Catalysts for Change in Board Governance Practices: The Case of the Introduction of National Policy 58 - 201 in Canada

INTRODUCTION On April 15, 2005, members of the Canadian Securities Administrators issued National Policy 58-201 Corporate Governance Guidelines which provides guidance on best governance practices to Canadian issuers. The National Policy 58--201's objectives were to achieve a balance between providing protection to investors and fostering fair and efficient capital markets and confidence in capital markets; be sensitive to the realities of the greater numbers of small companies and controlled companies in the Canadian corporate landscape; take into account the impact of corporate governance developments in the U.S. and around the world; and recognize that corporate governance is evolving. The guidelines in National Policy 58--201 were not intended to be prescriptive. Their objective was to encourage issuers to consider the guidelines in developing their own corporate governance practices regarding board independence, mandate, position descriptions, orientation and education, code of business conduct and ethics, as well as nomination. The goal of this paper is to explain the voluntary adoption of National Policy 58-201's governance guidelines. This topic has received little attention in the literature. The non-binding nature of National Policy 58-201 is consistent with the Canadian tradition of suggesting change at first. It is also interesting in that it differs from the American context where similar changes were mandated. We assess how Canadian TSX 300 issuers had adopted National Policy 58-201's best practices by 2004 and by 2006 to understand how issuers adopt board governance best practices. LITERATURE REVIEW AND DEVELOPMENT OF HYPOTHESES Boards of directors have multiple responsibilities and may be in conflict of interest while discharging them (Fama and French, 1983; Jensen and Meckling, 1976; Jensen, 1993). They approve the strategic direction of the company, establish a system of internal control and ensure the integrity of financial reporting (Naciri, 2010) and ensure that managers act in the interest of the shareholders (Shleifer & Vishny 1997). Regulators often take action to mitigate boards' conflicts of interest (Hail and Leuz, 2006) which are influenced by local legal frameworks (LaPorta et al., 2000, Udayasankar et al., 2008). Regulators and investors have common interest in good governance mechanisms since they help to maximize the value of the firm (Agrawal and Knoeber, 1996) and to mitigate risks (Finet, 2005) for all investors, including the numerous participants in savings and pension plans. In Canada, following calls from governance activists, investor protection groups and the public, financial market regulations have undergone important changes from the year 2000 (Carnaghan and Gunz, 2007), which were by and large localized adaptations of the U.S. Sarbanes-Oxley law (Rousseau and Talbot, 2007). The call for voluntary improvement in board of director governance practices with the adoption of National Policy 58--201 in 2005 leads to the following hypothesis: H1. Canadian issuers improved their board of director governance practices following the adoption of National Policy 58--201. Several Canadian issuers are cross-listed in Canada and in the U.S. Consequently, the boards of cross-listed issuers had to comply with Sarbanes-Oxley requirements before deciding whether or not to comply with the very similar National Policy 58--201 on a voluntary basis. Because this required very little additional work while making regulators and observers satisfied, one would expect that boards of cross-listed issuers would be more prone to conforming with National Policy 58--201 than boards of other issuers would be, leading to: H2. A Canadian issuer's obligation to conform to the Sarbanes-Oxley law increases the likelihood of conforming voluntarily to National Policy 58--201. Corporate accounting scandals have led various stakeholders to expect the adoption of best governance practices by issuers (Kang, Cheng and Gray, 2007). …

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