Evolving role of board reviews in driving director performance

Accurately assessing directors collectively and individually is no simple matter.

Few governance issues are more complex than measuring board performance. The symbiotic relationship between firm, management and board performance makes the measurement of board outcomes more art than science. And rarely clear-cut.

A board of an underperforming firm might be governing it well. But shareholders are unhappy with the negative shareholder return and blame the board for it. They do not see the work of directors to shape new strategy and help management turn around performance.

Equally, the firm’s poor performance could be because of bad strategic decisions and investments made five years ago when the board had different directors. The current board inherited firm, management and governance problems, and is addressing them.

Measuring individual director performance is just as challenging. An annual board review, the most common tool to measure performance, can provide limited insight if it only canvasses the views of directors, lacks transparency and is not linked to director development.

Moreover, it is hard to measure relative board performance – one board against another in its industry. Although some consultants provide generic comparison data, differences in strategy and company lifecycles complicate attempts to compare board performance, meaning only absolute rather than relative performance can be confidently assessed.

Performance, of course, works both ways. A high-flying firm could have a dysfunctional board that does not question why growth is consistently higher than the industry average, over-rewards management, is risk complacent and suffers from governance hubris.

“You cannot judge a board by the firm’s share price,” says Associate Professor Gavin Nicholson of QUT Business School. “It’s an indicator, but stakeholders must recognise board performance is a multi-year, multi-layered issue. Board performance can have long lead times.”

Dr Nicholson, a governance academic and author, says an annual board evaluation that has clear goals and is rigorous and challenging remains the best tool to understand, track and enhance board performance over time.

Nicholson has led many board reviews and helped develop board-evaluation tools for the not-for-profit sector through QUT. “Board evaluations have vastly improved,” he says. “If you go back a decade or more, the board-review process in many organisations was a ‘tick and flick’ exercise that was about compliance. Today, many boards invest a lot of effort in the review, to better understand their performance and areas for improvement.”

Boards are more focused on seeking external views of performance, says Nicholson. “In the past, board reviews were mostly about directors commenting on each other, the Chair and the overall board. High-functioning boards now seek the view of management on director performance and talk to auditors, key investors or other stakeholders. They are getting input from a wider source of stakeholders to understand board performance.”

Different performance-measurement techniques are also emerging. “The standard approach was directors answering lots of survey questions about their performance.

Those surveys are still important, but boards are increasingly using in-depth interviews with internal and external stakeholders (for consultant-facilitated reviews) and observational techniques.”

Nicholson, for example, has observed group dynamics in board meetings as part of the evaluation process. He looks for the level of inclusion, information summaries, discussion sharing and other cues of positive group dynamics at work. “Watching directors in action in a group setting is the next evolution of the board-review process,” he says.

More boards, says Nicholson, are maintaining a data pack from the annual review and giving directors access to it. “It’s very useful to allow directors to see the raw data for their performance, so they know that any feedback has not been skewed by the Chair’s interpretation, and that it is based on the data rather than on any individual bias.”

The main weakness in board reviews is a lack of action on the results: “Some Chairs are unwilling to provide frank and fearless feedback to underperforming directors. I’d estimate that at least eight out of 10 dysfunctional directors are not fully aware of their performance or that they need to improve. The vast majority of directors, of course, are not dysfunctional, but too many boards still tolerate underperforming directors and don’t manage their performance.”

Limited performance tools

The idea of “performance-managing” directors is complex. Good boards act in unison, so one director’s performance can influence another’s. The Chair’s performance greatly affects all directors, as does that of management; an executive team that is open and collaborative with the board and encourages its guidance can aid director performance.

Moreover, Chairs have limited tools for director performance. They cannot “hire or fire” directors because only shareholders have that power. Nor can they use financial incentives, such as withholding an annual bonus, because directors earn a fee.

The Chair’s main tool is privately suggesting to underperforming directors that they retire from the board or withdraws the nomination for a director’s re-election when his or her term expires. That can be problematic if an underperforming director is one year into a three-year term and refuses to leave, possibly because of not wanting to lose his or her fee.

Meanwhile, shareholders have few opportunities to assess directors in action. Institutional investors typically meet with the board Chair or the Chair of the Remuneration Committee, rather than other directors in investor-engagement programs. Too many directors meeting with investors could send mixed messages and create disclosure risks, but it also means shareolders only see most directors at the AGM.

Investors, therefore, have limited scope to gauge individual director performance, other than by holding the Chair or committee to account at re-election for specific problems such as poor alignment between pay and performance, or inadequate risk management. Shareholders voting against the election of individual directors has become prevalent in recent years.

For the most part, professional directors have the grace and self-awareness to retire from a board when it is obvious that they are not right for it. And experienced Chairs have the skill to manage the situation, privately and proactively, if a director’s underperformance cannot be resolved.

The board review is central to this process. Recommendation 1.6 of the ASX Corporate Governance Principles and Recommendations says boards of ASX-listed entities should disclose a process for evaluating the performance of the board, its committees and individual directors. And to disclose, for each reporting period, if a review was undertaken in accordance with that process.

The ASX Corporate Governance Council also encourages boards to disclose “any insights it has gained from the evaluation process and any governance changes it has made as a result”. But few listed companies disclose the outcome of the evaluation process in detail; most disclosure is limited because of sensitivities in reporting board performance.

Nevertheless, the ASX Corporate Governance Principles’ focus on the need for a “formal and rigorous” evaluation process has been central to the evolution of board reviews this decade. Many not-for-profit and larger private companies also follow the Principles’ guidance in this area.

Listed-company boards typically have an annual board review. In a three-year cycle, the first review might be conducted internally by the company secretariat, the second by a governance consultant or other external facilitator, and the third done internally. An external board review at least once every three years is common, although some boards might commission extra reviews as issues emerge.

An internal board review led by the company secretariat typically surveys directors about their performance and that of their peers and the Chair. That data might be used to inform individual performance, track overall board performance and provide insights for the following external board review.

An external board review can cost $10,000 to $100,000 or more, depending on its complexity. At the costlier end, the review could include in-depth interviews with directors and external stakeholders and may use sophisticated review techniques to understand how the board performed in a crisis or incident, and to assess group dynamics.

Board reviews broadly fall into four categories:

• the board wants an ongoing “health check” and to follow best practice with reviews (the most common category);
• the review is done mostly for compliance purposes;
• the board has identified a performance problem and uses the review process to better understand and address the issue; and
• the board suspects there is a performance problem and uses the external review to identify the problem.

Done well, the combination of internal and external board reviews should track individual and aggregate board performance over time, be linked to a director’s professional development (if a review shows extra training would be beneficial) and to the board’s skills matrix.

The matrix helps identify if the board has the right skills to govern the organisation, and the board review identifies if those skills are evident and implemented. As such, the board review is fundamental to the interplay between organisation governance and strategy.

A view from an internal facilitator

Corporate governance practitioner and author Robyn Weatherley has led many internal board reviews through the company secretariat. She says the key to effective internal and external reviews is board clarity on the process and its intended outcomes.

“There must be open dialogue and good engagement from directors on what they want the board review process to focus on. Having clear goals helps the board structure the most appropriate internal review or choose the best external facilator. A board, for example, might want to know if it is time for a refresh and uses the review process to achieve that goal.”

She says transparency and trust are central to effective board reviews. “You need directors to be relaxed and open with their views on the board’s performance rather than be guarded. That only happens if there is trust and directors know the board is genuine about working together to continually improve performance.”

The company secretariat, says Weatherley, should drive the internal review and facilitate the external review. “A good secretariat is always looking at ways to refresh the internal board-performance survey. Some foundation questions are there each year and are used to track longitudinal board performance. But it’s important to keep updating the questionnaire and include opportunities for open-ended commentary from directors.”

Weatherley, author of Eyes Wide Open, a governance guide for emerging directors, says a good board review is also linked to director professional-development opportunities. “The review might show a director would benefit from greater exposure to technology trends. So, the board organises training or presentations in this area, or encourages the director to seek his or her own training in this area. A proactive, positive and forward-looking review can be a magnificent tool to help directors better understand their performance and keep improving.”

She says the board’s review of the company secretariat in the review process is vital. “A secretariat can greatly aid board performance, and vice versa. So, it’s important the secretariat understands the board’s view on the secretariat’s performance and if there are opportunities to improve how it serves individual directors and the board.”

Ineffective board reviews tend to be static, solely questionnaire-based, inward looking and defensive, says Weatherley. “It’s not an effective review if directors answer the same questions year after year, are reluctant to provide constructive feedback about their peers when warranted or see the review as a negative process to identify underperformers or embarrass them. When this happens, directors become nervous and guarded about the review process and it is a lost governance opportunity.”

Room for improvement

Michael Robinson, a director of Guerdon Associates, a leading remuneration and governance consultant, breaks board reviews into three cumulative layers: directors reviewing themselves and their peers; management reviewing directors; and external stakeholders reviewing directors.

“In my experience, two of every three ASX 300 companies are still at layer one; their board review is based solely on director feedback,” he says. “That’s quite a low standard. The better boards ask management to review director performance and a small percentage go a step further and seek external views.”

Robinson says feedback from executives who engage regularly with the board is valuable. “It can be very insightful, and sometimes confronting, to understand how management perceives the board’s performance and whether directors individually and collectively add value to the executive team.”

External-stakeholder interviews are equally instructive. “An external facilitator might ask a key investor who engages with the chairman a few times each year to assess his or her performance. Or might speak to the audit firm or front-line staff to get their perceptions on the board. These views provide a richness of information you don’t get by asking only directors.”

Robinson says few boards use sophisticated, costlier review tools, such as Critical Incident Techniques, to understand how directors functioned in high-pressure situations. Or observational techniques to know if the board displays effective group behaviours, or technology that allows directors to provide real-time feedback on board performance.

Another shortcoming, says Robinson, is poor alignment between the board review and director development. “Often, there’s insufficient active director development as the result of a review. The evaluation might prompt a director to seek his or her own training but little of this development is provided by the company or is part of a considered approach to long-term director development.”

Robinson is always concerned when director ratings in board reviews are too uniform or too high. “It’s a red flag when there is low diversity of views, directors are giving themselves high ratings, there is low dispersion of results and few genuine value-adding comments. It suggests directors are patting themselves on the back and that hubris has crept into the board.”

He believes boards should disclose more of the review’s findings to stakeholders. “Obviously, boards cannot disclose individual performance in detail. But it’s possible to provide general commentary on the results of the review, such as a board identifying that it needs to enhance a particular skill set and what it intends to do about it through director development.”

Robinson adds: “Board evaluations have improved and organisations invest a lot more effort in them than in the past. But there’s scope for a lot more growth in board reviews to drive performance. Too many reviews are still antiquated or compliance focused.”

Higher governance expectations, younger directors driving change

Jane Bridge, a founder and managing director of Boardroom Partners, a board advisory firm, says the ASX Corporate Governance Principles and Recommendations on board evaluations and skill matrices have strengthened demand for comprehensive, externally facilitated board reviews.

The Financial Services Royal Commission and the Australian Prudential Regulation Authority’s view on governance, through its report into the Commonwealth Bank, are other drivers of rising demand for board reviews.

“We are getting more requests for board evaluations and note that boards are investing more time and resources in the process,” says Bridge. “Many boards we deal with tend to have a clear view on the objectives of the review and how it can drive performance. Also, they want to ensure they meet or exceed best practice in board-evaluation policies and processes.”

The emergence of younger directors on boards is also driving interest in board reviews, says Bridge. “There’s a generation of younger directors who grew up with 360-degree performance reviews as executives and understand the value of regular constructive feedback. They are generally more open to performance assessment and expect it as part of the role. ”

Bridge says high-performing boards use evaluations to test different aspects of their performance. “They might want to know if board skills need to be updated, or if its board and committee-meeting agendas could be improved, or if committees are performing as intended. Today’s reviews are more targeted and less about answers to a generic survey.”

Bridge says there is also a risk-management aspect to board evaluations. When asked if shareholder class actions against listed companies could seek information on the board review, she says: “It’s quite reasonable that litigants might ask on what basis the board was assessed, by whom, and if there was evidence that the board was doing its job.”

Bridge adds: “If litigants could establish there was no process for a review, that the board followed poor practices, or that the review identified board dysfunction that was not addressed, then that could be taken into account in any decision about the particular case. However, reviews are not intended to provide a shield for poor behaviour and a worthwhile review will never begin with this as an objective.”