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Reviewing The Situation

05 July 2019 by Ben Harber and Shaun Zulafqar

Reviewing The Situation

We take a look at the importance of board effectiveness reviews

Following the publication of the new corporate governance code and changes in rules requiring AIM Companies to adopt a corporate governance code, public companies, regardless of size, are now expected to focus on the leadership and effectiveness of its board. The FRC Board effectiveness guidance paper published in July 2018 defined an effective board as one that sets the company’s purpose and strategy to deliver it, underpinned by the values and behaviours that shape its culture and the way it conducts its business. Boards should be able to explain the main trends and factors affecting the long-term success and future viability of the company. The FRC Board effectiveness guidance has been structured to cover the below key areas:

  • board leadership and company purpose
  • division of responsibilities
  • composition, succession and evaluation
  • audit, risk and internal control remuneration.

The focus on board effectiveness reflects factors that have shaped public company governance in recent years, including:

  • high-profile examples of board oversight failures
  • focus on composition, diversity and inclusion policies
  • increased complexity, uncertainty, opportunity and risk
  • pressure from stakeholders for companies to better explain and achieve current and long-term performance.

One tried and tested method to evaluate and test a board’s effectiveness is by conducting a board evaluation. In our experience of completing board evaluations, effectiveness is usually determined by two sets of factors, procedural and behavioural. Procedural factors include how meetings are arranged, conducted, timeliness of papers and board composition and structure. Behavioural issues cover items such as current skills, quality of meetings, effectiveness of chairperson and alignment with shareholder and stakeholder values.

How to conduct a board review

Responsibility for implementing and conducting a board evaluation rests with the chairperson and the company secretary. Both should work closely together to tailor the process to the company’s needs. Those responsible for conducting it should ensure that the evaluation is balanced and does not focus primarily on procedural factors. The chairperson should also ensure that the evaluation is not seen as a “box-ticking” exercise, where the board simply declares that it has performed satisfactorily. Instead, the process should test the robustness of the board and its structure to identify areas of weakness and current strengths that could possibly be enhanced.

As a guide, those conducting the evaluation should consider:

purpose – boards need to firstly consider motivating their directors to conduct an effective evaluation. Therefore, setting clear objectives becomes imperative. Objectives can be; demonstrating a commitment to corporate governance, identifying weaknesses and identifying skills gaps
evaluation – who the evaluation will cover? Whilst the evaluation will most likely cover the entire board companies may wish to consider extending the evaluation to the next level of management as they will report to executive directors and may on occasions be responsible for providing updates and agenda items for discussion at board level
method – how will the evaluation by conducted? By interviews, survey, questionnaire, external/internal evaluation? In our opinion, the best results are obtained by conducting surveys and interviews together
implementation – what will the company do with the results? Evaluations should reveal issues such as skills gaps, resource issues, diversity, succession, strategy and areas of training and development to name a few. The chairperson, the rest of the board and the company secretary should develop an implementation programme and an estimation of completion dates.

Once the evaluation is complete, the company secretary should provide a report to the board. The report should include current strengths and weaknesses along with proposed remedial actions. Unless it is the company’s first evaluation the company secretary should also provide a comparison with the previous results, highlighting any improvements or recurring issues. The company secretary and chairperson should both take an active role in ensuring progress against the remedial actions and ensure that the board preserves momentum in achieving better results at the next evaluation.

After the evaluation, the chairperson should also consider:

  • has the evaluation identified actions for the board to discuss and implement;
  • how the board wishes to disclose and summarise its evaluation process
  • has the board considered a feedback loop so that evaluation results are revisited and tested quarterly, annually or biannually
  • did the evaluation provide enough information that the company has appointed the right directors for its strategic aims?

Disclosure of your board evaluation

Investors and stakeholders have a vested interest in the outcome of board evaluations. According to guidance produced by the OECD, investors and other stakeholders appear to appreciate hearing about the assessment process, they are interested in the ‘why’, ’what’ and ‘how’ of evaluations. Stakeholders are even more interested in the ‘story’ behind the boards and the strategic direction of the company.

Unfortunately, many companies adopt ‘boilerplate’ wording and tend to use the same statement every year with only minor changes. We would recommend companies maintain an open style of communication and be more forthcoming, providing more meaningful evaluation disclosures within their annual report.

In line with OECD guidelines, we recommend the statement contain an action plan that enables shareholders and other stakeholders to review the process on a year-on-year basis and also makes it possible to keep track of improvements and issues.

Boards are being constantly challenged on performance and composition .Therefore a board should address these challenges by demonstrating to its shareholders and stakeholders that it has firstly conducted an evaluation process and secondly it has identified key areas for growth, improvement and enhancing long-term value. The board should also consider the impact that the disclosure of evaluations has on building trust with its shareholders and stakeholders. 

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