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«RISK OVERSIGHT AND GOVERNANCE | 20 QUESTIONS SERIES 20 Questions Directors Should Ask about Building and Sustaining an Effective Board Elizabeth ...»

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20 Questions Directors

Should Ask about

Building and Sustaining

an Effective Board

Elizabeth Watson, QC


20 Questions Directors

Should Ask about

Building and Sustaining

an Effective Board

Elizabeth Watson, QC



This paper was prepared by the Chartered Professional Accountants of Canada

(CPA Canada) as non-authoritative guidance.

CPA Canada and the authors do not accept any responsibility or liability that might occur directly or indirectly as a consequence of the use, application or reliance on this material.

Library and Archives Canada Cataloguing in Publication Watson, Elizabeth, author 20 questions directors should ask about building and sustaining an effective board / Elizabeth Watson.

(20 questions series) ISBN 978-1-55385-915-4 (pbk.)

1. Boards of directors. 2. Boards of directors--Canada. I. Chartered Professional Accountants of Canada, issuing body II. Title. III. Title: Twenty questions directors should ask about building and sustaining an effective board. IV. Series: 20 questions (Chartered Professional Accountants of Canada) HD2745.W38 2015 658.4’22 C2015-901336-4 © 2015 Chartered Professional Accountants of Canada All rights reserved. This publication is protected by copyright and written permission is required to reproduce, store in a retrieval system or transmit in any form or by any means (electronic, mechanical, photocopying, recording, or otherwise).

For information regarding permission, please contact permissions@cpacanada.ca iii Preface The Risk Oversight and Governance Board of the Chartered Professional Accountants of Canada (CPA Canada) has prepared this 20 Questions briefing to assist our members in understanding how an effective board of directors is constituted and maintained. This may sound like familiar territory, but those who have served will know that often boards are so busy trying to fulfill their mandates that there is little time to step back and reflect on what is working, what may not be working and why (or why not). Just as the complexity of doing business in the 21st century has increased over previous decades, so too have the requirements and demands made of boards of directors and their members — and the potential liabilities.

20 Questions Directors Should Ask about Building and Sustaining an Effective Board has been informed by some of the best current thinking on such issues as: the recruitment and retention of board members, board renewal, the setting of term limits, the meaning of “diversity” and how to achieve it, directorial independence, and many others.

Whether you are currently serving on a board, considering accepting a directorship or interested in learning more about what such a commitment would entail, we are confident that the information presented in the following pages will offer much food for thought, and perhaps illuminate some challenge you are facing.

The Risk Oversight and Governance Board is grateful for the invaluable contribution of author Elizabeth Watson, QC of Watson Advisors Inc., whose insight and wisdom course through this publication. We thank as well our fellow board members and the staff of CPA Canada for shepherding this document through to completion.

Bryan Held, FCPA, FCA, ICD.D Interim Chair, Risk Oversight and Governance Board iv 20 Questions Directors Should Ask about Building and Sustaining an Effective Board

–  –  –

Establishing the Board (Structural Considerations) 3

1. What is the optimal size of a board?

2. What are the independence requirements for directors?

3. What role do shareholders play in the selection of directors?

4. What information should be covered with director candidates upon their election to the board?

5. What compensation should be paid to directors?

Sustaining the Board (Skills, Leadership and Culture) 11

6. What skills and experience should directors have?

7. What personal characteristics should directors possess?

8. What leadership positions are required on the board?

9. What skills are required of directors doing committee work?

10. Does diversity matter?

11. What information is required to adequately orient new directors?

12. What kind of continuing education is important for directors to pursue? 22 vi 20 Questions Directors Should Ask about Building and Sustaining an Effective Board

13. How do directors’ qualifications and attributes affect a board’s culture? 22

14. What time commitment is expected of directors?

–  –  –

17. What is the relationship between individual director evaluation and board renewal?

18. How should a board plan for board-chair succession?

19. How can director candidates be found?

20. How should boards evaluate director candidates?

–  –  –

Introduction Over the last decade, there have been significant changes to corporate governance practice, encouraged in large part by legislation, regulatory requirements and the building of consensus around best practices. Despite these developments, there are still many high-profile examples of poor governance, poor corporate performance and corporate failure. Such examples have led to renewed recognition that the most significant contributors to a highperforming board are the quality and experience of individuals serving on that board and the way in which those individuals work together. For this reason, CPA Canada determined that it would be useful to revisit its guidance in the area of board composition and succession. Effective board functioning will be dealt with in a forthcoming CPA Canada publication.

20 Questions Directors Should Ask about Building and Sustaining an Effective Board provides insight and guidance on the various elements involved in creating a high-performing board — including board structure, ideal director characteristics, board leadership, planning for director recruitment and sustaining the competency of directors through orientation and ongoing education.

The 20 questions are structured to guide readers through the various stages of a board’s evolution, from creation through to renewal. As such, the questions

are grouped under the following sub-headings:

Establishing the Board (Structural Considerations) • Sustaining the Board (Skills, Leadership and Culture) • Renewing the Board (Succession Planning) • This 20 Questions publication is intended to provide useful information for directors, shareholders and others interested in building and sustaining a highperforming board. The questions and suggestions for recommended practice are set primarily within the context of publicly listed companies, but the concepts and principles may be extrapolated for other circumstances as well.

2 20 Questions Directors Should Ask about Building and Sustaining an Effective Board The structure and composition of a board are important elements that contribute to a board’s effectiveness, and a well-composed board is a crucial prerequisite for effective governance. Equally important, though, when assessing a board’s level of performance is how a board performs its work. This includes such elements as having clear roles and responsibilities, effective decision-making processes in place and a constructive board-CEO relationship. These elements are not specifically addressed in this publication, but they are essential in order for a great group of directors to perform well.

Establishing the Board(Structural Considerations)

This section contains commentary on some of the essential elements to consider when establishing a board: the board’s size and composition (including requirements for director independence) and the director election process, including the role of shareholders.

1. What is the optimal size of a board?

Legal requirements in most jurisdictions specify a minimum number of board members (usually three), but typically there is no maximum limit.

There is no one “perfectly sized” board, and in fact it is considered leading practice to determine proactively the optimal size of an organization’s board of directors based on that organization’s unique circumstances.1 While research suggests that a group of five or seven is an optimal size for decision-making, various other considerations come into play in a board setting.

A board must be large enough to ensure that there are sufficient members to manage the board’s workload (including committee work) and that, collectively, the board members have the required skills to govern.

These considerations must be balanced, however, against the need to ensure that the board is small enough to enable interactive discussion (i.e. conversational turn-taking) and engagement by all directors. Large boards can prove cumbersome and can make the meaningful exchange of ideas, information and creative thinking difficult, if not impossible.

They can also weaken individual directors’ accountability.

1 Walker, A Review of Corporate Governance in UK Banks and Other Financial Industry Entities: Final Recommendation.

4 20 Questions Directors Should Ask about Building and Sustaining an Effective Board

–  –  –

In 2011, the smallest board in Canada had three directors and the largest had 21. 2 In both Canada and the United States, larger, more complex companies typically have larger boards (e.g. 13 or more directors) than smaller companies. However, nine is the average board size for listed companies in both countries.3

2. What are the independence requirements for directors?

Corporate governance guidelines adopted by the Canadian Securities Administrators,4 and applicable to most public companies in Canada, provide that a majority of directors on any board should be “independent” (as defined below). In addition, stock exchange rules in both Canada (TMX5) and the US (NYSE and NASDAQ)6 require that the boards of listed companies should be constituted with a majority of independent or ‘unrelated’ directors.

The precise meaning of “independence” varies across jurisdictions and readers should refer to the applicable definition in the specific rules that govern them. In general however, a director is considered “independent” if they have no direct or indirect material relationship with the company which could, in the view of the board, reasonably interfere with the exercise of that director’s independent judgment. The Canadian governance guidelines7 also enumerate specific kinds of relationships that preclude 2 Korn Ferry, O’Callaghan, Corporate Board Performance and Director Compensation in Canada: A Review of 2012, p. 35.

3 Ibid.

4 CSA National Policy 58-201 — Corporate Governance Guidelines (NP 58-201), National Instrument 58-101 — Disclosure of Corporate Governance Practices (NI 58-101) and Multilateral Instrument 52-110  — Audit Committees (MI 52-110) 5 TMX Company Manual, s.473 6 NYSE Listed Company Manual Section 303A.01 and Nasdaq Equity Rule 5605(b)(1) 7 Multilateral Instrument 52-110, Section 1.4 Establishing the Board (Structural Considerations) an individual from being considered “independent,” including: former employees or officers (within the last three years); immediate family members of former or current officers; and anyone who has received more than a specified amount of compensation from the corporation (with the exception of directors’ fees) in the previous year.

As part of their disclosure obligations, boards should communicate their approach to directors’ independence, as well as the independence status of any director nominees. Some boards require directors to complete an independence questionnaire to ensure that all regulatory aspects of independence are explored and then disclosed as appropriate.

While the regulatory definition of independence is important, the pursuit of effective governance arguably requires the consideration of a much broader concept of independence — whereby each director exercises “independence of thought” and makes decisions in the best interests of the company, without being “captured” by management or inappropriately influenced by other directors. For example, in a school, club or business setting the power dynamic in the boardroom may be influenced by relationships that exist between or among directors, and between a director and a member of management. This may make other participants unwilling to challenge or advance their own views. Some also argue that overly generous directors’ pay and long board tenure may inhibit a director’s real independence. The UK Governance Code appears to presume that a director who has served for more than nine years is no longer independent, requiring the board to explain why that person is still considered independent “in character and judgment.”8 8 The UK Corporate Governance Code (2012), Section B.1.1.

B.1.1.The board should identify in the annual report each non-executive director it considers to be independent. The board should determine whether the director is independent in character and judgment and whether there are relationships or circumstances which are likely to affect, or could appear to affect, the director’s judgment. The board should state its reasons if it determines that a director is independent

notwithstanding the existence of relationships or circumstances which may appear relevant to its determination, including if the director:

• has been an employee of the company or group within the last five years;

• has, or has had within the last three years, a material business relationship with the company either directly, or as a partner, shareholder, director or senior employee of a body that has such a relationship with the company;

• has received or receives additional remuneration from the company apart from a director’s fee, participates in the company’s share option or a performance-related pay scheme, or is a member of the company’s pension scheme;

• has close family ties with any of the company’s advisers, directors or senior employees;

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