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Board Evaluations: Good Defence & Good Offence

Concerns regarding board effectiveness have recently escalated among institutional and activist investors, prompting inquiries into board tenure, term limits, and performance evaluation methods.

Questions like “How long have these individuals served on the board?” and “How can we assess their performance?” are compelling boards to reevaluate their stewardship ratings.

However, despite external scrutiny, most board members believe they fulfill their duties satisfactorily.

In a collaborative study with the Rock Center for Corporate Governance at Stanford University, nearly 90 percent of directors asserted that their board possessed the requisite skills and experience to oversee the company effectively.

On average, directors rated their boards a four out of five for effectiveness, with 73 percent affirming that individual directors were highly proficient.

Despite this perceived competence, there are discernible fissures in board functionality.

Only half of the surveyed directors (52 percent) felt their board effectively addressed underperforming or misbehaving members.

Similarly, just over half (57 percent) believed their board efficiently recruited new talent to refresh capabilities before becoming obsolete.

The acknowledgment by nearly half (46 percent) of directors that certain board members wielded disproportionate influence highlights the disparity in power dynamics.

While more vital directors typically exert more influence, vocal but less qualified members may sway decisions, leading to a scenario where passive yet competent peers yield to their assertive counterparts.

The Underperforming Director — A ‘Third Rail’ For Boards

Indeed, one of the most notable revelations from our study was the desire among directors to remove underperforming peers from their boards.

When asked how many fellow directors they would consider removing due to ineffectiveness, 28 percent cited one director, 18 percent mentioned two directors, and eight percent indicated three or more directors.

The reasons for such sentiments vary, ranging from professional factors, such as outdated expertise, to behavioral issues, such as overly aggressive or passive engagement in board discussions.

Addressing the issue of underperforming directors, however, presents a delicate challenge in the boardroom.

While some directors are highly valued and deemed irreplaceable, others may cling to their positions despite diminishing contributions.

With the average tenure of public company directors spanning nearly a decade, confrontations with long-serving colleagues are understandably unwelcome.

Compounding the problem is the failure of many boards to conduct regular performance evaluations of individual directors.

Without proper assessments, underperforming directors may linger beyond their effective tenure, diminishing the overall efficacy of the board.

Left unchecked, such situations can become toxic, leading to outright dysfunction. Consequently, negative boardroom dynamics can attract investor scrutiny, prompting boards to adopt defensive postures.

Also, Read: Are You As Ethical As You Think?

Getting Into Diagnostic Mode: Doing Evaluations Right

To prevent dysfunction from taking hold, the chairman or lead director must adopt a diagnostic approach and take evaluation results seriously.

Leading boards already embrace rigorous annual performance reviews, moving beyond compliance-driven assessments.

A comprehensive evaluation should address overall board performance and individual director contributions, aiming to identify and rectify behavioral and procedural issues.

Just as CEOs assess their teams annually, boards should conduct similar evaluations to gauge governance effectiveness, skill sets, and relevance of experiences.

Feedback is essential for directors to grow and enhance their effectiveness. Some directors may find more excellent value elsewhere, and retaining them when they’re not contributing significantly doesn’t benefit the company or the director.

Our extensive work with boards globally has identified common traits of successful board evaluations.

Success isn’t just about following the evaluation process; it’s about genuinely assessing what the board does well and where improvements can be made. Effective evaluations focus on how the board can enhance its company governance.

Drawing from successful board evaluation processes, here’s what has proven effective:

Investment From Board Leaders In The Process: Instead of limiting the evaluation to a strictly legal perspective, the board should approach it emphasizing leadership development and governance enhancement.

Board leadership must take charge of this process, demonstrating a top-level commitment by entrusting the evaluation to the chair, lead director, or chair of the nominating/governance committee, who should drive the assessment and endorse any necessary improvements.

Assessing Both Individual And Team Performance: The board should pose challenging inquiries beyond governance procedures and explore individual director performance, qualifications, contributions, and collective effectiveness.

Queries may include: How can the entire board enhance its effectiveness? Are all members making equivalent contributions?

What improvements can be made to the board’s interaction with management?

Does the board possess a comprehensive understanding of the market and customer segments?

Is the board clear about its role, ensuring appropriate management oversight without delving into micromanagement?

Taking Into Account The Future Needs Of The Company: The company should assess whether the board’s composition aligns with the business requirements in the short, medium, and long term, such as one, five, and ten years into the future.

One method would involve creating a matrix outlining the requisite experience, skills, and industry or market insights necessary for the company to implement its future strategy effectively.

This matrix can then be compared against the competencies of the existing board members.

THE BEST BOARDS ARE ALREADY ADOPTING RIGOROUS ANNUAL PERFORMANCE REVIEWS AND MOVING PAST MERE COMPLIANCE-DRIVEN, CHECK-THE-BOX EVALUATIONS.

Consistent Standards Applied To All Directors: Seeking to address ineffective behavior by an individual director, such as monopolizing boardroom discussions or failing to contribute adequately, requires a delicate approach.

Boards can mitigate potential contention by gathering individual feedback for each director, ensuring no single director feels unfairly singled out for criticism.

Documentation Of Evaluation And Next Steps: A summary of the evaluation process should be meticulously prepared, outlining the methodology employed and general observations gleaned.

To mitigate potential sensitivity and liabilities faced by directors, it’s imperative that the summary refrains from making any conclusions or assertions of incompetence, wrongdoing, or failure to perform.

Each director’s specific feedback should be structured uniformly, accompanied by individual calls to action aimed at collectively enhancing the performance of the overall board.

This approach ensures that feedback is constructive and conducive to fostering a culture of continuous improvement among board members.

Education And Structural Support For Directors: Periodic sessions should be convened to enhance the board’s comprehension of industry trends, market dynamics, macroeconomic factors, and broader leadership issues.

Instituting policies such as rotating committee memberships and establishing protocols for addressing underperforming board members can establish a framework for enhancing director effectiveness.

By subjecting themselves to the same rigorous assessment process applied to management, boards can fortify their efficacy and demonstrate their commitment to prudent governance practices.

These self-assessment endeavors not only underscore the board’s dedication to process, engagement, and excellence but also exemplify a proactive approach to governance.

Moreover, such assessments signify diligence and foresight, potentially preempting future challenges.

As investors increasingly assert their influence in advocating for board changes, evaluations serve as a tool for defensive and proactive measures, allowing boards to address concerns systematically and implement necessary changes.

You Might Like To Read eDiscovery: Best Practices in Global Financial Services Organisations.

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