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Independent directors are key to proper governance

Creating a structure to ensure that directors are fully independent of management is step one -- and the most important step -- on the journey to superb corporate governance.

I am sure that others will deal comprehensively with this aspect of corporate governance so I would like to address another aspect. It is the importance of choosing the right goals and objectives for management to pursue, measuring progress against these objectives regularly, and rewarding management for achieving them.

I was a CEO for 20 years and I regularly visited institutional investors who were interested in our company. Almost always they would tell me that they would like me to find opportunities to use spare cash to create quality long-term growth. Dividends were important but came second. However, if there was spare cash, it should be returned to the shareholders. I vividly remember one shareholder saying, "Newall, in our experience, a CEO sitting on a pile of cash is an accident waiting to happen."

How, then, did North American companies become so fixated on delivering the next quarter's numbers even to the detriment of quality long-term growth? This obsession has contributed to the unethical manipulation of the accounting books we've seen so often.

At CPR, one of the most critical objectives is to deliver an operating ratio that ranks with the best in North America. It will take several years to achieve, has required huge investments of new capital and massive reorganizations of management.

But management has the solid support of the board on the primacy of this objective over near-term EPS [earnings per share] growth. CP is already the North American leader in rail safety.

At Nova, improving cash flow cycle time (CFCT) is a critical long-term objective that improves annual performance. Last year, at the worst of the chemical cycle, they reduced debt by over $300-million, partly due to progress with CFCT. They are the best in their industry. Each year they reduce fixed costs per unit of production by a minimum of 5 per cent.

Think of the cumulative impact on the quality of the business. They are already the lowest-cost producer of olefins and polyethylene in North America. The company is focused on being the world's best commodity chemical company. This objective rules.

The CP and Nova action plans will deliver very strong, high-performance companies for decades to come. This illustrates why I believe that boards must guide management to focus on improving the underlying quality of the business in the short, medium and longer term. Near-term EPS growth must be subordinated to this focus. The management team must have a high sense of urgency about delivering results but must not be rewarded for placing short-term earnings first.

© The Globe and Mail

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