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Independence makes big gains in the boardroom

Tougher rules and shareholder pressure have pushed Corporate Canada to appoint a far greater number of independent directors to their boards and key committees, our third annual review of governance practices reveals. And, as JANET McFARLAND and ELIZABETH CHURCH discover, boards are going further than ever, adopting changes that allow directors to act more independently

The Globe and Mail, Oct. 12, 2004

The boards of Canada's largest companies have become far more independent over the past two years, pushed by stronger rules, higher stakes and shareholder pressure, Report on Business's extensive third annual review of Canadian corporate governance practices reveals.

Companies have made significant shifts in the makeup of boards and their key committees, appointing a far greater number of independent directors, the Report on Business review shows. Boards are also embracing more procedures designed to boost independent action by directors -- for example, an increasing number of boards say they regularly hold private meetings of independent directors with no management present.

"What you are seeing is the slow adopters catching up," said Arthur Sawchuk, chairman of Manulife Financial Corp. He said that, now that most companies have implemented reforms, it is time for boards to move beyond establishing safeguards to focus on growth.

For the second time in three years, Manulife finished in top spot in the Report on Business rankings of governance practices among companies on the S&P/TSX composite index. Manulife scored 95 out of 100 in the latest survey, after tying for first in 2002.

There was a three-way tie for second place, with Bank of Montreal, Finning International Inc. and Suncor Energy Inc. all scoring 94.

David Beatty, an independent director on the board of Bank of Montreal and managing director of the Canadian Coalition for Good Governance, says there have been broad improvements to governance in recent years as unfolding scandals have made directors keenly aware of the consequences of weak standards.

"It's definitely moving to the good over the last three years," he said in an interview. "I feel I'm running down the hill behind the stone, with my hand keeping it rolling to make sure it's going. . . . In Corporate Canada, the larger corporations are very much seized with the issue of governance."

The Report on Business review found that only 7 per cent of companies in Canada's benchmark S&P/TSX index still do not have a majority of independent directors on their boards, down from 21 per cent in 2002, when Report on Business first conducted its landmark research. And a full 59 per cent have boards with more than two-thirds of their directors entirely independent from management, up from 43 per cent two years ago. (The statistics are from only the 183 companies that have been in the index for each of the past three years.)

Major missteps not only spark visits from investor groups, companies have found, but also multiple shareholder lawsuits, and a sharp selloff of shares.

Bill Mackenzie, president of shareholder activist Fairvest Corp., says shareholders are sending their most direct signal to companies through their proxy votes. Major institutional investors now routinely withhold their votes for directors who are not independent, especially if they sit on the critical audit and compensation committees.

"Certainly we've recommended against a number of directors at numerous companies on the basis of independence," he said.

In response, companies have been moving quickly to reformulate their boards to reassure investors that directors' interests are fully aligned with those of shareholders rather than management.

Among the striking changes, the Report on Business data show that 86 per cent of companies now have fully independent audit committees containing no members of management or related directors, compared with 56 per cent in 2002.

Also in 2004, almost 65 per cent of companies had independent compensation committees to review executive pay, up from 42 per cent in 2002.

And more companies have also appointed a fully independent chairperson to oversee boards, continuing to move away from combining the chair and chief executive officer positions. In 2004, 77 per cent of S&P/TSX index companies had split the roles, up from 70 per cent in 2002.

Even more significantly, companies splitting the two roles are appointing chairpersons who are not members of management or otherwise related to the company. In 2004, 44 per cent of companies have fully independent chairpersons, up from 34 per cent in 2002.

Some of the independence changes to boards have been forced on companies by new regulations, especially in the United States. The Sarbanes-Oxley Act, passed in 2002, requires companies to have fully independent audit committees, while New York Stock Exchange listing rules now require companies to have independent compensation and nominating committees, as well as a majority of independent directors.

Even those companies that trade only in Canada are facing regulatory pressure to make changes. Most of Canada's provincial securities commissions have adopted new rules requiring boards to have independent audit committees by July, 2005, at the latest. And regulators are also drafting voluntary guidelines that will recommend majority independence on compensation and nominating committees.

Charles Baillie, the former chairman and chief executive officer of Toronto-Dominion Bank, who now sits on several boards, says companies are responding to the times by reforming their governance practices, but cautioned that directors must not be distracted by this.

"There has been so much pressure because of the scandals to make sure your governance looks good," he said. "There are pluses to that, but there are dangers, too. The board needs to be sure that it has good governance, but it must not get consumed by process."

Critics of regulatory intervention have complained about the independence trend, noting that directors who meet strict independence rules may not actually perform well, and say independence itself does not guarantee directors are knowledgeable and diligent when they sit at the board table.

But shareholders say independence generally has a logical benefit because directors are distanced from management, and is a factor that can be measured from a distance, even if shareholders cannot individually assess the mindset of each director.

"No one is going to be inside every person's head," argues Mr. Beatty from the Canadian Coalition for Good Governance, which represents large institutional investors. But he said experts and shareholders typically agree that independence is generally positive.

For many directors and governance experts, the solution is to consider independence to be a starting point for a good board, but not the final answer.

"The independence issue is important and necessary but not sufficient," notes David Nadler, chairman of New York-based Mercer Delta Consulting.

Mr. Nadler, who has worked with numerous boards, said many directors are technically independent but fail to act independently.

"There is another dimension that is harder to measure, which is psychologically how willing is someone to challenge the CEO and stake out an independent position," he said.

He believes the most essential element for fostering independent behaviour is the existence of regular meetings of independent directors without management, which is now a requirement for companies listed on the New York Stock Exchange. Canada's securities regulators have also recommended in-camera meetings for companies as part of the draft of new voluntary governance standards.

"I think it is one of the big, unheralded changes," Mr. Nadler said.

Indeed, many prominent directors in Canada say meetings without management present have been a key feature of independent board behaviour, allowing directors to freely raise concerns before problems become crises.

"If there are issues, it is really important that they are nipped in the bud. That, I think, is the magic of in-camera sessions," said David Galloway, a long-time director and new chairman of Bank of Montreal.

In fact, many veteran directors say that, as board members become more at ease speaking their minds in private, it becomes easier for them to voice concerns with the CEO in the room. Such freedom of communication, they say, can be even more constructive.

David O'Brien, chairman of Royal Bank of Canada and EnCana Corp., and a director on several boards, said as boards gain experience with in-camera meetings, he finds they are more comfortable expressing opinions during private sessions that include the CEO.

"There is a tendency in the early days for people to complain about this, that and the other thing, which frankly would have been better if the CEO had heard it and responded," he said. "I have said [as chairman] if there is anything you think the CEO should hear, I want you to say it now -- otherwise, it just becomes a carping session."

In 2004, the Report on Business review found that 47 per cent of S&P/TSX companies said they hold in-camera sessions at each board meeting, while another 22 per cent said they hold them regularly.

These changes form part of a broad improvement in governance standards since the Report on Business began its review in 2002.

In 2004, for example, 10 per cent of companies received a score of 90 or better in the Report on Business survey, up from 5 per cent in 2003 and just 2.2 per cent in 2002.

At the other extreme, fewer companies scored in the lowest tier below 50 this year. Just 11 per cent of companies scored 50 or worse in the study, down from 15 per cent in 2003 and 27 per cent in 2002.

Despite these gains, there are still areas of broad weakness.

Boards do not appear to be growing noticeably more diverse, for example, with 46 per cent of companies having no women on their boards, a level basically unchanged from last year.

While a handful of Canadian companies have eliminated their subordinate voting share structures in the past year, the use of unequal voting shares remains common in Canada. The Report on Business's 2004 review found 23.4 per cent of S&P/TSX companies have unequal voting shares, compared with 26 per cent 2003.

And another area of weakness continues to be disclosure of compensation policies, with only a few companies providing detailed explanations to shareholders of the procedures used to set CEOs' bonuses. Only 5 per cent of companies earned full marks in the Report on Business ranking for their compensation disclosure practices, while 22 per cent earned a score of zero for providing no information at all about the financial factors that are taken into account when deciding compensation.

Michael Wilson, a corporate director and chairman of the Canadian Coalition for Good Governance, said the CCGG has tried to focus on some of the weakest governance examples, and has lobbied companies to make changes.

He said the standard response from some companies is that they are not interested in governance, and consider the only important factor to be their financial performance.

But he says the two cannot be separated. Companies with poor governance have a higher investment risk, he says.

"Why put my customers' money in them," asks Mr. Wilson, who is also chairman of investment firm UBS Canada.

"If I have a choice between two companies, [poor governance] is the risk element that is going to influence me away from a particular company."

These are the 10 top-rated companies in the Report on Business 2004 survey of corporate governance in Canada. Companies were rated on board composition, compensation features, shareholder rights and disclosure practices.

No. 1: MANULIFE FINANCIAL - Rating 95/100

No. 2: (tied) BANK OF MONTREAL - Rating 94/100

No. 2: (tied) FINING INTERNATIONAL - Rating 94/100

No. 2: (tied) SUNCOR ENERGY - Rating 94/100

No. 5: (tied) BANK OF NOVA SCOTIA - Rating 93/100

No. 5: (tied) CN RAILWAY - Rating 93/100

No. 5: (tied) CANFOR CORP. - Rating 93/100

No. 5: (tied) ENBRIDGE INC. - Rating 93/100

No. 5: (tied) ROYAL BANK OF CANADA - Rating 93/100

No. 5: (tied) SUN LIFE FINANCIAL - Rating 93/100


At the top: Manulife Financial

Chairman Arthur Sawchuk says it is time for boards to focus on value creation, rather than protecting the reputations of management and directors. B9

At the bottom

Some of Canada's biggest companies don't heed investor concerns and regulators' guidelines about buffing up their governance record. B11

The rankings

Canada's definitive ranking of corporate governance and board composition, and a peek inside the Report on Business marking system. B10


The new directors on board

It helps to have a blue-chip background, but the clubby world of directors is getting more diverse. Also: How Harlequin's Donna Hayes got on the TD board.


Winds of change

In an era of increased accountability, investors make public demands for change. And behind the scenes, directors undergo performance reviews.


Tackling turmoil

Boards have handled a range of crises this year, from bankruptcy protection to allegations of shareholder impropriety. They're finding new ways to manage the turmoil.


More data

A full explanation of the ROB governance standards, plus the item-by-item results for each company in the survey at

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