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A Challenging Environment for Boards & Directors
Sarbanes‐Oxley, stock exchange rule changes and shareholder activism have all had a major impact on the operations of boards of directors in recent years. Boards and individual directors have come under increasing pressure to improve their overall performance and governance. Boards are now being held to a higher level of accountability – both legally and publicly – than ever before. As the authors of a USC/Heidrick & Struggles study on board effectiveness note:
Directors are expected to know more, do more,
and take more responsibility...”
While board accountability and responsibility have increased, there is still significant room for improvement in terms of the effectiveness of boards in addressing these heightened requirements. Only 31% of directors rate their boards as “very effective”, a number that has remained relatively flat since 2003.
Boards of directors have responded to this challenge by tightening policies and procedures, and adopting frequently emerging “best practices” in board and corporate governance. One practice that has emerged and is gaining significant traction is regular board self‐evaluation.
The Movement Towards Formal Board Evaluations
In 2004, the New York Stock Exchange adopted a requirement that the boards of listed companies must conduct regular evaluations of their boards of directors. This applied to both the board as a whole, as well as the audit, nominating/corporate governance and compensation committees. Since the institution of this requirement, the number of boards conducting full-board performance evaluations on a regular basis has increased dramatically.
Beyond regulatory compliance, however, increasingly large numbers of non-NYSE private and public companies are also adopting board evaluation processes to improve the overall performance and effectiveness of their boards. According to a Pricewaterhouse Coopers survey of over 1,000 corporate directors, in 2007, 88% of public companies conducted a full-board evaluation on a regular basis, up from 33% in 2002. In addition, 78% of NASDAQ companies now conduct a regular full-board evaluation, even though it is not a NASDAQ requirement to do so. This trend has filtered down to board committees as well: 90% of public company board committees now conduct annual evaluations.
A Requirement for Nonprofit Organizations As Well
The boards of nonprofit organizations are also beginning to adopt structured self-evaluation processes. This movement should not be viewed as a “nice to have” trend, but rather a requirement on equal footing with that of for-profit enterprises. Consider, for example, the fact that there are approximately 95,000 nonprofit organizations in the United States with over $1 million in annual revenues, and almost 3,000 with annual revenues in excess of $100 million. Factor in the mission-critical constituencies that these organizations serve, and you can easily see that the level of financial responsibility and stakeholder accountability for these nonprofit boards meets and, in many cases, exceeds, that of many for-profit corporations.
In light of this increasing accountability, 52% of nonprofit boards, for example, have conducted a self-assessment, double the percentage from 1994. However, this number still falls far short of their for-profit counterparts.
Benefits of Formal Board Evaluations
All of these organizations are instituting regular board evaluation processes to achieve the following key benefits:
- Performance Assessment: Identify areas of strength and weakness, and help make changes that positively impact shareholder value
- Continuous Improvement: Continuously improve the performance and effectiveness of the board over time
- Accountability: Hold directors accountable for their performance
- Composition: Tailor the overall composition of the board and its committees to best serve corporate objectives
- Alignment: Better align the board with the overall corporate strategy
- Communication: Provide an objective, fact-based vehicle for board member communication regarding performance and responsibilities
- Transparency: Improve board transparency and add credibility in the eyes of the shareholders
As the authors of the Pricewaterhouse Coopers study note: “The periodic need to look inward and accurately gauge one’s own performance is a necessary function for all high-performing organizations. Corporate boards are no different. An honest evaluation helps ensure the board as a whole and its individual members are maintaining peak performance and operating effectively.
Boards that have implemented formal evaluation processes are now beginning to reap the benefits by seeing a marked improvement in their performance. As evidence, boards that have done a self-assessment were rated significantly more effective by chief executives than those who have not (55% vs. 38%).
Board Evaluations: A Tool for Ensuring Director Effectiveness
In addition to providing a number of benefits to the board as a whole, the vast majority of directors (79%) believe that a formal board evaluation process is the most important tool available for ensuring individual director effectiveness.
This is a critical hot-button, as 23% of board directors feel that there is a member of their board that needs to be replaced. The reasons behind this include skill set miss—matches, lack of engagement, unpreparedness, and length of tenure.
Progress ... But Still Significant Room For Improvement
In order to realize the benefits of board evaluations, most companies have established rudimentary internal processes to accomplish this task. However, these processes – most of which are manual and ad-hoc – do not provide the depth, breadth, standardization or repeatability necessary to fully reap the benefits of a formal board evaluation. In fact, only 11% of board members feel that their whole-board evaluation process is "very effective", and 43% feel that there is significant room for improvement, rating their current process only "somewhat effective" or "not at all effective".
The data on individual director assessments is even more pessimistic: only 8% of directors think that their evaluation process for directors is "very effective".
In light of these numbers, the authors of the Pricewaterhouse Coopers survey conclude that "these results show many boards are not maximizing the usefulness of (the board evaluation) process, which, among other things, directors have told us can improve board communication, provide focus for board and management recruitment efforts, and identify ways to streamline board processes to make the best use of directors’ time."
BoardEvals has been developed to address this need in the market by replacing the adhoc, manual processes used by most companies today with a standardized, automated board evaluation process that saves time and expenses, while improving corporate governance practices.