Corporate Governance and Crown Corporations in Disarray

Commentary, Crown Corporations, Ian Madsen

There have been a number of issues and problems in ordinary corporate governance in recent years and decades.  Boards of directors of corporations are charged with supervising management of those corporations.  Boards establish performance standards for those managers, and set their pay levels.  They also are responsible for appointing auditors who scrutinize the books of the company, to ensure that the revenues, costs, the assets and liabilities are all accurately reported in its financial statements.  

Yet, despite the discipline of the marketplace, and the twitchy financial markets, they have fallen down again and again, for example: Bre-X, Sino-Forest, Enron, Home Capital, and the securitized subprime mortgage meltdown that began ten years ago, slowly accelerating into the devastating global financial crisis.

There is supposed to be something called ‘shareholder democracy’, where ordinary investors can nominate directors and advance corporate bylaws that can improve management accountability and reign in compensation that can have little correlation with corporate financial or operational results.  

There have been substantial advances in these efforts in the past several years, led by ‘activist’ investors such as aggressive hedge fund and private equity players, and some motivated institutional investors such as pension funds that recognize that simply selling out from an underperforming company may leave them with fewer investment options in the future.  Ultimately, the market for corporate control, via takeovers, is used to wrest control from recalcitrant and lacklustre managers, bringing some disruption when restructuring occurs, but also reallocating corporate assets to their most profitable use.

Yet, there are no such remedies in the Crown corporation world.  Directors of Crowns are political appointees, whose interests and strategy are aligned with the provincial or federal regime of the day.  Some of them may have technical, managerial, directorial, or financial expertise, but the main criterion for consideration for board appointment is loyalty to the political party that put them on that board.

Executive compensation cannot be based on stock options or share price performance, as there are no shares publicly traded in Crown corporations, or they lose their non-tax status.  They also have other goals besides maximizing current or future profits or profit margins, eliminating them as criteria for evaluating, and rewarding, managerial performance.  

Being non-taxable, and having access to lower-cost provincial or federal debt funding, their cost of capital is much lower than for private sector companies, especially since their equity capital (contributed directly by government) is erroneously viewed as ‘cost-free’.   Hence, a very low rate of return on assets is the bar they may or may not hurdle, guaranteeing a low-to-mediocre rate of return.  So, the managers have little risk of being terminated for poor performance.  (Incidentally, the best managers may not wish to work in such mediocre and low-reward firms.)

Provincial and federal ten year bonds yield around 2%.  That should not be the measure of an adequate corporate rate of return; it would not be acceptable to any individual or institutional investor with the array of stock market and other opportunities available.  Taxpayers deserve better.

Crown directors have even less vulnerability.  So, such dismal returns can be perpetuated indefinitely, with taxpayer money being locked into investments that abysmally underperform those available in the public stock markets and elsewhere.  The only thing worse is when politicians and their bureaucratic underlings actively meddle in Crown strategy, further reducing profitability as a priority.

Finally, Crown corporations are company-museum preservation vehicles; they are inherently backward-looking, seeking to protect industries and sectors that are in flux.  Even such businesses as telecoms and power utilities have technological, legal, regulatory, and political risk and change:  it is not clear that taxpayers should be exposed to such risk, when the entire investment could be lost, either gradually as sluggish Crowns hesitate to adapt (possibly shedding staff); or more swiftly and savagely.

The only thing worse than not-so-benign neglect is the sort of empire-building and social-political goal-seeking that provincial politicians have tried to do with the various provincial power companies, or the federal government has done in a number of specialty firms (especially in import-export and business development loans).  Crown corporate governance is inherently almost impossible to be effective, and has failed to stop disastrous, costly new investment.  There is hope for improvement, if the discipline of markets is brought to bear to reform and re-direct these flailing and insufficiently accountable Crowns.