Why Conduct Board Evaluations?
Credibility with the Investment Community
In our first article in this series we referenced a 1998 Russell Reynolds survey of the best institutional money managers. That survey reports that 70% of those institutional money managers in the US alone have made decisions not to invest in a company because of poor corporate governance practices. With so many companies losing significant stock evaluation in 2000, investors are looking to make more prudent decisions based on the soundness of the companies, which is a product of the quality of leadership the companies receive, including a board’s effectiveness.
Recruiting Capable Directors
In 1999 Korn/Ferry published the 26th Annual Board of Directors Study of more than 1000 directors, including 215 CEOs. Respondents almost unanimously indicated one of the two dominant challenges facing boards over the next five years is finding enough qualified and diversified directors. Eighty-four percent of the respondents in the same study see a direct correlation between the quality of the board and shareholder value.
An effective and talented board is needed to attract other strong directors with specific competencies and expertise required to support the strategic direction of the company. Experienced and talented directors, especially those with CEO experience, are in great demand as potential directors; but they have limited time to serve due to the demands of their own organization. They are choosy and only want to be on a board that:
- makes it worth their time and energy,
- “feeds them” in terms of their own professional growth, and
- provides important links to their own business.
Weak boards do not meet the first two of these criteria and, therefore, often have difficulty in recruiting the level of competencies they need thus affecting the quality of the board and its correlated effect on shareholder value.
Retaining Strong Inside Executive Talent
Progressive CEOs that attract additional strong senior/executive level leaders become very frustrated with having to “kick the ball and drag the board.” They need a partner to be a sounding board in complex decisions and to be eyes and ears to a complex and changing external environment. These strong CEOs have other opportunities put in front of them and a weak board runs a serious risk of losing a strong CEO and the executive team which sees the barriers the CEO is encountering in a weak board.
Establishing Board Accountability
CEOs must hold executive staff accountable and to the extent he/she does not, the organization is likely to under perform. The board must hold the CEO accountable for achieving his/her performance expectations. If it does not, the organization is likely to under perform. The board is accountable to shareholders but must really hold itself accountable and, if it does not, the organization is likely to under perform. The board must also hold itself accountable for its own development.
As boards and CEOs talk about “raising the bar” a board must raise its own bar and create the optimal partnership with the CEO.
So Forming a Governance Committee and Governance Policies is Enough, Right?
Simply forming a governance committee does little to develop a board, especially a weak board. Policies that are not practiced are useless. Looking at organizations like Firestone and Texaco, and the challenges they have faced as a result of internal management decisions and/or neglect, one cannot help but wonder—-“Was the board doing its job?”
Fifty-six percent of the respondents in the Korn/Ferry study indicate they have a formal committee that reviews corporate governance processes and board operations. This is down from 58% a year ago but up from 41% in 1995. While boards may have governance committees, only 37 percent report that the performance of their board is formally evaluated on a regular basis. And while 73 percent of the respondents believe individual directors should be evaluated regularly, only 26 percent currently do so. This requires courage few boards demonstrate, even when they have a lot of weak directors. We very frequently encounter CEOs or progressive directors bemoaning the weak directors and the seats they take up on the board that could be filled with talent that adds value to the strategy.
The most progressive organizations do form a governance committee, which assumes the task of reviewing and/or developing governance policies. More importantly, these organizations are pro-active in assuring that the board has a process to evaluate its own effectiveness, and often that of the directors, in a regular e.g. annual, process.
Evaluation- a “Roadmap” For Development
The board needs a “roadmap” by which to develop itself and hold itself accountable. The best foundation for such a roadmap is an effective, regular board and director evaluation process. Such a process can:
- focus attention on the key factors which can improve board performance,
- shift the board’s paradigm about what it should be doing,
- enhance the effectiveness of the working relationship with CEO, and
- increase motivation of directors to learn, change and develop the board’s practices and the behavior of directors.
Boards that do not evaluate their own effectiveness run an increasing risk of developing the following:
- complacency;
- myopia;
- not being able to attract and retain quality directors and a quality CEO;
- limiting shareholder value by creating a skepticism among institutional investors as to the effectiveness of corporate leadership in the future; and,
- increasing director liability because of weak board and/or director performance.
The Korn/Ferry study indicated that 58 percent of those who do board evaluation report the process to be effective or very effective. Of course the degree of effectiveness depends on how it is done, the honesty of the directors in their assessment and the effectiveness of how they use the results.
Spencer Stuart annually publishes its Spencer Stuart Board Index, the oldest board survey of its kind including 100 leading edge companies and proxy analyses of S & P 500 companies. The Index reports that, “Awareness of the importance of board evaluations has grown markedly” with just less than half reporting having a formal evaluation process in place. Of those boards that have a formal evaluation process in place, 73% indicate that they evaluate the board annually.
The Evaluation Process
Board Evaluation
An evaluation process can assess the effectiveness of the board in following its own governance policies or in evaluating itself against the “best practices” of boards of high performance organizations. We recommend the latter, especially if a board is weak, has directors who have considerable tenure, directors who have not been on other boards (to see what other boards do well) or a board that has a “not invented here” mindset.
If you decide to lead a board evaluation process, there are some recommendations we can make that usually result in an effective and fair process. The process is effective in that it covers the issues critical to board and director performance and accountability and lays a foundation for the board to chart a targeted course for follow-up developmental action. It is also effective in getting directors to start to reflect on how they do what they do and the effects this has on corporate development and outcomes.
The recommended evaluation process is fair in that it gives all directors an opportunity to express their views as input into whatever decisions the board might make about changing its practices.
Setting and Evaluating Specific Performance Goals
We believe a board should set annual goals for itself, including board development goals, and evaluate its own effectiveness in achieving those goals. To enrich developmental insight, we also believe that for each goal, directors should be asked to reflect on what the board did that contributed most to their effectiveness in achieving the goal and what barriers did they encounter that limited goal attainment, if they fell short of the goal. These questions help a board reflect on what it is doing that is or is not working. This reflection in turn increases awareness and learning and the opportunity to create a “roadmap” for its development as a board.
All of this is important in the board holding itself accountable for effective fulfillment of its own role in achieving specific goals, just as the board should hold the CEO accountable for achieving his/her specific goals
Assessing How the Board Works
Beyond asking the directors to assess how the board did in meeting its own performance goals, it is most important to ask the board to reflect on how it does what it does. The board’s working processes strongly affect whether it has the effects it intends to have. The use of the best practices of effective boards is an appropriate benchmark for a board to use as a basis of self-reflection.
Not all board assessments allow directors to assess the board against “best practices.” As you compare approaches to assessment, look for the following elements.
Within the area of Information, ensure that it addresses such issues as:
- is the board is getting the information it needs,
- is the breadth of information required adequate,
- is the information accurate and timely, and
- does the information provided adequately keep the board abreast of external as well as internal issues.
Within the area of Board Meetings, ensure that directors have an opportunity to reflect on such aspects of the conduct of their meetings as:
- the extent to which meetings create an environment for honest expression of views from everyone,
- the extent of open-minded listening,
- the balancing of pace AND thoroughness in meetings,
- the adequacy of time spent on strategic focus, and
- whether directors attend meetings having done their homework and are prepared to discuss key issues.
Within the area of Board Composition, ensure that directors focus on such issues as:
- the manner and practices of the board that assure it has the breadth and depth of competencies it needs to support corporate strategy,
- the board’s process for attracting and selecting new directors,
- the board’s effectiveness in confronting less effective performance among directors, and
- the board’s effectiveness in making the best use of the competencies among directors.
Within the area of Board Accountability, see that directors explore issues regarding:
- how well the board fulfills its responsibilities and monitors its own effectiveness in doing so,
- effectiveness in accountabilities such as assuring alignment of company, values, purpose and strategy with business planning processes,
- how well the board evaluates the CEO,
- assuring that long and short term plans are realistic,
- the board’s effectiveness in monitoring progress on critical and strategic matters, and
- how well it holds itself accountable to fulfill its own roles and meet its own objectives.
Within the area of Relations Among Directors and with Management, see that directors reflect on questions regarding interpersonal relationships among directors and the culture that exists within the board. This would include:
- whether directors have norms of being willing to say what needs to be said to assure the best decisions are made,
- openness in communication with senior management,
- support of management after strategic decisions have been made, and
- sufficiency of comfort with each other to ask questions and offer advice.
Within the area of Board Mindset, ensure that it addresses such issues as the board’s willingness to:
- commit the necessary time to do a good job,
- change and to challenge assumptions, and
- put aside personal interest frontiers in the interest of the greater good and well being of the shareholders as a whole.
Director Evaluation
The Korn/Ferry Study indicates that while about 73 percent of all respondents believe individual directors should be regularly evaluated as to their performance, this study AND the Spencer Stuart Board Index both find that only about 20 percent actual perform such evaluations. “We should, but we don’t.” What if we heard that from our management? Would we accept that, especially when the focus of the day is, “We have to raise the bar”?
The best boards tend to use director evaluation as a part of holding themselves accountable and as a part of their board development process. Director evaluation is usually done by using either peer evaluation, self-evaluation or a combination of both. Our experience is that the combination is most effective because it creates a gap analysis between the way the director rates him/herself and the way peers rate him. This dissonance can create movement.
We recommend again using the “best practices” approach. This means directors rate themselves and/or others on behaviors that are observed by the directors of best boards. This sets a standard for “raising the bar” and educates directors while they reflect on these behaviors in themselves and among peers.
Peer Evaluation
Next to the combination that produces the gap analysis, the peer evaluation is strongest in providing the most insight to directors. However, most boards and directors do not have the will to “go there” in part because it may shake the roots of the “good ole boy” tree.
We suggest using a questionnaire of best practices and have each director rate each of their peers. We also suggest that there be private feedback to each director. It is helpful to introduce such a process the first time by providing feedback in a manner that each director will be the only one to see his/her results. It is a “freebie” that sets the code of behavior being evaluated. The next time, and for each subsequent rating, the nominating committee, executive, committee, governance committee or ad hoc evaluation committee will review results of all the directors’ ratings.
Self-Evaluation
This is better than no evaluation, but not as strong as peer evaluation. It may best be used as an introduction to the director evaluation process in general. In this regard, we recommend using the “best practices” having each director simply rate him/herself on behaviors that are observed by the directors of best boards. At least this begins to plant the idea of where the bar is and what the director should be considering about the effects of his/her behavior on the board.
Combination Peers/Self-Evaluation
The advantage of this approach is the gap analysis. Using the “best practices” approach, each director rates all the others AND him/herself on the same competencies. The report format shows a director how he/she was rated on each competency, the average rating of all the other directors combined on each competency and how that compares with the director’s self rating.
So What? Now that the questions have been asked.
The questions asked of the board stimulate reflection among directors. However, the real insight and development comes with the feedback of results that highlight trends, patterns and key perception differences. Our experience is that this cannot be done effectively as an agenda item at a regular board meeting. The greatest learning and potential for change occurs when the group focuses on the most relevant issues from the feedback at a meeting venue other than its normal setting e.g. a board retreat. This helps change the paradigms and expectations that this is not going to be another “business as usual” meeting.
The most productive route is to summarize the data and focus on the issues where the board sees itself as needing to improve. In setting up this focus we recommend feeding in the “best practices” of boards of high performance organizations on the areas identified by the board’s own ratings as areas for improvement. This particularly engages the interest of the most capable directors, makes the case for change to all the directors and spurs the stronger directors to influence the others through peer pressure.
After the board sees the results of its own data summarized, and the “best practices” are presented, the directors are led through a process of action planning to lay a course forward. This course reflects what it will choose to do differently and how it will monitor itself in doing so to hold itself accountable.
The Action Planning may include things such as changing in the way information is handled, how meetings are conducted, how strategic progress is monitored or how directors are selected and/or replaced.
Re-Evaluation
Research indicates that the best boards set objectives for their own development based on evaluation, such as that described above AND re-evaluate themselves annually to assess progress. Without some sort of re-evaluation, the board cannot very effectively hold itself accountable for evolving itself to align with and support the corporate strategy.
So What’s a CEO to Do? … Lead the Board
As a CEO, or progressive director, sees the need for the board to develop itself to effectively fulfill its role, the question becomes, “How do I get the board to determine that it needs to develop itself and what practices can be enhanced. A common paradigm among boards is the old, “If it ain’t broke, don’t fix it.” In today’s world, that kind of complacency is often catastrophic and increases director liability. The most progressive and capable directors expect healthy evaluation and are attracted to boards that employ such a practice on a regular basis.
The CEO, and/or progressive directors, owe it to the shareholders to challenge the board to be accountable for its own effectiveness. A key starting point is to establish a base line and a foundation for a developmental “roadmap.” The best course for shaping an effective roadmap is an effective evaluation, feedback and action planning process.
A key question for a CEO or strong director who sees a need to develop the board is how to get the board to commit to this course and follow through on it. A key starting point is forming an alliance between strong directors and the CEO to lay a course for doing this. A board evaluation can often be an important “next step” for boards that have already formed a governance committee. The executive committee may also play this role. The essential point is that the process needs leadership, not merely a mild proposal to a board, especially a weak or marginal board. The case needs to be made for board development and evaluation rather than taking a tentative stance of “What do you think guys?”
One option is to feed your strongest, most progressive directors with the information about what other good boards are doing, e.g. using some of the information we have cited in this series of articles. The executive or governance committee of your board is a likely candidate for reviewing this information. They also need to understand what will be involved in the evaluation process, help shape it and be prepared to stand behind it when the more cynical, intransigent or threatened directors start to resist it.
Assuming that almost all, if not all, directors see ways the board could be more effective in its role, each would like to be able to influence the board to make those improvements. An evaluation can be positioned as a way for all directors to express their views anonymously regarding the improvements they believe would help the board.
Where apathy or resistance is anticipated to the idea of doing an evaluation, it is often helpful to focus on development instead. To do this, the suggestion of having an off-site board retreat where board development is the key topic is helpful. Let them know it will include information about the “best practices” of other boards. You can then indicate that a helpful step in preparing for the retreat to help make it most relevant is to send out a questionnaire in advance for them express their views about the board as they see it. The focus on development, rather than assessment, generally feels less threatening and there is curiosity about what other boards do.
Richard Furr, Ph.D. is President and Lana Furr is Vice President of Furr Resources, Inc. For more information contact Richard Furr at rfurr1@triad.rr.com or visit www.boardanddirectors.com
