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Board evaluations and effectiveness reviews

The board, its composition and evaluation of performance is central to corporate governance. Increased scrutiny has recently focussed on the activities of the board and its committees particularly post the banking crisis and experience shows that a successful board is not guaranteed by just bringing together successful people.

All boards, and their committees, can benefit from evaluations: in particular subsidiary boards are often training grounds for listed company boards and getting into good governance practices at subsidiary level can pay dividends later on.

Board evaluations can bring tremendous benefits and a properly conducted evaluation can contribute significantly to performance improvements on three levels: organisational; board and individual member level.

One of the main goals of board evaluation is to enable boards to purposefully identify and surmount the barriers that impede their effectiveness. Establishing an effective process for board evaluation can send a positive signal to the organisation that board members are committed to doing their best.

What is new?

The Financial Reporting Council (FRC) announced the new UK Corporate Governance Code (Code) back in June 2010. The Code applies to accounting periods beginning on or after 29 June 2010 and applies to all companies with a Premium Listing of equity shares regardless of whether they are incorporated in the UK or elsewhere.

The principles in the Code, on a ‘comply or explain’ basis, are that:

  • boards should state in the annual report how performance evaluation of the board, its committees and its individual directors has been conducted (Code reference B.6.1);
  • board evaluations of FTSE 350 companies should be externally facilitated at least every 3 years, and any other connections between external consultants and the company disclosed (Code reference B.6.2); and
  • non-executive directors, led by the senior independent director, should be responsible for performance evaluation of the chairman, taking into account the views of the executive directors (Code reference B.6.3).

Performance evaluations have been in the Code for some time but the three yearly external facilitation element is a new provision and one listed companies will have to take into account. 

Why externally evaluate?

External facilitation once every three years has a role as it helps to gain a view on how a board is doing compared to other comparator boards. A good external facilitator can add much external perspective which a board would otherwise not be able to access. An external view can be both challenging as well as reassuring: both aspects are important to boards and directors in equal measure so external facilitation has a valid place. 

Board evaluations, when completed properly, can identify areas of strengths and weakness, leading organisations to make changes that positively impact performance and shareholder value. Done well they can provide independent and impartial advice, objectivity and rigour especially if facilitated externally.

However, research has shown that the majority of companies are not submitting themselves to independent board performance evaluations. Indeed the changes in the new Code are not mandating externally facilitated board evaluations: a company merely has to explain why it is not appropriate to undertake one. Why is it that boards have been reluctant to have external facilitation? Costs may be a factor but also lack of available information and guidance on best practice may contribute to a reticence by boards.

Road map to best practice

One size does not fit all and getting the scope of evaluation right is critical. There are four main reasons for undertaking board evaluations:

  • the need to address specific issues;
  • the need to benchmark performance against other companies;
  • the need to ensure that the board is doing the best it can; and
  • the need to be seen to be doing something.

Determining the best approach (internal or external, quantitative or qualitative)

The chairman sets the tone from the top and plays a pivotal role in the evaluation. 

Determining the scope of the evaluation undertaken and whether it extends to board committees and individual directors is key as these are increasingly important to overall governance within a company.

Understanding the options available 

The options chosen will depend on the cycle that the company is in and what the company is seeking to achieve from the evaluation. Options range from:

  • self-assessment/DIY questions through to external software solutions;
  • facilitated self-assessment through to bringing in an external third party provider to issue an independent report or undertake an independent assessment of the whole board 

Implementing the result

It is important to employ the right follow-through to implement the changes highlighted as necessary or desirable. Results can be used to initiate group discussion as well as to implement process changes if identified. The role of the chairman is key to introduce follow-up items on subsequent agendas so that they are acknowledge and completed.

Basic management principles can be initiated to create action plans with specific time lines for implementing the evaluation recommendations and for monitoring the recommendations. The outcomes from an evaluation and actions resulting from the evaluation should form a continuous process of improvement. Board development plans can be a successful outcome of any evaluation.

Disclosure and reporting for optimal advantage

Investors need to know if a board is an effective board and good corporate communication can do much to convey the board’s message to investors and other stakeholders on what outcomes arise from evaluation. Investor relations teams can be useful in this regard. At a minimum the board should provide the following details:

  • what was reviewed as part of the evaluation (including the rationale behind the decision);
  • who conducted the evaluation including the rationale behind their selection;
  • the nature of the evaluation process;
  • the key findings and lessons learnt; and
  • any follow up action required, and by whom.

Challenges/pitfalls that companies could face? 

  • It is important to avoid conflicts of interest when engaging an external facilitator. Independence of the facilitator is important. Some facilitators have greater advantage and insight but may be conflicted for other reasons. A key issue is whether the facilitator is skilled at board evaluations and has a successful track record. It should always be part of the due diligence to ask for a client list and to take up references before engagement.
  • Board evaluation should not just be an annual event: high performing boards tend to devise other mechanisms in addition to the annual evaluation review to ensure on-going performance improvement.
  • A key objective for all boards is how to run the board at a high level of challenge so that people feel free to disagree from time to time and put their own perspective forward even if this is contrary to the ‘group think’. One of the key lessons from some of the less successful boards was that people did not feel that they could speak up: board evaluations are a good discipline to check if members feel that they can do just that.

About the author: Vanessa Jones was the Head of Corporate Governance at ICAEW. She is a Barrister and Chartered Secretary and has worked within the listed and non-listed corporate sector in both in-house legal and company secretarial roles.