Unfinished business: Where corporate governance still falls short

Corporate governance standards are continually rising. And while many Canadian companies are rising to that challenge, others still lag.
After decades of reforms, it is tempting to think that the big issues of corporate governance have been largely resolved, but many remain controversial. In areas such as diversity, compensation and shareholder rights, shareholders are pushing back on poor processes and complaining about the lack of progress.
Many of Canada’s corporate giants have polished their policies in an attempt to receive governance blessings from proxy advisory firms, rating agencies and influential shareholders. Smaller companies, in particular, lag behind, struggling to meet new expectations.
This is the first year Global Governance Advisors has joined as a partner in Board Games, The Globe and Mail’s annual corporate governance rankings. For 2022, we have overhauled the criteria to put more emphasis on areas of pressing shareholder focus. Board Games has increased its expectations for diversity, annual say-on-pay votes by shareholders on executive compensation, excessive use of stock options and CEOs sitting on other corporate boards, among a number of criteria.
As part of that new emphasis, we have taken a closer look at just a few of the hot spots of governance where companies, shareholders and regulators might all do better.
The Globe and Mail’s comprehensive ranking of Canada’s corporate boards
Board Games 2022: How we ranked Canada’s corporate boards
Board Games Methodology for 2022
When Mark Podlasly was arranging a panel discussion on Indigenous participation in corporate boardrooms for last year’s First Nations Major Projects Coalition conference, he knew the field of potential speakers was thin. Still, seeing it up close was startling. At the end of 2020, Indigenous board members at Canadian public companies numbered seven in total.
“We had five of the seven on the panel. We knew everybody,” said Mr. Podlasly, the coalition’s director of economic policy, a director of Hydro One Ltd. H-T and member of Canadian National Railway Co.’s Indigenous advisory council. “We were giving each other numbers: ‘You’re number five.’ It’s just comical in some ways.”
In most ways, it’s distressing, and exposes another major gap in equality in Canada. Women, people of colour and other diverse directors are still underrepresented on most corporate boards, but the proportion of Indigenous directors is strikingly low, especially given the continuing disputes over land access and the news coverage of the painful legacy of residential schools.
The number of Indigenous directors has more than doubled since the end of 2020, but it’s still just 17 out of a total of 1,945 board seats at 269 public companies, according to a report on diversity disclosure by the law firm Osler, Hoskin & Harcourt LLC. That equates to 0.9 per cent of board members, while Indigenous people make up 5 per cent of Canada’s population.
The shortfall is baffling, Mr. Podlasly said, given the risks that companies face dealing with Indigenous issues and responding to thorny questions from institutional investors about diversity. “It could be an opportunity or a chance for market differentiation between companies if they would take that step, but not a lot of them have done it,” he said.
Boards often make excuses, such as claiming there are few Indigenous candidates with the right skill sets or experience in executive positions – contentions Mr. Podlasly calls absurd.
In this year’s National Indigenous Economic Strategy for Canada, led by Saskatchewan Senator Marty Klyne, increasing boardroom participation is a priority item. The report said board certification programs should be amended to meet First Nations, Métis and Inuit needs, and there should be a national database of certified, board-ready Indigenous director candidates. It even called for legislation to increase the number of Indigenous people on public and private boards.
On the corporate side, companies need to develop dedicated programs to recruit Indigenous talent, said Dustyn Lanz, senior adviser at ESG Global Advisors. In addition, helping Indigenous youth get on the first rungs of the corporate ladder will create opportunities in the future, he said.
There are efforts under way. The Institute of Corporate Directors has launched an educational program for Indigenous and non-Indigenous directors. The University of British Columbia’s Sauder School of Business is compiling a list of Indigenous people who want to acquire the necessary skills to become candidates for boards.
One rich source of board members consists of First Nations, Métis and Inuit-run corporations, which operate in numerous industries to provide economic benefits for their communities, said J.P. Gladu, founder of the consultancy Mokwateh and director of such companies as Suncor Energy Inc. and Broden Mining Ltd.
The benefits are especially important for companies with operations that require engagement with Indigenous communities, especially in the resource extraction and infrastructure sectors, Mr. Gladu said.
“You cannot build anything in this country now without our consent,” he said. “Without working with us, your uncertainty is going to increase, your cost of capital is going to go up, your timelines are going to be extended because of the regulatory work. It’s just going to be a real mess. So, invest the time and energy on the front end and do it right.”
-Jeffrey Jones
Canadian telecom giant Telus Communications T-T Inc. tested the water this summer with a controversial billing tactic. To cover the processing fees it pays banks and credit card companies, Telus announced that it would add a surcharge to the bills of landline customers who pay their monthly bills by credit card.
The move rankled many Telus clients, who felt it was unfair to be penalized for how they paid, and a public uproar ensued. The move was ultimately blocked by the federal telecom regulator, but what went little noticed was the potential for conflict of interest at the highest level of both companies: Victor Dodig, the chief executive officer of Canadian Imperial Bank of Commerce CM-T, sits on Telus’s board of directors. So does John Manley, who was CIBC’s board chair until last year.
Nothing suggests there was wrongdoing by either party, but CIBC is one of Canada’s leading credit card issuers. Telus, meanwhile, is the first major Canadian company to try adding a surcharge – something that wasn’t possible until a recent court ruling opened the gates for companies to try. While Telus’s idea was shot down by the regulator, its plan could have materially affected credit card fees that CIBC earns, because it might deter Canadians from using their cards as often as they had.
Board overlap of this sort was once a common feature of Canadian business, but interlocking directors, as they are known, aren’t seen as frequently any more. Yet the practice hasn’t disappeared. If anything, some interlocking webs have only grown stronger in recent years – particularly between Canadian banks and telcos.
The month before Telus’s credit card announcement, Royal Bank of Canada RY-T, the country’s largest company by profit, appointed BCE Inc. CEO Mirko Bibic to its board of directors. Former RBC CEO Gord Nixon is already the chair of BCE’s board. Also, David Denison is a director of both companies, and Jennifer Tory, who recently retired as a top executive at RBC, was named a BCE director last year.
Data on the full extent of interlocking directors in Canada are hard to come by, but the practice spans industries. In mining, for instance, veteran gold sector executive Kevin McArthur is on three boards: First Quantum Minerals Ltd. FM-T, Royal Gold Inc. FOXG-X and NovaGold Resources Inc. NG-A. In oil and gas, Hal Kvisle, the former CEO of TC Energy Corp. TRP-T and Talisman Energy Inc., is board chair of Arc Resources Ltd ARX-T. and a director of Cenovus Energy Inc. CVE-T, which compete with each other.
What makes the issue more complicated is that blatant overlap is only part of the issue. It is likely, said Sarah Kaplan, a University of Toronto professor and expert on governance issues, that there is “a form of board overlap that we may not even be able to see.”
Board appointments are often based on referrals, and veteran directors have the sway to get proteges and professional friends on boards other than their own, which can establish an invisible overlap. Often, directors “are beholden to the people who got them into those positions,” Ms. Kaplan said.
The intangible nature of personal relationships also makes it hard to know how a board is really operating, and how often personal connections really affect board decisions. “The reality is, investors are never going to be inside the boardroom,” said Jennifer Coulson, senior managing director for environmental, social and governance matters at BCI, which manages $211-billion on behalf of 11 public sector pension plans in B.C. “We’re never going to actually see those personal dynamics.”
Board overlap isn’t always a bad thing. Some boards are happy when their company’s CEO becomes a director elsewhere, because the CEO gets a broader perspective on managing and governance.
But some appointments are a bridge too far, and the U.S. Justice Department is starting to crack down on interlocking directors. In October, seven directors resigned from corporate boards in response to concerns about violations of a rule that prohibits directors and officers from serving simultaneously on the boards of competitors.
In Canada, the issue rarely gets any airtime – not even from the likes of proxy voting advisory firms Institutional Shareholder Services Inc. and Glass Lewis & Co. So long as directors keep to the informal rule of sitting on three boards or less, “from a proxy advisory lens, it’s not problematic,” said Kelly Gorman, an executive vice-president at Kingsdale Advisors.
–Tim Kiladze
Canada introduced annual shareholder advisory votes on executive compensation, known as say-on-pay, in 2010. Since then, pay has exploded, and shareholders have given their blessing.
The median pay package for CEOs at 100 large Canadian companies was up in 2021 by 23 per cent from 2020. Yet shareholders have been wildly approving: The average say-on-pay approval vote in the 2022 proxy season was 92.1 per cent, up from 91.2 per cent in the prior year, according to data from Kingsdale Advisors.
Advocacy group the Shareholder Association for Research and Education, or SHARE, helped bring say-on-pay to Canada. Kevin Thomas, its CEO, said the state of it today “pains me.”
“We got that power, but we didn’t really take it to its logical extent, in terms of the responsibility attached,” he said. “You’ve got asset managers and the financial sector drinking pretty much from the same cesspool that the boards and all the consultants draw from – they see high executive compensation as the norm, actually something that they aspire to.”
The disconnect, where high pay yields high approval ratings, comes from the fact that the votes are a blunt instrument for expressing views on compensation, according to many compensation specialists interviewed by The Globe. Plenty of shareholders may dislike one part of a compensation plan, or feel mild discomfort at what executives are being paid these days, but if the company’s share price is up, they’ll likely cast a “yes” vote.
Paul Gryglewicz, a senior partner at Global Governance Advisors, the data partner for Board Games and The Globe’s annual executive compensation report, said say-on-pay votes target how companies approach compensation and the structure of the pay arrangements, as opposed to the amounts or the growth. “Say-on-pay is not intended to control pay levels.”
That means say-on-pay results should be graded on a kind of curve, where numbers that earn you a B grade in school are more like a D in the compensation world.
Flunking is rare – just six companies in 2021 and three in 2022 failed to get 50-per-cent support from shareholders. Anything less than 80-per-cent approval is seen as a negative vote. Board Games, as well as proxy advisory service ISS, expects companies to increase their disclosure and reach out to stockowners if they fall short of that threshold. The results of those conversations need to appear in the next proxy circular.
Continued trouble from shareholders may get personal: The proxy advisory services may recommend shareholders withhold votes from the directors who serve on a board’s compensation committee. And at most companies, if directors fail to get a majority, they must resign.
“I see public companies take it very seriously,” said Kingsdale’s Ms. Gorman. “It’s a non-binding resolution, but what I always say about that is there are consequences.”
For an example of a company that listened, look to RioCan Real Estate Investment Trust, which got 24-per-cent support in 2021. It was believed to be one of the worst say-on-pay showings in the 10-plus years of Canadian voting. The REIT’s board formed a special outreach committee and contacted 40 of its 50 largest unitholders, holding 16 meetings.
By October, RioCan had overhauled its compensation program: It eliminated stock options, ceased special awards to executives, pegged pay to a median of a reconstituted peer group, changed the performance metrics it used and increased shareholding requirements for the CEO. In 2022, RioCan received 90.6-per-cent support in say-on-pay.
Most companies, however, don’t have as many problems as RioCan did, raising the question of whether “yes” and “no” should be the only two options available to shareholders.
“As opposed to using just a black-and-white on-off switch, why not use a scale?” asked Christopher Chen, the managing partner of Compensation Governance Partners. “Use a 1 to 5, use a 1-2-3, get a 3.4 or 4.5. You can see a gradation of what it means.”
–David Milstead
Look at the pay packages at some companies, and you might think stock options are going out of style. BCE, for example, discontinued use of them in 2021, instead shifting to stock awards that executives could only cash in if the company hit financial targets. Nearly half the companies in The Globe’s annual survey of CEO pay didn’t give their top executive any options at all.
Then, look at other companies, and it’s as if options are more popular than ever. In 2021, Nuvei Corp. NVEI-T gave CEO Philip Fayer an option award valued at more than $80-million, and Dye & Durham Inc. DND-T gave CEO Matthew Proud options it valued at $98.8-million. Clearly, the reports of stock options’ death are greatly exaggerated.
The problem with options, critics say, is that the rising tide in a surging stock market lifts all option holders’ boats. In years when broad markets or hot sectors rise sharply, options can bring executives millions even if their company’s financial or stock performance is below peers. Once options are exercised and the profits are made, executives keep their money even if the stock price backslides, hurting long-term investors.
“If you’re in a company that’s commodity-based and the market goes up – like for gold – that has nothing to do with individual performance and helping create value at the company,” said Catherine McCall, the executive director at the Canadian Coalition for Good Governance, a group of institutional investors. “And we don’t see how why you should be compensated for luck or for something that’s outside of your control.”
For 2022, Board Games required companies to have dilution – stock options outstanding as a percentage of shares – below 8 per cent to get marks in the category. There were 53 companies that scored zero because their dilution was too high.
Also, the annual stock-option grant for 2021 needed to be less than 1.5 per cent of shares outstanding to get marks. There were 15 companies that scored zero.
Compensation specialists say, however, that stock options will never go away. Some companies that are giving mega-grants to their CEOs are trying to mitigate the blowback by creating vesting thresholds, saying their stock price must rise significantly higher than the exercise price before the options can be used.
But the toughest critics of options are generally not swayed by that approach, preferring performance share units, or PSUs, that are tied to underlying metrics such as revenue, profits and relative shareholder returns, and that generally pay out after three years. It’s mature companies, often dividend payers, that are emphasizing those programs. Younger, growth-oriented companies are still handing out options.
“We still see room for options,” said Ryan Resch a partner of compensation consultancy Southlea Group. “They provide for longer-term orientation beyond three years. And unlike PSUs, you don’t have to necessarily worry about what the underlying measures are and how you calibrate. It’s pretty straightforward – but they do need to be managed carefully.”
–David Milstead