Better Guidance For Neds - Ensuring The Board Is Skilled Appropriately

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Better guidance for NEDs — ensuring the board is skilled appropriately By James Beck, Managing Director, Effective Governance

A study of more than 100 board reviews undertaken globally over a five-year period by Egon Zehnder International,1 revealed that most boards face five key challenges.2 1. Inadequate competencies — Although the vast majority of board members are capable, other members are not fully qualified to play their most critical roles. 2. Lack of diversity — Comfortable collegial environments may discourage robust, constructive debate and stifle independent thinking. 3. Underutilisation of skills — Even competent directors feel their skills are underutilised due, for example, to lack of briefing on critical issues and under-involvement in key decisions. 4. Dereliction of duties — As an example of not fulfilling their duties, less than half the directors reviewed in the study believe their company has the right balance between shortand long-term goals or that their boards have sufficient debate on strategy. 5. Poor selection and assessment processes — Board members are typically very critical about their selection and the way their performance has been reviewed (or not reviewed) in the past. As the study reveals, many boards either lack competent members or underutilise the skills of directors, a factor that has come into sharper focus with the global financial crisis.

CAMAC review To address the issue of board competency, the Australian Government has requested its corporate law advisory body, the Corporations and Markets Advisory Committee (CAMAC), to examine the guidance required for executive directors and nonexecutive directors (NEDs) to fully understand the responsibilities of their roles and in particular ‘what support can be provided to increase the engagement of NEDs with their position on the board and bring an independent and broad view to board decision making’.3 The results of CAMAC’s review are to be released in April 2010 and will likely see changes to the ASX Corporate

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Governance Council guidelines and similar guidelines from other corporate regulators. As the terms of reference for the CAMAC review highlight, Australian NEDs do not have access to the same basic guidance about their roles and responsibilities as that available to UK directors through the Financial Reporting Council’s Combined Code of Corporate Governance.4 Schedule B of the Combined Code is not extensive, but it does outline the care, skill and diligence a NED should exercise. Such guidance is a starting point, but boards are negligent if they do not inform directors what is expected of them during the director nominations process and, at the latest, the orientation program.

Expectations and competencies Boards that make the expectations on directors clear from the outset may even find that prospective board members will reconsider their nominations if they know they do not have the requisite skills and knowledge. These expectations include the director’s ability to commit time to the role — a sometimes overlooked aspect of board membership. Another expectation may be that a director will use their networks to benefit the organisation, as is often the case in not-for-profits. However, if such an expectation is not communicated, those networks may well prove worthless. What competencies should directors possess to be effective? There is no simple answer. It depends on a number of factors such as the organisation’s industry (for example, credit unions, not-for-profit organisations, mining industry), current and anticipated challenges, the regulatory environment, the organisation’s business or operational model, required roles of the board, and the abilities of the senior management team.5 High performance boards will periodically consider the balance of knowledge, skills and experience around the boardroom table to determine whether any change in membership is necessary. This will involve consideration of: • the present composition of the board, its strengths and weaknesses including weak or uncooperative performers

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the qualities and skills that the company needs on its board such as – experience of industries and professional disciplines – knowledge and experience of corporate governance and – personal qualities the changing needs of the company and the expected pattern of retirements on the board.

Competencies not a guarantee of success Board members, or indeed any employee, cannot perform to expected standards without competencies, but specific competencies such as legal or engineering qualifications, for example, cannot guarantee that they will perform adequately as directors. Sometimes competent individuals may fail on a board due to personal and environmental factors out of their control. Based on our experience in reviewing many boards, an analysis of director competencies should consider three areas. 1. Behavioural factors include both personal and interpersonal competencies, which provide the platform for most work and governance roles. Examples are common sense and sound judgment, enthusiasm and resilience, analytical decision-making ability and effective communication skills. 2. Governance issues encompass financial literacy, strategic awareness, risk management orientation. 3. Technical skills are also important, including legal, accounting and engineering abilities. Clearly, directors will not be strong in all areas. Specific technical skills, such as accounting or legal qualifications, are generally not a requirement for a majority of board members. Thus, current directors, as well as board candidates, should have well-developed behavioural competencies, be able to master the governance competencies and add functional expertise in the form of their technical competencies to a board or management team. In some organisations, the technical expertise a board member brings may not be regularly available to the management team and can be invaluable. Such specialist knowledge may offset any lack of governance knowledge on the director’s part; that is up to the individual board.

Board renewal via succession planning or external advisers It is important that a board has a good understanding of what skills it has and the skills required. It should take a strategic perspective to adapt to the organisation’s current and future environment, particularly in light of issues such as climate change, which may entail changes to board

composition and a focus on succession planning at board level. Board skills analysis can also be effective where replacing current directors is not an option. Where a board finds it is lacking in essential competencies — while not ideal — the slack may be taken up by a highly competent management team or by external advisers and consultants. If the board knows its deficiencies and addresses them in some form, that will go a long way towards individual board members demonstrating the care, skill and diligence expected of a director. Accountability for board performance will continue to intensify and goes beyond the guidance to directors that may be provided by our regulators because of the CAMAC review. This is due to ongoing shareholder activism, media attention and community outrage over the type of corporate behaviour witnessed in cases such as James Hardie. Whether a regulatory requirement or not, a board wishing to move to a higher level of performance should consider analysing the capabilities of those who govern the organisation to ensure their skills are sufficient to carry out its current and emerging roles. As US governance experts Jay Conger and Edward Lawler state ‘in staffing most boards, it is best to think of individuals contributing different pieces to the total picture that it takes to create an effective board’.6 An effective board is well-balanced. It is one way to reduce the risk to an organisation and to individual directors from poor decisions made because of inadequate knowledge of governance, strategy, compliance, risk management or the financial aspects vital to the viability of the organisation.

Notes 1

The study included surveys of over 1,000 directors. The organisations involved covered a wide range of businesses, from large to small, listed public companies as well as government and family-owned, and based in every major industry sector

2

Thomas C, Kidd D and Fernández-Aráoz C, 2007, ‘Are you underutilizing your board?’, MIT Sloan Management Review, Vol 48 No 2, pp 71–76

3

Terms of reference on guidance for directors, August 2009, available at www.camac.gov.au [24 September 2009]

4

Financial Reporting Council, 2008, The Combined Code on

5

All boards will also generally require certain broad

Corporate Governance, London: Financial Reporting Council knowledge such as an in-depth knowledge of the company and an understanding of the industry in which it operates. This knowledge can be developed during the induction process and early in the director’s tenure 6

Conger J A and Lawler III E E, 2001, ‘Building a highperforming board: How to choose the right members’ Business Strategy Review, Vol 12 No 3, pp 11–19 G

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