Formal board evaluation is still at a nascent stage in Hong Kong. CSj looks at the potential benefits of the process and explores why companies in Hong Kong have been reluctant to embrace what is fast becoming a standard part of good corporate governance practice.

Companies operate in a complex and highly competitive environment today, and having an optimally functioning board is clearly an essential part of remaining in business. Formal board evaluation has therefore become a standard part of corporate governance practice in many developed jurisdictions around the world.

A regular, formal board evaluation process enables the board and management to identify potential areas for improvement in the way the board operates. The process aims to give some answers to the key questions surrounding board performance – is the board culture conducive to a challenging debate? Is there effective communication between the board and management? The evaluation can also be a good opportunity to assess whether the composition of the board is fit for purpose. Is the board sufficiently diverse in terms of skills, professional background and gender? Does it have the right balance of skills and attributes required to lead the company into the future?

If an experienced external party is appointed to conduct the board evaluation, the company also benefits from an objective assessment of board performance and can benchmark that performance against companies in comparable industries and markets.

Board evaluation would, then, seem to be a good idea – so why are so few companies in Hong Kong engaged in the practice? A recent report by Spencer Stuart (see 2015 Hong Kong Board Index at: www.spencerstuart.com) suggests that only 21% of Hang Seng Composite LargeCap Index (HSLI) 88 companies have performed a board evaluation and only a handful of these companies have used external parties in the process.

The above figures may be somewhat misleading in that they only capture the formal board evaluations which have been disclosed to the market. The likelihood is that most boards in Hong Kong will be engaged in some form of board evaluation, even if that is no more than an occasional discussion about how the board is performing and about how to improve board processes. At the very least, however, the current data implies that relatively few companies in Hong Kong are moving to the next step and setting up a regular and formal evaluation process.

What is holding Hong Kong back?

Since Hong Kong Exchanges and Clearing Ltd (the Exchange) consulted the market in 2010 on whether to include a recommended best practice (RBP) on board evaluation in Hong Kong’s Corporate Governance Code, there has been an ongoing discussion in the market regarding the potential benefits and costs of board evaluation.

A number of potential obstacles to the wider adoption of formal board evaluation in Hong Kong have been raised, among them the financial costs involved and the potential loss of confidentiality. Certainly, board evaluations conducted by an external consultant will involve a financial cost which, for smaller companies, could be a disincentive, but a formal internally conducted evaluation, which is a more common scenario in Hong Kong, can be done at very little cost. Such evaluations do, however, incur time rather than financial costs, requiring the chair and the company secretary to devise the questionnaires, analyse the completed questionnaires and compile the results into a report.

Similarly, loss of confidentiality may be a concern where the evaluation involves bringing in an outsider to assess board performance. However, as mentioned earlier, the vast majority of evaluations conducted in Hong Kong are conducted internally. Even where external parties are brought in, they generally fulfil an educational role – such as briefing the board about the performance criteria to look at in their internal evaluations, rather than as a direct participant in interviews or information gathering.

Dr Kelvin Wong, Deputy Managing Director of Cosco Pacific Ltd, believes that the debate about the relevance of board evaluation to Hong Kong needs to take into account the local business environment and, in particular, the concentrated ownership structure of most listed companies here. He believes that a structured, transparent board evaluation process should be encouraged, but it should be done in a localised way, carefully attuned to the local business environment.

‘This doesn’t mean that board evaluation is not suitable for Hong Kong,’ he says, ‘but the way we conduct evaluations must be thoughtfully designed to adapt to Hong Kong’s business environment. In the US, most listed companies are owned by a diverse group of investors. Among them, institutional investors represent another powerful corporate governance mechanism. So, in addition to financial performance, board evaluation is an important yardstick for shareholders to measure how well the board performs. It is not rare for institutional investors to launch a campaign to oust the CEO or other independent directors of the board if they do not live up to their expectations.’

This situation contrasts with Hong Kong’s business environment where the majority of listed companies are family controlled or state-owned enterprises. ‘In Hong Kong, I don’t think the chairman or CEO of a family-controlled or state-controlled company can easily be unseated as a result of a board performance evaluation. Therefore, we cannot follow blindly the way that the US or other Western countries do evaluations without considering our own situation,’ he adds.

Another possible reason for the reluctance of Hong Kong companies to embrace board evaluation is the potential implications for board relationships. Is there a fear that the process could cause destructive confrontations and power struggles? Certainly, Hong Kong companies seem generally keen to keep personalities out of the process. Hence the fact that peer evaluation of directors is very rare in Hong Kong and the focus of board evaluations tends to be on assessing overall board effectiveness.

‘The issues to be covered should be prioritised according to their importance in order to carry out a comprehensive evaluation,’ Dr Wong says. He adds that the evaluation should focus on areas where there is a consensus that improvement would be beneficial and where there are a range of views on performance.

Dr Wong adds that the role of the chairman is crucial to the success of board evaluation. He or she sets the tone from the top and has the ultimate responsibility for carrying out the board evaluation. If the chairman is not fully supportive of the process, or does not see the benefit of it, the evaluation could turn out to be a mere box-ticking exercise.

The regulator’s view

As mentioned above, the Exchange consulted the market in 2010 on whether to include a recommended best practice (RBP) on board evaluation in Hong Kong’s Corporate Governance Code. The Exchange noted the increasing focus on board evaluation in other jurisdictions in its consultation paper. Its proposed RBP – which recommended that listed companies conduct a regular evaluation of its own, and individual director’s, performance – was opposed by over two-thirds of issuers that responded, but gained majority support from market practitioners and professional bodies.

‘Some opposing respondents felt that most Hong Kong issuers are not ready for board evaluation,’ says Grace Hui, Managing Director, Chief Operating Officer of Listing at the Exchange. ‘Nonetheless, many opponents said that they would be supportive if the evaluation of individual directors was omitted from the RBP. The Exchange considered there was merit to the opposing views and decided to drop the individual evaluation part.’

In view of the responses to the last consultation, the Exchange believes that the market is unlikely to be supportive of an upgrade of the board evaluation RBP to comply or explain at this stage.

‘When formulating policies, the Exchange benchmarks its proposed rules against those of other developed markets and assesses their potential impact on the Hong Kong market,’ Hui explains. As a comparison, the UK currently requires, on a comply-or-explain basis, listed firms to disclose how the evaluation of the board, its committees and its directors has been conducted. It does not require disclosure of the results of the evaluation. Similarly in Australia, a listed issuer only needs to disclose on a comply-or-explain basis the process for periodically evaluating the performance of the board, its committees and individual directors.

‘On disclosure of the process of evaluation, we will continue to review the developments in this area. On disclosure of the results of board evaluation, given that there is no such requirement in other international exchanges, we do not believe that it should be a requirement in Hong Kong, but we will continue to monitor the developments,’ Hui adds.

The role of the company secretary

Given the benefits of the formal board evaluation process, and the fact that few companies in Hong Kong have yet to incorporate such evaluations into their corporate governance regimes, should company secretaries be promoting this issue to their boards?

The Institute’s Corporate Governance Conference 2012 indicated that most company secretaries in Hong Kong would be highly reluctant to initiate a proposal to get board evaluation onto the board’s agenda. A conference poll revealed that a majority (51%) of attendees thought that boards would reject any recommendation to instigate formal board evaluation. Among that majority, 11% believed that company secretaries bold enough to propose board evaluation would be shown the door.

Dr Wong believes that, while the company secretary plays a facilitative role in the implementation of board evaluation, promoting this issue in companies without a formal board evaluation process should be handled with care. ‘Without the full support and endorsement of the chairman, the company secretary is not in a position to initiate board evaluation. I would say it is a very sensitive and sometimes political issue. So keep your personal opinions out of the process and apart from procedural issues, unless you are also an executive director of the board,’ he says.

In companies that have already embarked on the board evaluation journey, the company secretary generally plays a key role assisting the chairman (or, in the UK, sometimes the senior independent director) in managing the process. ‘As an officer of the company and a key interface between board and management with a responsibility for promoting good governance, the company secretary is well placed to manage an independent, impartial and effective process,’ says David Simmonds, Group General Counsel, Chief Administrative Officer and Company Secretary, CLP Group.

As mentioned above, the cost of internal evaluations is principally the time needed to see the process through rather than the financial outlay required. The services of the company secretary are therefore highly useful to oversee the process. The company secretary will generally be very familiar with the workings of the board and will also typically have the trust and confidence of the chairman and other directors to carefully analyse the feedback collected and to impartially discuss with the chairman, and where appropriate, follow up with management on suggestions and concerns, if any, so as to formulate appropriate recommendations for the whole board to consider.

If the board evaluation is conducted by an external party, the company secretary would also be expected to play an important role in the appointment and engagement process. In Hong Kong, a number of management consulting firms and executive search firms offer board evaluation services to their clients. The company secretary is also well placed to brief and prepare the consultant on a wide range of matters concerning the board, its practices and board dynamics.

Jimmy Chow, Journalist, and Kieran Colvert, Editor, CSj

CSj’s previous article on board evaluation (‘Asking the right questions: board evaluation and the company secretary’) is available in the online journal (http://csj.hkics.org.hk, see the December 2012 edition cover story).

 

SIDEBAR: A case scenario: CLP Group

Though board evaluation is not yet a common practice in Hong Kong, there are a small number of companies for whom the process has become an integral part of their corporate governance practices and philosophy. The CLP Group is one. The CLP Group carries out board evaluations on an ongoing basis with an independent external evaluation every three years. CLP also discloses a summary of the findings of its board evaluations in its annual reports and/or on its website.

‘Although most companies that carry out a board evaluation have chosen to do it internally, CLP does both internal and external evaluations,’ says David Simmonds, Group General Counsel, Chief Administrative Officer and Company Secretary, CLP Group. ‘We commenced with an evaluation conducted by an external consultant in 2012 and followed that with our own internal evaluations in 2013 and 2014.’

CLP’s internal evaluations have been conducted by the company secretary in the form of a questionnaire to all directors individually, with a focus on the implementation of the recommendations of the previous years’ board performance evaluation. External evaluations typically involve a questionnaire and individual interviews with directors with responses generally aggregated without attribution.

‘In the past, we covered areas such as board dynamics and culture; organisation of the board; committee organisation; board composition; board involvement and engagement; communication with shareholders and stakeholders; and overall board effectiveness,’ says Simmonds.

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