To Inspire or to Require: Achieving Better Governance and Corporate Responsibility

May 20, 2003

Headlines about Enron and WorldCom may be shuffling steadily toward the back pages of the papers as the various bankruptcy and legal proceedings wend their way forward. But the atmosphere of suspicion and mistrust that these scandals unleashed is still very much with us.

In my mind, three questions have yet to be fully resolved. What should investors do? What should governments do? And what should companies, their directors and CEOs do?

Dale Richmond has talked about what one big investor is doing, and I want to come back to some of the issues he has raised. But first I want to say a few words about what I see as the priorities at this point for governments and regulators, and then bring you up to date on what CEOs are doing, with respect both to corporate governance and to the highly related issue of corporate responsibility.

The regulatory question today, as it was a year ago, still boils down to this: To what extent should Canada differ from the United States?

There are two facets to this question. First, to what extent do we in Canada think there is a better way to inspire investor confidence than copying the Sarbanes-Oxley Act? And second, to what extent does the different structure of our capital markets require different approaches?

The continuing argument over the first facet boils down to the relative merits of principles-based versus rules-based approaches to governance. Both sides of the case are well known, and I will not repeat them here.

The fact is that we need a mix, always have and always will. And both new rules and tougher principles have roles to play moving forward.

New rules raise the minimum of what is acceptable. Stronger principles raise the norms of actual behaviour beyond this legal minimum.

Rules and enforcement punish misbehaviour. Principles and comprehensive disclosure turn good behaviour into a source of competitive advantage.

The second aspect of the regulatory question has to do with the structure of Canada’s markets. Most large Canadian issuers already, or are likely to, need access to American markets and will be subject to Sarbanes-Oxley anyway. But Sarbanes-Oxley is proving to be particularly problematic and costly for small-cap companies. And the vast majority of Canadian public companies rate as what the United States refers to as "nano-caps".

I am not suggesting that investing in smaller companies should be on par with placing bets at a crooked casino. The issue is what mix of new rules and tougher principles will be most effectiveness in boosting Canada’s competitiveness – and that means its ability not just to attract new issuers, companies that want to grow, but also to attract new capital, new investors.

This leads me to another element in the current discussion: the need to simplify Canada’s regulatory structure. It simply does not make sense to have 13 different regulators in a market the size of Texas. Dallas, Austin and Galveston don’t have their own securities regulators. Why does Canada need the equivalent?

Sooner rather than later, it seems to me, provincial governments need to bite the bullet on this one, use the power of delegation suggested by the regulators in their USL discussion paper, and create a simpler and cheaper single window for securities regulation in this country.

To summarize the regulatory issues, therefore, I think two things still have to happen within the next year. First, we need to see a new mix of rules and guidelines take effect, one that will add to rather than subtract from Canada’s ability to attract investors. Second, these changes have to be shaped as a coherent Canadian response to global investor expectations. And if we cannot get our act together as a country, we will simply end up with a single national regulator called the United States Securities and Exchange Commission.

Having said my piece about regulatory issues, let me turn to what companies, their boards and CEOs are doing.

Last year’s crisis of confidence led to an unprecedented level of discussion on governance issues amongst the members of the Canadian Council of Chief Executives.

The initial result was a major statement entitled Governance, Values and Competitiveness: A Commitment to Leadership. This statement made extensive recommendations for improving governance practices in Canadian companies. And it also suggested that CEOs, not just investors and boards, have important roles to play in driving change.

That is why our central recommendations focused on improving transparency and CEO accountability. Our members said they have no qualms about making a detailed certification comparable to the one required by Sarbanes-Oxley. And we offered some blunt thoughts about the need to re-examine CEO compensation, and make sure that there is an appropriate balance between short-term and long-term incentives.

That one, I have to say, flowed from an earlier survey in the late 1990s. At that point, member CEOs highlighted the growing influence of institutional investors – pension funds and mutual funds – on an increasingly wide range of issues including executive compensation. And they suggested that the dominant concern of institutions as a group had become short-term stock price performance rather than longer-term growth.

To be fair to Dale and his colleagues, CEOs identified mutual funds rather than pension funds as the group most concerned with the short term. But I would suggest that the extent of this short-term fixation in the late 1990s had an impact on the incentives that boards gave to management – and that are now being rethought. The old adage — "Be careful what you wish for. You may get it." — comes to mind.

In addition to the specific recommendations, our members committed to being forces for change – within their own enterprises and within the business community. And while CEOs were not alone, I think that is one reason we have seen such a high degree of change in governance practices even in the absence of new regulations.

To name just one example, the current annual meeting season has continued the trend toward splitting the positions of chairman and chief executive officer. Yet this is an issue that is not even addressed by Sarbanes-Oxley.

The Council’s underlying message was that neither new rules nor new practices will be sufficient to restore investor confidence and public trust. Trust is something that has to be earned through action, and action, we suggested, has to start with the right tone at the top. Trust is about values, and all rules can do is protect us from what we don’t trust.

Our statement therefore went one step further. We suggested that in order to rebuild trust, being guided by the right moral compass was not enough. The values that CEOs profess to believe have to be backed up by action, the kind of action that drives the culture of the entire organization.

We suggested that a CEO’s and a company’s values get expressed two ways in particular: internally through the company’s code of ethics and conduct; and externally through its stakeholder relationships and corporate citizenship. In order to sustain and grow a business, you need to retain the trust not only of investors, but of many other people whose decisions can affect your business.

As Len Brooks suggested this morning, a company’s practices in terms of corporate responsibility or corporate citizenship do more than reflect its moral compass. They also constitute a very pragmatic strategy for risk management.

As David Ticoll noted at lunch, companies today operate in the nude. Transparency is not an option. It is just today’s reality. For good or ill, anything a company does anywhere in the world affects its reputation everywhere in the world.

Its reputation affects its relations with governments and regulators, its licence to operate, if you will. It affects relations with customers. Of growing importance, reputation also affects a company’s ability to recruit and retain talented people.

Len Brooks noted that in 2000, recruiting skilled staff had become the number one challenge for companies, and that success meeting this challenge depends on talented people feeling comfortable not only with what you do, but how you do it.

I would add that a survey of the member CEOs of the Council identified human resource issues — the ability to recruit, retain and develop staff — as the number one driver of corporate investment in the community. And that was back in 1996, in the days of the so-called "jobless recovery", when the war for talent was far less intense than today.

And of course reputation affects investor perceptions of risk. These perceptions in particular can have an abrupt and very real impact on a company’s share price, and therefore also on management compensation.

A company cannot effectively manage its reputation only by playing defence. A successful strategy also has to involve concerted efforts to build up reserves of trust before crises occur.

This is why corporate strategies for community investment have become much more sophisticated in recent years. And as community investment becomes more closely integrated with corporate strategy, a much wider variety of tools and objectives have come into play.

The crisis of confidence in corporate leadership and market-based policies certainly reinforces the business case for community investment within individual companies. But it also is driving greater collaboration and coordination within the corporate community.

Last year, for instance a task force of 36 chief executives working within the World Economic Forum produced a joint statement entitled Global Corporate Citizenship: The Leadership Challenge for CEOs and Boards.

While noting that globalization has had a huge positive impact, the statement acknowledges widespread concerns that its potential has not been met and that many people still face high levels of inequality, insecurity and uncertainty. In challenging business leaders around the world to help address these issues, it suggested three principles to guide their actions.

First, it said the greatest contribution business can make to global development is to create jobs and wealth while making every effort to enhance the positive effects of business activity and to minimize the negative impacts.

Second, it said that to be good citizens and to succeed in business, companies have to identify and work with all those who can influence their activities, including employees, customers, shareholders, host communities and governments.

And third, it said bluntly that leadership for corporate citizenship rests with directors and chief executives, and suggested that driving change in this respect involves four steps: First, provide leadership. Second, define what it means for your company. Third, make it happen. And fourth, be transparent about it.

These principles are being reflected in Canada within this country’s premier vehicle for collective engagement on corporate citizenship issues, the Imagine program of the Canadian Centre for Philanthropy.

Imagine began life as one of the first and most successful of the "percent clubs". In establishing a donations benchmark of one percent of pretax profits as a standard for good citizenship, it had a measurable impact in increasing the level of corporate donations to charities through the 1980s.

By the late 1990s, thought, this basic concept built on pure philanthropy was looking dated and inadequate to deal with the increasingly sophisticated models of community investment being developed by Canadian companies.

A leadership forum in 1998 co-sponsored by the CEO Council launched a major strategic review of the program and what turned into an extended discussion about how best both to capture the full dimensions of today’s community investment activities and to motivate companies to increase their level of activity.

The result is a new commitment that boils down to six words: "one percent, one project, one page."

It includes the old one percent benchmark for donations and the related commitment to encourage and facilitate both the personal giving and volunteer activities of employees. The difference is that we are trying to put more emphasis on the outcomes than the inputs. Inputs still matter, but it is what gets done with them that really counts.

In addition, therefore, chief executives will be asked to champion personally at least one community project that they believe is innovative and leverages the particular skills and competencies of their companies to make a real difference in their communities.

And thirdly, Imagine members will be asked to demonstrate their leadership publicly by dedicating at least one page of their annual reports or equivalent publications to a report on their community activities. The goal is both to help other companies and community organizations pick up and run with innovative ideas and to encourage other companies to join the commitment to Imagine’s principles.

The new Imagine commitment, along with a Canadian version of the World Economic Forum’s call to action, is in the final stages of approval and will be launched later this year. And the Canadian Council of Chief Executives will continue to work closely with Imagine as we move forward.

I want to emphasize that this kind of initiative has to be voluntary. It cannot be required. If companies are to sign on to this kind of commitment, they have to see it as a source of competitive advantage.

In this sense, I am worried by some signs that the idea of corporate responsibility is still having trouble, at least in some companies, in making the leap from a moral "nice to do" to a strategic "must do".

For instance, in reinvigorating the Imagine commitment, we are trying to recognize and encourage a broader range of corporate activities in the community, one that goes well beyond cash donations to charities.

But as we have explored ways to expand the scope of the Imagine commitment, some have expressed worry that changing definitions might have a perverse impact and encourage some companies to cut back rather than increase their charitable donations as measured by the old standard.

This raises a basic question about how good citizenship is measured. Is the 1 percent Imagine commitment a ceiling, a reluctant obligation that gets a box ticked off in a social audit? Or is it a floor, a minimum indicator of a company that is intent on providing inspiration and leadership in our communities – and that understands the strategic corporate benefits of so doing?

It is this lingering uncertainty that brings me back to the role of the shareholder in good governance and corporate responsibility. It is now conventional wisdom to say that responsible behaviour is good for shareholders.

But what do shareholders, especially the big institutions, really think? Is good corporate citizenship a key strategic issue in making investment decisions, or is it just a frill, a factor considered at the margins?

In this respect, I was struck by how many of the CSR initiatives described by Dale Richmond as supported by OMERS were primarily defensive in nature: aimed at avoiding negative risks rather than tapping into Len Brooks’ six hypernorms as part of a positive growth strategy.

So, are the costs involved in good corporate citizenship and corporate responsibility still just a necessary price of doing business in an era of rising public expectations? Or is a company’s community investment a positive indicator of enhanced risk-adjusted returns, a source of competitive advantage?

There seems little doubt about where the majority of CEOs stand. According to a survey by the World Economic Forum, for instance, 68 percent of chief executives worldwide said corporate social responsibility is vital to the profitability of any company, with only 14 percent disagreeing.

Similarly, a survey in the late 1990s of the members of our Council, then the Business Council on National Issues (BCNI), found that most Canadian chief executives believe that successful and growing businesses must be based in strong and vibrant communities, that the health of one is mutually dependent in the long run on the health of the other.

In short, most CEOs believe that corporate responsibility matters to the success of their enterprises. But my sense is that many also doubt whether investors really share this belief, especially when a commitment to doing the right thing for sustainable growth runs smack into missing the latest quarter’s guidance by a penny a share.

Ultimately, I would suggest, the extent of additional commitments to corporate responsibility will reflect what the marketplace believes will best contribute to building profitable businesses.

When it comes to good corporate citizenship and social responsibility, CEOs can inspire, and regulators may require. But in the end, what we will get will be determined by what investors truly desire.