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'Everybody is in a state of self-examination'

Boardrooms are finally beginning to change after a year of focus on corporate governance, writes JANET McFARLAND

After more than a year of intense focus on corporate governance, Canada's boardrooms are showing signs of concrete change.

Governance experts say that months of talk about improving boards of directors is translating into action, and companies are making a slew of reforms in areas such as committee composition, board practices and compensation policies.

"One of the things that has happened is that everybody is now in a state of some kind of self-examination, really looking at whether we are doing all the things we need to," said Diane MacDiarmid, chief executive officer of Mercer Delta Consulting Canada.

Ms. MacDiarmid said she has especially noticed her firm's clients are focused on moving beyond merely technically complying with the Toronto Stock Exchange's recommendations for boards.

"We are beginning to see a move away from straight compliance with whatever set of regulations to something more about effectively using the resource that is the board," she said.

"Historically, there have been many boards that have effectively had the role of rubber-stamping management decisions. I think most corporations have realized that is just a complete squandering of a very valuable set of resources."

Experts say that one of the most popular areas of change today is in board assessments, where directors assess their boards' operations to try to improve practices.

Many boards have been doing assessments of the board as a whole but more are now considering adding self-assessments of individual directors and even peer assessments of individual directors by others on the board.

Toronto lawyer Peter Dey, who sits on the boards of companies such as CP Ships Ltd. and Camco Inc., said assessments have become more important and less routine.

"I think the evaluation system is now being applied with greater rigor," Mr. Dey said. "All directors, as a result of that, are conscious that their contribution is being judged, and they're very anxious to make a meaningful contribution."

A joint survey by Patrick O'Callaghan & Associates and Korn/Ferry International, released in January, showed that 60 per cent of Canada's 313 largest companies have formal board assessments, while another 31 per cent said they do some form of informal assessment. But only 15 per cent of boards reported that they have a formal evaluation of individual directors.

Mr. O'Callaghan said boards tend to move along a continuum as they develop a "culture of evaluation," starting by developing mandates and job descriptions for committees and directors, then doing board assessments, then self-assessments and, finally, peer assessments of individuals.

"The time has come," Mr. O'Callaghan said. "Many boards have been through the process over the last four or five years and they're at a point now where they have good board and CEO evaluation, and it's time to see how they can evaluate individual directors."

Boards are also now commonly holding meetings of directors without anyone present from management, allowing directors to talk openly.

And Mr. Dey said boards are also trying to find ways to make part-time directors more familiar with a company's operations to deepen their understanding of key strategic issues.

For example, he said one board he sits on has asked directors to make presentations to the board on various key issues, requiring them to work with senior management to prepare the information.

"As an example, the board could say: 'Peter, at the next meeting, we want you to present something on the security requirements given what's going on in the world.' To me, it's an interesting technique for getting directors really engaged in the business," Mr. Dey said.

Bill Dimma, a director on the boards of companies such as Home Capital Group Inc. and Magellan Aerospace Corp., said boards have responded quickly to make improvements because the turmoil caused by corporate scandals in the United States has had such a direct impact on share prices.

"Of course, if it didn't have an influence on the share price, perhaps the influence on directors wouldn't be so great," said Mr. Dimma, who is the author of Excellence in the Boardroom, a corporate governance book.

"But look what has happened in the market. And a significant part of that has been loss of faith in CEOs and in boards and in the free enterprise system. So we ought to be paying attention."

Mr. Dimma said he has seen the most reform in the past year at the level of board committees, especially the audit, compensation and corporate governance (or nominating) committees.

The New York Stock Exchange introduced new rules last summer requiring listed companies to have these three committees, and to have them composed entirely of independent directors. In the United States, audit committees also face new requirements under the federal Sarbanes-Oxley Act, including a requirement to have at least one accounting expert on the committee.

Many Canadian firms are matching these standards, either because they are listed on the NYSE, or because they want investors to see that they follow best practices.

Mr. Dimma said he sits on all three of those key committees at different companies, and has seen shifts in all of their operations. But he said the audit committee has had the most change.

After the collapse of Enron Corp. in late 2001, audit committees became a particular focus because they are directly responsible for supervising the external auditor and reviewing a company's financial statements.

Mr. Dimma said audit committee members are now much more sensitive to the importance of the responsibility and to the liabilities that go with the job. Meetings are longer and many more questions are being raised as directors insist on understanding key decisions. "Nothing is taken for granted," Mr. Dimma said.

There is also more assessment of the financial literacy of committee members, and some companies are adding new directors to their audit committees to boost their accounting expertise. Suddenly, chief financial officers and former heads of accounting firms are the new hot directors being recruited for boards.

Mr. Dimma said audit committees are now taking far more direct responsibility for supervising auditors, shifting the focus of auditors away from management and toward the board.

"The external auditor traditionally might have had a formal relationship with the audit committee but the day-to-day stuff was between management and the auditor," Mr. Dimma says. "I think most external auditors, until recently, saw their line of responsibility and accountability usually to the CFO."

Mr. Dimma said he believes the shifting of accountability is somewhere in transition, as boards increasingly take a more active role in managing the auditors.

"I'm pretty confident that within a couple of years, that transition will be complete," he says.

Nominating or corporate governance committees are also seeing changes. These committees are responsible for proposing new nominees to the board, moving the responsibility away from management or the chairman.

Few companies even had such committees a decade ago -- or even five years ago -- and new directors were nominated by the board as a whole, often on the advice of the chairman and the CEO.

Now almost every large company has a nominating committee, and those that don't have one are moving quickly to create one to comply with NYSE standards.

Mr. Dey said nominating committees tend to professionalize the search for new directors.

"The concept of the Old Boy's club is really a concept of the past," he says. "I think boards are much more creative when it comes to seeking directors. They look first of all for the right skill set. They've studied the range of competencies on the board and they look for people to fill the holes."

Compensation committees have also become a particular focus of reform. Many activist shareholders have particularly focused on compensation-related issues in their protests, and stock options have drawn sharp criticism for being excessively dilutive to shareholders and for failing to align the interests of management with those of shareholders.

Mr. Dimma said he has seen compensation committees most especially debate whether compensation is in line with the company's recent performance.

"There's definitely more of an attempt to link performance and compensation than in the past," Mr. Dimma said.

He said compensation committees are also beginning to hire their own consultants to advise on appropriate compensation levels, because consultants hired by senior executives are perceived as being aligned with management when recommending compensation increases.

"There's a feeling that we don't want to use the recommendations of the external compensation consultant that management has used. Or we don't want to rely solely on that," Mr. Dimma said.

Ms. MacDiarmid at Mercer Delta Consulting said she has also noticed a greater interest in corporate governance reforms among closely held companies, which often are run by the founder and largest shareholder.

"I think in general the tide is changing for everybody in the sense it's moving all boats in different directions," Ms. MacDiarmid said. "I've had conversations recently with some controlled companies and they are interested in using the [board] more effectively."

Many of these companies have traditionally resisted requirements that dilute the CEO's power, such as guidelines to have a majority of independent directors or to separate the roles of chairman and CEO.

But Ms. MacDiarmid said some of these companies are facing pressure to change as they list on U.S. exchanges or seek financing outside Canada, where there is less willingness to accept different governance standards for family-owned companies.

"The world is becoming a much more global place, and we're not just talking about being capitalized in Canada any more for most of these companies," she said.

© The Globe and Mail

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