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Board Performance - Who Cares

Rare is the company that does not periodically review the performance of its key contributors. Individuals, work teams, business units and senior managers all come under close examination. However, it is arguably the single most important contributor that often manages to elude our scrutiny. This contributor is The Board.

Why should there be all this focus on corporate navel-gazing? Whilst one objective may be to identify less efficient Boards and directors, there is also a less pessimistic motive. Namely, to help Boards do their job more effectively. While directors generally contribute positively to their Boards, many of them have not been given "a strict and clear set of expectations". An evaluation process lays out these expectations and gives feedback to both the CEO and the directors.

Current Trends in Assessing Board Performance

Individual director evaluations are gaining currency in companies with cutting-edge governance practices. However, it is the evaluation of both directors AND Boards that is quickly becoming understood as the best form of practice. In some cases Board Evaluation is mandatory due to increasing pressures from shareholders, regulators and the investment community.

The governance scandals at NAB, HIH, OneTel, Time Warner, Enron, WorldCom, and other high-profile companies have only intensified the call for this new practice. Edward Lawler III, a management professor at the University of Southern California’s Marshall School of Business and the director of the USC Centre for Effective Organizations, predicts that "evaluating Board performance is eventually going to become a necessary condition for getting Directors liability insurance, or at least for lowering its cost."

Firms that rate companies on their governance practices, such as Institutional Shareholder Services, already take evaluations into account. ISS says it gives credit for Board-performance reviews in its scoring system and is considering doing the same for Individual director evaluations in the future.

With the exponential rise in shareholder activism over the last decade, pressure to heighten the accountability of the Board has led to a greater focus on formal appraisal processes, for both Boards and directors.

McKinsey's 1997 survey of US institutional investors claimed that shareholders would pay up to 16% more for stock of companies, which had "good corporate governance" practices.

Beginning in 2003, the New York Stock Exchange required the Boards of its listed companies to conduct self-evaluations at least annually. Some governance experts anticipate such exercises to become the norm for any large public company, regardless of trade location.

This is an age in which directors are being pushed to increasingly higher standards of performance, by investors, regulators and in some cases by the courts. Attorney Bill Ide of McKenna Long & Aldridge therefore believes that implementing a Board evaluation process makes sound legal sense.

Data on the prevalence of Board and Director assessments is a not an easy task to reconcile. The key players producing data in this field are the consulting companies Korn/Ferry and Mercer, and Fortune 1000 Magazine. Similar data from Australia is not readily available.

The following analysis integrates all the various surveys within the US; you will note the consistent pattern that is emerging in the field of Board assessment.

 

1998

2003

Formal Individual Board Member’s Evaluation

19%

29%

Formal Whole Board Evaluation

33%

56%

According to Mercer and UCS, in the large companies of the US, the practice of Board evaluation is more prevalent, with figures of up to 70%. In Asia Pacific, Korn and Ferry found this figure to be 41%.

The number of Boards that undergo periodic formal evaluations is increasing, and it appears that this trend will only increase further as awareness of Board evaluation, and its benefits, grows.

 

Current Practices in Director and Board Evaluation

Director’s performance

It is universally recognised and promoted by the Australian Institute of Company Directors (AICD), that Board members need feedback about their performance in order for them to develop their skills and ensure a more effective contribution. Often members are informally evaluated in a "hit or miss" black box process that does not provide beneficial feedback or valid data.

A peer process of evaluation is often undertaken. This process involves Board members evaluating each other and providing feedback to those responsible for nominating individuals to the Board. Major shareholders and stakeholders also occasionally partake in this process.

The criteria for assessment typically includes

  1. How well Board members understand the company’s strategy.
  2. Whether members stay abreast of current trends and issues impacting the industry and their company.
  3. Members meeting attendance record and their contribution to discussions.

 

Board evaluation

Although individual evaluations are important, it is essential to evaluate how the entire Board performs as an entity. This requires a formal annual review of Board performance. One element should be a self-review, in which Board members are asked to look at how the Board has performed during the last year. Institutional and major investors, market analysts and regulatory bodies may also be asked to provide their input. By these means the Board is able to discuss performance in light of several sources of evaluation, thereby allowing a more thorough analysis. This is documented within the Korn/Ferry survey, which indicated directors view the evaluation process as significantly more effective when Boards receive feedback from company stakeholders

Research shows that very few companies are actually gathering information from non - Board members in order to evaluate their effectiveness. This is a practice that will be most likely to develop slowly, however one that should be of great benefit.

 

Conducting Board and Director Assessments – the Options

Formal evaluation of Boards is conducted annually. The assessment process typically begins at the start of the company’s fiscal year, when the directors meet in a full Board session to determine the measures for use for the coming year. At the end of the fiscal year, the Board meets and evaluates itself against these measures. The final evaluation results are communicated to the Board in summary form. In many companies, this assessment meeting serves, not only as the annual review, but also as the time to identify areas for improvement over the coming year.

The evaluation is typically conducted through a lead director, chairman or external consultant. Data may be gathered through a questionnaire completed by all directors and then followed up with a confidential one-on-one interview in person or by phone. Similar processes are used to collect information from key stakeholders.

 

Questionnaires typically use a mix of numerically scored multiple choice items as well as open-ended questions. The scores on the questionnaire help the Board rank and benchmark themselves objectively along a series of dimensions. Areas of strength and weakness are clearly identified and differing points of view on the same activity, or behaviour, are highlighted.

 

Interviews are conducted by external parties or by an individual member of the Board. This member is frequently the chair of the governance or remuneration committee. The interviews allow for a greater exploration of issues, allowing topics not included in the formal questionnaire to be discussed.

Final evaluation results are presented to the Board. The results should be reported in summary form and without attribution to individual Board members. The Board discusses the areas identified for improvement and creates appropriate action plans.

In presenting the results to the Board, not only is the content of the presentation important but also the tone. The most effective presenters are those who are skilled listeners and hold the trust of Board members.

Many directors express their support of the evaluation process, a process that provides a discipline and structure, enabling problem areas to be identified. By making the process anonymous, Boards increase the likelihood of sensitive issues being raised.

 

Independent experts on group process can observe some Board meetings and contribute advice as to how the Board’s performance may be improved. With little or no vested interest and an understanding of group-process issues, outside experts are better positioned to recognise dysfunctional dynamics. They can also draw attention to implicit rules of behaviour that may be interfering with the amount and candour of information flowing among Board members.

Some Boards also employ a Balanced Scorecard as a tool to assess performance. The Board agrees on the elements of the scorecard and then formally discusses their progress against them on a 6-monthly basis. Below is an outline for such a Scorecard.

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Benefits of Board Evaluations

Perhaps the most consistent and clear benefit observed in those companies that have adopted Board appraisals, is a commitment by directors and the CEO to devote more time and attention to long-term strategy. This by itself is an outcome significant enough to justify implementation, however other benefits include:

1. Improvement of Board Operations - Board evaluations formally invite feedback and reflection on the Board’s performance. This ensures greater attention is given as to how the Board actually operates. It can often lead to more streamlined meetings, added informative materials and sessions, greater influence by Board members on the shape of meeting agendas and further contributions by members to the sessions.

2. Positive Group dynamics – Focusing on group dynamics and collectively reflecting on the Board’s performance after the evaluation, directors declare that groups tend to function more effectively as a team.

3. Clarity about the role of directors and committees - Through examination of individual and group responsibilities, the evaluation process encourages Boards to spend more time and thought on their actual roles and responsibilities, leading to a clearer understanding of the individual roles of director, committee, and CEO.

4. Involvement - Disciplined reflection on the directors’ participation and activity level at meetings can increase the level of involvement by all members of the Board.

5. Early warning system - By measuring performance against tangible objectives, a Board can more easily anticipate problems. The results of the evaluation process can provide substantial evidence regarding the areas in which action must be taken.

The Australian Institute of Company Directors has no information on how Australian Boards review their performance. The New Zealand Institute of Company Directors has an "Evaluation Best Practice" for New Zealand Directors. EMD’s experience in this area is that Australian practice mirror the trend in the United States.

People and organisations cannot learn without feedback. No matter how successful a Board is, it is bound to succeed further if it is reviewed intelligently. Individual Director and Whole-Board performance reviews, through the Board Scorecard and questionnaire style feedback, appear to the most beneficial and appropriate forms of assessment.

 

Those who have served on a Board recognise the essential issue and dilemma: a Board is a group of diverse people with varying skills. What matters, and indeed what will determine the quality of its collective authority, is the quality of the Board dynamics, the quality of the relationship between Board and senior executives and the quality of the reporting processes.

How do you undertake Board and Director performance analysis and how do you communicate the process and the results to your inquiring shareholders, members or stakeholders?

What Next?

If you are interested in more information please give us a call on +61 412 026 909 and ask to speak to one of our consultants. 

Alternatively e-mail us at info@emdgroup.com.au or use the form on our Contact Us page.

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