As part of its enhanced listing standards, in 2003 the New York Stock Exchange modified its listing requirements to require corporate boards and their committees to undertake annual evaluations. However, the NYSE did not specify or provide any guidance as to how the evaluations should be conducted. With the lack of guidance on the self-evaluation process, it is not surprising that board practices have been widely divergent. Some boards employ detailed written questionnaires, with directors responding to dozens of questions and an independent firm analyzing and reporting the results. By contrast, other boards satisfy the self-evaluation requirement through a brief discussion at a board meeting, with either a director or the corporate secretary leading the discussion. While Nasdaq and the other exchanges do not require annual evaluations, many companies have undertaken an evaluation process as a matter of good corporate governance.
While approaches to board and committee self-evaluations will vary considerably from company to company, and even from year to year, several important questions should guide the evaluations process.
1.What Are the Goals Of The Self-Evaluation Process?
The board and committee self-evaluation process should not be viewed as a "check-the-box" exercise, but as a valuable tool to improve director, board and corporate performance. At its core, the self-evaluation process seeks to measure two types of performance. First, the self-evaluation will ask whether the board or committee effectively carried out the specific responsibilities assigned to it in its governing documents, such as in a committee charter. Measurement will typically involve a 1-through-5 (poor to excellent) rating on the performance of each major responsibility assigned to the board or committee. Second, the self-evaluation will seek to measure broader and more strategic aspects of board or committee performance. For example, has the board set the right tone, operated at the right level of oversight, been effective in processing information, shaping corporate strategy and making decisions, and followed through on key matters? Its "scores" in each of the categories of performance provide the board or committee with its "report card" on these important issues.
2.Who Should Lead The Process And Who Should Participate?
For NYSE companies, the nominating and corporate governance committee is assigned responsibility for overseeing board evaluations, so the chair of this committee will typically manage the evaluation process. In other settings, this role may be assumed by the chairman of the board or the lead or presiding director. The leader of the evaluation process must ensure that the chairman of the board, the chairs of board committees and the chief executive officer have appropriate roles in the process.
Whoever leads the evaluation process must be committed to "owning" the process, not only for purposes of completing the self-evaluation, but on an ongoing basis. Being responsible for board evaluations is a year-round job, with the leader ensuring that the board follows through on recommendations that come out of the process, integrates the self-evaluation with other board processes (such as development sessions and re-nominations), and maintains continuity from one annual evaluation to the next. An effective annual evaluation should result in an "action plan" for the board or committee, and the leader of the evaluation process should monitor the plan throughout the year.
With respect to participation in the evaluation process, consideration should be given to whether input will be limited to directors themselves or whether other persons who work with the board or its committees will provide comments. For example, in an evaluation of the audit committee, the directors might seek input from the chief financial officer, general counsel, treasurer, controller and director of internal audit. By using such a "180 degree" process, directors may compare how they rate their own performance with the ratings given by the members of management who deal with the particular issues every day.
Finally, those directors responsible for the evaluation must decide whether the process would benefit from the participation of a facilitator. Depending on the style of the process, the corporate secretary may take on this role or the board may employ an independent facilitator or governance expert to assist in the process.
3.What Process Should The Board Use For The Evaluation?
In designing the self-evaluation process, directors should consider (a) whether the process will include written questionnaires, a live discussion or interviews, (b) how rigorous the process will be in any given year, and (c) whether there are any unique issues that may affect the design of the process.
In deciding whether to use written questionnaires or to rely on a live discussion at a meeting, an important consideration is whether the particular directors are likely to engage in an open and candid discussion of board performance. If there is any sense that individual directors may want to raise sensitive issues, it may be preferable to allow for written responses, which will ensure that directors' remarks remain confidential. Interviews are not typically used in the evaluation process, though individual participants may seek to discuss sensitive issues with the person facilitating or leading the process.
The board and committee evaluation process should be dynamic, with several factors suggesting that different levels of detail and different approaches to the process may be appropriate from one year to the next and from one committee to the next. If a board has conducted thorough self-evaluations for several years and has had no major challenges or changes in its composition over the past year, then a more truncated "bring down" type of process may be satisfactory. On the other hand, where a board has struggled with important issues during the year, had turnover in its membership or leadership, or found significant issues in previous self-evaluations, it may benefit from a more rigorous process. Those responsible for designing the self-evaluation process should not pre-judge the board on these types of issues, but should be realistic about what the self-evaluation process is likely to yield.
Before embarking on the annual self-evaluation, board leaders should consider whether there are special factors that suggest modification of the usual processes. For example, if the company is the subject of sensitive litigation or enforcement matters, the board should be especially careful with any written product generated from the self-evaluation process.
4.Should The Directors Be Evaluating Each Other?
Increasingly, directors and other stakeholders are asking whether the evaluation process should include a "peer review" in which the directors assess the performance of each individual director, in addition to assessing board and committee performance as a whole. Though controversial, there has been increased use of peer review in recent years.
Peer reviews can be accomplished through written questionnaires, individual interviews or a combination of the two. As with the overall board self-evaluation, the review can be conducted by the chair of the governance committee, the lead director or a third-party facilitator. Typically, the review will begin with each director completing written questionnaires, or being interviewed, relating to other directors. At the conclusion of the process, the facilitator will meet with each director to discuss his or her performance and areas where the director may make greater contributions to the board. The facilitator will also report to the board as a whole, identifying areas of strength and making suggestions for improvement without "naming names."
Proponents argue that a confidential peer review leads to improved board performance. Directors receive acknowledgment of their contributions and suggestions on how they may contribute more to the board, and may be motivated by the sense of individual accountability. Directors also report that the increased focus on the performance of individual directors often provides greater insight into the performance of the board as a whole.
Critics suggest that peer review can take a considerable amount of time and lead to unnecessary finger pointing that undermines the collegiality of the board. It may also dissuade potential directors from joining the board. Critics of peer review argue that if there is a strong governance committee chair or lead director, that person should be able to address issues of individual performance without the time, expense and difficulty of a peer assessment.
Using The Self-Evaluation To Improve Board Performance
Rather than focusing only on how an annual self-evaluation should be conducted, board members should consider the more important question of how self-evaluations can be used to improve the performance of the directors, the board and, ultimately, the company itself. From this perspective, the self-evaluation is more than an isolated annual event - it provides information that flows into other board and corporate processes. Effective self-evaluations will provide critical information about the composition of the board (for example, whether a new director with a particular skill set might be added to the board), the board's relationship with management, and the effective operation of the board and its committees. Board leaders should view annual self-evaluations not as exchange-mandated events, but as dynamic processes that will improve performance.
Jeffrey M. Stein is a Corporate Partner and Laura Oleck Hewett is a Senior Corporate Counsel at King & Spalding. As part of its focus on corporate governance, King & Spalding, together with Tapestry Networks, has created the Lead Director Network, a group of lead directors, presiding directors and non-executive chairs from many of America's leading companies that meets to discuss how to improve the performance of their corporations and earn the trust of their shareholders through more effective board leadership. Reprinted by permission of Directors & Boards.