The Coming Revolution in Corporate Governance · The Coming Revolution in Corporate Governance Most of the talk about better corporate governance has focused on the independence of

The Coming Revolution in Corporate Governance

By Richard Leblanc and James Gillies

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I M P R O V I N G T H E P R A C T I C E O F M A N A G E M E NT

- 1 - Ivey Business Journal September/October 2003

The Coming Revolution in CorporateGovernance

Most of the talk about better corporategovernance has focused on the independence ofdirectors and the separation of the CEO and chair.Not so, argue these authors, who point out thatthe most important factor is board process -- howboards work and reach the decisions they do.Improving process will not only improve boardgovernance but will prove that there really is alink between a board of directors and a firm'sfinancial performance.

By Richard Leblanc and James Gillies

Richard Leblanc is a professor the Schulich Schoolof Business, York University, and a lawyer,management consultant and an advisor on boardsof directors and effective corporate governance.Dr. James Gillies is professor emeritus of policy,and founding Dean of the Schulich School ofBusiness, who throughout his career has servedon more than 30 public, private and not for profitboards. This article is based on their forthcomingbook, The Coming Revolution in CorporateGovernance.

"Directors are like parsley on fish decorative butuseless."

-- Irving Olds, former chair, Bethlehem Steel

Writing in the autumn 1994 issue of The Ivey BusinessQuarterly, Donald Thain, Professor Emeritus of TheWestern Business school (as it was then called),unleashed a scathing attack on the Toronto StockExchange Corporate Governance Report. This attackwas unique in two respects. First, almost no onecommenting on the Report (soon referred to as the DeyReport after its chair, Peter Dey) agreed with Thain;

most other commentators thought the Report was rathergood. And second, Thain's comments were essentiallyirrelevant as the Report continues to be used as afoundation upon which other reports on governance ofCanadian corporations are built. Indeed, the Report itselfhas been revisited twice - once formally and onceinformally.

The essence of Thain's criticism of the Dey Reportwas that its findings and recommendations were notbased on any serious research about corporategovernance and that it did not take the problems ingovernance seriously enough. As a result, therecommendations of the Committee, in Thain's view,were based on opinions rather than fact and did not dealwith some of the really difficult questions of corporategovernance in Canada: Wrote Thain: "For some reason….the mandate 'to conduct a comprehensive study' waslost, and given the political power of those who control

corporations, the deeply entrenched old board cultureand the strong resistance to change in the status quo,change in corporate governance, no matter howobviously needed, will be difficult and controversial.… As it stands, the TSE report is at best a dubious andcontroversial beginning point for dialogue."

As very recent history has shown, Thain was prescient.By any definition, the decade of the nineties has not

it means that regulators, chiefexecutive officers and directors, whenthey are searching for ways andmeans of improving corporategovernance, are functioning in aknowledge vacuum


been a particularly good period for corporate governancein general and for research or regulatory change ingovernance in particular. While a number of books onthe topic have been published, they, like the TorontoStock Exchange Report, are based primarily on theexperience of the authors and the availability of dataconcerning boards in annual reports and other publicrecords. Consequently, the regulations that have beendeveloped to govern corporations in the 1990s have beenbased on very limited knowledge about the factorsinfluencing corporate decision-making.

While Thain is probably correct in his view that thereis far too little knowledge about how boards make theirdecisions to permit the drafting of appropriateregulations to improve corporate governance, and thata great opportunity to start obtaining such informationwas lost when the Dey commission did not undertakefundamental research in the area, he is probably wrongthat the situation will not change. Indeed, in spite ofthe strong resistance to change and the support for thestatus quo, which is probably as strong now as it wasten years ago, there is a very good chance that somevery revolutionary changes in governance will begin totake place in the first decade of this century. As wesuggest in this article, it will happen for three reasons:(i) the tremendous fall-out from recent failures incorporate governance in the United States; (ii)recognition that the reforms which were touted as beingso significant in the 1990s were relatively innocuous;and (iii) most importantly, by far, path-breaking newresearch on the factors impacting on board decision-making.

Recent corporate governance failures:

In the early years of the twenty-first century corporatemalfeasance and individual scandals have rocked thecapital markets, led to the loss of fortunes by the richand bankrupted the poor, and destroyed the confidenceand faith of investors in many of the institutions thatare fundamental to making the capitalistic marketsystem work. During a two-month period (May-June)of 2002, the headlines of major stories in the majorbusiness magazines tell the story. A sampling of thoseheadlines is below.

In a chart entitled "A Question of Accountability,"the New York Times listed examples of major Americancompanies where there were "auditing lapses," "thehiding of loans or losses," "insider trading" and"inflating revenue," (16 June 2002 at BU12). It readslike a Who's Who of North American business - ArthurAndersen, Deloitte & Touche, Ernst & Young, KPMGand Price Waterhouse Coopers, AdelphiaCommunications, Enron, Kmart, PNC FinancialServices Group, Tyco International, WorldCom,ImClone Systems, Computer Associates International,CMS Energy, Dynegy, Edison Schools, GlobalCrossing, Halliburton, Lucent Technologies, NetworkAssociates, Qwest Communications International,Reliant Resources, Trump Hotels and Casino, WasteManagement and Xerox. Canadian examples ofcorporate failures and scandals include Livent, BreX,YBM Magnex and Philips.

In spite of sweeping generalizations made by thepopular press concerning the causes of these and other

Table 1 Headlines of Major Stories in Leading Business Publications, May-June, 2002

“Special Report: The Crisis in Corporate Governance,” Business Week, 6 May 2002

“Trouble in the Boardroom,” Fortune, 13 May 2002 at 113;

“Enron’s Demise Has Taken the Shine Off the Boardroom Table,” Financial Times, 30 May 2002 at 14;

“Tyco Board Is Criticized for Kozlowski Dealings,” Wall Street Journal, 7 June 2002 at A5;

“The Wickedness of Wall Street,” The Economist, 8 June 2002 at 11


past corporate failures, relatively little appears to beknown about why or how several of these failuresoccurred, including how and why key decisions weremade, or not made, and the manner in which boardsacted and why they acted the way they did. Of course,there may very well be multiple, interdependent causesfor a given corporate failure, including the irrationalityof the markets, the philosophy of maximizing short-termshareholder value and personal greed. But given that akey task of a board of directors is the independentoversight of management and corporate stewardship,one may conclude that at least some of these corporatefailures may have been caused by the inability of boardsto operate effectively, i.e., a failure of board process.Indeed, in the aftermath of the failures and scandalsassociated with many companies, it has beencommonplace for the media to attribute many corporatefailures to poor corporate governance practices(whatever this may mean). A question often posed is"Where was the board?" In fact, this question was usedas the sub-text of the Dey Report. It is a particularlyrelevant one in instances when a company fails, eventhough the board of directors had a high profile orseemingly qualified directors sitting on it, which in morethan a few instances was the case. (For example, the

Chairman of Enron's Corp.'s Audit Committee, RobertK. Jaedicke, was a retired accounting professor and pastDean at the Stanford Graduate School of Business.)

Because of this inference between corporatewrongdoing and corporate governance, the publicconcern for "corporate accountability" in the U.S. gaveway to questions about "corporate responsibility," tocharges of "corporate corruption," and finally toregulation of "corporate governance." In July 2002,George W. Bush, delivered a major speech - a speechbilled as important as a State of the Union address - oncorporate responsibility. In this address, he outlinedproposals for imposing strict discipline and punishment

on corporate wrongdoers, and reiterated hisadministration's support for corporate governancereforms. He pledged a strengthening of the Securitiesand Exchange Commission (SEC) and endorsed the newlisting proposals being advanced by the New York StockExchange (NYSE). Not to be outdone, in the samemonth, the United States House of Representatives andthe United States Senate overwhelming passed H.R.

3763, widely known as the "Sarbanes-Oxley Act of2002" which called for broad new regulations - describedas the most far-reaching in over 70 years - of issuers ofpublicly traded securities, corporate directors andindependent advisors such as auditors and lawyers. TheAct was signed by the President and enacted into lawon July 30, 2002. A short time later, the New YorkStock Exchange (NYSE) began enacting governanceguidelines for its listed companies.

Will this legislation be effective? Might theAmericans learn from the Canadian experience over thelast decade? Unfortunately, given what we know aboutcorporate governance, it is at best debatable that theseregulations, as they currently stand, other than increasingthe costs of operations of governments and corporations,will do much to improve corporate governance inAmerica.

The "board structure" approach to corporategovernance reform:

When "board structure" is analyzed, it is normal toconsider three items:

(i) leadership, e.g., a non executive Chair vs.having the same person occupy the posts ofchair and CEO (sometimes referred to as "CEOduality");

(ii) composition, e.g., the number and percentage

any explanation of how boards makedecisions is missing, and yet this maywell be the most important factor indetermining the effectiveness of thegovernance of an enterprise

It is "board effectiveness" not "boardstructure" that must be analyzed, forit is the effectiveness of the board inthe decision-making process that inthe final analysis determinescorporate performance


of outside directors vs. inside directors; and(iii) size.

So far as these 3 items are concerned, the 14 TSXgovernance guidelines include requiring having a chairseparate from the CEO, at guideline 12; "unrelated"directors on the board and committees (i.e., addressingindependence), at guidelines 2, 3, 4, 9 and 13; and boardsize at guideline 7.

What, exactly, is known about "board structure"?

Of necessity, because of lack of information,researchers, regulators and nomination committees havetended to view board effectiveness from the vantagepoint of the above three dimensions. In other words,boards are seen from the perspective of having a separatechair, a majority of outside directors, and an optimalsize (e.g., an 8-11-person board may be considered tobe optimal). Directors are classified ratherhomogeneously as being "unrelated" vs. "related"(Canada), "independent" vs. "non independent" (UnitedStates and Australia) or "executive" vs. "non executive"(United Kingdom), depending on how the degree of"independence" is being conceptualized by the regulator

drafting the regulation or the committee selecting thedirector. Needless to say, in the TSX Guidelines andsimilar guidelines, such as those of the NYSE, the mostimportant question associated with board structure hastraditionally been the "independence" of directors. (e.g.,"Report of the NYSE Corporate Accountability andListing Standards Committee" New York: New YorkStock Exchange, 2001) at guidelines 1, 2 and 4 6. Seealso The Australian Stock Exchange CorporateGovernance Council, "Principles of Good CorporateGovernance and Best Practice Recommendations",

Australian Stock Exchange (ASX), March, 2003), atprinciple 2; and D. Higgs, "Review of the role andeffectiveness of non-executive directors", London:Department of Trade and Industry, January 2003) at,inter alia, paragraph 6.19 and chapter 9.)

It is always assumed that an "independent" director issomehow or other a better director. That the exchanges

should have such guidelines is really quite strangebecause there is absolutely no evidence linking boardstructure - and specifically, board as well as directorindependence - to the financial success of firms. Indeed,so far as the literature on board independence isconcerned, "Nearly two decades of research find littleevidence that board independence enhances boardeffectiveness. Studies have, however, found a negativeeffect." (J.D. Westphal, "Second Thoughts On BoardIndependence: Why do so many demand boardindependence when it does so little good?" TheCorporate Board, September/October 2002, pp. 6-10at p. 6).

And so far as the literature on director independenceis concerned, "The most important predictor of directoreffectiveness is not independence, but strategicexperience that matches the company's needs."(Westphal, ibid. at p. 8). (Professor Westphal's researchinvolved "[r]esponses to a survey of over 500 outsidedirectors from Forbes 500 companies..." and"questionnaire data from two different samples ofoutside directors at large and medium sized U.S.companies collected at two points in time (1996 and1999)." (Ibid.).) Yet, paradoxically, in spite of theevidence from these studies that independence is not amajor factor in corporate performance (see Table 2 onnext page), regulators in the United Kingdom, Australia,United States and Canada continue to focus upon it in

If a particular board therefore doesnot have the full set of requiredcompetencies covered off in abalanced way across all of itsdirectors, it will not be effective underthe above model, despite theindividual competencies of directors

Not astonishingly, therefore, given thefact that boards are groups, the mostimportant factor in board process isthe inter-relationship among andbetween directors, which in turn islargely based on the behaviouralcharacteristics of individual directors


Table 2

A CRITIQUE OF BOARD STRUCTURE: WHAT HAS THE EMPIRICAL EVIDENCE FOUND?

On the relationship between board size and corporate performance:

“Although a host of theory-driven rationales suggest a relationship between board of directors size and firm performance, the literature provides no consensus about the direction of that relationship.” (D.R. Dalton, C.M. Daily, J.L. Johnson & A.E. Ellstrand, “Number of Directors and Financial Performance: A Meta Analysis” (1999) 42:6 Academy of Management Journal, pp. 674-686 at 674) (Emphasis added.)

“Board size is another issue for which there is no apparent consensus.” … “This article has largely focused on board composition measures primarily because they represent the bulk of the empirical studies that have been conducted in the area of corporate governance.” (J.L. Johnson, C.M. Daily & A.E. Ellstrand, “Boards of Directors: A Review and Research Agenda” (1996) 22:3 Journal of Management, pp. 409-438 at 431) (Emphasis added.);

On the relationship between independent governance structure and corporate performance:

“[B]oth researchers and practitioners have focused largely on the conflicts of interest between managers and shareholders and on the conclusion that more independent oversight of management is better than less. Independent governance structures (e.g., outsider-dominated boards, separation of the CEO and board chair positions) are both prescribed in agency theory and sought by shareholder activists. Were independent governance structures clearly of superior benefit to shareholders, we would expect to see these results reflected in the results of scholarly research. Suchresults, however, are not evident (C.M. Daily, D.R. Dalton & A.A. Cannella, Jr., “Introduction to Special Topic Forum – Corporate Governance: Decades of Dialogue and Data” (2003) 28:3 Academy of Management Review, pp. 371-382 at 374.) (Emphasis added.);

“Nearly two decades of research find little evidence that board independence enhances board effectiveness. Studies have, however found a negative effect.” (J.D. Westphal, op. cit. at p. 6);

“The most important predictor of director effectiveness is not independence, but strategic experience that matches the company’s needs. … Evidence that director experience is critical to board effectiveness is relatively new. However, evidence that board independence has neutral to negative effects on board effectiveness is not. The first research casting doubt on the value of board independence appeared in the late 1980s. Since then, not only have advocates of governance reform in the U.S. continued to focus on this issue, but the board independence mantra has spread to


their regulatory efforts.

What does this mean for boards and individualdirectors?

Most of the types of reforms and changes thatregulatory agencies have enacted, and which corporategovernance scholars have called for in the past, havehad to do with board structure, i.e., the number ofindependent directors, the separation of the position ofchair and chief executive officer, the size of the board,et al. And yet, as Table 2 indicates, the evidence fromthe research, slim as it is, indicates that these things

really make no difference in general board performance.And no one has been able to find a positive relationshipbetween good corporate governance, as currentlydefined, and corporate financial performance.

Yet nevertheless, of the 194 respondents interviewedin our study of corporate governance, includingregulators, shareholders (both institutional and retail)and corporate directors (who constituted the majorityof respondents), the vast majority was overwhelminglyof the view that a relationship does exist betweencorporate governance and the financial success of thecorporation. In other words, the directors interviewed

other countries, including Canada, the U.K. and Germany.” (Westphal, op. cit. at p. 10);

On the separation of chair and CEO:

“We question the need for such a policy [of ‘separating the CEO and board chair positions’]. This activity becomes even more questionable in light of the failure to consistently link the separate board leadership structure with enhanced firm performance.” (C.M. Daily and D.R. Dalton, “CEO and Board Chair Roles Held Jointly or Separately: Much Ado About Nothing?” (1997) 11:3 Academy of Management Executive, pp. 11-20 at 19) (Emphasis added.);

“While agency theorists would prescribe boards composed of outside, independent directors and the separation of CEO and board chair positions, neither of these board configurations is associated with firm financial performance (Dalton et al., 1998).” (Introduction to Special Topic Forum – Corporate Governance: Decades of Dialogue and Data” (2003) 28:3 Academy of Management Review, pp. 371-382 at 374.) (Emphasis added.);

On outside directors:

“In summary, research on the potential impact of outside directors’ representation on corporate performance yields mixed results.” (S.A. Zahra and J.A. Pearce II, “Boards of Directors and Corporate Financial Performance: A Review and Integrative Model” (1989) 15:2 Journal of Management, pp. 291-334 at 316) (Emphasis added.);

“Generally, the results suggest that there is no statistical evidence of a relationship between corporate performance and proportion of outside directors on the board…In addition, when the composition of the board is analyzed, there is no convincing evidence that outside directors from the financial industry or from the same line of business enhance the value of the corporation.” (B. Amoako-Adu and B.F. Smith, in R.J. Daniels and R. Morck, R., eds., Corporate Decision-Making in Canada (Calgary: U. Calgary Press, 1995: 413) (Emphasis added);


believe that better boards make for better companies.Yet researchers, at least with respect to board structure,have not been able to prove this. Regulations regardingboard structure, therefore, may not make any difference,as Don Thain originally suggested as long ago as 1994.In other words, if the TSX guidelines work, corporationsthat comply with them should have an effective board

and those that do not, should have an ineffective board.This appears not to be the case, currently, based on (i)recent empirical evidence on board structure and (ii)the findings on which this article is based. In fact, oneof the individuals interviewed for this study, who wason the original TSX committee, remarked that, "TheTSE guidelines are like describing hockey by describingthe rink. You can fit all of the guidelines but have aterrible board."

Interestingly, the original 1994 TSE committee ongovernance reconvened in 2000 and, on July 10, it statedin a news release:

"The Committee noted that many boards didrespond positively to the Report. There is aconcern, however, that the response of a numberof corporations may have been more structuraland more procedural than substantive. TheReport contains Guidelines, which proposestructures for governance systems that establishboards of directors independent ofmanagement… Boards which implement theGuidelines may achieve structuralindependence, but structuring boards in this wayis only part of the answer. Boards must also

function independently…"

Corporate governance and corporate financialperformance: A relationship?

If directors are overwhelmingly of the view that betterboards make for bettercompanies, it seems entirelyreasonable, and quite plausible,that the fact that quantitativestudies have been unable toidentify a relationship betweencorporate governance andcorporate financialperformance does not meanthat a relationship does notexist between the two. Whatthe disconnects between whatdirectors think, whatresearchers can prove, andwhat regulators regulate,probably mean that the proper

type of research on corporate governance has not beendone, or, it has been done badly. More significantly, itmeans that regulators, chief executive officers anddirectors, when they are searching for ways and meansof improving corporate governance, are functioning ina knowledge vacuum; that is, they are makingregulations and decisions without any real knowledgeabout what is going on in boards of directors or, at worst,on the basis of an incorrect understanding of the majorfactors impacting on corporate governance.

What is truly astonishing, given the enormous amountof work that has been done on corporate governance, ishow little has actually been learned about the value of"corporate governance" and what is actually involvedin effective governance. The fact is that in spite of allthe discussion, writing and analysis, there has not beena great deal of research on "how boards actually work",how they make decisions, or on how directors interactwith each other. Remarkably, in spite of all thecommissions and reports, there is not much more knownnow about how boards actually operate - what makessome effective and others not - than there was a halfcentury ago. There are several explanations for this trulystrange situation. First, the cynics may be correct, nonemay exist. Second, there may be so many internal and

Figure 1

Corporate Governance and Corporate Financial Performance

x

?

?

BoardStructure

Board Effectiveness

CorporateFinancial

Performance

external contingencies and intervening and moderatingfactors causing a corporate failure - a natural disaster, awar, et al. - that it may simply be impossible todemonstrate a causal link between board governanceand corporate performance. Third, many of the factorsinvolved in corporate governance are incapable of beingexpressed in forms that can be measured. Fourth, theremay exist a time lag between board structure and boardfailure, which makes any relationship difficult to find.And fifth, there may be, as Professor Westphal suggests,a conspiracy theory because academics and regulators"have chosen board independence as a rallying cry orunifying theme of the governance reform movement,and to change the message now would diminish thefocus, unity and credibility of the movement".(Westphal, op cit. at p. 10).

None of the above explanations is particularlycompelling. A much more likely reason for therelationship not being demonstrated is the fact that inall the research, there is no analysis of how boardsperform as boards - how they make decisions - and ofthe impact of the behavioural characteristics of variousdirectors on the decision-making process. In short, inall of the work that has been done, any explanation ofhow boards make decisions is missing, and yet this maywell be the most important factor in determining theeffectiveness of the governance of an enterprise.

And so the mystery remains. The current reality ofcorporate governance knowledge is that, the "what" and"how" of a board of directors its work and its processis still the "unicorn" of corporate governance. No onehas demonstrated that there is a relationship between

Board Tasks

Board Effectiveness

Board Structure

Corporate Financial

Performance

Board Process

Board Membership

(This model is based on a study of twenty-one boards and committees in action and interviews with almost 200 directors. For a full discussion of the methodology used in the study, please see R. Leblanc's J. Gillies' forthcoming book.)

Figure 2

Board Effectiveness

?

- 8- Ivey Business Journal September/October 2003

corporate governance and corporate performance,although everyone knows that there is one. So yearafter year, in the aftermath of the failures and scandalsof major companies, the question is posed "Where wasthe board?"

A new model of board effectiveness

In order to understand the factors necessary to assurethat corporate governance is "substantive," for whichthe original TSX Committee has called, the innerworkings of boards of directors must be assessed. It is"board effectiveness" not "board structure" that mustbe analyzed, for it is the effectiveness of the board inthe decision-making process that in the final analysisdetermines corporate performance.

The effective board

There is no doubt that an effective board must be builton a foundation of members who are independent. Butit must have two additional features. It must be made-up of members with the competencies required by thecorporation to fulfill its strategies and to meet itsobligations, and the members must be able to worktogether to come to effective decisions. In other words,

for a board of directors to accomplish the tasks assignedto it, it needs to have the right board structure, supportedby the right board membership, and engaged in the rightboard processes. Without such a balance it is difficult,if not impossible, to have the effective interactionbetween and among fellow board members andmanagement that is essential for overall effectivedecision making.

Board membership is defined as how directors cometo be recruited onto a board, the balanced competenciesof existing members, and the methods that are taken toremove a director from a board (e.g., director tenure orretirement). Board membership includes the fullpanoply and balancing of all director competencies in

matching the strategic needs of the company. If aparticular board therefore does not have the full set ofrequired competencies covered off in a balanced way

across all of its directors, it will not be effective underthe above model, despite the individual competenciesof directors.

Board process is defined as how directors makedecisions and the behaviour of the individual directorsthemselves. The reality is that boards of directors, likemost groups, are made up of a diverse group ofindividuals, all of who behave differently. Somedirectors do not speak because they fear they will reveala lack of knowledge about a topic and embarrassthemselves in front of their peers. Others remain silenton an issue because they don't want to question the ideasand concepts of accepted expertise, and some simplydo not participate in decision-making because of a lackof interest. And then there are directors who act in anexactly opposite fashion - they speak without muchknowledge, never worry about embarrassing themselvesand are oblivious to the opinions of experts.

Not astonishingly, therefore, given the fact that boardsare groups, the most important factor in board processis the inter-relationship among and between directors,which in turn is largely based on the behaviouralcharacteristics of individual directors. What may be

Figure 3Models of Board and Director Effectiveness

Board effectiveness (BE) depends upon board structure (BS) + board membership (BM) + board process (BP).

BE = BS + BM + BP

DE = DI + DC + DB

Director effectiveness (DE) depends upon director independence (DI) + director competence (DC) + director behaviour (DB).

it is the selection of chair that mattersmost to board process, not theseparation (of chair and CEO)


termed "functional director types" include Conductor-Chairs, Change Agents, Consensus-Builders,Counsellors and Challengers. Conversely,"dysfunctional director types" include Caretaker-Chairs,Controllers, Conformists, Cheerleaders and Critics.Interestingly, whether a chair is effective or not, underthis classification scheme - i.e., a Conductor-chair orCaretaker-chair - depends on the competency andbehaviour of that chair, irrespective of whether the chairalso occupies the post of CEO or not, contrary toconventional wisdom. In other words, it is the selectionof chair that matters most to board process, not theseparation (of chair and CEO).

The effective director

"Board effectiveness" and "director effectiveness," inturn, are interrelated and affect each other. In otherwords, the effectiveness of individual directors and howthey interact with each other has a great deal to do withdetermining board effectiveness. If it is otherwise, howcan we explain boards that have failed, yet supposedlyhad effective directors on them? How do we know thatsuch directors were "effective"? And if they were, whywas the board as a group ineffective?

It is not possible to have an effective board withouteffective directors. There are three factors whichdetermine whether or not a director is effective - (i)director independence, (ii) director competencies and(iii) director behaviour. The models of board anddirector effectiveness and their interaction are presentedin Figure 3. When putting a board together, or regulatinga board, the first of these three factors largely seems togovern, primarily because so little is known aboutdirector competencies and especially director behaviourwithin boardrooms. But even the first of the three,director independence, is somewhat different whenanalyzed in terms of board action than it may appear tobe from an examination of external information.

The coming revolution in corporate governance

It may well be that there is a tenuous link betweenboard structure and board performance, since structureis certainly a necessary condition for board effectiveness,but clearly it is far from a sufficient condition to assurethat a board operates in an effective fashion. The onlypossible way to know whether boards operate well is toobserve them in action - to see and understand theprocesses by which they reaches decision. The missinglink in establishing the relationship between boardgovernance and corporate performance may be anunderstanding of that activity called board process.

Indeed, board process may be the single mostimportant factor in determining a board's effectiveness,that is the capacity of a board to make appropriatedecisions while overseeing that management operatesin the best interests of the corporation and itsshareholders. Uncovering "how boards work" hastremendous practical significance. It may mean thatchairs, nomination committees and directors, whenputting together a board of directors, or adding to anexisting board, should greatly decrease their focus onfactors such as "structure" and "composition."

This is not to suggest in any way that directorindependence is unimportant, but only that it should notbe seen as a panacea for all corporate governance ills.There are difficulties with the notion of independenceitself. It is quite difficult to measure and it is contextual,relevant to a particular director, his or her circumstancesand relationship to management or the controllingshareholder. Social relationships, friendships and otherforms of conflicts that are not readily detectible cancompromise independence. Independence thereforedoes not always manifest itself within a boardroom,regardless of how a particular director is beingcharacterized outside of the boardroom. In short,competencies and behaviour matter more than doesindependence.

The news from the regulatory world is not positive.For some reason, despite the evidence to the contrary,regulators, as the Sarbanes-Oxley legislation in theUnited States and both the TSX and now NYSEgovernance guidelines so clearly demonstrate, are

The missing link in establishing therelationship between boardgovernance and corporateperformance may be an understandingof that activity called board process


fixated on regulating structure and form. And chairs ofnomination committees seem to still be focused onselecting board members on the basis of their reputationand relationship with existing board members.

But these are obstacles that time and knowledge willovercome.

Is it important that change does take place? Theanswer is, of course, yes because everyone -stakeholders, the community and the nation -- benefitsfrom well-run corporations and suffers from those thatare not. And better corporate governance is clearly theway to improve the operation of enterprises.

It is most important to find the relationship betweencorporate governance and corporate financialperformance. We know that there must be somerelationship and all corporations, stakeholders andregulators will benefit from knowing what it is.Unfortunately, finding the answer is going to be difficult,but not insurmountable. Unlike the unicorn, it willprobably not be found.


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The Coming Revolution in Corporate Governance · The Coming Revolution in Corporate Governance Most of the talk about better corporate governance has focused on the independence of