Evaluating the Board of Directors: International Practice
It has become a familiar refrain post-Enron and post-2008 Financial Crisis that to be truly effective, the board of directors of a company needs to increase its role in the area of risk management and managerial oversight. But legal systems around the world increasingly recognize that boards also have a vital role to play in giving strategic advice and support to senior management.
A well-functioning board provides companies with a clear competitive advantage. Such a board can help build connections with government, society and other stakeholders. They can assist company leaders in making better decisions and avoid tunnel vision by providing them with relevant information on the current state of the business environment in which they operate. Boards can also facilitate the identification of new business opportunities or provide a better sense of their peers and competitors. Finally, pro-active board members with diverse and relevant expertise can help business leaders in identifying “expertise gaps” on their executive teams. It is in this context where a well-functioning board can have the most impact on a company’s business strategies and capacity for innovation.
However, many board members complain that there is not enough time to discuss future strategic direction, innovation, or value creation. It is an often-heard complaint that board members of listed companies spend most of the time at board meetings discussing issues related to past-performance and regulatory compliance. In such a context, the ability of board members to add genuine strategic value is severely compromised.
This is not to understate or dismiss the monitoring function. Obviously, in a contemporary regulatory context, it is vital that a board devotes energy to monitoring compliance. However, it is equally important to stress the value of board diversity and, in particular, the importance of board members that can help develop new business strategies in partnership with senior executives. After all, such procedures are crucial to the long-term success – possibly even the survival – of any firm.
In our new paper, Evaluating the Board of Directors: International Practice, we begin by arguing that the performance and effectiveness of a board need to be measured along “four dimensions,” namely:
• The quality of the monitoring and risk-management role.
• The quality of the strategic and other business-related advice.
• Board dynamics and board members’ pro-active participation.
• Board composition and diversity.
Such a framework recognizes the multiple functions that a board needs to perform in a contemporary context and moves beyond the control-oversight function that often dominates the current discussion.
Board evaluation – measures implemented by a company to gather information on board performance – is, therefore, a vital tool in assessing board performance along these four dimensions. Since this type of internal evaluation can help improve the effectiveness of a board, it should come as little surprise that many countries are increasingly implementing rules and regulations regarding such evaluations.
Our paper provides an overview of current international practice regarding board evaluation and identifies best practice in this field. Twenty jurisdictions are examined, and five different regulatory approaches are identified, ranging from no formal regulatory action through to those jurisdictions that have introduced a combination of formal measures supported by informal guidance and case studies.
The paper concludes that the most valuable and useful board evaluation exercises are built around four fundamental principles. These principles offer answers to the following questions:
• When should a board be evaluated? Don’t wait for problems to initiate evaluate but institutionalize systems for a continual process of self-evaluation.
• What should be evaluated? Give equal weight to all “four dimensions” of board performance and don’t over-emphasize the compliance-risk management function.
• Who should conduct the board evaluation and how should it be implemented? Ensure that diverse perspectives, criteria and data-collection/analysis methods are integrated into an open and inclusive evaluation process.
• How should the evaluation be disclosed/reported? The style and format of reporting-disclosure of the results of the evaluation should be seen as an opportunity and not an obligation.
The main conclusion is that “Done Right,” the board evaluation process is not just another formality in the corporate governance of a company but can provide a significant opportunity for self-learning and improved performance.