What Lurks Within

What Lurks Within:The Risky Business of Board Assessment

by Deborah Wallace

As a by-product of the Sarbanes-Oxley Act,the NYSE added annual board self-assessment to its new listings rules. If handled skillfully and within the broader context of governance reform, the requirement could prove positive. The board self-assessment rule, which also applies to the audit, governance and compensation committees, may help fuel a much-needed shift toward a more trustworthy corporate culture. For that to happen boards and regulators must address a number of thorny issues. Less obvious than others, some could be consequences of seemingly well-intentioned decisions.

Although the positive and negative impacts of this sensitive mandate will most likely not show up for several years, both regulatory agencies and boards would be well advised to take time now to consider the different ways and arenas in which Section 303A.09 of the NYSE’s final listings rules might play out. At a minimum, they should be better prepared to manage whatever negative repercussions may arise in order to mitigate setbacks to efforts in governance reform.
While there has been an onslaught of newly enforced governance rules since the 2002 SOX Act, little attention has been given to individual directors. The NYSE self-assessment rule focuses attention on them. It is a rule that hits home and hits hard for directors. While some boards have been conducting self-assessments for many years, even before 2003 when the NYSE’s new rules for listed companies went into effect, the stakes are much higher now.

Out in the open

There has always been resistance to – or at least anxiety about – assessments. Those reactions may be heightened and more widespread now that the process has “gone public”. All NYSE-listed companies are required to disclose in their annual reports not only a description of the assessment process but also those areas in which the board will seek to improve.

Some directors may think that publicly acknowledging the need for improvement (even though individual cases are not made public) is admitting weakness, prompting them to question their value to the board and the board’s ability to govern effectively. Such a negative reaction could, in turn, drive stock prices down and create adverse shareholder reactions. Directors who are fearful and lack confidence in their own ability to govern may be less candid in assessing themselves. When fear of ‘being found out’ kicks in, the assessment process is sabotaged, undermining the original intent to repair corporate misconduct.

Concern about confidentiality of data collected is another issue that can potentially dilute the integrity of a director self-assessment process, and can be a further disincentive to provide honest responses. If an assessment finds its way out of the boardroom, could it become evidentiary material? What are the consequences for a director whose assessment is either intentionally or inadvertently misinterpreted? Contemplating these scenarios could dissuade both exemplary and underperforming directors from providing anything but the safest responses.

Drawing attention

Beyond the impact to individual directors, implementation of a self-assessment process has significant implications for the entire board. For an aligned board, committed to director professionalism standards, the self-assessment process serves as a vehicle for board development. Collective data will be reported to the entire board as a matter of course, providing the basis for discussion about strategic issues such as director recruitment, assessing board balance and reviewing delegation of responsibilities and roles. Individual feedback sessions will also be conducted and used as a guide for each individual director’s development. In short, the board will be nourished by the process.

For a fractured and dysfunctional board, however, the self-assessment process has little chance of contributing to improvement of its practices or behavior. A well-designed process for a dysfunctional board has little value. It is more likely that the process will highlight and augment the board’s chronic problems. As with individual director dilemmas, trying to implement an assessment process in an unsupportive or toxic environment would be a counterweight to any efforts to improve governance processes. In these situations, focusing on board development as much as possible in advance of conducting assessments will result in the most promising course of action.

A small part of the puzzle

Up to this point board assessment has been discussed as an isolated event in order to highlight its specific challenges. In practice, of course, this isn’t the case. Assessment is a single component in a much larger system of interrelated governance components. But all systems share some common characteristics. Change in one component results in change in another. In addition, change is not immediately apparent and as a rule manifests at a much later time producing unintended consequences.

Some of the components that make up a governance system are the board’s attitude toward having its performance monitored; the relationship among its directors; the relationship between the board and the CEO; the board’s day-to-day operating principles; and the role the board plays (monitoring or advising) with management. Any of these elements can contribute to the way an assessment is designed, conducted, utilized and influences outside reaction.

System components outside the boardroom, such as the board’s reputation, its relationship with investors and its relationship with outside regulators can also influence the assessment process. If a board is enjoying a good reputation it may be reluctant to reveal anything about itself in an assessment that could compromise its reputation or that might prompt investors to question just how capable the board is in representing their interests to management.

Board assessment is a complex and risky process that needs to be approached with great sensitivity to each individual director’s reactions. Maintaining awareness of the rule’s influence on the larger system and its function within that system is the key to its success and effectiveness

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