A new lens is being applied to board performance. The demands and expectations on board members are changing dramatically with a clear focus on how boards are making decisions and responding to issues such as technology disruption, climate change and delivering a contribution to wider society.
But are board performance evaluations keeping pace with these changes in focus and how robust are they? The 2018 UK Corporate Governance Code retained the 2016 Code requirement for FTSE 350 companies to undertake an externally facilitated board evaluation once every three years. The FRC Guidance on Board Effectiveness states that external facilitation can “add value by introducing a fresh perspective and new ways of thinking, and a critical eye to board composition, dynamics and effectiveness”. This is true, but only if they are undertaken in the right spirit.
In 2018, Deloitte undertook an analysis of the 2017 annual reports of the FTSE 250 to build up a picture of the board performance evaluation practices in those companies. The results showed that, as expected with a three-year rotation requirement, approximately one third of companies disclosed that they had undertaken an externally facilitated evaluation during the year.
While the number of disclosed external evaluations was not surprising what did surprise us was the lack of clarity and transparency around the nature of these external evaluations. We found that just over half of those companies disclosing that they had undertaken an externally facilitated review had either provided no detail in relation to the nature of that review or had just undertaken an online board survey facilitated by an external body.
A positive change
Moving to the disclosures in the 2018 annual reports, we undertook a survey across a sample of 100 companies across the entire listed company population and once again the results showed that around one third of that sample had disclosed that they had undertaken an externally facilitated review. This time we observed that around one quarter of the companies disclosing that they had undertaken an external review failed to explain the nature of the review. However of those companies providing a description, it was clear that the incidence of survey only reviews had decreased dramatically with the majority reporting a combination of board interviews, observation and survey.
It is positive to see such a change between 2017 and 2018 and we hope that the situation on transparency will improve again in 2019 with the new code requirement for the nomination committee’s report to disclose the nature and extent of the external evaluator’s contact with the board. It is clear that if companies are to realise the benefit from an externally facilitated board review then the reviewer needs to have interaction with the board members and to use their experience and expertise to provide insights to drive continuous improvement in board performance.
The next area for nomination committees to focus their disclosures on is in relation to how the board performance evaluation has or will influence board composition (as required by the 2018 code). In our survey of a sample of 2018 annual reports we observed that less than a fifth of companies surveyed had provided clarity on the impact of the board evaluation process. If a board is unable to demonstrate that a performance evaluation has made a positive difference—where the board and/or governance arrangements have really been challenged on whether they are fit for purpose to meet the future expectations of investors and wider society—then does this suggest that the board evaluation process is treated as little more than a box-ticking exercise? As noted above, the board performance evaluation process should provide an opportunity to drive continuous improvement in the board. A box-ticking exercise does not benefit anyone—shareholders, stakeholders or the board members themselves.
Rigour and transparency
This issue was highlighted by the Department for Business, Energy and Industrial Strategy in a feedback statement on its Insolvency and Corporate Governance consultation paper. The paper noted that “whilst many companies are embracing best practice in dealing with issues identified in evaluations, some do not” and that “the standards or thoroughness of these evaluations can vary significantly”. In response the government asked The Chartered Governance Institute to convene a group including representatives from the investment community and companies to identify further ways of improving the quality and effectiveness of board evaluations including the development of a code of practice for external board evaluations.
Earlier this year The Chartered Governance Institute launched a consultation on the effectiveness of independent board evaluation in the UK listed sector, which put forward the following three matters for consideration:
- a code of practice for the providers of board evaluation services, and formal arrangements for implementing and monitoring such a code;
- voluntary principles to be applied by listed companies when engaging external reviewers to undertake board evaluations; and
- guidance for listed companies on disclosure of the conduct and outcomes of their board evaluation, in accordance with the 2018 UK Corporate Governance Code.
We are yet to see the outcome of this consultation, but the Deloitte response supported the conclusions set out in the BEIS Insolvency and Corporate Governance paper and agreed that there would be benefit derived from greater rigour and transparency around the board evaluation process from sourcing the provider, delivery of the review through to reporting on the outcomes.
We believe boards and evaluators should be given the opportunity to apply the code and principles suggested by The Chartered Governance Institute on a voluntary basis and that the FRC, or its successor body, should provide access to a list of signatories. Self-certification by the providers of board reviews, transparency in the assessment of that self-certification plus periodic inspections by the FRC, or its successor body, should provide sufficient incentive for meeting the standards set out in the code of practice. This, coupled with a robust and transparent tendering process by the listed company, should drive the desired behaviours and enhance the impact of this key element of our governance eco-system.
Tracy Gordon is director at the Deloitte UK Centre for Corporate Governance.