Environmental, Social & Governance Briefs

Report: Director Assessments Are Lacking

July 01, 2019

(This blog post originally appeared as an article in the June 26, 2019 Directors & Boards magazine.)

Director assessments in the United States need an overhaul.

The annual board performance assessment, when conducted, tends to rely on director surveys and other self-evaluation tools. But more importantly, companies continue to forgo or at least forgo reporting, a systematic process that extends beyond the collective performance of the board or its committees to also evaluate the contribution of individual directors, according to a recent review of disclosure documents filed by companies in the Russell 3000 index.

Only 14.2 percent of the Russell 3000 companies report having instituted such an annual process at the individual director level, a share that has barely grown since 2016 (13.2 percent); in the S&P 500, the percentage remains shy of 30 percent.

That’s a problem, especially in an ever-changing, business-risk environment.

Performance assessment is an indispensable human capital management tool for today’s business organizations. It fosters accountability, encourages self-improvement, informs the talent development process, and ultimately ensures the alignment of skills with the company’s long-term strategy. And it’s just as critical at the top leadership level, including the leadership of the board of directors.

Clearly, new risks and opportunities abound, so directors must periodically conclude that the board continues to operate effectively and that its composition and internal competencies remain adequate to the challenges faced by the company.

Unfortunately, some of the largest U.S. companies with well-regarded boards of directors still lack a sophisticated, strategy-driven director performance assessment process. While directors have made tremendous progress in thinking about the performance evaluation of the CEO, they do not always put the same rigor and discipline into their own.

Indeed, board turnover and refreshment rates are significantly lower than in Europe and other parts of the world. It is easy to understand why. The job of the corporate director is prestigious and well compensated. It offers exposure to challenging business issues. Most board members enjoy their directorships and, justifiably, would want to prolong them as much as possible, even though changing business circumstances would warrant new skillsets.

To promote change in the composition of the board and a more dynamic pool of public company directors, some countries in the world have actively pursued a number of regulatory and self-regulatory approaches.

Canada, India, and some members of the European Union, for example, passed statutes prescribing maximum terms of board service (as low as six years, in France). Others such as the United Kingdom have adopted a comply-or-explain principle urging companies to either terminate a director after a certain number of years or explain why he or she has become so indispensable.

So far, state corporate laws in the United States have been much more skeptical about any mandatory approach that would curtail the board’s own business judgment and may force it to do without critical talent. In particular, solutions restricting board tenure based on term limits are unanimously viewed by U.S. proxy advisors and main institutional investors as excessively rigid, and mandatory retirement policies based on age can pose discrimination issues. (In the Russell 3000, only one-quarter of companies adopt age-related policies, with limits that over time crept up to 75 years of age).

For all these reasons, a well-designed individual director assessment is a powerful tool to drive collective board performance and enhance each director’s effectiveness. It provides actionable feedback for directors and can do better than one-size-fits-all solutions such as term limits to support the board succession process.

Here’s some advice on how to bolster individual director assessments:

• Focus on assessment design. Boards that want to improve their overall board performance and effectiveness should consider designing an assessment process that extends to the performance of individual directors and combines in-person interviews, best-practice benchmarking and electronic surveys. While surveys have the benefit of generating quantifiable findings that can be compared and benchmarked over time, interviews enhance those insights with nuances that may not otherwise be captured. If a written questionnaire is indeed used in the process, it should include not only multiple-choice answers but also open-ended questions that can then be discussed during the individual interview.

Boards and directors benefit from the feedback, as strong directors get positive reinforcement for the behaviors that set them apart, while average directors can receive clear guidance on what they can do to improve and work with board leaders to implement those changes.

• Create benchmarks. A strong individual director assessment process begins with an understanding of the external business environment and the strategy of the company. That context helps to define the skills and capabilities needed on the collective board. This preliminary analysis should include rigorous external governance and best practice benchmarking so that each board member can directly appreciate and react to possible situations where the board appears to depart from those best practices.

Finally, the board needs to have a clear view of the behaviors and soft-skills that make a great director, such as the ability to ask hard questions, to constructively challenge management when the answer is not satisfactory, and to avoid “groupthink.”

• Set up one-on-ones. Armed with those benchmarks, it is advisable for a trusted board leader (ideally, an independent chairman or the lead independent director), the general counsel, or a third-party (such as a board advisory and effectiveness practice from a leading professional services firm) to conduct individual meetings with each director to ascertain his or her respective view of their own capabilities.

The interview should be viewed as a 360 assessment, where each director comments on the strengths and weaknesses of governance practices and their fellow board members. The interviewer should specifically ask each director questions around the expertise that their peers bring to the board – not a laundry list, but the top two or three skills for each person. All the gathered data should be distilled into insights about individual board members, then be written up into strengths, opportunities, and development recommendations. The feedback is best given by a board leader who has exceptional soft-skills that can continually monitor each director’s progress against the assessment.

This type of individual director performance assessment can be truly transformative for the board, as it is conducive to nuanced, specific insights and recommendations for improvement. It has an added benefit: It can form the basis for strategy-driven director succession planning and board refreshment.

(Figures cited in this article are based on Corporate Board Practices in the Russell 3000 and S&P 500, a comprehensive review of U.S public company proxy disclosures and organizational documents. The project is a partnership between The Conference Board and ESG data analytics firm ESGAUGE and was developed in collaboration with Debevoise and Plimpton, Russell Reynolds Associates and the Weinberg Center for Corporate Governance at the University of Delaware.)