The use of external advisers to help boards assess their effectiveness is a well-established practice among listed companies, and increasingly in other sectors as well. Indeed, the UK Corporate Governance Code first recommended that FTSE 350 companies carry out an externally facilitated review at least every three years in 2010. In annual reports published in 2019, 38% of FTSE 350 companies reported that they had done so the previous year. Extrapolated over three years, this suggests nearly full compliance with the code. By comparison, only just over a third of listed companies across Europe carry out an external review that frequently.
Objectives of board evaluations
What is the purpose of board reviews, as it is important to have a clear understanding of what the objective is in order to be able to assess how well it is being met. There appear to be two distinct views: the majority one that such reviews serve to inform a continual process of self-improvement, something that an external reviewer can assist by providing a different perspective, fresh insights and a degree of objectivity. The alternative view is that the purpose is to provide an assessment of whether the board is or is not effective, in either absolute or relative terms—in effect, an assurance function.
We agree with the majority view and share the concern expressed by many respondents to the consultation that treating evaluation as a sort of audit of the board’s effectiveness risks raising unrealistic expectations about the ability of the review (or reviewer) to predict or prevent future failings. It also implies that the responsibility for determining what actions the board should take rests with the reviewer not the board itself, but that responsibility cannot and should not be transferred.
We believe that the role of the external reviewer is to assist the board by identifying any issues that it should consider; the role of the board is to take appropriate action to address them; and the role of shareholders and other stakeholders is to hold the board to account for the effectiveness of those actions.
The ability of shareholders and stakeholders to carry out that role depends on the information that companies choose to share on the process and outcome of the review. At present this could best be described as variable, although there are signs that the code changes in 2018 may already be having a positive effect.
Transparency in external board reviews
The theme underlying many of our recommendations to government can, therefore, be summed up in the word “transparency”; transparency from both reviewers and companies about how reviews are carried out.
It is reasonable for shareholders and others to ask for evidence that boards are taking their responsibility to improve their own performance and that of their companies seriously, including through their choice of external reviewer. More transparency would also benefit companies and board reviewers if it helped to alleviate lingering suspicions in some quarters that the relationship between them is cosy or conflicted.
With that in mind, the Institute has published:
A voluntary code of practice for providers of external board performance reviews to FTSE 350 companies; Guidance for listed companies when reporting on their annual board performance review; and Voluntary good practice principles for listed companies.
The aim of the voluntary code of practice is to encourage more transparency about how external board reviewers conduct reviews and their qualifications for doing so. It covers four broad topics: competence and capacity; independence and integrity; client engagements and client disclosure. Reviewers are asked to commit publicly to the standards in the code by becoming signatories.
The code highlights some issues that external reviews might be expected to address, and some processes by which a reviewer might assess the board’s performance but does not mandate a methodology to be followed. We do not think it appropriate to be prescriptive, as the support that is needed by one board may be very different from that needed by another.
The new guidance is designed to assist listed companies with their reporting obligations under the UK Corporate Governance Code and deals with both internal and external reviews. We are very pleased that the FRC has endorsed the guidance (and said that it will incorporate it into the “Guidance on Board Effectiveness” when that is next updated).
The guidance is supplemented by a set of good practice principles, which companies are encouraged to apply when engaging an external board reviewer. We consider that the principles reflect existing good practice.
We look forward to hearing how the government chooses to carry this work forward.