From boys club to culture club
By Simon Hally
A joint committee makes a number of hard-hitting suggestions for change in the role and structure of Canada's corporate boards
For years, boards of directors were seen as Old Boys clubs: groups of stiff old men in dark suits who got together for perfunctory meetings where they rubber-stamped management decisions they didn't really understand. Like all stereotypes, this was based on an element of truth. After all, it was widely accepted that corporate performance was management's responsibility; and while boards were legally
necessary, they were largely irrelevant.
But attitudes have certainly changed. In the 1980s - the era of leveraged buyouts, corporate raiders, hostile take-overs and widespread restructuring - it became clear that, in the struggle for control of corporations in North America and elsewhere, shareholders' interests were frequently being downplayed, or downright ignored. Corporate boards of directors, it was believed, were failing to perform their primary duty of overseeing management on behalf of shareholders. Reforms were needed, and the term "corporate governance" came into general usage.
Now, more attention than ever is being paid to enhancing the structure and role of boards, whose performance has come to be recognized as an important factor in protecting shareholder rights and maximizing shareholder value. High- profile business disasters such as Confederation Life, Royal Trust, Bre-X, YBM Magnex and Livent have highlighted the need for change in the way companies are governed in Canada.
"Corporate governance is a vital link that connects investors to companies," says Barbara Stymiest, president and CEO of the Toronto Stock Exchange (TSE). "Sound corporate governance is crucial to healthy capital markets. Protecting the interests of shareholders enables issuers to access competitively priced capital."
Adds Bill Hess, president and CEO of the Canadian Venture Exchange (CDNX): "People who invest in a company want to have a sense of assurance about how it's managed, and how effectively management is monitored. Investors want to know they have a voice in the boardroom, and an eye on the company's direction."
That kind of conventional wisdom is what led to the establishment last year of the Joint Committee on Corporate Governance by the TSE and CDNX, along with the Canadian Institute of Chartered Accountants (CICA). Its mandate is to review the current state of corporate gov- ernance in Canada and make recommendations for changes that will ensure Canadian corporate governance is among the best in the world.
In March, the 12-member joint committee - chaired by Guylaine Saucier, former CICA chair, and including Yves Fortier (chair and senior partner of Ogilvy Renault), former New Brunswick premier Frank McKenna (of McInnes Cooper & Roberston), John Roth (president and CEO of Nortel) and Tullio Cedraschi (president and CEO of CN Investment Division) - issued its interim report. It contains 27 recommendations, from stronger powers for audit committees, written charters for boards of directors, regular board meetings without management present, and nonexecutive chairs. Comments were to be sent by the end of May, and the final report is scheduled to be issued in September.
In the move to enhance board performance, institutional shareholders and fund managers have played a major role, by demanding effective governance from the companies in which they invest. The Ontario Teachers' Pension Plan Board (OTPP) states on its website: "We define corporate governance as the system by which companies are directed, controlled and evaluated. Corporate governance should affect every area of management of a corporation. It includes the review and approval of plans of action, corporate objectives, internal control systems and the engaging of regular management performance reviews. It also encompasses the timeliness and accuracy of corporate disclosure."
And the OTPP is prepared to use its clout to make its views heard: "We consider the right to vote as one of our most effective tools for promoting good corporate governance. We take the issue of voting very seriously. Our objective is to vote every share of every company we own at every meeting of that company's shareholders." Of course, investors can also vote by buying or not buying a company's shares, depending on the degree of confidence they have in the way that company is governed. Thus, good corporate governance can be an advantage for corporations in the competition for capital investment.
"With increasingly global capital markets," says Tom O'Neill, CEO of PricewaterhouseCoopers and a member of the joint committee, "it is essential that standards of governance in Canada's companies keep pace with the rest of the world. Otherwise, they risk being undervalued by the markets and losing investor loyalty and confidence."
Interestingly, while it is generally accepted that good corporate governance is necessary for superior corporate performance, there is little firm evidence to support that view. This is partly because boards work behind closed doors. The result, as noted by David Leighton and Donald Thain in their 1997 book, Making Boards Work, is that "the board of directors remains a kind of 'black box,' whose internal workings can only be surmised from public information about decisions announced and actions taken."
Richard Leblanc of York University's Schulich School of Business agrees. In the background paper he prepared for the joint committee, he quotes Jean-Claude Delorme, former chairman and CEO of the Caisse de dépôt et placement du Québec: "As long as we do not show that a relationship exists between [corporate governance and corporate performance], the principles of corporate governance, in the best of cases, will be the object of polite attention or, perhaps more often, the object of generalized skepticism."
The Saucier committee is unfazed by these concerns. In its interim report, it states: "We believe - on the basis of our own experience - that good governance can and does make a difference to corporate performance."
Beyond the Dey Report. The establishment of the joint committee was the first major initiative in the area of corporate governance in Canada since the 1994 publication of "Where Were the Directors?" - a TSE committee report that came to be known as the Dey Report (after the committee's chair, Peter Dey). It identified the principal responsibilities of the board of directors: stewardship of the corporation, strategic planning, identifying and monitoring the main risks of the business, appointing and developing senior management and implementing a communications policy. It also suggested how the board and its committees should be structured, and addressed the issue of directors' civil liability regarding timely disclosure of corporate information. The Dey Report was an important milestone in the development of corporate governance standards, and led to the adoption of disclosure guidelines by the TSE.
In early 2000, however, at a reunion meeting of the Dey committee sponsored by the TSE and the Institute of Corporate Directors, members expressed concern that, although structural changes have been made in the way corporations are governed, these changes have not led to a more basic cultural change. "The Canadian corporate community has not yet fully endorsed a 'corporate governance culture,' " members said.
Saucier says that is why the main thrust of her committee's interim report is not to propose new rules, but to encourage a change in behaviour. "We do need governance structures," she says, "but beyond that, we need competent, experienced board members." She says the Dey Report was the first building block. The structure it recommended is in place. "Now," she adds, "we need to do what we can to ensure the behaviour that will lead to good governance culture. In Canada we're pretty close to the leading edge of good governance, but it's something that should go through continuous improvement."
As the title of the interim report, "Beyond Compliance: Building a Governance Culture," suggests, the joint committee is aiming to move from structural issues - rules and practices for corporations - to encourage a culture of behaviour that will enable good governance to flourish.
In its interim report, the joint committee outlines some of the guiding principles it followed:
The objective of governance is to promote healthy, competitive corporations.
Behaviour (what boards do and how they do it) is more important than structure.
Disclosure is preferable to regulation.
Although regulation is appropriate for enforcing minimum standards, there is no single best model for effective governance. Different corporations have different needs at different times. Thus, guidelines are better than regulations, and disclosure of behaviour against guidelines is the best way to improve governance over time.
Governance is important for smaller companies as well as large ones. Also, it is advisable not to overburden the boards of smaller companies with imposed struc-tures that can be costly and are more appropriate for larger organizations.
Ownership patterns can influence the role of boards. Because corporate governance is not only practised in widely held public companies, recommendations must also take into account corporations that have "significant shareholders" - ones that can exercise a majority of votes for the election of directors. The joint committee distinguishes between three types of public companies: corporations that are widely held; those that have a significant shareholder who may or may not be management; and subsidiaries whose significant shareholder is itself a public corporation.
The committee begins by recommending that every board have a charter, which should be disclosed to the company's shareholders. The charter should confirm the board's responsibilities, such as selecting, appointing, evaluating and, if necessary, terminating the CEO; succession planning; approving the compensation of senior management; strategic planning; and assessing the contribution of the board, its committees and all directors annually. It must also disclose any limit on the board's authority by the influence of a significant shareholder; if the corporation is a subsidiary, the charter should reflect the board's responsibility to ensure minority shareholders are treated fairly in dealings between the parent and subsidiary.
The report goes on to make some recommendations for improving disclosure of corporate governance practices. One is that the TSE guidelines should be revised to include the principles for effective governance recommended by the committee. All boards should provide complete disclosure of their corporate governance practices, at least annually, in relation to the board's charter and each of the guidelines.
The committee also clarifies the role of the audit committee. "The role of external auditors is crucial to good governance," stresses Saucier, "because, like the board, they are accountable to shareholders with the job of overseeing management." There are three audit committee recommendations in the interim report. First, the committee should be composed entirely of outside directors who are also unrelated. Second, the members should have a basic level of "financial literacy," and at least one should have "accounting or related financial expertise." The CICA, in consultation with other organizations, should develop guidance for determining financial literacy requirements and educational programs. Finally, audit committees should have a formal charter setting out their responsibilities.
An important area addressed by the committee is the need to educate and train potential new directors. Some observers claim that in Canada there may not be enough qualified and experienced directors to go around. This has led to criticism that the boards of large Canadian corporations are characterized by cross-directorships, overworked members and poor attendance at meetings.
"Directors often sit on too many boards at once," says Richard Finlay of the Centre for Corporate & Public Governance in Toronto, who points to the membership of the joint committee itself as an example. "With only three members of the committee collectively holding positions on 17 boards, it is obvious that the current pool of directors is overstretched."
Saucier wholeheartedly agrees that a shortage of qualified directors is a concern. "I believe the figure is that one-third of current directors will be retiring in a few years because of age," she says.
The committee recommends that the Institute of Corporate Directors play a more active role in developing educational material for directors and potential directors, in partnership with the Canadian Institute of Chartered Accountants and other professional associations or educational institutions. It also says boards should focus on opportunities for training and educating directors, and should support directors who want to take advantage of those opportunities.
Mixed reviews. The interim report has received both positive and negative reactions from those with an interest in corporate governance. (Considering the somewhat arcane nature of the subject matter, interest in the joint committee's interim report has been surprisingly high: by early June, there had been more than 5,000 downloads of the 72-page report from the committee's website, www.jointcomgov. com.) On the positive side, there are comments such as those from Brian Lechem, founder-president of the Institute of Corporate Directors and editor of the newsletter Boardroom: "The Saucier Committee is to be congratulated on producing a forward-looking, entirely practical and pragmatic report on the future of corporate governance in Canada."
Then there are opinions such as those from Robert L. Leclerc, chair and CEO of Echo Bay Mines, a Colorado-based company listed on the TSE and AMEX. He says the interim report "has been delivered with little more than anecdotal support for the assertions made and conclusions reached. Further, we find the tone generally to be one of condescension.... It is our fervent hope the interim report be allowed to die a natural death."
The Centre for Corporate & Public Governance's Richard Finlay has described the interim report as a "complete disappointment" that fails to address the problems that led to corporate scandals such as Bre-X and Livent. What is needed to improve the state of corporate governance, he says, is stricter enforcement, not more nonbinding guidelines.
Peter Dey disagrees. "The joint committee was absolutely correct to focus on behaviour rather than on structure," says the former chair of Morgan Stanley Canada (he is now a securities lawyer with Osler Hoskin & Harcourt). "It is time for governance in this country to move to the next level, and the joint committee is aiming to do that. It has provided a useful discussion of the responsibilities of directors and the chair. Governance does not lend itself to regulations. You have to give corporations flexibility. Regulation should come through the market, not be imposed by the public sector."
For her part, Saucier says members of the joint committee were unanimous in their view that guidelines and disclosure are preferable to regulations.
More stringent regulations are not out of the question, however. Referring to the TSE's current guidelines on corporate governance, David Brown, chair of the Ontario Securities Commission, recently told the Canadian Pension Benefits Institute that, "from the OSC's point of view, we are now operating under the premise that voluntary action has not resulted in needed reforms. We are prepared to make regulatory changes if that seems desirable to implement any of the [Saucier] committee's recommendations."
Once the Joint Committee issues its final report next month, it will be up to the stock exchanges to decide what action, if any, to take as a result of its recommendations.
The recommendations at a glance
Other committee recommendations
The Joint Committee on Corporate Governance makes 27 recommendations in its interim report. Here are some of them. (Full details are available at www.jointcomgov.com.)
Disclosure
Audit committees should report annually to shareholders.
Boards should report annually to shareholders on their risk management activities.
The approved position descriptions for the board chair, lead director, directors and corporate secretary should be disclosed to shareholders on request.
The board should affirm to shareholders that elected directors have the skills and experience that are required to guide the company.
The Institute of Corporate Directors and the CICA should work together to promote full and fair disclosure of corporate governance practices and should provide information and advice about "best practices."
Responsibilities of outside board members and the chair
Certain functions should be the exclusive responsibility of outside (nonmanagement) directors, consulting closely with the CEO and acting within the committee structure. Their recommendations should go to the full board for approval. These functions include developing the charter of the board and developing position descriptions for directors, the board chair and the CEO.
There should be a position description for the board chair, who should be explicitly responsible for ensuring that regular assessments of the board, committees and individual directors take place; that an appropriate committee structure is established; and that the functions identified in the board charter, and the specific functions for which outside directors are responsible, are effectively carried out.
Independence
Boards should have nonexecutive chairs. If they do not, they should disclose the reasons, and whether they intend to have nonexecutive chairs in the future.
Boards chaired by the CEO are required by current guidelines to have a lead director. In such cases, the leadership role of the lead director regarding the independence of the board must be clarified and enhanced. There should also be a position description for the lead director that makes it clear that he or she is responsible for ensuring that the board can act independently of management, including monitoring the performance of the CEO. The lead director should be identified in the annual report.
Outside directors should meet regularly at every meeting without management present. These sessions should be chaired by the nonexecutive chair or lead director, who should discuss with the CEO any issues arising from the meetings. Other recommendations address matters such as enhanced disclosure, education and training, directors' liability, accounting issues (concerning differences in accounting treatment between Canada and the United States) and directors' remuneration.
Out with the old, in with the new
David S.R. Leighton and Donald H. Thain, professors emeritus at the Ivey School of Business, sum up the changing expectations and attitudes of corporate stakeholders as the "old code" and the "new code" of behaviour for corporate directors (see Making Boards Work: What Directors Must Do to Make Canadian Boards Effective, McGraw-Hill Ryerson, 1997).
The old code
1. Total loyalty to the chair. The chair is usually the CEO as well, and the most basic business maxim is that you must get along with the boss.
2. Support management at all times. Since the old-style director remains detached from the operations and internal problems of the business, this requirement is self-evident.
3. Always try to get along with fellow directors and never let differences surface.
4. Be legally correct. Minutes should be short and carefully crafted by a cautious lawyer, and personal notes about sensitive matters should be destroyed.
5. Participate constructively. Don't upset the chair or your colleagues by asking too many questions.
6. Don't take the job too seriously. If you know too much about the company and its related industries, you'll get into a depth and range of concerns that will cause problems both for you and the rest of the board.
7. Go through the right channels. Directors should communicate only through the chair. Never go "behind the chair's back" and contact directors outside the meetings.
8. Be discreet. Always watch what you say and to whom you say it, and support the necessary tradition that calls for cabinet secrecy and confidentiality, solidarity and unanimity.
9. Take your perks and keep quiet. If the chair does something nice for you that is obviously costly, don't embarrass him by asking if you should pay personally, and don't tell anyone else. How you will be expected to repay will be obvious when the time comes.
10. Don't rock the boat. For some older chair and CEOs, the board is a necessary evil - make the best of the situation. You're more an employee than an investor.
The new code
1. Manage the business and affairs of the corporation. You have the legal obligation to "manage or supervise the management of a corporation." Directors can delegate authority but not responsibility. This is a major change leading to uncharted waters, but likely it's irreversible.
2. Function as a trustee and consultant. You will be held to high standards of professional conduct and performance as a trustee for shareholders and others. You also have a broad responsibility as a consultant and guide to top management.
3. Take the job seriously and do it well. You must be sensitive to what is going on and be prepared to take a position based on informed analysis and wise judgment. The new-style director errs on the side of doing too much rather than too little.
4. Do what is right. On major issues particularly, you must take a prudent, tough-minded position. This requires the fortitude to oppose the majority and risk being unpopular.
5. Support those who are worthy. There is bad in the best CEO and good in the worst. Support should be earned primarily on the basis of performance and rationality, not tradition and political considerations.
6. Use the board routines and infrastructure. Any board has a complex system of communications, information, meetings, committees, routines and relationships. Use it skilfully in
pursuing success for the company.
7. Get the information you need. Managers frequently give directors information that is inadequate, incomplete, disorganized, late or lost in masses of detail. Insist on receiving the information necessary for making major decisions.
8. Build good relationships. Stay in touch with the chair, managers, friends and contacts, to understand how others perceive and react to the problems and strategic agenda of the company.
9. Work on getting the culture right. The new code calls for informality, dialogue, openness, humility and positive attitudes in the behaviour of boards.
10. If necessary, rock the boat. All companies make mistakes. Behind every major mistake stands a board that is responsible and perhaps should have known better. The new code requires that directors be responsible for maintaining a healthy tension between them and management.
A primer on crisis planning for directors
"In every single business failure of a large company in the past few decades, the board was the last to realize that things were going wrong." Management guru Peter Drucker's comment on the effectiveness of corporate boards has certainly held true for Canada's most spectacular corporate flameouts of the 1990s. Confederation Life, Bre-X and Livent all came to a nasty end that left investors, employees, customers, suppliers and the public in a state of befuddlement.
Could better corporate governance have helped any of these companies? The answer in every case is yes. If there had been a fundamentally different governance culture in these firms, with the boards assuming responsibility for monitoring management, the crises probably would never have occurred. Still, it's important to distinguish between crises that arise as a result of unwise strategic decisions or poor risk management, made presumably with overt or tacit approval of the board - as happened with Confederation Life, Bre-X and Livent - and those that are not directly related to particular board or management decisions. For example, a company might have to deal with an unexpected takeover bid, a major product failure or the sudden incapacitation or death of the CEO. These kinds of emergencies can happen to any corporation at any time and will present serious challenges.
Boards therefore need a crisis management plan or system in place to enable them to cope with this sort of eventuality. Such a plan might address questions such as:
Should a single director or committee of the board be charged with taking control if specific kinds of crises should arise?
What particular expertise do the individual directors have that might be of use, such as technical knowledge in the event of a product-related crisis?
If a crisis occurs, is there a system in place for contacting and communicating with board members to enable quick action to be taken?
Are directors kept up-to-date on a regular basis about corporate and industry developments that might affect the company, such as the possibility of takeover attempts or acquisitions?
Does a single director or committee have responsibility as leader if a crisis occurs within the company's senior management?
What resources might be available from outside the company to help deal with a crisis, and how could they be accessed?
In Corporate Boards: New Strategies for Adding Value at the Top, Jay A. Conger, Edward E. Lawler III and David Finegold also recommend exercises to simulate how the board might respond to particular crises. "Ideally, undertaking crisis response exercises may help prevent or at least reduce the severity of a crisis," the authors state. "For example, simulating the response to a lawsuit for fraud may uncover weaknesses in existing audit procedures, which in turn can lead to financial monitoring."
Planning for crises is almost a contradiction in terms. If the timing or nature of a crisis were predictable, it wouldn't be a crisis. By taking sensible precautions and ensuring that a positive governance culture exists, however, any corporation's board and management can help prevent major problems from becoming crises, and maximize the chances of getting through a real crisis without long-lasting damage.
----------------------------------------------------------------------------
Simon Hally is a Toronto-based freelance writer.
cica.ca |
