officer (CEO) usually are responsible for maintaining the risk management and internal control system of the company (CGR, 2013). The directors of the company usually monitor the corporate governance periodically through the report presented to them by the managers. However, they do not check the authenticity of the reports and are usually dependent on the internal auditors for checking the genuineness of the report. Corporate Governance & Sustainability Accounting The depletion of social and natural resources can be a consequent of irrational economic decisions taken by the management of the company. The management of the company is focused on developing new economic models that have social and economic effects in the society. Sustainability accounting is a tool which helps in understanding how the traditional forms of accounting can be extended to take account of the sustainability impacts at the organizational level. Institutional shareholders are increasingly becoming the majority shareholders in listed companies across the world hence their interest in the link between corporate governance and socio-environmental performance has also heightened. Most of the Australian companies are under public pressure to provide information related to social, cultural and environmental performance (Rao, Tilt and Lester, 2012). The environmental reporting helps in providing information related to the impact of company activities on the environment and community. Environmental reporting has helped most of the Australian companies to gain stakeholder support and identifying risks involved in the operational activities of the company. It is not mandatory for the Australian oil companies to disclose information related to sustainability accounting. It has been observed that strong corporate governance mechanisms have increased the levels of disclosure of accounting information (Rao, Tilt and Lester, 2012). There was an increasing trend for Australian oil companies to provide information related to social and environmental accounting. Some of the oil companies of Australia like Zeta Petroleum Plc and Woodside Petroleum Limited use the Triple Bottom Line (TBL) accounting method to disclose information (UNSW, 2013) but majority of the oil companies use annual report as a medium to disclose environmental information (Rao, Tilt and Lester, 2012). TBL also includes information related to the responsibilities undertaken by the company for societal and community benefits. As per a study conducted by Ernst & Young, 147 senior managers out of 100 Australian companies were interviewed which also included managers of leading Australian oil companies (Rao, Tilt and Lester, 2012). Majority of the managers believed that adhering to corporate social responsibility standards and reporting environmental information increases the profitability of the companies. The managers of the oil companies want to disclose environmental information due to various reasons which includes the desire to adhere with the legal requirements, responsibility and accountability beliefs, compliance with the borrowing requirements, community expectations, desire to fulfill community expectations, and the opportunity to win rewards for accurate environmental reporting (Rao, Tilt and Lester, 2012). Although the outcome of environmental reporting is not quantifiable it is a strong belief among the managers of the company that accurate and quality sustainability accounting improves the financial and non financial returns of the company. Some managers of Australian even believe that the entire profitability of the company depends upon accurate and high quality sustainability accounting. As per a recent report it was observed that low level of environmental and sustainability accounting exists among Australian companies (Rao, Tilt and Lester, 2012).It was recommended in the report that the need and significance of environmental reporting needs to be widely understood by the managers of the companies. It was recommended in the report that accessible and effective guidelines need to be developed (Rao, Tilt and Lester, 2012). This would help the companies to develop a broader accountability context that would be reflected in the reporting practices of the public and private Australian companies. Apart from practicing sustainability accounting it is important for the companies to disclose the environmental information to the government, stakeholder and customers. The managers and the board of directors need to be motivated to disclose instruments and methods used for environmental reporting (Taylor et. al., 2005). The agency theory focuses on the fact that disclosure by the companies is motivated by factors like welfare or economic considerations (Clarke, 2007). The agency theory provides a conceptual framework in examining the annual reports of the Australian companies. The theory focuses on the fact that each participant of the company focuses on maximizing their own utility. The essence of the agency theory is that there is separation of ownership and control (Clarke, 2007). There are two participants; ‘agents’ and ‘principals’. The theory proposes that the principals (investors) require the agents (managers) to utilize their funds effectively and generate a substantial amount of return on their funds with additional profits (Clarke, 2007). The principal and agents may engage in certain business activities that will enhance their personal welfare or utility by taking advantage of the fact that most of the decision making and use of high quality knowledge is not observed by the principals. Since the basis of the agency theory is utility maximization by the principals and agent, problem would arise between the shareholders and the management of the company. One of the simplest ways to prevent problems occurring between principals and agents is to prohibit the managers and shareholders to focus single mindedly on utility maximization for their own personal welfare. The active participation of both the shareholders and the managers is required for maintaining an ecological sustainability. The strategies supporting the environment welfare and ecological sustainability are observed as opportunities by the stakeholders which can help the company to gain competitive advantage over its competitors (Dunphy, Benn and Griffiths, 2003). For example simple processes like product redesign of an existing product by recycling the materials used in existing products will help in reduction of costs and increase the savings. New process and products are developed by the management of the company as a substitute for the existing environment damaging products that help in catering to the societal needs (Dunphy, Benn and Griffiths, 2003). Implementing and adhering to the environmental policies will portray the company as a responsible organization which tries to help the society by manufacturing products and delivering services which are ecologically safe (Dunphy, Benn and Griffiths, 2003). Summary & Conclusion The abundance of oil reserves in Australia has paved the path for the success of the Australian oil companies. As mentioned before that most of the Australian oil companies are listed on the ASX and are a significant contributor the Australian economy. The study examined how a good corporate governance system affects and increases the corporate performance of the company. A good corporate governance framework is dependent on the legal, institutional and regulatory environment. A good corporate governance system also depends upon the smooth relationship between the stakeholders, shareholders and the management of the company. Most of the Australian companies are aware of the societal and environmental responsibilities vested upon them. They also regularly monitor the board composition for effective internal control. New economic models which can improve the current process and the ecological sustainability have been developed by the companies. However, conflict may arise between shareholders and the management of the company regarding process implementation which needs to be sorted out with the help of Agency or Stakeholder theory. The theory will act a guide to resolve conflict between shareholders and managers and help in increasing the corporate performance. References AED, 2011. Australia [pdf] Available at: < http://www.eia.gov/cabs/Australia/pdf.pdf > [Accessed 18 May 2013]. ASX, 2013. 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