News

Standing in the rain in the Kenyan bush with a satellite phone, David O'Brien realized that being a corporate director isn't like it used to be.

Mr. O'Brien was on safari last January while Fairmont Hotels & Resorts Inc. was considering a hostile takeover bid. Despite his remote location, he knew he had to participate in a board discussion.

"There I was, standing out at 10 in the evening in Kenya, with the rain pouring down, trying to point toward the sky so I wouldn't lose contact," he says. "I was standing there for an hour and a half discussing the Fairmont issues."

It has been five years since the collapse of Enron Corp. led to a revolution in boardroom practices and director behaviour. And during that time, corporate governance has moved from the sidelines to centre field as directors face an increasingly demanding job.

It's a situation few would have imagined a decade ago when governance took a back seat while corporate profits soared and executive compensation began to hit the stratosphere. But those carefree days came to an abrupt end after a series of corporate scandals led to new regulations for boards and new expectations from investors.

This year, Report on Business completed its fifth annual survey of corporate governance practices at Canada's largest public companies. As part of the project, ROB examined whether all the reform has made a difference for Canada's largest companies. Does governance matter? And has it led to better practices?

The answer is clear: Yes, governance matters, and, yes, real and meaningful reforms have happened in Canada's boardrooms. With five years of data available, it is undeniable that most corporate boards are more independent from management than ever before.

And most have also adopted significant new practices to ensure they are operating professionally — such as director performance reviews.

As part of our review this year, ROB asked an array of senior corporate directors how they feel governance has panned out in practice — whether the trends have made a meaningful difference in the real world at the board table. Some directors cited concerns about details of various reforms that have emerged, but all were unanimous in agreeing that profound and positive change has occurred.

For Mr. O'Brien, there is no doubt that governance has changed for the better — even if it means having to attend late-night board meetings in the rain.

"The experiences of Enron and WorldCom and others focused the mind as to what the role of the board was," says Mr. O'Brien, who is chairman of both Royal Bank of Canada and EnCana Corp. "I think the whole emphasis on governance has raised the bar substantially in terms of board performance."

Agrium Inc. chairman Frank Proto says one of the key developments in the whole corporate governance movement has been that it has forced long-time directors to go back to the grassroots and "re-examine" that they are working for shareholders.

"There were a lot of boards where directors and management were getting too close," he says.

"I have sat on boards of public corporations for some years, and I remember some meetings of committees and board meetings which were almost perfunctory — I'm not proud of that," recalls Alcan Inc. chairman Yves Fortier.

"But today there is an awareness that makes it mandatory for directors to spend a hell of a lot more time, to do a heck of a lot more work and preparation, and to be more conscientious and diligent."

Beyond a change in director attitudes, one of the most important developments in recent years has come from the investor community, where good governance has emerged as a key concern. Investors are increasingly criticizing weak practices or voting proxies to express unhappiness with board decisions, such as excessive compensation.

Governance expert Peter Dey says he believes the most important development in corporate governance in recent years has been the realization by investors that it is linked to good performance.

"If you're still debating whether good governance contributes to corporate performance, then you're back in the last century. That debate is finished," Mr. Dey argues.

As well as chairing the board of Addax Petroleum Corp., Mr. Dey also recently became chairman of investment banking firm Paradigm Capital Corp. He says it would be difficult for critics to question the value of governance if they had to "live it" daily.

"I defy these people .ƒ|.ƒ|. to try to recruit a new director when the board is dominated by individuals who are beholden to the CEO," he says. "I defy them to go to an underwriter and say, 'I want to raise $100-million and my board is comprised of a bunch of people who are all beholden to the CEO.'ƒ|"

Investors say that while shareholder returns remain the key criteria for investing, good boards and good governance are increasingly accepted as the key underpinnings — the necessary platform to bolster performance and mitigate risk.

Brian Gibson, senior vice-president of the Ontario Teachers Pension Plan, says good governance practices are not the goal in themselves. The goal is delivering a better outcome to shareholders. "All this governance movement .ƒ|.ƒ|. is really a wake-up for everybody. Let's organize ourselves properly and remove anything that might be an impediment. The best boards have done that, and the challenge now is being more effective."

ROB's governance data shows a remarkably rapid revolution in corporate governance practices over the past five years.

Boards have become strikingly more independent from management, for example. In 2002, one in five boards had a majority of directors who were related to management. This year, the number has dropped to 6 per cent. Similarly, 43 per cent of boards had a related director on their audit committees in 2002 — based on ROB's strict definition of independence — compared with 8 per cent today.

Boards have also embraced a number of key reforms. In 2003, for example, 42 per cent of companies said their directors were required to meet a share ownership target. This year, almost 70 per cent of corporations in the S&P/TSX index have an ownership requirement, although the figure is much lower at income trusts in the index.

Some directors say various governance rating systems such as Board Games have helped to promote reform by compelling firms to consider their practices, even if they don't choose to make changes.

"Checklists aren't the only answer," says Carol Stephenson, a corporate director and dean of the Richard Ivey School of Business at the University of Western Ontario. "But it is making people stop and say, 'Where are we? And if we aren't following best practices, is there a good reason why we are different?'ƒ|"

Critics, on the other hand, say it is futile for anyone to try to assess governance from outside the boardroom by relying on factors that don't capture how directors actually behave.

Power Corp. of Canada and its public units have all been perennial low scorers in the Board Games governance project, losing marks in areas such as board and chairman independence, as well as various disclosure practices. Chairman Paul Desmarais Jr. has been a critic of these governance measures.

Mr. Desmarais declined to comment for this story, but has argued in the past that there is too much emphasis on director independence, even to the point that controlling shareholders of companies are considered "related" directors and are limited from sitting on key board committees. At the company's annual meeting this year, he explained that Power Corp. is driven by the quest for long-term shareholder returns, which is the most important measure of governance quality.

"Long-term returns to shareholders are a meaningful indicator of the effectiveness of a corporation's governance system," he said, as he highlighted the company's stellar returns over the past 30 years.

But Power Corp. may not be typical. It has attracted investors for decades because of the unsullied reputation of the Desmarais family for creating wealth. They haven't stumbled. And its dual-class shares have left minority investors with little clout to wield anyway. Both factors have left the family with more freedom to eschew recent trends.

Other companies have felt far more pressure to make changes, or have found it more difficult to defend practices that fall outside the mainstream, especially when profits slip or disappear.

On the other hand, it is clear that good governance is not a panacea, either.

It is easy to point to companies with blue-chip boards of business leaders who followed all current best practices, yet still faced scandals, earnings restatements and shareholder lawsuits. Nortel Networks Corp. is one classic example, where executives were accused of manipulating earnings to bolster their bonus payouts.

Tim Rowley, director of the Clarkson Centre for Business Ethics and Board Effectiveness at the University of Toronto, says the big governance lesson he has learned in recent years is that compensation trumps governance.

"You can get all the governance structural things right, but if you don't get the right pay package that gives the CEO the right incentives, you'll never see it come out the other end in terms of financial performance," he says.

Governance also doesn't promise good returns. Some companies with good marks in the Board Games study have weak five-year returns, and vice versa.

Many governance experts say it is not surprising that there isn't a clear correlation between governance practice and corporate profits because so many other factors are involved, not least of which are the work of management and the demand for products being sold.

Many directors believe the value of governance may be more directly linked to managing risks.

Jim Fisher, a director on the Canadian Tire Corp. Ltd. board and vice-dean of the Rotman School of Management at the University of Toronto, says good governance will help uncover problems earlier where they exist. And companies that don't have a "compelling" product or service may be "put out of their misery" earlier.

"Not all business ideas will work. Not all companies will be successful. That is not a judgment on governance," he argues.

Corporate governance is now beginning to face a new challenge — not from its critics but from its strongest supporters. Some voices are suggesting governance reform should end, at least among companies with leading practices, because more change will reap diminishing returns.

Manulife Financial Corp. chairman Arthur Sawchuk, whose company ranked at the top of ROB's ratings this year, says shareholder activism can go too far, forcing too much focus on compliance with new best practices and not enough on strategic issues.

"I think the job is done. There isn't much more that somebody can cook up, and I'm afraid it won't be of much value," he says. "The battle is pretty much won. We can declare victory, and let the other smaller companies catch up."

Manulife may indeed have won the battle — it certainly has been a fixture at the top of governance ratings lists. But a chasm remains between companies such as Manulife and those that have embraced few standard governance practices. This year, 11 per cent of companies assessed by ROB received a score below 50 out of 100, and only 14 per cent scored above 80.

"We are not kidding ourselves, there is still a lot to be done with mid-sized companies — they are really lagging," says Mr. Gibson of Teachers.