Could do better: the need for tougher board reviews

Heed this cautionary tale of two boards. Both carried out reviews of their directors’ efficiency and effectiveness, in line with good governance advice. Both noted improvements over the previous year.

One, a prominent member of its country’s blue-chip stock index, gave “a positive assessment overall” to supervisory directors’ work. The other, one of the largest companies in its sector, deemed the work of its directors and committees “highly effective”.

These glowing assessments adorned the last annual reports of, respectively, Wirecard, the German payments processor, and Carillion, the UK construction group, before they imploded.

In the light of what happened later, bruised investors can probably think of saltier adjectives than “effective” to describe the work that directors were doing on their behalf. Earlier this month, indeed, the UK started disqualification proceedings against eight directors and former directors of Carillion. Which raises a question: what is the point of board performance evaluations?

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That question has hung over the practice since 2003, when the late Derek Higgs, a former banker, first proposed enshrining annual appraisals in the UK governance code.

The idea, then and now, is that such reviews help boards improve their own performance. Sceptics at first worried about a plague of box-ticking. Some directors snorted at the very idea that the experience and judgment for which they had been hired could be appraised by costly know-nothing consultants.

Damning the idea with faint praise, one told a 2005 survey: “These assessments are undoubtedly of help. Where they go wrong is in being (a) annual, (b) ritualistic and (c) conducted by people who would never sit on a board nor understand its function.”

Still, Higgs's recommendation stuck, augmented by official UK guidance for chairs to consider external evaluation of the board at least every three years. In 2003, a third of boards had never formally assessed their own performance and more than three-quarters of non-executives and over half of chairs had never had a formal review. A government-commissioned report by Icsa, the Chartered Governance Institute, published last week, now reckons almost all the UK's 350 biggest listed companies conduct three-yearly external reviews, while just under 40 per cent of listed companies across Europe have adopted the habit.

Light-touch

Wirecard’s self-appraisal is the lightest touch approach, short of not bothering. Then comes Carillion, which used a consultant to conduct an online survey. Others pay for a deeper dive, including face-to-face interviews with directors and observation of meetings.

In other words, compared with the no-homework, pre-Higgs world, boards have progressed. Some still set and mark their own homework. An increasing number pay someone to set and mark their homework. All can still decide, however, how much to tell their parents about their results.

After the report is issued to the board, it is up to the company how to present the findings. Up to a point, this makes sense. Non-executives might, for instance, tell a reviewer that the chief executive behaves like a tyrant, which is still a common governance flaw. But despite the UK regulator’s hope that more companies will detail the outcomes of evaluations and the actions taken, it is still implausible such a CEO would be outed as a monster in the annual report.

To these drawbacks, today's sceptics add worries about potential conflicts of interest for long-serving advisers. "Board reviews are a bureaucratic process that waste time and add no value," one chief executive of a small listed company told a parliamentary review in 2018. "There are two issues; 1. Self-evaluation is pointless. 2. Paid external advisers will not jeopardise future fees with harsh truths."

As for warning of, let alone preventing, Carillion-shaped disasters, board reviewers point out they can hardly be expected to know in enough detail the challenges directors might face in future, let alone how they might react.

“Even if we had that level of access, we would be open to be gamed by the client,” one told me.

As a catalyst for positive change at misfiring boards, robust director appraisals are essential. They could be even better. Icsa’s report recommends some ways: it lays out a code of practice for reviewers and some principles for companies, including the need to explain how they deal with conflicts, if they use the same reviewer for more than six years.

Board evaluation is, though, never going to provide a comprehensive scandal alarm system. A review may help reassure outsiders the board is taking its responsibilities for self-improvement seriously, but it cannot guarantee the directors and their company won’t fail in future.

– Copyright The Financial Times Limited 2021