UBLIC ARKETS Corporate Goverance Overload€¦ · of less than $75 million – 2009. The proposed Canadian rules also require companies to file a report by management that describes

OCTOBER 2005 l exchangemagazine.com l 23

Corporate Goverance OverloadCan we please stop now, before it’s too late?

BY J IM KOPPERSON

PUBLIC MARKETS

In February, the majority of our provincial securities regulators published forcomment, “Multilateral Instrument 52-111 Reporting on Internal Control overFinancial Reporting”. The proposed rules will require management of most

Canadian public companies to evaluate the effectiveness of their companies’internal controls and have their auditors report on these controls. The proposedinternal control instrument is substantially the same as the requirements of Sec-tion 404 of the Sarbanes-Oxley Act of 2002, which has been rammed through inthe United States, purportedly in response to large corporate frauds such asEnron and WorldCom.

The Canadian equivalent of SOX 404 is being phased in over four years, startingwith financial years ended on or after June 30, 2006, as follows:• Companies with a market capitalization

of greater than $500 million – 2006;• Companies market capitalization of

$250 million or more but less than$500 million – 2007;

• Companies with a market capitalizationof $75 million or more but less than$250 million – 2008; and

• Companies with a market capitalizationof less than $75 million – 2009.The proposed Canadian rules also

require companies to file a report by management that describes the effectivenessof the companies’ internal controls including: • A statement of management's responsibility for establishing and maintaining

internal controls;• A statement identifying the framework used by management to evaluate the

effectiveness of internal controls; and• Management’s assessment of the effectiveness of internal controls and disclo-

sure of any material weaknesses in internal controls.The proposed internal control instrument does not specify the methodology to

be followed or procedures to be performed to complete management's assessmentof their internal controls. It indicates only that the assessment should be basedupon procedures sufficient to both evaluate the design and test the operatingeffectiveness of the controls and requires that companies file a report in whichtheir auditors expresses an opinion on management's assessment of the effective-ness of the company’s controls. The internal control audit report and the auditreport on annual financial statements must be prepared by the same audit firmthat does the company’s statutory audit and the audit must follow Canadian Insti-tute of Chartered Accountants standards.

The implementation dates are supposedly being phased in to provide smallercompanies time to prepare for compliance with the requirements and to ensurethat adequate resources are made available. Not surprisingly, many Canadian SECregistrants and U.S. public companies have found that complying with the newrules is extremely costly and time consuming and many are balking, contendingthat the costs are far outweighing the benefits. On the other hand, the new rulesappear to be a gold strike for professional services firms and an emerging cottageindustry of “corporate governance experts”.

A Practical View From the FieldWhile I sympathize with what probably once was a noble objective on the

part of securities regulators to curb abuses among large public companies, mypersonal view is that the snowball effect that has resulted has gone far beyondanything that will have any practical benefit, particularly for smaller public

JIM KOPPERSON IS

CHIEF FINANCIAL AND

VP, CORPORATE

DEVELOPMENT OF

RDM CORPORATION.

exchange oct05 pgs23-40 9/6/05 2:55 pm Page 23

24 l exchangemagazine.com l OCTOBER 2005

companies and their shareholders. Ifind it actually quite perverse that thelarge accounting and law firms thatthe regulators were just a short timeago chastising are now poised to bethe only ones to really benefit fromthe increasing burden of regulatorycompliance that is being forced upontheir clients.

To put things in perspective, in fis-cal 2004 the company I work for gen-erated approximately $17 million inrevenue and managed a small profitof under $500,000. My estimates sug-gest that the costs of being a smallcap pubic company in Canada alreadyrange between $500,000 and$1,000,000 annually, so in reality thefirst half to two-thirds of our profitsalready went towards regulatorycompliance (auditors, lawyers,investor relations, regulatory filings,D&O insurance, etc.) and the remain-der was left over for our sharehold-ers. To put this another way, ourannual payroll is approximately $6million dollars, so the cost of regula-tory compliance already results in ushiring between 10% and 25% feweremployees than we otherwise wouldhave. I also believe (and I am notalone) that complying with the newrules may very well double theseannual compliance costs. Large enti-ties may have the resources to shoul-der a doubling of their compliancecosts but I can say from first handexperience that small companiessuch as ours definitely do not.

The U.S. regulators’ strategy withrespect to SOX appears to have beenakin to “damning the torpedoes”; mostsmall cap U.S. public companies willattest that they have been forced tocomply with the full weight of SOX ina relatively short period of time withno real meaningful exceptions or con-cessions. While I am disappointed thatCanadian regulators are poised tointroduce their own “Canadianized”version of SOX, I am somewhatencouraged by the phased implemen-tation afforded to smaller Canadianpublic companies. My hope is that bythe time small cap companies arerequired to implement the proposedrules we will all have learned soberinglessons from the carnage that I believewill be left in the wake of the U.S. SOXexperience – that is if there are anyU.S. small cap public companies leftstanding to tell about it by the time2009 rolls around. Can we please stopnow before it is too late?

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The Gap in GAAPCan financial statements be trusted?

BY ALLAN FOERSTER

GUEST COLUMN

The headlines continue to proliferate with accounts of corporate financialrecords being restated, with the result that millions of dollars of shareholdervalue has evaporated. Ignoring the oft-reported examples of corporate

accounting malfeasance, how could honest, intelligent managers, shareholdersand auditors miss such gross misstatements? Further, with the enhanced attentionbeing paid to financial statements through the past debacles of Enron, Worldcomand Nortel, and the introduction of increased attention on financial controlsthrough audit required attestations introduced by Sarbanes-Oxley and currentlybeing explored by Canadian regulators, why are financial statements not to betrusted? Or can they be trusted if users gained a better understanding of the under-lying conceptual framework that governs the structure of Accounting Principlesand Concepts? I support the latter ofthese two positions.

The “Expectation Gap” between usersof financial information and preparers offinancial information is not new, but Ifear it is growing. First and foremost,users need to understand that GAAP(Generally Accepted Accounting Princi-ples) does not equal GAAP. This ambigui-ty is due to the adoption of differentaccounting standards depending on thejurisdiction. GAAP under Canadian and International reporting beingprinciple/judgment based differs from the detailed rule orientation of US account-ing standards. Recently, the Accounting Standards Board in Canada announced aphase-in over a five year period commencing in 2006 converging Canadianaccounting standards with those of the International Financial Reporting Standardsadministered by the International Accounting Standards Council.

Why not conform to US accounting standards? Paul Cherry, the Chairman of theAccounting Standards Board commented in a recent interview that “it would be amassive undertaking to comply with US GAAP so I think we are making a moreinformed decision than would have been possible five to 10 years ago.”

Translated, perhaps given theaccounting scandals in the US, the goldstandard of financial reporting is notUS GAAP. In fact, Cynthia Glassman,Commissioner of the SEC acknowl-edged in a speech that “most impor-tantly, we must reduce the financialreporting system’s reliance on rulesand move towards an objectives-ori-ented system. Standards have to flexi-ble enough to reflect a company’s busi-ness while being sufficiently standard-ized so as to let the market comparedifferent companies.”

Fundamental to financial reporting isan understanding and appreciation ofthe extent to which estimates are usedin compiling financial statements. Anyelement of precision cannot and shouldnot be afforded to financial statements.Considering everything from allocatingthe cost of long term assets over theiruseful life to the rate of return expectedon pension plan assets, estimatesimpact the valuation of numerousassets and liabilities and as such have adirect impact on the reported income orloss for the period reported.

Unfortunately, these judgment callshave become fertile ground for thosewho might chose to distort reportedresults by manipulating the estimationprocess to provide the desired results.Standard setters could go a long wayto assist users of financial statementsby requiring prepares of financial state-ments to set out clearly and conciselythe estimates used in one central areaof the financial statement notes ratherthan having them sprinkled throughoutthe financial report.

Users of financial information need to

ALLAN FOERSTER

IS A LECTURER AT

WILFRID LAURIER

UNIVERSITY. email:

[email protected]



also be wary of the manner by whichfinancial results are reported. More andmore we hear reports of corporate per-formance “ex items” or “before items”and the ever popular EBITDA (EarningsBefore Interest Taxes Depreciation andAmortization) and Pro Forma results.These management “excuse me” itemsmay not be deliberately hidden fromusers of financial statements but neitherare they clearly reported. Sometimes,the exclusion of an item from operatingearnings is appropriate. For instance,the one-time write down of goodwillcould be a good thing. The danger is theone-time item that becomes a regularoccurrence that never seems to impactoperating earnings.

In a recent study completed byRichard Bernstein, the Chief US Strate-gist for Merrill Lynch reported a dis-turbing trend towards a growing gapbetween “real earnings” (GAAP deter-mined earnings) and reported orannounced earnings. Investors need torecognize that metrics such as EBITDAand Pro Forma are not governed byaccounting standards and as such tendto be massaged by financial managersto meet “street expectations”. Hereresides the devil in the details. Themyopic focus on a magical quarterly

Earnings Per Share figure as a truereflection on management’s perform-ance has led invariably to inappropriateapplication of GAAP and dart boardaccounting estimates with the misguid-ed goal that seldom results in maximiz-

ing long term shareholder value. Howoften have we heard the explanationthat irrational financial executivebehaviour that eventually leads toaccounting fraud was motivated by theneed to “meet the numbers”? That wasthe plea of Worldcom’s CFO Scott Sulli-

van’s testimony against his formerfriend and CEO Bernie Ebbers that ledto the latter’s 25 year sentence andgave Sullivan a relatively light five yearpunishment, reflecting the value of hisco-operation with prosecutors.

How do we get management tofocus on creating value, not just creat-ing numbers? Solving this concern willnot be the result of discovering somemagical elixir. Nor will it assist theprocess by merely blaming accountingstandards. Given that billions of dollarschange hands through variousexchanges on a daily basis based onreported earnings, balance sheet val-ues and prospects about the future, thedependence on accurate and timelyfinancial information is critical to theefficient allocation of capital. Financialinformation can not be contrived toreflect success but must reflect on atransparent basis the actual perform-ance of the business. To achieve thesegoals will require a change in theunderlying culture of quarter by quarterperformance to one that rewards andvalues transparent financial reporting,providing the financial informationmanagers require to make the neces-sary decisions to create long termshareholder value.

I find it perverse that the

large accounting and

law firms who regulators

were just a short time

ago chastising are now

poised to be the only

ones to really benefit.

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The Champion ChairmanUnderstanding the Top Ten Traits of an Excellent Board Chairman

BY J IM BROWN

BUILDING BETTER BOARDS

As spotlights continue to glare on governance as a business concern, moreand more attention shifts to a role that has long been a title of status andpost of privilege. It’s becoming clear that Chairman of the Board is a desig-

nation with responsibility, not rights.Whether you’re looking for a great chairman or wishing to be one yourself,

you’ll want to be well aware of the topten traits that distinguish a championchairman.

Outstanding record of integrity andtrustworthiness:

Character qualities are an absolutemust of any person serving in this highlyresponsible role. Purdy Crawford, formerchairman of Imasco and Canada Trustand Chair of the Five-Year Review Com-mittee examining securities legislation inOntario, advocates that “the number one responsibility of a Board of Directors is tobe the guardian of corporate values ... to make sure that the CEO and the otherleaders are people of integrity and that they ‘walk the talk’.” For this to be possible,a board needs the chairman to be both an example and a proponent of integrity.

Bias to take leadership:Champion chairs don’t sit still in a leadership vacuum. They take action. Board

members – as much as they are leaders in their own right – expect the chair to ful-fill the role as leader of the board when handling meetings, addressing problems inthe company, and confronting challenges within the board.

Passion for the company and its mission:Without passion fuelling the chairman’s involvement, she will only be doing a

job. This role demands more. Having a vision for what the business could be willdrive her commitment to do much more.

Excellent communication skills, both written and verbal:Communication is a two-way process that allows for exchange of meaning. Lis-

tening is essential – some say we havetwo ears and one mouth and theyshould be used in that proportion!When the chairman has spoken – orwritten – you want people to under-stand the message clearly.

Self-confidence balanced withhumility:

People are looking to follow some-one who knows where he’s going. Self-confidence is key. But taken too far, it’sdangerous. Humility keeps it in check.And humility provokes him to seekfeedback from his peers, to be open-minded to the opinions of others, andto ask board members what theyexpect of the chairman.

Commitment to building a high-per-forming leadership team, promotingboth results and relationships:

The fact is ... results are required orthe company fails. The championchairman artfully combines a determi-nation to get results with an under-standing that results come from peo-ple. Highest results come from a teamthat knows each other and draws oneach others’ strengths and talents, sup-porting every individual. To foster this,Purdy Crawford advises that a chair-man is wise to stay in touch with eachdirector – contacting them by phone,occasionally meeting for lunch, andperhaps identifying items for in cameradiscussion.

Solid understanding of the dis-tinction between governance andmanagement:

The experiences of each director willlure them into operational details sothe chairman is pivotal in helping the

JIM BROWN IS A

CONSULTING PARTNER

WITH STRIVE, WITH

OFFICES IN GUELPH

AND OHIO.

email: [email protected]



board do the board’s job and allowingmanagement to do its job.

Thorough knowledge of meetingprocedures:

Whether it’s parliamentary procedureor some other shared code for operat-ing a meeting, the chairman must knowit and follow it naturally so everyonecan relax and focus on the purpose ofthe meeting rather than the process. Asbasic as this ability sounds, it is impera-tive for a champion chairman.

Ability to build consensus:Decision making is not just about

majority votes. It’s about agreeing onthe best answers to challenging prob-lems. Joe Martin, a seasoned corporatedirector and a professor at RotmanSchool of Management, emphasizes

this important skill of the chairman anddescribes it as “finding the highestcommon denominator.” Consensusbuilds commitment to a course ofdirection and reinforces the value ofteamwork.

Familiarity with people, publicrelations and ‘politics’:

Savvy in dealing with people and inthe public arena is a critical skill for thechairman who will typically be calledupon as the spokesperson. She willneed to be aware of the games peopleplay and the traps they tend to set.

You’ll notice that being a championchairman goes well beyond meetingmanagement. It’s a responsibility thatrequires time and talent before, during,and after meetings. It’s a role thatdemands character, competence, andconfidence. And the reward of excel-lent chairing is a board completely ful-filling its job of governing the business– directing and protecting in the bestinterest of the company’s owners.

A board needs

the chairman to

be both an example

and a proponent

of integrity.



Think back to the best course you can remember, in high school, college oruniversity. What made it the best course? You probably looked forward tothat time of day; you probably did well and understood the material, and you

probably had fun.How many of your employees feel that way about coming to work? In most

organizations you can count them on one hand, and the exceptions are some ofthe most profitable organizations in theworld – GE, Toyota, Motorola.

What makes these companies greatplaces to work is, they are “LearningOrganizations.” They understand wherethey have been, and they know wherethey are going. To a student, or anemployee, this usually means clearexpectations and support in achievingvery specific objectives.

Students and employees function bestin an environment that provides very clear expectations and a structure that con-siders some very specific “learning” needs. Let’s look at the concept more closelyby exploring the learning process from the instructor’s perspective.

PreparationAn instructor can make or break

any learning exercise in the prepara-tion stage. Inadequate planning forclassroom activities can result in any-thing from chaos – as students engagein thoughts and activities that havenothing to do with the course material– to frustration, with students strug-gling to make sense of the material.This will result in frustrated, day-dreaming students who would ratherchat with their neighbor. Ensuring thatstudents understand the course mate-rial, and make connections to previouslessons, requires a thorough teachingplan that considers the conceptsbelow.

Willingness One of the main challenges for an

instructor is to take a diverse group ofindividuals with different backgrounds,experience, skills and expectations,and bring them together in an environ-ment conducive to learning. The stu-dents need a common understandingof the necessary background informa-tion and they must be “ready to learn.”Students, like employees, come toschool with plenty of things on theirminds to distract them. It’s the instruc-tor’s responsibility to prepare the stu-dents to learn.

The Learning OrganizationClear expectations and specific objectives

BY DOUG CATER

MANUFACTURING METHODS First ImpressionsEnsuring a good first impression on

any topic requires the instructor tostimulate the students and provide apositive experience. An unpleasantexperience, or confusing material, willresult in very little learning as studentstune out and turn off. Students willlearn best if the expectations are clearand the experience is enjoyable andsatisfying. Positive reinforcement andconsequences are always more effec-tive than using punishment or negativeconsequences. Recognition andrewards are an effective way to ensurea positive experience.

RepetitionEveryone learns differently; howev-

er, most pedagogies allow for repeti-tion, and there is essentially no differ-ence between retention of a physicalskill and retention of list of facts. Prac-tice makes perfect! Until we have hadmultiple opportunities to use what wehave learned, our potential for retain-ing it will be low. Further, our ability toevaluate and apply what we havelearned will be enhanced by practice,review and application. Good instruc-tors will conduct multiple sessions andprovide ongoing reviews and

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summaries to drive home the conceptsor facts.

IntensityA student fully engaged in a fun and

exciting exercise will learn faster andretain more than a student stuck in aboring classroom focused on routinememory work. Most individuals learnbetter from observing activities thanfrom reading about them, and even bet-ter by experiencing them “hands on.”

We learn better by doing, where wecan fully experience the concept ratherthan attempting to conceptualize. Welearn better when we can apply ourknowledge and make mistakes. In aclassroom this can be tough and theinstructor has to work hard to createthe “environment,” using videos, role-playing, demonstrations and plenty ofgraphics and visual tools. It is no dif-ferent in the workplace. Get out of theclassroom and go kick the tires on theshop floor!

TimingInstruction and theory provided

without the opportunity to practice, orwithout the requisite preparation, willnot result in learning. Even if the pre-requisites are in place but the training

is provided too soon before it can beapplied, much will be lost. Short termmemory and long term memory aretwo completely different animals, andsolidifying facts and skills into thelong-term part of our memory requiresrepetition and many links to existingknowledge.

VolumeWe only have so much capacity and

learning takes time. Trying to teach toomuch, too fast, will result in selectivelearning. Most students confrontedwith information overload will uncon-sciously filter a portion of what is beingheaped on, retaining some of what is

learned at the beginning or the end,and they’ll lose much of what was inbetween.

FeedbackOne of the most important responsi-

bilities of the teacher is to provideongoing feedback. A student who doesnot receive proper feedback will not beas engaged. As well, they risk makingmistakes that can “solidify” incorrectthinking or practices. Once developed,incorrect habits can be more difficult tobreak than establishing good habits inthe first place. Ongoing evaluation(written, oral or practical testing)allows the teacher to gauge learningand offer timely feedback that correctsand solidifies learning.

Yes, ongoing training is fundamentalto the creation of a Learning Organiza-tion. But it doesn’t automatically resultin learning. It needs to be wellplanned, considering the audience; itneeds to be current and timely; itneeds to be interesting and supportedby application and plenty of practice.Most important however is the ongo-ing evaluation of the student’sprogress, and the subsequent feedbackprovided.

Instruction and theory

provided without

the opportunity

to practice will not

result in learning


Documents

UBLIC ARKETS Corporate Goverance Overload€¦ · of less than $75 million – 2009. The proposed Canadian rules also require companies to file a report by management that describes