The  Demise  of  HIH    Corporate  Social  Responsibility  and  the  Law  

January  2012

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BUSM4139 Assignment 1

1.20.12

Assignment 1 Group Assessment

Corporate Social Responsibility and the Law

MBA (Executive)

Lecturer/Teacher’s Name Tutor (or Marker’s) Name (if applicable) Rhett Martin

Rhett Martin

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  HIH Paper 1

 

BUSM4139: Corporate Social Responsibility & The Law: HIH Paper

This paper investigates the collapse of HIH Limited [HIH] and whether the company had

any definable corporate social responsibility policy and whether their policy, or the lack of a

meaningful policy, had any input into their demise. On 15 March 2001 the major companies

in the HIH insurance group were placed in provisional liquidation, and the magnitude of the

HIH group’s obligations emerged. Formal winding-up orders were made on 27 August 2001

(Owen 2003). The Commonwealth Government established ‘The HIH Royal Commission’

[Commission] headed by Justice Neville Owen with broad powers to investigate and make

recommendations. The Commission was appointed to review corporate regulation, audit and

corporate governance of HIH.

This paper argues that HIH was engaged in ineffective corporate governance, lacked moral

gumption and a virtuous culture, and an ambiguous corporate social responsibility [CSR]

policy led to the demise of HIH which ruthlessly impacted the Australian community. Matten

and Moon (2008) consider that CSR is the … idea that it reflects the social imperatives and

the social consequences of business success.” Business responsibility for wider societal good

is reflected by clearly articulated and communicated policies and practices of corporations,

yet the responsibility lies at the discretion of the corporation (Matten & Moon 2008).

Friedman differentiates CSR from core profit-making responsibility of a business (cited in

Matten & Moon 2008). However, if a corporation wishes to be perceived as a ‘good

corporate citizen’ or having a ‘moral personality’, CSR policy operates under the guise of

effective corporate governance and corporate culture.

The Corporations Act 2001 defines a corporation as a legal person, and as Sheppard (1994)

suggests … an organization is the interactive human embodiment of that legal person.”

Sheppard (1994) argues that by looking at … corporations as organizations we can see they

also possess cultures, which are independent of each individual in the organization.” Sheppard

(1994) contends that corporations may have a … moral life by reason of the fact that within

them is a living corporate culture that can give the organization a moral personality.” CSR

policy is observed with the morality of a corporation, which is based on the ethical standards

within the boardroom, which are transferred to the corporation, and thus the corporation can

be judged morally.

Culture bonds an organization, unites people, and helps accomplish desired ends (Bolman

& Deal 2008). CSR policy operates under the guise of corporate governance where the board

of directors is responsible for the make-up and enforcement of corporate governance and

where by association, corporate governance and corporate culture are inextricably linked with

  HIH Paper 2

 

BUSM4139: Corporate Social Responsibility & The Law: HIH Paper

CSR. Sheppard (1994) explains it is those … at the pinnacle of corporate governance, the

board of directors, who are the natural people within the corporation … to give emotional

impetus to moral prerogatives the corporation.” A moral act is undertaken by, an ethical

person, a courageous person, or a person with ethical virtue (Grassl 2010).

The Organization for Economic Co-operation and Development (OECD 2004) sees

corporate governance as only one part of the environment in which an organization operates.

According to OECD (2004) regulatory and market constraints, in addition to factors such as

business ethics, corporate environmental awareness and community interests, can exert

pressure on the performance of an organization in which a company operates.

Following the collapse of HIH, the Commission looked at HIH’s corporate governance

policies and their role in business operations and, more importantly, its ultimate demise. In

doing so the Commission faced a dilemma in its report, and as Justice Owen envisaged …

could it conclude that systems or practices did not comply with desirable corporate

governance standards when the existence or content of those standards might be thought to

have been unclear at the time” (Mills & Marjoribanks 2011)? Justice Owen addressed this

dilemma by asking … What would those who have an interest in the company's success

sensibly expect of those responsible for putting the relevant corporate governance practice

into effect?”

The Commission's view was that if the way in which the practice was or was not carried

out fell materially short of that sensible expectation, and then it would be undesirable (Owen

2003). This approach led the Commission into making many findings of 'undesirable

corporate governance' in circumstances, but stopped short of finding a breach of the law. It

also found that pressure by senior management had unduly influenced the Board, and

therefore … failed to subject management proposals to sufficient scrutiny” (Mills &

Marjoribanks 2011).

The Commission viewed corporate governance policy as a living organ in a changing

environment requiring constant review, where corporate culture evolved and therefore

promoted corporate governance policy as more than just … the framework of rules,

relationships, systems, and processes within and by which authority is exercised and

controlled” (Owen 2003). Justice Owen (2003) advocated corporate governance as … a

practice that initiates clear strategic direction for the corporation at board level, which leads to

the right questions being asked and procedures put in place to ensure that the answers reflect

  HIH Paper 3

 

BUSM4139: Corporate Social Responsibility & The Law: HIH Paper

the creation of long-term and sustainable benefit for the corporation, its shareholders,

employees, and its external stakeholders”, (Owen 2003) namely its customers, creditors

including suppliers and service providers, the community and the environment.

As the Commission pointed out, the HIH Board of Directors and Senior Management were

remise in their duties whereby no system was in place which would periodically assess the

practical effectiveness of its corporate governance model, rather, HIH delved into blatant

mismanagement (Owen 2003).

These ‘duties’ referred to by the Commission are specified under the Corporations Act

2001 s181 whereby the Australian Securities and Investments Commission (ASIC 2010b) is

the corporate regulator, are imposed on company directors and are stated as:

1. The duty to exercise their powers and duties with the care and diligence that a

reasonable person would have which includes taking steps to ensure they are properly

informed about the financial position of the company and ensuring the company

doesn’t trade if it is insolvent;

2. The duty to exercise their powers and duties in good faith in the best interests of the

company and for a proper purpose;

3. The duty not to improperly use their position to gain an advantage for themselves or

someone else, or to cause detriment to the company; and

4. The duty not to improperly use information obtained through their position to gain an

advantage for themselves or someone else, or to cause detriment to the company.

HIH senior management failed to report to the Board important facts regarding the

operation and direction of the company, which perpetuated an undesirable corporate culture.

From the company’s creation until his retirement in 2000, CEO Ray Williams held

unquestioned influence and authority … even as his business judgment faltered,” … he

remained unchallenged” (Mills & Marjoribanks 2011). A failure of senior management to

question his decisions, influence, or the direction of the company meant a total lack of

accountability to the Board of Directors.

Therefore senior management’s performance was not managed nor held accountable by the

Board. This became evident six years prior to the collapse in an audit report describing HIH

as a … company which has not yet made a complete transition from an entrepreneurially run

company influenced strongly by senior management, and from which senior management

  HIH Paper 4

 

BUSM4139: Corporate Social Responsibility & The Law: HIH Paper

benefits significantly, to that of an ASX listed company run primarily in the interests of

shareholders” (Owen 2003).

It was also identified that the Board had an inability to voice any clear strategic direction,

purpose or governance and that … the chairman of the HIH Board argued that HIH’s strategy

was international growth and diversification” (Owen 2003). Justice Owen suggested that

more than a simple statement of intention was required to create a corporate strategy plan.

Justice Owen’s critique required that directors should probe senior management rather than

being controlled by them; furthermore directors abdicated responsibility important matters

such as disclosing conflict of interest. Owen (2003) referred to a … flawed understanding of

the concept of conflict of interest” citing an example where two non-executive directors were

paid significant consultancy arrangements that were not disclosed.

It was further noted in the Commission’s findings that where strategies had been

developed, they had not evolved over time nor been questioned, updated or … subjected to

rigorous analysis to gauge its continuing suitability in a changing environment” (Owen 2003).

Justice Owen found that whilst the CEO had a strategy for the company’s direction, it was

not documented. Therefore Board members had very little knowledge of the strategy and

were unable to undertake any critical analysis of those strategies. Justice Owen believed that

… all those who participate in the direction and management of public companies” … need to

identify and examine what they regard as the basic moral underpinning of their system of

values. They must then apply those tenets in the decision-making processes.”

The Commission found the collapse of HIH was not as a result of fraud or other illegal

activities. Rather it was the consequence of failing to have corporate governance policies

resulting in … attempts to paper over the cracks caused by over-priced acquisitions and too

much corporate extravagance based on a misconception that the 'money' was there in the

business” (Brendon 2003).

The basis for HIH’s huge losses was that inadequate provision was made for insurance

claims, and past claims were not properly priced. HIH mismanaged its core business activity

(Brendon 2003) and liabilities were not understood, analyzed, properly valued and disclosed,

nor … risks were properly identified and managed” (Owen 2003). Risk management should

go beyond statements, guidelines and policies (InConsult 2011). In chorus, the Commission

Report states that the fundamental reasons for HIH’s failure was poor management and greed

  HIH Paper 5

 

BUSM4139: Corporate Social Responsibility & The Law: HIH Paper

characterized by lack of attention to detail and skills, lack of accountability for performance,

and lack of integrity in the company's internal processes and systems.

Justice Owen stated … HIH had a corporate governance model.” ... There were guidelines

for corporate governance, underwriting practices and investment guidelines. They just weren't

adhered to very often.” Owen (2003) further commented on the essence of good corporate

governance … the governance of a public company should be about stewardship. Those in

control have a duty to act in the best interests of the company. They must use the company's

resources productively. They must understand that those resources are not personal property.”

Poor leadership and inept management marked the last years of HIH and an attitude of …

apparent indifference to, or deliberate disregard of the company's underlying problems

pervades the affairs of the group” (Owen 2003).

The impact of the collapse of HIH on the legislative and regulatory framework has been

significant. The establishment of the Australian Accounting Standards Board (AASB) under

ASICA 2001 is a good example. The AASB requires that the investments of a general

insurance company, which would normally be treated as non-current assets, be brought to

account as revenue items at market value. The AASB standards deal with the public

disclosure of information in the interests of the promotion of good corporate governance. The

ASIC Act also provided a revised framework governing takeovers of companies (Maltas

2005).

The General Insurance Reform Act 2001 (date of assent: 19 September 2001) was

hurriedly legislated and the Corporate Law Economic Reform Program (CLERP) Act 2004

(Alcoc & Bicego 2003) galvanized the financial reporting framework of the Corporations Act

2001 by expanding the functions of the Financial Reporting Council to include overseeing

auditor independence. Auditors must now report to ASIC if they have been influenced,

coerced, manipulated or misled, there must be a rotation of the auditor, and financial

restrictions and mandatory disclosures of any interests are now in place. CLERP also protects

any employee who reports a suspected breach of law to ASIC and establishes improved

shareholder participation (Maltas 2005). The Australian Prudential Regulation Authority

(APRA) now has a more aggressive enforcement culture over banks, credit unions, building

societies, general insurance and reinsurance companies, life insurance, friendly societies and

most members of the superannuation industry.

  HIH Paper 6

 

BUSM4139: Corporate Social Responsibility & The Law: HIH Paper

In March 2003 the ASX Corporate Governance Council published its ‘Principles of Good

Corporate Governance and Best Practice Recommendations’. For the top ASX 500

companies, Listing Rule 4.10 requires a statement in a company’s annual report disclosing the

extent to which best practice recommendations have been followed during the reporting

period and Listing Rule 12.7 requires an entity to have an audit committee at the beginning of

its financial year (Maltas 2005).

Justice Owen found that there was … little, if any, evidence that the board periodically

assessed the company’s corporate governance practices to ensure that they were, and

continued to be, suited to the changing environment in which the company operated” (Owen

2003). It is possible this may have been appropriate in the early stages of the company’s

growth however, as the company expanded a more robust corporate governance model with

stronger checks and balances was required. The danger of this practice is that, among other

things, it can lead to the ‘tick the box’ approach … There is little point in having a corporate

governance model if the directors fail to examine periodically its practical effectiveness”

(Owen 2003).

The Royal Commission's findings regarding corporate governance are likely to prove

compelling importance to companies and their directors and executives. The Commission

emphasized that it would be a mistake to dismiss HIH as simply a corporate aberration. One

consequence of the Commission's report is that it reinforces ‘investors' perception that

'undesirable corporate governance' equals 'investment risk' (Mills & Marjoribanks 2011). The

Royal Commission’s recommendations are recognition of the importance of CSR. To the

present day, Commonwealth Legislation and ASX Listing Rules have strengthened corporate

governance both in substance and form under which the guise of CSR operates. However, the

Commission fell short of recommending prescriptive forms of CSR, rather relying on best

practice recommendations, as guide to good corporate governance.

Nohria et al. (2003) found that without exception, companies that outperformed their

industry peers excelled at strategy, execution, culture, and structure and the mastery of any

two out of four secondary management practices - talent, innovation, leadership, and mergers

and partnerships. The Royal Commission clearly points out that HIH was lacking in most, if

not all of these practices. An authoritative CEO and senior management, whereby self-interest

and conflicting interest ran rampant, dominated HIH and its ineffectual Board. Causal for the

demise of HIH was mismanagement and borne from this, ethical misconduct that was ratified

  HIH Paper 7

 

BUSM4139: Corporate Social Responsibility & The Law: HIH Paper

by the severe penalties and incarceration of officers of HIH following the collapse (ASIC

2011a).

Nohria et al. (2003) contend that for a corporation to succeed, it is imperative to build the

right culture, a culture promoting high-level performance and ethical behavior by design and

support. … Culture affects behavior and behavior will ultimately affect performance”

(InConsult 2011). CSR policy at HIH was as worthless as the paper it was written on and

reflected the unethical standards of executive directors within the boardroom. CSR policy

was neither designed in the spirit of good corporate governance, nor was it supported as such,

and its ineffectiveness permeated the organization’s culture as a whole, manifested through

inefficiencies in strategy, structure, execution and accountability.

Senior mismanagement and an ineffectual Board upheld an apathetic corporate culture,

which ultimately led to the collapse of HIH. If CSR involves taking actions that reduce the

extent of externalized costs, then HIH failed. We concur with the Commission’s

recommendations, and that the penalties and incarceration imposed was appropriate. We

believe nothing would have avoided this catastrophe and conclude with this statement from

Justice Owen:

… A cause for serious concern arises from the group’s corporate culture. By

‘corporate culture’ I mean the charisma or personality … that guides the decision-

making process at all levels of an organization. In the case of HIH, the culture …

resulted in decision-making that fell well short of the required standards” …

There is probably no better example of what I mean than failure of risk

identification and risk management within the (HIH) group” … if a director could

not articulate the strategy of the company he or she should not be on the board”

… I consider that this is an area in which the governance of HIH was deficient”

(Owen 2003).

  HIH Paper 8

 

BUSM4139: Corporate Social Responsibility & The Law: HIH Paper

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