March 28, 2001 THE OBJECTIVE: A CULTURE OF CORPORATE GOVERNANCE Outline of Comments to be Made to the Third Asian Roundtable

on Corporate Governance The Role of Boards and Stakeholders in Corporate Governance Theme VI: The Profile of Directors What qualities should directors possess, and how do companies find competent directors? Peter Dey, Chairman Morgan Stanley Canada Limited Introduction Director qualities represent the sweet spot of corporate governance reform. To address the issue of director qualities, I want to approach the topic first from the general perspective of reform in governance and the objectives we are searching for in governance reform and then relate the objectives to the specific issue of director qualities. To do so, I will take the liberty of talking about my own experience in governance reform which will not be dissimilar to the experience of many of you and extract from this experience the lessons (which are a work in process) on how to upgrade the quality of governance through improving the qualities of directors. The presumption about our common experience in governance reform is one that I think I am entitled to make because of the common standards that are being imposed upon corporations accessing capital markets in all of the major markets of the world by international investors.

Where Were the Directors? The Committee which I chaired in Canada resulted in a 1994 report with the above title. The title was controversial because it raised a question about the role of the board of directors in corporate governance. The title attempts to capture the defensive character of Canadian boards at the time; the Committee was formed as a result of a number of influences: i. there was a widespread debate in Canada about the importance of governance but the debate was disorganized and lacked focus; ii. there had been a number of high profile corporate failures, especially in the financial services sector, and questions were asked about the role of the directors in these circumstances; iii. there was a fear that if the private sector did not organize the debate and lead the reform, the public sector would seize the initiative and the end product would be less effective.

ffd8ffe0 ffd8ffe0 ffd8ffe0 ffd8ffe0 00104a46 00104a46 00104a46 00104a46 49460001 49460001 49460001 49460001 02010048 02010048 02010048 02010048 00480000 00480000 00480000 00480000 ffe20c584 ffe20c584 ffe20c584 ffe20c584 943435f5 apparent from the 943435f5 title 943435f5 identified 943435f5 The Report and it is 0524f464 the 0524f464 board of directors 0524f464 as the 0524f464 body 94c45000 94c45000 94c45000 94c45000 10100000 10100000 10100000 10100000 c484c696 in corporatec484c696 governance systems mostc484c696 critical toc484c696 enhancing e6f02100 e6f02100 e6f02100 e6f02100 governance. 0006d6e7 0006d6e7 0006d6e7 0006d6e7 47252474 In doing this, we had the 47252474 luxury of presuming that 47252474 there 47252474 existed a developed infrastructure 22058595 for governance reform; 22058595 by this, I 22058595 am referring 22058595 a2007ce0 to well-developed business a2007ce0 corporations statutes, a2007ce0 wella2007ce0 developed 00200090 securities regulatory systems, efficient markets in securities; 00200090 00200090 00200090 (the fundamental necessity for this infrastructure is the theme of the OECD 00600310 00600310 00600310 00600310 00061637 Principles of Corporate Governance). 00061637 00061637 00061637 3704d534 The initial Canadian focus 3704d534 was on the board of 3704d534 directors 3704d534 for three 65400000 reasons: 65400000 65400000 65400000 00049454 00049454 00049454 00049454 32073524 i. the board is32073524 responsible for32073524 supervising 32073524 the 74200000 management of74200000 the business of the74200000 corporation; 00000000 74200000 00000000 responsibility, the board00000000 acts as a00000000 fiduciary and00000000 ii. in discharging this 0000000f 00000000 interests of the company 00000000 00000000 acts in the best 6d600010 0000000f 0000000f 0000000f 6d600010 interpreted to mean 6d600010 in the best6d600010 interests of0000000d 32d48502 0000000d generally; and 0000000d 0000000d shareholders 02000000 32d48502 32d48502 32d48502 02000000 performance 00000000 iii. the accountability02000000 for corporate02000000 00000000 00000000 ultimately falls00000000 to the board and this00000000 00000000 existence of00000000 accountability is00000000 enforced both through00000000 the 00000000 00000000 other the various legal00000000 liability mechanisms and00000000 through 00000000 00000000 measures and market00000000 forces. 00000000 corporate 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 Upgrading the Boards00000000 Role in Governance 00000000 00000000 00000000 00000000 00000000 00000000 To upgrade the boards00000000 role in governance, we00000000 01163707 00000000 00000000 recommended three00000000 types of reforms: 27400000 01163707 01163707 01163707 15000000 1we gave definition to the 27400000 boards responsibilities, 27400000 i.e. ensure 27400000 the 03364657 corporation has a strategy; 15000000 understand the risks of 15000000 the 15000000 business; 36300000 implement plans for 03364657 management succession; 03364657 have a 03364657 18400000 communication policy; 36300000 and implement internal 36300000 control 36300000 measures 06c77747 (post-publication of the Report, we were told this, i.e. defining 18400000 18400000 18400000 07400000 board responsibilities, was the most important contribution 1f000000 06c77747 06c77747 06c77747 we could have made to board empowerment); 014626b7 07400000 07400000 07400000 2we introduced the 1f000000 concept of the unrelated 1f000000 director (by 1f000000 unrelated we 07400000 20400000 meant independent of 014626b7 management) 014626b7 014626b7 01472585 07400000 07400000 07400000 95a00000 the20400000 board's 20400000 20400000 if 21800000 01472585 01472585 principal 01472585 01467585 95a00000 95a00000 95a00000 95a00000 21800000 21800000 21800000 22c00000 01467585 01467585 01467585 01462585 95a00000 95a00000 95a00000 95a00000 22c00000 22c00000 22c00000 24000000 01462585 01462585 01462585 014646d6 95a00000 95a00000 95a00000 e6400000 24000000 24000000 24000000

responsibility is to recruit the CEO, evaluate the CEO and replace the CEO, then the board must not only in fact be capable of exercising these powers but also must be seen to be capable of exercising these powers; 3. we made a series of recommendations on board structure and functioning including recommendations on the size of the board, committee structure (nominating committee, audit committee); the role of the chair of the board and also on board evaluation. None of these guidelines were mandatory. The only mandatory feature was that each corporation disclose its governance system. This occurred in 1995. We have now had five years experience; with this experience, I would like to talk about what we have learned about the process of governance reform in the hope that our experience may be of some value to others engaged in a similar process; and as I said, because governance is organic, reform is a work in process, I will also have the opportunity to learn from the experience of reformers in other jurisdictions.

ffd8ffe0 ffd8ffe0 ffd8ffe0 00104a46 00104a46 00104a46 49460001 49460001 49460001 02010048 02010048 02010048 00480000 00480000 00480000 ffe20c584 ffe20c584 ffe20c584 943435f5 943435f5 943435f5 0524f464 0524f464 Years Later The State of Governance Five 0524f464 94c45000 94c45000 94c45000 Although many boards responded 10100000 10100000 positively to the 1994 initiative my concern five years 10100000 later was that the commitment to c484c696 c484c696 good governance had lost momentum. Accordingly, the c484c696 Committee reconvened five years e6f02100 e6f02100 after the initial Report to draw attention to this loss of e6f02100 momentum and to encourage our 0006d6e7 0006d6e7 original sponsor, The Toronto Stock Exchange, to 0006d6e7 47252474 constitute a new process which 47252474 22058595 would recapture the early commitment to governance. 47252474 22058595 The principal conclusion from this 22058595 a2007ce0 reunion was that although structural changes had been a2007ce0 00200090 corporations are governed, these changes had not led a2007ce0 made to the way Canadian 00200090 00600310 The corporate community, in our view, had not yet fully 00200090 to a more basic cultural change. 00600310 endorsed a corporate governance 00600310 00061637 culture. 00061637 3704d534 00061637 3704d534 65400000 3704d534 65400000 00049454 65400000 The Structural Response 00049454 32073524 00049454 Let me try to paint a picture of the32073524 74200000 type of corporation which we characterized as having 32073524 responded only structurally to74200000 00000000 the initiative; the structural response has many of the 74200000 following characteristics: 00000000 00000000 00000000 00000000 0000000f 00000000 a beautifully crafted system of governance, proudly disclosed 0000000f 6d600010 0000000f 6d600010 a board of directors6d600010 0000000d which meets at regularly scheduled times and seldom 0000000d if ever deviates from0000000d 32d48502 this schedule 32d48502 02000000 32d48502 a board of directors02000000 00000000 which owns little or no stock and is compensated only 02000000 in cash 00000000 00000000 00000000 00000000 00000000 a board of directors00000000 00000000 which does not have a non-executive chair or has a 00000000 passive lead director 00000000 00000000 00000000 00000000 a board of directors00000000 00000000 which does not actively participate in setting the 00000000 00000000 agenda for board00000000 meetings 00000000 00000000 00000000 00000000 00000000 a board with directors 00000000 00000000 who would find a rescheduled board meeting or a 00000000 board meeting which runs longer than planned, a major 00000000 00000000 00000000 inconvenience 00000000 01163707 00000000 00000000 a board which is pre-00000000 27400000 wired to approve virtually all of managements 01163707 15000000 discussion initiatives after little 01163707 27400000 03364657 27400000 a board of directors15000000 36300000 which does not have a formal director evaluation 15000000 process 03364657 18400000 03364657 36300000 06c77747 some of whom are deafeningly silent, and try to a board with directors, 36300000 18400000 make up for the18400000 07400000 silence by being the first to make a motion or second 06c77747 a motion on a topic06c77747 1f000000 which the other directors have debated 07400000 014626b7 07400000 a board with some1f000000 07400000 directors whose director books make a loud 1f000000 cracking sound014626b7 20400000 when the books are opened for the first time at the 014626b7 directors meeting 07400000 01472585 07400000 20400000 95a00000 20400000 I could go on, but you get the01472585 21800000 picture. 01472585 95a00000 01467585 95a00000 21800000 95a00000 21800000 01467585 22c00000 01467585 95a00000 01462585 95a00000 95a00000 22c00000 22c00000 24000000 01462585 01462585 014646d6 95a00000 e6400000 95a00000 24000000 24000000

A Culture of Corporate Governance It is in the interests of each marketplace that the market be characterized, amongst other things, for its genuine commitment to corporate governance. What is meant by a culture of corporate governance? The mode of behaviour of the principal players in governance systems, i.e. the directors, shareholders, officers (and other stakeholders) must reflect a deep and abiding commitment to governance a commitment which comes naturally.

How to Develop a Culture of Governance The question then is how does one go about changing the mode of behaviour of corporate officers and directors to develop a culture of governance. I have reflected on the roots or sources for the development of a culture in any context and my conclusion is that for any particular mode of behaviour to become part of a culture, the behaviour must be a product of passion. A culture of corporate governance means that the principal players, the directors, care deeply about the corporation and about the governance process engaged in by the board. The directors, in addition to having a passion for governance itself, (which is simply a process for achieving corporate objectives and not an objective of itself), must have regular one-on-ones with officers of the company; board meetings must be viewed as a command performance and a welcome outlet for director concerns; directors must constantly work to achieve the appropriate balance between management and the board this relationship, ie the relationship between management and the board must be characterized as one of constructive tension; this relationship is the key to a good governance system; management must view the board as a vital resource to the execution of the corporations business plan; and the characteristics outlined above of a corporation responding to governance reform structurally must be absent.

How to Energize Boards of Directors, i.e. What is the Source of Passion for Governance? Developing a culture of corporate governance requires leadership and leadership comes from the chair of the board. The chair of the board should not be the CEO. As chair, the CEO has a conflict of interest. The board is responsible for supervising management; the CEOs responsibility is to manage the business. These two separate responsibilities should not be confused. All boards should have a non-executive chair to drive the development of a culture of governance.

Board Constitution The constitution of the board should be a matter for continuous review. It is a basic principle of a well-governed board that director recruitment is managed by a nominating committee comprised of a majority of unrelated directors. The qualifications required to be an effective director have been steadily rising. Qualifications include financial literacy (not debits and credits, but understanding the principal financial parameters for valuing the business and for assessing its performance), an understanding of the strategic planning process, an understanding of human resource development and an ability to understand and execute the specific responsibilities imposed on the board. Corporations in all jurisdictions would be better positioned to participate in a globalized business environment if greater diversity were brought to the composition of boards. Too often, new directors are recruited from the old

ffd8ffe0 1 ffd8ffe 00104a46 000104a4 49460001 64946000 02010048 10201004 00480000 80048000 ffe20c584 0ffe20c58 943435f5 like the boys network, that is to say, people known well to the existing board who are much 4943435f 0524f464 and the existing board. Potential sources of new directors include former senior public servants 50524f46 94c45000 and it is growing number of qualified women in management; it is important to broaden the pool 494c4500 10100000 important to ensure that the board has the appropriate skill set for supervising the 01010000 c484c696 companys business. 0c484c69 e6f02100 In recruiting directors, the nominating committee must be able to detect that passion for 6e6f0210 0006d6e7 governance and for the successful management of the business of the corporation. 00006d6e 47252474 evaluation An important component of the director recruitment process is a regular and aggressive 74725247 22058595 generally. of the contribution of individual directors and of the effectiveness of the board 42205859 a2007ce0 revision Too often, board changes only come as a result of gross underperformance. Continuous 5a2007ce 00200090 board at of the constitution of the board will ensure that the appropriate skill set is present on the 00020009 00600310 to all times and will send a strong message to the existing board that the board is willing 00060031 00061637 reconstitute itself if it feels that directors are not contributing. 00006163 3704d534 candidate In a recent discussion with an individual who I would characterize as a very attractive 73704d53 65400000 for any board, his stated criteria for joining a board were: 46540000 00049454 1Is the meeting schedule for the board compatible with the candidates schedule?; 00004945 32073524 2Is the corporation engaged in a business that the candidate is interested in and 43207352 74200000 therefore the candidate is in a position to make a contribution?; and 47420000 00000000 00000000 00000000 3If the candidate doesnt like the direction of the corporation is the candidate willing to 0000000f walk from the board? (This same director noted with astonishment the few, if any, 00000000 6d600010 resignations by Canadian directors from boards over disagreements with the policy 00000000 direction 0000000d f6d60001 of the corporation.) 32d48502 00000000 02000000 d32d4850 4 00000000 20200000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 00000000 01163707 00000000 27400000 00116370 15000000 72740000 03364657 01500000 36300000 00336465 18400000 73630000 06c77747 01840000 07400000 1f000000 006c7774 014626b7 70740000 07400000 01f00000 20400000 0014626b 01472585 70740000 95a00000 02040000 21800000 00147258 01467585 595a0000 95a00000 02180000 22c00000 00146758 01462585 595a0000 95a00000 022c0000 24000000 00146258 014646d6 595a0000 e6400000 02400000

Concluding Thought We are beyond structures for corporate governance; structuring a governance system is not rocket science. Anyone can just do it!. We must pursue a culture of corporate governance. International investors manage mobile pools of capital acutely sensitive to the quality of governance in various marketplaces. Any suggestion of a less than diligent approach to corporate governance increases the risk premium investors will demand thereby raising the cost of capital for corporations dependent on the marketplace thereby making the corporations less competitive.