Large corporate demergers. Recent Australian experience (2000–2019) and its implications

This thesis examines the recent history of demergers undertaken by large Australian companies between the start of 2000 to the end of 2019. There were 16 demergers by ‘large’ (i.e. ASX Top 100) companies in this period. One aim of this thesis is to assess the performance of these historical demergers. Hence, this thesis focuses on execution issues (in particular, board decisions about asset distribution and accounting for these unique transactions). More generally, commercial performance and regulatory compliance are also examined. The historical reviews are undertaken to provide a fact-based foundation for the overarching aim of the thesis, which is to examine the current Australian regulatory regime, and to investigate the extent to which it remains fit for purpose in the demerger context. The approach taken includes an in-depth case analysis of each demerger, guided by a meta theory perspective involving accounting, legal and regulatory perspectives. The ultimate objective is to deliver a detailed critique of the regulatory framework in the light of outcomes of the case studies, in particular, with respect to regulatory compliance. In addition, the thesis identifies several matters of concern related to the adequacy and appropriateness of communications with shareholders. The thesis makes recommendations to improve the provision of information that reflects the ‘best interest’ obligations of directors, consistent with statute and case law. This thesis comprises three separate studies. Two are historical, corresponding to commercial performance and accounting compliance with respect to the demerger process. The third involves a review and critique of the existing regulatory provisions in this demerger context. Study 1 examines the performance of the 16 demergers with respect to the market as well as financial and operational performance. This study indicates that a substantial majority of the demergers did deliver increase in shareholders’ value (as measured by increase in combined market capitalisation up to three years post demerger). However, the 16 demergers varied considerably in terms of this increase in value. Study 2 examines the seven demergers that occurred post the 2008 release of Interpretation 17 Distributions of Non-cash Assets to Owners by the International Financial Reporting Interpretations Committee. It finds that compliance was poor—several boards signed off on an accounting treatment that generated nonsensical, negative demerger reserves, ranging from quite modest levels up to the $5.8 billion reserve that Wesfarmers recorded. These negative reserves were created where the boards had insufficient retained earnings to distribute the demerger dividend. The universal judgement of these boards that this treatment was an acceptable accounting practice is surprising. It was also misleading for shareholders. It is akin to the culture and practices of the banking industries, so roundly criticised by Commissioner Hayne in his report of the Banking Royal Commission findings in 2019. In this thesis, accounting treatment decisions and their implications are analysed in detail. All are found wanting owing to inappropriate accounting, presentations and disclosures. The role of auditors in signing off on this accounting treatment is a concern and worthy of independent future examination. Study 3 necessitates a detailed reading and critique of the various components of the regulatory framework. The starting point is the statue, as reflected in the Corporations Act 2001 (Cth) as amended. This document presents concepts and principles that need to be followed for business conduct in Australia. Included within this Act is a four-step recipe upon the determination that a director has a conflict of duties or of interest. These are, sequentially: (i) advice, (ii) removal of the conflict, (iii) recusal and (iv) resignation. This sequence is a sound and practical process for an individual director in conflict. However, this thesis finds that when strictly applied to the demerger context, with current practice, the entire board is conflicted. No guidance is given about an alternative to this four-step recipe for the structural conflict that sees all directors conflicted. The thesis approaches this problem by recommending a caveat that requires directors of demerging parent companies to place their shareholding (direct or beneficial), in escrow for a period (to reduce the value of privileged knowledge post demerger) from announcement to listing plus two years. Several other recommendations are made for regulatory changes arising from this research. Specifically, the thesis makes a total of nine recommendations based on the analyses and findings from these three studies. If implemented as a package, they would together contribute to steps that might be taken by regulators to improve the prospects of shareholders ‘best interests’ being given the pre-eminence the regulations prescribe. These recommendations manly cover specific requirements to improve the levels of transparency and disclosure to shareholders. In particular, these cover inclusions in the Scheme Booklet that clarify the consequences of the directors’ decisions on total assets and total debt and separate components of total equity. Within the annual reports, there should be requirements for the reconciliation of net assets transferred, a full analysis of the opening balances for the NewCo on demerger and the outlawing of the establishment of nonsensical, obfuscating, negative reserves. Last, there should be a requirement for directors to sign a Directors’ Declaration document to acknowledge their acceptance of their conflict-of-interest circumstance and, consequently, a requirement for entering into a formal agreement that directors of the pre-demerged group enter into a period of escrow with respect to all shares owned or controlled by them or related beneficiaries. The agency theory is adduced in support of these recommendations but only in the context of in extremus. This thesis contends that if this package of recommendations were adopted collectively, a significant improvement in the regulatory framework would result. Last, the thesis presents a linear algebraic analysis of the full dataset. This analysis identifies cash flow from operations as the dominant explanatory variable at both time intervals of the first annual report (AR1) and third annual report (AR3) post demerger, a pleasing concordance between analysis and intuition.