Corporate Governance Questions

Often, framing questions well is more important than coming up with the ‘right’ answers. This is certainly the case when addressing the vexing issues surrounding 21st-century corporate governance or accountability. While it is tempting to identify individual scapegoats, the issues are typically too complex to allow for such simplistic approaches. As Peter Drucker said almost 30 years ago, “Whenever an institution malfunctions as consistently as boards of directors have in nearly every major fiasco of the last 40 or 50 years, it is futile to blame men.”

A column by Gretchen Morgenson in the New York Times late last year illustrated the concern. In it, she focussed on the fact that each of three major US public companies (Sunoco, Paccar Inc. and Tetra Tech Inc.) have two long-standing directors who also served on boards of companies that were centrally involved in the US mortgage meltdown (Fannie Mae, Countrywide, Washington Mutual and IndyMac Bancorp). While acknowledging the (admittedly, enormously impressive) qualifications of this random group of directors, the author appeared to conclude that they were too timid, lazy or greedy to do their job properly. She commented that they were able to “skate away” from problems that occurred on their watch, and cited their continuing service on major corporate boards as an example of “refusal of those involved in the debacle to accept responsibility for it.”

Without knowing the specific facts (which the author did not describe), it is difficult to respond other than with the reasonable observation that most directors with qualifications and reputations of the calibre that she described make a significant effort to be thoughtful about their role. One may also observe that each of the failed institutions on whose boards these particular directors served were highly regulated, and that, by all accounts, the failures were as much political and regulatory in character as they were ones of board oversight.

Regrettably, such effort to assign blame will likely provoke facile responses. It mistakenly emphasizes individuals as the source of what tend to be systemic failures, and often results in regulatory responses that deny human nature and encourage bureaucratic formalization.

Recognizing the limits to our virtues may be as important as addressing our vices. When Pope John Paul II eliminated the role of the Devil’s Advocate (a canon lawyer whose job was to argue against the canonization of candidates), he was able to canonize over 500 individuals, as compared to only 98 canonizations by all of his 20th century predecessors.

One lesson that should have been learned from the recent market failure is to be modest about expectations, and vigilant about continuously reflecting on governance and regulatory processes. A survey of public risk disclosures of major financial institutions just before the start of the financial crisis uniformly indicated stellar risk management processes. Presumably, the answers were genuine, if naïve. Such ‘Potemkin villages’ can only lead to complacency and public mistrust. We need to ‘keep it real.’

Why does this matter? Never before has the role of corporate directors been more challenging or important. Absent a radically new paradigm, this is likely to continue to be the case. Rather than pretending that all is well or, worse, continuing to maintain the appearance of quick ‘solutions,’ would it not be preferable to step back and focus on framing the questions better? Before assigning blame, should it not be asked whether these enormously qualified and experienced people were being asked to do a job that they could reasonably be expected to perform?

Corporate governance has become a victim of its own success. What is expected of directors has tended to grow with each crisis for which they are blamed. Not surprisingly, a recent survey of 45 directors of US public companies by the Harvard Business School’s Corporate Governance Initiative concluded that directors themselves are becoming interested in getting better clarity and a more precise understanding of their proper role, and view this (rather than government action) as key to enhancing board effectiveness.

Framing such questions is not a simple exercise, and may well lead to surprising ideas. For example, the first of the recent Harvard Business Review’s list of “breakthrough ideas for 2010” cites data that suggest that the manner in which directors’ legal duties have been tied to maximizing shareholder value has actually led to lower shareholder returns! The issue may be less one of corporate ‘ownership’ or which stakeholders should enjoy ‘primacy,’ and instead more one of trying to figure out how to optimize corporate performance (and value) by finding ways to overcome short-termism. Shareholder value is a result, rather than a strategy. The author suggests that a focus on customer value may be a better way to achieve that result.

It may well be that we are reaching a point of diminishing returns in efforts to tweak corporate governance standards. Repeated attempts to regulate executive pay are a case in point. There are bigger questions to be asked, and different actors to engage. For example, a fertile ground, in terms of exerting influence to encourage a focus on longer-term sustainability and accountability, must surely be how best to engage the large institutional investors that now dominate markets in most asset classes, and whose mandates (and obligations) tend to be longer-term in nature. These investors have the resources and influence, and are learning how to use them. How can we ensure that incentives are properly aligned, both for them and their services providers?

The leverage in framing such questions could be extraordinary. There is a relatively small and coherent network of major public pension funds around the world. Canada could easily take a lead role, as it benefits from a disproportionate number of world-class players (including the likes of the Canada Pension Plan Investment Board, the Ontario Teachers’ Pensions Plan, the Caisse de Dépôt, and the British Columbia and Alberta Investment Management Corporations) that are leaders in best practices.

Likewise, Canada enjoys a number of world-class controlling shareholders (such as the Desmarais, Southern, Thomson and Weston families) who have demonstrated the challenges and benefits of long-term stewardship. Here, too, Canada might have an important perspective to contribute on the need for leaders (including, but not limited to, corporate directors) to extend their horizons – further ahead and beyond a narrow view of the scope, risks or impacts of the activities undertaken by their organizations.

As we have become more acutely aware of the interconnectedness of issues and institutions, and of the need to overcome personal and institutional myopia, a critical challenge has emerged: How can we best recalibrate governance structures and regulation to promote sustainable, long-term growth? How can we best address fundamental imbalances? What role should ownership play in governance? Neither facile and heavy-handed regulatory interventions nor unrealistic expectations of market (or governmental) actors are likely to help us overcome short-termism and achieve a more responsible and balanced approach to business and investment. The starting point must be to think hard about framing the right questions.

biolineMarshall Cohen chairs the Advisory Board of the Hennick Centre for Business and Law at York University, and is counsel at Cassels Brock & Blackwell LLP.

Ed Waitzer holds the Jarislowsky Dimma Mooney Chair in Corporate Governance at York University, and is Director of the Hennick Centre. He is also a partner of Stikeman Elliott LLP and a former Chair of the Ontario Securities Commission.

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