The Canada Institute of the Woodrow Wilson International Center for Scholars, the Canadian Association of New York Foundation, and the Canadian Consulate General co-hosted a breakfast meeting in New York City with the two authors of the Canada Institute's most recent One Issue, Two Voices publication titled "Corporate Governance in Canada and the United States: A Comparative View."

This fifth issue in the One Issue, Two Voices series provides an up-to-date snapshot of how corporate governance practices differ between Canada and the United States, and the implications for companies engaged in cross-border business. In recent years corporate governance has become a subject of lively debate in business, legal, and investment circles in both Canada and the United States. However, corporate governance standards and compliance vary significantly between the two countries. The two authors, Professor Jay Lorsch of the Harvard Business School and Edward Waitzer of the Canadian law firm Stikeman Elliott, explained the causes and effects of the Sarbanes-Oxley Act (SOX) and why each country has tackled corporate governance differently.

The U.S. Congress passed the Sarbanes-Oxley Act as a response to the high-profile corporate scandals of 2001-2002. Since then, critics have argued that the legislation has become a burden to many companies. Professor Lorsch argued that Sarbanes-Oxley has proved an acute challenge for accounting firms, who have seen their lucrative consulting practices curtailed, limiting them to lower-margin auditing work. The creation of the Public Company Accounting Oversight Board sharpened the emerging culture of relentless pursuit of SOX compliance, the new focus of the accounting industry. The demise of Arthur Andersen also made the industry more risk averse, according to Lorsch. As a result, fees for auditing have gone up dramatically—driven in part by Section 404 compliance, now the "bread and butter" of risk-averse accounting firms—as have complaints of the burden imposed by compliance (especially from smaller firms). In Canada, small companies looking to raise capital are opting to do so abroad, avoiding regulations at home altogether (e.g., in the United Kingdom's A-market). Lorsch argued that the Securities and Exchange Commission may be able to provide relief for smaller companies through changes in the application of Section 404, but there is little appetite in the U.S. Congress to revisit Sarbanes-Oxley, certainly not before the November congressional elections.

Edward Waitzer also bemoaned the "dumbing down" of the accounting profession as accounting firms became more risk-averse and managers spent too much time on mundane tasks. Asked whether such aversion to risk was now well entrenched and whether it could be reversed, Waitzer reminded the audience "not to underestimate the trauma caused by the Enron and WorldCom scandals" especially among Members of Congress and Department of Justice officials. Lorsch acknowledged that the accounting firms did indeed get "burned" by the Enron and WorldCom scandals. "The real problem" however, "is risk aversion at the level of directors." Many no longer want to serve on boards because they believe it is too risky. Even though this is not true—the law protects them—the perception of risk is now pervasive. Lorsch was careful to stress that the changes to corporate governance witnessed over the past few years are not due to Sarbanes-Oxley alone, but also to changes in the requirements for stock market listings. New requirements for independent directors have had the most palpable impact on the structure of corporate boards.

Lorsch suggested a number of downsides regarding these new stock market and SOX requirements. Regarding independent directors, Lorsch pointed out that limited knowledge of the business they oversee and limited time to do so adversely impact effective oversight. In fact, there are still no studies to show whether independent directors have a positive correlation with a company's corporate performance. He also voiced concern over the role of shareholders in corporate governance, saying that they hardly play an active role except under extreme circumstances. Finally, he remarked that in the United States there was now "too much focus on compliance" at the expense of legitimate differentiation between the needs and obligations of larger versus smaller firms. He suggested the Dutch model—"comply or explain"—as an alternative. Waitzer, however, noted that were problems with this option, because "best practices" tend to become default norms..

Waitzer further addressed the impact of Sarbanes-Oxley on the Canadian corporate world. He remarked that the passage of the Act did not prompt Canadian leaders to improve their own corporate governance rules. Rather, for Canadian decision makers, reacting to Sarbanes-Oxley was "about managing perceptions and expectations vis-à-vis U.S. counterparts" and "maintaining investor confidence." "The good news," according to Waitzer, "is that we got a 'lighter' version of U.S. rules; the bad news is that the emperor has no clothes." Indeed, there is insufficient enforcement since Canada still relies on a fragmented regulatory model—one which has taken a back seat to U.S. enforcement authorities in addressing scandals such those at Bre-X, Hollinger, and other Canadian companies. Some progress is in sight, however. Waitzer explained that the two leading self-regulating bodies have agreed to consolidate into a single entity, but remarked that the approval process would be lengthy: "I expect it will take at least one year to get approval through the regulatory process even though it has broad support." Yet Canada is not alone in facing such problems. He pointed out that in many countries regulation often emerges at the "sub-sovereign level," even though capital markets are transnational. If the trend toward stock market consolidation accelerates—if, for instance, two major stock markets such as New York and London were ever to link up—Waitzer argued that there would be a greater need for global oversight mechanisms. In the meantime, regulation as it currently stands tends to crowd out public equity in favor of venture capital on the one hand, and private equity on the other.

David N. Biette
Director, Canada Institute
(202) 691-4133

Drafted by Christophe Leroy