Board evaluations have long been standard practice among public companies. With shareholder interest in corporate governance practices at an all-time high, the focus on board evaluations is expected to increase. Given that board evaluations can be an effective tool to improve board and company performance, now may be a good time to review your company’s current board evaluation process and the disclosure of that process.
The Evaluation Process
A recent study by PwC found that 63% of directors believe self-evaluations are mostly a “check the box” exercise. This attitude may stem from the fact that NYSE listed companies are required to conduct evaluations on an annual basis. (See NYSE Rule 303A.09; NASDAQ does not require an annual evaluation.) That means that a significant number of boards may be missing out on a valuable opportunity to identify issues with and improve on various board functions. Evaluations may provide helpful information about how the board conducts its meetings and interacts with management, what type of board education programs are needed in the upcoming year and whether the current structure of the board is appropriate in guiding and executing the company’s strategy. The evaluations may identify small changes, like changing the order of items on board meeting agendas, or more substantive areas for improvement, like a gap in expertise and the need to add a new director.
Because the process should fit the board’s culture, there is no one-size-fits-all approach to designing effective board evaluations. Furthermore, a process designed years ago may no longer fit the current culture and strategic goals. Therefore, it is necessary to re-evaluate from time to time the effectiveness of the process and implement any necessary changes.
In taking on this challenge, you should consider the following:
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What is the current culture? Are director interactions formal or informal? Are there clear leaders and followers? Does anyone unduly dominate the meetings? Are there factions (activist investor or private equity fund designees, long-tenured versus recently elected, etc.)? Do some directors seem passive or prefer anonymity?
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What are the objectives? Has an area of concern (like lack of board alignment) been identified? Or is the board engaging in the process to determine what, if anything, might be done better?
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Who will be evaluated? The board as a whole? Each committee? Will individual directors review each other? Will individual directors perform a self-evaluation? Will the board solicit the opinion of members of management that have regular contact with the board?
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Who will do the evaluating? Recent trends show a slight increase in the retention of external advisors to conduct the evaluations, but the majority of public companies still employ an internally driven process lead by either the Chairman, Lead Independent Director, Chair of the Nominating and Corporate Governance Committee or General Counsel.
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How will they be evaluated? Typically, evaluations are conducted using written questionnaires or interviews. Written questionnaires may include any combination of a standardized survey of questions, comment sections meant to facilitate the explanation of the standard survey of questions and open-ended questions intended to solicit feedback. Interviews may be conducted on an individual basis or in a group setting. The objectives of the evaluation will dictate the content of questions being solicited. And the questions should be refreshed on an annual basis to ensure they are relevant and effective.
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What will be done with the results of the evaluations? This will partially depend on the method of evaluation but may include a discussion of the results, a memo summarizing the results or an individual meeting with each director. The company should also use the results of the evaluations to resolve issues, make changes and achieve goals.
While the benefits of board evaluation are widely accepted, it is important to consider how such evaluations may impact the collegiality and trust that is vital for board room discussions, along with what, if any, impact the board evaluation process may have on director candidates. Another consideration in designing the process is how evaluation material could be used in litigation and what the board can do to mitigate that risk. On one hand, it is important for the board to develop a written record that demonstrates that the board acted deliberately in conducting evaluations. On the other hand, questionnaires and other evaluation material are discoverable and may contain damaging information regarding board performance. Accordingly, it is important to consider whether questionnaires and other evaluation material need to be retained after the evaluations have taken place. Regardless of whether the evaluation material is retained or not, it is important that the board apply this policy consistently for all evaluations – good or bad – year after year.
Enhancing Disclosure of Board Evaluation
While most U.S. public companies have a board evaluation process in place, the disclosure explaining the evaluation process (whether in the proxy statement of corporate governance guidelines) is minimal. Recently, however, the Council of Institutional Investors released a report entitled Best Disclosure: Board Evaluation, which delineates two approaches for disclosing board evaluations that the Council believes are helpful to investors. The first approach describes the board evaluation process and the mechanics of the board’s self-evaluations. The second approach provides not only a description of the process employed to evaluate the board, but also the takeaways and results of the evaluation.
One U.S company that has presented a more in-depth description of its board evaluation process is General Electric. The disclosure does not appear in the company’s proxy statement, but instead it is contained in its “Governance and Public Affairs Committee Key Practices” document. General Electric’s proxy statement provides a high-level overview of the process and directs shareholders to the “Governance and Public Affairs Committee Key Practices” document by providing a link. An excerpt from the disclosure is provided below:
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Method of Evaluating Board and Committee Effectiveness. The committee will oversee the following self-evaluation process, which will be used by the board and by each committee of the board to determine their effectiveness and opportunities for improvement. All of the board and committee self-evaluations should be done annually at the November board and committee meetings. Every October, an independent expert in corporate governance will contact each director soliciting comments with respect to both the full board and any committee on which the director serves, as well as director performance and board dynamics. These comments will relate to the large question of how the board can improve its key functions of overseeing personnel development, financials, other major issues of strategy, risk, integrity, reputation and governance. In particular, for both the board and the relevant committee, the process will solicit ideas from directors about:
a. improving prioritization of issues;
b. improving quality of written, chart and oral presentations from management;
c. improving quality of board or committee discussions on these key matters;
d. identifying how specific issues in the past year could have been handled better;
e. identifying specific issues which should be discussed in the future; and
f. identifying any other matter of importance to board functioning.
The independent expert in corporate governance will then work with the committee chairs and the lead director to organize the comments received around options for changes at either board or committee level. At the November board and committee meetings, time will be allocated to a discussion of – and decisions relating to – the actionable items.
Robust disclosure of the board evaluation process is not yet common practice. However, shareholders value the board evaluation process and are eager for details about the process, what the board has learned from the process and how the board intends to address issues or objectives identified in the process. Accordingly, companies should expect to receive more interest (or pressure) to adopt a more formal evaluation process and provide more robust disclosure about the process.
Whether to address existing board effectiveness issues, to simply update outdated processes or to anticipate increased shareholder interest in board functionality, now is a good time to review your company’s board evaluation process and related public disclosures.
