Board effectiveness

Has your business adopted appropriate policies and practices to ensure that its board is effective?

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The recurrence of major business scandals contributed to or caused by a failure of governance suggests that establishing and maintaining effective boards remains a challenging issue for businesses and organisations.

The collapse of Enron (2001) and Lehman Brothers (2008) are oft cited examples, as are the collapse of Northern Rock plc, the near collapse of HBOS, RBS, and the Co-op Bank and, more recently the VW’s vehicle emissions scandal which may cost VW in excess of US$50 billion to resolve. Governance failures can contribute to massive losses for shareholders and stakeholders, and give rise to fundamental questions on the license to operate and the validity of the business model. A weak or dysfunctional board poses a significant threat to the ongoing success of a business and no business is likely to succeed or thrive for any length of time without an effective board.

Sound corporate governance, the systems and processes by which a business is managed, controlled and led, is essential for a business to be successful. The hallmarks of good governance have expanded as the scope of the world's leading governance code has broadened. Codes such as the UK Corporate Governance Code (2016) are comprehensive and give a useful governance agenda for companies. The leading codes are revised periodically to ensure they remain fit for purpose and reflect developments in the real world.

The implementation of codes has to be driven by a combination of each company having the resolve to do so, because it makes good business sense, and shareholders performing a stewardship role to hold the company and its directors to account. This is entrenched in the approach of "comply or explain", which reflects that the codes are not a rigid set of rules but principles which should be applied unless the company explains to shareholders the rationale grounds for not doing so.

Given the long list of corporate and organisational failures, investors, analysts and stakeholders understandably seek assurance that boards have the internal processes required to enable them to ensure that the correct matters are reserved for the board and that the board is appropriately engaged to ensure that those matters are addressed at the right time, with the right information, by the right people. One element of this is ensuring that the composition of the board enables it to avoid "groupthink" and to bring informed insights and challenges to all issues before it.

Many factors contribute to a board being effective. The list is lengthy but includes:
● Clear division of responsibilities at the head of the company between the running of the board and executive responsibilities for running the company
● A chairman who leads the board and ensures its effectiveness
● Non-executive directors on the board constructively challenging and helping to develop strategy and thereafter assessing its execution
● The board and its committees having a diverse and appropriate balance of skills, experience, independence and knowledge
● A formal, rigorous and transparent procedure for appointment of new directors
● Directors having sufficient time to fulfil their duties
● Directors receiving an appropriate tailored induction and thereafter regular updates to refresh skills and knowledge
● Being supplied in a timely manner with information in a form and of a quality which enables them to carry out their duties
● Term limits for members and chair positions
● The directors submitting for re-election at regular intervals subject to satisfactory performance
● Formal and rigorous annual evaluation of performance
● Presenting a fair, balanced and understandable assessment of company's position and prospects
● Determining the nature and extent of risks it is willing to take and maintain a sound risk management and internal controls systems
● Remuneration that was designed to promote long term success of the company
● Satisfactory dialogue and opportunity for engagement with shareholders
● Clear succession plans in place for CEOs and chairs
● Regular reviews for whole board, committees and individual board members
● Formally defined role for board in the case of a crisis

Boards can be ineffective because of weak leadership by the Chairman/Chairperson ("Chair"). A high-performing board requires a chair to set the tone of governance at the board and across the organisation. This will include setting the board's agenda and ensuring appropriate time is allocated to strategic issues, allowing a culture of openness, meaningful debate, effective contribution from directors and constructive relationships between executives and non-executives. Importantly the chair must ensure that directors receive accurate, timely and clear information. In many of these activities the chair will be assisted by a competent company secretary.

It is also important that the board include an appropriate combination of executive and non-executive directors, with sufficient independent directors who are selected with due regard to the benefits of diversity in combating the chilling impact of group think. Diversity of backgrounds, expertise, gender and race can contribute to this. Directors must possess an ability to deal with difficult issues, to get to the heart of matters and to communicate with clarity and without rancour. Effective boards are likely to be directly engaged in what happens within the company, how staff are treated and motivated, and what the customer is experiencing at all company touch points. Asking the hard questions, challenging assumptions and orthodoxies, and even expressing strong and dissenting views are all appropriate and welcome elements of board member engagement. Frequently, key decisions on issues such as ethics, sustainability and long term risk are taken inside board committees, which in turn need appropriate remits and governance.

The Board

The 'board' is a body of appointed members (directors) who collectively oversee the activities of a company or organisation. The members are usually elected by the shareholders of the company at an annual meeting. The board has the ultimate decision-making authority within the business, apart from powers which are reserved for shareholders such as approval of dividends, annual reports and accounts, political donations and others. Board members usually include the most senior company executives ('executive directors') as well as non-executive directors who may be independent and amongst them will possess complementary skills and experience required by the company. Therefore, not all board members will be directly engaged in the day-to-day operations of the business but the entire board is held liable (under the doctrine of collective responsibility) for the consequences of the company's policies and actions.

An effective board

'Effective' means able to accomplish a purpose, to achieve or produce the intended or expected results through appropriate means consistent with the company's values. Thus an 'effective board' will ensure that governance structures, policies and culture consistently deliver both the short and long-term objectives of the business model.

Corporate governance

'Corporate governance', as defined by the 1992 Cadbury Committee "is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders' role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. The responsibilities of the board include setting the company's strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board's actions are subject to laws, regulations and the shareholders in general meeting."

Business culture

'Business culture' can be defined as an organisation's values, vision, working style, beliefs and habits. It is a key component in any organisation, impacting the strategic direction of a business and influencing decisions, management and all business functions. It is often characterised as 'the way we do things around here'.

Groupthink

'Groupthink' is a psychological phenomenon that occurs within a group of people in which the desire for harmony or conformity in the group results in an irrational or dysfunctional decision-making outcome.

UK Corporate Governance Code

The 'UK Corporate Governance Code' (formerly known as the Combined Code) sets out standards of good practice for listed companies on board composition and development, remuneration, shareholder relations, accountability and audit. The code is published by the Financial Reporting Council (FRC).

Section B of UK Corporate Governance Code

'Section B of the UK corporate Governance Code' deals with board effectiveness, covering: composition, appointments, commitment, development, information & support, evaluation, and re-election.

Small and Medium-sized Enterprise (SME)

Companies House defines SME’s as any business which has less than 250 employees and either A) an annual turnover of £25.9m or less; OR B) a balance sheet of £12.9m or less. SMEs are commonly Private Companies Limited by Shares, whose shares are held privately. It should be noted that the OECD and EU definitions preclude subsidiaries (or ‘linked enterprises’) from being categorised as SMEs regardless of employee numbers or turnover.

Multinational Corporations (MNC)

Large or multinationals are any companies which do not satisfy the SME requirements. MNCs are also frequently Private Companies Limited by Shares, or Public Limited Companies, whose shares are traded on stock exchanges, and which are usually subject to exchange listing rules and other governance and reporting regulations.

Section 172

Section 172 is part of the UK Companies Act 2006. It states:

172 Duty to promote the success of the company

(1)A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to—
(a) the likely consequences of any decision in the long term,
(b) the interests of the company's employees,
(c) the need to foster the company's business relationships with suppliers, customers and others,
(d) the impact of the company's operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct, and
(f) the need to act fairly as between members of the company.
(2)Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes.
(3)The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.

Answering YES

Small and medium-sized businesses (SMEs) MUST

Describe the policies and practices they pursue to identify and address the risks to board effectiveness

Reveal that at least two members of the board (excluding the Chair) are non-executive independent directors, or explain why this is not the case

Describe the review process for the board

State the aims and/or purpose of the business and describe how the board’s activities support their realisation

Small and medium-sized businesses (SMEs) MAY

State any beliefs or values which influence their approach to corporate governance and culture

Explain how a supportive, inclusive culture is promoted both within the Boardroom and across the company

Explain any further relevant information

Large and Multinational Corporations (MNCs) MUST

Describe the policies and practices they pursue to identify and address the risks to board effectiveness

Explain how and how often a board effectiveness review is carried out by an independent, external consultancy, and to what extent its findings are published or shared, or explain why this is not done

State purpose of the business and describe how the board’s activities support its realisation

Large and Multinational Corporations (MNCs) MAY

State the values, principles and ethics which influence their approach to corporate governance of the board and the company

Explain how a supportive, inclusive culture is promoted both within the Boardroom and across the company

Explain what policies and practices they have in place to facilitate members of their board being able to fully contribute and engage in open, constructive debate, on strategic, risk and other difficult issues

Describe how relevant responsibilities and duties are explained to board members i.e. describe the induction process

Identify the different roles within the board, the chairs and committees, and explain any policies and practices on separating powers

Explain how the company identifies the skills, experience, knowledge and other characteristics for board membership which it deems necessary and how this exercise is applied in relation to recruitment of board members and the chair

Describe how diversity is promoted and groupthink avoided

Explain how members of board committees are appraised to possess appropriate skills and knowledge

Explain what training and development is undertaken by board members

Explain the evaluation process as applied to the board collectively, directors individually and to committee members

Describe information sharing practices and whether board members are able to access independent information

Describe any term limits that may be in place for members and chair positions

Explain any further relevant information

Answering NO

All Businesses MUST

Explain why they do not or cannot answer YES to this question and list any mitigating circumstances or any other reasons that apply

All Businesses MAY

List any practices that are relevant, but not sufficient to answer YES, such as sourcing some goods and services locally, but not as a matter of policy

Mention any future intentions regarding this issue

Explain any further relevant information

Answering NOT APPLICABLE

All Businesses MUST

Confirm that they do not have a company board and explain why not

All Businesses MAY

Disclose according to the guidelines for answering YES, or as close as possible, or otherwise demonstrate equivalent

Mention any future intentions regarding this issue

Explain any further relevant information

DON'T KNOW is not a permissible answer to this question

Version 4

This question has multiple scorecards.

A) Small and medium-sized businesses (SMEs)

To receive a score of 'Excellent'

Establishing and maintaining an effective board is a core issue, demonstrated through the adoption of various best practices

Examples of policy and practice which may support the EXCELLENT statement:

  1. Actions of the board actively seek to support the purpose of business
  2. Board governance is guided by strong ethics, values and principles
  3. Actively builds and supports an ‘open board’ culture
  4. Actively builds and supports mutual respect between directors
  5. Regularly reviews past decisions, particularly those with poor outcomes
  6. Clearly outlines the board-level decision making process and allocation of authority
  7. Explains how an appropriate and healthy balance of executive and non-executive directors on the board is struck
  8. Complies with Section B of UK Corporate Governance Code where applicable and relevant
  9. Promotes importance of diversity of thought across the board, and actively incorporates this factor into recruitment processes
  10. Undertakes regular reviews of board, committee and board members
  11. Open, timely and effective sharing of information with the board and other key positions
  12. Formal succession arrangements in place for the chair and senior management positions.
  13. Employees’ views taken into account by the board, either by representatives, or by other mechanisms
  14. Boards are clear in their goals and have the diversity of skills present in order to achieve them
  15. Composition of board is diverse, including diversity of thought, background, profession, age, education level etc, and is integral to the recruitment process
  16. Board engages in long term planning for the success of the business
To receive a score of 'Good'

Commitment to the effectiveness of the board is clear and many best practices are successfully pursued

Examples of policy and practice which may support the GOOD statement:

  1. Undertakes appropriate succession planning
  2. Complies with Section B of UK Corporate Governance Code where applicable and relevant
  3. Ensures Directors have sufficient time to undertake their duties
  4. Actively considers the size, style and skills of the board
  5. Diversity is evident on the board and prominent in recruitment policies
  6. Appointments for new board members are openly advertised
  7. Clear procedures for holding board accountable
  8. Processes in place to review past decisions
  9. Clear communication with stakeholders and shareholders
  10. Has appropriate measures in place to address risk
  11. Policies are in place to ensure progressive refreshment of board members, for instance mandatory retirement ages and term limits
  12. Clear definition of different roles for each board member
  13. Employees’ views are taken into account by the board
To receive a score of 'Okay'

The importance of board effectiveness is recognised, as demonstrated through the adoption of some appropriate policies and practices, albeit adopted in an-hoc fashion; OR board effectiveness is irrelevant to business

Examples of policy and practice which may support the OKAY statement:

  1. Describes one or more practices which promote effectiveness of board
  2. Recognises the validity and desirability of the UK Corporate Governance Code
  3. Explains factors which may constrain efforts to improve board effectiveness
  4. Provides satisfactory explanation that board effectiveness is not relevant or applicable to the business
  5. Some efforts towards board diversity
  6. Some accountability mechanisms exist, but they are not always fully utilised
  7. Some definition of different roles, but this is not always clear
  8. Attempts to take employees views into account are ad-hoc
To receive a score of 'Poor'

No compliance with practices associated with board effectiveness and minimal recognition of board effectiveness as a salient issue, OR business acknowledges its performance is below expectations

Examples of policy and practice which may support the POOR statement:

  1. No statement of future intent in regards improving practices
  2. The firm has adopted some policies or practices that seek to implement an effective board, but these are poor or ineffectual
  3. The business fails to monitor or measure board effectiveness
  4. There is little or no transparency on board effectiveness
  5. Business fails to meet minimum standards or regulations
  6. Little diversity on the board

B) Large and Multinational Corporations (MNCs)

To receive a score of 'Excellent'

A clear commitment to maximising the effectiveness of the board is evident, demonstrated through various examples of innovative practices designed to pursue and improve on transparency, communication and effective decision-making. Recognition that striving for board effectiveness is an ongoing pursuit with NEDs and all other relevant stakeholders fully involved.

Examples of policy and practice which may support the EXCELLENT statement:

  1. Actively builds and supports an ‘open board’ culture
  2. Actively builds and supports mutual respect between Executive Directors and NEDs
  3. Demonstrates that the board listens to and engages with stakeholders
  4. Has a ‘code of practice’ to ensure a minimum standard of external board review is met and potential conflicts of interest are addressed
  5. Meets an appropriate level of transparency in review methodology, recognising that sensitivity around some issues may prevent full public disclosure.
  6. Full cooperation apparent between the company and independent evaluator/reviewer to ensure integrity of review process
  7. Regularly reviews past decisions, particularly those with poor outcomes
  8. Clearly outlines the board-level decision making process and allocation of authority
  9. Ensures at least 50% of the board (not including the Chair) are NEDs
  10. Ensures risk is seen as a key aspect of the decision making process, not just as a standalone compliance issue
  11. Complies fully with the UK Corporate Governance Code
  12. Facilitates the attendance of external board reviewers at board/committee meetings
  13. Facilitates meetings between the executive committee and external board reviewers
  14. Actively measures progress of action plan following external board reviews
  15. Actively recognises/commentates on board effectiveness (e.g. through the Chairman’s statement in the annual report)
  16. Promotes importance of diversity of thought across the board, and actively incorporates this factor into recruitment processes
  17. Undertakes regular reviews of board, committee and board members
  18. Open, timely and effective sharing of information with the board
  19. Formal succession arrangements in place for CEO and chair
  20. Tailored training for board members is provided on an ongoing basis
  21. Employee representation or active consultation with employee representatives
  22. Stakeholders are able to access and engage with board
  23. Boards are clear in their goals and have the diversity of skills present in order to achieve them
  24. Composition of board is diverse, including diversity of thought, background, profession, age, education level etc, and is integral to the recruitment process
  25. Board engages in long term planning for the success of the business
To receive a score of 'Good'

Committed to ensuring effectiveness of the board, as demonstrated through examples of good policies and practices, which are implemented in a considered, strategic manner

Examples of policy and practice which may support the GOOD statement:

  1. Appropriately uses information made available to the board
  2. Board actively seeks out information to aid effective decision making
  3. Mixture of skills and experience from board members
  4. Undertakes regular evaluations with clear objectives, using feedback from various sources
  5. Implements recommendations based on review or can justify not implementing any/all recommendations
  6. Complies with most Section B provisions in the UK Corporate Governance Code
  7. Undertakes appropriate succession planning
  8. Diversity is evident on the board and prominent in recruitment policies
  9. Workers are represented on the board, or are able to engage with board
  10. Appointments for new board members are openly advertised
  11. Clear procedures for holding board accountable
  12. Processes in place to review past decisions
  13. Clear communication with stakeholders and shareholders
  14. Has appropriate measures in place to address risk
  15. Policies are in place to ensure progressive refreshment of board members, for instance mandatory retirement ages and term limits
  16. clear definition of different roles for each board member
  17. induction is provided for all new board members, with regular updates
To receive a score of 'Okay'

Policies and practices to establish effectiveness of the board pursued on an ad hoc basis; company meets and occasionally surpasses legal minimum requirements; OR board effectiveness is not relevant to the business

Examples of policy and practice which may support the OKAY statement:

  1. Complies with some Section B provisions in the UK Corporate Governance Code
  2. Strategic report contains material which is not obviously relevant or material to shareholders and other stakeholders
  3. Facilitates external board reviews though without a clear strategy for recommendation implementation
  4. Does not have a detailed vision of how risk or profound changes to circumstances are approached
  5. Ensures Directors have sufficient time to undertake their duties
  6. Statements of future intent in regards improving practices
  7. Provides satisfactory explanation that board effectiveness is not relevant or applicable to the business
  8. Evaluations are sporadic, or merely a tick-box exercise
To receive a score of 'Poor'

Little to no compliance with best practices, no apparent commitment to board effectiveness OR company admits its performance falls below expectations

Examples of policy and practice which may support the POOR statement:

  1. No statement of future intent in regards improving practices
  2. The firm has adopted some policies or practices that seek to implement an effective board, but these are poor or ineffectual
  3. The business fails to monitor or measure board effectiveness
  4. There is little or no transparency on board effectiveness
  5. Business fails to meet minimum standards or regulations
  6. The company actively undermines its critics, lobbies the government or is engaged in PR activity to prevent improvement in practice, legislation, monitoring or accountability
  7. Board ineffectiveness has been shown to have led to harm to the company
  8. Significant issues have not been resolved due to board level negligence