Board Performance Evaluation – A Framework for Good Governance

Adithya. S

Introduction:

• A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. They shall be responsible for the day to day affairs of the Company
• The challenge for boards is to prevent crises in the organisations they govern.
• Performance evaluation is a key means by which boards can recognise and correct corporate governance problems and add real value to their organisations.

Governance failure:

• Governance failures may result in either a significant reduction in, or total destruction of, shareholder wealth.
• Governance failure can be classified into four categories
  • Strategic failure
  • Control failure
  • Ethical failure
  • Interpersonal Relationship failure
• Board evaluations provide a process for boards to identify sources of failure.
  

-The Principles of Good Corporate Governance and Best Practice Recommendations (ASX Corporate Governance Council, 2003) in Australia,

– The Combined Code on Corporate Governance (Combined Code) in the U.K.,

– OECD Guidelines and

– Higgs Report

All make specific recommendations for the regular review of board performance.

Regulatory Framework in India:

• Section 178(2) of the Companies Act, 2013 requires Nomination and Remuneration Committee to formulate Performance Evaluation Policy.
  

• Board Report shall disclose the Performance Evaluation Policy
  

Performance Evaluation of the Board:

• Board evaluation tends to break down into two basic areas:
  • People Factors
  • Process Factors
• Out of the above two factors, People Factors is considered to be more important. People Factors deals about “How the Directors work as a team” “What are their interpersonal skills” “Are the decisions reached by the whole board” “Do the decision intake the Shareholders views” etc.

Who will be evaluated?

• Executive Director i.e. Managing Director, Whole Time Director
• Non Executive- Non Independent Directors
• Non Executive- Independent Directors
• Chairman of the Board
• Board’s Committee
• Board as the whole
  

 Who will do the evaluation?

• The performance evaluation of all the independent directors shall be done by the entire Board of Directors, excluding the director who is being evaluated.
  

• Independent Directors are required to evaluate the performance of non – independent directors, Executive Directors and Board as a whole.

What will be evaluated?

• Board’s Effectiveness
• Board Relationships
• Board’s Performance Objective
• Performance of Each Director
• Effectiveness of the Board’s Committee
  • Choosing what to evaluate will depend on board size and structure, as well as how the board executes its key functions (e.g., strategy formulation, service, monitoring, compliance and risk management).

Parameters for evaluation: (Illustrative List)

Factors to be considered in the Performance evaluation of an Executive Director and a Non Independent Director:

 Factors to be considered in the Performance evaluation of an Independent Director:

 Factors to be considered in the Performance evaluation of the entire Board:

 Factors to be considered in the Performance evaluation of Chairman of the Board:

• Is the chairman demonstrating effective leadership of the board?
• Are relationships and communications with shareholders well managed?
• Are relationships and communications within the board constructive?
• Are the processes for setting the agenda working?
• Do they enable board members to raise issues and concerns?
• Are all directors allowed or encouraged to participate fully in board discussions?
• Is the company secretary being used appropriately and to maximum value?

Factors to be considered in the Performance evaluation of Board’s Committee:

• Does each board committee have adequate and appropriate written terms of reference?
• Is the volume of business now handled by the committee (particularly the audit committee) set at the right level?
• Does the committee work in an ‘inclusive’ manner or has it, for example, resulted in executive directors not involved in the respective committee feeling distanced from those matters covered by the committee’s area of activity?
• How effective are the board’s committees? (Specific questions on the performance of each committee should be included such as, for example, their role, their composition and their interaction with the board.)
• Are board committees used to the best advantage? A more effective use of the nomination committee might be to widen its remit to embrace management development.

Source: Higgs Report

What techniques will be used?

• Qualitative techniques and
• Quantitative techniques
  • Quantitative data are in the form of numbers
  • Qualitative data are not in the form of numbers and will be required for any other type of research question like “what”, “how”, “why”, “when” and “where”

The performance evaluation cycle:

• The Higgs Report recommended evaluation ‘at least once a year’ and the Companies Act, 2013 requires formal annual evaluation of its own performance and that of its committees and individual directors.
• Although the annual review is the most common form of evaluation, this does not necessarily make it the most effective.
• Evaluation of Board’s performance every six months may be more appropriate.

Conclusion:

• Implementing a robust and successful board, director evaluation is one important way to ensure that a board can avert governance failure and consequent organisational failure.