How do you topple a giant? As the biblical David discovered in the Valley of Elah, one little pebble can fell Goliath.
In the 21st Century, the giant is huge corporations like the once formidable Enron corporation. The Texas company employed 21,000 people and had $60 billion in assets before it went bankrupt in 2001 amid financial and accounting irregularities.
The pebble is a five-letter word: the board.
The new corporate wisdom in a post-Enron world is this: the strength (or weakness) of a company is contingent upon the strength (or weakness) of its board of directors – that independent group of people who oversee the paid management team on behalf of shareholders. Among other things, boards hire and fire the chief executive officer, review financial statements (and can appoint an independent accountant and auditor), and engage in strategic planning and risk management.
In corporate-speak, the role of the board falls under the rather bureaucratic moniker of corporate governance. In plain language, corporate governance is about the relationship between shareholders who invest, the CEO who spends the investment and the board, which bridges the two. Ultimately, though, corporate governance is about the safety of your retirement savings.
Though you may not realize it, you're a shareholder if you've invested in mutual funds or a pension plan. Those funds and plans invest your money, typically in publicly traded for-profit corporations. To the degree that these corporations are properly run, and that assumes having an effective board, your retirement savings are secure. But, as Enron investors discovered, when the giant falls, your savings evaporate overnight.
The strength of a board can be measured in two key areas (though there are many to consider):
- Are board members sufficiently independent from management that they can red flag items of concern?
- Do board members have access to detailed and timely reports in order to spot concerns?
Post-Enron, there have been major overhauls in corporate governance standards to ensure board independence and transparency of information, particularly from auditors and accountants. Leading the charge in Canada is the Toronto-based Canadian Coalition for Good Governance, formed in 2003. The CCGG helps its members (45 investment companies representing $810 billion of assets under management) build effective boards. In 2003, the coalition developed 12 guidelines outlining "minimum standards and best practices" for corporate boards. The guidelines are voluntary, and go beyond legal regulations.
"Regulations are only minimum standards," said Michael Wilson, CCGG chair and former federal finance minister, in his address to the coalition's annual meeting last June. "The truly effective boards are those that operate at the best practice level – those companies that have implemented excellent governance practices not because they were told to do so by a regulation, but because they want to; because it is what their shareholders would expect them to do; because it makes good business sense."
What are some of those best practices? They are constantly evolving: today's best practice may be tomorrow's minimum standard. But for the moment, the key word in corporate governance is independence, says Wilson. "Boards have appointed more independent directors, increased the independence of the committees, split the roles of chair and CEO and scheduled in-camera meetings of only the independent directors at each board meeting," Wilson said.
Another key word in governance is executive compensation, specifically the push by shareholders to tie compensation to performance. The full list of CCGG guidelines is on their website, but they also include:
- That board members own a minimum number of shares in the company (that way their own investments are on the line, too);
- That the majority of board members (at least two-thirds) be independent (meaning they have no material relationship with or financial benefit from the company other than director fees and share ownership);
- That board committees be composed exclusively of independent directors, because the heart of board oversight takes places in committees;
- That audit committees (which review financial statements and financial controls) fully comply with enacted and emerging regulatory standards in Canada (set by provincial Securities Commissions), and the U.S.
"The work of audit committees is critical to the restoration of confidence in Canadian capital markets," state the CCGG guidelines. At minimum, audit committees must have "transparent and understandable financial statements prepared that fairly reflect the financial affairs of the corporation." The CCGG also recommends that audit committee members be financially literate, as well as independent of management.
That didn't happen in the Enron case. A combination of accounting irregularities and poor oversight brought down the giant. New corporate governance rules, particularly in the area of auditing, aim to avoid a similar disaster here. Those rules and guidelines build on two key reports in Canada, and one U.S. law: The 1994 Dey Report, by the Toronto Stock Exchange Committee on Corporate Governance; the 2001 Saucier Report, sponsored by the TSE, the Canadian Institute for Chartered Accountants and Canadian Venture Exchange; and the U.S. Sarbanes-Oxley Act, passed by Congress in 2002. Generally, they stress independence, transparency and skill-competency at the board level.
Though the reports are targeted to for-profit companies that are publicly traded, "the principles apply equally to not-for-profit and charitable corporations," state lawyers Michael Watts and Kathy O'Brien in an article in Law & Governance.
Certainly the ripple effects of new corporate governance guidelines are making their way into churches, including The Presbyterian Church in Canada. The church's rough equivalent of a corporate board is the General Assembly, with the Assembly Council being the smaller body that provides oversight in between annual assembly meetings. "Some of the major shifts we've seen in governance are toward much more detailed auditing practices," confirms Stephen Kendall, principle clerk of the Assembly Council.
Currently, the PCC is audited by Price Waterhouse Coopers. "As you would expect, they have been responding to these changes for a number of years, and so the approach they take is one of increased demands in reporting requirements," said Stephen Roche, the church's chief financial officer. "The audit committee has been responsive to that, as has management."
Still, those increased reporting requirements are time consuming, and aren't limited to the PCC itself. The need for documentation extends to the church's partners overseas, too, particularly if these partner-projects receive government funds through Canadian International Development Agency. Rick Fee, general secretary of the Life and Mission Agency, and acting director of Presbyterian World Service and Development, has undergone a CIDA audit. The audit stems from new accounting rules that Fee suspects are prompted by fears of charitable donations funding terrorism overseas.
"Where previously funds were considered expended when they left a Canadian bank, no longer would that be the case. But only when they were properly expended at the other end for the project for which they were approved," explained Fee. This means PWS&D partners – some of whom are without computers, and electricity – must keep detailed written ledgers and receipts, and provide those to CIDA auditors. PWS&D staff is on the hot seat to chase those records. Since August, the audit has taken 50 per cent of the time of three staff members. "This degree of scrutiny is very time consuming and is costing us a lot of energy and money," comments Fee. "Some of the Canadian public will be assured that our money is being properly handled and will say we want this degree of scrutiny. But other Canadians might be generally scandalized by the effort that goes into it, or maybe just lament that the world has thus become."
Though the prompts may vary, improvements in governance practices are being adopted at a growing number of companies and charities. At the corporate level, according to the Rotman School of Management (University of Toronto) Board-Shareholder Confidence Index, the number of well governed companies has almost doubled in three years, from 46 in 2002, to 81 in 2005. However, 71 of the companies measured, almost half, still have work to do. That probably applies to some charities, as well.
It seems there's no turning back on what the world has become – a place where constant vigilance against fraud or incompetence are the order of the day. But the payoff is gigantic – no small pebbles will fell the giant of your investments and donations.
