Is Your Board Governing Itself Effectively?

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday June 24, 2013 at 9:33 am
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Editor’s Note: The following post comes to us from Maureen Errity, Director, Center for Corporate Governance at Deloitte LLP, and is based on an article featured in a Center for Corporate Governance newsletter.

Never before has the role of board members been so important to organizations and investors. With many boards stretched beyond capacity trying to meet stakeholder needs and compliance requirements, board members must provide strategic leadership, stewardship, and governance.

Effective governance requires a proactive, focused state of mind on the part of directors, the CEO, and management, all of whom must be committed to business success through maintenance of the highest standards of responsibility and ethics. Recent studies, such as the 2012 Board Practices Report: Providing Insight into the Shape of Things to Come (previously discussed here), a publication from the Deloitte Center for Corporate Governance and the Society of Corporate Secretaries and Governance Professionals, suggest that there has been progress in revamping governance practices and establishing board infrastructure, effectiveness, and engagement.

The Deloitte Governance Framework, as outlined in Framing the Future of Corporate Governance: Deloitte Governance Framework, helps organizations form the basis for the tools that help boards and executives quickly identify potential opportunities to improve both effectiveness and efficiency and provide an end-to-end view of corporate governance. Within the framework, the board can develop a set of key objectives for each of the six elements (see Figure 1).

Figure 1: Deloitte Governance Framework

The governance element within the framework is described as the board establishing structures and processes to fulfill its responsibilities while considering the perspectives of investors, regulators, and management, among others. In this framework, it is recommended that the board select its members and leaders via an inclusive, objective, and thoughtful process, aligned with company strategy. Board infrastructure, effectiveness, and engagement are important components of the governance element.

Board infrastructure

At the foundation of good governance is the board’s involvement in developing and maintaining effective documentation, structures, and processes. Board infrastructure encompasses a variety of aspects, such as:

  • Documentation: Includes the processes and policies the board should have in place to be most effective (e.g., code of conduct/ethics, board and committee charters, meeting agendas, and corporate governance guidelines).
  • Board and committee structure: How the board and committees are set up (e.g., the number of members that are on the board and each committee; the leadership structure in terms of chairman/CEO combined roles and lead directors; and standing committees of the board and other committees that may be needed).
  • Board processes: The formal processes the board undertakes to govern (e.g., the process by which the board identifies, recruits, and selects its members and the process of setting its calendar, meetings, and agendas).

Board infrastructure is the backbone of the governance element for the board and its committees. Without a strong infrastructure, many boards are unable to function to their full potential and often face internal and external challenges.

Board effectiveness

Corporate boards today are expected to be more engaged, more knowledgeable, and more effective than in the past. There are a few tools, such as board evaluations and board education, which a growing number of boards are using more frequently to examine and improve their effectiveness.

“The rationale for board and director evaluations has emerged from the wider debate concerning higher standards of corporate governance by stakeholders, better board performance and greater professionalism amongst directors,” state Ingley and Van der Walt, “Risk Management and Board Effectiveness”, International Studies of Management and Organization, Corporate Governance, 2008.

Board evaluations are recognized as an essential component of good governance practices, and if done correctly, they can benefit not only the board and directors, but also the organization and its stakeholders. Survey results included in the 2012 Board Practices Report show that 78 percent of respondents complete a full board performance evaluation; however, only 10 percent of respondents replied that individual peer evaluations are led by a third-party facilitator. The survey also shows that 60 percent of respondents say their organization provides industry-specific training and 70 percent say their organization provides a formal orientation program for new directors.

Educational programs are an integral part of the development and enhancement of board members. Current topics being covered in board education range from the regulatory landscape to sustainability, risk, and strategy.

Board engagement

Board engagement has been a recurring topic in the governance landscape. Engagement can be defined in many ways and can include various parties: it may relate to how management works and corresponds with the board; how the board interacts with the CEO; how the board and management interact with stakeholders; and how board members interact with each other.

Management engages with the board at various levels. An effective relationship between the two is essential for the board and management to fulfill their responsibilities. The governance oversight model outlined below can aid in identifying attributes that help determine the level of information the board should receive from management and assess overall board performance.

Effective boards govern in constructive partnership with the CEO and recognize that that the effectiveness of the board and the CEO are interdependent. The board and the CEO are allies in ensuring the organization’s strategy, mission, and goals are carried out. The board works with management and ultimately defines the strategy in alignment with the mission, and management executes the strategic objectives and goals. In the 2010 BoardSource Leadership and Engagement publication, BoardSource establishes four levels of engagement between the board and CEO:

  • Governance as an observation: The CEO has a high level of engagement and the board has a minimal level of engagement; the CEO ultimately displaces the board.
  • Governance as leadership: The CEO and the board both have a high level of engagement—the CEO is in a constructive partnership with the board.
  • Governance as attendance: The CEO and the board both have a low level of engagement; essentially, the CEO is going through the motions with the board.
  • Governance as micro-management: The CEO has a low level of engagement and the board has a high level of engagement; the board ultimately displaces the CEO.

Direct interaction between boards and shareholders is commonplace in countries like the United Kingdom, where various board members—in particular, the chairman of the board or independent directors—routinely meet with key shareholders. But in other markets, such as here in the United States, many boards have delegated shareholder engagement activities to the investor relations or management functions.

Often, investor relations personnel were not able to provide the same level of comfort and assurance on governance-related matters as board leaders. As a result of recent regulatory changes, such as say on pay, management and shareholder engagement is on the rise in the United States.

The State of Engagement between U.S. Corporations and Shareholders, a study commissioned by the IRRC Institute and conducted by Institutional Shareholder Services Inc., is a benchmarking engagement, or the dialogue between public companies and their investors. The report notes that engagement has become a focus of regulatory changes and governance reforms during the past decade, and the fallout from the financial crisis has increased the focus on engagement. In many instances, shareholders are satisfied with management’s interaction, but for those who ask to meet with a board member—often the compensation committee chairperson—companies are more open to meeting the request.

This trend is supported by the 2012 Board Practices Report, in which more directors report having direct contact with shareholders or shareholder groups—42 percent this year compared to 36 percent in the 2011 survey.

Board culture can complicate matters, especially if the board members’ personalities conflict with the company’s culture. There is also the issue of group thinking, where the dissenting opinions of individual board members tend to be stifled for the sake of consensus. This can result in a wall of silence between board members. Board member interaction can make or break the dynamics of the board.

Governance oversight model

The Deloitte Governance Framework provides a model of leading practices for boards to consider in executing their oversight responsibilities. The framework sets out four attributes that help assess the board’s performance level and put the framework into action. Boards can use these attributes to help identify strengths and opportunities for improvement within each of the governance elements:

  • Skills and knowledge: What are the skills that are needed for the board to effectively execute its responsibilities?
  • Process: What processes are required for the board to both understand and properly oversee the activities of the organization?
  • Information: Is the information received by the board adequate to support effective oversight and decision making?
  • Behavior: Does the board’s behavior support and reinforce strong oversight?

A board’s maturity with respect to each element may range from low to high, but the board should take the time to assess how well it believes it is performing. The following table outlines a maturity model that can be used to evaluate what likely constitutes a high-performing board for each attribute with respect to the governance element of the framework.

Representative Governance Oversight Model

Skills and knowledge
  • Understands corporate governance and its application to board structure, operations, processes, and procedures
  • Understands the organization, its businesses, and underlying drivers
  • Has relevant, recent experience in the industry, adjacent industries and markets, or competitors
  • Has knowledge of the interests and priorities of stakeholders
Process
  • Understands the risks inherent in the organization’s governance programs
  • Selects qualified, independent board members, aligning overall board composition with the organization’s strategy
  • Establishes and periodically reaffirms board leadership
  • Establishes and ensures compliance with board operating principles and governance policies
  • Designs and implements a committee structure that complements and enhances the work of the board
  • Assesses and continually improves the board, its leaders, and committees
  • Engages with stakeholders
  • Oversees public disclosures related to board operations
Information
  • Receives verbal and/or written feedback and development plans resulting from periodic assessments
  • Receives board governance documents and related tools (e.g., board calendars, planning tools) for review and improvement
  • Receives thought leadership or continuing education related to board governance developments
Behavior
  • Displays ownership and commitment to governance excellence and continuous improvement
  • Creates a culture of collaboration, engagement, and healthy tension among board members
  • Holds board members accountable for their behavior

Concluding thoughts

The governance element is an essential element that assists boards in carrying out its fiduciary responsibilities. It helps boards improve its overall operating effectiveness. High-performing boards understand that the infrastructure, effectiveness, and engagement elements are not an exhaustive list for board governance. What these areas do suggest is guidance that can help boards operate more efficiently and make more informed decisions.

 

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