Board effectiveness: What do you need to do?

On 3 March 2011 the Financial Reporting Council (FRC) published its new Guidance on Board Effectiveness (Guidance), which replaces Good Practice Suggestions from the Higgs Report (known as the Higgs Guidance).

The Guidance is intended to make boards think about how they can carry out their role most effectively, focusing on the leadership and effectiveness of the board. It addresses those issues in Sections A and B of the UK Corporate Governance Code (Code) that companies, board members and investors have asked for guidance on.

The Guidance embodies the shift in emphasis underlying the recent developments in corporate governance in the UK, namely, that ensuring appropriate structures and processes are in place is not sufficient on its own – boards need to focus on the way in which they carry out their role and their own behaviour.

This briefing looks at the contents of the Guidance and at the critical questions the key players need to ask themselves to ensure board effectiveness.

To be an effective board, the participants need to understand what constitutes an effective board. The Guidance describes an effective board as one that “develops and promotes its collective vision of the company’s purpose, its culture, its values and the behaviours it wishes to promote in conducting its business”. It emphasises that challenge is as important as teamwork and, as such, an effective board will not always be a comfortable place.

The key functions of an effective board identified by the Guidance are to:

• Provide direction for management
• Demonstrate ethical leadership – promoting defined culture and values
• Create a performance culture that drives value creation without excessive risk
• Make well-informed and high-quality decisions
• Create the framework for helping directors meet their duties
• Be accountable
• Think carefully about its governance arrangements and evaluate their effectiveness

As set out in the Code, the chairman has overarching responsibility for leadership of the board. This means creating the conditions for overall board and individual director effectiveness. Critical to this is making sure that there are no ‘no go’ areas – the board must be able to operate oversight in all areas. Similarly, the chairmen of board committees must create the conditions to ensure the effectiveness of their committees.

The role of the chairman is key to establishing the framework for an effective board. A chairman should therefore ask himself or herself whether he or she is fulfilling the various components of the role set out in the Guidance. For example:

Leadership

• How do you demonstrate ethical leadership in your role as chairman?
• Do you encourage all board members to engage in board and committee meetings by drawing on their particular skills and experience?
• How do you promote and participate in director development (including your own development)?
• What actions have you taken based on the results of board evaluation?

Board agenda

• What measures have you put in place to set the board agenda?
• How do you ensure issues relevant to strategy, performance, value creation and accountability are reserved for board decision?
• What procedures are followed and information considered in determining the nature and extent of the risks the company is willing to embrace in implementing its strategy?
• What do you do to enable non-executive directors to test proposals of executive management?
• Do you allow sufficient time for debate at board meetings and are the other directors happy with the amount of time which is made available for debate?
• Where appropriate, do you commission an independent report, obtain experts’ advice or establish special sub-committees of the board to consider or challenge particular issues?
• Is there a process for reviewing past decisions and the decision making process, particularly decisions with poor outcomes?

Information flow

• What arrangements are in place with executive management to receive adequate information on the issues considered by the board?
• How and when is this information received?
• What arrangements are in place with the company secretary to ensure timely distribution of information to board members?
• Are other directors satisfied with the flow of information – what improvements would they suggest?

Board evaluation

• Is the outcome of a board evaluation shared with the whole board and how is it fed into the work on board composition and the design of induction and development programmes for directors?
• Do you have a review loop to consider the effectiveness of the board evaluation process?

Communication

• What do you do to build relationships between executive and non-executive directors and between non-executive directors and management outside the boardroom?
• What kind of support and advice do you provide for the executive directors and, in particular, the CEO?
• Do you make executive directors aware of their responsibilities when joining the board?
• How often and on what issues do you consult the senior independent director?
• What do you do to communicate with shareholders and other stakeholders and how do you ensure other directors are made aware of their views?
• Does the board as a whole review disclosure on governance arrangements in the corporate governance report?
• Do you report personally about board leadership and effectiveness in the corporate governance report?

Succession planning

• How often does the board consider succession planning and its composition?
• What factors are discussed and what information is received on this issue?
• How do you identify gaps in the skill sets of the board as a whole?
• What diversity policies are applied to succession planning and board composition and how effective are these?
• Is the company developing internal talent and capability through initiatives such as middle management programmes and mentoring schemes?

As well as performing the role of senior independent director (SID) specified in the Code, the Guidance highlights the critical role played by the SID when the board is undergoing periods of stress, when he or she is expected to work with the chairman, other directors and/or shareholders to resolve significant issues.

The board should have a clear understanding of when the SID might intervene in a particular issue to maintain board and company stability. Examples of this and questions a SID should ask himself or herself to determine whether he or she is performing the role adequately include:

Managing the relationship between chairman and CEO

• If there is a dispute between the chairman and CEO, what action do you take to identify and help to resolve the dispute?
• What action do you take if decisions are being taken by the chairman and CEO without full board approval?
• How do you identify and mitigate the negative impact of a dominant personality or group of directors on the board?

Communication

• How do you identify concerns shareholders or non-executive directors may have that they consider are not being addressed and how do you deal with this?
• How do you identify when board members are not supportive of a particular strategy and what action do you take in these circumstances?

Succession planning

• How do you ensure succession planning is being properly considered?

The SID should have a defined role which is set out in writing and which takes into account the above issues.

Executive directors are equally responsible as non-executive directors for creating an effective board, including the performance of the functions of an effective board identified above.

Executive directors should consider the following questions to help determine whether they are contributing to an effective board:

Induction and training

• Did you receive an appropriate induction on joining the board and do you continue to receive regular training in the context of fulfilling your role as a board member?

Wider function of the board

• In performing your role are you considering the functions of an effective board as well as your responsibilities as part of the CEO’s executive team?
• What do you do to encourage non-executive directors to test your proposals?

Non-executive director experience

• Are you a non-executive director on another board, or have you considered taking up such a position?
• If so, what skills and experience developed as a non-executive have you applied to your role as an executive member of the board?

If you are the CEO:

Relationship with the chairman

• What is your relationship with the chairman and what are you doing to develop and/or maintain that relationship?

Enforcing governance standards

• What do you do to support the chairman to ensure that appropriate standards of governance permeate through all parts of the organisation?
• What do you do to ensure non-executive directors are able to test proposals of executive management?

Communication

• What measures are in place to enable you to ascertain the views of employees on issues relevant to the business and what do you do to communicate these to the board?
• Do you facilitate the sharing of executive directors’ views on the business and, where there is a divergence of views, do you explain this in a balanced way to the board?
• What feedback do you get on this?

Finally, if you are the CFO, what do you do to ensure high-quality financial information is delivered to the board on the company’s financial position in a timely manner?

The Guidance specifies that it is the role of non-executive directors to uphold high standards of integrity and probity and, critical to the performance of their role, they should ensure they are devoting adequate time to the discharge of their responsibilities.

Non-executive directors should consider the following questions to help determine whether they are contributing to an effective board:

Induction and training

• On appointment, did you participate in a formal and tailored induction and how comprehensive did you think it was?
• If any improvements could be made, have you communicated these to the chairman?
• Is there an initiative to partner you with an executive board member to assist you in acquiring an understanding of the main areas of business activity, especially areas involving significant risk?
• Have you visited and talked with senior and middle managers in those areas?
• How much time do you devote to developing and refreshing your knowledge and skills and how do you go about doing this?

Time commitment

• How much time are you required to devote to your role and how much time do you devote to it?
• Are you required to commit additional time in certain circumstances, such as an acquisition or takeover or as a result of a major difficulty with operations?
• Did you appreciate the time commitment involved prior to taking on the role and did you assess the likelihood of you being able to make a positive contribution in your role as a member of the board?

Information flow

• Do you receive adequate high-quality information to enable a thorough discussion of the issues at board meetings?
• Are you informed of what is expected of you on a particular issue?
• If not, have you communicated any deficiencies to the chairman or SID?
• How are the views of shareholders and other stakeholders communicated to you and to what extent do you take these into account in board discussions on a particular issue?
• Do you consider sufficient time is made available to debate significant issues at board meetings?
• Is there ever any reluctance to involve the non-executive directors in decision-making or are matters brought to the board for sign off rather than debate?
• Is an expert's opinion obtained on all matters where you consider it appropriate?
• To what extent does the assessment of risk form part of the decision making process?

The company secretary plays a leading role in good governance by supporting the chairman and helping the board and its committees to function effectively.

In performing his or her role, the company secretary should ask himself or herself:

Information flow

• How do you collate high-quality information required by board members to make decisions?
• When presenting this information, does the board paper inform the directors what is expected of them on a particular issue?
• Are the directors happy with the level of information received and its presentation?
• How do you identify when expert opinions are required and are these obtained?
• Is there a process to communicate follow up actions to board members following board meetings within appropriate timescales?
• Where appropriate, do board papers describe the process used to arrive at and challenge a proposal prior to it being presented to the board?
• Are minutes of committee meetings, where appropriate, circulated to all directors and is sufficient time after committee meetings allowed for the committees to report to the board?

Induction and training

• What role do you play in director induction and training?
• Is there a process in place to obtain director feedback on training and deal with requests for further training?
• How is training for a particular director tailored to the results of the board’s evaluation processes?

Governance arrangements

• Do you, together with the chairman, periodically review whether the board and other governance processes (for example board and committee evaluation) are fit for purpose?
• What is the outcome of these reviews and are improvements or initiatives considered that could strengthen the governance of the company?

Critical to developing and maintaining an effective board, a board must continually monitor and improve its performance. The Guidance considers that this can be achieved through board evaluation for which the chairman has overall responsibility as indicated above. Chairs of board committees should also be responsible for the evaluation of their committees.

Board evaluation should explore the effectiveness of the board by considering the questions raised above in the context of the role of the chairman, SID, executive directors, non-executive directors and company secretary, as well as considering how the board works together as a unit and the effectiveness of contributions made by individual directors.

Boards are coming under increasing scrutiny over their role in improving company performance while, at the same time, managing and controlling risk. Central to this are the governance arrangements in place to improve board effectiveness and ensure the values and culture of an organisation, which are established by the board, permeate all levels of the organisation. Corporate governance is not a box ticking exercise - it is about implementing the spirit of the Code. It is the responsibility of all those involved in a company’s governance to put this into effect.