A closer look at the board review process...

What are our directors bringing to the (board) table?

Having considered the foundational issue of who should carry out the review, and established the underlying governance structure, we turn to the question...

What does a board review involve for individual directors?

Within the broader review of the entire board (to be discussed later), the contributions of each director must be assessed.

Many director appraisals are currently conducted in an informal way, with the chairman personally assessing each director’s performance and commenting privately to the director involved. But the pressure is on for director appraisals to be more formalised. A board policy decision, with the full support of all the directors, is needed to introduce such a process.

With the support of board members obtained, the next step is to clarify the criteria to be used for the evaluation. The chairman should outline the purpose and process of the assessment. Desirable director attributes and core competencies can provide a pro forma for the individual appraisal. The chairman’s statement laying out expectations of time commitment, skills, specific expertise and experience provided at a new director’s appointment, should be revisited, especially in light of any changes in the company’s strategic situation.

In a formalised director performance review, the data collection stage follows. This might involve interviewing each director to discuss their experiences as members of both the main board and any committees. Information is also obtained by analysing attendance records, and board and board committee minutes, looking for innovative contributions to discussions and decisions.

Sometimes peer-review techniques can add value to the process. Taking this further, a 360 approach could be beneficial, involving too the opinions of external auditors, institutional investors and company staff who have come into contact with the director.

Following the data gathering, a confidential report to the chairman will be drafted. Given the personal nature of the report, most chairmen will discuss the relevant portion with each director one-to-one. The discussion should cover a strategy for further personal development activities, such as committee leadership or membership on other boards.

Adopting an annual routine of director evaluation not only ensures compliance with many codes and listing rules, but is as vital for healthy governance as are long established executive appraisal systems for healthy management.

‘Comply or Explain’ at its best

Dramatic reactions to new guidelines that require the annual re-election of board members has hit the news today. The FT reports how three of the UK’s biggest investors have written to 700 companies to encourage them to “ignore” the provision in the 2010 Corporate Governance Code.

The paper’s wording is, however, perhaps unhelpful. Colin Melvin, Chief Executive of Hermes Equity Ownership Services – one of the companies involved in the letter sending – said he was encouraging companies to practise their rights and “explain” rather than comply. This is quite different to ignoring the provision altogether and, aside from whether director election practices should or should not be changed, the situation highlights the advantage of the UK Code.

If Corporate Governance in the UK resembled the US system, where legislation rather than codes of best practice constitutes the main determiner of corporate behaviour, today’s story would read quite differently. Large companies would be forced to undergo an upheaval in the foundational area of director election, to the displeasure of their major investors, or else risk expensive and hugely damaging legal action if they resisted the measures.

As it is, under the UK Code’s trademark “comply or explain” approach (see pp. 4-5 http://www.frc.org.uk/documents/pagemanager/Corporate_Governance/UK%20Corp%20Gov%20Code%20June%202010.pdf), the outcome of the FRC’s provision is positive despite being ill-received by some. While Legal and General and Fidelity welcome the new guidelines, the FRC has been forced to closely re-examine provision B.7.1 and defend its value to big names like Hermes, Railpen and the Universities Superannuation Scheme who oppose the measure and have laid out their reasoning to hundreds of FTSE 350 companies. In turn, if these companies choose to reject the Code’s call, they will explain their stance carefully to shareholders in the Annual Report. The atmosphere is one of rigorous dialogue and well-considered progress.

In the ever-changing, multi-faceted and oftentimes ethically equivocal realm of corporate governance, this is exactly the culture of intelligent exchange that is needed and that is fostered by the “comply or explain” approach. In the best practice system, power is placed not in the hands of central government or the judiciary, but where it belongs, in the hands of boards and, ultimately, shareholders.

Blunders at Buncefield? Explosive, expensive... inexcusable?

In the last few days the Crown Court ordered five companies to pay almost £10m in combined fines for their part in the Buncefield explosion five years ago. Gordon MacDonald of the Health and Safety Executive concluded his comments to the press by highlighting the corporate governance, namely risk assessment, issues that the case raises:

From the boardroom down, companies must ask themselves these questions: ‘Do we understand what could go wrong? Do we know what are our systems are to prevent this happening? Are we getting the right information to ensure us that these systems are working effectively?’” (http://www.bbc.co.uk/news/uk-england-10660356)

It is clear that the ‘boardroom down’ control activities of energy giant Total, as well as well as local firm Hertfordshire Oil Storage Limited, were deficient. The standard of risk assessment systems and, specifically, the implementation of COMAH (Control Of Major Accident Hazard) regulations within the companies must be scrutinised for fundamental corporate risk assessment features, such as:

• clear objectives communicated to employees on risk assessment and control issues
• significant internal and external operational, financial, compliance and other risks identified and assessed on an ongoing basis
• a clear understanding by management and others on what risks are acceptable to the board
• clear strategies and policies for dealing with risks identified
• a prevailing company culture, reflected in the code of conduct, human resource policies and performance reward systems, that supports the business objectives, risk management and internal control system
• a co-ordinated effort by different parts of the company on decisions and actions

Only by addressing these areas can Total’s Lee Young’s comments that “this was an unprecedented incident from which we and the industry have learnt many lessons” be ratified.

A closer look at the board review process:

A panoramic snapshot of power

In reviewing the performance of the board as a whole, it is important to first ask...

What is the underlying governance structure?

Answering this fundamental question will establish the governance power base of the enterprise and determine where ultimate power lies to change the governance structure.

Tricker asks: ‘Who controls the voting equity? Is there majority control? Do informal power blocks exist? What changes might occur over the strategic time horizon?’ (Corporate Governance: Principles, Policies, and Practices, 317).

In a widely held listed company, any blocks of voting shares that could or do influence corporate governance will be considered in detail. In a subsidiary or associate company, the expectations of the parent company must be taken into account.

Having established the existing governance structure, it is possible to consider whether the present relationships with the investors, owners and shareholders are satisfactory. How could they be improved? More importantly still, are there any possible changes in ownership on the horizon, and what might be the implications?

It is important to capture this broad view of the business before homing in on board specifics. When, in the next stage of the review, board structure, style and strategy are examined, they can be viewed in terms of their contribution to holistic business success.

A closer look at the board review process:

Playing possum and wrestling wombats

The 1998 UK Hampel report (http://www.ecgi.org/codes/documents/hampel.pdf) called for formal procedures to ‘assess both the board’s collective performance and that of individual directors’ (3.13). But research three years later by PricewaterhouseCoopers showed that only a third of UK companies did so. I’ll focus in my next few blogs on the first of the two-part review structure, with the question...

What does a board review involve for the board as a whole?

Research has shown that the typical corporate governance indicators, such as board structure, the independence of directors, and the use of board committees, are not the best predictors of board effectiveness. Less specific indicators, sometimes called ‘soft’ governance, such as the working relationships between directors, the standard of chairmanship, or directors’ knowledge of the company, are more significant.

Information for a board review is obtained from an analysis of board and board committee agenda, papers and minutes, from interviews with each director, company secretary and staff, top executives, group discussions, and director workshops and from interviews with investors, auditors, analysts and internal staff.

In terms of the collective board, a competent and regular board performance review should:

• Ensure that appropriate disclosure and accountability are being provided
• Review current board and board committee practices and improve efficiency
• Review the effectiveness of the board’s strategic thinking and decision making
• Provide an ongoing challenge to attitudes in boards with long serving directors
• Create the climate if a change of chairmanship is needed
• Provide information for the board’s corporate governance report and respond to questions from shareholders and other stakeholders

For the board assessment section of the overall review process to be focussed and fruitful, it’s vital that directors resist ‘playing possum’, as the Australians say, hiding themselves and their activities. An open attitude and clear objectives, such as the ones above, will prevent the board review process from becoming a paper shuffling, box ticking WOMBAT (waste of money, brains and time) and instead constitute an efficient use of resources with highly relevant outcomes.

Painful and positive or just positively painful? A closer look at the board review process...

The newly refurbished Corporate Governance Code 2010 states that, “evaluation of the board of FTSE 350 companies should be externally facilitated at least every three years” (B.6.2). This is a wake-up call for private, public and listed companies alike to the need for penetrating and purposeful assessment of board performance, requiring a revisit of some of the variables the review process involves. Firstly...

Who should carry out the board review?

The chairman often assumes the role, but experience has shown that this approach lacks the independence and objectivity that a serious review really needs. As Tricker puts it, “the chairman is effectively marking his own examination paper” (Corporate Governance: Principles, Policies, and Practices, 315).

An experienced INED, perhaps the senior INED, could be asked to lead the review. Or, a special board committee, typically made up of INEDs, might take on the role. Some boards give the responsibility to the audit committee using the internal audit function. Whilst an executive director such as the CEO or CFO will have appropriate knowledge of the business and the board, his or her perspective is unlikely to be seen as objective by other board members.

An alternative approach is for the board to seek an independent perspective, inviting someone outside the board to lead the review process and report. A past chairman – who would have knowledge of the business – is a possibility, but here there could be a lack of objectivity on board politics. Another possibility is a respected chairman or INED from the board of another non-competitor company.

Then, of course, there are independent organisations and firms of consultants up for the job. Unfortunately, some of those offering such services do not yet have a lot of experience at carrying them out. (Management consultancy projects call for an altogether different mind-set to those dealing with board level interactions and political processes.) In response to the Code provision that FTSE 350 companies arrange externally-facilitated board reviews at least every three years, the IoD pointed out that:

scepticism about the effectiveness of external facilitators, and the fact that presently there are only a few organisations with sufficient quality and experience to perform such a role, could mean that companies are slow to comply with this new requirement.

When it comes to board assessment then, the ‘who’ question is not answered straightforwardly. Factors to take into account include the nature of the corporation, the culture of the board, and the relevant pros and cons of different candidates for the task. Get this bit right, and the review itself has a fighting chance of being accepted, efficient and energising.

More to come on What does a board review involve?

Board Performance Review

The Combined Code Of Corporate Governance has "Performance Evaluation" as one of its main principles:

"The board should undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors"

Why undertake a board review? The worst response is 'because we are require to do so by regulations'. A more positive response is that 'we see the review as a fundamental part of our corporate governance processes. Our corporate governance strategy is a basic part of our over-all corporate strategy.

(Tricker; Corporate Governance; Principles, Policies, and Practices 2009)

Clearly, the board should seek to derive real benefit from the review and not to see it as threatening in any way. To do this the board needs to find the right partners to undertake the assessment and ensure that the process fits in with the rhythm and cycles of the board and the organisation's operations.

So, what does such a review comprise? Coming soon.................................