ACC8801 Corporate Governance - James Hardie: Restructuring, removing and reviewing the social contract - Case Study Assessment Answers

December 27, 2017
Author : Julia Miles

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Question:

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(Source: Lisa Barnes, University of Newcastle)

On Thursday 15 February 2007, the Australian Securities and Investments Commission (ASIC) commenced civil penalty proceedings relating to James Hardie. Both current and former directors and executives were investigated on matters of possible criminal issues, especially in relation to the Medical Research and Compensation Foundation (MRCF). On Friday 16 February, the then Chair of James Hardie, Meredith Hellicar, and several directors resigned their positions.

History of James Hardie

James Hardie was founded in the late nineteenth century, and became an iconic company, especially in Australia in the twentieth century, for mining, importing and manufacturing asbestos-based products. Commonly referred to as ‘fibro’, fibro-cement played a key role in the growth of expanding cities as it was a cheaper alternative to brick, but supposedly safe and durable. However, fibro sold by James Hardie was made of asbestos, which even back in the 1930s was known to be ‘causing deadly lung disease’ (Ministry of Health Report 1938, cited in Kjellstrom 2004). Indeed, for James Hardie, the first workers’ compensation case occurred in 1939 (Hills, 2005); but it was not until the mid-1960s that James Hardie was given information on asbestos-related diseases among its employees in which they were told that liabilities could be as high as A$1.5 million, which set against shareholders’ funds of $30 million seemed significant (Haigh, 2006). Despite these health warnings and potential impact of liabilities from compensation, James Hardie continued to manufacture the product until 1987.

Asbestos and its health impacts

Asbestos has been found to cause many medical conditions including lung disease and, in particular, mesothelioma, lung cancer and asbestosis. Mostly, however, it takes between 15 to 30 years before symptoms present themselves after people are exposed to asbestos dust (Smartt, 2004). Asbestos was mainly used in domestic and industrial buildings, brake linings, fibro sheeting, pipes and insulation. The health effects of its use are not limited to employees, however; they also include neighbours of mines and manufacturing plants, and demolition contractors. These effects are recognized internationally (Jackson, 2004).

The fact that the medical implications of exposure to asbestos were known as early as the late 1930s, and that James Hardie knew about it via their own employees’ workers compensation claims in the 60s, and the fact that it took another 20 years until the manufacture of asbestos products ceased, showed that manufacturers ‘knew at an early stage about the dangers of asbestos and made a commercial decision to keep producing it, thereby jeopardizing lives’ (Spender, 2003: 235).

The Medical Research Compensation Foundation (MRCF) and restructure

In early 2001, the board of James Hardie made several announcements, one of which was the establishment of the MRCF. This fund was to ‘compensate sufferers of asbestos related diseases and claims against two former James Hardie subsidiaries and fund medical research aimed at finding cures for these diseases’ (JHIL, 2001). The fund was established to effectively resolve any liability in relation to asbestos, which would then allow the board to concentrate on growing the company ‘for the benefit of all shareholders’ (JHIL, 2001). The foundation was supposed to have sufficient funds (A$293 million) to cover all legitimate past and future claims; the funding was by way of ownership of subsidiaries Amaca and Amaba which had net assets of $293 million, and James Hardie also stated that any leftover funds would be used to support further research on lung disease (JHIL, 2001).

Later in 2001, a new holding company was set up, called James Hardie Industries NV (JHI NV), and the group moved to the Netherlands where Australia has no civil law enforcement agreements. The decision to restructure and relocate was granted by the Supreme Court of New South Wales, based on the assurance by the company that any future claims would be met and backed up by partially paid shares in JHIL held by JHI NV. However, these shares were subsequently cancelled when JHIL (later known as ABN 60 Pty Ltd) vested in a new company, the ABN 60 Foundation, which was still supposedly able to meet any obligations for the MRCF. The complex structures and restructure of James Hardie made it harder to guarantee the liability of claims would be met.

The MRCF, however, had been substantially underfunded. A report by KPMG re-estimated the liabilities to be A$693 million, rising to $1044 million in 2000 (Haigh, 2006). The shortfall caused much activity by lobby groups such as trade unions and local councils, resulting in the 2004 Jackson Inquiry. The findings indicated that James Hardie had acted within the law; however, it also discovered that James Hardie did not use reliable actuarial estimates, the company had made misleading public statements and appeared to be deliberately avoiding its moral obligations to society (Tozer and Hamilton 2006).

The future for James Hardie and its victims

James Hardie agreed that the MRCF was underfunded. In 2005, James Hardie signed a Final Funding Agreement (FFA) with the NSW state government, where claims were re-estimated to be A$4.5 billion over 40 years (Slater and Gordon, 2005). Negotiations then began with the Australian Taxation Office to set up a charitable organisation to fund the rest of the expected liabilities related to asbestos exposure. The arrangement established the Asbestos Injuries Compensation Fund Limited (AICFL), which would receive income annually from James Hardie according to a formula based on a percentage of ‘free cash flow’ and a ‘cap percentage’.

The arrangement was agreed to by shareholders in early February 2007 as it ‘is consistent with current investor and Australian Community expectations’ (JHI NV, 2007). Little did James Hardie know that one week later, ASIC would commence proceedings into the actions of former and current directors and executives, alleging breaches of the Corporations Act 2001. The five allegations were:

  1. Misleading communications in 2001 regarding the establishment of the MRCF.
  2. Failure to disclose in relation to Deed of Covenants between MRFC and JHIL.
  3. Restructure of the group: The scheme of arrangement, specifically the information memorandum, was misleading in terms of its lack of disclosure in relation to the meeting of future obligations.
  4. Misleading executive presentations: in 2002, presentations made to institutional investors contained information on the supposed adequacy of the MRCF in meeting its obligations in relation to asbestos liabilities.
  5. Failure of care and diligence: in relation to the cancellation of shares in JHIL, and the failure of information disclosed to ASX and ASIC in relation to the cancellation.

Currently, according to ASIC (2007) ‘the investigation, which continues, has involved a complex corporate structure, it has spanned three countries (the US, the UK and Australia) and it has involved about 348 documents, 72 examinations and the issuing of 284 notices to obtain evidence’. The investigating continues as does the increase in the number of victims being identified and claims sought. It appears that the profit motive was prioritised by James Hardie at the expense of the social contract.

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Solution:

Identify the various stakeholders of James Hardie and list next to each stakeholder group what corporate governance responsibilities are owed by its board of directors and senior management to each stakeholder group. It is possible that some corporate governance responsibilities are owed to more than one stakeholder group. Where this occurs (in your opinion), you should combine the relevant stakeholder groups into the identification of the specific corporate governance responsibility(ies).

Stakeholder Group of James Hardie Corporate governance responsibilities owed
Government James Hardie must comply with the government rules and regulation, and also, with the Corporations Act (Brown, Beekes and Verhoeven, 2011). James Hardie must consider the best and appropriate ways of collaborating with the state and local governments to ensure that it implements activities in line with partnership and support.
Regulatory agencies, such as, Australia Security Investment Commission (ASIC). James Hardie has a responsibility of complying with the regulatory rules and regulations, particularly, in regards to financial reporting, corporate governance, and environmental regulations (Bryans and Le, 2016). James Hardie must comply with regulations regarding consumer safety and product quality, to guarantee that it does not cause harm to the wider society. James Hardie must comply with Australia Security Investment Commission (ASIC) corporate governance and responsibility regulation regarding financial reporting, disclosures, and audit of the financial reports. Comply with the regulations regarding CSR principles and ethical practice, which ensures the protection of consumers from harm (Ferguson et al., 2011).
Consumers James Hardies owes consumers the responsibility of placing them first, provide them with a constant supply of high quality products, which do not cause harm, whether in the short term or long term (Kathy Rao, Tilt and Lester, 2012). James Hardie has the responsibility of providing products that constantly meet the safety standards of use, and does not result in harm or pain. The company is expected to act in due care and diligence to ensure safety of the consumers (Leong et al., 2015).
Community James Hardie must collaborate with the surrounding communities to ensure that the activities of the company do not cause any harm, or hamper the environment. James Hardie should play its role as a corporate citizen, and ensure that its products and services do not harm the surrounding communities and environment (Pham, Suchard and Zein, 2011). Also, James Hardies must strive to solve any underlying problem that faces the community. James Hardie owed the society some compensation for the harm in the society (Moerman and van der Laan, 2015).
Employees James Hardie has the responsibility of providing a conducive and safe environment for employees to work. An environment that is free from harm. James Hardie has the responsibility of creating a culture where every employee is respected, and are accorded with a satisfactory and safe working environment (Pham, Suchard and Zein, 2011).
Investors James Hardie owes investors and shareholders to raise the organizations corporate value through stable and consistent long term growth, and enhance the management transparency through the appropriate and timely disclosure of financial and business reports, dialogues, and information. In addition to this, Jamie Hardie must disseminate corporate strategy and information with a significant emphasis on fairness, timeliness, sustainability, and accuracy (Suchard, Pham and Zein, 2012). James Hardie should carry out investor relations (IR) activities to grasp interactive and smooth communication through annual or bi-annual general meetings (Kathy Rao, Tilt and Lester, 2012).
Employee families James Hardie must take an active role to support their employees and their families make healthy decisions, and enhance the lives of working parents. Also, James Hardie must offer programs to support the employees and their families’ wellbeing. James Hardie must partner with employees to ensure an adequate work-life balance to guarantee that employees spend more time with their families. It shows that the company is invested in its people for the long-term (Holland and Pyman, 2011).
Partners James Hardie has the responsibility to carry out fair and open transactions with its business partners, in a manner that does expose the partners to civil suits and liabilities (Suchard, Pham and Zein, 2012). James Hardie has the responsibility of sharing its objectives, goals, and responsibilities with its partners, and highlight how they are partnering to attain their objectives (Ferguson et al., 2011).
Media Partner with media organizations to communicate CSR activities, and develop approaches that enable the company disseminate information. Foster a partnership that is based on trust, honesty and integrity.
Asx James Hardie must comply with the best practice recommendations and principles of Good Corporate Governance offered by the ASX Corporate Governance Council (Bryans and Le, 2016). Listed companies, such as, James Hardie should comply with the recommendations and principles of ASX, and thus, under its rules, James Hardie should establish the level and extent to which it has not applied the ASX Corporate Governance Council Recommendations in its financial and compliance reports.

Q2 Outline the key corporate governance issues in the James Hardie case, by referring to the ASX corporate governance principles and recommendations (2007) that should have been applicable to James Hardie if the company had not re-structured their organisation offshore.

ASX Principle Key corporate governance issue corresponding to that ASX Principle

  1. Create a solid foundation for the oversight and management.

A company listed at the ASX must setup ad disclose the respective responsibilities and roles of its management and board, and how their annual performance is evaluated and monitored (Kathy Rao, Tilt and Lester, 2012).

  1. Structure the board of governors to raise and add value.

Companies listed at the Australian Securities Exchange (ASX) must have a board of a suitable composition, size, commitment, and skills to facilitate the adequate discharge of its duties and responsibilities effectively (Moerman and van der Laan, 2015).

  1. Act or behave ethically and responsibly (Kathy Rao, Tilt and Lester, 2012).

A company listed at the ASX must act or behave ethically and responsibly.

  1. Safeguard corporate reporting and integrity.

A company listed at the ASX must have a rigorous and formal procedure, which independently safeguards and verifies the integrity of corporate and managerial reporting.

  1. Make balanced and timely disclosures.

A company should make balanced and timely disclosures in all matters and issues concerning it, such that, a material individual would expect to get a material influence on value or price of securities (Moerman and van der Laan, 2015).

  1. Respect the responsibilities and rights of security holders.

A company listed at the ASX must respect the rights and responsibilities of the security holders by offering suitable information and resources, which expect them to exercise their rights and responsibilities accordingly (Suchard, Pham and Zein, 2012).

  1. Manage and recognise risk.

A company listed at the ASX must setup a sound risk management policies and framework to facilitate the periodic review of the effectiveness of that framework.

  1. Remunerate responsibly and fairly.

A listed company should pay its directors sufficient remuneration to attract and keep high quality directors, and also, design its executive remuneration to attract, motivate, and keep high quality senior executives (Porter and Miles, 2013).

Q3 Give examples of actions that the company could have taken in order to comply with the ASX guidelines that you have identified as being applicable above in your answer for Q2, and provide your reasoning for selecting these actions (15 marks)

ASX Principle Actions company should have taken to comply with the ASX guideline

  1. Create a solid foundation for the oversight and management.

James Hardie should have clearly articulated the division of roles and responsibilities between the management and board to reduce collusion and misunderstandings about their respective responsibilities (Tricker, 2015). The rolw of the board at James Hardie is to offer leadership and strategic objectives for the firm. The management of the firm should usually be responsible for executing the strategic objectives, and functioning within the regulatory requirements and risk appetite of the firm (Pham, Suchard and Zein, 2011). Also, James Hardie should have a written agreement with every director, and senior managerial executives establishing the terms of the work and appointment.

  1. Structure the board of governors to raise and add value.

James Hardie’s board should have a sufficient number of independent non-executive directors who can hold the management accountable and challenge them to represent the best interests of the firm, and its security holders (Moerman and van der Laan, 2015). This would enable James Hardie serve the interest of the stakeholders as a whole; rather than, those of interest groups.

  1. Act or behave ethically and responsibly.

James Hardie should comply with regulations and legal obligations to be ethical (Moerman and van der Laan, 2015). However, acting in an ethical and responsible manner goes beyond a mere compliance with regulatory and legal obligations to acting with integrity, honesty, and in a way that is consistent with reasonable expectations of the wider society. James Hardie should act as a good corporate citizen by respecting human rights of the society and employees (Lange and Cegolon, 2015).

  1. Safeguard corporate reporting and integrity.

James Hardie should have an audit committee whose role and responsibility is to review and make appropriate recommendations to the board, particularly, on the adequacy of its corporate reporting responsibilities. In this case, report on the asbestos scandal. Furthermore, James Hardie should have an external auditor whose responsibility is to review the adequacy of the corporate responsibility, and report on the company’s risk and exposure, and threats which affect the business (Moerman and van der Laan, 2015).

  1. Make balanced and timely disclosures.

Listing rule 3.1 of ASX requires firms to make timely disclosures. Thus, James Hardie should have a written and formal policy directed to ensure that it follows and complies with this obligation to ensure that all stakeholders have a timely and equal access to information. The information should cover performance, position, governance, and ownership (Lange and Cegolon, 2015).

  1. Respect the responsibilities and rights of security holders.

Under the auspices of the corporate governance framework, James Hardie, should be able to hold the board and management accountable for the firm’s performance (Holland and Pyman, 2011). However, for this to occur, James Hardie needs to offer accurate and timely information, which enables the stakeholders exercise their rights accordingly.

  1. Manage and recognise risk.

James Hardie must set up risk management practices t help protect the established value, and also, to assist in recognising and capitalising on the opportunities, which create value. It offers the board an opportunity to determine the extent of the risks that it is willing to take to attain its objectives, and avoid taking significant risks that erode its value, such as, the asbestos scandal (Hills, 2005).

  1. Remunerate responsibly and fairly.

James Hardie should have a transparent and formal process of establishing its remuneration procedure. Furthermore, pay must be linked to performance, and how it is linked to cultivating value within the firm that is articulated to stakeholders (Holland and Pyman, 2011).

Q4 How were the long term interests of each of these stakeholder groups affected or exacerbated by James Hardie directors’ decision to continue to manufacture the asbestos based product from mid-1960s until 1987?

Stakeholder Group of James Hardie How long term interests of stakeholder groups were affected or exacerbated
Government The government lost significant revenue from James Hardie, as a holding company James Hardie industries NV relocated to Netherlands (Hills, 2005).
Regulatory agencies, such as, Australia Security Investment Commission (ASIC). It cased regulatory agencies, such as, ASIC, to enhance their regulatory activities, and enhance their rules and regulations. Several new measures have been introduced to safeguard the society, or consumers against harm from companies (Gunz and van der Laan, 2010).
Consumers The health of consumers deteriorated as they developed asbestos-related diseases (Hardie-Bick, 2012).
Community The surrounding communities faced significant health issues from asbestos-related sickness.
Employees It hampered the health of their employees, who were exposed to asbestos for years, and developed asbestos-related diseases (Gunz and van der Laan, 2010).
Investors The investors fund was gradually depleted over the years, as the liabilities grew. The shareholder value reduced significantly, as the value of the company was shattered by its growing negative publicity. The investors lost essential assets, such as, the ownership of Amaca and Amaba to the MRCF to cater for the past and future claims. Furthermore, the investors witnessed claims grow from A$1.5 million to A$ 4.5 billion (Hardie-Bick, 2012).
Employee families The families of employees faced significant challenges, as they had to cater for the sick, and had to undergo rigorous process of filing for liability claims. Also, they lost significant source of income through incapacitation of a member of their families (Galbreath and Shum, 2012).
Partners The partners experienced growing negative image, and loss of significant business value in the society. The partners witnessed their valuable investment lose significant value, as a result of business and negative publicity (Gunz and van der Laan, 2010).
Media The media received misleading information from James Hardie, particularly, in regards to the formation of MRCF.
ASX The ASX developed stringent corporate governance rules, as a result, of the James Hardie case (Fernando and Sim, 2011).

Q5 Comment on the decision made by the board of director in mid-1960s. Was it legal at that time (i.e., mid-1960s)? Was this ethical decision making at that time (i.e., mid-1960s)? Include in your answer a discussion that demonstrates the difference between business ethics and moral ethics. Provide a reasoned argument to support your answer.

In the 1960s, the post-war Australian society started focusing on causes, which occasioned the emergence of anti-business attitudes, which developed as many people rose against the vested needs that controlled the political and economic sides of the society known as the military-industrial complex (Ferguson et al., 2011). Additionally, the post-war Australian society experienced the reduction of inner cities and the development of ecological issues, such as, disposal waste and pollution. It occasioned the rise of consumerism actions taken up by independent organizations, individuals, and groups to protect the rights of consumers. The rise of the consumer rights groups and organizations was occasioned by the publication of Ralph Nader “unsafe at any speed”, in the United States, which led to the passage of the Consumer Bill of Rights in 1969 (Darian-Smith, 2015). However, in Australia, the consumer rights protection law was passed by the commonwealth parliament in 1974. Thus, in the mid-1960s, there were no law governing companies against consumer rights. In this regard, the decision taken by James Hardie in the Mid-1960s was legal, as it was not prohibited by any law. Although, James Hardie’s actions were not considered illegal, they were widely viewed in the society and business circles as ethical issues that companies must address (Brown, Beekes and Verhoeven, 2011). Prior to 1960s, ethical issues related to business activities were usually discussed within the auspices of philosophy and theology. In that period, the individual moral issues linked to businesses were addressed in religious centres, such as, churches and mosques. The religious leaders questioned how businesses operated in line with biblical principles. They questioned business practices in issues relating to wages, consumer rights, morality, and labour practices. For instance, the Catholics focused on social ethics that were expressed in a sequence of papal encyclicals, which includes concerns for moral practices in business, such as, living wages, workers rights. The religious moral practices on business focussed majorly on humanistic values, and not on material values, and also, improving the conditions of the poor within the society. The question of business seeking profitability, at the expense of consumers was being discussed at the precincts of churches (Ferguson et al., 2011). In this view, the James Hardie’s decision was considered as being unethical, as it demonstrates how businesses sought to maximise profits and value, at the expense of human lives. James Hardie decision to consider A$1.5 million as being negligible, as the expense of its investors A$30 million fund, is considered as being unethical business practice, and fails to consider the value of human lives; that is, its employees, consumers, and its surrounding community (Brobeck and Mayer, 2015). During that period, the ethical concepts adopted were largely individually based, and thus, were largely moral ethics. Moral ethics was based on personal beliefs on what is considered as being right and wrong. However, such religious and moral beliefs provided a basis for the development of business ethics. The religious teachings caused universities and colleges to start teaching social ethics (Kathy Rao, Tilt and Lester, 2012). The development of teaching programs led to the growth of business ethics, as companies began applying moral frameworks on the way they did their businesses. The ethical perspectives started changing the way businesses operated, and caused the creation of standard business ethical practices, across various industries in the world. As a result, of its actions in the 1960s, the past and present directors of James Hardie were found liable, as their actions resulted in the development and growth of asbestos-related sickness years later (Galbreath and Shum, 2012).

Q6 How did the actions of various stakeholders potentially threaten James Hardie's ability to achieve corporate sustainability?

Specific Stakeholder Group How did actions threaten James Hardie’s corporate sustainability
Board of Directors In 2001, James hardie set up the Medical research Compensation Fund (MCRF) to fund the claim of people suffering from asbestos-related related diseases, against the company’s two former subsidiaries. The MCRF was formed to offer compensation to future claimants, and permit the board to concentrate on enhance the value of the company on behalf of shareholders (Brown, Beekes and Verhoeven, 2011). The MCRF had funds of A$293 million, which according to JHIL was sufficient to meet the needs of future claims. However, a report by KPMG claimed that MCRF was largely underfunded, as its estimated liabilities were A$693 million, and expected to increase to A$1044 million (Ferguson et al., 2011). The failure by the James Hardie board to use reliable actuary estimations threatened to hamper the ability of the firm to pay future liability claims. Underfunding the MCRF threatened the ability of JHIL to meet its corporate sustainability, as it hampered the ability of the firm to attain of its business objectives. Furthermore, it exposed the company to significant civil law suits, which would affect the future viability of the firm, as its value would be eroded by future claims and liability suits (Bryans and Le, 2016).
Investors The shareholders formed a new holding company James Hardie Industries NV (JHI NV), and moved its operations to Netherlands, a country that did not have any civil law enforcement agreements (Moerman and van der Laan, 2015). Although, the New South Wales (NSW) Supreme Court permitted James Hardie the decision to restructure and relocate provided that any future liability claims will be backed up and met by partially backed shares in the James Hardie Industries Limited (JHIL) owned by JHI NV. However, these shares were cancelled by the firm, which was then recognised as ABN 60 Pty. Although, its new foundation ABN 60 Foundation, was able to meet any future liability claims; the foundation’s complex and restructured system made it difficult for people to claim for liability (Porter and Miles, 2013). This threatened to hamper the ability of people suffering from asbestos-related diseases to get their much need compensation. The complex structure negative influenced the ability of ABN 60 Pty to meet its corporate objectives, as it was not sustainable in meeting its liability claims in asbestos-related suits (Kathy Rao, Tilt and Lester, 2012).

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