If evaluating boards of directors was a product the “evaluation” would be just beyond the product launch stage. Indeed, it’s only in the past few years that more and more companies have started to conduct evaluations. This may explain why the potential for evaluations is far greater than their practice. These co-authors have excellent recommendations for improving evaluations and making them an effective tool of sound corporate governance.
The corporate boardroom remains the ultimate black box. What we know is that a group of strongwilled individual leaders — predominantly white males — are put in a room together four times a year, and expected to provide decisive leadership, and deliver corporate performance to exacting governance standards. Yet, they get no feedback about their collective and individual leadership. What happens behind the closed doors of the inner sanctum – how the executive and non-executive directors function as a leadership team — remains shrouded in what might politely be called confusion.
While boards are charged with responsibility for delivering governance and for meeting justifiably tough new regulations on governance, the human dynamics at work in the boardroom are barely acknowledged and still less understood. Regulating a system you don’t understand is unlikely to solve its inherent problems – and is potentially dangerous. Bureaucratic control often has dysfunctional consequences.
Our lack of understanding of the dynamics of board behaviour was brought home by the spate of corporate scandals in recent years. When Jeffrey Sonnenfeld, a corporate governance expert based at the Yale School of Management, examined the boards at Enron, WorldCom, and Tyco – some of those pilloried for recent corporate scandals – he found no broad patterns of incompetence or corruption in the board room. In fact, the boards of these companies exhibited some of the best governance practices in terms of structural and procedural issues such as attending meetings, make up of committees, board size and composition, financial literacy. They also scored highly on accountability mechanisms such as codes of ethics and conflict of interest policies. The uncomfortable fact is that even if these governance checks had been in place, Enron, in particular, would have passed with flying colors. This unmasks a real danger in corporate governance checklists, including the requirements of the Sarbanes-Oxley Act, namely that they miss a more fundamental issue.
In response, growing attention is now paid to board performance and companies are under growing pressure to evaluate the performance of their boards. The pressure comes from a variety of sources. Most obviously, the regulators are upping the ante on board evaluation. In the US, the New York Stock Exchange introduced new rules requiring board evaluation in 2004. In the UK the Combined Code introduced in 2003 made evaluation mandatory. In Canada, the 2001 report from the Joint Committee on Corporate Governance, chaired by Guylaine Saucier, talks of moving beyond compliance to build a “governance culture.” Elsewhere, the trend is equally clear as, investors, fund managers, insurers, capital markets and the media press for greater levels of evaluation and transparency.
Yet, for companies to view calls for board evaluation as just another box ticking exercise would be a missed opportunity. Providing feedback to board members should be an integral part of continuous leadership development – if companies are able to overcome some basic obstacles. Having heard the increasing chorus, boards would then face a problem: There is minimal guidance as to how board evaluation should best be carried out. We are a long way from universal agreement on when boards should be evaluated. The New York Stock Exchange, for example, politely asks that companies “address” evaluation annually. In the UK, the Higgs Review suggested that evaluation should be systematic, rigorous, collective as well as individual, and occur annually. The UK’s Combined Code leaves the door open for a variety of interpretations. “The board should undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors,” advises the Code.
At the cell telephone giant Vodafone, for example, the board, its committees and individual directors are all evaluated annually. The chairman assesses the non-executive directors; the CEO reviews the executive directors; and the senior independent director reviews the performance of the chairman. “Each board committee undertakes a review of its work and in relation to the performance of the board, the chairman invites suggestions from all directors as to ways in which the board and its processes may be improved,” says the company’s annual report. While Vodafone is developing questionnaires for future use, it publicly states its faith in an internal process. More unusually, the UK retailer Marks & Spencer actually based its own performance review on an employee survey.
Ins and outs
Lacking precise instructions but accepting the requirement for board evaluation, companies tend to follow one of two broad approaches: either internal or external evaluation. Internal evaluation remains by far the most popular approach. In the UK, research by the consulting firm Independent Audit in 2004 found that 73 percent of companies used self-assessment.
Internal evaluation usually involves structured discussions between the chairman and board members, and sometimes the circulation of a questionnaire which is completed confidentially and then discussed by board members. The process has the advantage of being reasonably straightforward to organise and relatively cheap, but is prone to being self-congratulatory. Turkeys, as a rule, do not vote for Christmas.
The second general approach is to bring in external consultants – typically, to conduct interviews and provide recommendations. While this approach potentially offers greater objectivity, it also has a number of drawbacks. Board members may be inclined to view the consultants with sometimes illdisguised skepticism. After all, board evaluation is a developing and imprecise art (or science depending on your perspective) and consultants may not fully grasp the nitty gritty of the business. It is also expensive. One multinational company is believed to have paid CAN$450,000 for an evaluation.
The solution may lie in a middle trajectory, using an external facilitator and a self-assessment tool. This is an approach now being adopted by a growing number of companies. Typically the outsider is an academic or consultant – ideally, perhaps, an independent, but known, quantity.
Who is chosen to conduct the evaluation is only the starting point. Four other issues must to be clarified. First, companies need to decide who is to be evaluated – the board as well as all its committees? On the question of who should be covered by the evaluation process, this is generally wide ranging. The entire board of executive and non-executive directors is usually covered. All the main committees – audit, finance, nominations and remuneration – are also covered.
Colgate-Palmolive, for instance, has a long established evaluation process. It began formal board evaluations in 1997. Board committees also conduct self-evaluations which are then reviewed by the board. Colgate complements this with evaluations for individual directors.
Second, there is a need to be clear about what issues will be covered by the evaluation. Should it, for instance, consider only one-dimensional hard issues, such as the meeting schedule, time allocation on the agenda or circulation of papers, or more broad questions of culture and trust?
At the moment, there is a tendency to focus board evaluation on relatively straightforward, one dimensional issues. One reason for this is that such issues provide easily quantifiable data — neat boxes that are more readily ticked. So, for example, the make-up of committees; length of tenure of board members; regularity of meetings; the background of board members; and the circulation of meeting agendas will be analyzed.
This is useful, but not sufficient. While well meaning, many of the broad recommendations are blunt instruments at best, and a likely cause of dangerous unintended consequences, at worst.
The third key issue is related to this: whether to use questionnaires or interviews as the means of generating information on which to base an evaluation. Questionnaires are quick, cheap and provide comparable data. But, they can appear impersonal, threatening and may lack depth. Interviews are clearly more personal and create a much deeper pool of data. The trouble is that they are slow, time consuming, expensive and produce a sprawling mass of data. Good practice is often a mixture of a robust questionnaire; carefully constructed and selected interviews; followed by a discussion.
This leads to the final critical area: how the information generated is managed. How should the information be handled – what is and should be public knowledge, and what should be kept confidential?
Clearly, there are issues of confidentiality. Without reasonable safeguards, directors are unable to enjoy candid and productive conversations with outsiders. At the same time, companies are obliged to make some of the information public. Unless the boundaries are clear, board evaluations are unlikely to generate useful recommendations. (Where outsiders are used, reasonable assurances must also be provided that information gathered through board evaluations will not be used as a lever to generate additional consulting work — in much the same way as auditing and consulting is now split.)
Best practice usually involves individual data for all directors being shared with the chairman and data for the executive directors also being shared with the CEO. This is then discussed in a follow-up session.
Towards enlightened evaluation
The best evaluations take a broader perspective. They look at the climate, culture and leadership of the board; the levels of trust and the feelings between board members; and the team dynamics of the board. If the point of board evaluation is to improve performance, such insights into the leadership behaviour of board members, individually and collectively, is crucial.
“Potentially, boards have three resources to use: power, information, and knowledge. When these three resources are present and effectively directed at, first, handling emergencies; second, making sure an effective strategy is in place; and, third, truly influencing the decisions of the chief executive officer (and who succeeds the CEO), then we can say that the board is acting in a high-performance way,” observes the American board effectiveness expert Edward Lawler. “But there’s another key point that should be stressed. A board is a group, perhaps in some cases, a team. Boards need to be assessed by the same conditions and behaviors that lead groups to be effective.”
Jeffrey Sonnenfeld agrees. When he compared boards of high profile companies that failed with those considered paragons of best practice, he found that the only significant area of difference was the degree to which the board was performing as an effective team, or “high functioning work group”.
“We need to consider not only how we structure the work of a board but also how we manage the social system a board actually is,” Sonnenfeld observed. “We’ll be fighting the wrong war if we simply tighten procedural rules for boards and ignore their more pressing need — to be strong, highfunctioning work groups whose members trust and challenge one another and engage directly with senior managers on critical issues facing corporations.”
Sonnenfeld notes that stock ownership, financial literacy, attendance records, service of the former CEO, and “independence” do not seem to correlate in a meaningful way to performance of the company or the board.
More enlightened companies are already moving in this direction. The UK- based insurance company Legal and General, for example, has been conducting this type of wide ranging survey for several years – well in advance of Higgs. At telecoms company Cable & Wireless, the board’s non-executive directors annually review the relationship between the chairman and CEO “to ensure that the relationship is working to promote the creation of shareholder value”.
Making it work in practice
Making all this work is highly demanding. But it is a vital leadership issue. It requires the full support of the chairman and CEO. If they do not support it, evaluation quickly degenerates into a box ticking exercise which sheds little light on anything.
It also requires that there is a productive relationship between executive and non-executive directors. Indeed, properly structured, the annual board evaluation process itself offers a means to raise awareness of issues among non-executive and executive directors. The greater interaction offered by evaluation should also improve their relationships. Indeed, the more directors are involved in the development and design of the process the more they are likely to commit to any action related outcomes.
Managing this process is an assessor or facilitator who needs to be known to the board members or recognised as knowledgeable. For the man in the middle, credibility and independence are crucial.
The end point of the evaluation is a one-to-one session for each board member with the chairman – sometimes with the external facilitator available for separate assistance if required. In addition, there are board discussions to address collective issues – again typically with the facilitator present.
If the board is doing its job, the end result of the evaluation process is unlikely to be seismic. It is, or should be, part and parcel of a continous leadership development process. Just as in any formal appraisal system there should be no huge shocks. Well managed, evaluation should encourage a board to focus and adjust its thinking and actions. Small shifts in thinking and behavior can produce substantial impacts. “Boards that assess their members and themselves tend to be more effective than those that don’t,” conclude the American academics Edward Lawler and David Finegold after extensive research into corporate governance.
In the longer term, it is also important to keep the evaluation process fresh. Any appraisal process fails when it becomes no more than a routine or ritual. For example, Rob Margetts, chairman of BOC, follows up his board’s externally facilitated questionnaire-based evaluation with a more focused, internal discussion which he leads personally the following year. Through a series of structured interviews, he is able to pick up on the areas for attention highlighted by the previous year’s survey.
But while board evaluation is clearly useful and can improve board effectiveness, it does not necessarily provide easy answers for investors. Public reporting of board appraisal processes is typically brief and lacking detail. Using board evaluations to compare the performance of one board to another is still all but impossible. Here – as in other areas of board appraisal – there is scope for development as boards become more comfortable with the process and recognize the scope for sharing information in ways which benefit all stakeholders.