How Should Board Directors Evaluate Themselves?

Board self-evaluations are now a requirement at many companies. But what’s the most effective way for directors to assess their own performance?

Board directors are facing increasing scrutiny. In the wake of the New York Stock Exchange’s own scandal with its former CEO Richard Grasso,1 the NYSE now requires the boards of all the companies it lists to conduct periodic self-evaluations. Furthermore, both Morningstar and Standard & Poor’s2 consider board self-evaluation as one criterion in their governance ratings of corporations. The practice has even become increasingly mandated in the nonprofit world. The National Association of Independent Schools, for example, currently requires the boards of private schools to conduct self-evaluations. And board directors in the United States aren’t the only ones feeling the pressure. In Finland, for instance, the boards of all public companies must routinely assess their own performance.3 Still, the practice is far from universal. NASDAQ, for one, does not currently require board self-evaluation of its members. Nevertheless, NASDAQ companies that do undertake board self-evaluation have the opportunity to get ahead of the curve and position themselves in the vanguard of good governance.

But what exactly is the best way for a board to evaluate itself? Unfortunately, board directors have generally had little guidance in this area. To investigate the different self-evaluation practices used, we studied eight boards that have engaged in self-evaluations for at least two annual cycles. We found that the companies were using a variety of practices for collecting data and for preserving the confidentiality of this information. The differences among these practices can be summarized by four distinct approaches to self-evaluation: informal, legalistic, trusting and systematic. Each of the approaches has important implications for a company’s board rating, directors and officers (D&O) insurance and various legal issues.

Why Self-Evaluations?

In a 2004 survey conducted by Korn/Ferry International, 72% of board directors indicated that their performance ought to be evaluated. Yet only 21% of the boards of public companies actually conduct such assessments. Part of the problem is that organizations often don’t know how best to implement a board self-evaluation procedure. Many simply avoid the practice because they fear alienating individual directors. Others have implemented the process only to become frustrated because it took so much time and produced so few results.

According to James Doty, a partner at Baker Botts in charge of the international law firm’s board self-evaluation program, companies need to address two core governance dilemmas when implementing any self-evaluation procedure.

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References

1. P. Elkind, “The Fall of the House of Grasso,” Fortune, Oct. 18, 2004, 284.

2. Standard & Poor’s criteria, methodology and definitions for developing board of directors ratings are available at www2.standardandpoors.com/NASApp/cs/ContentServer?pagename=sp/sp_article/ArticleTemplate&c=sp_article&cid=1021558139012&b=10&r=1&l=EN.

3. J. Erma and J. Kivinen, “Finnish Corporate Governance,” European Lawyer (April 2004): 58.