Every year, the Globe & Mail team of Report on Business writers undertake a review and ranking of companies using considerations related to corporate governance.  And with inclusion of trusts in the S&P/TSX Composite Index, they have tested their abilities to include just the 15 largest trusts along with other public companies. The first round of results might be interesting in general.

Findings Varied in and Reflective of Context

First it should be noted that the annual survey involves only the largest companies and so the largest trusts that meet the S&P criteria for inclusion in the most general index.

The study is a sample of a sample of companies.  And within that realm, the survey attempts to find a useful score for 209 of the thousands of companies listed on the TSX.  Several companies should have been included, but were not based on lack of timely information.

Working with the assistance of the Clarkson Centre for Business Ethics & Board Effectiveness at the University of Toronto, the Report on Business Corporate Governance Rankings set out several measures that provide a potential combined score of 100, with points aportioned as follows:
- Board composition - 40;
- Compensation - 19;
- Shareholder rights - 28;
- Disclosure - 13.

In addition, the five-year total return is provided as of September 30 to “address concerns from some low-scroing companies that it is more important to consider their history of strong financial performance.”

The specific details for each company end up being important in really understanding how corporations are governed and for whose benefit. But the survey provides a general feeling for what is going on using the guidelines offerd by regulators as a starting point in order to determine which companies go, “beyond compliance”. Not that we’re talking about following guidelines only and not meeting regulations or standard legal practice.

For all companies and trusts, the Rankings suggest to their authors that:

* Some companies are doing a good job of corporate governance with an average score of 72, up slightly from just less than 70 last year;
* Some companies are doing a poor job with 6 involveing the CEO or executives in determining their own compensation.
* New companies in the evaluation tend to have lower scores with an average score of approximately 55, compared to returning companies with an average score of roughly 75.
* Rankings confirm that public companies tend to be run by an old boys network with 44 percent of the sample running without a single woman on their board of directors.  Two companies operate in contrast with boards consisting of one-third women.
* Independence is a concern as most companies, 59 percent, don’t have an independent chairman while 8 percent operate without an independent majority of directors on the board.

Against this backdrop, Any Hoffman reports that “Under the spotlight’s glare, trusts slowly embrace reform....Canada’s largest income trusts may have the heft to play in the benchmark index majors, but when it comes to corporate governance practices they’re still in the minor leagues.”

When the largest trusts are considered in the “annual Board Games study”, the authors suggest that the average score was 66 out of 100 with BNP.UN scoring the lowest with 50 and COS.UN scoring the highest at more than 80.

David Beatty, managing director of the Canadian Coalition for Good Governance suggests that, it’s “deeply disturbing....I don’t believe governance has been an issue in the conversion process. The underwriters and the people who are bringing them public aren’t particularly interested. The law firms are following their mandates and the companies are focused on other things.”

They Report on Business says that, the chairman of COS.UN believes trusts “should strive for the same governance standards as corporations”.  With a leading governance score among the trusts being ranked this year, Canadian Oil Sands CEO, Chuck Shultz only just recently completed a 12-day governance course offered by the Institute of Corporate Directors. As an example of moves by COS.UN that gain points on the Ranking scale, the Board cancelled all director options based on the sense that, “There was the perception that options were not right for directors.”

Other trusts that responded to the survey by indicating desire to do better with their ranking and by meeting general expectations of corporate standards, included AET.UN. However, ARC Energy officicals also noted that they were not “comfortable” with the notion of full corporate democracy in which unit owners might vote for individual directors or trustees. They suggest that it is too difficult to find “suitable directors” to open up the possibility of public election “as if they’re politicians seeking support.”

Then again, democracy depends on an informed electorate with ability to see the differences in qualifications and have a legitimate voice in evaluating useful qualities.  And whether public company or trust, the public markets currently do little to promote a fair playing ground when it comes to supply of fundamentally useful information to investors and business management.

The assumption is that large investors and fund managers have the money to buy the information and the talent to influence companies appropriately.  Quite naturally, support for good governance is expressed in the Globe report by major pension fund managers like Brian Gibson, senior vice-president of the $88-billion Ontario Teachers Pension Plan.

Some trustees or directors actually acknowledge that they themselves do not necessarily need industry specific expertise to provide useful talent to a board.  The example given was COS.Un where a woman was included on the board without industry specific expertise but with useful experience as the former chairwoman of the Alberta Audit Committee.

None-the-less, acheivements by the trusts so far:
* All of them had a majority of independent directors.
* Some trusts require unit holders to elect trustees who then hire directors for oversight in the underlying operation of the business so creating “indirect lines of accountability”.

Only two trusts had trustees and directors, YLO.UN and FDG.UN, but neither trust had indepedent trustees constituting two-thirds of their members.

Drawbacks with the trusts being scored given their corporate structure:
* Only a minority had a board that was more than two-thirds independent;
* Continued use by 3 trusts of expensive external management contracts, historically more common in the oil and gas and REIT sectors. Breaking or reshaping those contracts has provided a big payday to managers when the trust “internalizes” the management role to realign accountability and responsibility for unit holders. But also, “fat fees that often come with these deals make board oversight of executives very difficult”.
* Trusts are no better than corporations in terms of board diversity and the inclusion of women. Only one-third had a woman on the board with none having more than one.

Like many private companies that make new issues of shares to the public:
* Several trusts have committees “stacked with former management or related directors”;
* Few trusts fully explain executive compensation.
* Two trusts had no compensation committee;
* Two other trusts had no nominating committee:

External management contracts serve the trust in the same way as “poison-pill” type arrangements serve public companies, triggering massive payouts with a change in structure in order to protect the enterprise from unwanted takeover bids.

Analysts watching the corporate governance issue and invited to comment for the article included Gordon Tait at BMO Nesbitt Burns in Calgary and Alice Sun Dunning from CIBC World Markets. Both emphasized the role of large institutional investors in bringing trusts up to the standards of public companies.

As noted for the Rankings report, it is individual “retail” investors who make up the majority of investors in most trusts. And it is acknowledged that individual shareholders have few rights.  Not uncommon among public companies that allow owners to vote for trustees or board members, income trusts generally fail to allow unit holders to vote for anything other than a slate of trustees or directors. The only exception found was FDG.UN.

The Rankings highlight the idea that the income trust structure is different from a corporate common share or other form of security, so implying that governance “hurdles” can be even higher. For example, the articles suggests that when trusts have both trustees and directors, there is a form of insulation—or we’d say in some cases the potential for an added conduit—for communication between unitholders and managers.

Current Trust Rankings Using Existing Methodology

The scores provided for trusts in the Report on Business Survey:

TRUST = Board composition (40) + Compensation (19) + Shareholder rights (28) + Disclosure (13) = TOTAL (100)
Followed by the 5-year total return (%) to Oct. 14 if operating as a trust for that time.

Canadian Oil Sands - 33 +16 + 22 + 9 = 80
257.8% Total Returns

Fording Canadian Coal - 25 + 16 + 24 + 13 + 78
New issue in last five years

Enerplus Resources - 37 + 15 + 20 + 6 = 78
140.1%

RioCan REIT - 31 + 12 + 20 + 11 = 74
123.8%

Petrofund Energy - 32 + 11 + 20 + 7 = 70
18.7%

PrimeWest Energy - 27 + 14 + 18 + 10 = 69
- 1.0%

Superior Plus - 31 + 7 + 20 + 10 + 68 = 72.1
New in last five years

ARC Energy - 22 + 16 + 22 + 8 = 68
93.9%

Provident Energy - 34 + 9 + 18 + 6 = 67
128.3%

Yellow Pages - 23 + 10 + 20 + 12 = 65

Energy Savings - 26 + 11 + 18 + 7 = 62

H&R REIT - 29 + 9 + 18 + 6= 62
67.6%

Peyto Energy - 25 + 8 + 16 + 5 = 54
2,714.40%

Pengrowth Energy - 22 - 9 - 16 - 6 = 53
- 2.8

Bonavista Energy - 14 + 10 + 18 + 5 = 47
New in five years

One critical observation on the rankings that the Report failed to provide: Technically the age of the trust issue is not being compared on an equivalent basis. Yet the transparency of information related to the structured of the trust is obvious in what might otherwise be considered an anomoly in report.  Whereas Bonavista Energy and Peyto Energy both converted from company to trust less than five years ago, it is only Peyto units that allow for direct translation of past share performance into current unit performance for purposes of reporting total returns over a five year period.  Only Peyto chose to structure its shares as trust units without issuing new shares or complex varieties of other securities at the time the trust was established. 

Points ought to be given for simplicy of equity offerings and simplicity in the trust structure.  This enables investors to understand how a company or trust and underlying operation work together or not.

We also observe that our iTrustIndex of total annualized returns on a trust unit from the point of issue or conversion from share to trust, provides a measurement of performance that is perhaps more useful than a simplistic five-year total return measurement.

What to Make of All This?

David Beatty of the Coalition for Good Governance also summarized with the useful insight that, “[Income trusts] are very different creatures and very much understudied and underappreciated in terms of their governance risks.”

He also suggested that one might not expect smaller trusts to do any better than the large trusts in terms of good corporate governance. He saw there being, “...real opportunity for some of the bigger and more responsible income trusts to come forward and start promoting their own governance as a means of differentiating themselves from the pack.”

We’ll call Mr. Beatty on this and see what we can do to improve the situation. Thinking along the same lines, retail investors would agree with suggestion that it’s “increased scrutiny” that encourages trusts and companies “to clean up their act....A street lamp is the best policeman.”

And it’s with the desire for good corporate governance, in no small way, that TrustInvestor members initiated the iTrustInstitute.  Corporate governance shapes the potential for trust returns to investors, competitive capacity in finanical markets and translates corporate returns into real economic growth.