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«Canadian Evidence of Adherence to “Comply or Explain” Corporate Governance Codes: An International Comparison* STEVEN E. SALTERIO, Queen’s ...»

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Canadian Evidence of Adherence to “Comply

or Explain” Corporate Governance Codes:

An International Comparison*

STEVEN E. SALTERIO, Queen’s University

JOAN E. D. CONROD, Dalhousie University

REGAN N. SCHMIDT, University of Saskatchewan


This study documents the rate of compliance by Canadian public firms with

corporate governance recommendations imposed by the Canadian Securities Administrators. Canada uses a “comply or explain” governance structure in which harmonized provincial regulation establishes mandatory disclosure of governance practices. Firms can be compliant with these requirements either by voluntarily adopting the recommended best practices (i.e., adopt) or by explaining the alternative practices implemented to achieve the same governance principle (i.e., explain).

Firms that fail to comply (i.e., neither adopt nor explain) are in violation of Canadian securities regulation with respect to governance. Using a hand-collected sample of 742 Canadian public companies and 16 governance recommendations, our results show that an average of 82 percent of firms complied by adopting the best practice and an additional 4 percent complied by explanation. Our study also shows that 39 percent of Canadian publicly traded firms were completely compliant with all 16 recommendations examined in this study, either by adoption or explanation. To provide a broader context for these results, we compare rates of compliance in Canada to rates in Australia, a country broadly similar to Canada with comparable governance recommendations. The Australian Securities Exchange supplied data sample of 1334 Australian companies reports a complete compliance rate of 74 percent compared to Canada’s 39 percent complete compliance rate. Our analysis shows that compliance by adoption of best practice is more common in Canada, whereas compliance by explanation is more common in Australia. In our analysis of compliance with individual recommendations, we find that half of the recommendations are more likely to be complied with in Australia, and the other half are more likely to be complied with in Canada.

Keywords Governance; Regulation; International; Comply or explain * We thank Qiu Chen and our team of fifteen Queen’s University recent B.Comm graduates for assisting us with collecting the data for this study. Funding from the Social Sciences and Humanities Research Council of Canada (SSHRC) and the CA-Queen’s Centre for Governance is gratefully acknowledged.

We also thank the Australian Securities Exchange (ASX) for generously providing its data for comparison purposes.

AP Vol. 12 No. 1 — PC vol. 12, no 1 (2013) pages 23–51 © CAAA /ACPC

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With the rapid increase in the number of regulatory bodies issuing codes of governance “best practices” for public companies (Aguilera and Cuervo-Cazurra, 2009), two dominant approaches have emerged: mandatory rule-based systems and principles-based “comply or explain” systems. While much is known about the United States’ mandatory rule-based approach to corporate governance (e.g., Coates, 2007; Hochberg, Sapienza, and Vissing-Jorgensen, 2009; Zhang, 2007; Wang, 2010;

Bargeron, Lehn, and Zutter, 2010; Gao, Wu, and Zimmerman, 2009), there is much less known about the principles-based “comply or explain” approach.

Despite this, the “comply or explain” approach has been adopted by all AP Vol. 12 No. 1 — PC vol. 12, no 1 (2013) ADHERENCE TO “COMPLY OR EXPLAIN” CODES 25 Organization for Economic Co-operation and Development (OECD) member countries except the United States (OECD, 2004).

What is commonly referred to as a “comply or explain” approach is more accurately described as an “adopt or explain” approach. In general, these codes of corporate governance have an overarching set of principles or goals, accompanied by suggested “best practices” for achieving the desired result. Firms comply with these requirements either through voluntarily adopting the recommended best practices (i.e., adopt) or through an explanation of the alternative practice used to achieve the governance principle (i.e., explain). Firms are noncompliant if they fail to adopt and fail to provide an explanation. The governance codes address issues such as board independence, composition of committees, compensation, ethics, board mandate, director nomination, board member assessment, orientation and continuing education of board members, position descriptions, and audit committees (see Canadian Securities Administration (CSA), 2004a,b as examples).

Canada has been cited by the OECD for having the second strongest set of security regulations in the world, following New Zealand (OECD, 2006: 125–26), and ahead of the United States. Canada was among the original set of countries adopting the “comply or explain” approach. However, the extent of noncompliance and the specific governance areas in which noncompliance exists is currently unknown. Therefore, the aim of this paper is twofold: first, to document the extent to which Canadian publicly traded companies are in compliance with certain corporate governance recommendations, and second, to situate these Canadian levels of compliance by comparison to Australian levels. We contrast Canada and Australia as both are British Commonwealth countries that have comparable “comply or explain” corporate governance approaches and recommendations, among other similarities (e.g., governmental systems based on states/provinces in a federal form;

Kilcullen, 2000). Beyond identifying specific governance areas where one country’s compliance rates may differ from the other, comparison of compliance rates across these two countries may offer insight into further research that may hypothesize why the differences and similarities exist.

Identifying areas of Canadian corporate governance noncompliance and differences relative to another country should be of interest to a broad range of stakeholders, such as boards of directors, public accounting firms, and the provincial securities commissions. In the realm of corporate governance and control, boards of directors are viewed as the ultimate internal control authority in firms. The board of directors will directly affect the approach that a firm takes in relation to its accountability and monitoring requirements overall, as well as its responsibility for financial reporting specifically (e.g., Beasley and Salterio, 2001; Lu, Richardson, and Salterio, 2011; CSA, 2004c). In addition, public accounting firms often provide information about best board and audit committee practices (e.g., Deloitte, 2011). Finally, the Office of the Chief Accountant of the various securities commissions carry out much of the scrutiny of compliance with governance codes (e.g., CSA, 2007). Hence, answers to the questions posed in our study are relevant AP Vol. 12 No. 1 — PC vol. 12, no 1 (2013)


to a wide range of parties interested in governance issues with a unique Canadian flavor.

To answer our research questions, we examine sixteen corporate governance best practices that are common to the Canadian and Australian codes of governance. We examine compliance in a hand-collected sample of 742 Canadian corporations and trusts, where compliance is defined as “adopting” best practice or “explaining” the alternative means used. Adoption was the alternative chosen for 82 percent of individual items, explanation in 4 percent, and 14 percent were noncompliant.1 However, on a cumulative basis over the sixteen items, only 39 percent of companies were compliant for all sixteen items of governance disclosure. In the Canadian sample, noncompliance was a particular issue for five recommendations, including: disclosing board duties, independent chair of the board, disclosure of ethics code waivers, code of conduct, and remuneration committee.

The Canadian data is then compared to Australian Securities Exchange (ASX) supplied compliance data for the average of 1334 Australian corporations and trusts. For the sixteen nearly identical best practice recommendations, we find that the level of cumulative total compliance occurs in Australia at nearly twice the rate as in Canada (74 percent versus 39 percent of all firms). However, when looking at individual items, Canadian firms overall score higher in the adoption of best practice category (82 percent versus 70 percent). Further, when individual recommendations are examined, best practice adoption rates for specific items indicate that there are no differences between the Canadian and Australian adoption rates. When overall compliance (i.e., adoption plus explanation) is tested for individual items, there is again no clear winner: Australian firms on average comply to a higher degree for eight of the sixteen recommendations, and Canadian firms on average comply to a higher degree for seven of the other of the sixteen recommendations. These findings underscore the need for future research to further examine why certain firms comply or explain with certain governance disclosure requirements and others do not.

This study makes three important contributions to the corporate governance literature. First, this study documents the extent to which Canadian public firms adopt best practice corporate governance recommendations. Second, this study identifies areas in which Canadian public company disclosures are noncompliant with corporate governance securities regulation (i.e., did not adopt best practice or provide explanation). Finally, by contrasting the Canadian and Australia data, this study provides a rich context in which to situate the Canadian rates of compliance.

We also identify differences across the two countries in firms’ choices of “adoption” versus “explanation”.

1. Compliance through adoption or mandatory disclosure is specified in Section 2.1 (“Required Disclosure”) of National Instrument 58-101 Disclosure of Corporate Governance Practices, as adopted by the Canadian Securities Administrators (CSA, 2004a). Noncompliance with the mandatory disclosure requirements indicates a violation of Canadian securities regulation with respect to governance.

AP Vol. 12 No. 1 — PC vol. 12, no 1 (2013) ADHERENCE TO “COMPLY OR EXPLAIN” CODES 27 In the following section, the Canadian institutional context is outlined, documenting the current state of corporate governance in Canada followed by a comparison of the Canadian institutional context to that of Australia. We then outline our method, data, and assessment of the extent of compliance with Canadian governance requirements. The next section explains the results of our statistical tests to contrast the Canadian data to the Australian data. Finally, conclusions and implications for Canadian corporate governance are discussed.


Corporate Governance: The Canadian Institutional Context The Canadian system is a variant of the “comply or explain” approach to corporate governance regulation, whereby a set of principles are enunciated and guidelines identify “best practices” as to how corporations achieve the goal of each principle. As noted by the CSA, the guidelines are not necessarily intended to be prescriptive and alternatives to identified best practices are acceptable (CSA, 2004b). Specifically, the Canadian regime is one of voluntary adoption of best practices but with mandatory disclosure of either the adoption of these best practices (i.e., “adopt”) or disclosure of how the alternative practice employed achieves the goal (i.e., “explain”) (CSA, 2004a, Section 2.1). In some cases, this explanation might lay out alternate measures taken to meet the governance goal, and in other cases, explanation simply justifies the departure. As such, a company is considered compliant either through substantively adopting the guideline’s best practice or through including appropriate disclosure of non-adoption.

The required corporate governance requirements, which came into effect on June 30, 2005, are contained in National Instrument 58-101 Disclosure of Corporate Governance Practices (CSA, 2004a) and best practices are enumerated in the companion National Policy 58-201 Corporate Governance Guidelines (CSA, 2004b).2 These requirements apply to all TSX companies, with less extensive disclosure provisions required for TSX Venture companies.3 Canada’s corporate governance reform began in the mid-1990s as an exercise in self-regulation by the Toronto Stock Exchange (TSE) to improve the quality of listings (Dey, 1994, 1999). Minimal governance standards were considered a first step (see Daniels and Waitzer, 1993 for a discussion of the previous period). The initial identification of Canadian best practices stemmed from the TSE-sponsored

2. In addition and in regard to audit committees, Multilateral Instrument 52-110 Audit Committees (CSA, 2004c) was effective as of March 30, 2004 with subsequent amendments effective June 30, 2005.

3. The TSX is the Canadian senior market which had 104.6 billion shares traded during 2010 for a traded value of $1,390.7 billion. In contrast, the TSX Venture is the Canadian junior market which had 67.3 billion shares traded during 2010 for a traded value of $34.3 billion (TMX Group, 2011a).

AP Vol. 12 No. 1 — PC vol. 12, no 1 (2013)


Dey Report of 1994 (Dey, 1994), whose original fourteen guidelines reflected the “best practices” of the day. In 2002, regulators became more focused on corporate governance practices, consistent with the corporate governance reformation in other countries and fueled by the U.S. financial reporting scandals (Di Pietra, McLeay, and Ronen, 2010; Hill, 2008). The CSA announced in 2002 that each province would take over the enforcement of the TSE “comply or explain” code and that the CSA would update best practices on an urgent basis. These updates were significantly influenced by the United States Sarbanes-Oxley Act of 2002 (U.S. Congress, 2002), by new U.S. stock exchange listing requirements (NYSE,

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