By Oliver Parry, Senior Advisor on Corporate Governance at the Institute of Directors
The UK Corporate Governance Code, first published in 1992, makes clear that an effective board is one that provides entrepreneurial leadership within a framework of prudent and effective controls. The board must also promote its collective vision of the company’s purpose, its culture, its values and the behaviours it wants to see from the firm’s executive team.
These ideas are now the mainstay of corporate governance in the UK and are crucial if the modern board is to adapt to the increasingly complex challenges they face. Put simply, the importance of board effectiveness is rising at the exact same time as the pressure placed upon them is on the rise. While many boards are alive to these challenges, and undertake boardroom evaluations in order to assess their effectiveness, many have fallen short of what we have come to define as the standard for an effective board. In a report published in April 2015, EY and The Investment Association argued that two key areas were crucial for a board to be effective. First, boards must keep up to speed with a rapidly changing business landscape and understand changes in best practice. Second, as simple as it may sound, board members must talk to each other, share ideas, experience, successes and failures.
This argument, hardly revolutionary, has been around for some time, but its importance is as high as ever – especially when it comes to succession planning. Ask any chairman, non-executive director or governance professional and they will usually tell you it takes time for a new board director to adjust to the company culture, the ways of the board and their specific role around the table. Some argue that it can take up to year and, as companies grow increasingly complex, sprawling across sectors and time zones, this is certainly the case in the FTSE 100. Putting the time aside to not only pick the right candidate, but also prepare the rest of the board for their arrival and make sure they hit the ground running is a role for the most senior figures.
Handling uncertain futures
The future is, of course, inherently unpredictable and sometimes new board directors don’t have the time to adjust. Take, for instance, the appointment of Carl-Henric Svanberg, current chairman of BP. Carl-Henric joined shortly after the Deepwater Horizon disaster. Within a few days or weeks, he was compelled to meet the President of the United States to explain BP’s response to the crisis.
That the future is unpredictable and the fact that businesses are more complex than ever before means that an effective board is pivotal to a company’s long-term success and sustainability. There remains extensive discussion among boards, investors and regulators about the issues that contribute to board effectiveness and, more crucially, how boards can evaluate their progress.
In order for a board to be truly effective, the chairman needs to nurture conditions that allow non-executive directors and board committees to function in a way that promotes the long-term interests of a company. This requires inclusive leadership, contributing to the selection of board members, structuring and leading discussions and managing his or her time and their ‘bandwidth’ across multiple roles – in other words, how thinly are they spreading themselves across multiple directorships and positions that put a demand on their time? This is important, especially as so many chairs hold a number of board mandates in various companies, in differing sectors and jurisdictions. As such, a chairman needs to continually assess their own availability in light of the likely needs of the companies they serve.
“In order for a board to be truly effective, the chairman needs to nurture conditions that allow non-executive directors and board committees to function in a way that promotes the long -term interests of a company”
But ensuring board effectiveness is not just a role for the chair. Non-executive directors should constructively challenge the overarching strategy of the business. As such, non-executives themselves play an absolutely crucial role in both sustaining and improving board effectiveness. Directors can not only challenge executives and hold them to account but also use their own experience to influence strategy. The pressures on non-executives, as well as chairs, is also on the up, as they are expected to take a lot more responsibility for their actions, both from shareholders and regulators.
This means they have to think carefully about how much work they take on and what type of training and development they need. It’s important to remember that a notional 40-day-a-year board commitment could easily take twice as long. One need only look at recent corporate governance scandals to see how busy even the non-executives are.
This begs the question, however, of what makes an effective non-executive director. One theory is that inexperienced NEDs can become effective under a good chairman; however, boards can be a strange and intimidating place for a novice. You often find that the most outspoken and opinionated former chief executive, carrying out their first board mandate, suddenly loses their voice. As such, non-executive directors need a combination of training, mentoring and exposure to the board. This should take place continually throughout a non-executive’s career, not just for a few months at the beginning.
We have heard much in recent years about the importance of gender diversity on boards. It is both right and a great achievement that in little over four years female representation on FTSE 100 boards has doubled to more than 25 per cent. Diversity contributes to the effectiveness of a board, especially in terms of its impact on the atmosphere at the top table of our largest organisations.
According to EY, “many chairmen initially appointed female NEDs to the board in order to comply with the Davies Review, but the appointments have brought significant benefits”. In particular it cited the quality of discussions on specific issues, an enhanced ability to consider issues from different perspectives, and more openness to asking probing or searching questions. Increased boardroom diversity is having a great impact on more accurately reflecting their organisation, customers and wider society.
Management consultants will tell you the ultimate measure of board effectiveness is company performance. However, as recent scandals have shown, such as the one at Volkswagen, results over the short and even medium-term can be an illusion of how well a board is performing its duties. It is important that board evaluations, therefore, are not unduly influenced by a good – or bad – set of quarterly results.
The UK Corporate Governance Code specifically details that boards must undertake a formal and rigorous annual evaluation of their own performance, their committees and individual directors. Every three years FTSE 350 companies are required to undertake an “externally facilitated board evaluation at least every three years”. This practice is also widespread in Canada, France, the United States, Spain and Italy. It is also gaining support in the Asian markets. When done well, board evaluations provide a forum for directors to review and reinforce appropriate board and management roles and ensure that issues that may lie below the surface are identified and addressed promptly. Ultimately, evaluations give the board an opportunity to identify and remove obstacles to better performance and, importantly, highlight best practices.
Companies and the boards that govern them are facing increasingly complex challenges. Running a bank today is completely different to running one in 2007: regulation has increased and media and shareholder scrutiny is sharper than ever. Technological innovation is also rapidly changing and this is having an impact on how companies operate and how they are managed. One need only look at the recent spate of cyberattacks in the UK and US as an example of this rapid change. To deal with these challenges – and whatever the next ones on the horizon may be – it has never been more important to have a cohesive, prudent and effective board.
About the Author:
Oliver Parry is Head of Corporate Governance Policy for the Institute of Directors. He joined the IoD in June 2014. A former communications director at the Financial Reporting Council (2011 – 2013), he has previously worked for Redleaf Polhill, a leading investor relations and advisory firm in the City of London and for Cicero Consulting, where we advised a range of blue chip FTSE 100 companies on their corporate affairs. Oliver began his career working for Patrick McLoughlin in his parliamentary office and also has a stint at Conservative Party Central Office. He read History at Newcastle University.