Back to Basics: Why the Board Evaluation is a Critical Building Block

This is Part 1 in our blog series on Board Evaluations. To access other posts, see below:

Part 1: Back to Basics: Why the Board Evaluation is a Critical Building Block
Part 2: What Are the Barriers to Effective Board Evaluations Today?
Part 3: Five Elements of a Successful Board Evaluation
Part 4: Recommended Evaluation Formats: Mapping a Three-Year Plan
Part 5: How and When to Choose a Facilitator for Your Board Evaluation
Part 6: Three Guidelines for Taking Action on Board Evaluation Results

You’ve just boarded a routine plane flight from New York to San Francisco. The airline staff and boarding process appear to be operating as usual, so you settle into your aisle seat with the expectation of an uneventful flight. Now, imagine if I told you that it’s been several years since the airline performed any kind of routine maintenance on your plane. Rather, they’ve performed an occasional once-over inspection, but then failed to take action on any warning signs or precursors to malfunction. It’s also been 10 years since your pilot has been trained on new aircraft equipment or had his vision tested. Have I altered your comfort level for this flight?

With a dramatic metaphor, it’s easy for board members to put themselves in the shoes of today’s institutional investors and proxy advisors. Shareholders don’t always get to peek behind the boardroom curtain, so they just want to know that the team of people piloting today’s companies is operating efficiently and equipped with the necessary skill sets.

Board evaluations offer all parties the opportunity to streamline the governance and refreshment practices that occur at the board level. The evaluation process allows boards to measure and adjust their composition and strategy, while investors are able to gain confidence in the board’s preparedness for the future. In BlackRock’s recently published Engagement Priorities for 2017-2018, the world’s largest institutional investor reaffirms its focus on board evaluations in the years ahead:

Board composition, effectiveness, and accountability remain a top priority… We will seek to better understand how boards assess their performance and the skills and expertise needed to take the company through its future multi-year strategy (rather than the last one).

BlackRock, Engagement Priorities for 2017-2018

With industry-wide agreement that evaluations are a critical board process, we’re left to ruminate on the recurring statistics. On the whole, why aren’t more boards benefiting from the evaluation process?

Board Evaluations: A Look at the Numbers

At first glance, research paints a picture of director confidence (via a recent study by Stanford’s Rock Center for Corporate Governance).

89% of board members say that their board has the skills and experience necessary to oversee the company.
78% of directors are satisfied or very satisfied with their board evaluation process.

However, when we consider the function or purpose of board evaluations, we’re left to question the assessment process of today’s boards—and why many boards are struggling to extend evaluation insights to action.

Only 57% of directors strongly agree or agree that their board is effective in bringing new talent to refresh the board’s capabilities before they become outdated (Rock Center study).
34% of corporate directors say that their board did not make any changes as a result of their last self-evaluation process (PwC’s 2016 Annual Corporate Directors Survey).
45% of corporate directors say someone on their board should be replaced (PwC’s 2018 Annual Corporate Directors Survey).
Only 23% of board members rate their boards very effective at giving direct feedback to fellow directors (Rock Center study)

“When we look at the effectiveness of today’s board evaluations,” said TK Kerstetter, “we find that today’s companies are scattered across the spectrum. At one end, you have boards that are so focused on the evaluation process that they automatically eliminate the lowest ranked director every year (that may be a little aggressive)… On the other end of the spectrum you have boards that don’t even conduct an annual evaluation or they do a check-the-box exercise that is not reviewed by anyone and doesn’t hold anyone accountable.” Good board leadership will support an evaluation process toward the middle of the bell curve, said Kerstetter.

Why We’re Focusing on Board Evaluations This Year

We believe that an effective board evaluation process is the key to solving many of the critical challenges facing today’s boardrooms—from the pace of technological innovations to the need for diverse skill sets to specific matters of director tenure or underperformance.

For this reason, we’re embarking on a six-part series, which is designed to do several things: First, we’ll strip away the pretense and examine the real challenges and inherent barriers to the evaluation process in today’s boardrooms. Next, we’ll do our best to streamline and summarize best practices across the industry, from selecting the proper evaluation format to taking action on board evaluation results. Here are the specific topics you can expect us to cover in the weeks ahead:

Don’t miss our episode on board evaluations, where Stanford University’s David Larcker shares the results of his recent study on board assessments: How do corporate directors rate their performance? How well are they actually doing?