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The Heartbreaking (But All-Too-Common) downfall of XYZ Corp. Add to ...

It was at a board meeting in the middle of 2009 that I finally lost it as a corporate director.

It had been a sometimes exasperating three years since I joined the board of directors of a small, TSX-listed manufacturer-let's call it XYZ Corp. What made this moment stand out was the response I got when I read a passage aloud from a two-year-old report on one of the company's factories.

The report observed that the departments at the plant communicated with each other so poorly that the place tended toward "disaster management only." Engineering, maintenance, quality control and the rest each did their own thing, coming together as a team only when there was a serious problem. But then there would be no plan to get production back on track once matters were under control. This pattern, the report noted, tended to lead to new problems erupting in other areas.

I then asked the CEO-who we'll call Smith-if things had improved. Smith admitted that, now, two years later, the problems at that facility had not been fixed. Well, top marks for honesty.

It was disturbing enough to learn that this situation had been festering for two years after XYZ had been told about it. But even worse, it soon became clear that the board was simply not going to hold CEO Smith, or anyone else, accountable for this mess.

This actually didn't come as a huge surprise. Alas, XYZ was a model of the lax corporate governance that plagues too many Canadian public companies.

Between its IPO and its sale to a competitor roughly a decade later, XYZ lost money in all but one year. The sale price was less than 4% of the IPO price. Over the final three years, Smith, who had been CEO since before the IPO, had terminated seven senior executives, each of whom had been with the company for less than three years.

But the board was never able to bring itself to seriously consider replacing Smith. I was not the first board member to try to bring about change at the top. It just couldn't happen.

Why? Because of the too-close relationship between board and senior management-the most intractable problem in corporate governance. It's something often framed in moral terms: Think of the outrage in the United States over monster CEO bonuses. But the costs go far beyond any affront to our values.

Suffer the little shareholders, to begin with. Boards that will not impose accountability on a CEO are rolling out the red carpet for financial underperformance.

And when workers see that the higher-ups are not held accountable for their missteps, it engenders a cynicism that over time can permeate an entire organization. If a workplace starts to resemble the anti-office of Dilbert, make no mistake about who is responsible: the board of directors. Ordinary employees deserve better.

On a larger scale, if companies are being run more for the benefit of management than shareholders, or if they are run poorly because cozy governance keeps weak management in place, it will involve the entire economy in a misallocation of resources and thereby make all of us-well, most of us-a little poorer.

The implicit message from directors to shareholders runs something like this: "Give us your money and we will represent your interests in an organization managed by people who have an incentive to steal from you and who we've known for years and with whom we confer regularly in private meetings. You don't get to attend these meetings or even get to know what goes on in them. In the meetings with management, we will set their level of compensation and then, with their approval, we will set our own level of compensation. Don't worry, the two processes are totally unrelated. No, you don't get to vote on the level of compensation for either them or us-and, yes, you will be paying for all of it. You can trust us because we're independent of these people with whom we've been conferring privately for years." It's almost like something out of a Kafka novel, with the shareholder in the role of the confused and doomed protagonist.

You might respond that the reality at most companies is not so bad as this caricature would suggest. But the egregious cases that do come to light illustrate a basic contradiction that all public companies must contend with: Boards have to fulfill two roles that can be hard to reconcile.

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