Assessing board and individual director performance

Holding individual directors accountable for collective decisions is problematic.

Resignations of prominent company directors at AMP and other large organisations this year reinforce how stakeholders are ensuring boards are accountable for scandals. But a persistent governance conundrum remains: how to assess board and individual director performance.

Institutional investors have shown they will use their vote on the remuneration report to send a message to the board on issues beyond pay. Or vote against the re-election of directors, such as the Chair of the Audit and Risk Committee, if they are unhappy with aspects of board performance.

But as stakeholders single out directors, only the board can truly assess director performance and its evaluation is not disclosed. Also, board decisions, such as executive pay, are made in unison, yet investors might vote against the re-election of an individual director, such as the Chair of the Remuneration Committee, if they are unhappy with the alignment of pay and performance.

There is no easy solution. Reporting individual director performance to the market, as assessed through board evaluations, could create defamation or market-disclosure issues.

Also, expanded commentary on director skills in the Board Skills Matrix in annual reports could expose governance weakness to competitors and lead to questions about whether boards are fulfilling their duty if there are persistent, serious skill gaps.

Annual director elections is another idea to enhance director accountability. Yet forcing directors to seek re-election every year (instead of every three years) could empower shareholder activists and create company instability.

Federal Treasury, in its submission to the Financial Services Royal Commission in July, recommended annual elections of directors, term limits and restrictions on the number of board seats directors can hold. AICD has warned a move to annual director elections could encourage risk aversion or short-term thinking by boards.

"Annual re-election is considered to provide a regular and timely mechanism for boards and shareholders to consider individual director performance, thus improving the focus of directors on the need to be engaged in their role," Treasury wrote. “However, criticisms of annual re-elections include that it would incentivise directors to take a short-term approach, may reduce the experience and effectiveness of non-executive directors in challenging management, and may impose additional compliance costs.”

Directors of ASX-listed entities are required to be appointed for terms of up to three years, a rule that is broadly consistent with approaches in other markets. A few jurisdictions, including the United Kingdom, have mandatory annual re-election of directors. The UK introduced annual director re-election in 2010 for FTSE350 companies in response to the governance failures during the Global Financial Crisis, and has consulted on extending this principle to all UK companies with a premium listing on the London Stock Exchange.

Graham Bradley AM FAICD, non-executive chair of HSBC Bank Australia, EnergyAustralia and GrainCorp, is against annual director elections. “BHP Billiton and Rio Tinto moved to annual director elections many years ago because they are dual-listed in Australia and the UK, and it has not made any difference to their director re-elections,” he says. “The downside is that annual director elections enable activists to potentially destabilise the board at every Annual General Meeting. Also, annual director elections would create extra cost, time and risks for boards.”

Bradley says it is wrong for stakeholders to hold individual directors accountable when things go wrong. “The principle of collective accountability for boards is very important and we depart from it at our peril. It is impossible for investors to assess the performance and contribution of each director, yet they are increasingly holding individual directors to account.”

Boards, says Bradley, must be accountable for aberrant behaviour or reputation-damaging events in organisations they govern. “But it is wrong to single out the Chair for higher accountability than other directors, or to target individual directors for decisions that the board made in unison. Although it depends on the circumstance, the full board should be accountable rather than individual directors.”

He says shareholders should trust the board to implement a rigorous performance-review process for directors, (which typically alternates annually between internal and external facilitation of performance assessment). All ASX-listed companies are required to have and disclose a process for periodically evaluating the performance of the board, its committees and individual directors, and disclose whether a performance evaluation was undertaken in the reporting period.

“Wisely, the ASX Corporate Governance Principles and Recommendations do not require disclosure of the evaluation results,” says Bradley. “To do so would inhibit frank and open discussion with directors on their performance, and any market disclosure on this issue would inevitably be moderated by defamation concerns. It would be unhelpful for the board and for director collegiality for board evaluations to be disclosed.”

Bradley says board accountability can be enhanced by directors owning more shares in companies they govern. Some fund managers have called on boards to have greater “skin in the game” (through share ownership) and better align their rewards with those of shareholders. “I have encountered directors over the years who believe owning shares in their company somehow impunes their independence. I disagree, and have introduced policies in organisations I chair that require directors to accumulate at least one times their annual director fee in shares, bought on the market. It’s healthy for directors to own shares in organisations they govern.”

Director accountability can be further safeguarded through clear processes on other board appointments. Boards that Bradley chairs, for example, require directors to seek approval before accepting an additional position. “If I think a director has too many commitments, and another appointment could affect his or her performance, I say so. Proxy advisers look closely at directors’ board commitments when they are coming up for re-election.”

Bradley says these and other internal board processes for director accountability mostly work well. “It’s hard to be a passenger on any public-company board these days. If a director is underperforming, the issue will be quickly identified and if it cannot be resolved, the Chair will ask the director to retire from the board. There’s a lot of accountability in place.”

Engagement disclosure

Governance expert Ulysses Chioatto says the best form of board and individual director accountability is market engagement. That is, the Chair and other directors regularly meeting investors and stakeholders to hear their concerns and respond to them.

Dr Chioatto, an Adjunct Associate Professor in Law at Western Sydney University, says lack of reporting on stakeholder engagement impedes this accountability. “It’s impossible to know how much engagement a listed company has with stakeholders, or benchmark it with its competitors. A board that meets lots of investors each year is potentially more accountable than another that has limited or sporadic stakeholder engagement.”

Chioatto says there is an opportunity for listed companies to disclose their stakeholder engagement and main announcements in the Annual Report. The section would list the company and board’s major engagement activities in the financial year.

“If companies are serious about their ‘social licence to operate’ they should disclose the main stakeholders they met through the year, in bullet-point form in the Annual Report,” says Chioatto. “Investors can then make an informed decision on whether the organisation is addressing the needs of a range of stakeholders and giving them a chance to comment.”

He adds: “Companies and boards that have an extensive engagement program have a good story to tell. This reporting would also highlight companies that do little on engagement, and are potentially less accountable to stakeholders. This information could make a real difference.”

Chioatto, a former executive director of proxy adviser Institutional Shareholder Services (ISS) in Australia, says more directors should meet stakeholders. “It’s entirely appropriate that the Chair leads the board’s investor-relations effort and I understand the risk of having different directors talking to the market and potentially sending mixed messages. But this risk is manageable in the context of Australia’s continuous-disclsoure regime.”

The benefit, says Chioatto, is more directors understanding stakeholder concerns and investors having an opportunity to “eyeball” and assess directors beyond the Chair or head of the REM committee (who might contribute to investor relations on pay matters). “If you want directors to be more accountable, find ways for them to spend more time with stakeholders.”

Chioatto says boards should use technology to improve stakeholder engagement. “Don’t wait for the Annual General Meeting, which has an outdated format. Overseas companies are using new technologies, such as smartphone apps, to gauge stakeholder sentiment in real time. That’s real accountability when the board understands what stakeholders are thinking now about the organisation, listens to their concerns and responds where appropriate.”