Every year The Globe and Mail’s Report on Business ranks governance of Canada’s corporate boards in the “Board Games.” In the recently published 2018 edition, the boards of directors of 242 companies and trusts in the S&P/TSX index were assessed. The companies are awarded points for various categories, namely, board composition, shareholding and compensation, shareholder rights, and disclosure. Companies with more stringent governance policies in place are awarded higher points. For example, a company with two-thirds independent directors will be awarded more points for that category than a company that has the majority of its directors being related directors. Notably, three of the companies in the bottom 10 of the Board Games are cannabis companies.
Why it’s important?
Oftentimes, investors are more tolerant of less mature companies (such as cannabis companies) lacking good corporate governance. These investors may prefer management spending resources on more pressing issues such as complying with federal and provincial regulations on marketing, selling and packaging. This forgiveness in the market combined with favourable regulatory outlook has led many cannabis companies to enjoy good performance despite poor governance practices.
The effects of strong corporate governance are not always clear and can seem more important for companies when times are bad rather than when times are good. However, over the long term, an independent board, strong controls, transparency and shareholder rights generally increase market value.
Maintaining a higher share price is important for cannabis companies that wish to expand through equity financing. Many cannabis companies in Canada have gone public by way of reverse takeovers (RTOs) rather than by traditional initial public offerings (IPOs). Contrary to IPOs, RTOs do not necessarily involve a financing component, and as such, when a secondary offering is eventually performed by the cannabis company, a higher share price will result in increased financing. Whether the cannabis company has gone public through an IPO or an RTO, having a higher share price improves prospects in a secondary offering.
A corporation may also want a higher share price to prevent a hostile takeover. We expect to see continued hostile activity in the cannabis sector as the industry matures and consolidates.
How to improve
There are some simple steps cannabis companies can undertake to improve their corporate governance practices. Shifting the board mix away from the founders to more independent directors, disclosing processes for the board stock ownership, or implementing board self-evaluation procedures are some steps that can create more stringent governance practices that will be of value to investors.
The author would like to thank William Chalmers, articling student, for his assistance in writing this legal update.