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Saturday, Feb. 4, 2006

Governance changes more than skin deep

Globe and Mail
Wednesday, Sep. 24, 2003

The danger with a project like Board Games -- the Report on Business annual assessment of corporate governance practices in Canada -- is that it can inadvertently encourage superficial reform.

Companies can make skin-deep structural changes, or even just change some disclosure practices, and see their marks improve against some of the survey categories. Yet nothing fundamental has improved at the boardroom table, and shareholders are no better served.

Indeed, with a plethora of governance ratings available these days -- including ISS, S&P, Moody's, GovernanceMetrics and various media projects -- some companies are almost certainly going to end up making minimal adjustments so that they can tick off the boxes on various questionnaires. "Sure, we have a board assessment process. Tick. Sure, we ask our directors to own shares. Tick." And this is pretty much the only actual effort that goes into those issues.

But is this all that's going on?

In short, it's not. The latest ROB rating of corporate governance practices found widespread improvements this year across a range of issues, even though the assessment system was toughened to try to ensure it measured true reform. To do this, ROB delved more deeply into the quality of companies' actual practices to see how sincerely best practices have been embraced.

For example, the survey this year examined what kinds of board assessment systems companies say they have adopted, and awarded higher marks if companies disclosed that they have set up a good system to assess the work of individual directors. Companies got lower marks if they made only superficial mention that they do assessments, or said they do not assess the work of individual directors, but only the board as a whole.

In another area, ROB awarded more marks to companies that say they set aside time at every board meeting to have in-camera sessions without management present. This is a widely recommended practice to ensure directors feel free to air their concerns bluntly, without worrying about pulling their punches in the presence of management. This practice is so valuable it's a mandatory requirement for companies listed on the New York Stock Exchange.

In the ROB study, companies that reported their boards only meet "regularly" or "occasionally" without management present got fewer marks than those that say it's done at every board meeting. The hope was that this would reward companies that have made a true effort to adopt a rigorous system.

In the same vein, the ROB review expanded its assessment of stock option programs. Last year, the study only measured stock option dilution levels. But this misses concerns about option programs, and can reward companies that make huge annual grants of options that can be quickly exercised. Because these options do not remain outstanding for long, the "overhang" of high potential dilution can disappear quickly. Yet these option plans are not moderate or favourable to shareholders.

So the ROB study decided to also look at annual grant rates, vesting periods and other option plan features, to try to ensure that full marks only go to those companies that have truly thought about the real impact of option plans.

Despite these and other changes, all made to ensure top marks would be awarded only for absolute gold-standard practices, marks in the survey rose significantly. More than two-thirds of companies saw their scores climb in 2003 from 2002. (Because of the tough new marking changes, the totals are only roughly comparable.) The average mark climbed to 66.5 out of 100 from 61.7 last year. Just 13.5 per cent of companies got a score below 50, while 24 per cent were below 50 points last year.

This has to be encouraging. It means that for every company out there that makes superficial improvements, there are others that have done much more. They have changed their boards, adopted new practices, looked at their compensation systems and improved their disclosure.

The next hurdle: Canada's smaller companies. The ROB study only looked at 207 companies in the benchmark S&P/TSX index, and even some of the smaller companies in this elite group need improvements. CoolBrands International, a fast-growing frozen treat maker that joined the index last year, has just one independent director on its board (a self-employed businessman who owns a plumbing company), and the rest are members of management.

Companies that aren't in the index have an even spottier track record. Some have taken governance seriously and have made improvements. But for the most part, governance reforms have tended to penetrate only the very top tier. And because the big firms have a high profile, it could encourage a complacent belief that governance reforms are finished because most companies now have decent structures and practices.

The best conclusion to draw from the 2003 data is that there have been changes to boards and their practices, but areas of weakness remain. Big companies have areas that still need work, and small companies are going largely unassessed. It's getting better, but we're not there yet. Application Error

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