This article is based on the Institute’s Report on Improving Corporate Governance in Hong Kong, prepared by Syren Johnstone and Say H Goo, and follows on from the last article on the importance of independent non-executive directors. It focuses on how board evaluations can improve board effectiveness
The corporate board plays a vital role in leading an organization. Among other actions, the board ensures the organization is protecting its shareholders’ assets, sets management business targets and missions and monitors their progress. In order to ensure that the board is effectively undertaking these roles, many organizations undertake board evaluations – recognizing it as an essential component of good governance. In many jurisdictions, regular board evaluations are a listings requirement, often on a comply-or-explain basis, although it is generally not required to make the evaluation results public.
An article from CSj, the monthly journal of The Hong Kong Institute of Chartered Secretaries, entitled Board evaluation: is Hong Kong missing out? describes the purpose of a board evaluation as to enable “the board and management to identify potential areas for improvement in the way the board operates.” Through evaluating its performance and culture, a board can determine whether it is fit for purpose, and is sufficiently diverse.
The EY Center for Board Matters listed eight strategic benefits of evaluations:
- Providing clarity on the roles of directors and the board
- Strengthening understanding of the operations of the organization
- Identifying gaps in knowledge and expertise related to the risks and opportunities for the organization
- Developing deeper understanding of sector dynamics
- Testing the board’s understanding of key shareholders’ views on the organization’s strategy and governance
- Identifying process management improvements
- Fostering alignment and agreement on purpose and strategy
- Protecting against weak team dynamics
There are two types of board evaluation:
- Internal board evaluation: typically led by the board chair or a committee chair (e.g. the governance committee). This allows for the evaluator’s knowledge of the board and its activities to be utilized – however self-evaluation may be less critical than that of external evaluators and the evaluator may lack assessment expertise.
- External board evaluation: involving third-party evaluators who bring objectivity to the process. They can also provide more structure and rigour and benchmark against other boards, which the third-party has previously evaluated. External evaluations are increasing in global markets.
Board evaluations in Hong Kong
Hong Kong currently has recommended board evaluations as a best practice for listed companies. The guidance does not however include any detail as to what the evaluation should consider; makes no disclosure requirement; and has no element for external assistance in evaluating the board.
Although the Stock Exchange of Hong Kong has undertaken two consultations on formal requirements for board evaluations, there has been no follow up. Reasons for the lack of progress include concerns regarding confidentiality of board activities, financial and time costs, and the ownership of companies – with many Hong Kong-listed companies being state-owned or family-controlled.
As such, formal board evaluations are not standard practice in Hong Kong. According to a report produced by the global executive search and leadership consulting firm, Spencer Stuart, the Hong Kong Board Index 2015, just 21 percent of Hang Seng Composite LargeCap Index companies undertook formal board evaluations. Notable examples include the MTR Corporation, which undertook an evaluation in 2014 when faced with “intense public concern and criticism,” as it was described in the Independent Board Committee on the Express Rail Link Project.
Board evaluations overseas
In the United Kingdom, formal board evaluations were recommended by the 2009 Walker Review. The Corporate Governance Code requires that board evaluations should be undertaken annually – with the findings disclosed. The evaluation must be led by non- executive directors and include evaluating the board’s performance against other requirements under the code including (i) the skills, experience, independence and company knowledge of the board; (ii) how the board works together as a unit; and (iii) other factors relevant to the board’s effectiveness.
In the United States, although board evaluations are not required by the corporate governance code, the system of corporate governance is board-centric with State and Federal laws protecting the interests of shareholders. In fact, the Spencer Stuart report notes that “98 percent of S&P 500 boards conduct some type of evaluation and 33 percent conduct an evaluation on the full board, committees and directors.”
In Singapore, the corporate governance code requires a formal annual assessment of the effectiveness of the board, but board evaluations are often compromised in government-linked and family-owned companies – where the independence of board members charged with undertaking evaluations, namely members of nominating committee, is open to question.
Recommendations for Hong Kong
The Report on Improving Corporate Governance in Hong Kong recommends that board evaluation requirements should be more stringent, and strengthened from being a recommended best practice to a comply- or-explain provision within the Corporate Governance Code. Annual evaluations should be undertaken, based on publicly agreed terms of reference and involving independent non-executive directors or third-party evaluators. It also proposes the introduction of a new recommended best practice, modelled on the U.K. approach, concerning how the evaluation exercise should be undertaken.
Effective board operations are vital to the long-term success of an organization – shouldn’t shareholders be assured that boards are regularly evaluating their performance and taking follow-up action where necessary?