Board evaluation is a formal periodic evaluation of the Board as a whole, its committees and individual Directors (including Chairperson). The raison d’être of this evaluation is the improvement of the performance of the Board, its committees and individual Directors. It seeks to identify areas of improvement, so that the Board can consciously work on them for improving its processes and practices, and delivering better outcomes.
While the concept of Board evaluation is not new, it was mandated in India for the first time in April, 2014, with the enactment of the Companies Act, 2013 (the Act). In India, it has to be an annual exercise.
As per the Act, the Nomination and Remuneration Committee (NRC) has to specify the process for effective evaluation, which is to be carried out either by the Board, by the NRC or by an independent external agency. NRC is also tasked with reviewing the implementation of this exercise. SEBI LODR Regulations, 2015 (LODR) require the NRC to formulate criteria for such an evaluation. The Annual report of each company is to contain a statement indicating the manner in which the evaluation exercise was carried out.
Schedule IV of the Act, which contains the “Code for Independent Directors (IDs)” sets out, in some detail, the process of Board evaluation. It mentions that IDs have to hold at least one meeting in every FY, without the attendance of non-IDs and members of management, to review the performance of non-IDs and Board as whole, and also to review the performance of the Chair of Board, taking into account the views of Executive Directors (EDs) and Non-Executive Directors (NEDs). Also, the evaluation of IDs is to be done by the entire Board, excluding the ID being evaluated. Schedule IV goes on to state that reappointment/extension/ continuing of term of an ID would depend on the evaluation.
A number of questions have been raised on the detailed mention of the process of evaluation in the Schedule. While law is expected to provide broad directions, the modalities of how to conduct the evaluation process should be left to the company. Further, the objective of any evaluation exercise should be improvement. The binary approach of determining whether an ID should stay or go, depending on the evaluation, rules out the healthy option of retaining an ID, and improving his/her performance. The lack of any reference to a feedback loop or action plan arising at the conclusion of the process, makes it a futile exercise for companies who only focus on tick-box compliance, without viewing this provision as value-adding. Separate meetings of IDs in most companies are now restricted to 1 mandatory meeting, with the agenda of those meetings restricted to only discussions around Board evaluation. The modalities of how an exclusive meeting of IDs would ascertain the views of EDs and NEDs, are matters that have been overlooked.
In 2017, there was a major amendment to Schedule IV. PSUs were exempted from the provisions relating to evaluation, if the concerned Ministries or Departments of the Central Government or the State Governments were carrying out the evaluation. There have been questions raised on this exemption, since IDs represent the interest of all stakeholders, and so their evaluation should not be treated differently from that of IDs on non-PSU Boards. Also, IDs in PSUs are appointed by the Government, and for the Government to carry on their evaluation, the result of which is not disclosed in the Annual report, does raise eyebrows.
In 2014, when Board evaluation was first introduced in India, most Boards and Directors were averse to it. The reasons behind this ranged from discomfort around criticism and peer evaluation, to the wording of the Act, which mentioned the ultimate objective of this exercise to be to decide whether a Director was to continue as a Director or be asked to leave. There was a general feeling that this evaluation exercise could be used by Boards to get rid of Directors. As a result, the first few years saw most Boards rely on online platforms that could host questionnaires, answers to which were to be given on a scale of 1 to 5. Most Directors responded to these questions with a score of 5 (5 being the best), and the entire purpose of seeking improvement, which ought to be the result of such an exercise, was lost. Companies that relied on physical questionnaires had an additional problem of who should do the safekeeping of the responses, and very often the Secretarial team was required to keep these documents, to the discomfort of Directors.
In 2017, SEBI issued a Guidance Note on Board Evaluation to guide listed entities on various aspects of Board evaluation. The stated intent was to help companies to improve the evaluation process, derive the best possible benefits and achieve the objective of the entire process. The note was divided into the following sections –
- Subject of evaluation i.e. who is to be evaluated.
- Process of evaluation, including laying down of objectives and criteria to be adopted for evaluation of different persons.
- Feedback to the persons being evaluated
- Action Plan based on the results of the evaluation process
- Disclosure to stakeholders on various aspects
- Frequency of Board Evaluation
- Review of the entire evaluation process periodically.
The note contains some prompts/questions that could be considered while preparing questionnaires for evaluation. It also mentioned that while an external evaluator was not mandatory, it was a good idea to have an external evaluation once in a while.
An evaluation exercise, if done properly, is without argument, an excellent tool to enhance Board effectiveness. Some of the important parameters to be decided by the Board/ NRC are –
- What will be the methodology – A questionnaire approach, an interview approach, or a combination thereof. While a questionnaire approach is simple as compared to the other approaches, it may result in a box ticking exercise as it would usually involve ranking on a scale of 1 to 5, with limited scope for qualitative aspects to be captured. An interactive approach may factor in qualitative aspects, but there could be reluctance on the part of a Director to share his/her views, especially if they are not comfortable with the person conducting the interview. A mix of both these approaches could ensure that the conversations remain focused, and constructive.
- Questionnaire approach – In case questionnaires have to be administered, the questions have to be finalised at an appropriate level within the company. Secretarial or HR department may not be ideal for this.
- Who will conduct the exercise – Internally, by an external agency or jointly by both of them. Internal persons may not have the experience of conducting such an exercise. Also, confidentiality of responses from Directors may be compromised. An external agency, with persons having Board experience handling such assignments, can factor in Board dynamics and cultural aspects, that a sensitive exercise like this need to respect. Companies may use the services of external agencies for either only administering the questions or for having interactions too. The major advantage of getting an external agency is that the exercise is likely to be independent, and the agency is likely to suggest ways of improving Board effectiveness.
- Choosing an external agency – If the Board decides to hire an external agency, due care should be taken to choose an agency which has Boardroom experience. Also, the same agency should not ideally conduct the exercise year after year.
- Sensitising the Board – It is very important to sensitise the Board that the objective of the Board evaluation exercise is improvement of Board processes and performance of the Board as a collective. Trust of the Board members, and honesty while responding are vital for this process to be successful.
- Feedback – An evaluation exercise is incomplete without a feedback. While responses are collated, the Chair of the Board must take the extra step and provide feedback to the Board as a collective on its strengths and areas of improvement. A similar process should also be followed for committees (to be done by Committee chairs), and individual Directors (to be done by the Chair of the Board or of the NRC). The feedback to the Chair of the Board can be given by the Chair of NRC or the Lead ID, if the Board has one.
- Action plan – On the basis of areas of improvement, the Board must develop its action plan for improvement in the future.
Over the years, more and more companies have started seeing value in Board evaluation. Companies have recognized that this exercise has several advantages. If done right, it provides valuable inputs on areas of improvement for the Board and its committees. A few companies have also started using the result of individual Director evaluation as a factor when determining individual profit linked commission. Also, what has added to the comfort of individual Directors is that the provisions relating to Board evaluation have rarely been used to remove a Director.
The exercise of Board Evaluation should be carried out in spirit, and not in letter alone. There is a need for more Boards to focus on strengthening the role of NRC in this process. Questions or pointers should not focus on factors such as composition alone, but should dive deeper into processes and participation. Feedback and action plan are also imperative to the success of this exercise. As in UK, the result of evaluation for each Director, and action plan should also be disclosed in the Annual Report, so that shareholders, who appointed the Directors know where each Director stands. This is an important step in the shareholders holding their representatives accountable.
FY 2020-21 is over. Most companies have completed the exercise of Board evaluation. Assuming that at least some of these have been honest exercises, what should the companies do next?