How should board directors evaluate themselves? Board self-evaluations are now a requirement at many companies. But what's the most effective way for directors to assess their own performance?

Publication: MIT Sloan Management Review

Publication Date: 22-SEP-05

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COPYRIGHT 2005 Sloan Management Review

Board directors are facing increasing scrutiny. In the wake of the New York Stock Exchange's own scandal with its former CEO Richard Grasso, (1) the NYSE now requires the boards of all the companies it lists to conduct periodic self-evaluations. Furthermore, both Morningstar and Standard & Poor's (2) consider board self-evaluation as one criterion in their governance ratings of corporations. The practice has even become increasingly mandated in the nonprofit world. The National Association of Independent Schools, for example, currently requires the boards of private schools to conduct self-evaluations. And board directors in the United States aren't the only ones feeling the pressure. In Finland, for instance, the boards of all public companies must routinely assess their own performance. (3) Still, the practice is far from universal. NASDAQ, for one, does not currently require board self-evaluation of its members. Nevertheless, NASDAQ companies that do undertake board self-evaluation have the opportunity to get ahead of the curve and position themselves in the vanguard of good governance.

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But what exactly is the best way for a board to evaluate itself? Unfortunately, board directors have generally had little guidance in this area. To investigate the different self-evaluation practices used, we studied eight boards that have engaged in self-evaluations for at least two annual cycles. We found that the companies were using a variety of practices for collecting data and for preserving the confidentiality of this information. The differences among these practices can be summarized by four distinct approaches to self-evaluation: informal, legalistic, trusting and systematic. Each of the approaches has important implications for a company's board rating, directors and officers (D & O) insurance and various legal issues.

Why Self-Evaluations?

In a 2004 survey conducted by Korn/Ferry International, 72% of board directors indicated that their performance ought to be evaluated. Yet only 21% of the boards of public companies actually conduct such assessments. Part of the problem is that organizations often don't know how best to implement a board self-evaluation procedure. Many simply avoid the practice because they fear alienating individual directors. Others have implemented the process only to become frustrated because it took so much time and produced so few results.

According to James Doty, a partner at Baker Botts in charge of the international law firm's board self-evaluation program, companies need to address two core governance dilemmas when implementing any self-evaluation procedure. Specifically, Doty contends that a board needs to (1) encourage bold decision making by the CEO without becoming a passive entity that permits imprudent risks; and (2) maintain an environment of collegiality while avoiding the danger of creating harmonious but dysfunctional "group think." Achieving both objectives is easier said than done, but a self-evaluation process that is properly designed can be a substantial aid.

Any self-evaluation practice should be designed and structured so the board can investigate the following: How are we as a board contributing to the overall effectiveness of the organization? At many companies, a self-evaluation might be the only time during the year when the board asks itself such a fundamental question. During such a meeting, the directors should focus mainly on reviewing management's contribution to shareholder value.

When conducted properly, self-evaluations can be a powerful tool for improving the board's performance. A 2003 study by Mercer Delta Consulting found that self-evaluation was significantly related to board effectiveness with respect to specific functions, such as the ability to balance the interests of different stakeholders. The following cases illustrate just a few of the myriad ways in which self-evaluations can bring to...

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