In 2002, Report on Business developed a marking system to rate Canada's corporate boards based on a demanding set of "best practices" that draw from the recommendations of major institutional investors, academics and industry associations. The measures go far beyond the regulatory requirements set by Canada's securities regulators, and beyond new U.S. regulatory requirements.
After the first rating appeared, companies and investors offered feedback on how to improve the system. ROB added new categories and reduced the number of marks that can be earned in other areas.
The changes mean this year's marks are not precisely comparable with last year's, but because most of the categories are the same, ROB has included last year's mark to provide a rough comparison. We also included the five-year total returns for each company a demand of companies that rated lower in the review, but have a history of strong financial performance.
The marks are based on information published in the most recent annual shareholder proxy circulars of 207 companies in Canada's benchmark S&P/TSX index at the start of September. Three were excluded because they have not issued annual proxy circulars, including Air Canada, which is restructuring under bankruptcy protection. The chart shows the total mark for each of the four main categories, as well as last year's total mark. Full details of each company's marks are available at www.globeandmail.com/business. Here's how we marked them.
Board composition, worth 40 marks out of 100
1. What percentage of the company's directors are fully independent? That means directors are not management, relatives of management, former members of management within the previous five years, or people whose firms do business with the company, such as lawyers, accountants, consultants or investment bankers. ROB also marked as related those directors who come from a parent company that controls a public subsidiary.
Eight marks for boards with at least two-thirds independent directors; four marks if more than 50 per cent are independent; zero if there are a majority of related directors.
2. What percentage of the audit committee is fully independent?
Six marks if the committee is fully independent; two if there are one or more related directors who are not management; zero if a member of management is on the committee.
3. What percentage of the compensation committee the committee that determines executive pay is fully independent?
Four marks if the committee is fully independent; two marks if there are one or more related directors who are not members of management; zero if a member of management is on the committee or if there is no committee.
4. What percentage of the nominating committee the committee responsible for recommending new directors to join the board is fully independent?
Three marks if the committee is fully independent; two marks if there are one or more related directors who are not members of management; zero if a member of management is on the committee or if there is no nominating committee.
5. Is the role of chairperson and CEO split?
Five marks if the job is split; just two marks if the chairperson is a related director; just one mark if the chairperson is also a member of management. Two marks if the jobs are not split, but the company has appointed a lead director.
6. (a) Do three or more directors serve together on another company's board, creating the potential for a close-knit block of directors? Does a top member of management (CEO, executive chairman or president) swap boards with the top executive of another company?
Three points if no, zero points if yes to either question.
6. (b) Are any directors on eight or more corporate boards? (Not-for-profit, charitable or industry association boards don't count.)
Two marks if no; zero if yes.
7. Are there any women on the board?
Two points if one-third or more of the directors are women; one point if there is at least one woman; zero points if there are no women.
8. Does the board have a system to evaluate its performance?
Four points if there is a formal evaluation of the board and its committees, and if there is a formal peer evaluation done by all board directors; three points if there is a board and committee evaluation, and some form of individual director evaluation; two points if there are board and committee evaluations; one point if there is a casual mention of evaluation, but no details of a formal process; zero points if there is no evaluation.
9. Do independent directors meet without management?
Three points if directors meet without management at every meeting; two points if it is done regularly; one point if it happens occasionally; zero points if there is no mention of it or there are no meetings without management.
Shareholding and compensation, worth 21 marks out of 100
10. (a) Are directors required to own shares? (Stock options don't count.)
Four points if the requirement is mandatory and equals at least three times the annual retainer paid to directors, or 3,000 shares; two points if the requirement is lower; zero points if no requirement.
10. (b) Do the directors own shares in the company?
Four points for yes, but deduct one point for each director who owns less than 1,000 shares or $25,000 after a year on the job, or less than 2,000 shares or $50,000 after two years on the job, whichever is less. The calculation is based on the current share price.
11. (a) Is the CEO required to own shares? (Stock options don't count.)
Two points if share ownership is mandatory, or if the CEO is the majority or controlling shareholder of the company.
11. (b) Does the CEO own shares?
Three points if the CEO owns more than 50,000 shares after two years in job; two points if the CEO owns more than 20,000 shares; zero points if less than 20,000. For CEOs on the job less than two years, ROB lowered the ownership requirements to qualify for full marks.
12. Does the company give loans to its senior executives?
Four points if there are no loans, or if the company is a bank and makes consumer loans at consumer rates; zero points if loans are interest-free; three marks for loans to buy shares if they are under $500,000; two marks if over. If loans are for other purposes, two marks if they are under $500,000; one mark if over $500,000.
13. How good is the disclosure of compensation policies for CEOs?
Four points if the company explains in detail how it awards the CEO's bonus, including financial goals that must be reached, how much these targets count toward the bonus (compared with personal performance factors), and whether the criteria were met in the past year; three marks if the financial criteria for a bonus are disclosed, but details of the financial targets are missing; two points if only some criteria are mentioned; one point if there is only a cursory mention of benchmarks or performance criteria; zero points if there are no clear benchmarks identified or if it just says compensation is based on "corporate performance." We subtracted a mark if a bonus is guaranteed in a CEO's job contract, irrespective of performance; we deducted a point if the only requirement is revenue growth or operating income growth, because this can create a dangerous bias toward top-line growth even if unprofitable.
Shareholder rights issues, worth 24 marks out of 100
14. Do all directors stand for election annually? Or do directors serve staggered terms, making it difficult to oust an unpopular group?
Two points if yes; zero if no.
15. (a) Are stock options excessively dilutive for shareholders?
ROB assessed the number of options outstanding, plus the number that have been approved for issuance by shareholders, but have not yet been granted to employees. This shows the total potential number of shares that can be granted to option holders without further shareholder approval being required. For companies with multiple classes of shares, the survey measures the potential dilution of the class of shares that is diluted by exercising options, typically the widely held common shares.
Six points if the potential dilution is less than 5 per cent of current outstanding shares; five points if dilution is between 5 and 10 per cent of outstanding shares; zero points if the options are more than 10 per cent dilutive to shareholders.
15. (b) Is the annual grant rate excessive?
Two points if the number of options granted in the prior year was below 2 per cent of the total outstanding shares; zero points if it is above 2 per cent.
15. (c) Is there a vesting period before options can be exercised, creating a long-term compensation incentive?
Two points if there is a vesting period; zero points if some portion of options are immediately exercisable upon granting.
16. Has the company improved its option plan with more features?
16. (a) Is there an option plan for directors, and is there a limit to the number of options directors can receive? This is a good way to ensure directors cannot take advantage of their control over stock options.
Two points if there are no stock options for directors; one point if there is a cap on director option grants; zero points if directors participate in the option plan at the board's discretion.
16. (b) Has the company introduced other features to improve its option plan, such as performance requirements that must be met before options can be exercised, or requirements that shares must be held for a period after options are exercised, or a formal policy to permanently significantly reduce the use of stock options?
Two points if yes; zero points if no or if a company has repriced its stock options in the past year.
17. Are there non-voting or subordinate voting shares?
Eight marks if no. ROB gave reduced marks depending on the gap between the percentage of votes controlled by the superior voting shares and the percentage of the company's equity they represent. Zero votes if the voting control is five times greater than the equity ownership stake in the company.
Disclosure issues, worth 15 marks out of 100
18. (a) Does the company have a full statement of corporate governance practices?
Two points if the company fully addresses all of the topics required by the Toronto Stock Exchange ; one point if there is a partial statement; zero points if there is no statement.
18. (b) Does the company offer a detailed explanation of which directors it considers to be independent or related, and why?
Three points if there is full disclosure; two points if a company calls a director with close relationships an "independent" director; Zero points if related directors are not identified by name, including a statement that a "majority" or a specific number are independent, without identifying their names.
19. Does the company disclose how much it paid its auditor for consulting and other work?
Three points if all details are disclosed; two points if there is disclosure but the consulting fees were higher than the audit fees; one point if consulting work is double the audit work.
20. Does the company disclose detailed biographies (including other boards that directors sit on) to explain directors' qualifications to represent shareholders ?
One point for each.
21. Does the company disclose director attendance records at board meetings?
Two points for disclosure, but minus one point if a director missed more than one-third of board meetings.
22. How often did the board and committees meet last year?
Three points for full disclosure; two points for partial disclosure; zero points for no disclosure.