In 2004, the New York Stock Exchange adopted new corporate governance rules that require boards of listed companies to conduct annual self-evaluations. The purpose of these assessments is to determine how effectively the board and its committees are functioning and to determine if the board is living up to its fiduciary responsibilities to shareholders.
More specifically, board self-evaluations are primarily meant to help identify the board’s areas of expertise, and whether the board or individual members are lacking any critical skills. Secondarily, the evaluation should determine whether the board is using its time efficiently. The assessments also provide individual board members and committees with feedback on their performance, which in turn can be used to develop self-improvement plans. Perhaps most important, the evaluation process demonstrates to investors that the board is working to improve its governance skills and, by extension, it assures the owners that the board is paying attention to shareholder value. In that sense, the process may be considered invaluable. In fact, the exercise is becoming popular with boards of companies that are not listed on the Big Board, such as those listed on the Nasdaq Stock Market, which currently does not require listed companies to conduct a formal evaluation. A recent survey by Thomson Financial, conducted in conjunction with Directorship, found that 93 percent of those surveyed conduct an annual self-evaluation.
The current NYSE rules stipulate that a nominating committee made up of independent directors must oversee the evaluation process and that specific evaluations must be made of the audit, compensation, and corporate governance committees. After completing a self-evaluation, the listed company typically reveals the existence of a process and then provides a brief outline of that process in its annual proxy statement. The results, however, are not required to be published.
Where the NYSE rules fall short, however, is that they do not specify how the evaluation process should take place. There are no set guidelines for the questions that should be asked or the format for the assessment. In short, it is up to individual boards to formulate their own plans for evaluation. The lack of a set of rules around conducting an evaluation provides for flexibility, but it can also make the process more difficult. And since evaluations are a relatively new requirement, a set of best practices has yet to emerge.
A number of consequences must be considered before instituting any board evaluation program. For example, some board members might resent being evaluated by their peers or wince at the time it takes to conduct the process. Then there is the potential impact on unit cohesiveness. What would happen to the group’s ability to work together if one or two board members were to receive an unusually harsh review from their peers? A fair concern would be that such a confrontational approach might hamper the collegial atmosphere or cause animosity among the group. With that in mind, there are several things that companies can do to get their directors on board with the self-evaluation process. First, rather than focus solely on individual performance, although individual assessments are important, the evaluation process should primarily revolve around group dynamics. In other words, the evaluation should focus on questions and issues such as:
■ What are the board’s strengths and weaknesses?
■ Does the compensation committee, for example, meet often enough to fulfill its duties?
■ Does a particular committee receive and process information in an efficient manner?
■ Does a committee keep the board apprised of risks and uncertainties in the areas of its expertise and responsibility?
By focusing the majority of the evaluation process on the committee’s progress, as opposed to the individual’s performance, directors will likely be more accepting and will readily participate in the process. Group cohesiveness can also be a big selling point, since far too often directors are asked to sit on boards where the atmosphere is not collegial or where there is a lack of communication between individual board members. The evaluation process can help to improve communications by pointing out these deficiencies and demonstrating how they are hindering performance of certain committees or the board as a whole.
Perhaps the best way to get board members to buy into the evaluation process is to have them design or assist in designing the evaluation. According to the Thomson survey, 78 percent of respondents indicated that their boards help to construct the evaluation process. To that end, many boards either work independently or with an outside party to develop a list of topics that might be analyzed and which methodologies, such as surveys or interviews, will be used to conduct the evaluation.
There are benefits to designing the procedures internally. The most obvious is that it is cheaper than retaining outside counsel. The board also knows the company better than any outside party and should be better equipped to come up with a format to identify and assess the issues and concerns it faces. However, a third party, particularly if it has extensive experience within the industry in addition to experience with various survey methods, may provide the board with a fresh perspective and can often complement internal efforts.
The process
Generally, most boards select one of three methods, or a combination of each, to conduct their evaluation. The first method is the self-assessment survey, which, according to Thomson’s poll, is used by 82 percent of boards. As the name suggests, directors are surveyed or issued a questionnaire that asks their opinion on a variety of topics related to their personal development. The other methods are one-on-one interviews (used by 26 percent of the sample group) and group question-and-answer sessions (31 percent).
Regardless of the format, questions often revolve around the director’s ability to interact with other members of the board. They may also probe how the individual board member has responded to particular events. The purpose of this line of questioning is to get the directors to identify their strengths and weaknesses and to use that information to develop self-improvement plans.
Specific questions may include the following:
■ Do I communicate and share information with fellow board members often enough and effectively?
■ Am I making my thoughts and concerns known on key issues?
■ Am I an asset to the board in the sense that I regularly contribute new ideas and genuinely help guide the company as necessary?
■ Am I willing to take a stand on an issue even if it is unpopular or contradicts the board’s thinking?
■ Do my abilities, background, and experience complement the board?
Sometimes these surveys are collated and then shared with other board members. But most of the time, these evaluations remain private. Only the director and a board member chosen to review the surveys are privy to the information. The chosen board member will then relay the director’s concerns to the governance committee or the board chair but, again, on condition of anonymity. By conducting the survey in this manner, a more thorough, candid response may be elicited.
Some boards will also use surveys to evaluate the board as a whole. Under this method, surveys are given to individual directors. The surveys are often filled out anonymously and revolve around the performance of the overall board. Individual questions tend to be more open-ended and seek fairly specific comments about how board members think that certain committees, or the entire board, might use their time more efficiently. The responses are typically presented to the board at a formal meeting. Responses may be reviewed individually, but again they are typically kept anonymous.
The least-used board assessment method is the peer evaluation. With this approach, each board member is asked to anonymously review and/or rate their fellow board members individually. When the process is completed, the results are compiled and given to each director to review. The results also are shared with the chairman of the board, who in turn may or may not conduct a follow-up one-on-one interview with the director to see how they may improve.
Many companies tend to forgo this method because it can be divisive and often does not deal as directly with the problem as a one-on-one conversation. However, as board evaluations become more prevalent, and directors become more accustomed to the scrutiny that they receive both internally and externally, the prevailing sentiment is that they will become more popular.
No Good Deed
What about the risk that the evaluation process may be used against the company at a later date in a lawsuit? This is a valid concern that many companies have. (Several survey respondents raised the litigation issue when asked about the downside to conducting such evaluations.) After all, the company could be criticized or held liable for not addressing a specific issue in enough detail or for not adequately resolving a given matter. With that in mind, some companies go paperless. That is, they document that a board evaluation process exists and describe the process in detail in the board minutes or some other venue. However, individual evaluations are conducted orally to minimize the paper trail.
While it is unlikely to stop an aggressive plaintiff attorney, one approach that may serve to limit prying eyes from seeing the results of the evaluation is to not release them to anyone or to actively discuss the findings in the public domain. In fact, many companies have chosen this course of action. While the NYSE may require companies to outline the processes they are using for the public, it does not require them to publish their findings.
Individual directors, committees, and the board as a whole can and should develop actionable plans based upon the evaluation results. Individuals will typically generate a plan for personal improvement with the governance committee or with the person they conducted their one-on-one interviews. Committees and the board as a whole typically vote on plans for improvement after assessing their results as a group.
A good board assessment plan is a learning process. It also provides a benchmark for future reviews. After the first evaluation, assessments of all three groups (individuals, committees, and the board) should also include an evaluation of prior years’ follow-up actions to judge their adequacy.
Even those companies not listed on the NYSE are finding value in board evaluations, and a number of them say they will begin conducting self-evaluations in the future if they don’t already. For some companies, the aim is still compliance: There is a presumption in the marketplace that other exchanges may institute a similar evaluation policy. Therefore, those conducting the evaluation are doing so to have a system up and running before it is officially mandated. Others are considering the process simply because their companies have plans ultimately to trade on the NYSE.
Yet plenty of companies are conducting the process for more altruistic reasons. For example, 22 percent of survey respondents indicated that their firm is considering instituting a self-evaluation in order to demonstrate to investors that the board is serious about enhancing its performance. Done correctly, boards will find the exercise a valuable one, no matter what their reasons for implementing it.