The New York Stock Exchange requires that the board of each publicly traded corporation “conduct a self-evaluation at least annually to determine whether it and its committees are functioning effectively.” The purpose of this exercise is to ensure that boards are staffed and led appropriately; that board members, individually and collectively, are effective in fulfilling their obligations; and that reliable processes are in place to satisfy basic oversight requirements.
Research evidence suggests that, while many directors are satisfied with the job that they and their fellow board members do, board evaluations and boardroom performance fall short along several important dimensions. In particular, board evaluations do not appear to be effective at the individual level. Only half (55 percent) of companies that conduct board evaluations evaluate individual directors, and only one third (36 percent) believe their company does a very good job of accurately assessing the performance of individual directors.
Directors also have only modest satisfaction with boardroom dynamics. Only two thirds (64 percent) of directors strongly believe their board is open to new points of view; only half strongly believe their board leverages the skills of all board members; and less than half (46 percent) strongly believe their board tolerates dissent. Forty-six percent believe that a subset of directors has an outsized influence on board decisions (a dynamic referred to as “a board within a board”). The typical director believes that at least one fellow director should be removed from their board because this individual is not effective.
These are troubling statistics that suggest that many companies do not use board evaluations to optimize the contribution of their members.
A board evaluation typically starts with a review of board structures and processes, and is often performed by the general counsel or outside legal counsel. It includes a checklist of items that public companies are required to review and the standards associated with them. The more difficult but also more value-producing part of the board evaluation process is to review the contribution of individual directors and the interpersonal and group dynamics among board members.
Key elements should include the following:
How You Lead
This section evaluates the effectiveness of board leadership, including the lead independent director (or independent chairman) and committee chairs. It examines how the leader was chosen, the skills and experiences that this individual brings to bear, and his or her leadership style. The company should develop criteria for these roles and evaluate the available skill sets of its members to determine who is most suitable. Companies should avoid appointing a leader by default (i.e., the person who volunteers to do the job or the most senior member of the board) or solely looking to the required background (such as a qualified financial expert) because temperament is often key to effectiveness in the role. These individuals are the interface with management and need a communication style that is clear, concise, and constructive. A successful board leader needs to be adept at translating the voice of the board to management, and the voice of management to the board. The lead director, for example, should facilitate the board in a way that earns respect from its members. He or she is responsible for encouraging broad participation, cajoling if necessary, and bringing the right people into the conversation at the right time. This requires effort both within and outside the boardroom itself and requires a range of leadership styles to line up effectively with the board’s diverse members. Finally, the lead director can also be responsible for managing the evaluation processes and delivering feedback or arranging coaching for directors that require it.
The inadequacy of leadership among many boards is evident from survey results. Only 72 percent of directors believe their leader is effective in inviting the participation of all directors, and only 68 percent believe the leader is effective in inviting the participation of new members. Only 60 percent believe their lead director “asks the right questions.” Worse, only a quarter (26 percent) believe that director is very effective in giving direct, personal, and constructive feedback to fellow directors.
How You Manage
This section evaluates the manner in which board meetings are conducted, including whether they are organized for maximum productivity and the honest exchange of ideas, and whether they encourage the full participation of all members. Particular attention should be paid to committee meetings and executive sessions. According to many directors, the “real work” of the board takes place in committees. The evaluation process should determine whether clear expectations are established for the work conducted by committee members and whether committee reports are effective in keeping the full board informed about key issues facing the company. The evaluations should also review executive sessions, which take place outside the presence of management and include only the non-executive (i.e., outside) directors on the board. When structured properly, executive sessions ensure that the day’s meetings are productive and serve as an important forum for framing and reviewing discussion topics. Non-executive directors meet at the beginning of the day, before the CEO joins, to discuss key topics and identify areas where directors want to learn more information from management. They then meet again at the end of the day to review and contextualize the information they learned and bring closure to the discussion. When effective, these sessions last no more than 10 to 15 minutes. Long meetings can be a red flag, indicating that board members do not feel comfortable expressing their honest opinions in front of management and instead wait until management is not present to speak freely. This dynamic is detrimental to decision-making.
Survey evidence indicates that this can be a problem for many companies. Only two-thirds (68 percent) of board members say they have a very high level of trust in their fellow directors, and only 63 percent believe their board very effectively challenges management. Half (53 percent) believe that their fellow directors do not express their honest opinions in the presence of management.
How You Contribute
Finally, board evaluations stand to improve by rigorously reviewing the manner in which board members interact, including which directors participate and how decisions are made. Leadership, coaching, and feedback are critical in this regard. Directors have important functional knowledge but are generally not instructed on how best to contribute this knowledge in a boardroom setting. Many come from executive, managerial, or professional backgrounds where they hold positions of leadership. They are brought onto the board to contribute this expertise, but not in a manner that stifles debate and shuts down discussion. They are not recruited to boards to provide the last word on topics, with other directors deferring to their opinion. They are recruited to contribute knowledge that the group as a whole can use to make better decisions. In truth, there is no reason to believe that forming a board from a group of successful CEOs will produce a high-functioning board.
Research evidence demonstrates that many boards suffer from poor group dynamics. Three-quarters of directors believe their fellow directors allow personal or past experience to dominate their perspective. A significant minority (44 percent) say that their fellow directors do not understand the boundary between oversight and actively trying to manage the company. Thirty-nine percent report that their fellow board members derail the conversation by introducing issues that are off topic.
All publicly traded companies are required to conduct an annual evaluation. The evaluation process can be greatly improved by treating the board as a high-performing group of individuals and evaluating its leadership, management, and group dynamics, as illustrated above.
This post comes to us from Taylor Griffin, David Larcker, Stephen A. Miles and Brian Tayan. Ms. Griffin is the Chief Operating Officer of The Miles Group. Professor Larcker is the James Irvin Miller Professor of Accounting and Senior Faculty at the Rock Center for Corporate Governance at Stanford University. Mr. Miles is the founder and Chief Executive Officer of The Miles Group. Mr. Tayan is a researcher in the center. The post is based on their recent article, “Board Evaluations and Boardroom Dynamics,” available here.