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Shaping good conduct: The search for more effective systems of corporate governance has created a unique opportunity for strategic financial management professionals.

Improving corporate governance is one of the hottest topics in boardrooms, regulatory commissions, and business newsrooms around the world. Reasons for this stem from a variety of problems that surfaced in the 1990s, such as well-publicized business failures that have been related to inadequate governance structures, including Bre-X, Livent and YBM, and questions about the adequacy of management in organizations like Air Canada, Moore and Nortel.

Continuing concerns about improving corporate governance have also been voiced in such reports as the influential "Crystal Report on Executive Compensation" by analyst Graef Crystal, which debates whether boards act in the best interests of shareowners, particularly in the area of setting executive compensation.

Statements expressed by securities regulators, such as David Brown, chair of the Ontario Securities Commission (OSC), suggesting that external auditors are increasingly becoming advocates for their clients instead of impartial arbitrators of financial statement disclosure fairness are also influencing decisions pertaining to corporate accountability.

And finally, there has been significant non-compliance with the voluntary recommendations of the Dey Cormmittee, suggesting that TSE registrants disclose their firms' activities in relation to a variety of corporate governance "best" practices (see "Corporate Governance," by Brace McConomy and Merridee Bujaki, GMA Management, October 2000). The joint committee's recommendations focus on the major issues identified in corporate governance, such as the fiduciary role of the board, yet despite their context in corporate culture change, they are surprisingly focused on form and structure.

The increasing interest in, and the demand for, higher standards relating to corporate governance have created a unique and timely opportunity for management accountants -- and other strategic financial management professionals -- to align the strategic vision of the profession with the emerging demands for more effective systems of corporate governance.

The evolution of corporate governance principles

Discussions of corporate governance operate at cross-purposes since there are different and potentially conflicting definitions of the concept. Understanding these differences is a first step in supporting an informed discussion about corporate governance and developing a standard definition for it.

The setting

At the aggregate level, corporate governance is about governing an organization. The players in the governance process are the principals or shareowners of the organization, management, board of directors, and auditors. The principals hire managers to pursue their objectives for the organization. The managers are expected to act in the principals' interests in managing the organization. While the principals nominally appoint the board of directors to oversee management, the reality of the modern corporation is that management usually appoints the members of the board. Furthermore, while the principals hire the independent auditor who reports on a fairness evaluation of the financial statements and related disclosures, the reality is that management most often selects and determines the compensation level of the auditors. Management can also influence the auditors via their purchase of non-audit services from the professional service firms that public accounting firms have morphed into in recent years.

Suggested roles for corporate governance

The setting of corporate governance raises three important sets of issues. The first is that management may operate the organization to achieve management's interests rather than the principals' interests. Since, in most settings, management appoints both sets of overseers (the board and the auditors) and can offer the monetary incentive of continued employment to both, the potential for moral hazard exists, in that management can bend both the board of directors and the auditors to its will. This is a fiduciary issue since it can result in an inappropriate transfer of organization resources from the organization's principals to its management. This role may be referred to as the "internal control role" of corporate governance.

Second, management may act honestly but incompetently in managing the organization's affairs. This issue elevates the role of the board of directors in evaluating the business and functional level strategies developed and implemented by management. Some observers have argued that the role of the board of directors is to provide a proactive, comprehensive and independent review of these strategies. Other observers believe that the role of the board is reactive, providing for management succession when the current management has failed. This role maybe referred to as the "control role" of corporate governance.

And finally, the third issue is that appearances of propriety can be deceiving in corporate governance. It costs nothing for ineffective boards to mimic the practices of effective boards by complying with structure requirements, but not delivering the expected results of effective corporate governance. Focusing on internal controls does not ensure effective corporate governance if it is construed as effective control of the organization.

While all perspectives on corporate governance agree on the importance of the fiduciary issues in corporate governance, differences arise in the nature and importance of the control role, and how difficult it is for ineffective boards to mask their lack of stewardship.

Alternative perspectives on corporate governance

The fiduciary perspective. Traditionally, corporate governance focused on, and reflected, fiduciary concerns. Governance was considered adequate if management took steps to ensure that the organization's assets were protected from loss or theft. For this reason, good corporate governance was, and in some circles still is, associated with adequate and effective internal controls.

The Toronto Stock Exchange (TSE), reflecting the conclusions of the influential Dey Committee on corporate governance, focused its governance evaluation and guidelines on the organization's internal control, management information, and risk management systems. According to the TSE, corporate governance means the process and structure used to direct and manage the business and affairs of the corporation with the objective of enhancing shareholder value, which includes ensuring the financial viability of the business.

While this definition appears to promote the fiduciary and evaluating role of governance and advocates a social responsibility, the TSE current governance guidelines focus almost exclusively on controls designed to ensure board independence and issues relating to managing organization risk. There are no specific guidelines relating to supporting a control role for boards of directors; hence, the perspective is decidedly fiduciary.

This preoccupation with structure (controls) rather than process or results (control) is evident in the criteria that some reviewers have used to rank boards in terms of their governance practices. For example, in the article "Why Boards Matter" (Canadian Business, October 29, 2001) two criteria were used to rank boards: how well each company adhered to the TSE governance guidelines and evidence of board independence. It is relatively easy for ineffective boards to imitate the practices of more effective boards and thus receive such a seal of approval.

The stakeholder perspective. The stakeholder perspective on organizational governance is based in social equity and welfare principles. This approach advocates identifying stakeholders who have claims on the organization; the rigorous specification of tights and responsibilities amongst those stakeholders; and the development of accountability, reward and punishment systems to support the rights allocations. In this view, the organization is a mechanism that, amongst other objectives, should be a model or tool of social justice. This perspective is evident in the World Bank's definition of corporate governance, which states that it holds the balance between economic and social goals and between individual and communal goals. The governance framework is there to encourage the efficient use of resources and equally, to require accountability for the stewardship of those resources.

Some writers have addressed the stakeholder perspective from the narrower perspective of the legality of organization activities. Management literature discusses this perspective under the aegis of internal control, ethics control and risk management systems. Some parties have treated ensuring the legality of organizational activities as an element of corporate governance. For example, RT Capital was charged with, and subsequently fined for, high closing activities (stock manipulation) by the OSC, which argued that these activities were taken as a failure of effective board stewardship and a lack of effective corporate governance in the firm.

The control perspective. This perspective identifies the primary role of governance as the effective use of assets in pursuing organizational objectives -- a significant and important departure from the fiduciary role envisioned by the internal control perspective. The following Organisation for Economic Cooperation and Development (OECD) definition of internal control reflects this perspective:

Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation...and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance.

The rights definition. In "Governing the Modern Corporate," (the Economist, May 5, 2001), the American approach to governance is identified using the concept of shareholder rights. From this definition, good corporate governance exists when shareowners have the ability, through votes at annual meetings or through forceful boards of directors, to overthrow existing management when appropriate. From this view, effective corporate governance is achieved through laws that enhance the ability of shareowners to express their preferences in a democratic way, either by their direct actions or indirectly by having boards of directors reflect their majority preferences.

A comprehensive definition. It is evident that some of the above definitions of corporate governance reflect elements of internal control and control perspectives. The following definition appears to include key aspects of the above perspectives:

Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders' role in governance is to appoint the directors and auditors and to satisfy themselves that an appropriate governance structure is in place. The responsibilities of the board include setting the company's strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board's actions are subject to laws, regulations and the shareholders in a general meeting. ("The Report of the Committee on The Financial Aspects of Corporate Governance," The Cadbury Report, April 1992)

Outcomes -- not controls

A distinguishing characteristic of many of the perspectives on corporate governance is a focus on controls (rules and structure), rather than outcomes (process or results). This characteristic has provoked comments from skeptical observers that the governance movement, which has been driven primarily by accounting bodies, is riddled with self-denial and window-dressing that do not deal with the underlying fundamentals, nor with thoughtful proposals for improving corporate governance. The preoccupation with controls rather than outcomes is likely the reason that the report of the TSE-CICA Joint Committee on corporate governance entered the world with a thud rather than a bang.

Terrance Corcoran commented in the National Post (March 10, 2001) that "while the accountants busy themselves with soft and fluffy 'corporate governance' issues...their real business of accounting is falling away." This commentary is unfortunate for two reasons. First, it reflects a growing lack of confidence in public accounting and the ability of regulators and professional accountants to implement a credible and effective process of corporate governance. Second, it fails to recognize some important developments in the principles of corporate governance that accounting bodies have developed but failed to advocate forcefully both to their own members and to the regulatory community.

The issues that need to be resolved include the following:

1. Should corporate governance include both the fiduciary and control roles?

2. Whose interests should be reflected by corporate governance principles -- only those of the principals', or those of a broader set of stakeholders?

3. Should the role of the board of directors be proactive or reactive?

A suggested course of action

From the commentaries reported above, it is clear that the institutional investment community is losing patience with the lack of progress exhibited by the various constituencies that have proposed corporate governance principles but failed to propose and implement effective systems of corporate governance. The approach undertaken by the TSE to date, and that of the joint Committee's interim report, which focuses on controls rather than outcomes, is ineffectual and will not address the concerns and issues that critics of current corporate governance practices have raised.

What is required is an acceptance of the broad view of corporate governance, such as the one proposed by The Report of the Committee on the Financial Aspects of Corporate Governance or The Criteria of Control Board in Canada, recently renamed the Risk Management and Governance Board. (For a summary of the various approaches to corporate governance see "Corporate Governance: The Role of Internal Control," Emerging Issues Paper, Strategic Management Series, CMA Canada, Mississauga, Ontario, 1999.)

It is unlikely that a view of corporate governance that includes broad social issues would be acceptable in North America, although corporate governance should include controls that ensure that the organization will operate within societal laws and expectations of "good conduct."

Within this view, the role of the board of directors should be clearly specified. In a provocative article by John Pound, entitled "The Promise of the Governed Corporation" (Harvard Business Review, March/April 1995), the writer argues that boards should be required to undertake substantive and independent reviews of both the organization's systems of internal control and the efficacy of the organization's systems of planning and control. This is difficult to achieve as board members are commonly rated on how much of a "team player" they are throughout their careers. Yet, here, they are asked to act as an independent check on the very management that in all likelihood appoints and remunerates them.

Glorianne Stromber, a former commissioner of the OSC, stresses the board's role of undertaking an independent evaluation of management initiatives. She echoes Pound's perspective of the importance of understanding the behavioural dynamics involved in the board's stewardship in her comments on the focus of the Joint Committee on Corporate Governance's Interim Report:

"The fundamental reluctance of directors to question management or committee initiatives has all too often undermined and will continue to undermine so many well-intentioned governance measures. This reluctance exists whether the board is chaired by a non-executive chair or by the CEO with a lead director. This reluctance is also likely to taint the frankness and usefulness of assessments of the board's effectiveness as a whole or of the effectiveness of individual directors..."

The role of the management accountant

Within this context, a critical role emerges that reflects the domain and defined territory of management accounting to provide strategic performance information that will allow both management and an independent board of directors to evaluate current management strategies. This information is already present in some organizations in the form of strategic performance measurement systems, such as the balanced scorecard, which requires that management develop, articulate, communicate and monitor its chosen strategies.

Furthermore, management accounting knowledge of how different information needs to be tailored for different decisions and decision-makers could lead to more useful and understandable reports for boards and board committees. This implies that management accountants need to have a greater exposure to directors, so that they can shape directors' information systems. That information system should be responsive to directors' needs via mechanisms, such as secure Web sites with relevant and reliable corporate information in a format easy for busy directors to utilize in their monitoring and evaluating roles.

Management accountants and other strategic financial management professionals who are directors of corporations also have an important role to play. They need to demand from management the information and information systems that will allow them to carry out their roles effectively and efficiently. As independent critical thinkers, management accountants who are directors need to foster a climate on the board that enables directors to feel that it is not just acceptable but necessary that they raise the tough questions about management strategy and initiatives.

The key to corporate governance reform does not lie in specifying controls that are easily mimicked by those companies that prefer form to substance. Although they may well be necessary conditions, they alone are not sufficient enough to promote effective organizational control. The key to reform lies in creating a climate among a well-educated set of directors that is conducive to openness and questioning of key management assumptions and proposals. This requires that directors serve only on a limited number of boards so that they have the time to devote to board and committee activities; they have or obtain an in-depth understanding of the industry; they are truly financially literate; they have a substantial personal investment in the company; and they are known as independent thinkers. Whether any blue-ribbon commission or regulator can effect this sort of change is indeed an open question.

Anthony A. Atkinson, Ph.D., CMA, FCMA, is the associate director of research at the University of Waterloa's School of Accountancy. Steven Salterio, Ph.D., CA, is an associate professor at the same school Both authors have carried out research in corporate governance, the balanced scorecard, and performance measurement systems.

RELATED ARTICLE: Mini case study Changing Its Tune

How the Bank of Montreal changed its corporate governance climate in the 1990s:

* Decrease board in size from 29 in 1991 to 15 in 2000.

* Clear board responsibilities including:

* Selecting, evaluating, compensating and replacing the CEO;

* Selecting directors and evaluating board performance;

* Shaping, assessing and approving strategic plans and objectives;

* Overseeing ethical, legal and social conduct;

* Reviewing the financial performance and condition of the bank;

* Simple one-page "Charter of Expectations for Directors."

* Annual peer evaluation in which directors rate each other against the Charter, including such areas as strategic insight, financial literacy, business judgement and accountability, and communication. Participation is mandatory and each director receives a copy of feedback on his/her performance.

* Annual survey of board members to identify key governance concerns that are used to shape the board agenda for the next year.

* Rigorous continuation of membership policies including retirement t age 70, 75% attendance requirement and automatic tendering of resignation when principal occupation changes.

* Assignments of clear descriptions and responsibilities assigned to each board committee.

* Requirements that every director have a laptop with e-mail capability so that they can receive real-time updates of key company information.

The Bank of Montreal recently received a National Award in Governance from the Conference Board of Canada, and has consistently been recognized for the quality of its disclosures on corporate governance by the Canadian Institute of Chartered Accountants and the National Post Annual Report Awards.
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Author:Atkinson, Anthony A.; Salterio, Steven
Publication:CMA Management
Geographic Code:1CANA
Date:Feb 1, 2002
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