Board evaluation – The outside view
Some boards are still reluctant to commission an externally-facilitated board evaluation. Based on his substantial experience with ICSA Board Evaluation, Simon Osborne FCIS, Chief Executive of the Institute of Chartered Secretaries and Administrators (ICSA), points out that the external facilitator is there to help the board with its review exercise and, if conducted properly, an external evaluation elicits better information than an internally-devised questionnaire.
When the UK Combined Code on Corporate Governance adopted for the first time in 2003 a recommendation that boards should undertake a formal and rigorous evaluation of their own performance, and that of their committees and individual directors, the Institute of Chartered Secretaries and Administrators (ICSA) in London had already been offering this service commercially for a couple of years. It took some time for the business to build up owing principally to the natural conservatism of directors and reluctance to submit themselves to scrutiny, particularly by an external body.
The advent of a formal provision about board evaluation in the UK’s 2003 Combined Code, which followed the 2002 review by the late Sir Derek Higgs into non-executive directors, prompted a number of organisations to offer board evaluation services. However, take up by listed companies was fairly slow and, for the most part, boards which chose to undertake an effectiveness evaluation did so as an internal exercise rather than engaging the services of a third-party provider. Nonetheless, a number of more innovative boards of directors, led by their even more innovative chairmen, engaged external providers of board evaluation services and slowly the business grew.
Up to and including 2011, ICSA Board Evaluation in London undertook between four and six evaluations each year. In one or two cases we were invited back the following year to do a repeat evaluation, which invariably demonstrated that the board in question had materially improved its performance as a result of adopting recommendations which we had made. Initially, however, there was still quite widespread resistance to using an external provider. Many companies preferred to use an internally-devised questionnaire while others turned to a favoured search firm (or headhunter). Experience has convinced us, however, that our approach of interviewing each director in a confidential one-on-one structured conversation is a considerable improvement on these questionnaires. There are six reasons why we take this position.
1. The structured interview permits a director to seek an explanation if he or she is unsure about the question being asked by the evaluator.
2. An interview encourages him or her to be totally frank and open without committing views to paper (a good psychological point!).
3. The evaluator is able to ask follow-up questions when a director expresses dissatisfaction with an issue, or to probe if the evaluator feels that a response merits deeper discussion.
4. The whole evaluation process is personalised and tends to elicit better information.
5. Questionnaires are generally devised in-house and have a tendency to miss some of the key issues. Sometimes they get stale which can create a boredom factor.
6. We are not convinced the use of a questionnaire alone will satisfy the requirements of Main Principle B.6 of the 2010 UK Corporate Governance Code regarding rigour.
Thus we strongly favour a one-on-one interview with each director; actually it is a structured conversation. As anecdotal evidence in support of our approach, the company secretary of a major company described our process as coming ‘across very much as you facilitating the board’s own review of itself rather than you conducting an external “evaluation”. This approach works very well and avoids the needless fear and hostility public examinations bring’.
The ICSA approach
Obviously, before we start any assignment, we meet the chairman and company secretary to ascertain the chairman’s agenda; essentially what the chairman hopes or expects to get out of the evaluation process. We meet separately with the company secretary to gain an understanding of the personalities involved and the key issues. Throughout the process we maintain close links with the company secretary whose role is key to the overall success of the assignment. Then, we conduct our confidential oneon-one interviews with each director.
We write up the notes of the interview which are then sent to the director confidentially (preferably to his or her home address) for correction and signing off. In compiling our draft report we draw extensively on what directors have told us in interview. However, we are punctilious in anonymising all the quotations which we use so as to ensure that no comment may be tied to an individual director. We believe profoundly that that level of confidentiality helps to assure the success of our process.
The use of search consultants or headhunters to undertake board evaluations is now less common in the UK, although we know of one major bank whose governance might have benefitted from being less wedded over a number of years to a single headhunter’s approach to board evaluation. The death knell for headhunters providing these services more widely was sounded by Sir David Walker in his report A review of corporate governance in UK banks and other financial industry entities (26 November 2009).
Recommendation 12 in that report stated that ‘the board should undertake a formal and rigorous evaluation of its performance, and that of committees of the board, with external facilitation of the process every second or third year. The evaluation statement should either be included as a dedicated section of the chairman’s statement or as a separate section of the annual report, signed by the chairman. Where an external evaluator is used, this should be indicated in the statement, together with their name and a clear indication of any other business relationships with the company they may have and that the board is satisfied that any potential conflict given such other business relationship has been appropriately managed’.
Sir David Walker’s review prompted the UK’s Financial Reporting Council to bring forward a review of the UK’s Combined Code on Corporate Governance. Reflecting Recommendation 12 in Sir David’s report, the 2010 edition of what is now known as the UK Corporate Governance Code provides in Main Principle B.6 that ‘The board should undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors’. It goes on to say in Code Provision B.6.2 that ‘Evaluation of the board of FTSE 350 companies should be externally facilitated at least every three years. A statement should be made available of whether an external facilitator has any other connection with the company’. The new code applied to accounting periods beginning on or after 29 June 2010, so most UK listed companies were applying the code from sometime in 2011 onwards.
That marked a significant upturn in the expressions of interest which we received. Hitherto, most interest which converted into actual assignments had come from FTSE 100 companies, or larger companies in the FTSE 250. Particularly since early autumn 2011, the upturn in new assignments has grown so that ICSA Board Evaluation is becoming a growing business activity for the ICSA in London.
For the most part, companies embarking on an externally-facilitated evaluation for the first time prefer to confine the evaluation just to the board. That is understandable. It is much less challenging emotionally for a whole board to be evaluated. The boards of new clients have some understandable nervousness about adopting a new way of evaluating their performance but, in our experience, they seem entirely content with the report and with the process which leads to its production. We do stress to our clients that one can have too much governance. That is not said to denigrate in any way the importance of good governance; quite the reverse. It is simply that one has to be proportionate. It is for that reason that we offer separate processes to evaluate the board, the main board committees and individual directors; the last being a much more challenging process requiring a degree of emotional intelligence on everyone’s part.
Although we offer a ‘deep dive’ approach to the evaluation of board committees, we suggest, when we are working with a board for the first time, that we undertake a review of the key issues relating to board committees in a lighter touch way. The board can then leave the deep dive evaluation to a future year if they wish to re-engage us.
The evaluation which is rarely requested is the evaluation of individual directors. ICSA engaged the services of an organisational psychologist when devising its process, which has to be handled with sensitivity and care. Our approach involves a paper-based peer group review with each director assessing their performance and then assessing the performance of their board colleagues. This is a particularly useful method for identifying directors who do not perform as well as others (for a variety of reasons) and may feed helpfully into the review of board composition by the nomination committee. Most boards, however, seem to prefer an internal evaluation of individual director performance, relying on the chairman to undertake that review and to feedback to each director in a one-on-one discussion. That is fine, provided the chairman has the ‘intestinal fortitude’ for what may sometimes prove to be a challenging aspect of the role. As Sir Christopher Hogg, the immediate past chairman of the UK’s Financial Reporting Council, has suggested, boardrooms should not necessarily be ‘comfortable places’.
Reporting on the evaluation process
My final point concerns the rigour with which boards report on the board evaluation process in their annual reports. I suggest that there are five key points to which boards should try to adhere:
1. what has been reviewed (board, committees, directors) with an explanation if, say, only the board was being reviewed
2. who conducted the evaluation and an explanation of how any conflicts of interest were managed or disregarded
3. an outline of the nature of the process
4. an outline of key findings, lessons learned, and
5. follow up actions agreed by the board.
My experience over a number of years has been that whenever a company begins the account of its board evaluation process by asserting (and thus parroting the UK Corporate Governance Code) that the process has been ‘formal and rigorous’, I begin to lose the will to live! The unimaginative use of that phrase, perhaps to try to throw the reader off the scent, confirms to me that the board has likely preferred (again) to use an internally-driven questionnaire. In fact, the chief executive of one client remarked to us that the problem with his board’s questionnaire was that, not only did he know the questions, he knew what answers he would be giving!
In making that last point, let me stress that we do not believe that an internallydriven evaluation process is inherently bad, or that an externally-provided service is inherently good. There are some genuinely rigorous internal processes; and there are several quality providers among ‘the opposition’, though one hears very occasional reports of other providers’ processes not having been well received. I expect that they pick up the odd murmur about our service! In our view, it is the sensibly blended use of both approaches which seem to offer a happy medium for many boards. There is certainly sufficient competition in the UK market for boards to use different providers whenever they determine to seek an external evaluation.
We believe that we have a high rate of satisfaction from our clients, but on rare occasions we find that boards are a little over sensitive to criticism. We regard this as something that goes with the territory; an external facilitator may raise an issue that one or two board members have been aware of but have been reluctant to speak about not to upset the status quo. However, as Stephen Hawking once said: ‘The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge’.
Simon Osborne, FCIS Chief Executive
Institute of Chartered Secretaries and Administrators