Board building – Improving the effectiveness of your board
CSj looks at some best practice recommendations on board governance, their possible applications in the local business environment of Hong Kong and the company secretary’s role in boosting the effectiveness of boards.
Board governance – how complicated can it be? Get your directors together, serve them coffee and let them get on with the business of deciding the future of the enterprise. If only it was that simple. As readers of this journal well know, getting the right people on your board and creating the right environment for effective decision making is a tricky business. The more you look into the details of board governance, the more complex the picture becomes. Are your directors adequately informed about the issues they are discussing? Are the personal dynamics on the board conducive to a good debate? Is there effective communication between the board and management? Do you have the right balance of independent directors and executives?
Fortunately, boards have been around for long enough for a fairly comprehensive body of board governance recommendations to have built up. This article will take a look at some of the salient recommendations and test their application in the local environment in Hong Kong. In addition, it will also take a look at the role of the company secretary in building an effective board. The ultimate responsibility for ensuring that the board is functioning effectively lies with the chairman. However, assisting the chairman, company secretaries have an integral role to play in board governance, both through their board support services and by virtue of their unique perspective as the only non-director who sits on the board.
Understanding the remit
This might seem like a very obvious point to begin with, but, as the former board ‘doctor’ Gregg Li pointed out in his article series in this journal ‘Boardroom pathology: six lessons in self-treatment’ (CSj, February 2010), there are a surprising number of boards that don’t really understand the purpose of having a board. ‘Such boards often follow the letter of the law on board practice and conduct themselves as dictated by their lawyers. Meetings and discussion items become a ritual and, while the legal requirements for board practice may be met, one really wonders whether the board has any life at all,’ Mr Li wrote.
Even where boards know and understand their remit, the principle function of the board – formulating strategy and addressing risk – can still get buried under the routine matters that directors need to attend to. The approval of the previous minutes and a discussion of ‘matters arising’ are of course important, but frequently board meetings start with these matters and, if the discussion gets bogged down in the details, when the board finally turns to the critical areas for discussion and decision making, spirits are flagging and time is running out.
Company secretaries can assist the chairman to address the lack of focus discussed above. This could involve tracking where the board spends most of its time, ensuring that strategy and risk are on the agenda and ensuring that adequate discussion time is given to them.
Getting the right talent
Another critical point for board governance is the question of how to find the talent you need. Nicholas Charles Allen, Chairman of Link Asset Management Ltd, which manages Link REIT, the largest real estate investment trust in Asia, points out that a good recruitment process needs to look beyond the candidates’ CVs. A candidate’s suitability for a board position will be measured against a set of criteria including, but not limited to:
- industry knowledge or ability to acquire that knowledge
- personal and professional integrity
- communication skills and the ability to work harmoniously with fellow directors and management, and
- demonstrated and recognised knowledge, experience and competence in business, including financial literacy.
The candidate is also expected to know how to analyse information, think strategically, and review and challenge management in order to make informed decisions. ‘Before the recruitment process, we would first do a skill-set analysis, and then go out and look for someone who fits these characteristics. Of course we have people who are very experienced in the property sector, but we also have members who have plentiful experience in law, accountancy and investor relations,’ Mr Allen says.
He adds, however, that recruiting independent non-executive directors (INEDs) often presents a challenge in Hong Kong due to the relatively small pool of INED talent. ‘I think Hong Kong has a relatively small pool of potential INEDs. Although headhunters know the people well and they know how to find them, everybody knows each other in Hong Kong. I personally would like to see more high-calibre people join that pool. It sometimes needs a bit of hard work to find the people that we want,’ he says.
The increased responsibilities and liabilities of the director’s role, however, are making many potential INEDs think twice about going into professional directorship. Eric Yeung, a Partner within PwC’s Risk Assurance practice, confirms that tighter regulations, together with greater public scrutiny and shareholder activism, is driving higher expectations of the directors role. ‘An area where director responsibilities are greater relates to the oversight of the company’s risk management and internal control systems,’ he notes. He adds that directors should familiarise themselves with the relevant regulations and engage in continuing professional development in order to ‘up their game’ in terms of boosting their effectiveness.
‘Meanwhile, issuers should also invest more in director training. This could keep directors abreast of the latest regulatory changes, while helping them understand trends and issues that concern the company’s business and industry,’ Mr Yeung says.
Ensuring board diversity
The recruitment process is further complicated by the need to ensure that the board has a diverse mix of skills and backgrounds. This is principally about guarding against the ‘groupthink’ syndrome, which is a risk if the board is composed of like-minded individuals who have similar ages, backgrounds and experience. Board diversity can also provide a company with indirect benefits, such as positively impacting a company’s reputation, and a company’s ability to recruit and retain talent. From a management perspective, diverse board members may help infuse diversity across its corporate culture and signal to employees the company’s commitment to diversity.
Since 2013, Hong Kong’s Corporate Governance Code (see ‘What does the code say?’ below) has required listed companies to have, and report on, a policy on board diversity. Mr Yeung also points out that Principle 3.1 of the International Corporate Governance Network Global Governance Principles states that the composition of the board should reflect a sufficient mix of individuals with relevant knowledge, independence, competence, industry experience and diversity of perspectives to generate effective challenge, discussion and objective decision-making.
Dr Kelvin Wong, Executive Director and Deputy Managing Director of COSCO Pacific Ltd, believes that this issue needs to be seen in the context of the local culture and demographics in Hong Kong. In this context, he says that diversity should not be narrowly limited to address race, gender or nationality. ‘The suitability of a director should be judged on his or her skill set, integrity, professionalism and passion regardless of gender, race or national origin. It makes little sense to set the ratio of male or female members on the board purely for the sake of having a more diversified board,’ he says.
For INEDs in particular, there are many characteristics to consider beyond their professional skills, he adds. ‘The mindset of being warm at heart, cool in mind is far more important than whether the candidate is a man or woman, Chinese or Indian. That said, any candidate, regardless of his or her racial or ethnic affiliation, should deserve an equal opportunity.’
Dr Wong adds that another issue here is the need to foster the right environment for debate and decision-making on the board. This might call for a degree of tact and diplomacy on the part of the directors. In a conservative, family-controlled business in which the founder as chairman takes a more assertive, magisterial style, for example, the independent directors have to find the right tone in discussions – providing unbiased opinions but doing so in a non-confrontational manner. ‘From my perspective, board diversity means composing the board of unique skills, backgrounds, experiences, perceptions, attitudes and philosophies in order to create a more capable governance,’ he says.
Keeping directors informed
Board governance best practice lays great emphasis on the need to keep directors well informed. Hong Kong’s Corporate Governance Code (Code Provision A.6.1) requires, on a comply-or-explain basis, every newly appointed director to receive a comprehensive, formal and tailored induction on appointment. At Link REIT newly recruited directors are given a two-day induction, arranged by the company secretary, to acquire the knowledge and information needed in order to have a proper understanding of the company’s operations and businesses as well as their responsibilities.
‘Visits will also be arranged for the new directors to visit our properties and meet other executives or heads of business lines in order to understand what we’re doing. These visits and meetings are important to supplement their skills. As part of ongoing director training, we also encourage directors to attend seminars and conferences to keep them aware of what’s going on within the industry,’ Mr Allen says.
Environmental, social and governance data is now a key focus for stakeholders and has become equally important. Accuracy and relevance are the key.
While induction is clearly key, best practice in board governance also requires companies to consider the other end of the life cycle, namely, ensuring term limits on directors. Link REIT has clear guidelines as to the desired length of service of non-executive directors. Having a fixed tenure for non-executive directors helps the nomination committee plan ahead to ensure that the recruitment process goes smoothly.
Chairman and CEO duality
Another board governance area where Hong Kong practice does not always follow international best practice, is the recommendation for the chair and CEO roles to be performed by separate individuals. Hong Kong’s Corporate Governance Code includes a Code Provision(A.2.1) calling for a separation of the roles of the chairman and chief executive, but this has the lowest compliance rate of any provision in the code.
Hong Kong is by no means alone in this respect, having a single individual performing both roles is not uncommon in the US, though listed companies, in particular banks, in the US are increasingly under pressure to split the roles. Wells Fargo has recently changed its boardroom rules to require the roles of CEO and chairman be kept separate. JPMorgan Chase is also under pressure to split the roles. About a third of shareholders in Wall Street bank voted at its last two annual meetings that it should do so.
The rationale behind this best practice recommendation is that the CEO and chair play distinctive but complementary roles to each other and there is a need to ensure that there is a balance of power and authority so that no individual has unfettered powers of decision and control. Where a CEO is also the chair there is the danger he or she will have too much control of the board and this will reduce its effectiveness in monitoring management.
Eric Yeung ascribes the low compliance rate with the Code Provision on chair/CEO duality to the fact that many listed companies in Hong Kong have a family-dominated shareholder base. ‘Typically the dominant shareholder, usually the founder of the business, feels more confident in setting the strategy for the company,’ he says. He adds that, in some cases, having the same person in both the chairman and CEO roles can provide strong, consistent leadership, thereby enabling more effective planning and better execution of long-term strategies.
‘There’s no absolute right or wrong for CEO duality,’ Dr Wong says. ‘In some industries that have a fast-changing competitive landscape or frequent regulatory changes, having a unity of command at the head of the company allows it to make faster, more consistent decisions. This also allows the company to send a reassuring message to shareholders.’
Finally, board governance best practice also calls for regular appraisals of how the board is performing. Hong Kong’s Corporate Governance Code recommends that the board should conduct a regular evaluation of its performance (Recommended Best Practice B.1.9). A regular, formal board evaluation process enables the board and management to identify potential areas for improvement in the way the board operates. 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.
However, having a formal board evaluation process is still relatively rare in Hong Kong. The latest Spencer Stuart Board Index (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.
This is another area where the company secretary can play a facilitative role. Ensuring, for example, that the board is aware of the trends relating to board evaluation and that the board discusses what form of board evaluation might be appropriate in their individual circumstances.
Jimmy Chow, Journalist, and Kieran Colvert, Editor, CSj
SIDEBAR: What does the code say?
Many of the best practice recommendations in board governance discussed in this article are included, either on a voluntary basis or subject to comply or explain, in Hong Kong’s Corporate Governance Code.
The board’s remit
Principle A.1. An issuer should be headed by an effective board which should assume responsibility for its leadership and control, and be collectively responsible for promoting its success by directing and supervising its affairs. In doing so, directors should take decisions objectively in the best interests of the company. The board should regularly review the contribution required from directors to perform their responsibilities to the issuer, and whether they are spending sufficient time performing them.
Induction of directors
Code Provision A.6.1. Every newly appointed director of an issuer should receive a comprehensive, formal and tailored induction on appointment. Subsequently he should receive any briefing and professional development necessary, to ensure that he has a proper understanding of the issuer’s operations and business and is fully aware of his responsibilities under statute and common law, the listing rules, legal and other regulatory requirements and the issuer’s business and governance policies.
Code Provision A.5.6. The nomination committee (or the board) should have a policy concerning diversity of board members, and should disclose the policy or a summary of the policy in the corporate governance report.
Chairman and CEO duality
Code Provision A.2.1. The roles of chairman and chief executive should be separate and should not be performed by the same individual. The division of responsibilities between the chairman and chief executive should be clearly established and set out in writing.
Recommended Best Practice B.1.9. The board should conduct a regular evaluation of its performance.