In governance circles today, the conversations about board performance and evaluations continue to advance.
Governance advocates, proxy advisors and institutional investors encourage varying approaches to evaluating directors, assessing board effectiveness, and raising the bar on expectations for director contributions and performance.
Many community bank directors, however, are reticent to go down the board assessment path, fearing that the process will somehow result in their removal from the bank’s board. The goal of any evaluation, however, should not necessarily be to weed out directors, but rather to highlight areas for board and director improvement, and encourage continual forward movement on good governance.
In our view, there are three general types, or levels, of board evaluation to consider:
Level 1: A general assessment of the board overall and how the group is functioning. This evaluation might include areas such as:
Do we have the right committee structure, leadership and meeting frequency?
Are we as a board focusing our time on the correct and critical topics?
Do we have an appropriate and valuable range of skills and experiences around the board table to govern effectively in today’s industry climate?
Level 2: This typically involves an element of “self-assessment,” focused on what individual directors believe they contribute. This analysis highlights contributions of a technical, industry, business, community or other relative area. Self-assessments also aggregate the collective skills sitting in the boardroom, and help to inform the board about where there are critical gaps in the needed skills.
Level 3: This is where some trepidation arises—the individual evaluation. This assessment involves each director providing confidential feedback on their fellow directors, and should always be facilitated by a third party. Using an outside resource to review and compile the data provides a level of professional insulation between directors, and ensures anonymity of the assessments.
Peer evaluations can serve an important function by informing directors as to how their peers view their contribution. When viewed in conjunction with self-assessment output, it can provide a comprehensive, objective look at how each director views their contribution relative to how their contribution is viewed by their colleagues.
Many board members fear an assessment will expose shortcomings as a director. However, the goal of evaluations is to highlight areas for improvement and strengthen governance—not necessarily cull the herd. There are plenty of examples of directors whose contribution had slipped a bit due to personal or business distractions without realizing this shift occurred. In these instances, peer feedback was instrumental in helping that director return to highly engaged participation.
It’s also common to see individual feedback highlight areas where directors needed updated training or a refresher course in bank operations or oversight, often resulting in additional training for all directors.
One of the hallmarks of the most effective boards is a desire for continuous improvement, and striving to become a “strategic asset board.”
To be sure, board members whose contributions have declined considerably and remained below expectations for an extended period might need a “tough love” conversation. A board seat is a precious thing, and every director must bring current and valuable skills and experiences to the board table.
Directors whose lengthy tenure or legacy contributions are simply not up to current needs and governance standards—and who lack the fortitude for improvement—should ask themselves whether the bank would be better served by a different individual in that seat. It takes real maturity, self-awareness and a view for the “greater good” for a director to make such a determination.
Boards have long held to age limits more than term limits as a vehicle to repopulate their boardroom. Yet as directors age, many institutions are raising or waiving the age requirements to retain experienced directors. Good reasons exist to keep veteran directors, but a board seat should be earned through performance. Seats should not be “institutionalized“ to an individual or family if those representing select interests are not qualified to contribute in a meaningful way and put the institution’s interests above their own.
The highest performing boards make it a policy to conduct some form of evaluation on a regular if not annual basis. Whether though a general, self or peer assessment process, more informed boards make better decisions around board composition and continued director service.
Boards with the strongest, most capable and engaged directors will have the greatest ability to survive and thrive in a consolidating industry. Boards that utilize some form of assessment are more likely to be among the survivors going forward.
There has never been a more challenging time to be a bank director. The combination of today’s hugely competitive banking market, increased regulatory burden and rapid technological developments have raised the bar for director oversight and performance. In response, an increasing number of community banks have begun to assess the performance of directors on an annual basis.
Evaluation of board performance is done in many ways, and ranges from an assessment by the board of its performance as a whole to peer-to-peer evaluation of individual directors. Public company boards are increasingly being encouraged by institutional investors and proxy advisory firms to conduct meaningful assessments of individual director performance. The pace of turnover and change on most bank boards is slow, and more often the result of mandatory retirement age limits than focus by the board on individual director performance. This may be untenable, however, as the pace of external change affecting financial institutions often greatly exceeds the pace of changes on the bank’s board.
While some institutions prefer a more ad hoc approach to assessing the strengths and weaknesses of the board and its directors, we suggest that a more formal approach, perhaps in advance of your board’s annual strategic planning sessions, can be a powerful tool. These assessments can improve communication between management and the board, identify new skills that may not be possessed by the current directors, and encourage engagement by all directors. If used correctly, these assessments often provide valuable information that can focus the board’s strategic plan and help shape future conversations on board and management succession.
So what are the key considerations in designing an effective board evaluation process? Let’s look at some points of emphasis:
Think big picture. Ask the board as a whole to consider the skill sets needed for the board to be effective in today’s environment. For example, does the board have a director with a solid understanding of technology and its impact on the financial services industry? Are there any board members with compliance experience in a regulated industry? Does the board have depth in any areas such as financial literacy, in order to provide successors to committee chairs when needed? Do you have any directors who graduated from high school after 1985?
Develop a matrix. Determine the gaps in your board’s needs by first writing down all of the skill sets required for an effective board, and then chart which of those needs are filled by current directors. Then discuss which of the missing attributes are most important to fill first. In particular, consider whether demographic changes in your market will make recruiting a diverse and/or female candidate a priority.
Determine the best approach to assessment. Engaging in an exercise of skills assessment will often focus a board on which gaps must be filled. It can also focus a board on the need to assess individual board member performance. Many boards are not prepared to launch into a full peer evaluation process, and a self-assessment approach can be a good initial step. Prepare a self-assessment form that touches upon the aspects of being an effective director, such as engagement, preparedness, level of contribution and knowledge of the bank’s business and industry. Then, have each director complete the self-assessment, with a follow-up meeting scheduled with the chair of the governance committee and lead independent director for a conversation about board performance. These conversations are often the most impactful part of the assessment process.
In addition to assessing the human capital needs of the board, several other topics should be raised in most board assessments.
Communication between management and the board: As demands on the board change, providing directors with the same board packets and agenda as ten years ago may not make sense. Soliciting thoughts on how the content and presentation of board materials could be more helpful and whether the board’s agenda should change is a good exercise for any institution.
Buy, sell or hold? While strategic matters are best addressed through group discussion, gauging directors’ views on the strategic direction of the institution can also help shape the tenor of the board’s future discussions. Understanding individual directors’ justifications for a potential sale as part of the assessment process may allow for solutions short of a sale of the bank.
Board assessments are a key component of a healthy board environment, as they can provide management and the board with insight into the true feelings of the board of directors on a variety of issues. Careful evaluation of which assessments to utilize and the timing in doing so can allow a board to better adapt to a rapidly changing marketplace.
Recruiting the right members for the board is becoming an increasingly crucial task. The workloads of boards have increased, making ineffective members more of a drag on the other directors. Regulators are emphasizing the quality and effectiveness of boards in exams. The board’s performance is an important part of a bank’s CAMELS score, the rating system regulators use to assess the health of a bank. It is challenging today for banks to make and sustain a return on investment that will satisfy shareholders, making the board’s job of overseeing management more important.
Assessing their own performance and recruiting new members are critical tasks for boards as they try to survive in the new banking landscape, which is heavy with regulation and in many markets, short on growth. Choosing wisely on a new director is a critical factor in board performance, and yet many boards wait too long to beef up the quality and effectiveness of their boards, say many governance advisers.
Jim McAlpin, a partner at the law firm Bryan Cave LLP in Atlanta, who has decades of experience working with boards, says that out of 10 board members, typically only three to four make a difference. They are the ones who serve on multiple committees and make sure the board’s work gets done. They are the ones who drive decision making and add value to the institution. Everybody else? Well, they serve, but definitely in a secondary role. Boards often rely on age limits to gently roll off an underperforming board member, but since age limits have risen in the past few years, that can take too long.
“We really haven’t challenged people to become effective,’’ McAlpin says. In some cases, there may be a legitimate reason for that. A family owned bank might want to have multiple family members on the board for reasons other than overseeing the management team. High profile members of the community may serve an important role in representing the bank in the community and at charitable functions. Historically, for many banks, this has not been a problem. But for boards that want to improve their bank’s profitability, now is the time to beef up their own performance.
There are three steps to building a strong board: assessing what your board needs, recruiting people with the right skills and backgrounds, and getting rid of ineffective directors.
Assessing the Board’s Needs
First of all, not every bank wants the same thing out of its board. Community banks may emphasize the role of board members in bringing business to the bank, for example. Larger banks, certainly those well above $1 billion in assets, are going to look to other leadership qualities and certain skill sets as being more important than recruiting business to the bank.
Assessing what the board needs most could be accomplished with a simple grid listing the names of the directors followed by the skills the board needs, (e.g. financial expertise, M&A expertise, industry experience), the governance experience of each member (e.g. nominating committee or public company experience), and individual qualities (e.g. age, gender or racial diversity, retired). The chairman or lead independent director can check off which director fits the different boxes in the grid to get an overall view of the board’s composition and what it needs.
The Skills You Need on Your Board
Differing committees will need different skills.
As a sound governance practice, all boards should have a non-executive chairman or, if the CEO is also the chairman, a lead independent director, says Peter Crist, chairman of the board of $17-billion asset Wintrust Financial Corp. in Chicago and chairman of Crist Kolder Associates, an executive recruiting firm that does a lot of board recruiting. That creates checks and balances between management and the board, and ensures the board is operating effectively. A respected executive with broad business acumen and who is also a strong communicator with excellent interpersonal skills is perfect for this role, says Crist. However, the role is not for someone with an ambition to run the company. If the chemistry between the CEO and lead independent director or non-executive chairman is poor, the function of the board suffers. The lead independent director or chairman also acts as a buffer between management and the board, making sure the board doesn’t intrude on management’s duties.
Bank boards also need members with financial expertise who can serve on the audit committee and know accounting rules and how to read a financial statement. The Federal Deposit Insurance Corp. Improvement Act requires banks with $3 billion or more in assets to have at least one person on the audit committee with banking or related financial management experience. The Sarbanes-Oxley Act requires public filers with $500 million or more in assets to disclose in their annual report whether they have someone on the audit committee who meets the definition of a financial expert. The audit committee chairman is a critical role on the board, and should engender confidence in the company at the board, management and investor levels, says Crist. This person should probably qualify as an independent director with the time to commit to this demanding role. Ideal candidates include retired executives who have been CEOs with strong financial skills, or a public company chief financial officer, or perhaps a broadly experienced audit firm partner.
Boards can also benefit from having members with CEO or chief operating officer experience and can support the bank’s CEO by bringing a level of experience handling strategic matters or mergers and acquisitions, for example. A properly functioning board acts as a sounding board for the CEO, says William Reeves, senior member of recruiting firm Spencer Stuart’s global financial services practice. “The CEO needs to feel the board is an advisor,’’ he says. “The best boards are interactive with the CEO in terms of strategy. They should be accessible and engaged.”
While it is difficult to find a current CEO to serve on the board, a second in command is often a good option and might very well become a CEO soon, says Crist. Sometimes tough to find is risk management experience on the board, as boards are responsible for overseeing the bank’s risk management, and people with deep knowledge of banking and credit can be useful in this area, including retired bank CEOs and chief financial officers. Regulators are putting pressure on banks to expand and improve management of the bank’s enterprise-wide risks and consider the board responsible for holding management accountable.
Also tough to find are board members with executive-level technology experience who can help a board address its various technological challenges, both today and in the future. Banks are finding diminishing traffic inside their branches, and are making important decisions about delivering bank services via the web or through mobile applications. Even if you can’t get Google’s chief operating officer to serve on your board, you can find someone with an interest in technology and its application to banking, says McAlpin. Don’t make the mistake of assuming this is a function of age rather than knowledge and interest level.
Moreover, Crist believes every board needs a diversity of backgrounds and perspectives. If everyone is a white, retired male, then the board isn’t hearing perspectives that might very well represent the bank’s customers and community. These days, boards are increasingly looking for women and minority candidates who bring other, much needed knowledge and experience to the board, including financial expertise, public company compensation oversight experience, or technological acumen.
Aside from hard skills such as financial expertise or human resources experience, there also are soft skills that are probably even more important. Some boards get so caught up in looking for a specific skill set, they forget about that. Are your board members good communicators? Do you have a board member who is disruptive to the conversation or dominates it, without letting other views in? Are they curious about the bank’s business and do they ask questions? Do they spend time learning what they don’t know about banking? Are the board and management helping with board training, perhaps having a part of every board session devoted to board education?
In addition to educating themselves and asking questions, McAlpin thinks a critical skill for board members is courage. “Courage is reflected in the ability to ask difficult questions,’’ he says. “That is a rare quality in my experience, someone who will sit there and say: ‘I don’t know why we’re doing it this way, can you explain?’’’
Are your directors comfortable with change? This could be a critical skill for a changing industry that really must keep up a changing population and consumer demands. “There is a problem with boards uncomfortable with change,’’ Crist says. “ You need to have people on board who have seen things and can get you through the changes.”
But who gets to decide who makes it on the board? Should it be a consensus decision after a round of interviews with fellow board members? Should the CEO decide?
The CEO’s Role in Board Recruiting
Historically, the bank CEO has always taken the reins in recruiting board members and assessing who is needed on the board. That’s often still true today. Good governance, however, gives the board and nominating committee the lead role in board recruitment and assessing the board’s performance. The nominating committee and bank CEO should be in lock step, however, in deciding the board’s needs.
“In the old days, the CEO would call me and say I need a new board member,’’ says Crist. “Now it’s the nominating committee.” Hiring a recruiting firm can help broaden the candidates available for the bank board, which can be needed if particular skills or backgrounds are hard to find. Of course, if a community bank only wants board members from a certain community who are well known by the board, hiring a recruiting firm is not needed.
For companies listed on a public exchange, there are specific restrictions on the CEO’s role. The New York Stock Exchange, for example, requires that all listed companies have a governance/nominating committee comprised only of independent directors who must nominate directors for shareholder approval. For NASDAQ OMX-listed companies, a majority of the independent directors of the board or a nominating committee comprised entirely of independent directors must nominate directors. Both also allow a company to provide investor-nominated candidates to the board as well. There is no prohibition against the board consulting with management on director candidates. The decision must be made by the independent directors, however.
Getting Rid of Someone on the Board
Recruiting is fairly easy compared to getting rid of someone on the board who is no longer effective or has become disruptive. Some boards try to handle this through age limits, relying on someone no longer contributing very much to age his or her way off the board. However, this is an ineffective strategy by itself, as many board members can and do serve effectively regardless of age. The best boards try alternative strategies in addition to an age limit. Board evaluations are an effective strategy for nudging poorly performing board members off the board. The chairman or lead independent director should handle the discussion of letting someone go.
Regardless of whether there’s a need to get rid of a poor performing board member, a best practice at all banks is to conduct a review of the board’s performance either yearly or, at the very least, every few years. This can take the form of self-evaluations, similar to what employees of the bank do, followed by a one-on-one conversation with the bank’s chairman or lead independent director. Such a practice can encourage board members to think about their own effectiveness as directors, and often leads to board members voluntarily stepping down when they realize they are no longer needed or not contributing as they had in the past. Another type of review is a 360 degree evaluation, where board members not only rate themselves, but everyone else on the board and the overall board’s performance. Lastly, boards can bring in an independent third party to help with the board evaluation, which can be a good practice if leadership wants a fresh look. However, third-party evaluators can engender suspicion and distrust among the directors, says Crist. He believes the board chairman or lead independent director should lead the process of evaluation.
The surprising thing is that many banks don’t do any sort of evaluation at all, says McAlpin. Evaluation should be done regularly, and not just in conjunction with a pending retirement. Boards tend to wait to recruit new directors until an older director retires, but Reeves encourages boards to think about what would help the business most. “We encourage people to reassess the strength of the board and think about what the weaknesses are,” he says.
Requiring that every board member stand for annual elections is becoming more common, as opposed to staggered elections for a class of directors every few years, says Crist. However, the company’s own bylaws may require staggered elections as a poison pill to prevent hostile takeovers. Another option to get rid of poor performing directors is to require an offer of resignation when there is a change of employment, such as a retirement or the loss of a job. Boards can always make an exception, but at least that provides the board with opportunity to review an individual’s service when that person’s status has changed.
The Value of a Strong Board
Determining who should be on your board (and getting rid of those who aren’t contributing at a high level) is a defining characteristic of strong boards. Reeves believes that poor board leadership was a factor in the failures of many banks during the financial crisis. Boards that lack any directors with long-term experience in banking, or the courage to ask important questions, or the financial expertise to see what was going wrong, can really sink a bank. A strong board, conversely, can help the institution thrive.