4 min read.Updated: 30 Mar 2021, 09:50 PM ISTSanjay Kallapur,Harish Raichandani
The pay-offs can be significant if companies take the exercise as more than just a regulatory burden
Every year, boards get an opportunity to improve their functioning, but many fail to seize it. We refer to the mandate that an evaluation of the board as a whole and each director be performed every year under the Companies Act of 2013 and the Securities and Exchange Board of India’s listing obligation and disclosure rules of 2015. This is a relatively recent practice the world over. While Board evaluations became standard in 1992 with the Cadbury Committee Report in the UK, recent years have seen it become mandatory in many countries.
Done well, board evaluation benefits the company in several ways. First, it helps build the right chemistry among board members, leading to their knowledge and skills being used more effectively. Second, it lubricates board functioning mechanisms, leading to more effective agenda-setting, information-sharing between executives and the board, and improved functioning of committees and their interface with the board as a whole. Third, it enhances the governance score, which is important to company valuation in an era when environmental, social and governance (ESG)-oriented investment funds are gaining traction.
Board members of top companies are highly accomplished individuals. Yet, the best individuals do not necessarily make the best team; boards are no exception. A lack of cooperation results in collective performance falling short of the sum of individual capabilities, and the most important determinant of synergy is the chemistry among members. In the absence of appropriate chemistry, even accomplished individuals perceive a lack of psychological safety and take the path of least resistance, which leads to groupthink. The best cure is a periodic self-assessment that helps empower every voice in the boardroom, leading to a culture of openness. For example, in a board evaluation facilitated by one of us, candid peer feedback resulted in a change of participation norms; dominant members showed a willingness to be challenged, and relatively quiet members became more communicative. This resulted in enriching discussions and a roadmap to mitigate technology and market risks that had been a blind spot for the dominant members.
In our experience, the time spent on enhancing board functioning in its regular meetings is severely constrained by increasing mandates, especially in regulated industries. An annual evaluation offers a welcome opportunity to do it. It helps revisit various processes, such as agenda-setting, information flow between executive and non-executive directors, the functioning of committees, and stakeholder engagement structures. In one example, an evaluation led to the expansion of a board committee’s scope, thereby freeing up the board’s time while letting more attention be devoted to those issues. In another case, the anonymity of the exercise helped members own up their knowledge and proficiency gaps, which led to a well-structured board development programme in fintech and macro-economic developments.
Finally, board evaluation contributes to an enhanced ‘governance’ score on ESG, a barometer that is increasingly used by investors and lenders. Some of the best governed companies, as identified by International Finance Corp’s Corporate Governance scorecard 2019 for S&P’s BSE-100 companies, reported multiple pay-offs from board evaluations: training for identified knowledge gaps of board members, improved succession planning for key executive positions, mitigation of top risks, and accelerated growth.
The rigour of the evaluation process is reflected in a firm’s annual report. For example, Marico mentions that it was facilitated by the board’s chairman, supported by the chairperson of its nomination and remuneration committee. The feedback was shared individually with each director. The focus areas identified for improvement in the previous year and actions taken are reported, as well as those identified for the coming year. Another good example is Cipla, which reports that the suggestions of directors increased overall board effectiveness, improved succession planning, and optimized the strengths of individual directors through training. Many other companies, however, merely report that an evaluation was carried out in accordance with requirements, suggesting that it was done as a tick-the-boxes exercise. Quite a few are silent on the matter, which raises the question of whether it was done at all.
Companies are left to decide their own board evaluation process, making it a benign mandate framed as a guideline rather than a set of rigid rules. Several companies, however, seem to consider it just another check-the-box exercise. Reports of a sample of BSE-500 companies reveal that over 60% of companies did not carry out evaluations in 2019. Half of these are listed public sector enterprises. This is paradoxical behaviour by boards that are otherwise known to seek liberation from the tick-box mandates. The other paradox is that the government, which had promulgated the law, does not enforce it on the companies it owns.
We call upon board members, especially chairpersons of nominations and remuneration committees, to ensure that this season their exercise goes significantly beyond a tick-the-box exercise and demonstrates that ‘feedback is the breakfast of champions’. For, this small step can energize directors and unlock company potential.