Investors Want More Transparency on Director Evaluations

Is yet another corporate governance reform making its way from the United Kingdom to our shores? Just as shareholder say-on-pay voting made the migration to American proxies, investor advocates are hopeful the same will happen when it comes to improving disclosures about director self-evaluations.

Since 2010, the U.K.’s Financial Reporting Council amended its corporate governance code to lay out how frequent and detailed the board self-evaluation process should be for traded companies. Ongoing efforts continue to refine how much of those assessments should be made public.

England isn’t alone in that effort. In Canada, board self-assessment disclosures are required by the Canadian Securities Administrators. In Europe and Australia, disclosures are also a common practice and companies delve into specific findings. A push is now on for American companies to move toward similar practices.

“The U.S. is not the global standard for corporate governance in many respects and this is just one more example of where we are behind the curve,” says Amy Borrus, deputy director for the Council of Institutional Investors, a non-profit association of pension funds, endowments, and foundations.

In the United States, although board self-evaluations are commonplace—occurring at least annually or biannually at most public companies—there are very few regulatory requirements. The New York Stock Exchange modified its listing requirements in 2003 to require corporate boards and their committees to perform annual evaluations, for example, but Nasdaq still has no such formal requirement. Nor has the NYSE offered any guidance on how those reviews should be conducted, how boards should use the information, or of how the process should be communicated to shareholders.

There is no rule that requires self-assessment disclosures on the books at the Securities and Exchange Commission either, with one exception. Since 2006, the Commission has required investment company boards to conduct annual self-assessments with a focus on the effectiveness of the board’s committee structure, and the number of funds overseen by directors. These self-assessments, however, do not need to be in writing and can just be summarized in meeting minutes.

“It is just not common practice to disclose this information in the United States,” Borrus says. “It is often just one sentence, ‘the board evaluates itself,’ period.”

Looking for More

Against this backdrop, CII has released research intended to bolster its call for improving the accessibility of these disclosures. The goal, Borrus says, is to move away from disclosures that focus exclusively on the mechanics of how an assessment was conducted without venturing into the results. “We don’t have a policy on what should be in the evaluation, but you would hope it is not just simply ‘fill out this questionnaire, and we will talk about the results in closed session.’ It has to be something more than that,” she says. “No one expects anyone to name names or include reviews of individual directors. We want to ensure that there is a vigorous process for how the board evaluates how well it is performing and, if there are gaps, what steps are taken.”

“The U.S. is not the global standard for corporate governance in many respects and this is just one more example of why we are behind the curve.”
Amy Borrus, Deputy Director, Council of Institutional Investors

“There is growing interest in the quality of the board of directors,” Eleanor Bloxham CEO of The Value Alliance and Corporate Governance Alliance, board, and executive educational and advisory firms, says. “Does the board reflect the right mix of skills and experience and perspective? How effective is the board? These are questions that active owners are asking.”

The evaluation process offers a way for boards to show they are proactive about particular issues, such as cyber-security and “willing to add new expertise,” Bloxham says. Other issues might include board diversity, an overloaded audit committee, or the need for an additional technology risk committee, she adds. Information shareholders want, according to CII, includes an explanation of who evaluates whom, who reviews the results, and how the board handles results. “More disclosure provides the opportunity for shareholders to gain new insight,” Bloxham says. “It will also require boards to sharpen their pencils and ask, ‘How do we address these things?’”

CII’s recent study singles out companies with an admirable standard for this sort of disclosure. General Electric—the lone U.S. company mentioned—offers a thorough disclosure of its board evaluation process in its “Governance and Public Affairs Committee Key Practices” document.

GE SETS A STANDARD

The following is from General Electric’s internal policy regarding its methodology for assessing board and committee effectiveness.
All of the board and committee self-evaluations should be dine annually at the November board and committee meetings. Every October, an independent expert in corporate governance will contact each director, soliciting comments with respect to both the full board and any committee on which the director serves, as well as director performance and board dynamics. These comments will relate to the large question of how the board can improve its key functions of overseeing personnel development, financials, other major issues of strategy, risk, integrity, reputation, and governance.
In particular, for both the board and the relevant committee, the process will solicit ideas from directors about: improving prioritization of issues; improving quality of written, chart, and oral presentations from management; improving quality of board or committee discussions on these key matters; identifying how specific issues in the past year could have been handled better; identifying specific issues which should be discussed in the future; and identifying any other matter of importance to the board functioning.
The independent expert in corporate governance will then work with the committee chairs and the lead director to organize the comments received around options for changes at either board or committee level. At the November board and committee meetings, time will be allocated to a discussion of, and decisions relating to, the actionable items.
Source: General Electric.

Also lauded was BHP Billiton, an Australian mining company. It offers an in-depth discussion of the evaluation process in its annual report and lists factors the board considers when evaluating its activities. A section is devoted to an overview of how each part of the process (individual director reviews, board chair review) is conducted. Also included is a high-level overview of board effectiveness and the performance of individual directors (without listing specific names). Agreed-upon improvements are summarized.

How much information a company discloses about the process could prove to be a delicate balancing act. “There needs to be candor and openness by the board members,” cautions David Hearth, a partner in the corporate practice of law firm Paul Hastings. “If they believe their comments will be part of some public record, it can diminish the effectiveness and purpose of the self-assessment. If there is a public narrative about the self-assessment process, and the outcome of it, that it could chill the process itself.”

Best Practices

A desired side-effect of transparency is that greater insight reveals how findings are used to solve problems. There are plenty of concerns the reviews could shed light on, and the most recent edition of PwC’s Annual Corporate Directors Survey illustrates how boards are challenged to keep themselves distraction- and dysfunction-free. One alarming finding: The level of dissatisfaction directors express with their fellow directors continues to increase. Thirty-six percent of respondents said someone on their board should be replaced—a jump from 31 percent only two years ago. Directors cited diminished performance due to aging, lack of expertise, and not being prepared for meetings as the top reasons for their dissatisfaction with peers’ performance.

With personality clashes, changing business models, and evolving risks threatening a company’s future, the importance of maintaining a cooperative board is clear. One piece of advice: Share the fact that you have a policy around self-assessment and shed light on the process you use. “That goes a long way toward people feeling that the board is being transparent,” Pamela Knecht, CEO of Accord, a Chicago-based consulting firm that specializes in governance services, says.

Most companies, as a centerpiece of their board’s self-evaluation process, if not the only piece of the review, ask directors to each fill out a questionnaire that assesses where they see gaps in expertise and needs for improvement. Some use oral interviews, conducted by an outside party, to supplement this information. “If a board is going to do a self-assessment, it must talk about the results and create improvement plans based on those self-assessments,” Knecht advises. “Otherwise, the self-assessment might become worthless.”  

Companies should be cautious not to rely too heavily on these questionnaires. “What written board self-assessments do not do very well is help you get under the hood of the car,” Knecht says. “The best functioning boards have learned how to work together and resolve their differences in healthy ways. Determining that you have reached that through just a written survey is pretty unlikely.”

It is important to make sure the board doesn’t fall into a rut and the self-assessment process becomes perfunctory,” Hearth says. Boards should reconsider the process itself and consider a different format if they think effectiveness has lagged.

The focus needs to be placed on developing consensus around action items,” he says. Which members are going to go to which educational events? Who is going to go to which conferences? Should an expert be brought in to conduct a training session that will enhance board expertise? What changes should be made to who chairs certain committees?

Getting to what Knecht refers to as “Governance 401” requires boards to develop at least five or six specific goals for improvement. The governance committee can then track the progress of those goals, she suggests. Individual board member assessments should be approached cautiously. “Boards should make sure they have mastered the basics of self-assessment and have a culture that leads to healthy and honest conversations before they attempt to get to that next level,” she says.

If companies eventually face heightened disclosure requirements, shareholder pressure is a more likely catalyst than SEC rulemaking, Borrus says.

“I could see this happening down the road, perhaps with a different SEC,” Bloxham says. “Before that, on a case-by-case basis, some shareholders might put up a resolution asking for that kind of information, or they might negotiate it and have companies fall into line.”