Asking the right questions – Board evaluation and the company secretary
The first piece of advice for company secretaries embarking on a formal board evaluation process for the first time should probably be don’t panic. The prospect of board evaluation is often quite daunting to the uninitiated, but perhaps for the wrong reasons. Company secretaries are uniquely well placed to engage with the board evaluation process since it calls for a close familiarity with board processes, the trust and confidence of the board, the chairman and the executive team, and the skill and perseverance to ensure that the right questions get asked. Does that sound like a job for you?
Would you feel comfortable about initiating a proposal to put board evaluation on the agenda of your board’s next meeting? The Institute’s Corporate Governance Conference 2012, held in October this year, indicated that most company secretaries in Hong Kong would be reluctant to do so. A conference poll revealed that only 16% of attendees thought that such a proposal would be welcomed by their board. The largest proportion (40%) felt that such a proposal would be rejected and a worrying 11% believed that company secretaries bold enough to propose board evaluation would be shown the door.
This nervousness surrounding the topic of board evaluation is somewhat strange, however, since most boards are already doing it. Kelvin Wong, Chairman of Hong Kong Institute of Directors and Deputy Managing Director of Cosco Pacific Ltd, points out that the fact that we don’t hear about companies doing it in Hong Kong doesn’t necessarily mean that it isn’t taking place at all.
‘You can only speculate that board evaluation is not a common practice in Hong Kong since only a few companies are public about what they evaluate – HKEx, China Light and Power and the MTR Corporation are some of the companies that maintain a very good practice regarding board evaluation. But with other companies, this doesn’t necessarily imply that they are doing nothing, just that they don’t feel they can communicate it.’ Wong adds that his own company, Cosco, has embraced board evaluation as part of its desire to be a pioneer in corporate governance and transparency. ‘I would rather ask the question myself than someone else ask it,’ he says.
The likelihood is that most boards in Hong Kong are engaged in some form of board evaluation, even if that does not amount to much more than the occasional discussion about how the board is performing or about how to improve board processes. The next step, ensuring that there is a formal process for evaluating the board’s performance, is a very logical one and highly relevant to the company secretary. Many of the questions that need to be answered in the board evaluation process relate to the company secretary’s role in supporting the board. Is the atmosphere at board meetings conducive to effective decision making? Is the board culture conducive to healthy, challenging debate? Is the board sufficiently diverse in terms of skills, professional background, gender, etc? Is there effective communication between the board and management?
In markets where formal board evaluation has become commonplace, the company secretary generally plays a key role assisting the chairman (or sometimes the senior independent director) in managing the process. Typically this will involve devising the questionnaires, analysing the responses and compiling the results into a report. Phillip Baldwin, HKICS Chief Executive, points out that some of the independent organisations that conduct board evaluations overseas are ‘set up by people who’ve been company secretaries and who know how to talk to boards and get the right answers’.
He adds that asking the right questions is absolutely critical to worthwhile and successful board evaluation, as are making answers non-attributable and, most importantly, expressing findings in the right way. ‘It needs to be constructive criticism and should recommend ways of improving and performing more effectively, not just saying that people are rubbish. Identifying areas where you need an extra person to get that mix on the board right – that’s where a board evaluator can come in. Usually no one thinks about something like that until something goes wrong.’
Given the close connection company secretaries have with the board evaluation process overseas, should they be driving the process in Hong Kong? Baldwin feels that adoption is not yet widespread enough for company secretaries to drive the process here: ‘At the moment it’s only just starting to come into Hong Kong, so it’s too early for them to take ownership of it.’
‘This is not something that a company secretary could try to impose on the board,’ adds Edith Shih, HKICS President and Head Group General Counsel and Company Secretary of Hutchison Whampoa Ltd, ‘but the company secretary is a very good person to execute it if it’s required.’
Board evaluation in Hong Kong
The need for formal board evaluations is now firmly on the radar in Hong Kong. In April this year, Hong Kong Exchanges and Clearing (HKEx) added a recommended best practice (RBP) to our Corporate Governance Code stating that ‘the board should conduct a regular evaluation of its performance’.
The vast majority of Hong Kong companies, however, have not made the step from an informal board evaluation process to a formal one. ‘Some companies are doing an excellent job, but Hong Kong is still lagging behind compared to our competitors from overseas: compared to Singapore, let alone the US and Europe,’ says Kelvin Wong.
Edith Shih identifies three potential obstacles to the wider adoption of formal board evaluation.
1. Cost. This, she points out, will be a major concern for smaller companies. ‘Cost is a big issue. We have a company in the UK which is listed on the AIM [the London Stock Exchange’s international market for smaller growing companies]. I inquired about the cost but the rates were so high that I could not recommend it,’ she says.
2. Confidentiality. This is a major concern for directors, she believes, because the information gathered for the evaluation will always be on record and potentially extremely sensitive if seen by someone outside the company.
3. Credibility. Regarding external evaluations, many directors simply don’t believe that an outsider can have any useful insight that they haven’t had themselves.
Other common objections to formal evaluation include the notion that it is unnecessary because the board’s performance is reflected in other, more important, ways. ‘A board will often say that their evaluation is there in the company’s share price,’ Phillip Baldwin says. ‘The problem is also looking at very senior people. They may resent it, or it may be difficult to quantify their performance. There could be a guy who doesn’t speak for six months but then makes that one comment in a board meeting that saves the company millions of dollars.’
He adds that there’s no point undertaking a board evaluation exercise if you don’t intend to act on the findings. ‘Is it creating value – is it going to make this board more efficient? You have to perform a cost-benefit analysis.’ This means the board, the chairman and the executive team have to believe that the process can benefit the board, whether by identifying relatively minor improvements to board processes (meeting agendas, format of board papers, etc), or more significant changes to the board’s composition and culture.
One potential problem, Baldwin says, is that the boards most likely to benefit from board evaluation are the very ones that are least likely to agree to it. ‘The irony of it is that a competent board is going to be able to distance itself and form an objective opinion of its own performance. A lesser board might be very aware of its own issues and not want them highlighted. A lot of the changes in listing rules and governance codes of conduct aren’t aimed at big companies who are already running good boards; they’re aimed at the smaller, mid-sized companies that may for example have a company secretary doubling up as a CFO.’
Another reason for the relatively low uptake for formal board evaluation is the closely held nature of a lot of the city’s companies. ‘A lot of Hong Kong companies are family owned, with boards made up of family members,’ says Baldwin. ‘It’s going to be a very brave evaluator who says that the chairman’s son isn’t pulling his weight.’ However, he adds that it isn’t helpful to stereotype family-owned businesses as inevitably being driven only by loyalty to each other and he stresses the importance of assessing each case individually. ‘You still have to look at the independence of board members. Brothers on the same board, for example, could actually be more independent because they don’t care what their brother thinks.’
Supply and demand
The shortage of companies able to provide competent external board evaluation services in Hong Kong at the moment may also be hampering its wider adoption – a chicken-and-egg situation, given that the reason for there being so few of those companies is at least partly a lack of demand. As well as specialist board evaluation consultancies, board evaluation services are also provided around the world by companies with a background in coaching and psychology; strategy and change consultants; recruiters and headhunters; other professional service providers; consultancies with a corporate governance background; and professional bodies.
‘The shortage of suppliers is an issue,’ says Phillip Baldwin. ‘You need someone independent to do it – having a headhunter do it creates an inherent conflict of interest and there’s a lack of independent board evaluators here. There’s definitely an opportunity for consultants to come in.’
External consultancy services are seen as the gold standard in board evaluation – they don’t have an incentive to make recommendations that will protect or drive their own business as headhunters do. Kelvin Wong cautions, however, that external evaluation is not the only way; while internal evaluations may be seen by some as compromised and limited in their scope, he says that they have their place.
Edith Shih confirmed that, for her AIM listed company, in lieu of incurring the expense of engaging external evaluators, a well-designed questionnaire was deployed to elicit board members’ views on their peers. ‘There is good learning derived from the findings of such a questionnaire which the board shares and reviews.’
‘Using external consultancy services is a widely adopted approach,’ says Kelvin Wong, ‘because it will give you independence and the board may lack the expertise to do it. But it’s not the only way: at other companies it may be done internally by the chairman and the HR department, for example. The point is how the board and the chairman are going to use the results of their board evaluation. They may have some underlying agenda. So it’s about building mutual trust and understanding among board members as to the value of board evaluation. Using external consultants may unleash anxiety.’
The ripple effect
The recommended best practice (RBP) in Hong Kong’s corporate governance code does not carry much weight. Currently it is a recommendation that the majority of companies in the city are choosing to ignore. To judge from the experience of other jurisdictions, however, regulatory requirements in this area are likely to escalate.
Formal board evaluation is becoming increasingly subject to regulation overseas in jurisdictions following the unitary board model. Jurisdictions following a two-tier board system, of course, have an inbuilt system for board evaluation since examining the efficiency and performance of the management board on a regular basis is one of the primary roles of the supervisory board.
Jurisdictions with code provisions on board evaluation include Canada, Singapore, Australia, the US, UK and France. Some differences exist between these countries in terms of the degree to which board evaluation is required and the degree to which companies are required to disclose the evaluation.
It seems likely, however, that tougher regulation in Hong Kong on board evaluation will be fiercely contested by listed companies. While market practitioners and professional bodies were mostly in favour of the new RBP on board evaluation in Hong Kong’s Corporate Governance Code, the majority of listed companies opposed it. HKEx originally proposed that the additional RBP would include a recommendation for individual directors’ performance to be evaluated. This was widely opposed on the grounds that ‘established corporate and cultural values would reduce individual performance evaluation to a mere box-ticking exercise,’ the HKEx consultation conclusions stated. Many respondents said they would be happy to support the proposal if that requirement were removed – which it was.
‘Family-owned firms don’t want to point fingers at individual directors and it is the same with state-owned enterprises,’ says Kelvin Wong. ‘Individual performance evaluation will break directors’ motivation to participate. So you evaluate the performance of the board and of its various committees. It’s an indirect approach, but it’s not that indirect.’
Is there a danger that the new RBP will only encourage box-ticking compliance on board evaluation? Edith Shih argues that even box-ticking exercises can have value. ‘The corporate governance scene has changed in Hong Kong; even the smallest changes used to be fiercely resisted. Even if it’s just a box-ticking exercise, companies might internalise it and it might lead to improvements. It’s better to have some degree of evaluation than to not have it at all.’
HKEx could, of course, force Hong Kong’s public companies to adopt board evaluation if it upgraded the RBP to a listing rule, but, given the relatively small number of companies that have adopted the practice so far, that would be a very unpopular move. ‘HKEx asked whether it should be made a code provision but the consensus was that people were not yet ready, so they made it an RBP,’ says Wong. ‘But it still has a ripple effect – for example, non-executive directors will urge companies to do it.’
And, says Shih, it’s on the radar now, and it’s up to companies to respond. ‘The fact that it’s an RBP means that it will grow into a code provision, and one day it will become a rule. My view is that it will take a few years.’ Nonetheless, board evaluation is coming, whether companies like it or not, and the time to prepare is now.
Richard Lord, Journalist