Following is a Financial Times article by John Plender
Published: January 20 2005 02:00
Evaluating board performance is a discipline that can no longer be sidestepped.
In the US, the New York Stock Exchange's guidelines on corporate governance require companies to "address" evaluation. While this falls short of a mandatory requirement, it would be difficult for a company to address the issue and declare it had decided against doing anything about it. In the UK, under the Combined Code, evaluation is mandatory. Elsewhere, evaluation is becoming best practice for company boards.
Yet, for boards wondering how to go about the task, the regulatory authorities and stock exchanges provide frustratingly little guidance.
The Combined Code, for example, says that there should be a "formal and rigorous annual evaluation of its own performance and that of its committees and individual directors". But it is silent on whether that calls for external or internal assessment and what, if anything, should be disclosed about the outcome. In practice, the Code's wording leaves room for a minimalist approach whereby directors anonymously fill in a self-assessment questionnaire asking about the basic workings of the board.
So what are the options for boards wanting to evaluate themselves? They extend from bringing in consul-tants to facilitate the self-assessment and generate an interactive dialogue with the board to commissioning a full-blown external assessment involving individual interviews with all the directors together with a board discussion of the findings and remedial action.
Many boards are wary of outside advice. Research by Independent Audit, a UK-based consultancy that advises on the effectiveness of boards and audit committees, shows that a majority of FTSE 100 companies prefer self-assessment. A separate survey by Independent Remuneration Solutions, a UK-based consultancy, found similar resistance to external reviews.
The preference for self-assessment is problematic - not least because it may prove to be no more than a warm, self-congratulatory pat on the boardroom back.
But several factors explain the objection of boards to external reviews. One is the cost of external advice. At GlaxoSmithKline, the fees for an evaluation by Anna Mann, the former headhunter, are rumoured to have been £240,000. Hardly peanuts. Another is that, given board evaluation is a relatively new game, the idea of paying large fees to people who are, in effect, learning as they go along, does not sit easily with directors.
A third is concern about exposing the inner workings of the board. In the US, this is a particular worry. Holly Gregory, a partner at Weil, Gotshal and Manges, a US law firm, says that documents thrown up by an evaluation may provide material for a discovery process during litigation. Weil, Gotshal and Manges - which acts as a facilitator for self-assessment for company board - has performed this role, unusual for a law firm, since it advised General Motors on board evaluation in the early 1990s.
Concern about confidentiality explains why chairmen often turn to headhunters. They find reassurance in extending an existing relationship. But if headhunters are good for helping in the recruitment of non-executive directors, they are not necessarily best placed to help in the evaluation of the board.
For instance, if a headhunter concludes that the board has been badly run, how will they tell the person chairing the board truths - given that that person is the source of headhunting fees? Also, if they conclude that the composition of the board is inappropriate, they could be regarded as drumming up extra business: any reshuffle would mean fat fees for their advice.
These conflicts ought to give a competitive edge to organisations that have been facilitating or conducting board evaluations for some time: for example, the National Association of Corporate Directors in the US and the Institute of Chartered Secretaries and Administrators in the UK. There are also small independent consultants focusing on board performance.
For all the negativity and difficulty surrounding external evaluation, it seems, nevertheless, that boards will be prepared to pay for independent scrutiny. As well as regulatory pressure in the shape of the NYSE rules and Combined Code, there is, according to Roddy Gow of Gow Board Consulting - which operates from offices in London and New York - pressure from the big professional investors.
Companies with a chequered history may be encouraged to undertake a formal board evaluation. But it may be wise for companies to do this - even if they have a good record: an external evaluation signals to the capital markets that a company is trying to raise the bar on board performance.
Not only fund managers are interested in board evaluation. Mr Gow says that corporate insurers are taking note. For underwriters, an external evaluation by a credible consultant would suggest a reduced governance risk. But there remains a practical difficulty. How do you obtain meaningful reporting of board evaluation that permits sound inter-company comparisons?
So far, reporting on board evaluation in the annual report tends to be bland, with little information on responses to findings. Yet there are exceptions. At Cable & Wireless, where the assessment is done in-house, the non-executives provide a statement explaining the evaluation and workings of the board, along with detailed comment on the relationship between the chairman and chief executive officer and on the challenges the board tried to address during the year.
Fundamental to board evaluation, according to Caroline Phillips of the ICSA, is the attitude of the chairman. If he is only doing it because he has to, she says, it will not work. The exercise should also be tailored to individual circumstances. If the board suffers from internal tensions, says Ms Gregory of Weil, Gotshal and Manges, open board discussion is not going to happen. Questionnaires and individual interviews may be more appropriate.
In the US and Europe, a learning process is under way. Yet it is hard to believe that the big investors will not in future pay more attention to this aspect of accountability. In fact, Calpers, the big Californian public employees' pension fund, says in its governance principles that no board can perform its function of establishing a company's strategic direction and monitoring management's success without evaluating itself.
Others will surely take a leaf out of Calpers' book. The merit of evaluation, especially when conducted with external help, is that it can force issues into the open.
Of course, the process can be uncomfortable - even for the head honcho. As Sir Adrian Cadbury, the pioneer of corporate governance in the UK, once remarked, an appraisal discussion with individual directors can rapidly turn into an appraisal of the chairman. But common sense suggests that some form of appraisal, especially one provided with competent, independent outside help, must make for a more effective governance.
PROS AND CONS OF EXTERNAL BOARD REVIEW
Corporate governance guidelines now require or encourage companies to evaluate board performance. But opinions differ on how this should be done: by self-assessment or with independent evaluators. Objections to outside assessors include:
* Costs. Consultancy fees for a review of board performance can be high.
* Quality. External review of board performance is a relatively young discipline, raising doubts about its efficacy.
* Confidentiality. Many boards are wary of revealing details of meetings and working processes. Supporters of external assessors point to the following:
* Improved market perception. Companies that initiate a board review are likely to be looked on favourably by investors.
* Lower governance risk. Corporate insurers may regard external review as a risk-reducing measure.
* Detecting problems. Obstacles are more likely to be identified and addressed.
For other articles in this series, go to www.ft.com/boardmanagement (subscription required).
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