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10.7 Board Self-Evaluation

In the aftermath of Sarbanes-Oxley, the stock exchanges mandated that boards of public companies and key committees, such as the audit committee, evaluate their own performance annually. Since there is no mandated or standard approach for such an evaluation, boards should select a process that best fits their needs. At a minimum, the director performance evaluation process should ensure that each director meets the board’s qualifications for membership when the director is nominated or renominated to the board. Evaluation of the board and committees should also determine whether each has fulfilled its basic, required functions.For additional thoughts on this subject, see Anderson (2006).

In designing a suitable process, questions, such as, Why are we doing this? What areas do we need to focus on? How can we receive valid feedback? How can we act on that feedback to make a difference? Where can we find the required expertise, internally and externally? Who do we want to handle, analyze, and provide feedback to the board? To the chairman or lead director? To the CEO? To committees? To individual directors? must first be answered.

Many boards are not sufficiently aware of the type of expertise that is available to assist them in board evaluation and development. As a result, they may overestimate their own capabilities in this area and underestimate the value of external resources. One place for boards to turn is their internal or external counsel. A number of law firms are broadening their scope of service to include board evaluation. This makes sense in a litigious environment where the fear of shareholder lawsuits has arisen and where directors may be worried that the information revealed in a board evaluation process may make them more vulnerable. Retaining legal counsel to perform the evaluation may reduce this fear by having counsel assert privilege over such matters. However, even without legal privilege being asserted by counsel over the evaluation process and its documents, courts are likely to have a more favorable view of a board that chooses to take a tough look at how it can do better, documents the process intelligently, and acts on what it finds rather than one that does not evaluate itself at all.

Others may bring more important skills to the table. For example, professionals in industrial and organizational psychology often have relevant training. Depending upon a board’s likelihood of being involved in litigation, it may be advisable to ask external counsel to work collaboratively with external experts specializing in board and director performance effectiveness.

While there is no single, best approach to board evaluation, best practice suggests that an effective board and director evaluation process is (a) controlled by the board itself—not by management or outside consultants; (b) confidential and collegial—it should foster an atmosphere of candor and trust; (c) led by a champion—alternatives include the non-CEO chairman, the lead independent director or equivalent, or the chair of the nominating and governance committee; and (d) focused on identifying areas of improvement—in areas such as creating a balance of power between the board and management, focusing the board more on long-term strategy, more effectively fulfilling the board’s oversight responsibilities, the adequacy of committee structures, and updating the evaluation process itself.

A good process also evaluates individual director performance—through self-assessment and peer review. This should include consideration of independence, level of contribution, and attendance; take specific board roles into account; and provide a basis for determining the suitability of a director’s reelection.