This article summarizes the third edition (2018) of CFA Institute’s publication, The Corporate Governance of Listed Companies, including supplementary briefs Role of Board of Directors and Board of Directors Structure, and highlights Canadian legal requirements under the Canada Business Corporation Act (CBCA).

Boards may adopt CFA Institute best practices voluntarily to enhance governance. Corporate governance is a set of control measures and procedures to manage companies. It defines the rights and responsibilities of management, board, controlling and minority shareholders and various stakeholders and minimizes and manages conflicts of interest among these groups. Good corporate governance practices ensure that:

• Boards act in the best interests of shareholders and independent of management and other influential groups
• A company acts lawfully and ethically with respect to all stakeholders
• Shareholders’ rights are respected and well communicated
• A company’s governance, financial and operating activities are reported to shareholders and relevant stakeholders in a fair, accurate, timely, reliable, relevant, complete and verifiable manner

Under CBCA, the board owes fiduciary duties to the corporation and not directly to shareholders. Ultimately, the strength of the shareholder voice through voting rights and an adequate structure of governance practices determines the success of its implementation.

Board of directors

The board of directors (hereafter “the board”) is the highest governing authority within the management structure of a corporation. Governance often affects the company value over a long timeframe, and the board is responsible for the overall strategy of the company. The board is accountable to select, evaluate and approve compensation for the company’s chief executive officer (CEO), evaluate the attractiveness of and approve dividends, recommend stock splits, oversee share repurchase, approve the company’s financial statements, recommend or reject mergers and acquisitions opportunities and the like. The primary objective of a corporate board is to protect the assets of shareholders and ensure they receive a positive return on their investments. Under Canadian corporate law, directors owe their fiduciary duty to the corporation itself, rather than to shareholders directly. In fulfilling this duty, directors may consider the interests of multiple stakeholder groups, provided their decisions are made in the best interests of the corporation.

Boards are composed of individuals elected by a company’s shareholders annually or for multi-year terms (“staggered” or “classified” board). Boards often operate on a rotating system where only a few directors are up for election each year. This impedes a complete board change in the event of a hostile takeover and is used as an anti-takeover device. Conversely, companies that prevent shareholders from approving or rejecting board members annually limit their ability to change the board’s composition when needed for strategic or market shifts.

To serve shareholders’ and the company’s long-term interests, board members need four commitments: independence, experience, resources and accurate information about the company’s financial and operating position.

To serve shareholders’ and the company’s long-term interests, board members need four commitments: independence, experience, resources and accurate information about the company’s financial and operating position.

Independence:¹ Company boards should have an independent majority (more than 50 per cent of the board) to mitigate conflicts of interest and foster independent decision-making of management. Except for the audit committee, Canadian rules emphasize disclosure rather than mandatory independence thresholds. To maintain independence, CFA Institute recommends current and former executives and directors of an issuer should not be permitted to sit as an independent nonexecutive director until five years after leaving the relevant positions. CFA Institute also recommends that independent non-executive directors should not have been connected to a director, CEO or substantial shareholder of the issuer within the preceding five years. Long-term participation of over 10 years may improve member’s knowledge of the company, but risks reduced independence. CFA Institute recommends boards limit the length of service of directors on a specific company to no more than 15 years.

Independent board members should meet at least annually without management or executive board members present and regularly report on their activities to shareholders. The board chair should not hold the title of CEO, as the separation of the chair and CEO positions is considered a best practice and ensures the board agenda is uninfluenced by the CEO and management team.

Experience: Boards should comprise of competent individuals and strive for diverse expertise and perspectives, including an increased investor focus. Directors should be able to make informed and independent decisions about company’s financial, accounting, strategic, business and legal matters and act with competence driven by their understanding of the company’s principal business. Boards should refrain from having members with many existing board representations so that members are not time-constrained.

Resources: Boards must have the authority to hire external auditors and other outside consultants without management’s intervention or approval. This mechanism alone provides the board with the ability to obtain expert help in specialized areas.

Accurate information: Board members must have access to complete and accurate information about the financial position of the company and its underlying value drivers to steer the company toward its best long-term interests.

CFA Institute has compiled A Checklist for Building Shareholder Value.

Board committees

Board committees covered by national corporate governance codes or exchangemandated guidelines include the audit committee, remuneration or compensation committee and nominations committee. The committee system is used to delegate specific tasks to committees of the board, all of which must have at least three members. A majority of the members must be either independent board members or non-executives. Committees examine specific issues, but the board retains final decision-making authority.

Audit committee: This committee ensures financial information reported by the company is complete, accurate, reliable, relevant and timely. This committee is responsible for hiring and supervising independent external auditors. In Canada, companies listed on the Toronto Stock Exchange are required to disclose whether the audit committee members are nonexecutive. Canadian securities rules require audit committee independence.

Remuneration or compensation committee: This committee ensures compensation and other awards encourage the board and management to enhance the company’s long-term profitability and value. This committee determines if the renumeration packages are commensurate with the level of responsibilities of the executives and if compensation drivers foster excessive risk-taking, manager entrenchment or abusive and unethical behaviours. The committee should link executive compensation to its longterm profitability and value relative to competitors and comparable companies and ensure alignment with company strategy, risk appetite and corporate culture. It is best that this committee include only independent board members. Canadian securities rules encourage compensation committee independence. In Canada, the Toronto Stock Exchange requires listed companies to report in their annual reports or their management information and proxy circulars whether they have a compensation committee and whether a majority of the board is independent.

Nominations committee: This committee identifies new board members and examines the performance, independence, skills and expertise of existing board members. They create nomination policies and procedures and oversee succession plan ning for executives and board members. This committee must remain independent to ensure the fairness of performance assessments and recruitment of individuals who work on behalf of the company.

Other board committees: These committees are tasked with addressing issues pertinent to the company’s specific industry, line of business and circumstances. These committees might be dedicated to risk management, ESG and sustainability, strategy or special situations critical for longterm shareholder value creation.

Continuous improvement model to enhance board effectiveness

Quality input from the management team is the most widely selected driver of exceptional board performance. Management provides information, and the board provides insight. Boards should invest 60 per cent of their time on strategy, talent and oversight, and the remaining on hindsight. Boards that work well with management require skills, proper board structure, a well-defined meeting agenda and post-meeting briefings. Great boards need great chairs, with the chair-CEO relationship at the heart of success. The continuous improvement model developed by Professor David Beatty at Rotman School of Management emphasizes key steps before, during and after board meetings. Based on this model, the chair should draft a well-defined agenda in consultation with the CEO and solicit input from directors individually prior to meetings.

The board meeting comprises two steps:

1) A directors-only meeting to discuss the agenda and
2) a directors and CEO meeting to discuss the CEO’s priorities.

The board meeting concludes with the management team leaving, followed by the CEO, leaving the directors in camera. It is recommended that the chair directly solicit feedback from each director, while the CEO debriefs the management team on performance and areas for improvement. The chair and CEO should review the return on investment from the meeting and identify opportunities for improvement. The chair should also follow up with directors several days after the meeting to support the continuous improvement model and the return on the board’s invested time.

Board communication with shareholders

Corporate boards communicate with shareholders primarily through formal disclosures such as annual reports, management’s discussion and analysis, management information circulars, governance and compensation disclosures, shareholder meetings and direct engagements. A board should not breach its fiduciary duty to the company by acting in the interest of any specific shareholder or disclosing material nonpublic information.

Shareholder mechanisms to improve corporate governance

Shareholders influence corporate governance through voting, electing or removing directors, approving major actions and holding the board accountable for oversight and long-term value creation. Institutional investors can engage with boards on capital allocation, risk and board composition. Shareholders may also use activism, share sales or legal remedies (e.g., CBCA s.241 Oppression Remedy). Proxy access in the U.S. allows nominating directors; in Canada, large shareholders (five per cent or more) can submit proposals, including nominations, and requisition meetings. Ownership structures, including dual-class shares, can disproportionately affect voting rights and shareholder influence.

Conclusion

The board is the key oversight body linking management and shareholders and the primary mechanism for implementing corporate governance. Board members owe fiduciary duties of care, loyalty and good faith to the corporation, requiring them to act prudently, independently and in the best interests of the company and its shareholders. Active and prudent shareholder engagement is the most effective instrument for the successful execution of corporate governance.