Investors are looking at boards of directors with a more critical eye than ever before. Many boards are raising age limits to elongate director terms, causing slow turnover in directorships. As a result, investors are concerned about the ability of board directors to keep up with the fast pace of regulatory concerns and the technological advances of today’s corporate world. Internationally, investors expect boards to perform meaningful board director evaluations. Whether board director evaluations are required by law or not, investors are looking for assurance that their boards of directors are fully equipped with optimal knowledge and expertise to keep ahead of their competition.
Meeting the responsibilities for regulatory requirements and inspiring the confidence of investors require board directors to thoroughly and continually perform self-evaluations of individual directors. Board directors need to set parameters to evaluate themselves against the objectives and goals that they set for themselves. Top areas of evaluation include each director’s involvement and participation in providing strategic direction, monitoring management, and providing support and advice to management.
Board evaluations are a time-consuming process that should be given the full weight of the time that they demand in order for them to have meaningful impact.
Director Evaluations: Sometimes Required, Always Valuable
In the United States, the listing rules of the New York Stock Exchange (section 303A.09) require corporations listed on the exchange to maintain and disclose their corporate governance guidelines and principles. Corporations must address board evaluations and annual evaluations of committee operations at least annually to assess whether they are functioning effectively.
Companies that are listed on NASDAQ are not required to perform director, board and committee evaluations, but it’s generally considered best practice for good corporate governance to do them anyway. Corporations that don’t willingly have a practice of implementing board evaluations will likely find that independent auditors will require a board’s evaluation of the audit committee as part of internal controls. This is just one way that the marketplace works to regulate itself.
At present, there is no universal process or common format for board evaluations. This may be a good thing by design, as evaluations should ideally be customized according to the industry, the corporate structure, the board culture and the unique needs of the corporation. What should be common to board evaluations is that the questions should seek to produce quantitative and qualitative measurements.
The board of directors decides when the board evaluations should be performed. In making this decision, corporate bylaws may require evaluations to be done at a certain time of year, according to a certain stage in the board cycle. Most corporations find it beneficial to schedule board evaluations consistent with the annual planning cycle. Other corporations tie their board evaluations to the strategic planning process. Either way works, as long as it happens.
How to Properly Use Board Director Questionnaires and Evaluations
To get the maximum benefit from board director evaluations, there needs to be a strong commitment from the entire board to approach the process with due diligence. Following through with this commitment requires strong leadership skills by the team that implements the evaluation process. Many corporations assign this duty to the governance or nomination committee. Throughout the process, board directors need to be reminded to resist the temptation to mark boxes hastily, rushing through their questionnaires. Board self-evaluation is a process that necessitates adequate time and fidelity to be meaningful.
Board committees can do a very simple thing to improve the quality of their board questionnaires. By periodically changing the questions on the questionnaires, and customizing them to meet the changing needs of the corporation, boards make the process more purposeful and prevent it from becoming a rote exercise.
Corporations sometimes hire external experts, consultants or advisors to help with board evaluations. Independent experts bring fresh perspectives and new approaches to the process, making questionnaires more customized and transparent. Boards can utilize third parties as independent leaders or as committee assistants that help to identify areas to evaluate and prepare useful questions using a rating scale.
Independent consultants may also help to facilitate and lead discussions. In addition to completing questionnaires, some corporations elect to conduct one-on-one board director interviews. The purpose of individual interviews is to gain comprehensive information and to help to analyze responses from the questionnaires.
The final step in the board evaluation process is to report the results to the full board and spend some time in deliberations about how they can use the results to develop action plans.
Getting the Best Outcomes From Board Director Evaluations
It’s important to remember that one of the main purposes of board director evaluations is to illuminate actionable areas where the board can improve upon its work. After the board identifies its action plans, the committee in charge of evaluations should re-evaluate them periodically to ensure progress.
Action plans may apply to individual directors such as providing them with additional opportunities for board training. The results of the evaluation process may also indicate the need for action for the full board, such as changing the demographics of the board or developing new amendments to board processes. The results of board evaluations may also indicate the need for dissolving certain board committees and establishing new ones. One of the more difficult issues that can result from board evaluations concerns board dysfunction. Independent advisors can be a significant asset in resolving internal problems within the board.
Investors and regulators will be assessing the board to see if they take the final crucial step of implementing changes as a result of the evaluations.
Boards should be prepared to respond to shareholders’ concerns about governance failures, rising age limits for board members and term limits.
Another important part of board evaluations is disclosure. Again, there’s no universal approach here. Boards may disclose their results by merely explaining the mechanics of the board evaluation process or by completing a summary of the key takeaways.
During the board evaluations, the board and management should give the process their full attention and pursue it with objectivity. Ideally, the board will already have a high level of trust among its members. Trust and confidentiality are the most important components to open the climate for candid discussion and objective feedback, and they are essential for successful board evaluations.