Board behavior and effectiveness are becoming increasingly visible to investors and other stakeholders. In the past few years, the European Commission has reinforced its focus on the corporate governance matters, issuing several rules and guidelines in this regard. Most of these raise, among other aspects, the issue of increased board responsibility in the corporate governance framework through better functioning and more appropriate structures.
In accordance with most best practice requirements laid out in corporate governance codes, the majority of European listed companies are now conducting board performance evaluations. Board evaluation is increasingly acknowledged as a vital process for improving board performance and dynamics, whatever the size, status or type of organization. If thoroughly conducted, a board evaluation (also called “board assessment”, “board review”) has the potential to significantly enhance board effectiveness, maximize strengths and tackle weaknesses.
Companies have various approaches to board evaluation, in terms of methodology and objectives. In setting up the framework, a company should ask itself whether the exercise is the result of regulation or a commitment to good governance thus merely a compliance exercise, or rather one aimed at sustaining the performance of the board. While meeting regulatory requirements may be part of the motivation behind this exercise, the primary driver should be a desire to build a high-performing board, well-suited to anticipate, meet and overcome the challenges ahead. Increasingly, boards are moving away from the “check-the-box” mentality towards utilizing evaluations as a tool to ensure they are aligned with the company’s long-term strategy.
Aside from the need for compliance with standard regulation, a firm’s approach should be subject to its board’s strategy, past or upcoming circumstances and the objectives of the assessment process. In-house processes may have the advantage of causing less concerns to boards that are reluctant to conduct a board evaluation. However, adopting only an internal mechanism throughout a board lifecycle may refrain board members from revealing some aspects that could be problematic, thus eroding the real picture. In line with general best practice an external evaluation should take place at least every three years within the board cycle. Several companies engage an external consultant more often, either annually or once every two years. Companies do not generally maintain a standard rule for such a schedule, which would not even be compelling as boards may experience interesting dynamics from one year to the next.
Specialization and independence of the external evaluator are key. Regular use of an external specialized consultant can improve board performance assessments by bringing an objective view and by providing a ‘best practice’ perspective. Given the potential conflicts, the external facilitator should neither have an ongoing nor recent relationship with the company, i.e. not engaging in other consulting services for the company or management. According to some emerging regulation (already in Italy and UK), companies must disclose publicly whether an external evaluator has any other connection with the company. The problem in most markets, however, is the limited number of specialized board evaluation consultants. As with all market issues, greater demand, however, would likely engender a better offer.
The involvement of the external party in the process can have several levels: it could offer independent advice to the board throughout the process, or simply act as impartial facilitator. Companies generally prefer the former approach, which ensures the most effective process, in the same time releasing the board from the pressure of conducting an evaluation internally.
A thorough and accurate board evaluation process can identify issues and enact reforms to improve performance. The board should agree in advance to the following:
- Scope and purpose of the evaluation
Board directors should have a shared commitment to the scope and purpose of the evaluation.
- Designated party
If done internally, the board should agree on a board member or committee to oversee the evaluation; alternatively, boards must appoint an independent, specialized external consultant to conduct the evaluation.
- Methodology and subjects included in the process
This should include how the evaluation is conducted (e.g. questionnaire, individual interviews or both) and whether the evaluation extends from board to committees and to individual directors.
- Areas of valuation
The board should agree in advance on the main areas to be examined. These include board agendas, information flow, the effectiveness of board meetings, the performance of individual committees, the relationship between the board and senior management, board’s approach to strategy, board’s approach to governance.
- A post-evaluation review should identify issues or threats, should embrace opportunities and adopt reforms which may be required.
Particularly if conducted by an external consultant, the evaluation process includes a review of board documentation, governance documents, charters, minutes, agendas and observations of board meetings. This part of the assessment is very important both as a preparation ahead of the discussions with the board members, and for enabling a complete assessment of the board functioning. Major facts happen during the year at the level of the board. These are to be acknowledged by the external advisor and brought back to board members’ analysis during the interviews.
The methodologies used to determine the evaluation output vary. The primary tool used in both jurisdictions is the questionnaire, although a tendency towards increasing use of interviews has emerged. Whether combined with questionnaires or not, confidential interviews have been recently emphasized as the most effective technique in drawing out board performance issues. While questionnaires address questions related to past performance, interviews allow for more space to approach the future plans and strategy of the board. Interviews also enable open discussions and diversity of interpretations, expanding the more closed questions that questionnaires are based upon.
The evaluation covers a wide range of issues, including competency of board members, information flow, board meeting dynamics, relationship with senior management, quality of board supervision and decision-making. While in the past boards used to be primarily internally focused, today they have to proactively scan the external environment for things that might impact the company. Therefore, within the evaluation exercise, forward-thinking companies place special emphasis on the board’s role in strategic decisions, aside from its monitoring tasks. The independent, specialized evaluator assists boards in answering some important questions, such as what should the board be doing in the critical areas of oversight, such as strategy and risk; and how and to what extent can the board be positioned as a strategic partner with the management.
However, board assessments are not a given remedy to boards’ problems. Even if an annual assessment is conducted, there is no guarantee that a board will implement needed changes. Various approaches may be taken by the board members while engaging in the evaluation process, whether conducted internally or externally. They may approach evaluations as a pro forma exercise, which can minimize insights, or they could take an honest look at whether board practices and composition are optimized to meet the company’s long-term goals. Surely, the latter approach enhances the effectiveness of the outcome of the evaluation.
Board evaluation should not be a mere function of compliance with the regulations; instead it should be a stimulating process for the board to acknowledge and reflect on its current framework, its strong and weak points, on opportunities to improve its functioning and performance. Boards will effectively address any limits or weaknesses only when they acknowledge what these are. An effective and well-governed board is willing to proactively consider the findings of the evaluation, holding open discussion of the findings, identifying issues for improvement and trying to enact improvements. Communicating the outcome of the board assessment process is an important means for the follow-up implementation and for enhancing dialogue with the stakeholders on board matters.
The board sets the tone at the top. Members are selected via a thoughtful process, considering their skills, characters, values and cultures to align them with the company’s own culture, values and strategy. When boards evaluate their qualifications and performance, through self-evaluation, peer evaluation, or third-party evaluation, they should consider whether specific skills have been exercised and which skills need improvement. Then it can more effectively draw a plan to acquire any talent needed to round out the composition. Surely talent can be recruited to succeed board members whose terms are coming to an end; but the required talent may also be developed within the existing board through board education. Integrity should be part of this review, as should competencies, behaviors and commitment of board members.