The original mission of the UK’s Cadbury committee in 1992 was to look at how well boards of directors, as fiduciaries, ensure the reliability of company accounts. During the inquiry its mission was expanded and the final Cadbury Report focused on broader corporate governance principles, including the need for the board to retain full and effective control over the company and to monitor the executive management. It concluded that the effectiveness with which boards discharge their responsibilities determines the UK’s competitive position.
Meanwhile, many companies in the US over the past five years have implemented a host of governance guidelines. This type of approach was initiated by General Motors but other companies have seen some of the potential benefits and developed their own guidelines. Investors like the California Public Employees’ Retirement System (Calpers) have graded companies based on their conformance with the GM guidelines. Business Week has also developed a rating system that enables it to release an annual ranking of the ten ‘best’ and ten ‘worst’ boards.
But all these efforts still focus on governance criteria, such as the number of independent directors, term of service, age limits, and so on. All are really only surrogate measures for a board’s true effectiveness rather than a measure of effectiveness itself.
In the wake of the January 1998 Hampel Committee Report, the London Stock Exchange will encourage companies to provide an overall description of the effectiveness of their boards. Just how to go about actually doing that is a question which is perplexing companies on both sides of the Atlantic.
Questions answered
At a recent Conference Board symposium, Peter Dey, chairman of the Toronto Stock Exchange commission, led a session on determining the board’s effectiveness. He raised five questions and corporate and institutional investor participants provided the answers.
What standards and metrics are appropriate for assessing the effectiveness of the board?
Companies need traditional performance metrics like return on assets, return on investment and, more recently, economic value added (EVA). But new measures are needed to judge company performance, not just on an absolute basis, but in comparison to a peer group and over a long-term time frame.
The board itself should decide on three or four main issues it wants to tackle over the next one to two years, then rate itself either on a scale of one to five or as a percentage of accomplishment. Top on the list of main issues is whether the board has achieved its desired range of financial and non-financial or strategic goals.
What impact does the board’s infrastructure (eg size, committee structure, and internal information flow processes) have on its effectiveness?
Boards should discuss how they are organized to achieve their strategic goals. They should consider whether they need to change the composition of committees and requirements for committee service. For example, audit committees may need more members with a greater degree of expertise in financial matters. They need to examine and improve information flow throughout the board and between the board and management.
How does the board’s composition, including its expertise, chemistry, and decision- making processes, relate to its effectiveness?
Members of the board should discuss whether they have the requisite expertise to achieve their strategic goals and, if not, how to obtain it. Executive search firms can ‘professionalize’ the board’s nominating process and bring before the board a broader range of talent than individual CEO and board contacts traditionally provide.
While the CEO should be involved in the nominating process, he or she should not drive this process; the board should. Boards should not reinstate directors automatically; rather, the nominating process should be viewed as a continuing opportunity to evaluate the strategic composition of the board.
How does a board evaluate itself either collectively or individually?
This is a sensitive issue since there is no body to evaluate the board other than itself. Some boards start with generalized discussions of what they do and how well they do it, but then move on to specific questionnaire rating systems. Ideally the process includes benchmarking the collective board against itself over time. Individual evaluations, the most sensitive issue of all, may be useful. Without a ‘champion’ on the board, however, it is not likely that a board will undertake either collective or individual evaluations.
How does the board go about making necessary changes in strategy, structure and processes to improve its effectiveness?
A board must be able to make corrections if it is not achieving its strategic goals. Continuous feedback and comparison of targets against financial and non-financial strategic goals are essential. A process for assessing and redirecting efforts must be in place.
Dr Carolyn Kay Brancato is director of the Conference Board’s Global Corporate Governance Center
