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© 2004 Tim Rowley & Matt Fullbrook, Rotman School of Management 1 Canada’s Corporate Elite The Gatekeepers of Good Governance Clarkson Centre for Business Ethics and Board Effectiveness December 2004

The Gatekeepers of Good Governance - Rotman School of ... · The Gatekeepers of Good Governance ... Elite, who drive corporate governance reform in Canada. 1. ... P s ho v i nd er

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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