Evaluating board effectiveness is crucial for improving companies’ performance and reducing the likelihood of corporate failures. For a board to be effective, it should clearly define its role and corporate purpose, have directors who work well as a group, and ensure new business opportunities are identified, while managing all existing and emerging risks.
Individual boards differ, but an appropriate structure, size and composition, including diversity of age, gender skills, backgrounds and experiences - quantitative aspects - are among important drivers of their effectiveness.
However, much more of what constitutes board effectiveness is about the behaviours of directors and board dynamics as a team - qualitative aspects. Corporate disclosure focuses on measurable aspects and provides a limited picture of a board’s practices. Reviewing public disclosures and ticking the boxes does not necessarily indicate good governance.
We think that board reviews are an effective tool for assessing the quantitative and qualitative aspects of board effectiveness. They are helpful in assessing board dynamics, which recent research suggests is a better predictor of company profitability than individual director demographic characteristics such as age or gender.
A board effectiveness review provides feedback for maximising the strengths of directors and boards and highlighting areas for further development. The main purpose of external reviews is to ensure that the board improves its own effectiveness and the company performance.
Effectiveness reviews are a relatively new phenomenon but are becoming the norm in many markets. Investors seem slower to engage on them but considering board effectiveness would help them better understand a company’s potential governance risks.
Internal reviews may feature a greater depth of company knowledge but an external assessment offers a fresh, independent and objective perspective, asking challenging questions and delivering demanding recommendations.
Globally, an internal review on an annual or periodic basis is most common. External reviews are recommended in many countries, including France, Saudi Arabia, South Africa, Spain, the UAE and the UK. A more comprehensive externally facilitated review is typically undertaken every three years.
We believe a review should cover a number of key areas, adjusted in line with the company-specific needs and circumstances. Robustness of the review process is key, so companies should use a clear framework.
A review may evaluate the board, its committees, their chairs, plus individual directors or key executives, looking at qualitative attributes and contributions, including cultural intelligence and persuasiveness.
We think that evaluation of board dynamics should cover how effective the board is at challenging and supporting executives, dealing with differences, handling conflict and tension, enacting effective leadership, and coping with dominant individuals. It should also review information flow between board directors and other executives.
Besides interviews, surveys and documents reviews, some reviewers use psychometric tests and benchmark against recognised governance practices.
Some companies are reluctant to disclose any outcomes because of confidentiality concerns, but we think annual reports should describe the process and outcomes of the review.
A review is likely to add value and reduce the likelihood of corporate governance failure only when the board is committed to continuous improvement rather than seeing it as a compliance exercise. And investors have an important role to play by asking for more visibility and following up on the outcomes.
First published 18 May 2021.
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