Frankfurt
How effective is your Board Evaluation?
Too many companies still evaluate board effectiveness in the past tense. The question “Why was the board not effective?” often carries significant reputational and legal risks. Wouldn’t it be better to focus on the present and the future and ask, “How effective is your board?” and “How does your board contribute to value creation? This is even more true in times of constant change, multiple crises, and geopolitical shifts, where the complexity and risks that boards must deal with have increased. Based on our extensive experience in board evaluation, benchmarking, and assessment for globally recognized organizations, we have summarized the changing requirements for board evaluation and developed suggestions on how to improve the impact of your next board evaluation.
The need for board evaluation and board review has increased dramatically
Board evaluation is becoming increasingly important due to pressure from key stakeholders:
Investors & Proxy Advisors: Investors are becoming more demanding, and perceived board weaknesses are increasingly attracting activist investors.1 The proxy advisor era has significantly increased the pressure on board effectiveness. Companies are being asked to demonstrate their belief in board effectiveness and value creation through high-quality evaluations, and to use these as an opportunity to reflect on board composition.
Regulators, rating agencies and the public: Regulators and rating agencies are increasingly demanding objective evaluation of board performance. ESG ratings are increasingly scrutinizing the quality of the board evaluation process with respect to sustainable corporate governance. In addition, board evaluation is increasingly becoming a standard of good corporate governance, as reflected in numerous recommendations and corporate governance codes.
CEOs and Management: CEOs and senior management are strong advocates of robust board evaluations, as an effective board also acts as an advisor to management, providing expertise in difficult decision-making situations. We recommend actively involving CEOs and senior management in the board evaluation process and seeking independent and objective advice. In our experience, involving the executive committee helps to initiate changes that not only improve board and management collaboration, but also have a lasting positive impact on the company’s value creation.
A board effectiveness review is an opportunity to step back and reflect on the culture and goals of the board. We believe there is no one-size-fits-all approach to board evaluation. However, boards should be aware that the effectiveness of board evaluations varies widely. Essentially, the effectiveness of the evaluation is determined by the issues of framework, priorities, methods, responsibilities, and the concrete implementation of the results.
What evaluation criteria does your board evaluation strategy focus on? What priorities do you set for your evaluation?
Effective board reviews evaluate performance on three levels: the board as a whole, the committees, and individual directors. Investors2 increasingly expect an evaluation that provides a complete picture of the board’s effectiveness. The integrated approach to board evaluation, which provides feedback on performance at all three levels, provides the best evidence and the greatest potential for improving board effectiveness and is now best practice among listed companies. More than half of the companies listed in the Stoxx 50 use this integrated approach to define the evaluation framework.
A board’s effectiveness is largely determined by its goals, structures, processes, and people. Board reviews should therefore take a holistic view of a board’s objectives, its structure, how it works, how it allocates its limited time to issues, and the culture of discussion. Too many board evaluation processes are still too process-centric. However, board performance is not determined by agendas and guidelines, but rather by the strategic direction and overall dynamics of the board, the way members interact with each other and with stakeholders, and the experience and expertise of individual members. An evaluation of the board should therefore be comprehensive, focusing on objectives, structures, processes, and people, and should go beyond the completion of checklists, so that concrete proposals and measures can be derived from valid findings.
In our experience, a comprehensive evaluation of the strategic orientation of the board and its committees against the backdrop of the company’s strategic orientation and intended development as well as future trends has proven to be useful. Another focus should be an analysis of the dynamics and culture of the board and its committees, as well as the dynamics among the members, with particular emphasis on the discussion culture. In addition, it has been shown that gaps in experience and expertise on the board lead to blind spots and expose the board to risk, especially when it comes to future issues such as technology and sustainability.
Through this comprehensive approach, boards can use the evaluation process as a benchmark and gain insight into how the board compares to its peers in terms of effectiveness, the extent to which it is addressing the changing priorities of investors, and whether the board’s strategic direction and existing experience and expertise are correctly positioned for future trends.
What methods do you use in your evaluation and how do you ensure its validity?
The way information is collected plays a key role in the quality of the board evaluation. Online questionnaires have their place, but they need to be used correctly and are not a sufficient method on their own. Online questionnaires are best used to formulate the key issues facing panel members and use the results as a starting point for structured face-to-face interviews to explore the key issues in more depth. Analytically valid assessments provide important insights, particularly at the level of the individual board member, but are limited in their power because assessments that merely reveal differences in mean scores do not provide meaningful insights or opportunities for improvement because the sample size simply cannot provide statistically significant data. Face-to-face interviews provide the nuance that any valid evaluation requires and are the foundation of any robust and effective evaluation. A comprehensive and robust board review should also include other data points such as minutes, voting patterns, member biographies and mandates, etc. In our experience, the best combination of methods depends on the specific situation.
Who is responsible for managing and conducting the evaluation process?
The number of companies using an independent third party to evaluate their board has tripled in the last five years. This is primarily due to pressure from investors, who increasingly expect more professional, objective, evidence-based and independent evaluation processes. Second, more and more boards are realizing that an evaluation by external consultants can provide them with in-depth insights and recommendations, particularly on how to improve the board’s performance and effectiveness.
In our experience, the best results are achieved by combining an annual self-evaluation with a comprehensive evaluation by external consultants every two or, at the latest, every three years, bearing in mind that the internal evaluation process needs to be regularly developed and adapted to changes to remain effective and to set the right priorities. The external evaluation should be used as a comprehensive assessment that goes beyond the corporate governance situation and analyzes and evaluate the strategic direction of the board, the experience and skills gaps in light of the company’s strategy and trends, examines the cooperation with management and focuses on the dynamics and culture of the board and its committees as well as the dynamics among the members.
In our experience, third parties should always be involved in such comprehensive board evaluations because, even with the best of intentions, there are limits to how objective internal people can be and how much openness can be expected. In addition, internal people often lack benchmarks and best-practice examples, which means that the information gained cannot be put into the right context, wrong conclusions are drawn, or inappropriate approaches are developed.
How are the results of the board evaluation translated into action, and how is implementation ensured?
New insights and the identification of opportunities are not enough. Any board review should therefore be seen as part of a broader, iterative evaluation process to improve the board’s effectiveness and efficiency, not as a one-off outcome. To achieve effective results and bring about change, progress should be continuously monitored and evaluated as part of the multi-year evaluation cycle.
Failure to evaluate boards is one of the most common reasons for our engagement. Time and again, we see committees presented with a list of ideas that do not consider implementation risks or scaling opportunities; often, the ideas and concepts are not prioritized or simply impossible to implement. With a sensitive topic like evaluation, it is also extremely important to present feedback and actions in a way that does not create mistrust or damage collegiality. Unsuccessful evaluations often have a significant impact on the dynamics and effectiveness of the committee, so issues should be discussed in a forward-looking manner with experienced experts and actions should be presented in a positive light.
Most of our clients rely on a comprehensive evaluation every two to three years and use the evaluation process not only to set priorities for the coming years, but also to critically review strategic direction and as a starting point for board succession planning, identifying specific skills and experience that should be replaced as members leave the board.
Authors
1 – ISS “Board refreshment is best implemented through an ongoing program of individual director evaluations, conducted annually, to ensure the evolving needs of the board are met and to bring in fresh perspectives, skills, and diversity as needed.”
– Glass Lewis “Glass Lewis strongly supports routine director evaluation, including independent external reviews, and periodic board refreshment to foster the sharing of diverse perspectives in the boardroom and the generation of new ideas and business strategies. Further, we believe the board should evaluate the need for changes to board composition based on an analysis of skills and experience necessary for the company, as well as the results of the director evaluations, as opposed to relying solely on age or tenure limits.”
– Vanguard Vanguard believes that “regular and meaningful evaluations enable boards to analyze their current composition and identify opportunity areas.”
– BlackRock “Board composition, effectiveness, diversity, and accountability remain top priorities.” Supports robust evaluation practices and disclosure.
– State Street Global Advisors SSGA views “board quality as a measure of director independence, director succession planning, board diversity, evaluations and refreshment, and company governance practices.”
– Northern Trust “Boards should, on at least an annual basis, formally evaluate the CEO, the board as a whole, and individual directors. Evaluation of the board as a whole should consider the balance of skills, experience, independence, and knowledge of the company on the board relative to the company’s long-term strategic plan. Evaluation of the board should also consider the board’s diversity, including gender, how the board works together as a unit, and other factors relevant to its effectiveness. Individual evaluation should aim to show whether each director continues to contribute effectively and to demonstrate commitment to the role.”
– Legal General Investment Management LGIM believes “the evaluation of directors is an essential way of improving board effectiveness and ultimately its performance. It is also a way for investors to determine the quality of debate and interaction between board members… LGIM expects an internal board evaluation to take place annually… External reviewers can also bring different perspectives on the functioning of the board, as well as experience of how other boards operate.”
2Council of Institutional Investors: Board Evaluation Disclosure, January 2019
