Looking in the mirror: board evaluation

Looking in the mirror: board evaluation

Catherine M. Daily is the David H. Jacobs Chair of Strategic Management, Kelley School of Business, Indiana University, cdaily@indiana.edu

Dan R. Dalton is Dean and Harold A. Poling Chair of Strategic Management, Kelley School of Business, Indiana University, dalton@indiana.edu

The evil queen in a children's fairy tale never doubted the answer to her query, "who is the fairest of them all''? But one day, the mirror's response defies her expectations – she is not, in fact, the fairest in the land; it is Snow White. We find this fairy tale a nice analogy for board of director evaluation processes. While we suspect that not enough boards actually gaze into the mirror, for those that do, and ask "who is the most effective board of all'', the answer may be less satisfying than they might hope.

One of the challenges of asking such self-reflective questions is that, like the queen in the fairy tale, we may not like the answer to our query. As any human resource specialist knows, performance appraisals are one of the most difficult aspects of a manager's job because few individuals enjoy the scrutiny of review and even fewer appreciate receiving critical feedback. Board members are not immune to these tendencies. In fact, the historical lack of systematic board evaluation processes, coupled with the traditionally non-confrontational culture of boards of directors, suggests that many boards are ill-equipped to engage in self-reflective evaluation. Setting aside any inclination to engage in board evaluation processes, many boards lack the metaphorical "mirror'' needed to engage in the process.

Board evaluation processes are, however, quickly becoming de rigueur. There are several reasons for engaging in regular board evaluation. First, it is simply "the right thing to do''. The only way to assess the performance of any group or individual is to measure it. Board evaluation provides the tools necessary for such measurement. Additionally, board evaluation demonstrates "good practice'' to shareholders, analysts, and other interested stakeholders. Third, whether boards engage in self-evaluation is now included in various board of director rating systems. The Institutional Shareholder Services Corporate Governance Quotient, for example, includes "board performance review'' (qualitative factors, item 52) in their rating system. Failure to have a performance review system in place negatively impacts the overall corporate governance effectiveness rating firms receive.

The Business Roundtable's recent Principles of Corporate Governance and the National Association of Corporate Directors' Recommendations for Reform Post-Enron both include recommendations that board members engage in annual evaluation of the board, board committees, and individual directors. Clearly, board evaluation is on the "radar screen'' for those monitoring effective governance practices.

Among the various approaches to board evaluation are several factors for board members to consider:

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  One of the first considerations in the development of any board evaluation process is having a well-developed document retention policy in place. Corporate counsel or outside counsel can assist if such a program is not already established at the company. Because board evaluation findings are "discoverable'' documents, directors need to ensure that a document retention process is both established and rigidly followed.

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  The next order of business is to either develop an evaluation instrument or retain an outside organization (e.g. consulting firm) to tailor an evaluation instrument to the needs of the board. Three levels of evaluation are recommended. One instrument addresses the board's functioning as a whole. A second instrument addresses the functioning of the various standing board committees, and a final instrument is a self-evaluation for individual board members. Our recommendation is that the evaluation instruments include both quantitative and qualitative measures to more fully capture board and board member performance.

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  A subset of the board, whether the Corporate Governance Committee, the board chairperson, or the lead independent director, should take responsibility for oversight of the evaluation process. This will provide a level of accountability that ensures the process is conducted on an annual basis. If the members of the board subgroup responsible for oversight of the evaluation process do not have the skills to analyze the completed evaluations, outside assistance should be retained, with the understanding that confidentiality is paramount.

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  A summary report of individual board members' responses, including the averages for quantitative measures and category-based summaries of qualitative measures, should be reviewed by the board subgroup responsible for oversight of the process. These results and the interpretation of the results should then be shared with the board at large. We recommend, however, that feedback specific to individual board member performance be shared by the board chairperson or lead independent director in one-on-one sessions with the respective board members, not in a public forum such as a full board meeting. Not only does this approach protect the individual board member's privacy, but it also helps ensure more accurate and honest feedback throughout the process.

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  An important component of any evaluation process is the follow-up once the results have been shared at both the board and individual director levels. Whether the board chairperson or lead independent director, a board member must assume responsibility for holding the board accountable for ensuring that deficiencies noted through the evaluation process are properly addressed. To do otherwise renders the process a mere exercise that is unlikely to yield tangible benefits.

Designed and implemented effectively, a board evaluation process can serve as an essential development tool to assist the board in enhancing its overall effectiveness. The process can also guide the board in identifying skills gaps on the board. These gaps provide valuable information to help the nominating committee determine future director recruitment needs.

Having a board evaluation process in place also signals to shareholders the board's commitment to effective governance and we encourage the board to share the reliance on a board evaluation process with shareholders. An important caveat, however, is that only the process, not the results, should be shared.

Board evaluation and self-evaluation may, and even should, uncover areas for improvement and gaps in performance. Members may therefore feel some reluctance to undertake the process. Failure to do so, however, means the board may operate at a less-than-optimal level of effectiveness. In this environment of increased scrutiny of boards and board practices, that is not a strategy we would recommend.