Chapter 18 - Muskrat Falls Inquiry

Chapter 18

Governance of Crown Corporations

CIMFP Exhibit P-01775

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0CIMFP Exhibit P-01775

Table of Contents

Page

Main Points 18—5

Introduction 18—7

Major legislative refonis of Crown corporation governance iii 1984 18—7Good corporate governance is more important than ever 18—8Focus of the audit 18—8

Observations and Recoin menda tion

Appointing Boards of Directors.. Board Chairs. and Chief Eecuti e Officers 18—9Boards of directors have a pivotal role 18—9Boards reflect Canadas diversity but lack other key skills and capabilities 18—10Appointments need to meet the boards skill and capability requirements IS—IlA need to maintain continuity and experience on boards of directors 18—13Other factors affect board functioning 18—14Chair appointments often made with limited board consultation 18—15Appointment of the chief executive officer is a key factor in corporate governance 18—15Centre selects model found least favour 18—17Centre searches model gol mixed reviews 18—17Board searches model seen as the most effective [8—I 7

A transition strategy may be necessary 18—18

Importance of the Audit Coinniittee 18—19Half of ihe audit committees were operating below an effective level 18—19Key gaps in practices 18—21

Approving Corporate Plans anti Ensuring Mandate Relevance 18—2!The corporate plan is the cornerstone of the control and accountability framework 18—2!Many deficient corporate plans are approved, and the government has limited capacity

to challenge them 18—22Need for a more systematic review of corporation mandates 18—25

Go ernance Protocol Between Ministers and Crown Corporations 16 26

Conclusion 18—27

About the Audit 18--29

Exhih its

18.1 Comments on Board Skills and Capabilities by Chairs and CEOs 18—1018.2 Selected Best Practices for Audit Committees [8—2018.3 Good Practices From Portfolio Management Groups [8—24

Appendices

A. List of Cro\\ it Corporations by Rcsponsiblc Minister 18—313. Roles arid Responsibilities I; nder the I ilmuAcuhl - lthflh!71S011/irfli - let I 8 32C. General Information on Special Examinations and Overview of Results 18—34D. Bcst Practiccs Applicable to Federal Crown Corporation Audit Comtiiittees 18—37

Report of the Auditor General of Canada — December 2000 18—3


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Main Points18.1 The management of Crown corporations has improved since the Financial Administration Act wasamended in 1984 to strengthen their control and accountability framework. Nevertheless, further improvement isneeded in some important areas like strategic and corporate planning and the measurement and reporting ofperformance. We found a need for special attention in three areas that are central to the way Crown corporationsare governed:

• boards of directors of Crown corporations need to be strengthened. They reflect Canada’s diversitybut lack other key skills and capabilities that are needed to function effectively and to carry out theirimportant responsibilities under the Financial Administration Act for the affairs of the corporation.Corporations need to better define their requirements for skills and capabilities and conimunicatethem to the government; the government needs to act on those requirements. Boards of directors alsoneed to be more engaged in the selection of their chair as well as the corporation’s chief executiveofficer (CEO). Without meaningful board involvement in the selection of the chief executive officer,his or her accountability to the board is weakened and corporate governance as a whole suffers.

• Audit committees in Crown corporations play a crucial role in financial reporting, risk management,and internal control. They are the “engine” of the board of directors. Yet half of the audit committeeswe examined were operating below an effective level. Serious weaknesses in an audit committee canundermine the overall strength of the board.

• Thc government has a limited capacity for reviewing and challenging Crown corporation corporateplans as a basis for approving them. Corporate plans set out the strategic direction of a Crowncorporation and are intended to be the cornerstone of the Crown corporation control andaccountability framework tinder the Financial .1dministration Act. The government needs tostrengthen its capacity to review and challenge these plans since, once approved, they are the basisfor holding Crown corporations accountable for conforming to government policy and for theiroverall perfoniiance. Furthermore, there is a need for a more systematic and regular review of therelevance of Crown corporation mandates.

18.2 Weaknesses in all of these areas impede the successful implementation of Part X of the Financial.4dminisnation Act and the quality of Crown corporation governance. They have been raised many times before,in Auditor General reports and other external studies and reports, but the weaknesses remain. Crown corporationCEOs and chairs view the resolution of these issues as critical and they need to be addressed with urgency. Otherindustrialized countries have moved ahead of Canada in these areas of Crown corporation governance.

18.3 Corporate governance refers to the process and structure for overseeing the direction and management ofa corporation so that it carries out its mandate and objectives effectively. It is critical that a Crown corporation, asa public sector body, be governed well if taxpayers money is to be well spent. Good corporate governance isimportant to maximize performance, prevent financial losses and help to achieve the corporate mandate. But it isin times of difficulty, turbulence and change that good governance is most critical.

Background and other observations

18.4 Crown corporations are distinct legal entities wholly owned by the government. They operate in manysectors, including transportation, agriculture and culture. They have more autonomy to manage than most other



government entities so they can operate in a more commercial manner. A board of directors oversees themanagement of each corporation and holds management responsible for the corporation’s performance. Thegovernment retains power and influence over Crown corporations in areas like appointments, remuneration forchief executive officers and directors, and approval of plans and budgets.

18.5 Cro’vn corporations account for a significant portion of government activity. There are currently41 federal Crown corporations (not including subsidiaries), employing 70,000 people. In aggregate (excluding theBank of Canada), they manage $68 billion in assets and $61 billion in liabilities. While Crown corporationsrepresent a significant opportunity to achieve public policy and other goals and to generate revenue, they alsorepresent significant exposure to potential financial losses and other risks.

18.6 In addition to our continuing work as auditors and examiners of most Crown corporations, we looked indetail at a representative group of 15 Crown corporations. We also compared Canadian Crown corporations withstate-owned enterprises elsewhere, and used the results of other research, studies, audits and roundtables tosupport our findings. In addition, we summarized the results of special examinations a type of value-for-moneyaudit of Crown corporations carried out between 1984 and 2000.

In view of the fact that many of the recommendations deal with Governor in Council discretion, no detailedresponses to the recommendations were made. Overall, the Privy Council Office states that the governmenthas made strides in a number of corporate governance areas, and is comnutted to examining measures toaddress areas needing improvement and to ultimately strengthening governance in Crown corporations. ThePrivy Council Office also states that it is paramount to ensure that appointments to Crown corporationsresult in strong boards of directors, and that the appointment process for Crown corporations be inclusive ofall interested parties, bearing in mind that appointments remain at the discretion of the government.

Reaction from Crown corporation chairs and CEOs indicate that, for the most part, they agree with therecommendations directed specifically at them.

18—6 Report of the Auditor General of Canada — December 2000



Introduction18.7 Crown corporations are distinctlegal entities that are wholly owned by thegovernment. Their use by government todeliver important public programs datesback to Confederation; they operate inmany sectors of the Canadian economy,including transportation, energy andresources, agriculture and fisheries,financial services, culture, andgovernment services. Crown corporationsvary widely in size and in the level offinancial support they receive from thegovernment.

18.8 Crown corporations account for asignificant portion of the government’sactivity. There are currently 41 Crowncorporations (excluding subsidiaries),employing 70,000 people. In aggregate(excluding the Bank of Canada), theymanage $68 billion in assets and$6 I billion in liabilities. While Crowncorporations represent a significantopportunity to achieve public policy andother goals and to generate revenue, theyalso represent significant exposure topotential financial losses and other risks.They have total debt obligations (debtspayable to Canada and to the privatesector) of $49 billion. Governmentbudgetary appropriations are $3.8 billionannually. Appendix A presents a list of allCrown corporations (excludingsubsidiaries) by ministerial portfolio.

Major legislative reforms of Crowncorporation governance in 1984

18.9 The Financial .1dnnnisnalion Act(Eli) was amended in 1984 to addressmajor performance problems in Crowncorporations. The amendments to the £1.1(Pail X) imposed a more rigorous regime,designed to ensure an adequate level ofdirection, control and accountability ofCrown corporations. All Crowncorporations fall under the F-i-I. except forsome exempt” corporations whereParliament agreed to create furtherdistance from the government.

18.10 The new regime created a uniquemodel for governance, establishing therelationship that should exist among aCrown corporation, the responsibleminister, the government and Parliament.The regime outlines the roles andauthorities of the corporation’s board ofdirectors, management, the responsibleminister, the Minister of Finance, theTreasury Board, the Govemor in Council,Parliament, and external and internalauditors (see Appendix B for details).

18.11 The regime attempts to balancethe Crown corporation’s relationship withthe government between its “arm’slength” independence in day-to-dayactivities and government’s appropriatedirection and control. Crown corporationshave more autonomy to manage than mostother government entities so they canoperate in a more commercialenvironment. A board of directorsoversees the management of eachcorporation and holds managementresponsible for the company’sperformance. Through the Crowncorporation’s chair, the board of directorsis accountable to a minister whorepresents the government and acts as thelink between the corporation and bothCabinet and Parliament. The governmentretains power and influence over Crowncorporations in areas like appointment andremuneration of directors and chiefexecutive officers, directives andregulations, and approval of corporateplans and budgets. Each Crowncorporation is accountable to Parliamentthrough the responsible minister.

18.12 The P1.4 amendments alsostrengthened internal audit and introducedspecial examinations (a type ofvalue-for-money audit) in most Crowncorporations, in addition to the annualaudits of financial statements. Specialexaminations provide the board with anindependent opinion on how well thecorporation is being managed. A Crowncorporation must undergo a specialexamination every five years; the

Crown corporations

account for a

significant portion of

the government’s

assets, liabilities and

expenditures.

Crown corporations

have more autonomy

to manage than most

other government

entities.

Report of the Auditor General of Canada— December 2000 18—7


Governance of Crown Corporalions

Research shows a

relationship between

good governance and

good results.

period 1996 to 2001 represents the thirdcycle of special examinations since the£4.4 was amended. Appendix C outlinesihe role of special examinations andprovides more detail on what theyexamine. It also presents an overallsummary of findings over the threeexaminaiion cycles to date.

18.13 Each Crown corporaiionsenabling legislation. whether a special actof Parliament or articles of incorporationunder I he C’u,iailu Businuss Corpoi’aIions-Ic!. sets out in broad terms its mandate.powers and objectives.

Good corporate go’ernalice is moreimportant than ever

18.14 Like most organizations. Crowncorporations face a complex and rapidlychanging environment. The private sectoris increasingly active in areas that oncewere the e xc Ins i ye domain of Crowncorporations. Technological advances andconsumer demands for new and differentservices create pressure for change.

18.15 Crown corporations must dealwith the added complexity of managing inthe public secior. Corporations in theprix ate sector operate to maximizeshareholder value. However, theobjectives of Crown corporations are notalx ays that clear. \ lany are required toachies e financial self-sufficiency whilemeeting public polic’ objectives (such asdelivering needed services thai are notcorn m erci ally xi able).

18.16 Corporate governance refers tothe process and structure for overseeingthe direction and management of acorporation so that it can’ies out itsmandate and objectives effectively. It iscritical that a Crown corporation, as apnblic sector body, be governed well iftaxpayers’ money is to be ‘veil spent.

18.17 Good corporate governance isessential if a Crown corporation is to fulfilits mandate. In good times, goodgovernance can increase the effectiveness

of performance and help to preventpotential financial losses, ineffectivenessand inefficiencies. But it is in times ofdifficulty, turbulence and change thatgood governance is most critical.

18.18 In the recent past, landmarkstudies (for example, the Cadbury Report,United Kingdom 1992, Gerard Veilletixsreport lJnfinished Business” in 1993. andthe 1994 Toronto Stock ExchangeGuidelines for Improved CorporateGovernance in Canada) have focussed onthe need to address gaps in corporategovernance. Corporate failures andscandals have been linked to weaknessesin governance. The Canadian Institute ofChartered Accountants, supported by theToronto Stock Exchange and the CanadianVenture Exchange. has established a JointCommittee on Corporate Governance toreview the current state of corporategovernance in Canada. compare Canadianpractices with international best practices,and recommend changes to ensure thatCanadian corporate governance is amongthe best in the world, It has become anaccepted reality for private and publicsector corporations that good governanceis essential to long-term success.

18.19 The literature shows arelationship between good governance andgood results. For example. companieswhose standards of corporate governanceare high are more likely to gain theconfidence of invesiors and support for thedevelopment of their businesses.

Focus of the audit

18.20 Our special examinations overthe last 15 years indicate that ovei’al I themanagement of Crown corporations hasimproved since the £1.4 was amended.Nevertheless, further improvement isneeded in some important areas likestrategic and corporate planning and themeasurement and reporting of corporateperformance.

18.21 Government documents,important studies, professional literatureand the accountability and control regime




for Crown corporations all point to thefundamental importance of effectivecorporate governance. However, our

experience with auditing Crowncorporations suggests a need for specialattention to three areas that are central tothe governance of Crown corporations:

• the process of appointing the chiefexecutive officer (CEO) and the boardchair and directors;

• the composition, role,responsibilities, and performance of theboard’s audit committee; and

• the government’s capacity to reviewand challenge the corporation’s corporateplan before approval and to ensure thatCrown corporation mandates continue tobe relevant.

18.22 Weaknesses in these three areasimpede the successful implementation ofPart X of the ELi and the effectivegovernance of Crown corporations.Previous reports of the Auditor Generalhave raised the need to resolve them, ashave studies and reports by others, but theweaknesses remain. This chapter discussesthem in detail. Crown corporation CEOsand board chairs cite as an ongoingfrustration these continuing weaknesses inareas they view as high priorities. Othercountries have moved ahead of Canada inthese areas of Crown corporationgovernance.

18.23 Given their importance to goodgovernance of Crown corporations and theconcerns identified during the course ofour previous audits, these three areas werethe focus of this audit. We set out toexamine how well these areas were nowfunctioning. The audit scope included keyprovisions of Part X of the P1.1 andparallel provisions in the enablinglegislation of Crown corporationsexempted from Part X. Further details onthe audit scope, objectives and criteria arepresented at the end of the chapter inAbout the Audit.

Observations andRecommendations

Appointing Boards of Directors,Board Chairs, and Chief ExecutiveOfficers

Boards of directors have a pivotal role

18.24 The government has stated,“Crown corporations will operate atpeak efficiency only when boards ofdirectors operate at peak efficiency”(Crown Corporations Direction, Control,Accountability, Government of Canada’sProposals, Privy Council Office, 1977).The P1.4 stipulates that the board ofdirectors is responsible for the affairs ofthe corporation. The Treasury Board’sguidelines on Corporate Governance inCrown Corporations and Other PublicEnterprises (1996) include a number ofways to strengthen the board’seffectiveness. The guidelines state that aboard of directors has a duty to overseethe management of its Crown corporationwith a view to both the best interests ofthe corporation and the long-term interestsof the government. To fulfil thatstewardship duty, the board is expected toexercise judgment in establishing thecorporation’s strategic direction,

safeguarding the corporation’s resources,monitoring corporate performance, andreporting to the Crown. The board isaccountable for its performance to theresponsible minister, and the minister isaccountable in turn to Parliament for theperformance of the corporation.

18.25 It is therefore in the government’sinterest to appoint strong boards ofdirectors. The appointment of directors isa fundamental prerogative of theshareholder in private sector and publicsector corporations, incltiding Crowncorporations. Under the F-I-I, theresponsible minister appoints directorswith the approval of the Governor inCouncil, following a review of theminister’s recommendations by the Prime

It is in the

government’s interest

to appoint strong

boards of directors to

oversee the

management of Crown

corporations.

Report of the Auditor General of Canada December 2000 18—9



Many chairs and CEOs

are not satisfied with

the mix of skills and

capabilities on their

boards.

Minister’s Office. The government needsto appoint strong boards, allow them to dotheir work, and dismiss those that do not.Given the pivotal role of the board ofdirectors in governing a Crowncorporation, we looked for timelyappointments of qualified directors whomet the requirements of both thegovernment and the corporation.

Boards reflect Canada’s diversity butlack other key skills and capabilities

18.26 The first step in any effectiveappointment process is to identify theskills and capabilities the positionrequires. The government has made acommitment to appoint, on the basis ofcompetence and equity, directors whomeet the following requirements:

• Appointees must meet the criteriathat may be specified in the corporation’sparticular enabling legislation.

• Geographic regions must be wellrepresented on the board and geographicconcerns taken into account.

• The capacity to speak both officiallanguages is often required.

• Persons appointed will betterrepresent women, visible nunorities,Aboriginal peoples, and people withdisabilities (So You Want AnOrder-In-Council Appointment? byPenny Collenette, Prime MinistersOffice).

18.27 The government has improvedthe gender balance and geographicrepresentation on boards of directors.According to the Conference Board ofCanada, Crown corporation boardscontinue to lead all sectors in boardgender balance, with women accountingfor 30 percent of directors, compared with10 percent in other sectors; and 18 percentof board chairs are women, compared with6 percent in other sectors. Sixty-fivepercent of Crown corporations viewgeographic representation as the topcriterion in the selection of new boarddirectors, compared with 25 percent ofprivate sector corporations.

18.28 Many Crown corporation chairsand CEOs report that they are not satisfiedwith the mix of skills and capabilities ontheir boards. According to the ConferenceBoard of Canada, 18 percent of Crowncorporations view a specific skill set tocomplement the board as the top criterionin the selection of new board directors,compared with 58 percent of privatesector corporations. When we askedCrown corporation chairs and CEOs whatnecessary capabilities or skills their boardsof directors were missing, they noted gapsin one or more of financial expertise andfinancial literacy, marketing. accounting,strategic leadership, previous experienceon a board of directors or relatedexperience, ideally in an organization ofsimilar stature (assets, revenues,complexity), and knowledge of thecorporation’s business. They also notedthe value of having a chair or one or more

Exhibit 18.1

Comments on BoardSkills and Capabilitiesby Chairs and CEOs

‘Polilics. gender and geography are the (op three selection criteria no’ Relevant businessexperience needs to be number one.’

twenty-five percent of the board today are out of their depth due to political criteria being used[for selection] instead of business.”

‘Depth of experience is needed, and character to promote a close working relationship with IheCEO.”

‘Experience in specific industries (for example, financial services) is essential to (he board, butignored in recent appointments.’

“We have lots of lawyers. which is fine, but could use at least one accountant,”




directors with previous CEO experience.Exhibit 18.1 presents some of theircomments.

18.29 We also asked chairs and CEOsabout the impact of these gaps in skills.Their responses indicate that the gapsundermine the board’s effectiveness. Forexample:

Today. the only individual on ourboard who has a strong financialbackground is the CEO... How canthe board direct. oversee or e ensupport the corporations workeffectively?

CEOs look to the board, andindividual directors, to run ideas by.and to engage in in-depthcxploration... This role of the boardcan’t he fulfilled now.

18.30 These gaps in hoard skills andcapabilities are a reflection of theappointment process. which we exaniinedin some depth. The selection process forboard directors must seek otit people withthe capabilities and skills that are essentialto the effective functioning of the board:that is in the interest of both thegovernment and the Crow n corporation -

The government needs to understand I lieskills and capabilities the corporationneeds and lacks on the board tshett itlooks for candidates to fill boardvacancies, At the same time, it also needsto meet its own objectives. ‘Ihe finalappointment must reflect the needs of boththe government and the corporation.

Appointments need to meet the board’sskill and capability requirements

18.31 Both the government and theCrown corporation have a role to play inensuring that directors have the necessaryqualifications to meet the board’s needs.Under the P4.4. the responsible ministerappoints the board of directors with theapproval of the Governor in Cottncil. Thatthe “board of directors should contributeto its own renewal” is also clearly stated

in the Treasury Board’s guidelines oncorporate govet’rtance:

The selection and recruitment ofknowledgeable and skilled candidatesto the board is of primeimportatice. Recommendations bythe existing board influence theselection and approval process. Theboard’s experience.. provides an idealbasis for lhe hoard to review thesuitability of its composition and theeffectiveness of its performance....The board’s self-assessment of theskills required can be a useful basisfor recommendations on theappoititment or replacement ofdirectors as terms approach expirv.The chair, on behalf of the board.shottld advise the appropriate ministerand the Director of Appointments inthe Prime Minister’s Office of thedesired mix of skills useful for theboard and, in particular. those skillsthat should be sought in upcomingvacaticies.

18.32 Consistent ‘vith best practices.boards need to produce profiles thatspecify the skills they require based onidentified needs or gaps. and that focus onthe posit iotis themselves rather than theindividuals who might fill them. Thehoard profiles must capture the skills thecorporation will tieed in the future tomove its strategic direction forward. Inhis 1993 report. Gerard Veilleuxrecommended the use of hoard profiles inCrown corporations. The Privy CouncilOffice, the Treasury Board, the AuditorGeneral. and several provincialgovernments endorsed therecomnietidat ion.

18.33 And yet we found that manyboards of directors have not developedsuch profiles. Itt 1995, we reported that13 percent of Cro\vn corporations wereitsing board profiles and we encouragedtitinisters to lend their support to thepractice. We find now that 34 percent ofall corporations have completed profilesor selection criteria for board metnbers.Typically, the Ct’owti corporation sendsthese to the minister’s office, and only

Gaps in skills and

capabilities undermine

the board’s

effectiveness.

Only 34 percent of

Crown corporations

have completed

profiles outlining their

requirements for

director skills and

capabilities.




Where the government

acted on board skills

profiles, the

appointment better

met the board’s needs.

sometimes to the Privy Council Office orthe Prime Minister’s Office.

18.34 Job descriptions for the board ofdirectors, the chair and the CEO canprovide a good context for developing theboard skills profile. The corporations thathave prepared job descriptions have foundthem en useful For example. theprocess itself builds a sharedunderstanding and communication amongthe players on their respective roles. andthe job description helps to outline thenature of the commitment expected whenrecruiting or orienting ne\\ boarddirectors,

18.35 Fewer than half the corporationsthat do use hoard skill profiles have foundthem effective in the selection ofdirectors, Many reported that while theycan and do suggest what they need infuture appointments, they have noassurance that the government takes theirsuggestions seriously; many said that thegovernment has not used their profiles atall.

18.36 \Ve reviewed a sample of boardappointments to better understand theprocess. At one extreme, the governmentmade the appointment afier consultingonly nominally with the board chairman,or not at all. In many cases, thecorporations had prepared skills profilesbut found thai ihe government did not usethem.

18.37 At the other extreme, thecorporation’s board of directors conductedthe search and recruitment andrecommended a single name to thegovernment for approval. In some of thesecases, the chair vetted the list of potentialcandidates for those who met theshareholder’s requirements.

18.38 In between these two extremes.the government led the search andactivel consulted with the board. Thecorporations developed board profiles thaithey believed the government used. Inthese cases, the chair had a good

relationship with the minister, a factor thatappeared to smooth the appointmentprocess.

18.39 We found that meetings betweenthe key players were also valuable incommunicating the board’s desired mix ofskills and capabilities that should besought in filling upcoming vacancies. Forexample, some board chairs took theinitiative to meet with the PrimeMinister’s Office and the Priv’v CouncilOffice in advance of a board vacancy todiscuss the needs of the board, in keepingwith the Treasury Board guidelines.

18.40 O’erall. we found that where thegovernment acted on the board’s profilesand stated requirements, the appointmentbetter met the hoard’s needs. For example,in some situations the ni n i ster sent theresumés of possible candidates to thecorporation for consideration and acted onthe corporation’s assessment of themwhen selecting board directors. Too often,however, the corporation had not assessedits requirements for skills and capabilitiesand the government did not consult theboard, which led to frustration, unmetneeds, and a weakened board.

18.41 Other industrialized countries areahead of Canada in their practices ofappointing board directors. In NewZealand, for example, the objective inselecting directors is to ensure that theboard has the necessary skills to enhancethe corporation’s performance and theinteraction and openttions of the board.and to ensure that the appointment isconsistent with the corporal ion’s strategicdirection and its needs. The processreinforces the in mister ‘s ‘ole inidentifying the skills needed n aparticular position on a Crown corporation

board, appointing a suitable candidate.and reviewing the perfonnance of thedirectors and the board, It begins withagreement between the minister and thecorporation on a board skills profile and itends with the appointment of the selectedcandidate, after consultation and/orinterviews ith the coipoi’at ion, the




responsible minister and the Minister ofFinance. This is followed by the inductionof the appointee. Ne\v Zealand publishesan outline of the key competenciesrequired in directors. For example,preference is given to candidates whohave experience in one or niore of thefollowing:

• governance in a significantorganization with a commercial focus;

• chief executive or seniornianagement positions in an organizationwith commercial attributes;

• senior positions in relevantprofessional disciplines, such as science,technology, finance, law, health,agriculture, and social policy; and

• related governance or managementpositions in community or professionalorganizations.

18.42 The United Kingdom has aCommissioner for Public Appointments,

whose objective is to manage anappointment process that vi II merit theconfidence of candidates and the public.The government requires that the processbe efficient, transparent, and based onmerit. The process incorporates a numberof procedures and principles such asscrutiny by an independent assessor,transparency and openness, andproportional it)’ (which means theappointment process is appropriate to thenature of the post and the magnitude of itsresponsibilities). All stages of the processare subject to audit. No one is appointedto a public body without some form ofinterview, and candidates must answer aquestion about their political activities, toprovide transparency and to identifyrelated skills and experience that could beuseful and that may demonstratecommitment. The government states thatpolitical activity and affiliation arenormally not criteria for appointment.

18.43 Two recently created Crowncorporations in Canada have adopted the

practice of appointing a nominatingcomniittee to identify director candidates,a model that could be used more widely.

18.44 Each Crown corporation shoulddevelop a board skills profile. The chaii;on behalf of the board, shouldcommunicate the profile to theresponsible niinister, the Privy CouncilOffice and the Prime Minister’s Office,as well as the board’s specific skills anticapability requirements for upcomingvacancies. The government should acton these stated requirements in itsselection of directors.

18.45 Each responsible minister andthe corporation should reach all

understanding on how the board will beengaged in the selection andappointment of directors.

A need to maintain continuity andexperience on boards of directors

18.46 We analyzed appointments madeto 15 Crown corporation boardsfrom 1996 through 2000. We drew ourdata from appointment guides publishedby the Privy Council Office, outlining theterms and conditions for all appointmentsapproved by the Governor in Council.

18.47 The £1.4 states that directors canbe appointed to tenim of up to three years,and reappointed if desired. It provides fordirectors to continue serving after theirterms have expired until either they arereappointed or a new appointment ismade. This provision ensures that boardscan continue to function, even if there aredelays in the appointment process.

18.48 The length of time directorsserve is improving, but still too short.Most directors of Crown corporations areappointed to the maximum three-yearterm allowed for by the £4.4. althoughthere have been some terms of one andtwo years. The biggest factor in the lengthof time a director serves on the board isnot the length of the term but rather thenumber of reappointments. There arepositive signs that indicate some

More directors are

serving on Crown

corporation boards for

longer periods.




There is a need for

better director training.

improvement. More directors are servingon Crown corporation hoards for longerperiods, which means that the number ofreappointnients is increasing.Sixty-four percent of incumbents eligiblefor reappointment have been reappointedfor at least a second term. This higher rateof reappointment has helped to increasethe average duration of service bydirectors, from 3.9 years in 1997 to4.6 years in 2000. However, length ofservice still lags behind the private sectorwhere, according to the Conference Boardof Canada, directors serve an average of7.7 years.

18.49 Appointment decisions are not

timely. Crown corporations report that aserious problem impacting on boardcontinuity and stability is the length oftime it takes to decide on manyappointments. The amount of time fromthe date a director’s ten expires to thedate of reappointment or appointment of anew director is called the “expiredperiod.”

18.50 We examined 79 appointmentswhose terms had expired over the lastfive years. While in 2000 the averageexpired period was five months, in70 percent of the corporations in oursample it was longer than six months —

and longer than a year in half of them. Inone Crown corporation, 80 percent of thedirectors have continued in expiredpositions for over a year, and the chairposition is vacant.

18.51 Appointment terms areunevenly staggered. In 6 of the 15 Crowncorporations in our sample, the currentterms of more than 50 percent of the boarddirectors will expire in a single yearand as many as 80 percent in twocorporations. The £1.4 requires that as faras possible no more than 50 percent of aboard’s director positions should expire inany one year. Coupled with the slowprocess of deciding on appointments, thiskind of turnover leaves many boards withconsiderable uncertainty about their

composition. Expiry dates need to bestaggered evenly to ensure that continuityof expertise and corporate memory is notcompromised.

18.52 The government should decideon Crown corporation directorappointments on a timely basis, improvethe staggering of term expiry dates andincrease the length of service ofqualified directors.

Other factors affect board functioning

18.53 Past reports of the AuditorGeneral have observed that new directorswere not adequately briefed on theirduties. Despite some improvement, thesituation today is similar. Crowncorporations generally provide orientationsessions for new directors, and some urgetheir directors to attend external trainingsessions. However, there is a need fortraining in the director’s responsibilities tothe corporation, the corporation’srelationship with the government,compensation policies for Crowncorporation executives, and boardprocedures. There is a need toprofessionalize the role of directors, manyof whom have had no previous experienceon boards of any kind.

18.54 The government, with Crowncorporations, should ensure that newlyappointed directors are provided withadequate orientation and training intheir responsibilities to the corporation,the corporation’s relationship with thegovernment, compensation policies forCrown corporation executives, andboard procedures.

18.55 Senior government officials andsome Crown corporations have raisedquestions and concerns about theappointment of public servants,particularly deputy ministers of federalgovernment departments, to boards ofdirectors of Crown corporations. Theseappointments pose particular challengesfor the individuals as well as for theboards on which they serve. The TreasuryBoard guidelines point out that the




knowledge and expertise of deputyministers can assist the board in betterappreciating government policy. Similarly,participation as a member of the board ofdirectors improves the deputy minister’sunderstanding of the corporation. Crowncorporations have raised other issuesabout public servants on their boards ofdirectors, including attendance records(particularly for deputy ministers), aconcern that some boards include toomany public servants, and a practice bysome deputy ministers of periodicallysending a substitute to a board meeting.The deputy minister sits on the board notas a source of direction from the ministerbut with the same statutoiy obligations asother directors. Yet some corporationsreport that other directors sometimes deferto the deputy minister because theybelieve he or she is a direct spokespersonfor the government. Some are alsoconcerned about the potential for conflictbet’veen the individual’s dual roles asdirector and as deputy minister. It isin] portant that deputy ministers beparticularly sensitive to these issues. Therole and attendance of public servants onCrown corporation boards of directorsneeds ongoing, close monitoring.

Chair appointments often made withlimited board consultation

18.56 The chair of a Crown corporationacts as the formal link between theminister and the corporation. The chairmanages the affairs of the board ofdirectors and is not a part of thecorporation’s managen]ent.

18.57 Under the MA, the Governor inCouncil has the authority to appoint andfire the chair, and to fix the compensation.The Act also provides for the board toinfluence the appointment, through aprovision that requires the responsible0] mister to consult with it. The chairs,CEOs and directors we interviewed saidthat the board needs to play an active rolein the chair’s appointment, includingassessing board needs and profiling skills.

We expected to find that the governn]entconsulted n]eaningfully with the board asa whole.

18.58 Many of the corporations in oursample report that there has been lin]itedconsultation with the board, if any, on theselection and appointment of the chair.

18.59 The government should ensurethat it consults with boards of directorsof Crown corporations on chairselection aad appointment.

Appointment of the chief executiveofficer is a key factor in corporategovernance

18.60 The key to good management ofa corporation is the chief executive officer(CEO). The £1.1 gives the Governor inCouncil the authority to appoint and firethe CEO and to fix remuneration. The Actalso provides for the board to influencethe CEO’s appointn]ent, in requiring thatthe responsible minister consult with theboard. The board has the authority toevaluate the CEO’s perfonance.

18.61 The Treasury Board guidelineson corporate governance in Crowncorporations stress the importance of therelationship between the CEO and theboard:

In a Crown corporation, the nature ofthe relationship between the CEO andthe board is often critical. The boardmust work with the CEO to build arelationship of openness and trust....An in]portant aspect.. .is to establish aclear accountability relationship forthe CEO to the board....

18.62 In the private sector, thisaccountability relationship is achieved byvirtue of the board’s power to hire and firethe CEO and fix remuneration. Thosepowers are critical to good governance inany corporation. But some have pointed toan accountability dilemma iii Croxvncorporations. After far-reachingconsultation and research, the PublicPolicy Forun]’s 1998 study concluded,“The lack of hire, fire and pay powers

There must be a

clear accountability

relationship between

the CEO and the

board.




Many Crown

corporation CEOs are

quite candid in seeing

that their essential

accountability lies with

the government and

not with the board.

over the president deprives Crown boardsof the most powerful accountability leverexercised by private sector boards.” ThePublic Policy Forum report added thatmany Crown corporation CEOs do notfeel accountable to their boards. It said,“Many Crown presidents, while paying hpservice to the valuable advice they receivefrom their boards, are quite candid inseeing that their essential accountabilitylies with the government and particularlywith those at the centre of it.”

18.63 Research by the ConferenceBoard of Canada indicates that 90 percentof Crown corporations hold the vie’v thatboards must be involved in the finalselection of the CEO. This is perceived asthe most significant issue in Crowncorporation governance. Asked what onething they would change in the selectionand appointment process, Crowncorporations overwhelmingly said theywould increase the board’s involvement inthe selection of directors and the CEO.

18.64 In our view, the CEOappointmcnt process ought to be measuredby more than the strength of the CEOselected. The appointment also needs toreinforce the CEO’s accountabilityrelationship with the board, whilepreserving the appointment prerogative ofthe Governor in Council. For example, if astrong CEO is selected but the chair andthe board lack confidence in the processthat led to that selection, then the singlemost in portant relationship in thecorporation between the chair and theCEO can begin with doubts and a lackof trust.

search for the new CEO but also made theselection \vithout meaningful consultationand buy-in from the board and the chair.In effect, the corporation was told who theCEO would be.

“Centre searches” model. In thismodel, the government ran the CEOsearch and recruitment process, but madethe selection only after meaningfulconsultation with and buy-in from thechair as proxy for the board. The chairwas a member of the search committee,along with representatives of the PrivyCouncil Office (PCO), the PrimeMinister’s Office (PiMO) and theresponsible minister. The searchcommittee established the selectioncriteria, in some cases using the board’sinput, and conducted the interviews. Theboard had no direct role, but in some casesthe chair went back to the board for inputon the shortlist of candidates. The PMOadvertised the position and acceptedcandidates’ applications. The searchcommittee conducted the initial screeningof applicants. The PMO confirmed theselection of the candidate recommendedby the search committee.

“Board searches” model. Under thismodel, the Crown corporation led theCEO search process through either asearch committee or the board. The boardasked the PCO and the PMO to suggestany additional candidates, andrecommended a shortlist to thegovernment. Candidates were interviewedby the board and then by the minister. Thegovernment made the final selection ofthe CEO.

18.65 We noted the use of threedifferent models in recent appointments ofCEOs to Canada’s Crown corporations.The models varied in approach, as did theway each applied the requirement for“consultation with the board’’:

“Centre selects” model. Theidentil5’ing feature of this model was thatthe government not only controlled the

18.66 The literature and best practicesshow conclusively that active andindependent board governance leads tostronger corporate performance. When theboard has no meaningful involvement inthe selection of the CEO, problems ofaccountability can arise between them. Inmany industrialized countries, boards playa leading role in the search for their CEO,not just in private sector firms but in




state-owned enterprises that arecomparable with Crown corporations.

18.67 Our interviews with a sample ofchairs, CEOs and directors of the Crowncorporations involved in the three CEOappointment models we have describedconfirmed that they strongly andconsistently favour a greater role for theboard in the CEO search and selectionprocess. They rated the three appointmentmodels in terms of governanceeffective ness.

“Centre selects” model found leastfavour

18.68 The Crown corporation leaderswe interviewed, including (perhapssurprisingly) the CEOs themselves, ratedthe “centre selects” model the worst of thethree by far. It is also the model furthestfrom good governance practices. Chairsand directors whose CEO was selected bythe “centre selects” model saidunequivocally that the exclusion of theirchair and board members in the CEO’sselection had led to serious governance

problems.

18.69 CEOs selected by this processquickly understand that their trueaccountability is to the government andnot to their board. They acknowledge thatthey gain access and influence with thecentre of government when thegovernment alone drives the selectionprocess. However, this very accesscompromises the board’s capacity togovern. Lack of government consultationwith the board on the CEO selection oftenamounts to lack of buy-in and the creationof a rift between the board and the CEObefore he or she even takes office. Ourinterviews with Crown corporation leadersindicate that the CEO must perceive thatthe board has real power and is leading theselection process if the accountabilityrelationship between the CEO and thehoard is to be effective.

“Centre searches” model got mixedreviews

18.70 Some see the “centre searches” asthe new model for CEO selection.However, while board chairs and thegovernment viewed it favourably, wefound that CEOs and directors were lesssupportive. The model has some definitestrengths. The board chair is on the searchcommittee along with the other keyplayers the Prime Minister’s Office, theminister’s office, and the Privy CouncilOffice; the PCO and the PMO have solidexperience in carrying out a searchprocess. This model also helps to buildrelationships among the players.

18.71 The model has some fundamentalweaknesses, however. First, boarddirectors state that they have had nomeaningful involvement in the C EOsselection under this model. The Crowncorporation’s involvement through thechair as sole proxy, while an improvementover the “centre selects’ model, is stilllimited. This model does not effectivelyengage the board as a whole in the searchprocess. As a result, the board may be lesscommitted to the selected candidate.Second and this is key thecandidates see that the PCO. the PMO andthe minister’s office dominate the process:they advertise for candidates andcandidates respond to them. Third, threeof the four participants on the searchcommittee represent the government,giving it the balance of power in selectingthe candidate. Overall, the “centresearches” model does not go far enoughand we would view it as a transitionalmodel.

“Board searches” model seen as themost effective

18.72 The model rated the mosteffective by chairs, CEOs and directorswas the “board searches” model. Thatthey see it as supporting good governanceand a strong accountability relationshipbetween the board and the CEO is clearfrom the following comments:

CEOs, chairs and

directors see the

“board searches”

model as supporting

good governance.




The government needs

to move toward a

process in which the

Governor in Council

selects the CEO from

board-recommended

candidates.

It worked, it included all levels in theprocess....

If the board is to fulfil its mandate, itmust be given a major role in CEOrecruitment.

Excellent model not only in terms ofthe result but also for board buy-inand the support of the new CEO. Themost important role of a board is tohire, retain, evaluate and conipensatethe CEO ofien taken out of ourhands by the shareholder.

18.73 The “board searches” model isthe niost consistent with best practices incomparable organizations. Also, chairs,CEOs and directors have reported strongmutual trust and respect among allcorporate players and with the governmentwhen this model is used.

18.74 The enabling legislation of sonicCrown corporations includes a “boardsearches” model. It gives the corporationthe statutory authority to appoint the chiefexecutive officer, with the approval of theGovernor in Council.

A transition strategy may be necessary

18.75 It has been argued that at present,some Crown corporation boards are notstrong enough to conduct the search for aCEO along the lines of the “boardsearches” model. We recognize that manyboards lack key capabilities and, as aresult, difficulties have sometimesdeveloped when the board searches”model has been used. In our view, thesolution is for the government to movetoward a “board searches” model in whichthe Governor in Council selects the CEOfrom a slate of board-recommendedcandidates as the government undertakesto strengthen Crown corporation boards.

18.76 The move to a “board searches”model calls for a transitional strategy thatcould be adapted to meet the particularneeds of each Crown corporation. Theextent of government support andinvolvement or external expertise couldvary, depending on a board’s capability at

any given time; an interim approach couldbe used to involve the board more directlyas it develops the capacity to carry out a“board searches” model. For example, the“centre searches” model could be adaptedto include members of the board’s searchcommittee along with the chair andrepresentatives of the PMO, the PCO, andthe minister’s office. Or a committee ofthe board could interview and makerecommendations on a shortlist ofcandidates selected by the chair, the PMO,the PCO, and the minister’srepresentative. In addition, boards mayrequire some training in how to conductan effective CEO search process.

18.77 The government remainsultimately accountable for theperformance of a Crown corporation, andthe MA gives the Governor in Council theauthority to appoint, fire and reniuneratethe CEO. None of this changes with a“board searches” model; the differencelies in who is seen by candidates and thecorporation to be leading the process. Thegovernment would need to work closelywith the corporation and remain directlyinvolved at each stage of the process,contributing selection criteria, forinstance, and suggesting potentialcandidates.

18.78 The board of directors of aCrown corporation, in directconsultation with the ministei thePrime Minister’s Office and the PrivyCouncil Office, should lead the processof selecting the corporation’s chiefexecutive officer for approval by theGovernor in Council. A transitionstrategy should be used where a boarddoes not yet have the capability to carryout this approach.

18.79 In each case, the responsibleminister, the Crown corporation, thePrime Minister’s Office and the PrivyConncil Office shonld reach annnderstanding on the respective roles ofthe board and the government inselecting and appointing the CEO.




Importance of the AuditCommittee

18.80 The audit committee is a corecommittee of a corporation’s board ofdirectors. It represents the engine” of awell-functioning board. Given the rapidlyincreasing scope and importance of itsrole, the audit committee’s effectiveness isattracting greater attention in thecorporate world.

18.81 An audit committee that operateseffectively can bring significant benefitsto the corporation. It can help to:

• improve the quality of financialreporting;

• ensure that key corporate risks areidentified and managed adequately;

• strengthen the internal auditfunction;

• enable the directors to contributetheir independent judgment and pl a’ apositive role in overseeing thecorporations business operations;

• facilitate better communicationamong management, directors and internaland external auditors;

• reinforce the independence of theinternal and external auditors;

• create a climate of discipline andcontrol that will reduce the opportunity forfraud;

• increase stakeholder confidence inthe credibility and objectivity of corporateperformance reports; and

• obtain greater assurance that assetsare protected and resources are managedeconomically, efficiently and effectively.

18.82 The EN specifically chargeseach parent Crown corporation toestablish an audit committee. Thecommittee’s legislated responsibilities areto oversee internal audit; review andadvise the board of directors on the

financial statements, the annual auditor’sreport and the special examination planand report; and perform other functionsdelegated to it by the board. However, theaudit committee usually assumesoversight responsibilities well beyondthese duties. It is expected to oversee themanagement of a wide range of financialand non-financial risks that affect thecorporation.

18.83 We looked at the perfoniiance of14 Crown corporation audit committees.We compared their practices with a dozenrecognized best practices (seeExhibit 18.2), to provide a basis for futureself-assessment and to identify potentialfor improvement in their performance. Weused a combination of document reviewand our own observations to assess theireffectiveness, given that the AuditorGeneral is the statutory auditor of mostCrown corporations (the complete list ofbest practices is provided in AppendiN D).

18.84 We expected that auditcommittees would have the appropriateskills and experience to carry out theirrole and their duties effectively. Becausethe best practices we selected forcomparison are viewed as key practicesand are consistent with existing ENrequirements, we expected that Crowncorporations would be using many ofthem. However, this is not what we found.

Half of the audit committees wereoperating below an effective level

18.85 Half of the audit coninuttees weexamined were considered ineffective oronly marginally effective. Of the14 committees, we found that:

• only one followed most of the bestpractices and was performing effectively;

• six followed many of the bestpractices and were reasonably effective;

• five others used only some of thebest practices and were only marginallyeffective; and

An audit committee

that operates

effectively can bring

significant benefits to

the corporation.

Half of the audit

committees we

examined were

considered ineffective

or only marginally

effective.




Exhibit 18.2 Audit Committee Responsibilities

The audit committee should ensure financial oversi2ht by:Selected Best Practicesfor Audit Committees • critically reviewing the interim and annual financial statements, the atiditor s report and the

management discussion and analysis section of (lie annual report: and

actively soliciting the external auditors judgments about not only the acceptability but the qualityof the corporation’s accounting principles as applied in its financial reporting. This discussionshould include such issues as the clarity of financial disclosure and the aggressiveness orconservatism of the corporations accotmuting principles and estiinatcs

The audit committee shotild ensure oversight of corporate books, records, financial atid ruanagenientcontrol and information systems, and management practices by:

• re’ ie”-ing the special examination plan and report prepared in the external examiner;

• actixelv soliciting information about significant risks and exposures and reviewing the adequacyof internal controls to manage those risks:

• reviewing the integrity and effectiveness of the management infonnation systems;

• reviewing internal audit plans and repons and management’s subsequent actions: and

• reviewing significant findings and recotnnsendations made by the eienml auditor and examinerand following tip on managements stibsequeni actions.

The audit committee shotild:

• enstire ethical oversight throtmgh the annual review of management’s cotnpl lance tth thecorporate code of condtict. and

• actively solicit all sensiti’e in formation t for example. senior management expenses, significantlitigation. non-comphance with laws and regtilations. misuse of corporate assets, illegalactivities).

Membership and Competencies

The atidit cotnininee should be composed ofat least three directors, the niajority of hom should nothe officers or employees of the corporation.

Althotmgh a variety of skills and experience is beneficial to an effectm’e and balanced auditcommittee, all members should be financially’ literate and at least one member should haveaccounting or related financial management expertise. Financial ‘‘literacy” signifies (lie ability toread and tmnderstand fundamental financial statements. incltidine a balance sheet, mmtcome statemetmtand cash flow statement, and the ability to ask probing qtmestiomis about the corporation’s futancialrisks and accotmating. ‘Expertise” signifies past enmplonient experience in finance or accotmnting.requisite professional certification in accouitting, or alty ocher comparable expericilce or hackgroundthat restmlts in the indivmdtmal’s financial sophistication (experience as a cluef executive officer tCEOI.for example. or other senior officer n tIm financial o’ ersight responsibilitiest

Operating Procedures

Ternis of reference. Atidit committees shotild have clear. writlen tenns of reference and operattngprocedures that specify the scope of the committee’s rcsponsibilities and how it carnes them out,including its stRicture, processes, and membership reqturements

iteeti ngs. The fteqtmency of audit committee meetings shout d he tailored 10 he responsibilitiesassigned, but should be at least quarterly. The audit committee should also meet periodically withmanagement, the external atiditor and the head of internal audit, in separate private sessions.




two were ineffective, despite using

some of the best practices.

The results demonstrate that the more bestpractices an audit committee uses, themore effective it is likely to be.

Key gaps in practices

18.86 Financial literacy andaccounting expertise. The compeienciesand experiences of its members are animportant factor in the audit committee’seffectiveness. Our assessment raised soniciniportant concerns:

• There were three audit committeesw itli at least one me m her who was notfinancially literate, and on one auditcommittee most members were notfinancially literate. Best practicerecommends all mciii hers have the abi I itvto read and understand fundantenialfinancial statements and the ability to askprobing questions about the corporation’sfinancial risks and accounting.

• Two audit committees had nomembers with any accotruting or financialmanagement expertise. Best practicerecommends at least one member haveprofessional certifrcation in accounting. orexperience that leads to financialsophistication employment as a CEOor senior financial officer, for example.

18.87 Financial oversightresponsibilities. A review of committeeminutes indicated that audit committeesgenerally follow only some of the bestpractices for ensuring financial oversight.Only two audit coniriiittees werefollowing most of die best practices.including performing a critical review ofinterim and annual financial statementsarid the managenienrt discussion andanalysis section of the annual report,soliciting the external auditor’s views onthe quality of the corporation’s accountingprinciples, reviewing the externalauditor’s significant findings andrecommendations, and following up oncorrective action by management.

18.88 Crown corporation auditcommittees generally revie\v internalattdit plans and reports and the actiontaken in response to them by management.However, only three audit committees welooked at considered the integrity andeffectiveness of management informationsystems. through brief discussion ofcorporate performance indicators.

18.89 Operating procedures. Theeffectiveness of its communications withmanagement and ‘\ ith the internal andexternal auditors is a factor in theeffectiveness of the audit committee itselfBest practices include periodic privatemeetings with the auditors to give theaudit committee a degree of independencefrom management and a furtheropportunity to freely ask probingquestions. Only four of the auditcommittees were holding private sessionswith the external auditor. and these variedin freqtrency.

18.90 The audit committee of eachCrown corporation should assess theextent to which it follows recognizedbest practices in order to identify areasthat need improvement, and should takeappropriate corrective action asnecessary. It should seek input to thisassessment from the internal auditgroup and the external auditor’.

Approving Corporate Plans andEnsuring Mandate Relevance

The corporate plan is the cornerstone ofthe control arid accountabilityIra Inewo rl

18.91 The Crown corporation has a keyrole i ri i nterpreti rig the mandate set out inits enabling legislation. The board ofdirectors oversees the determination of thecorporation’s core business and activities,its objectives for a five-year period arid itsstrategy for achieving them, and theindicators and targets it will use tomeasure success. It must determine how itwill balance its commercial objectives

The Crown corporation

has a key role in

interpreting its

mandate.

Report of the Auditor General of Canada — December 2000 I 8—2 I



The deficiencies in

corporate plans

undermine Crown

corporation

accountability.

with its public policy objectives, and thetrade-offs required to achieve that balance.For example, a corporation may need tostrike a balance between services that areneeded but will not produce profit andservices that are targeted morecommercially and generate profit. Thecorporation also needs to consider how itcan contribute to government prioritiesand initiatives while still ensuring that itsactivities are consistent with its mandate.It must address all of these issues in acorporate plan that the £1.1 requires it toproduce. Government approval of thatplan is required for Crown corporationsunder Part X of the 24.1. The corporateplan is the cornerstone of the control andaccountability framework for Crowncorporations. Where the governmentwishes to provide specific direction to acorporation, it may do so by directivepowers under the F-N, subject to certainstatutory I imitations.

18.92 The government is required toreview the corporate plan beforeapproving it in order to ensure that eachCrown corporation’s strategy maximizesthe achievement of its mandate. Weexpected that the government’s revie’vand challenge would be rigorous, askingquestions like the following:

• I-las the corporation properlyinterpreted its niandate?

• Are the corporation’s objectives,strategies and targets appropriate and doits perfonnance indicators provide astrong basis for holding it to account?

• Are the trade-offs the corporation hasmade bet\veen its commercial objectivesand its public policy objectivesreasonable?

• Do its performance targetssufficiently “stretch” the corporation?

• Has the plan taken governmentpriorities into account?

• Is the corporation capitalizedappropriately, and are targets for dividendsand return on equity appropriate?

• Has the corporation met its pastperformance targets?

• Is there a need to assess whether thecorporation’s mandate is still relevant?

Many deficient corporate plans areapproved, and the government haslimited capacity to challenge them

18.93 Our special examinations havefound that there are significantdeficiencies in some 38 percent ofgovernment-approved corporate plans, andless serious problems in a further28 percent. Problems include any or all ofthe following:

• absence of long-term plans;

• unclear or non-existent corporateobjectives, targets, goals and businessstrategies, as well as weak action plans;and

• little information by vh i ch to judgewhether the corporation is achieving itsobjectives.

18.94 These weaknesses undermine thecorporate plan as a basis for ensuring thatperformance and accountability aremaximized and the government’sobjectives taken into account. They alsoindicate that the government’s process forapproving corporate plans is deficient inchallenging Croxvn corporations toachieve optimal performance.

18.95 Crown corporation chairs andCEOs advised us that the governmentgave them little or no feedback on theircorporate plans. They commented, “It wasnot always clear what the shareholderexpected from its Crown corporations It\vas too often a one—way street, withCrown corporations always feeding thesystem about what they were doing, butnot hearing back from the shareholderabout what they ought to be doing.” ThePublic Policy Fornm’s 1998 report echoed




that conclusion, noting, “There is littlediscussion about these corporate plans,and the plans themselves become more

ritualistic than real in addressing thechallenges and choices facing Crowncorporations”

18.96 To determine why these problemsexist. we looked at whether thegovernrn ent (responsible minister,Treasury Board and Department ofFinance) has the capacity for rigorousreview and challenge of corporate plans asa basis for their approval.

18.97 Minister’s review. Theresponsible ni mister provides the firstgovernment review of a corporate plan.\Ve found that many corporations receive

little or no feedback on their corporateplan from their responsible minister. YetTreasury Board guidelines say that theannual submission of the plan is meant tobe a regular medium for the board and theresponsible minister to clan ft theirrespective appreciation of (liecorporation’s objectives. Generally.ministers have not responded formally tothe corporate plan with an indication ofareas of agreement as tell as differences.The lack of formal communication is lesstroublesome when there is ongoingdiscussion bet een the minister and theCrown corporation. Half of thecorporations we examined had a regularongoing relationship n ith the ministerHowever, the other half sm their niinisterrarely, if ever, even when they requested ameeting and even v lien there n crclong-standing, unresolved issues.

18.98 Crown corporations themselvescould do more to he aware of thegovernment’s concerns and priorities. Forexample, they could strengthen contactswith deputy in in i sters, in in isterial staff orother officials to seek a bettertinderstandi ng of the govern me nt’sobjectives.

18.99 The government could also domore. The government itself hasacknowledged the need to iniprove

communication. Government policypositions developed in 1982 stated:

To improve communication, thegovernment tvi II institutionalize theconcept of an anntLal shareholder’smeeting. Annually, each Minister astrtislee owner, will meet with boardsof directors to formally revie\vcorporate performance and tocommunicate specific government

objectives to the board. This will notimpede informal communication

between the appropriate Minister andthe corporation, but will underline theNi in ister ‘s responsibility to ensurethat the chairman and board ofdirectors of the corporation are keptfulls informed of governmentobjectives and that the boardsaccountability to the government ismaintained (Treasury Board ofCanada. Policy Statement,30 June 1982).

18.100 To properly exercise his or herresponsibilities for a Crown corporation.the responsible minister must be able toobtain and rely on the relateddepartment’s advice. Government policypositions in 1982 also stated:

To enhance its shareholder capabilitythe government wil I improve orestablish, where appropriate.machinery to assist N-I in isters withprimary responsibility for whollyowned corporations. What is neededis.. the establishment of effectivesupport for Ministers ‘‘‘to provideneeded direction. control andaccountability The government “-illseek to ensure that appropriateprocedures and mechanisms exist toco-ordinate review and approval ofcorporate submissions, in order thatthe government might respond to suchsubmissions in a thorough and timelymanlier peciahized units havebeen, or now will be, established toassist Ministers in the performance oftrustee shareholder or proprietorduties, Such units will have a directreporting link to the Minister and hisor her Deptity Minister. Thesearrangements will be developed toensure that effective communication

Many Crown

corporations receive

little or no feedback on

their corporate plans

from their responsible

minister.

Report of the Auditor General of Canada — December 2000 18—2 3



Review by the

Treasury Board and

the Department of

Finance is key to

approving corporate

plans.

between appropriate Ministers andcorporate boards is maintained orenhanced (Treasury Board of Canada.Policy Statement, 30 June 1982).

18.101 We found that many departmentslack the capacity to support ministers intheir responsibilities for Crowncorporations. Policy groups indepartments have played only a limitedrole, for various reasons. [n sonic cases,

the activities of the department and thoseof the corporation share little or nocommon ground. Some Crown

corporations reported that departmentslack knowledge about the commercialdimension of Crown corporations.

18.102 Portfolio management representsthe go ernments most recent effort toincrease departmental capacity in thisarea. The minister is asked to ensure thatall organizations under his or her authoritywork together to support the minister andthe government’s policies and programs.The Privy Council Office’s Advice toMinisters on Portfolio Managementstresses that portfolio management mustcontinue to respect the arm’s-lengthrelationship bet” een a Crown corporationand its responsible minister, thecorporations purpose as an instrument of

public polic. and in some cases, theabilit of the corporation to compete inthe marketplace.

18.103 \\e found that portfoliomanagement groups have generally notbeen active in supporting the iii inisters’

challenge and review of corporate plans.Only one of the portfolio management

groups has advised the minister onwhether or not to approve corporate plans.

18.104 Portfolio management groupsneed to be sensitive to and respect theindependence and autonomy of the boardof directors in overseeing the managementof Crown corporations. Their commentson corporate plans need to be at a strategiclevel.

18.105 At the same time, we saw somegood practices that could be applied morehroadl’,, as Exhibit 18.3 shows.

18.106 Reiiew by Treasury Board andDepartment of Finance. After reviewingthe corporate plan, the ministerrecommends it to the Treasury board forappro al: the Department of Finance alsoreviews it. if necessary. The Treasur’Board looks at the sirategic direction ofeach Crown corporation and the financialdecisions or recommendations proposedby the responsible minister. Ii alsoapproves the capital budget. certaintransactions, and for most corporations.the operating budger The Minister ofFinance is responsible for the terms andconditions of borrowing plans and fordirecting that any surplus nion cv held by acorporatioti he paid into the ConsolidatedReven ire Fund. ‘vi th the concurrence ofthe responsible minister arid the Governorin Council.

18.107 We found that sonic TreasuryBoard Secretariat analysts havechallenged Crc” n corporations to setmore demanding objectives and targets.and this has produced better plans.Generally. however. Crown corporations

Exhibit 18.3

Good Practices From PortfolioManagement Groups

• Some have regular meetings of tIm deputy minister and chief executive officers (CEOs), aridthe minister and chairs or CEOs, to discuss common issnres arid obiecirves.

• One minister wrote tetters to a corporation about government priorities

• One portfolio management group reviewed draft corporate ptans. gave coniirncnts to thecorporations and advised the minister on whether to recommend approvat of the corporateplans. This group is considering tIm possibility ofinrrodrrcing a written response to corporateplans from the minister and an appointment tetter to newly appointed chairs, indicating thegoveninient’s priorities,




report that Treasury Board Secretariatanalysts often pay too little attention tomajor strategic issues and too much tominor issues related to funding. Crowncorporations also report that someSecretariat analysts have lacked anunderstanding of the corporation and thecommercial environment in which itoperates, and did not know how to readfinancial statements. \Ve noted that anumber of the analysts are at junior levelsand many have had no previousexperience with Crown corporations.Treasur3 Board officials advise thatresource reductions due to ProgramReview, and a less focussed specializationin Crown corporations. may havecontributed to this situation. While theTreasury Board and the Department ofFinance have promoted a team approach.it is not clear which one is assessing thecapital structure of the large financialcorporations neither undertakes that roles’ stem atical ly . In light of the structuralchanges within the Treasury BoardSecretariat and Finance and theintroduction of portfolio management.there is a need to ensure that all thegovernment pla\ ers understand theirrespective roles and responsibilities inreviewing and challenging corporateplans.

18.108 Crown corporations should bemore proactive in finding ways to obtaininformation on government prioritiesand the government’s response to theircorporate plans.

18.109 To align expectations, eachcorporation and the responsibleminister should teach an understandingon the most effective ways to outlinepriorities, provide feedback and reachconsensus on corporate plansubmissions and to maintain ongoingcontact between them.

18.110 The government shouldstrengthen its capacity to ensure that itsapproval of corporate plans is based ona rigorous challenge and review. It

should strengthen departmentalcapacity to support ministers in theirresponsibilities for Crown corporations,and should ensure that all governmentplnyers understand their respectiveroles and responsibilities in approvingcorporate plans.

Need for a more systematic review ofcorporation mandates

18.111 Periodically, there is a need toconsider whether the mandate of a Crowncorporation is still relevant. We found thatin reviewing corporate plans. TreasuryBoard Secretariat analysts have sometimescommented on this. In other cases achange in government or minister, asignificant change in the economy, or aCronn corporation’s request for alegislative change can prompt a review ofmandate relevance. Boards of directorsclearly have an interest in mandaterelevance because the mandate affects thechoice of strategic direction and thedevelopment of the corporate plan. In allcases, the mandate review is afundamental assessment of the continuingrelevance of a Crown corporation’s role.Such reviews generally go well beyondthe scope of the annual corporate plan andare vital for ensuring that the corporationremains a cost-effective instrument ofpublic policy.

18.1 I 2 A decision to proceed with amandate review needs to be based on suchfactors as an ongoing assessment ofchanges in the operating environment; anexpressed need to make changes; a requestby the corporation for a mandate reviewor for legislative amendments that affectthe corporation’s mandate; or anunresolved conflict related to the mandatethat is holding up the shareholder’sapproval of the corporate plan.

18.113 We expected to find that mandatereviews are carried out regularly, reportedto all parties in the accountabilityframework, and engage all partiesconcerned, including Parliament. What wefound however, is that only two

Periodically, there is a

need to consider

whether the mandate

is still relevant.

Report of the Auditor General of Canada — December 2000 18—2 5



corporations are required by theirrespective enabling legislation to undergoperiodic mandate reviews.

18.114 We found that mandate reviewshave been carried out by a corporation orthe responsible minister’s department on agenerally ad hoc basis. Those done by thecorporation were not always brought tothe attention of the Treasury Board, theminister, or Parliament; nor did theyengage all of the parties concerned,including Parliament, or address all of therelevant issues. Mandate reviews led bythe minister, and supported by outsideexpertise as necessary, have a betterrecord of engaging all parties and bringingout issues that may not be identified in areview conducted by the corporationitself. We note that a legislative provisionfor mandate review ensured that it wascarried out when otherwise it might nothave been.

18.115 We noted that someparliamentary committees have heldhearings on the relevance of Crowncorporation mandates. In one case, aparliamentary committee had a majorimpact on the corporation’s move towardproviding more service to a group that is agovernment priority. Generally, however,Parliament has little direct involvementwith Crown corporations. It could takemore opportunity to meet with Crowncorporations and have them account fortheir results.

18.116 The government could considerthe following guidelines for conductingmandate revie’vs:

• Each review assesses the currentvalidity of the mandate, the continuingneed for the corporation, and its record ofcost-effective performance in meeting theneeds implicit in the mandate.

• Mandate reviews are led by theminister and supported by outsideexpertise as necessary.

• The corporation provides input to theminister-led review, but does not conductit or contract a third party to undertake it.

• The minister, in consultation with thecorporation and central agencies.determines the terms of reference for thereview with a focus on the criticalelements of the mandate. It may beappropriate to limit the scope of somereviews to particular aspects of themandate.

• Any third party contracted toconduct the review consults extensivelywith all parties concerned, inside andoutside government.

• The results of mandate reviews areshared with all parties in theaccountability framework corporatemanagement, the board, Treasury Board,the Department of Finance, theresponsible minister and Parliament.

• Parliament conducts hearings on theresults of mandate revie’vs, as appropriate.

18.117 The government shouldsystematically consider, at least every10 years, whether a review of eachCrown corporation’s mandate iswarranted. This should be triggered hyregulation or some other mechanism.The government should developguidelines for conducting mandatereviews, and should ensure that theresults of the mandate reviews aretransparent and reported to all partiesin the accountability framework.

Governance Protocol BetweenMinisters and Crown Corporations

18.118 In previous sections of thischapter we have cited the need fordialogue to reach an understandingbetween each Crown corporation and theresponsible minister on theimplementation of key aspects ofgovernance, including:

• how the board of directors will beinvolved in the appointment of the board,the chair and the CEO;




• how the government xviI Icommunicate any issues it wants a Crowncorporation to take into account in itscorporate plan;

• mechanisms for ministerial feedbackon the corporate plan; and

• procedures for handling ad hocissues and maintaining ongoing contactbetween ministers and corporations.

18.119 In addition, the dialogue couldcover elements such as:

• expectations for performancemonitoring;

• performance evaluations of boardsand CEOs and their remuneration; and

• potential conflicts of interest.

18.120 Each ni in ister ‘s situation isunique, and strategies need to reflect theminister’s needs and demands as well asthe needs of the corporation. Each timethere is a change of minister or a newchair is to be appointed, the agreementwould be reconsidered and reviewed. Thekey to success for both parties would bemanaging expectations. As a means ofconfiniiing the agreement, the chair of thecorporation could record his or herunderstanding of the agreement in writingand the minister could outline theagreement in a letter upon the chair’sappointment. The agreement thusdocumented would constitute agovernance protocol. Prospective newboard members would be given a copy ofthe protocol. A protocol that gave theboard a meaningful role would help attractstrong board members. and this wouldserve the interests of both the corporationand the government.

18.121 Each Crown corporation andthe responsible minister should reach acommon understanding on theimplementation of key aspects ofgovernance, and they should record thatunderstanding.

Conclusion

18.122 The management of Crowncorporations has improved in the 15 yearssince the Financial ri thninislralion .1 ctwas amended to introduce a strengthenedCrown corporation accountability regime.The results of our special examinationsbear this out. Nevertheless, furtherimprovement is needed in some importantareas of Crown corporation managementlike strategic and corporate planning andthe measurement and reporting ofperformance.

18.123 Our findings on the process forappointing boards of directors convergewith those of other studies to confirm thatthere is a need for the federal governmentto revisit and strengthen the process.Boards of directors are responsible for theaffairs of the corporation. Yet boards lackessential skills and capabilities that arerequired to effectively carry out their role.The government needs to meaningfullyinvolve boards in their renewal. Boardsand the government need to outline theirrespective skill and capabilityrequirements, and the government needsto act on them. Boards of directors alsoneed to take a more active role in theirchairs’ selection.

18.124 The government needs toimprove the timeliness of its appointmentdecisions and maintain its progress inextending the average length of timeserved by qualified directors. This willensure a nucleus of seasoned directorswho can provide institutional knowledgeand experience.

18.125 We found that accountability ofthe chief executive officer to the board isbest reinforced when the board takes thelead role in the CEOs selection, with thegovernment providing input and makingthe final decision. A transition strategymay be needed to reach this goal for someboards that do not yet have the capacity tolead the selection process.

A governance protocol

that gave the board a

meaningful role would

help attract strong

board members.




18.126 The effectiveness of auditcommittees is assuming ever-greaterimportance. We found that the practices ofaudit committees need to be strengthenedif they are to more effectively dischargetheir key roles and responsibilities inCrown corporation governance and thefinancial reporting process. Astrengthened audit committee will mean astronger board of directors.

18.127 The corporate plan is thecornerstone of Ihe control andaccotintabilitv framework for Crowncorporations. We found deficiencies inmany government-approved corporateplans. and a limited capacity ingovernment to review and challenge thoseplans as a basis for their approval. Theseweaknesses undeniine the corporate planas a basis for ensuring that performanceand accountability are optimized and thatthe government’s priorities have beenaddressed.

18.128 Periodically, there is a need toverify whether the mandate of a Crowncorporation is still relevant. Mandatere\ iew s are the standard tool for this.They have proved useful in realigningCrown corporation mandates. We found.hon ever. that the need for mandatereviews needs lo he questioned moreregularly, the results more ‘videlrepoiled. and the reviews led by thegovern men?. n ilh the involvement ofParliam en?.

18.129 There is a need for dialogue andconsensus het’s een each Crowncorporation and the responsible minister011 how each party will be engaged iniiiiplenienting key aspects of governance.The board of directors of each Crowncorporation and the responsible ministericed to document their sharedunderstanding of how these key aspects ofgovernance will be implemented, therebycreating a governance protocol.

tS.t3O We plan to follow up withintwo years on the recommendations wehave made iii this chapter, including those

on the quality and composition of boardsof directors. We vili also reviev theprogress made on the recommendations aswe conduct our annual audits and specialexaminations in individual Crowncorporations.

Pr/ti’ Council Office’s response: Goodcorporate governance is essential i/a

en corpot ‘at ion is to /i il_/Il its mandate.lie government has made strides in atuonher of corporate governance areas.ii ic/tiding iinprol ‘ing reappo in tn tentstatrs tics (64 percent of’ inciunbentseligible for reappointment are reappointedas directors for a second or third tell,?)and ensuring that appointments reflectCanada :ç diversitt:

Jinpro yea and inc,’eased comm unicationamong all the interested partners still be acritical ulictor in addressing cam teemsidentified in the studi and in respondingto the recommendations pitt fomis’amzJ.tfeasures it-ill be examined to addressareas needing iniprovemnent and toiiitunatelt’ stm’engthen corporategovernance in Croi,’n co’po’’ations

It is paramn ottilt that appoil it,nents toCrrni’n corporations result in strongboards of directors and that theappaintment process/or O’ou’ncorporations is /ncltmcive of all interestedpam-ties’. hearing in In imid that appo intn tentsto hoards of directors of (‘lint n

corpom’ations. including those of the chairand the chief executive of/Ice,: remain at

the discretion of the government

Crow,, corporations responses: [t is notpractical to obtain the responses of41 Crown corporations to therecommendations that app to themdirectly. However, we did discuss ourfindings and recommendations with thechairs and CEOs of 10 Crowncorporations. Generally, they supportedthe main messages of the chapter and, forthe most part, agreed with therecommendations directed specifically atCrown corporations.




About the Audit

Objectives

The audit sought to assess how wet] three key governance features of the Financial Administration Act (P14)are functioning in Crown corporations. These include the appointment process for directors, CEOs and chairs;the capacity of the government to review and challenge corporate plans and ensure mandate relevance; andthe composition, roles and responsibilities and performance of audit committees.

In addition, we wanted to provide a summary of the results of the three cycles of special examinations inCrown corporations.

Scope

The audit scope included a review of the key responsibility and accountability provisions of Part X of the P1:1and parallel provisions in the enabling legislation of Crown corporations exempted from Part X. We examinedthe practices of these Crown corporations and the various shareholder players to support the process forappointing directors, chief executive officers (CEOs) and chairs, to review and challenge corporate plans, andto ensure mandate relevance.

We compared these practices with standards and practices of state-owned enterprises in industrializedcountries. In addition, we interviewed chairs and CEOs, and examined appointment data from 15 diverseCrown corporations. We also examined the composition, roles and performance of audit committees in thesame sample. We further examined recent chair, CEO and director appointments in eight corporations. Weused the results of other research, studies, audits and roundtables to provide supporting evidence for ourfindings. All recommendations were made within the parameters of the existing EL-I accountability andcontrol framework, and respected the Governor-in-Council authority for appointments.

The chapter also provides a surnmaiy of the results of the third cycle of special examinations. Specialexaminations are a form of value-for-money audit carried out in Crown corporations.

Criteria

The following general audit criteria were applied. We expected that in order to protect the shareholder’sinterest, to ensure that Crown corporations achieve their public policy objectives effectively and efficiently,and to optimize their commercial objectives:

• There should be timely appointments of qualified board chairs, CEOs and board directors that meet therequirements of the government and the corporation and strengthen the accountability relationshipsamong the board, the CEO and the government.

• Audit committees should be constituted with appropriate skills and experience, carry out necessary rolesand responsibilities, and perform their duties effectively, as measured against best practices.

• The government should conduct a robust review and challenge of a corporation’s corporate plan, as thebasis for the plan’s approval.

• There should be assurance that the mandate of each corporation, including its public policy and financialobjectives, continues to be relevant.




Audit Team

Assistant Auditor General: John WiersernaPrincipal: Brian StromDirector: Rona Shaffran

Denis Scott

Marc SeguinSophia Khan

For information, please contact Rona Shaifran.




Appendix A

List of Crown Corporations by Responsible Minister

Minister Responsible for Crown Corporation

Agriculture and Agri-Food Canada Canadian Dairy CommissionFarm Credit Corporation

Canadian Heritage Canada Council*

Canadian Broadcasting CorporationCanadian Film Development Corporation*

Canadian Mu scum of Civil isationCanadian Museum of NatureCanadian Race Relations Foundation*

National Arts Centre Corporation*

National Capital CommissionNational Gallery of CanadaNational Museum of Science and Technology Corporation

Department of Finance Bank of Canada*

Canada Deposit Insurance CorporationCanada Development Investment CorporationCPP Investment Board*

Petro-Canada Limited

Fisheries and Oceans Freshwater Fish Marketing Corporation

Foreign Affairs International Development Research CentreS

International Trade Canadian Commercial CorporationExport Development Corporation

Industry Canada Business Development Bank of CanadaEnterprise Cape Breton Corporation

-

Standards Council of Canada

Natural Resources Canada Atomic Energy of Canada LimitedCape Breton Development Corporation

Public Works and Government Services Canada Canada Lands Company LimitedCanada Mortgage and Housing CorporationCanada Post CorporationDefence Construction (1951) LimitedQueens Quay \Vest Land CorporationRoyal Canadian Mint

Trans part Canada At antic Pi lotage AuthorityFederal Bridge Corporation Ltd., TheGreat Lakes Pilotage AuthorityLaurentian Pilotage AuthorityMarine Atlantic Inc.Pacific Pilotage AuthorityRidley Terminals Inc.VIA Rail Canada Inc.

Treasury Board Public Sector Pension Investment Board5* Excmpt fro in the acco ii ‘tab’ I tv lam cu o uk of the Financial Ad,nu,isoatio,, Ac!.




Appendix B

Roles and Responsibilities Under the Financial Administration Act

Crown Corporation - Shareholder

TreasuryChief Board, FinanceExecutive and PrivyOfficer (CEO)! Responsible Council Office Governor inManagement Board Minister (PCO) Council Parliament

Creation, Acquisition. Disposal arid Dissolution

Parents Recommends Review Approves

Subsidiaries Recommends Review Approves

Appointments

CEO and Provides Consults Appoints

Chair advice

Other Appoints ApprovesD irectois

Officers of Recommends AppointsCorporation

Remuneration and Other Benefits for Chairs, CEOs and Directors

Remuneration Approves Approves theand Benefits benefits other rate of

than remunerationremuneration and CEOand performancerecomm ends pa>’CEOperfonii an ccpay

Directives and Regulations

Directives Recommends Approves Receivesand tablescopy withParliament

Regulations Requests Recommends Recommend

- -

Approves

Plaits, Budgets and Reports

Corporate Plan Prepares Approves Receives and Review and Approvessubtu iss ion to recoin mends recommendMinister

Opetating Prepares Approves Receives and AppioveBudget submission to recommends

Minister

Capital Budget Prepares Approves Receives and Approvesubmission to recommendsMinister




Crown Corporation Shareholder

TreasuryChief Board, FinanceExecutive and PrivyOfficer (CEO)/ Responsible Council Office Governor inManagement Board Minister (PCO) Council Parliament

Plans, Budgets and Reports (cont’d)

Summary of Prepares Approves Approves and ReceivesCorporate submission to tables copyPlan/Budgets NI mister with

Parliament

Annual Report Prepares Approves and Receives and Receive Receivessubnuts to tables copyMinister with

Parlianient

Audits

Internal Audit Manages Approves auditplans andreceives auditrepo rts

Annual Receives Receives Receives May requireAuditors other reportsReport

Special Receives May receive May receiveExaminationReport




Appendix C

General Information on Special Examinations and Overview of Results

What are special examinations?

A special examination is a type of value-for-money audit of a Crown corporation. It serves to provide an independentopinion to the board of directors on whether the corporation’s financial and management control and infonriationsystems and management practices have been maintained so as to provide reasonable assurance that:

• the assets of the corporation have been safeguarded and controlled:

• the financial, human and physical resources of the corporation have been managed economically and efficiently;and

• the operations of the corporation have been carried out effectively.

Examining all systems and practices in detail is impractical and costly. Therefore, based on a thorough understandingof the corporation and its operating environment, and on a risk analysis, the examination concentrates on areas of thecorporation where any deficiencies that might exist could be significant.

All parent Crown corporations named in Schedule Ill of Part X of the Financial Administration Act (Eli), and theirwholly owned subsidiaries, are subject to special examinations. Crown corporations undergo a special examinationevery five years. The first five-year cycle of special examinations was conducted between 1984 and 1990. and thesecond between 1990 and 1996. The third cycle of examinations commenced in 1996 and will be completed by 2001.

How ninny Crown corporations are snbject to special examinations?

Thirty—nine Crown corporations were subject to a special examination during the third cycle. The Office has carriedout 29 of 31 examinations to date (two as joint examiner), while private sector practitioners have conducted 8. Theresults discussed hereunder are based only on the examinations carried out by the Office of the Auditor General.

Onr special examination findings indicate that management of Crown corporations is improving. Nevertheless,there are important areas that continne to require further improvement.

lypes of opinions reported

The following table sets out the types of opinions reported in all three cycles of special examinations (SE5). A cleanopinion” indicates that no significant deficiencies were reported. “Significant deficiencies” indicate one or moreinstances where there wasn’t reasonable assurance that assets were being safeguarded and controlled, resourcesmanaged efficiently and econoniically, or operations carried out effectively.

I’ Cycle — 2nd Cycle — .J 3rd Cycle —

Type of Opinion 26 SEs 32 SEs 29 SEs

Clean opinion 23% 22% 52%

Significant deficiencies 77% 78% I 48%

When comparing results of the third cycle to those of previous cycles, \ve see a significant improvement in theproportion of special examinations that had clean opinions.

To whom were special examinations reported?

When a special examination contains information that, in the examiner’s opinion, should be brought to the attention ofthe appropriate minister or Parliament, the examiner may do so. (This provision of the P.1.4 does not apply to Crown




corporations named in Part 2 of Schedule Ill of the Act and most exempt Crown corporations.) Reporting beyond theboard of directors is usually done when the significant deficiency is beyond the corporation’s ability to address on itsown. or when significant deficiencies noted in a previous special examination have not been adequately addressed, orwhen several significant deficiencies have been identified in a corporation’s systems and practices. Otherwise, thereport is provided to the board of directors only. The following table shows the proportions of special examinationsreported to the board and beyond.

Special examinations repoi ted to 1” Cycle 2nd Cycle 3rd Cycle

Board of directors only 8] % 63% 76%

Minister 11% 37% 24%

Parliament 8% —

The reduction in the number of reports brought to the attention of the appropriate minister in the third cycle is directlyrelated to the reduction in the number ‘a ith significant deficiencies: four reports with significant deficiencies that wentto the appropriate minister in the second cycle, had clean opinions in the third cycle. The fact remains, however, thatone quarter of Crown corporations had significant deficiencies that the examiner felt should be brought to the attentionof the ap popriate minister.

Vhnt significant deficiencies Were reported?

The following tables identify the systems and practices where significant deficiencies were found (one significantdeficiency may affect more than one system). While only significant deficiencies were identified in first and secondcycle special examination reports. tlurd cycle reports also included other important deficiencies that the examinerthought should be reported to the hoard. For the third cycle, the table identifies the systems and practices wheresignificant deficiencies were found, and gives an additional column combining them with other deficiencies found inthe third cycle.

Percentage ofCrown corporations with bothsignificant and

Percentage of Crown corporations with other

Systems and Practices (Areas) j significant deficiencies in identified areas deficiencies

]st Cycle 2nd Cycle 3rd Cycle 3rd Cycle

Corporate and strategic planning 50 38 66

Performance measurement and reporing 46 24 76

Operations 65 14 17 66

Human resources management 42 28 10 62

Asset and facilities management 46 25 7 14

Risk management 15 9 7 14

Environment 8 9 7 2 I

\Iarketiitg 27 22 3 3




Percentage of Crown corporations with significant deficiencies incorporate and strategic planning and/or performance measurement and reporting

Includes otherdeficiencies

Cycle 2nd Cycle 3rd Cycle 3rd Cycle

62 78 38 90

The reduction in the systems and praclices with significant deficiencies in the third cycle is directly related to theoverall reduction in the number of special examinations with significant deficiencies. However, it is slill of concernthat 38 percenl of Crown corporations had significant deficiencies related to corporate and strategic planning andperformance measurement and reporting (90 percenl had significant and other deficiencies combined). This indicatesthat these corporations do not:

• have well-articulated corporate visions, values and goals:

• have clearly expressed strategies or action plans to achieve their mission and vision:

• know the extent to which they are achieving their objectives: or

• report adequately on these objectives and strategies to Parliament and government.

Environmental and sustainable development issues in Crown corporations

Of the 29 special examinations of Crown corporations completed so far in the third cycle. 20 included the managementof environment and sustainable development issues. Those issues were excluded from the exaniinations of the 9 othercorporations after onr survey found no potentially significant environmental risks. Two of the 20 special examinationsreported significant deficiencies related to the corporations’ systems and practices for the environment and sustainabledevelopment. Neither corporalion had an en’ ironmental management system (a formal environmental policy.environmental objectives. measttrahle targets, and a process to ensure that environmental and sustainable developmentconsiderations are laken into account in decision making).

Some other areas for improvement were identified. These included the need for:

• a more comprehensive en ironmental management system (for example. a corporation might need to improveinformation, or to formalize and documeni existing procedures):

• improved measurement and reporting of environmental performance:

• more irain ing in environmental management: and

• a policy on environmental considerations in the awarding of offshore contracts.




Appendix D

Best Practices Applicable to Federal Crown Corporation Audit Committees

In this appendix, we present a comprehensive list of suggested best practices that are applicable to federal Crowncorporations and are complementary to the statutory requirements of audit committees under Part X of the Financial

.-lthninist,’ation Act. These best practices were taken from recent studies and publications in Canada and the U.S.,including the Report and Reco,n,ne,wlations of the Blue Ribbon Conan/I/ce on Improving the Effectiveness ofCorporate Audit Con,mit/ees, sponsored by the New York Stock Exchange and the National Association of SecuritiesDealers (1999), as well as various accounting and auditing publications.

We do not suggest that this template of best practices applies equally to all audit committees. Each audit committeeshould develop and observe guidelines suited to itself and its corporation. Some of these responsibilities may also beassigned to other board committees. However, as part of the audit committee’s periodic self-assessment, it shouldensure that key oversight responsibilities outlined in the best practices are assumed by it or another board committee.

Audit Committee Best Practices

(Those in bold were selected for comparison with current Crown corporation practices, as described in the chapter.)

Audit Committee Responsibilities

The audit committee should:

• ensure oversight of compliance matters by monitoring the corporation’s compliance with applicable laws andregulations.

• ensure financial oversight by:

— critically reviewing the operational and capital budgets, interim and annual financial statements, theauditor’s report and the management discussion and analysis section of the annual report; and

— reviewing the external auditor’s audit plans and actively soliciting his/her judgments about the quality, notjust the acceptability, of the corporation’s accounting principles as applied in its financial reporting.This discussion should include such issues as the clarity of financial disclosures and the degree ofaggressiveness or conservatism of the corporation’s accounting principles and estimates.

• ensure oversight of corporate books, records, financial and management control and information systemsand management practices by:

— reviewing the special exaniination plan and report prepared by the external examiner;

— actively soliciting information about significant risks and exposures and reviewing the adequacy ofinternal controls to manage those risks;

— reviewing the integrity and effectiveness of the management information systems;

— reviewing internal audit plans and reports and management’s subsequent actions; and

— reviewing significant findings and recommendations made by the external auditor and follow up onmanagement’s subsequent actions.




• confirm the external auditor’s independence through the receipt of a formal written statement from the externalauditor and through subsequent dialogue about any issues that may impact the objectivity and independence of theauditor.

• ensure ethical oversight through the annual review of management’s compliance with the corporate code ofconduct.

• actively solicit all sensitive information (for example. senior management expenses, significant litigation,non-compliance with laws and regulations. misuse of corporate assets, illegal activities).

The audit committee should, where warranted, advise the board of directors about any of these matters.

Membership and Competencies

The audit committee should be contposed of at (east three directors, the majorit’ of whom should not be officersor employees of the corporation. Audit committee members must have a significant degree of commitment to thecorporation that they take adequate time for meeting preparation. near-perfect meeting attendance, and ongoing

education about the corporation’s business and environment and topical issues.

Good governance dictates that the board be composed of individuals with certain personal characteristics such asintegrity, strategic thinking, and the ahilit to ask probing questions. Ideally, audit committee members would be themost qualified and experienced directors on the board.

Although a variety of skills and experience is beneficial to an effective and balanced audit committee, allmembers should be financially literate and at least one member should have accounting or related financialmanagement expertise. Financial “literacy” signifies the ability to read and understand fundamental financialstatements, including a balance sheet, income statement and cash flow statement, and the ability to ask probingquestions about the corporation’s financial risks and accounting. “Expertise” signifies past employmentexperience in finance or accounting, requisite professional certification in accounting, or any other comparableexperience or background that results in the individual’s financial sophistication (such as CEO or other seniorofficer with financial oversight responsibilities).

Operating Procedures

Terms of Reference. Audit Committees should have cleai; written terms of reference and operating proceduresthat specify the scope of the committee’s responsibilities, and ho’, it carries out those responsibilities, includingstructure, processes, and membership requirentents. This charter should be approved and reassessed periodically bythe board of directors.

Authority. The audit committee should have explicit authority to investigate any matters within its terms of reference,should be provided with the resources it needs, and shotild have full access to information and the organization’spersonnel. The committee should also be able to obtain independent professional advice.

Member Orientation. The audit committee should consider training and education programs for its men1hers toensure that they have current knowledge of the following:

• the committees responsibilities and the niethods of discharging them;

• the roles of the internal and external auditors;

• the corporation’s business, including products, systems, risks and opportunities; and

• basic elements of technical areas such as accounting principles and policies, internal control systems, andauditing.

Meetings. The frequency of audit committee meetings should be tailored to the responsibilities assigned, butshould be at least quarterly. The audit committee agendas are set with sufficient input from the chair of the




committee, the CEO, the chief financial officer and the internal and external auditors. Detailed minutes of themeetings should be prepared. The external auditor should be invited to every meeting. The audit committee shouldalso periodically meet with management. the external auditor and the director of internal auditing in separateprivate sessions.

Reporting and Self-Assessment. The audit committee should periodically report the results of its activities to thehoard of directors. Its charter should be disclosed at least triennially in the corporation’s annual report. The committeeshould also provide a general disclosure letter in the corporation’s annual report stating whether the audit committeehas satisfied its responsibilities during the prior year in compliance with its charter The disclosure should also statethat the audit committee:

• has reviewed the financial statements with management and has discussed the quality of the accounting principlesand significant judgements;

• has discussed the audited financial stateniens. accounting principles and sigailicant judgements with the externalauditor;

• has discussed the information provided by management and the external auditor: and

• believes, in reliance on the review and discussions with management and the auditors. that the corporation’sfinancial statements are fairl3 presented in conformity with generally accepted accounting principles in allmaterial respects.

The audit committee should periodically assess its effectiveness and the adequac\ of its mandate, and its chair shouldalso periodically assess the performance of individual committee members.

Report of the Auditor General of Catiada — December 2000 18—39


Chapter 18 - Muskrat Falls Inquiry

Documents

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