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Maryland Corporate - Client Memos

The New York Stock Exchange requires the board of directors of a listed company to "conduct a self-evaluation at least annually to determine whether it and its committees are functioning effectively."  Although the Nasdaq Stock Market does not have a similar requirement, board evaluations have become a general practice among public companies.  In addition, Institutional Shareholder Services Inc. in its QualityScore rankings considers whether a company discloses a policy of annual board evaluations and Glass Lewis & Co. "strongly supports routine director evaluation, including independent external reviews."  As investors, governance activists and other market participants continue to focus on director skill sets, board composition and board refreshment, board evaluations can play a vital role in aiding the board and its committees in improving their effectiveness and in identifying and addressing issues and potential problems.

There is no single right approach to the evaluation process.  Successful evaluations should take account of the particular circumstances of a company and its board and should be carefully reviewed and appropriately adapted each year.  At a minimum, a board evaluation process should allow for reflective consideration of all aspects of the functioning of the board and board committees (and the participation of individual directors if they are being evaluated) and promote full, honest and focused feedback.

Designing the Evaluation Process

The nominating and governance committee of the board is typically responsible for overseeing the board and committee evaluation process.  Initially, therefore, it is important to review the company's corporate governance guidelines and the committee's charter to be sure that they contemplate the nature of the desired evaluation.  In addition, the plan for the proposed evaluation should be reviewed in advance with the full board. Some companies also mention the annual evaluation in their director onboarding materials.

The key variables in the design of an effective evaluation process are:
  • Internal or External. The chief advantage of an internal evaluator (perhaps the non-executive chair, the lead independent director, the chair of the nominating committee or the chief legal officer) is greater understanding of and familiarity with the company and the directors; the chief disadvantage is that directors may not be as forthcoming with someone whom they know and work with, particularly if that person is a subject of the evaluation. The chief advantages of an external evaluation are independence and, if the evaluator is a law firm, potential enhancement of any available protection of the attorney-client privilege and/or attorney work product doctrine.
  • Written, Oral or Both. Most evaluations will include (a) written board and committee evaluation questionnaires, (b) director interviews or (c) both. Questionnaires ensure that all desired topics are presented and responses solicited. We typically use short numerical rankings – 1 to 3 or 1 to 5. Space should be left for comments on each question and comments should be encouraged. Interviews allow for pursuing issues as they arise either from the questionnaires and responses and/or in the interviews themselves, especially picking up on certain words or phrases. Our experience is that more – often much more – can be learned in full and open verbal engagement than from static questionnaires alone. Even if the incremental benefit of interviews is limited, it is likely to further validate the information in the questionnaires.
  • Subjects of the Evaluation. Although the New York Stock Exchange requirement is limited to the board and its committees, many companies also ask for evaluations of all directors or certain ones, such as the chair, lead director or committee chairs. Some companies seek evaluation of individual directors only every second or third year and others will seek feedback, usually orally, if there is a "problem director." Some companies also ask that senior managers be requested to complete evaluation questionnaires and be interviewed about their observations of the board and its committees or even about individual directors.
  • Timing. Most companies do their evaluations on a calendar-year basis. A comprehensive, well conducted evaluation process often takes several months or more to design and execute. Working backward from the desired time of the evaluation report is often effective in scheduling. If an evaluation report is contemplated in the first quarter, the evaluation itself is generally planned and considered in the fall, with questionnaires sent out in mid-December. (Exhibit A is a sample timeline for board and committee evaluations conducted by independent counsel in which a written report is contemplated.)

Evaluation Questionnaires

Generally, board and committee evaluation questionnaires should be designed to focus and stimulate thinking on the major issues in evaluating the effectiveness of the board and its committees.  The substance of the questionnaires (often framed as statements with which each director is asked his or her level of agreement) should focus principally on the two primary functions of a board of directors – oversight and decision-making – and also address board process and board composition.  Some examples of statements for each of these categories include:

  • Oversight of Management
    • The board as a whole has the appropriate knowledge, skills and experience to oversee the management of the company's businesses and operations as currently conducted.
    • The board has developed appropriate monitoring systems for, and exercises effective oversight of, management's operating, financial and ethical performance.
    • Management provides to the board the right information in the right amounts on a timely basis to enable the board to fulfill its continuing oversight responsibilities, including results of operations by business segment, variations from budgets, competition, innovation, risk, trends and performance compared, as appropriate, with peers.
  • Decision-Making
    • The board makes decisions with the appropriate information, advice, deliberation, clarity, speed and follow-up.
    • There is appropriate delegation by the board of matters to board committees and management.
  • Board Process
    • Each director is well prepared for, and participates effectively in, board meetings.
    • The board is collegial and candid in its deliberations, with mutual respect, trust and constructive cooperation among directors, and welcomes dissenting or contrary views.
    • The board uses its time in meetings effectively.
    • There is sufficient time and opportunity for non-management directors to meet and deliberate as a group.
  • Board Composition
    • The board has the appropriate number of members at the current time.
    • The board as a group has the appropriate balance, breadth and depth of relevant background, skill sets, diversity and experience to address the issues currently facing the company.
    • Each director understands and is engaged in and meaningfully contributes to the proper functioning of the board.

Board committee questionnaires should (a) follow a similar design to the board evaluation forms and (b) focus on the committee's responsibilities, principally as expressed in the company's corporate governance guidelines and in the relevant board committee charter.

Report

The manner of presentation of the results of the evaluation varies among companies and even within a company in different years.  Often, a report is made orally first to the nominating committee chair, sometimes accompanied by the board chair, so that they will be in position to address any potential problems, especially relating to an individual director.  Some nominating committee chairs may then present the report to the full board; others may prefer a presentation by the evaluator to the nominating committee and/or board. Some boards prefer written reports, some oral.  An effective report will (a) review the process undertaken and the numerical and other responses to at least the key questions in each questionnaire, (b) distill and organize the most significant comments in the written evaluations and the interviews and (c) note any patterns in the responses and comments. It may be helpful to compare current-year results with prior years.  The substance of the report should address board and committee strengths, areas for improvement, structure and process of the board and committees and other relevant governance-related matters.

Confidentiality

In order to promote the receipt and assessment of full and candid information during the evaluation, including interviews, it is important to assure directors at the outset that both their written evaluations and their oral interviews will remain completely confidential, without attribution to any director, and that the completed evaluation questionnaires and interview notes will be destroyed by the evaluator at the end of the process.  It may be helpful for the evaluator to confirm the destruction or deletion (to the extent possible) of these materials.