How Do Corporate Governance Structures in Canada Differ From Those in the United States?

Nicholas J Price
5 min read
Corporate governance is the relationship between shareholders, board directors and managers in determining the direction and performance of the corporation. Governance defines the powers and duties of the various parties and establishes the rules for how corporations govern themselves. Ultimately, corporations are accountable to their investors and good corporate governance helps to protect them.

The United States and Canada are close neighbors. Geographical proximity makes it easy for corporations to have equity stakes in both countries. This gives them the option of establishing their headquarters in either country. Deciding which country to establish their headquarters in is a significant decision because of the differences in each country's approach to corporate governance.

Corporate Governance in the United States

The United States follows a rules-based governance structure that is oriented toward mandatory compliance with legislation and stock exchange requirements. The rules generated from the federal government and the major securities exchanges such as the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ).

The system in the United States places a greater emphasis on regulatory enforcement than on voluntary compliance. Thus, it places the onus on the legislators and regulators to judge the adequacy of governance practices.

The one exception to the rules-based governance is that the law requires corporations to disclose the name of the audit committee member who is considered an expert in their annual report or explain why they don't have one. In this aspect, the rule follows a principles-based structure.

Sarbanes-Oxley Act (SOX) Requirements

The collapse of Enron and other financial institutions in the early 2000s prompted federal legislative changes. The Sarbanes-Oxley Act was signed into law by President George W. Bush in 2002. The goal of SOX was to eliminate accounting fraud and managerial wrongdoings to restore confidence in the U.S. financial markets. All corporations in the U.S. must abide by SOX regulations.

In turn, the major securities firms listed on the NASDAQ and the NYSE also changed the rules for the corporations that list with them.

SOX requires corporations to enlist independent auditors, enhances reporting requirements, requires disclosure of conflicts of interest, and describes penalties for noncompliance and fraud.

NYSE Requirements

The NYSE requires corporations to have a majority of independent directors on their boards. Corporations that list on their exchange must form a compensation committee as well as nominating and corporate governance committees that are both composed solely of independent board directors.

NASDAQ Requirements

NASDAQ doesn't require corporations on their exchange to establish formal compensation and nominating and corporate governance committees composed of independent directors. Corporations listed on NASDAQ ensure accountability for independence by forming compensation committees composed solely of independent directors who make recommendations to the board about executive and director compensation. Alternatively, some companies form boards that have a majority of independent directors.

Likewise, NASDAQ requires corporations to select director nominees either from a nominating committee with all independent board directors or from a board with a majority of independent directors.

Corporate Governance in Canada

By contrast, Canada follows a principles-based governance structure, which is similar to governance structures in the United Kingdom, Europe and Australia. A principles-based structure places the responsibility on investors to judge the adequacy of a corporation's governance practices.

A principles-based governance structure suggests, rather than mandates, governance principles. Canadian corporations must comply with suggested governance principles or disclose why they don't. For example, the law recommends that corporations have a majority of independent directors and, if they don't, to disclose the reason (or reasons) for it.

The one exception is with regard to audit committees, where the law mandates the rules for compliance.

A principles-based governance structure reflects various differences in corporate board dynamics. Canadian corporations tend to have smaller boards and fewer independent directors than U.S. corporations. Canadian companies also tend to meet more frequently than boards in the United States. Canadian board chairs are less likely to serve as CEO than board chairs in the United States.

Globally, it's considered good corporate governance for board directors to limit how many boards on which they can serve. Canadian corporations have directors who sit on more boards than directors in the United States, which appears to be a reflection of their principles-based system.

There are other reflections of Canadian boards that appear to stem from their principles-based structure. Canadian companies are less likely to have compensation committees and nominating and governance committees. They also tend to have significantly fewer independent directors on their committees, even though their governance structure recommends for them to have all independent directors on committees.

The passage of SOX motivated the Canadian government to review their own standards of governance and to make some long overdue changes. Their efforts resulted in new guidelines and governance requirements for companies listed on the Toronto Stock Exchange (TSX). New laws passed in 2004 include the National Instrument 58-101, Disclosure of Corporate Governance Practices, National Policy 58-201 ' Corporate Governance Guidelines, and Multilateral Instrument 52-110 ' Audit Committees.

In Canada, audit committees must have at least three independent members, and each member must be financially literate, or become financially literate, within a reasonable amount of time after being appointed. This was a surprising move since it veers away from a principles-based rules governance structure.

Canadian Courts Form the Checks and Balances for Corporations

The Canada Business Corporations Act issues rules for corporations in Canada. Corporate board directors are responsible for knowing the laws and their responsibilities under the law. While Canadian law allows corporations much flexibility in governing themselves, board directors may be held liable for their actions and inactions. Board directors who have certain areas of professional expertise may be held to a higher standard relative to their board service.

As with all board members, Canadian board members must always place the interests of the corporation ahead of their own interests, as required by the Duty of Care. Canadian courts are explicitly clear on their expectations for board directors. Despite the looseness of formal mandates and requirements, Canadian judges hold board directors accountable in court when necessary. Canadian courts provide the checks and balances that are necessary to ensure sound ethics and accountability.