Best Practices in Board Evaluation and Director Evaluation

Best Practices in Board Evaluation and Individual Director Evaluation The Canadian Society of Corporate Secretaries 11 th Annual Corporate Governance Conference August 23 – 26, 2009 St. John’s, Newfoundland and Labrador Beverly A. Behan Columnist: “The Boardroom”, BusinessWeek.com President: Board Advisor, LLC - New York Date: August 25, 2009

What Is an Effective Board? When you think of a “high- performing” or “world-class” Board: What is this Board particularly good at? If you walked into this boardroom, how would it feel? How would you describes the relationship between this Board and the CEO?

High-Performing Boards…… Are comprised of the right people Portfolio of skills/experience Engaged/make a meaningful contribution Representative factors Get the right information Director orientation/education Pre-reading materials Board presentations Updates between board meetings Make the best use of their time Focus on the most important issues Balance of presentation/discussion time Engage at an oversight level, not management level Agendas Information Composition

High-Performing Boards…… Have effective processes, especially with respect to: Corporate strategy CEO succession planning Board evaluation/Director evaluation CEO evaluation Risk management Have effective committees Board/committee interface is critical Committee membership and leadership Resources that support the committee’s work Board Committees Key Processes

High-Performing Boards…… Have effective leadership Draw out different perspectives Keep meetings focused on critical issues Work together well as a team Respect different perspectives Reach consensus/make decisions Have positive energy/engagement Work constructively with the CEO “ Constructive tension” between support/critique of management Raise tough, challenging issues Motivate and reward strong performance CEO Relationship Dynamics Leadership

In the US, High-Performing Boards are Rare According to the National Association of Corporate Directors (NACD) 2008: % Who Rated Their Board Private Companies (329 Directors) Public Companies (703 Directors) Highly Effective 16.2% 20.2% Effective 46.7% 60.1% Somewhat Effective 29.6% 15.6% Ineffective 7.6%

Degree of Board Engagement “ Certifies” to shareholders that: CEO is doing what Board expects; management is capable of taking corrective action when needed Emphasizes outside/ independent directors; meets independently without the CEO Stays informed of current performance; designates external Board members to evaluate CEO Establishes an orderly succession process Is willing and able to change management to be credible to shareholders The “ Engaged” Board The “ Passive” Board The “ Operating” Board The “ Intervening” Board The “ Certifying” Board Functions at discretion of CEO Limited activity and participation of Board Limited accountability Ratifying management preferences “ Partners” with CEO to provide insight, advice, and support to CEO and management team on key decisions and implementation Also recognizes ultimate responsibility to oversee CEO and company performance; dual role of guiding/supporting as well as judging the CEO Board meetings characterized by useful, two-way discussions of key issues/decisions facing the company Board members need sufficient industry and other expertise to add value to decisions Typical mode during a “crisis” situation Board becomes intensely involved in discussions of key decisions facing the organization and in decision-making Frequent and intense Board meetings, often called on short notice Board makes key decisions; management implements Not uncommon in early “start-ups” where Board members are selected to “fill gaps” in management experience Source: Building Better Boards, Jossey-Boss 2006

Board-Building Model Taking Stock of the Board Board Roles, Expectations and Level of Engagement Board Composition Board Agendas & Meetings Board Structure Board Climate/Dynamics Create Value-Added Engagement Assess Quality of Engagement Source: Building Better Boards, Jossey-Boss 2006 Board Information Board Processes Board Leadership

Board Evaluation: A Best Practice Around the World -1992: Cadbury Report (UK) first recommended conducting an annual assessment of the board’s performance as a “best practice” in governance -Conducting an annual board assessment is one of the guidelines in the modern UK Combined Code -OECD Corporate Governance Guidelines noted that regular evaluation of the board’s performance was one of the board’s key responsibilities -2003: New York Stock Exchange (NYSE) requires that all listed companies conduct an annual assessment of the performance of the board and its committees

A Best Practice in Canada - and a TSX Guideline -In Canada, the Dey Report in 1994 recommended that boards conduct an annual self-assessment of the Board -TSX Guidelines recommend Board and individual director self-assessment -There is no prescribed format for conducting the assessments -Assessment results are not filed or published anywhere

Most Board & Director Evaluations are Ineffective According to the National Association of Corporate Directors (NACD) 2008: % Who Rated Their Board & Director Evaluations Private Companies (329 Directors) Public Companies (703 Directors) Highly Effective 9.3% 15.6% Effective 25.4% 42.1% Somewhat Effective 36.9% 33.9% Ineffective 28.4% 8.4%

How to Avoid This Happening to YOU As Corporate Secretary, you need to be in a position to inform your Chairman/ Chair of Nom/Gov Committee of practices that avoid the board evaluation becoming a waste of board members’ time Use the right methodology Ask open-ended rather than closed-ended questions: BAD: Our board has the right composition GOOD: If we were going to add one new board member, what background/skill set should that person bring? The outcome should be an “Action Plan” of 2-5 items that will enhance the board; getting a “high score” isn’t the point

Choosing a Methodology/Design What are your objectives for the board evaluation? If it is primarily to achieve compliance with stock exchange requirements or “best practices”, choose a survey If you want to use the process to significantly enhance board performance, invest in an interview process with an experienced third party – and include management feedback. If you want maximum impact but have a small budget or a large board that make interviews cost prohibitive, consider a survey supplemented by a focus group There is no need to use the same process each year . Innovative boards use different methodologies to see the board’s performance through different lenses.

Surveys On a scale of 1 - 5 indicate the extent to which you agree with each statement: There are the right people on the Board. Everyone pulls his/her weight. Meetings are held with enough frequency. 1= strongly disagree 5 = strongly agree 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5

Interviews Confidential, structured interviews typically conducted by a third party but sometimes conducted by the Chairman, the Chair of the Nominating/Governance Committee or the corporate secretary; this methodology is used by 43% of UK boards What was the most significant decision this board made in the past year? If you could change one thing about this board, what would you change – and why? What do you see as the board’s most important priorities over the next 6, 12, 18 months? How would you describe the working relationship between the board and the CEO? What are the major risks facing this company?

Focus Groups -Subgroups of board members (4-5 directors) participate in focus groups to discuss key elements in board effectiveness -Most commonly used with large boards, such as not-for-profits where cost of individual interviews is prohibitive -Can be a useful team-building exercise for the board -Board members are often more reluctant to raise sensitive or difficult issues in a focus group than in one-on-one interviews

Other Design Factors to Consider - Feedback from senior executives who regularly interface with the board - Individual director evaluation - Board observation Some directors “play to the camera” - Review of Board minutes - Crown corporations (or similar bodies where a stakeholder has the right to appoint directors) Feedback from the appointing government body on their perceptions of board performance

What do you do with the feedback? Analyze It Analyze the key themes surfaced from the board assessment to help you determine: Strengths of the Board Areas for Potential Improvement Talk about it Schedule at least 2 hours (preferably half a day) for the board to discuss the results of the board assessment Discuss the top 2-5 areas for improvement and develop strategies to effectively address these Create an Action Plan (2-5 items) A roadmap for the board to use over the next 12 months to address possible improvements

“ We Had No Issues” -“We had no issues” in our board evaluation is a big red flag. It implies either that: The Board evaluation is very poorly designed; or The Board is “checked out” and doesn’t care - Good Boards are made up of accomplished business leaders who value continuous improvement These people always surface good issues and try to make good Boards even better

True Case Study 2006 CFO interviewed during board evaluation said: “ The Board is ok; they don’t get in my way. But I’d kill for someone to ask me a question about global corporate finance in a board meeting that made me really think.” Board Evaluation Action Plan 4 new directors to be added Changed board pre-reading information dramatically Created “expectations” for board members 2008 Same CFO interviewed during the board evaluation said: “ This board is night and day from the board we had 2 years ago. They’re fantastic – a true corporate asset.” “ I ask only one thing from this year’s board evaluation – 45 minutes on the agenda when I can just have “open discussion” with the board from time to time on key strategic issues. This board is better than McKinsey.” Board recognized for progressive governance

Two Top Issues that Arise in Most Board Evaluations: CEO Succession Planning Board Engagement in Strategy

CEO Succession Planning According to the National Association of Corporate Directors (NACD) 2008 : % Who Rated Their Board on CEO Succession Planning Private Companies (329 Directors) Public Companies (703 Directors) Highly Effective 8.9% 11.3% Effective 30.2% 37.7% Somewhat Effective 31.3% 35.3% Ineffective 29.5% 15.7%

Emergency CEO Succession Planning - Every board should have an emergency succession plan in place for the unexpected loss of: Chief Executive Officer Other top officers (eg. CFO, COO) Loss of all three top officers at once (the “company plane crash” or “scandal” scenario) - Emergency succession plans should be reviewed : On an annual basis with the full board Whenever a material change in company or board leadership occurs that could impact the plan

CEO Succession Planning Model Corporate Strategy Develop Future CEO Criteria Assess Internal Candidates Against CEO Role Profile Select New CEO Develop CEO Transition Plan Develop Plans for Internal Candidates Assess Internal vs. External Candidates Corporate Culture Business Model

2. Board Engagement in Strategy

Board Engagement in Strategy SWOT (Strengths, Weaknesses, Opportunities, Threats) Strategic Alternatives Strategic Choice Strategy Implementation Where most CEOs Engage their Boards On Strategy Optimal Point to Engage Board On Strategy

Individual Director Performance and Evaluation

The Best Directors Play Two Distinct Roles Watchdog Role Focus is on corporate oversight Approval of management’s decisions and actions Challenges management’s assumptions Raises challenging and sometimes difficult issues Sounding Board Role Focus is on “partnering” with management to benefit the corporation Provides advice, counsel, guidance, and mentoring to the CEO and senior management Facilitates business introductions Source: Building Better Boards, Jossey-Boss 2006

Types of Problem Directors -Pitbull -Pet Rock -Deer in the headlights -CEO Wanna-Be -Management lapdog -“Wowed” by prestige of being on this Board -Super-director

Individual Director Evaluation: Methodologies Director Self-Assessment : Board members rate themselves against a set of criteria (eg/ “I ask good questions in board meetings”) This can be useful for consciousness-raising with a new board or as a means of introducing this process It has limited utility, however. Inevitably some of the lowest performing directors give themselves the highest scores. Chairman Phone Calls/Meetings : The Chairman calls up board members and asks them if they feel anyone should not be re-nominated. This is not a true director evaluation process. No useful feedback is elicited on strengths and contributions of the high-performing directors This tends to be solely decision-making and not developmental Feedback is provided “too late” and typically with insufficient detail to be genuinely useful.

Individual Director Evaluation: Methodologies Conversation in the Nominating/Governance Committee “ Once a year, our Governance Committee talks about the performance of everyone on the board” This creates a two-tiered board dynamic and limits non-committee members from providing feedback. Director Peer Evaluation is far more progressive and useful than other methodologies. It is typically conducted using either: Surveys: Directors rate each other on a 1-5 point scale with write-in comments Confidential Interviews: May be conducted by a third party or the Chairman: Key interview questions: What is Director X’s most significant contribution to the board? What, if anything, could Director X do to be even more effective as a Board member? Should Director X be re-nominated to the board?

Individual Director Evaluation: Key Questions -Will this process be used: Solely for directors’ professional development? Part of the re-nomination process? -Methodologies Interviews Surveys -Who will deliver the feedback? Non-Executive Chair? Chair of Nom/Gov Committee Third party?

Individual Director Evaluation: The Key Keep it constructive Emphasize strengths and contributions so that directors understand where they are particularly effective; When raising shortcomings try to provide specific examples and keep comments constructive. Avoid personality-related comments that only create bad feelings The skill of the interviewer is critical: Third party vs. Chairman/board member??? Corporate secretary?? :

Questions and Answers/Discussion

Beverly A. Behan Has worked with more than 85 boards in Canada, the U.S. and internationally over the past 12 years. Conducted the board and director evaluation for the board of the Bank of Montreal from1997-2000; first major North American board to do an individual director evaluation Co-author: “Building Better Boards: A Blueprint for Effective Governance”, Jossey-Bass, 2005 Columnist, “ The Boardroom ”, for BusinessWeek.com since 2007 For more information, see www.boardadvisor.net

Best Practices in Board Evaluation and Director Evaluation

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