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Corporate Governance & CEO's Performance

 How to Evaluate the Board of Directors
The Board of Directors Scorecard

By Med Jones

December 5, 2009

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One of the byproducts of the global financial crisis is that more attention is being directed toward the board of directors. There is a significant rise in investors dissatisfaction, class-action lawsuits and shareholder activism. Shareholders' complaints include issues such as excessive executive compensation, conflict of interest, lack of governance, and passive participation of the board members.

President Barack Obama's reform of financial regulations brings more focus to  prompt corrective actions by federal banking agencies including one or more of the following:

• Improving management

• Ordering a new election for the institution's board of directors; and/or

• Dismissing directors or senior executive officers.

While the target of the new regulations is on the financial sector, the influence of such regulation will also impact publically traded companies.

Wall Street financial analysts, news media and blogs are paying more attention to the executive compensation in relation to the performance of the company. There are several famous examples where some boards compensated their CEOs with hundreds of millions of dollars even though the company lost money during their leadership. The boards are accused, in these cases, as either lacking the competence or the will to govern CEO compensation.

During the tenure of Henry McKinnell, the CEO of Pfizer from 2001-2006, the company lost more than $137 billion in market value. Yet, when he stepped down, he took an additional $213 million as a retirement package that included an $82 million pension, stock and other benefits.

According to a Forbes article, "Michael Eisner: Mouse in a Gilded Mansion". During the five years between 1996 and 2001, Disney's net income went from $1.2 million to a loss of $158,000. Yet Eisner received $737 million in compensation.

In these tough economic times, investors are becoming more proactive; they cannot afford to leave the governance of their investments to unqualified directors or to special interest groups. Boards are given more power to govern and control the performance of the CEO and the corporation.

Investors are starting to ask the following questions:

• Are the interests of the board members aligned with the shareholders or the CEO's?

• Are the board members qualified to govern on behalf of the shareholders?

• How does the board evaluate the company's direction?

• Is the board of directors required to direct the company or just govern the CEO?

• Does the board have the right skill-set, decision-making processes, and tools?

The two questions that board members must ask themselves are:

• Do we have the right information and tools to manage and improve our own performance as a governing board?

• Do we have the power, knowledge and tools to conduct a comprehensive and fair CEO evaluation?

Few organizations have come up with formal solutions to help investors evaluate both their CEOs and their board of directors. A number of leading experts suggest board self-assessments. This solution involves the use of management evaluation frameworks that only need to be applied once or twice a year. These formal evaluation frameworks not only define and clarify the overall standards of performance for the board, they also serve as educational, collaborative and consensus-building tools.

The Executive Education Institute created a board of directors scorecard as an effective self-assessment tool. The scorecard covers the essential elements of the board's duties and qualifications and is therefore a good starting point for an evaluation. In addition, the BoD scorecard covers the board's structure, culture, performance standards, quality of meetings, and strategic planning processes. The following partial list provides a sample of the evaluation elements:

1. Is there a formal policy document that defines the standards and procedures for the qualification, duties, nomination and selection of the board of directors?

2. What is the qualification of the chairperson of the board?

   • His/her independence?

   • What is his/her educational and industry background?

   • His/her board leadership and networking skills?

3. What is the optimal size of the board?

   • The number of board members can range from 3-33 depending on the company's size. The average number is 9 members. How size and the geographic location help or limit board communications?

4. What is the composition of the board?

   • What knowledge and qualifications does each member bring to the board?

   • What value-added networks do they bring to the board?

5. How independent is the board?

   • The compensation and the audit committees must be made up of independent members. What percentage are insiders vs. outsiders?

   • What special interest groups do they represent? 

   • Is their compensation aligned with the company's performance?

   • Do the members have a conflict of interest? Are they declared, monitored and managed?

6. Are the board members fully aware of their legal and ethical duties?

7. Is most of the CEO's compensation performance-based?

8. Are the inside directors qualified to review and approve high-level budgets prepared by upper management? Are they qualified for monitoring business strategy and core corporate initiatives?

9. Are the outside directors qualified to review and approve the strategic direction and key corporate policies?

10. Does the board evaluate their own performance on a regular basis?

11. How often and how well does the board communicate with investors?

12. How often and how well does the board communicate with the CEO and the executive team? Is the communication style active or passive? Political or cooperative?

Every board must be able to provide clear answers to the preceding questions. If the board is not able to answer all the preceding questions, then the board members suffer from governance blind spots or a potential weakness. IIM created strategic board retreats and development programs to help the board and their CEOs in answering these questions. In addition to developing board-level governance competencies, the goal of the strategic retreat programs is to improve the board and CEO collaboration, ensure a 360-degree business view and develop proper governance action plans. The strategic retreat sessions are facilitated by executive leadership and governance experts. The role of the experts is to facilitate the planning sessions and provide an external point of view to objectively validate the answers to each question.

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