Corporate Governance: A Personal Perspective

Verity Craig, Associate, Carmichael Birrell & Co. and Director, The Empire Club of Canada; The Reverend Dr. John Niles, Pastor, Victoria Park United Church and Director, The Empire Club of Canada; Dominic Gammiero, President and CEO, Nexfor Inc.; David Cardin, President, Maersk/Sealand; Munehiko Hino, President, NYK Line (Canada) Inc.; John C. Koopman, Partner, Heidrick & Struggles and 1st Vice-President, The Empire Club of Canada; Greg Pimento, Vice-President, Operations, Chemtrade Logistics; John F. Bankes, Managing Director, Artemis Management Group Inc. and Past President, The Empire Club of Canada; Rick E. Gaetz, President and CEO, Vitran Corporation; and Rod F. Barrett, Managing Partner, Stikeman Elliot.

Introduction by Ann Curran

In the wake of spectacular failures in corporate governance, such as Enron and Worldcom in the U.S., Bre-X and Livent here in Canada, investors are left wondering whom to trust. The U.S. has recently

October 17, 2002

brought in tough new governance standards and many here are wondering if Canada should follow suit and impose stricter standards, particularly in the area of board independence.

Our speaker today takes a long-term perspective on how to restore confidence in the capital markets. Drawing from both his experience as the federal government's top public servant as well as a businessman with a North American vision, Mr. Tellier questions whether tighter regulatory and legislative controls alone can produce the desired results. The fundamental issue of corporate responsibility is more than governance structures and rules.

Speaking of trust, some of you might be thinking who is Paul Tellier and what credibility and experience does he bring to this discussion? Well let me assure you that after I read you the abbreviated version of his biography, you will have no doubt that this man knows of what he speaks.

Paul M. Tellier was appointed President and Chief Executive Officer and a Director of the Canadian National Railway Company on October 1, 1992.

Mr. Tellier had been Clerk of the Privy Council and Secretary to the Cabinet of the Government of Canada, the top public servant in the country, since August 1985.

He is a graduate of the universities of Ottawa and Oxford, England, and was admitted to the Quebec Bar in 1963.

Mr. Tellier served in many positions in the public sector, including Deputy Minister of Indian Affairs and Northern Development in 1979 and Deputy Minister of Energy, Mines and Resources in 1982.

Mr. Tellier is a Director of the following companies: Alcan Aluminum Limited, BCE Inc./Bell Canada, Bombardier Inc., Grand Trunk Corporation and McCain Foods Limited. He is Vice-Chairman of the Canadian Council of Chief Executives and Co-Chair of their North American Policy Committee and is formerly the Chairman of the Conference Board of Canada and the Co-Chairman of the Canada-Japan Business Council.

Mr. Tellier was appointed Companion of the Order of Canada in 1993.

In 1997, Mr. Tellier was chosen by Railway Age as the Railroader of the Year. In 1998, he was selected by his peers in Canada as the CEO of the Year. In 2000, he was named Personality of the Year by the newspaper, Les Affaires.

In 2001, he received the McCullough Logistics Executive of the Year award from The National Industrial Transportation League and Logistics Management and Distribution Report.

Without further ado, I give you Paul Tellier.

Paul Tellier

I want to talk today about corporate responsibility. A free enterprise system in a democracy depends upon transparency and trust. Trust in corporate leaders. Trust in regulators. Trust in the legal framework. Trust in financial reporting. Trust in the accounting profession. In short, trust in corporate responsibility. The investment analyst, the small shareholder and the institutional investor all have to be able to believe that the numbers that are reported are correct.

In this light, the subject of corporate governance has recently become a cottage industry. In the past months, we have seen a great many studies, reports, statements and speeches on the topic. Last month, the Canadian Council of Chief Executives issued a set of guidelines.

What more can I add to what has been said or written? I am no Purdy Crawford--Canada's most respected director--and I do not have the responsibilities of David Brown, Chairman of the Ontario Securities Commission, or Barbara Stymiest, CEO of TSX Group. Why do I tread here? I have served in government for more than 20 years. Ten years ago, I found myself leading a large commercial organization--CN. Within three years, that company became listed in New York and Toronto. Based on this experience, I want to share some personal views on five corporate governance issues.

1. Short-term focus

First, when CN became publicly traded, I was struck by how much, as a chief executive officer, I was pressured to produce short-term results. Wall Street and Bay Street--particularly the sell-side analysts--tend to create tremendous pressure on corporate executives to focus on the financial results of the quarter.

There is an upside, but also a downside to this. The upside is that it imposes discipline on the executive office. We are kept on our toes. There is constant pressure

to remain accountable. We must have clear performance measures. We review the numbers almost every day with an eye to short-term results.

But I am concerned that we are not always as aware of the downside. This obsession with managing the earnings per share year over year makes it more difficult to make decisions that will yield results only in the mid- to long-term.

For instance, our industry is very capital intensive. We must re-invest almost 20 per cent of our revenues in capital expenditures every year. This is almost twice the amount of depreciation. We cannot defer these kinds of investments for safety and long-term growth just because we are expected to increase the cash flow.

Although I have been a CEO for 10 years, I still feel that the end of every quarter comes around awfully fast. I spend a great deal of time with the chief operating officer and chief financial officer in reviewing with senior executives the results quarter by quarter.

I believe that shareholders and employees would be better served if business executives were focused more on the longer term, while being guided by the performance signposts of quarterly results.

Executives need a great deal of integrity and fortitude not to succumb to the temptation of being too short-term oriented.

2. The securities industry

My second observation involves the nature of the securities industry.

Let me preface my comments by saying that I have enjoyed working with research analysts over the years. The great majority of them are bright, hard-working, competent, honest, and eager to do the right thing.

But the nature of the securities business, especially on the sell side, is to focus on short-term, quick-growth opportunities, sometimes to the detriment of stable, but less glamorous, businesses. The model some analysts used could be broader and more focused on the corporate strategy the business is pursuing. If the market is to restore investor confidence, it must be able to discern long-term value. The top-rated analysts already do that.

3. Corporate boards

My third comment has to do with boards. My experience on boards goes back 22 years. I want to make the following three points:

1. Boards should not be dominated by the CEO. CEOs and senior management to a large extent control the agenda and totally control the flow of information going to the board. A fine balance must be struck by putting enough, but not too much, information in front of the board. By putting too many topics on the board agenda, a CEO may be perceived as indecisive or weak. On the other hand, a CEO who enjoys a good board would be foolish not to actively engage his or her directors.

ii. Board meetings should not be a series of monologues. Management should resist the temptation to make endless presentations. Directors should resist being subjected to them. Presentations should not be a substitute for dialogue and discussion.

iii. Non-performing directors should be removed. Removing a non-performing director is an extremely important but also very difficult and delicate task. It is a task that must be performed. A sense of excellence has to start at the board level.

Shareholders have a right to demand the highest levels of performance from their directors. And the chairs of Canada's corporate boards must become more aggressive in inviting underperformers to step down.

4. The CEO

For my fourth observation, let me be equally demanding in what should be required of chief executive officers. Two points:

i. The character of the CEO. Over the past years, there has been a tendency to treat some CEOs as celebrities. A CEO has the responsibility to play a public role by answering questions from the financial community and the media. After all, we are talking about shareholders' money. I believe it is important for the CEO to be accessible, transparent and outspoken. If the CEO is competent in discharging this role, he becomes visible. But that visibility must be kept in perspective. The danger of one believing every newspaper clipping is always present, but should be avoided. As a result, I believe it is important for CEOs to emphasize the team. Let the strength of the team be a measure of the personal strength of the CEO. Good leadership thrives when one is surrounded by colleagues who can stand their ground. In the age of celebrity CEOs, it is more important than ever for boards to look deeper into the character of an individual to decide whether this is the right person to lead the company. What are the candidate's values and ethics? How deep is the sense of personal integrity? How does this person balance work and life? What does this imply about character? How sound is the individual's sense of judgment? The choice of CEO affects the entire culture of a corporation. Boards must seek individuals who will inspire an entire organization, with the values of fair dealing, probity, and integrity.

if. Listening to the shareholders. One of our institutional shareholders told me recently: "Many of the corporate governance issues would disappear if CEOs were listening more to their shareholders." I agree. I spend close to 20 per cent of my time on investor relations. I have resolved to sell less and to listen more. That is a personal commitment.

5. The legal framework

A fifth and final observation is that integrity cannot be legislated or regulated. No law, regulation, or guideline could have prevented what happened at Enron, WorldCom, or Tyco.

Responsibilities are shared among the board, the CEO and management, the investors, and the regulator. The disasters, that destroyed billions in shareholder value, were not discovered by regulators. The legal system came in after the fact.

Investors, especially institutional investors, must focus on the right values and reward the right values with their investment dollars.

The market should drive the desire of companies to set the highest standards of integrity, transparency and corporate responsibility.

Canada has benefited from a strong framework for corporate responsibility. It has been based primarily on guidelines and codes of conduct, supported by solid regulation, underpinned, when necessary, by legislation. The requirements in this regime have set very high standards for Canadian governance.

In response to the scandals in the United States, the Americans have increased their regulatory and legislative requirements. They have raised the bar in some areas above what is required in Canada. CN is publicly traded in both Canada and the United States. In order to stay competitive, CN must adhere to the highest possible standards.

So, although we are governed by Canadian law, we see ourselves as a North American company. We believe in meeting or exceeding the highest standards expected in the regime in which we operate. And so we decided to

voluntarily meet the requirements expected of our peers in the U.S. railroad industry.

Taking our governance to the next level

Ever since CN became a shareholder-owned company, we have sought to be a leader in corporate governance. We split the positions of CEO and chairman. We elect our corporate directors annually. Only outside directors make up our audit committee. There is no cross-director-ship, in the sense that the CEO does not sit on the board of any of the directors.

Our quarterly results are reviewed by external auditors and by the audit committee before their release. We share in advance the MD&A (management discussion and analysis) with the audit committee. We regard the requirements of securities commissions and regulators as a foundation to improve upon. We believe good governance is good business.

Many of these practices are becoming standards for good corporate governance. We are proud of these standards. Do we have more work to do? Absolutely.

This was brought into focus last week when the Globe and Mail's "Report on Business" published a series of excellent articles on corporate boards. It rated boards on four criteria: board composition; compensation; share-holder rights; and disclosure.

CN was ranked in the top quartile overall, but I will not be satisfied until we are ranked among the top five. This will require vigorous action on our part. CN has never shied away from this challenge before.

Several years ago, we said we would become the best railroad in North America. Some observers scoffed because, at that time, we were well back in the pack. Today we are number one.

Then we set a new goal. We said we would become the best transportation company in North America. We are working to make that happen.

Now I am determined to work with our Chairman, David MacLean, and the rest of the CN board to put our governance practices in the forefront of best practices. We are taking our commitment to corporate responsibility to the next level.

I am committed to ensure that CN appears in the top-five corporate boards of future corporate-governance surveys. And I challenge my colleagues in the executive suites of companies across Canada to compete with us for top honours. The quality of corporate governance has become a new standard to judge the quality of a company--and its potential value to investors.

Conclusion

Let me conclude by stating what is made obvious by the drop in the TSX and Dow indexes: We are facing a serious crisis of confidence in the market. The crisis has been fuelled by governance scandals. As a result, millions of people have seen their investments shrink or disappear. This has been very unfortunate for everyone involved, and it has damaged the ability of companies to raise needed capital.

From this rubble, we must build stronger foundations for corporate responsibility. This will happen. It will happen, in part, because most CEOs have survival instincts. Only a fool would ignore what is happening in today's market. To succeed, a CEO must now demonstrate a high degree of corporate responsibility. Any responsible leader has no alternative, but to review corporate governance practices, codes of conduct and general behaviour.

So there is a silver lining. In the years ahead, investors will end up with better-led, better-regulated and better companies to invest in.

From our short-term difficulties we will derive long-term benefits. This will be good for Canadian business. It will be good for Canada. We do not want a regime that will stifle reasonable risk taking and entrepreneurship. But we

must continue building a governance regime that will inspire confidence, and attract investment capital from around the world.

Thank you.

The appreciation of the meeting was expressed by John C. Koopman, Partner, Heidrick & Struggles and 1st Vice-President, The Empire Club of Canada.

John McLennan, Vice-Chairman and CEO, At&T Canada Corp., Gaylen A. Duncan, President and CEO, ITAC (Information Technology Association of Canada) and Ted Rogers, President and CEO, Rogers Communications Inc.