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Essay: How application of ASX Corporate Governance Principles could have turned around Woolworths Limited

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  • How application of ASX Corporate Governance Principles could have turned around Woolworths Limited
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Identify the Problem

This report aims at understanding how application of ASX Corporate Governance Principles and Recommendations could have potentially turned around Woolworths Limited – Masters Home Improvement.

Determine Relevant Information

(Rankin, 2017) defines corporate governance as “system by which corporations are directed and controlled”. Corporate governance also describes the framework of rules, relationships, systems and processes within corporations and defines accountability (ASX, 2014). Corporate underperformance is the company’s inability to meet the expectation of its stakeholders. Corporate turnaround means restructuring the company to return it to operational normality and financial solvency (Downey & CIMA, 2009). It usually involves a failure of leadership (Slatter, 2011) and lack of concern for corporate governance. The most important function of a board of directors is to foresee and manage risk. In case of Masters home improvement, it is evident that the board failed to gauge the risk with entering a market with virtually no gap and dominated by long standing players like Bunnings.

Masters was conceived in 2009 with an aim to put extra pressure on Westfarmers, owner of Coles, which also operated the top hardware player in the market, Bunnings. Masters started operations in 2011 in partnership with Lowe’s; by 2016 it had more than 60 stores (Evans, 2016). It was a recipe for disaster, a consequence of poor strategic decisions, overexpansion and ill-judged acquisitions (Hamilton & Mickelthwait, 2006).

Masters reported a total of $600 million in losses with over $3 billion of capital spending (Woolworths Ltd., 2016). It was restructured after Don Stallings, the managing director, was replaced by Matt Tyson. The roll-out was slowed down and investment was cut-back until the model was proven (McConnell, 2016). However, the fallout seemed inevitable and Masters stopped operation on December 11th 2016.

Enumerate Options

Woolworths needed a more effective risk management team, which would have foreseen the risks involved with entering a market or at least diverted the motive of bringing Masters into existence from attacking Westfarmers to actually looking for an entry into a profitable industry. The main fact that the Woolworths board failed to recognize is that Westfarmers allowed Bunnings to perform as a silo (Stewart, 2016). Recommendation 7.4 should have been followed in order to predict and manage material exposure to economic, environment and social risks (Hamilton & Mickelthwait, 2006).

In addition to that, the composition of Woolworths’ board lacks expertise in new business development, research and specifically home improvement industry as shown in the skills matrix presented in the corporate governance statement. Recommendation 2.6 deals with induction and professional training to be provided to the directors. It should have been applied to equip directors with better knowledge about new business development.

Principle 1 of the document states that “ a listed entity should establish and disclose the respective roles and responsibilities of its board and management and how their performance is monitored and evaluated” (ASX, 2014). Woolworths does specify the general roles of board and management. However, clear articulation of division of responsibility is lacking. Following Recommendation 1.1 would have given the board of directors a chance to create a path for the management to work upon.

Assess and Make Preliminary Decisions

These recommendations can be linked to agency theory. Rankin (2017) explains agency theory as a contractual relationship between the managers and the shareholders whereby the shareholders pass on the decision-making authority to the managers to manage their wealth. However, it is assumed that managers act on the basis of their interest which results in additional costs for the shareholders. One of the problems associated with owner-manager agency relationship is horizon problem (Rankin, 2017). Shareholders are usually interested in long-term growth of the company whereas managers look to solve issues with a short-term approach. In case of Masters, as mentioned by McConnell (2016), the board and the management was aiming at crippling Westfarmers by attacking its strongest venture, Bunnings. This was clearly a short-term approach towards dealing with an external threat. In addition to that, Woolworths board was not exactly working towards the shareholders’ interest by burning more than $3 billion of shareholders money in the home improvement project.

A robust risk management framework would have enabled the directors to gauge the foreseeable risk and the costs associated with it. It would have given the management a clear path about how to tackle threats involved in the home improvement industry. This eventually would have led to attacking their competitor, Westfarmers, in a more effective strategy.

On the contrary, being too focused on the risks involved would have limited the scope of growth and innovation (John, Litov, & Yeung, 2008). This could have been the board’s initial thoughts on going ahead with the Masters Home Improvement idea.

However, it is quite evident that the advantages of having a risk committee to continuously monitor the strategic risk framework outweighs the disadvantages, specifically in Masters case. Though Woolworths Ltd formulated an Audit, Risk Management and Compliance Committee (ARMCC), it did little to predict and place attention on the flawed plan to enter the home improvement sector.

Principle 2 states that any listed entity “should have a board of an appropriate size, composition, skills and commitment to enable it to discharge its duties effectively” (ASX, 2014). A structured board provides valuable insights regarding varied aspects of any project. A well composed board is a step to eliminate overlooking important but often not easily recognizable issues (Baysinger & Hoskisson, 1990).

On the other hand, with too many brains from different fields come different ideas. This may make it difficult to focus on one situation. In Masters case, it is quite evident that there are directors with great retail industry experience, though little in home improvement sector (Woolworths Ltd., 2015).

It would be safe to say that though the board did not have industry-specific knowledge, they did have the experience to deal with entry into a completely new market. However, frequent changes of managing directors questions the board’s commitment, which is an important aspect of Principle 2. By the time Matt Tyson took charge of the company from Don Stallings, he was a part of the solution rather than the problem (McConnell, 2016). It might have been too late for Matt Tyson to prevent the inevitable.

Principle 1 of ASX Corporate Governance Principles and Recommendations describes the importance of a clearly set out roles and responsibilities of the board and of the management. Recommendation 1.1 of Principle 1 suggests that “a listed entity should disclose: (a) the respective roles and responsibilities of its board and management; and (b) those matters expressly reserved to the board and those delegated to management.” (ASX, 2014). Though there is a brief commentary about the roles and responsibilities of the board and the management, there is nothing in specific. Clearly defined roles help in expectation setting and avoiding misunderstanding. However, stringent roles deter flexibility and may add to unwillingness to perform cross-divisional roles.

List Reasons Explicitly

In conclusion, the failure of Masters Home Improvement was a result of poor strategic thinking, a consequence of corporate governance failure. Poor strategic thinking which led to haphazard expansion and acquisitions can be attributed Woolworths’ epic failure. It can be deducted from the argument presented above that better application of Principle 7, Recommendation 7.4 by ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations statement. This, coupled with choice wrong locations, selling the wrong stuff and flawed workplace culture was the reason behind Masters downfall (Stewart, 2016). All of these mentioned causes can be traced back to lack of good corporate governance.

Self-Correct

There are several limitations that were met while writing this argument. There is no specific data regarding who was accountable for the projects and what was the actual responsibility of individual directors. In addition to that there is limited academic research done on this topic which makes it difficult to refer to secondary data. Corporate governance is a very subjective issue. Therefore, pointing out flaws in corporate governance is as subjective as the issue itself. Since there are multiple causes of the issue in question, this makes it difficult to narrow and limit the scope of research.

References

ASX (2014), Corporate Governance Principles and Recommendations.

Baysinger, B., & Hoskisson, R. E. J. A. o. M. r. (1990). The composition of boards of directors and strategic control: Effects on corporate strategy. 15(1), 72-87.

Downey, J., & CIMA. (2009). Corporate Turnaround. Topic Gateways(59), 2.

Evans, S. (2016). What went wrong at Woolworths’ Masters. Sydney Morning Herald. Retrieved from https://www.smh.com.au/business/companies/what-went-wrong-at-woolworths-masters-20160118-gm8fge.html

Hamilton, S., & Mickelthwait, A. (2006). Greed & Corporate Failure. In The Lessons from Recent Disasters. Gordonsville: Palgrave Macmillan.

John, K., Litov, L., & Yeung, B. (2008). Corporate governance and risk-taking. The journal of finance, 63(4), 1679-1728.

McConnell, P. (2016). Masters – A failure of corporate governance? The Conversation. Retrieved from www.thecoversation.com website: https://theconversation.com/masters-a-failure-of-corporate-governance-53619

Rankin, M. (2017). Contemporary Issues in Accounting, 2nd Edition. Melbourne, AUSTRALIA: Wiley.

Slatter, S. (2011). Leading corporate turnaround: How leaders fix troubled companies: John Wiley & Sons.

Stewart, E. (2016). Masters: Five reasons Woolworths is pulling the plug on struggling hardware chain. ABC News. http://www.abc.net.au/news/2015-05-06/five-reasons-woolworths-is-being-hammered-on-hardware/6450364

Woolworths Ltd. (2015). Corporate Governance Report. Retrieved from Sydney: https://www.asx.com.au/asxpdf/20150911/pdf/43184bkk8d2jjr.pdf

Woolworths Ltd. (2016). Annual Report 2016.

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