2006 | 2005
Canadian directors have been cleaning up their act since the collapse of WorldCom and Enron nearly five years ago sparked a North American corporate governance revolution. While governance was once merely a footnote in a company's annual report, now many of Canada's largest corporations brag about their independent directors, the top-notch financial experts sitting on their audit committees and their beefed-up board oversight.
Want proof of the dramatic overhaul in Canada's boardrooms? Just look back to the first Canadian Business corporate governance survey, published in 2001. The median score for companies that made the cut of our 25 top boards was 55 out of 100. This year, the median score for our highest-ranked companies is 94–and that's after we added more rigorous criteria and tightened the scoring. Even companies that scored low have improved. Back in 2001, the median score for companies at the bottom of our governance survey was just three out of 100. This year, it's 23. But those dramatic increases have stalled. The median score for all the companies we examined this year, top and bottom, was 60, slightly above the median score of 57 last year. (For the complete methodology, click here.)
Canada's boardrooms are now at a crossroads. Most major public companies have eliminated the clear conflicts of interests from their boards, recruited new, strong and independent directors to sit on reinvigorated committees, and now routinely require directors and officers to hold a significant amount of company stock to ensure they are in the same boat as shareholders. But that was the easy part. Shareholders and corporate governance advocates are watching to see if those same companies will take on the much more difficult task of boosting their board's overall effectiveness. “When it comes to improving the basic corporate governance structures, the low-hanging fruit has been plucked,” says Tim Rowley, associate professor at the University of Toronto's Rotman School of Management. “Now, directors have to deal with the more subtle and much more demanding job of creating a board that actually adds value to the company.”
The previous boardroom overhaul could seem like a cakewalk compared to this next phase in the governance revolution. There are no road maps to show directors how to improve the quality and flow of information from management to the board, or to help directors focus on plotting strategic goals and achieving solid, long-term corporate profitability. “The structural changes boards have put in place merely allow an effective corporate governance conversation between management and the directors to take place,” says Rowley. “Now, it's up to the directors to make sure those boardroom talks begin.”
The companies that topped our list of highest-scoring boards appear to have all the tools they need to facilitate that discussion. And once again, it is Canada's financial services and Old Economy companies that dominate this year's list of best boards. At the summit: Bank of Montreal (TSX: BMO) and Bank of Nova Scotia (TSX: BNS). Their shares have outperformed their peers over the past three years, and both banks managed to avoid the scandals that have plagued the Canadian Imperial Bank of Commerce (TSX: CM). For the first time since publishing our survey, CIBC has not made the list of top-scoring companies. And no wonder. Earlier this month, the bank announced it would pay US$2.4 billion to settle outstanding shareholder lawsuits related to CIBC's alleged attempt to help the now infamous Houston-based energy company hide billions in debt. In contrast, Bank of Montreal has been lauded for its governance standards and was one of the first companies in Canada to implement a comprehensive board evaluation system that examined not only the effectiveness of the board as a whole, but also the contributions of each director.
More companies than ever are receiving full points for hitting all the basic corporate governance marks. This year, 56 firms received the full 25 points for “board independence,” which takes into account the number of independent directors on the board and committees, whether the company has split the role of chairman and CEO, and if it has a single class of voting shares. That's up from 48 companies last year. The increase is more dramatic when it comes to the scores for “board accountability.” This year, 43 companies received the full 35 points for accountability, which measures such criteria as how much stock the directors and managers hold, how well the firm has kept a lid on stock options, and whether the board evaluates the contribution of each director annually. That's almost double the 22 companies that received full marks in 2004.
Unlike structural governance qualities that can be articulated in the company's annual management proxy circular and easily measured in governance surveys such as this, effective boardroom management can be seen only in the company's overall financial performance–or lack thereof. As a result, the Canadian Business governance ranking (unlike many other surveys) includes share performance in its criteria. Some companies argue that the vagaries of the stock market have little to do with corporate governance, and some governance advocates claim that good share performance unfairly shields companies with low governance standards. But for most shareholders, good corporate governance is a means to an end, a way of ensuring that the company managers spend the owners' money wisely and generate solid returns. Because we award points to companies whose three-year returns outpace the S&P/TSX composite index, some companies that have scored well in previous years did not make this year's list. The share performance of Edmonton-based Finning International Inc. (TSX: FTT), for instance, outpaced the TSX, but just barely, and Finning didn't earn enough points overall to make it on our list of 25 best boards. In short, it's not that Finning's board performed poorly; it's just that many other companies performed slightly better.
Many companies that have traditionally scored poorly in our survey made substantial changes to their boards. Montreal-based Quebecor Inc. (TSX: QBR.B), for example, scored just a single point last year in the independence category because its board was packed with former managers, consultants and directors with close ties to the company. Today, while the board continues to be dominated by president Pierre Karl Péladeau, enough independent directors have been recruited to move Quebecor off the bottom of the list. Meanwhile, independent directors at Royal Group Technologies Ltd. (TSX: RYG) forced out chairman Vic De Zen along with senior managers at the Woodbridge, Ont.-based construction supplier after news of an ongoing RCMP investigation into alleged wrongdoing as well as millions of dollars in related-party transactions uncovered by an audit. The removal of De Zen paved the way for Royal to flatten its share structure, eliminating the dual-class voting shares that have long been a thorn in the sides of shareholders and governance advocates.
But about half of the companies that scored poorly last year ranked just as badly this year. CoolBrands International Inc. (TSX: COB.SV.A) continues to have only a handful of independent directors, and the few who don't have ties to the company own almost no stock. Magna International Inc. (TSX: MG.SV.A) is still dominated by founder Frank Stronach, who tells governance advocates at every annual meeting what they can do with their suggestions for board improvements. And Biovail Corp. (TSX: BVF), despite a governance overhaul that included recruitment of new independent directors and a split of the role of chairman and CEO, continues to rely heavily on directors who have close ties to company founder Eugene Melnyk. But that may be moot should Melnyk follow through with plans to take the company private.
While a few companies still lack fully independent boards, most companies have at least a majority of independent directors. This year only 22 of the 228 companies examined scored zero for director independence, virtually unchanged from last year. That is, more than half of those 22 boards' directors were managers, former managers or relatives of management, or they had a conflict of interest such as payment for consulting work.
Improving governance structures is important, but moving to the next step and improving the overall effectiveness of the board is even more important, says David Beatty, managing director of the Toronto-based Canadian Coalition for Good Governance, which represents more than 45 institutional investors. Unfortunately, some directors, who have spent so much time on the structural part of the governance equation, may not press for the more subtle and less tangible improvements. “Directors have shown a lot of energy and a real willingness to change the way things are done in the boardroom,” says Beatty. “But there is a creeping ennui out there and a real danger that some directors are going to rest on their laurels.” It will be up to shareholders to ensure that board members, who are supposed to protect their interests, continue the governance revolution.