Testing directors

Most companies just limit evaluations to the overall boardroom assessment required under NYSE listing rules. Understandably, they would rather not put their directors in the spotlight if there is a risk the glare might highlight deficiencies. 

Director evaluations have the potential to make directors uncomfortable or even alienate powerful people who are unused to being judged. Even worse, if not conducted properly, director evaluations could lead to liability risks for the company. Imagine if the results of a negative director evaluation were to find its way into the hands of plaintiffs in a shareholder lawsuit. 

Yet a small but growing number of firms are testing directors individually – so there must be an upside. According to the Conference Board’s survey of 1,200 directors, about one third of boards evaluate board members individually, and 79 percent say individual directors should be evaluated regularly. This is a 12 percent increase on 2003. 

Why are more firms conducting evaluations? To start with, it’s hard to imagine any other job where performance is not measured. If directors are not evaluated on an individual basis, it’s difficult to know what their real contribution to the board is. In an age where the time demands on directors are skyrocketing and where one bad director could potentially open up liability for all directors, many boards are insisting that every member pull his or her weight. 

No paper trail

Although there are few rules, most appraisals are conducted verbally, and the results kept within the walls of the boardroom. ‘The overwhelming best practice is to perform individual director evaluations orally and not in writing,’ says Steven Barth, a partner at law firm Foley & Lardner LLP and program chair of the company’s National Directors Institute (NDI), an annual directors educational symposium. ‘These are typically sensitive matters that are most effectively handled in person. Moreover, the concern is that written individual evaluations, if critical, can provide a roadmap for a plaintiff’s attorney trying to prove negligence, incompetence and/or breach of fiduciary duty at individual and/or board level.’ 

Houston-based electrical toolmaker Cooper Industries has been conducting individual director assessments since before Sarbanes-Oxley. The board’s nominating committee examines directors’ performance when they are up for reelection. Any comments from other directors on a particular director’s performance are taken into account, as is the director’s attendance, participation and contribution record at meetings, according to Terrance Helz, associate general counsel and secretary at Cooper. 

Another company that conducts annual individual director assessments is Illinois-based First Midwest Bancorp. Directors provide a verbal self-assessment of their contribution to the board and the company’s success, their ability to keep up to date on strategic matters and their relationship with fellow directors, says Steven Shapiro, executive vice president and corporate secretary at First Midwest. Like Barth, Shapiro says corporate secretaries should be watchful of what is kept in writing. ‘You want directors to be able to say, Look I feel xyz, but you don’t want a plaintiff to say, Look you didn’t do xyz – you are liable,’ he explains. 

Creating accountability

But simply doing assessments does not ensure best practice or board effectiveness. For assessments to bring about positive results, it’s vital that boards follow through with recommendations made during evaluations. ‘Doing individual director assessments is good, but you should go with your eyes open,’ says Roger Raber, CEO and president of the National Association of Corporate Directors (NACD). ‘Don’t tread softly. You have to make sure every member of the board participates, and you want to make sure the recommendations that come out are implemented.’ 

Like any performance review, individual assessments have the potential to put directors in an awkward position. It’s hard for people to evaluate their peers and/or themselves, but boardroom experts report that the overall feedback from directors is positive. Giving directors a self-test often produces a healthy competitive environment for directors, and it creates a culture of accountability. 

‘By going through an assessment each year, directors get to prove their commitment year after year to the nominating committee and shareholders,’ notes Raber. ‘This creates a culture of accountability. Boards then have less of a concern about having passive directors or directors that just don’t get it.’ 

Obviously directors want to do well in these tests, and don’t want to be the weakest link in their group. ‘What we found was that once you start to explain and measure the success criteria, directors are more likely to perform and behave in that way,’ says Todd McGovern, a principal and corporate governance practice leader at Mellon Financial, a global financial services firm. ‘Directors are very successful people in their own right and want to be successful in this context, too, so explaining to them what the criteria are for being successful in a particular board situation is something they appreciate.’
 
Shapiro agrees a positive pressure arises from doing these assessments that ups boardroom productivity. ‘Directors take these evaluations seriously,’ he notes. ‘There is a peer pressure. Because all directors are doing it, and have done it in the past, they just want to be told what to do and they will do it.’
 
Corporate secretaries usually play an administrative part in these evaluations and, of course, an advisory role. They should discuss the adoption of a policy and work with the board to define a framework for that policy, advises Helz. ‘At a minimum level, corporate secretaries and/or general counsels should ensure the board and chairman are aware of the range of best practices and procedures used to implement effective board and director self-evaluations,’ Barth adds. 

Establishing a set of rules for directors to follow is a good idea; Cooper Industries’ board recently developed a policy for director assessments. ‘Our ground rules determine when we do assessments, how we do them and whether there are any issues that need to be addressed with an individual director,’ explains Helz. ‘For instance, our policy provides for a one-on-one discussion between either the chairman of the committee or chairman of the board and that particular director. Performing director assessments is a matter of directors fulfilling their fiduciary duties to ensue a firm has the right directors on its board and that the current directors are performing as expected.’ 

Finally, in order to make director assessments truly valuable, companies must find a framework that best suits their board – because one matrix does not fit all. For instance, one board might be comfortable with doing only self-assessments, while another might rather do peer-evaluations and others still prefer to do both. 

‘Work with your board to make it feel as comfortable as possible, and be as open as possible with the board,’ says Shapiro.