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© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 1
Canada’s Corporate EliteThe Gatekeepers of Good Governance
Clarkson Centre for Business Ethics and Board EffectivenessDecember 2004
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 2
Powerful advocates have pushed for corporate governance reform
A New Appetite for Governance Monitoring
A New Appetite for Regulatory Change
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 3
7
14
23
2002 2003 2004
76
57
43
2002 2003 2004
Companies scoring lower than 60 / 100
Companies scoring a perfect 100
The result has been a significant improvement in governance practices in the S&P/TSX Composite Index over the past two years.
Based on the Rotman Board Shareholder Confidence Index ScoresAll findings in this report are based on the S&P/TSX Composite Index
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 4
However, many boards remain below best governance practices.
% of Companies with sub-par governance practices in 2003 that remain sub-par in 2004
71.9%
78.7%
80.0%
80.9%
83.3%
Interlocks*
Board Evaluation
Dilution*
Director Evaluation
Share Structure*
* Share Structure – A deduction is made if more than 50% of a company’s voting power is controlled by less than 50% of outstanding shares.Dilution – Companies receive deductions for dilution when the number of outstanding options is greater than 10% of the number of outstanding sharesInterlocks – If the same two directors sit on more than one board together, there is a director interlock between the involved companies. Deductions are made if a company has more than one interlock.
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 5
Because we have seen positive change and stagnation in governance practices, we wonder “What are the factors that facilitate and block governance reform?”
Two factors affecting corporate governance reform are the network of elite corporate directors and corporate ownership structure.
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 6
Canada’s most influential directors are the CorporateElite, who drive corporate governance reform in Canada.
1. They represent a large number of companies
2. They represent half of the market cap of the S&P/TSX Composite
3. They are interconnected
The Influence of the Elite is driven by three key factors:
Corporate Elite
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 7
Director DistributionNumber of board memberships by director n=1689
1382
188
64 37 11 4 10
200
400
600
800
1000
1200
1400
1600
1 2 3 4 5 6 7
Number of boards
Num
ber o
f dire
ctor
s
5Godsoe, Peter C.
5Tapp, Lawrence G.
5Prichard, J. Robert S.
5Osborne, Ronald W.
5Newall, J.M. Edward
5Lanthier, J. Spencer
5Hushovd, Oyvind
5Fortier, L. Yves
5Cleghorn, John E.
5Bérard, André
5Baillie, A. Charles
6O’Brien, David P.
6McKenna, Hon. F.J.
6Mazankowski, Rt. Hon. D.F.
6Cockwell, Jack L.
7MacNeill, Brian F.
Number of BoardsDirector
Of the 1689 directors sitting on boards comprising the S&P/TSX Composite Index a small number of directors are extremely sought-after and willing directors.
0.95% of S&P/TSX Composite Directors sit on 5 or more
Composite Boards
Corporate Elite
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 8
50.69%31%
0.95% ofDirectors
31% of Companies
50% of CompositeMarket Cap
Collectively, this small group of 16 directors have disproportional influence in Canadian board rooms. They are the Elite 16.
16 Elite Directors…
sit on 68 Index boards…
Comprising $437b market capitalization
Corporate Elite
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 9
Difference in Average Market Cap
$6.43
$3.78
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
$7.00
Average Market Cap for elite Average market cap for entireS&P/TSX Composite
Ave
rage
Mar
ket C
ap ($
billi
ons)
70%
Members of the Elite 16 sit on the boards of the largest Canadian corporations
Corporate Elite
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 10
The Elite 16 sit on many of these boards together. Their shared board appointments form the Elite Network – a dense web of interlocks and influence.
Corporate Elite
S&P/TSX Composite Interlocks among the Elite 16 Directors (2004)
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 11
Networks are diffusion conduitsIn Toronto, the spread of SARS began with a single infected patient, and continued as hospital workers came in contact with their families and people in other hospitals.
Infected patient
Infected Nurses
Corporate Elite
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 12
Similarly, Gerald Davis’s research at the U of Michigan shows that practices “[appear] to spread through shared directors like a virus.” (Strategic Organizations, 2003)
Corporate Elite
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 13
Research has shown that influence and information travel between companies through shared directors.
Aside from two of the Elite 16 who are fully isolated, the flow of information through the Elite Network meets no obstruction.
Isolate
Isolate
Corporate Elite
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 14
Acquisition strategies diffuse across director interlock networks.
Firms are more likely to adopt an acquisition strategy if they share a director with a company that has an acquisition strategy in place (Haunschild and Beckman, 1998, Administrative Science
Quarterly).
Corporate Elite
Companies that have an acquisition
strategy
Companies with no acquisition
strategy
Shared Director
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 15
Corporate Elite
Companies with poison pill
Companies with no poison pill
Anti-takeover defense strategies diffuse across director interlock networks.
Firms are more likely to adopt poison pills if they share a director with a company that has a poison pill in place(Davis, 1991, Administrative Science Quarterly).
Shared Director
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 16
Individuals occupying positions at the core of a network control the diffusion of information through the network(Rowley, 1997, Academy of Management Review)
RobertPrichard
Robert Prichard is a principal gatekeeper of governance reform.
Corporate Elite
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 17
The companies represented by the Elite 16 are crucial to the reform of corporate governance in Canada
Similarly, the Elite 16 as a group are at the core of the network that makes up the S&P/TSX Composite
Corporate Elite
50.69%
31%
0.95% ofDirectors
31% of Companies
50% of CompositeMarket Cap
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 18
Average Scores of Directors with 5+ Boards
83.2
82.4
78.3
77.8
76.7
76.4
76.0
73.8
73.0
72.0
71.4
71.3
61.4
60.6
53.7
40.0
01020
30405060
7080
90
Fortier
, L. Y
ves
MacNeil
l, Bria
n F.
Baillie
, A. C
harle
s
Newall
, J.M
. Edw
ardO'Brie
n, David
P.Hus
hovd
, Oyv
indClegh
orn, J
ohn E
.
Lanth
ier, J
. Spe
ncer
Tapp,
Lawren
ce G
. Béra
rd, A
ndré
Pricha
rd, J.
Rob
ert S.
McKen
na, H
on. F
rank J.
Osborn
e, Ron
ald W
.God
soe, P
eter C
.Coc
kwell
, Jac
k L.
Mazan
kowsk
i, Rt. H
on. D
.F.
Ave
rage
Sco
re /1
00
Average company score forEntire S&P/TSX Composite
is 69/100
Generally, the Elite 16 have demonstrated a strong commitment to excellent corporate governance practices.
Corporate Elite
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 19
The effect of this commitment has been positive and significant
% of Companies with Best Practices
84%
61%79% 77%
58% 53%59%
52%
75% 73%
37%29%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Independence CEO/Chair Split AuditCommittee
Independence
CompensationCommittee
Independence
BoardEvaluation
DirectorEvaluation
% o
f Com
pani
es EliteNetwork
All otherCompanies
Corporate Elite
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 20
Most of the companies in the Elite Network demonstrate governance practices above and beyond those of the rest of the S&P/TSX Composite.
2004 Governance Scores - Elite Network
2 2
7
2
6 5 6 7 8
5 53
6
11110123456789
10
10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100Score/100
Num
ber o
f Com
pani
es
Averagen = 28
n = 40
59% of the Elite Networkis above average
Corporate Elite
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 21
Despite the influence of the Elite Network, companies with an imbalance of voting power are resistant to improvements in corporate governance.
2004 Governance Scores - Companies with both a Major Shareholder and Subordinate Structure
42
34 4
7
3 3 31 111111
01234567
10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100
Score /100
Num
ber o
f Com
pani
es
Averagen = 33 n = 7
Ownership Structure
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 22
% of Companies with Best Practices (2004) - Major Shareholder and Subordinate Share Structure
74%66%
79%91%
81%61% 56%
83%68%
49%68%
83% 76%
41%49%
66%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Inde
pend
ence
Shar
eO
wne
rshi
p
CEO
/Cha
irSp
lit
Audi
tC
omm
ittee
Inde
pend
ence
Com
pens
atio
nC
omm
ittee
Inde
pend
ence
Boar
dEv
alua
tion
Dire
ctor
Eval
uatio
n
Out
put
% C
ompa
nies
No subordinate ormajor shareholder(n=109)
MajorShareholder andSubordinateStructure (n=40)
Companies that have a subordinate share structure and a major shareholder are far less likely to demonstrate good governance than widely-held companies (no major shareholder) where every share gets one vote.
Ownership Structure
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 23
Control over these companies needs to move from the hands of controlling individuals into those of the board of directors, including the Elite 16, before governance reform will reach every company
Average Governance Scores
72.551
01020304050607080
Elite Network (n=57) Subordinate Structure andMajor Shareholder (n=40)
Ave
rage
Sco
re /1
00
Ownership Structure
© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 24
% of Companies w ith Best Practices - Interconnected Companies w ith Elite Directors
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Inde
pend
ence
CEO
/Cha
irSp
lit
Audi
tC
omm
ittee
Inde
pend
ence
Com
pens
atio
nC
omm
ittee
Inde
pend
ence
Boar
dEv
alua
tion
Dire
ctor
Eval
uatio
n
% o
f Com
pani
es
% of Companies with Best P ractices (2004) - M ajor Shareholder and Subordinate Share Structure
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Inde
pend
ence
Shar
eO
wne
rshi
p
CEO
/Cha
ir Sp
lit
Audi
tC
omm
ittee
Inde
pend
ence
Com
pens
atio
nC
omm
ittee
Inde
pend
ence
Boar
dEv
alua
tion
Dire
ctor
Eval
uatio
n
Out
put
Corporate Elite Ownership Structure
As the pressure increases on Canadian companies to improve governance practices, the Elite 16 must be the innovators that drive widely-held companies to remain at the forefront of change.
Elite Network Other CompaniesWidely-Held Major Shareholder