Gerry Brown, author of The Independent Director: The Non-Executive Director’s Guide to Effective Board Presence (published by Palgrave Macmillan).
Along with overseeing the company, nowadays all boards also need to scrutinize and examine themselves. This process – board evaluation – is something that every company needs to do on a regular basis. Board evaluation used to be a largely informal matter, in which the chairman would have a series of one-to-one conversations with other board members and ask them whether they thought the board was running okay. If they all did, no further action was taken; if there were issues, the chairman would try to deal with them. This kind of informal monitoring is actually very useful.
However, there is now a growing trend towards more formal evaluation of boards carried out by external parties, usually consultants. Headhunting firms often provide this service. In the UK it is now a requirement for public companies to have an external board evaluation carried out every three years. When it comes to conducting a board evaluation the list of the issues covered in the evaluation below is a very good example of an evaluation checklist.
1. Overall Impression of the Board
– Dynamics of the board
– Culture and climate in the boardroom
– Sense of teamwork
– Quality of discussion / balance of debate
2. Organisation of the Board
– Agendas, and formation of agendas; coverage of the right topics
– Reporting, including of board committees
– Meeting frequency and length
– Formal processes and duties
– Informal processes (including board dinners)
– Strategy sessions
– Information and support materials; company secretariat and support
3. Committee Organisation: Audit, Remuneration, Health, Safety & Environment, Nomination
– Meeting frequency and length
– Membership, internal attendees and adviser attendees
– Information and support materials
– Topics for the board versus topics for the committees
4. Board Composition
– Balance (including number of executives)
– Skill sets
5. Board Involvement and Engagement
– Directors’ knowledge of the business
– Relationships with management
– Contact outside the boardroom
– Strategy development
– Induction and training for new directors
6. Communication with Shareholders/Stakeholders
– Shareholder messages
– Analyst meetings and reports
– Chairman’s role with shareholders/stakeholders
– Other Directors’ role with shareholders/stakeholders
7. Looking Forward
– Succession planning (Executive and Independent)
– Directors’ development needs
8. Overall Board Effectiveness
– Progress since last board evaluation
– Fulfilment of fiduciary duties
– Ethics, Corporate Social Responsibility and Environment
– Compliance with UK Corporate Governance Code
– Expectations placed on directors including their responsibilities for governance and remuneration
– Support to the business
– Checks and balances
– Short- and long-term health of the business
– Senior Independent Director
– Independent Directors
– Executive Directors
Although different companies work in different ways, the usual procedure is for a consultant to interview each member of the board individually. Opinions are then collated and provided, on an anonymous basis, to the chairman in the form of a report. The process usually takes from four to six weeks. Good evaluation also serves as a way of sharing best practice. Consultants who are experienced at board evaluation will make recommendations based on what they have seen elsewhere. For example, they may advise on new ways of thinking about strategy, or suggest methods for handling management succession, based on their observations. This kind of advice can be very valuable. Once again, though, everything depends on the quality of the consultant and my advice is: choose your consultant wisely. So far, so good but what can go wrong? The worst things that can happen to a board are either a breakdown in relationships that leads to the board fragmenting into fractions, or a descent into collective complacency and inaction. Either can be equally disastrous, leading to the board taking its eye off the ball and making mistakes.
Failures of this sort are usually the result of some sort of underlying tension or pressure. Breakdowns in relationships often stem from tensions between members of the board. Jay Lorsch in his useful book The Future of Boards describes six tensions and how they arise:
1. Social cohesion tension. All boards need some social cohesion to enablethem to work together, but too much is definitely a bad thing. Social cohesion can pressure people into conforming with the majority point of view. Conformity itself is held to be a good thing, “in the best interests of the team.” Some non-conformity, a degree of irritant, is still required.
2. Dissension tension. On the other side of the coin, if there is too much dissension, the board can disintegrate into infighting and chaos.
3. Psychological safety tension. According to Jay Lorsch: “This is the shared belief that the group is a safe place for risk-taking, sharing unpopular ideas, and admitting errors. However, too much safety creates unhealthy ‘social loafing’.” Certainly boards should be encouraged towards creative thinking, but an element of realism is needed too. Board members need to remember that actions are not free of consequences. Too much safety, says Lorsch, and there is a tendency to forget the need for accountability.
4. Collectivist-feelings tension. Again to quote Lorsch: “It is critical to create a balance between operating and feeling a group and still valuing individual contributions.”
5. Diversity of thought tension. Boards need diversity in order to help them overcome the tendency towards excessive social cohesion. I t can be of real benefit for a board to have people from different background offering different points of view. However, diversity cannot get in the way of decision-making. There must be a mechanism for reconciling different points of view and achieving a rational consensus.
6. Strong leader tension. The board is a team, and every member of the team must be encouraged to contribute. Encouraging people to speak up and make contributions is one of the roles of the chairman. However, this can be difficult for some of the executive directors. It is hard for an operations director to speak freely in front of the Chief Executive Officer (CEO) —especially if his honest view clashes with that of his boss. Leaders, especially CEOs, need to sublimate their own egos to a degree.
Many, if not all, of these tensions are present, or potentially present, in most board relationships and need to be managed. There is no perfect solution, and the balance will change depending once again on the composition of the board and the pressures the business faces. Board members need to manage a series of trade-offs in order to keep the right balance in all six cases. If they fail, then, the board runs the risk of one or more of the following pathologies manifesting itself:
1. excessive conformity, or groupthink.
2. negative group conflict, or factionalism based on differences either in basicvalues and beliefs, or in personalities.
3. politicking, or people manipulating others in order to acquire more personal power. This can be a defensive mechanism if the power-seekers perceive that their own position is under threat.
4. habitual routines, or “that’s the way we do things around here.” People become ingrained in certain practices and actions, and cannot or will not change, even if a threat emerges.
5. shared information bias, or “we know what we need to know.” This pathology concentrates on knowledge that is already known and shared among the group, and does not seek to look any further and find out if anyone else has any further information to bring to the table.
6. pluralistic ignorance, where people have important opinions and viewsbut will not voice them because they fear to be seen differing from their colleagues. The “ignorance” results once again from a failure to share knowledge.
7. social loafing, where people work less hard when part of a team than whenon their own. This phenomenon was first noticed in 1910 when a sociologist found that teams of men engaged in a tug of war would, as individuals, pull less hard than if left to pull the rope on their own. On boards, this manifests itself in a “why should I get involved? Someone else will do it mentality.
8. group polarization, which in some ways is the opposite of groupthink. In group polarization, members of the group encourage each other towards more extreme thinking. Those members who have doubts are encouraged to set them to one side. The collective decision, which is finally reached, is thus more risky than any of the group’s members would have made if left on their own.
When boards fail, corporate governance breaks down and the company is at risk. So what is the best ‘Best Practice for Boards’? Let me set out six rules that I believe are essential to follow if boards are to function effectively.
Boards must be of a suitable size and diversity. Asking how large a board should be is a bit like asking how long is a piece of string, but there are some rules to follow. Firstly, the board should not be too large; it needs enough members to cover all the tasks that the board faces, but there should not be any supernumeraries. Secondly, there needs to be a balance of executive and independent directors. Executive directors need the advice, contacts, scrutiny, and questions that independent directors bring, but they should not feel swamped by these. The right number of directors to make a functioning team should be the basic rule of thumb. On diversity, the issue is much more clear-cut. Boards should be diverse. This is partly to avoid the drift towards groupthink and conformity, but it is also a matter of common sense. Peter Waine of Hanson Green, an experienced headhunter who has advised on the recruitment of many independent directors over the years, maintains that “three-quarters of the useful experience of a good independent director is generalist skills; sector experience is only the bottom quarter.” A diverse board – a “ministry of all the talents,” – can work together in a much more creative and exciting fashion to create and deliver a sound strategy. Diversity is essential.
Board members must contribute to every aspect of the board’s work. Board members should be energetic, inquisitive and attentive. They should be prepared to devote sufficient time to carrying out their duties, not just attending board meetings. They should be well informed about developments in their sector. They should participate fully in all discussions, expressing their views in a constructive way. Independent directors should, as Lawrence Christensen says, “be a guiding hand to develop the board to realize its full potential.” Of course, their ability to contribute depends on the culture of the board itself and whether the executive and independent directors work well together. “It is easy for executives to keep non-executives in the dark, if they want to,” says Peter Waine. “It is up to the chairman to create a climate where everyone can make a contribution.”
Boards must have strong leadership. In the UK, that means a strong independent chairman who is both an able diplomat and a superb organizer. He or she should also know the business very thoroughly. In the UK at the moment there is some discussion as to whether the chairman should be a sector specialist, especially in very technical and complex industries, such as banking. There are arguments both ways. What matters is the ability to learn quickly what the company is and how it worked. Crispin Simon, CEO at Biocompatibles, agrees. “I take the view that the chairman should be more detached and work to bring out other people’s views rather than expressing their own,” he says. “You could even argue that sector experience is a isadvantage, because you cannot help yourself from having views.” Lawrence Christensen also cautions that “the chairman should not get too close to the chief executive.”
Boards must have effective and functioning committees. Committees take the strain off the main board by dealing with specialized issues such as audit, remuneration, quality, safety, and so on. Their members must have at least a certain level of technical expertise in their particular subject; for example, it is mandatory that the chairman of the audit committee should be a qualified accountant.
Directors must be clear about their roles. Board members need to be clear about their individual roles and responsibilities. They need to be aware of the areas of expertise that they bring to the board, but also of the areas that others bring. Importantly, too, independent directors need to be aware of the roles and responsibilities of executive directors.
The board should evaluate its own performance. Evaluation of the board as a whole and its individual members should be undertaken on a regular basis using individual consultants, and feedback should be used to improve performance.
In the past this has been a contentious issue, and a number of critics have attacked board evaluation as being effectively a box-ticking exercise, which resulted in little real change. The competence of some of the external consultants has also been questioned. Fortunately, on this last issue there has been some progress and standards for board evaluation consultants are being introduced in the UK.
What conclusions should we draw? Clearly executive boards are powerful institutions, but they can be hampered or hindered quite easily if their members do not work together constructively. Independent directors play a very important role in ensuring that boards function effectively. Obviously, different kinds of owners, public and private, will have different agendas, and this can and very often does affect both the number of board members and the nature and background experience of directors, especially independent directors.
The need for effective boards and good governance shouldn’t really need to be made. Sadly, however, there are naysayers who conveniently or absent-mindedly forget that the real cost of ineffective boards are company scandals and the resultant costs to society this then entails in terms of reductions in wealth, employment levels and value of pension funds. Often there are also significant costs put upon us all as taxpayers – for example, the bailout of RBS – that could easily avoided if the preventative advice given in this article were more widely and consistently followed.
Gerry Brown is the author of The Independent Director: The Non-Executive Director’s Guide to Effective Board Presence published by Palgrave Macmillan.