Board evaluation: A gateway to stakeholders' trust

Such periodic assessments are significant parameters considered by institutional investors for rating the governance of companies

Published: 19, Jan 2017

Deloitte globally provides audit, tax, consulting, and financial advisory services to public and private clients spanning multiple industries. With a globally connected network of member firms in more than 150 countries, Deloitte brings world-class capabilities and high-quality service to clients, delivering the insights they need to address their most complex business challenges. Deloitte has in the region of 210,000 professionals, all committed to becoming the standard of excellence. In India, Deloitte member firms are spread across 13 locations with around 30,000 professionals who take pride in their ability to deliver to clients the right combination of local insight and international expertise.

Photo: Shutterstock
Photo: Shutterstock

The quality of performance of the board of directors of Indian corporations is under greater scrutiny now than ever before. Volatile market conditions, fluctuating global economies, and rise in the demands and expectations of the stakeholders are a few of the factors that have made board evaluation a necessity. This growing recognition has resulted in board evaluations becoming widely established internationally in rules-based as well as in principles-based jurisdictions, as a critical structural tool for assessing board effectiveness and efficiency. In India, board evaluation was a non-mandatory requirement under Clause 49 of the Listing Agreement, prior to the revision in the Clause 49 by Sebi in April and September 2014, but a few progressive companies, however, were conducting board evaluation voluntarily.

The listed Indian companies carried out a formal annual performance evaluation of the board, its committees, and individual directors and reviewed the performance of the chairperson in FY 2015 as mandated under the Companies Act, 2013 (the Act). While section 134 (3) (p) of the Act requires the report of the board of directors to incorporate a statement indicating the manner in which a formal annual evaluation has been made by the board of its own performance and that of its committees and individual directors, the process and the methodology of evaluation has been left to the discretion of the board and the responsibility for the evaluation assigned to the Nomination and Remuneration Committee.

Deloitte studied the annual reports of the 100 listed Indian companies with the objective of identifying the trends in the disclosures across five areas: Board evaluation, Internal Financial Controls (‘IFC’), Enterprise Risk Management (‘ERM’), Related Party Transactions (‘RPT’), and Compliance with applicable laws and regulations. The companies in the sample were selected from the major stock exchange indices such as the BSE Sensex, Nifty 50, S&P BSE 100, and S&P BSE 200 while ensuring proportionate representation from different industries and geographies. The reporting practices on the mandatory disclosures required under the Act and the additional disclosures made voluntarily by the companies bring forth some interesting insights. These insights are especially relevant in context of the recently released guidance note on board evaluation by Sebi. Let’s study these evident trends in board evaluation that emerge from the research-

Hiring an external consultant- Only 7 percent of the companies in the sample disclosed that they had engaged an independent agency for the evaluation of the board. Engaging an independent external consultant for conducting performance evaluations may bring in fresh perspective and make the overall process objective and transparent. In large international corporations, board evaluations are usually conducted by the governance and nomination committees with the help of outside experts. Yet, there are many companies, especially those in Europe and particularly in the UK, which advocate that the exercise should be conducted only by an independent external expert who would be in a better position to make a ‘truly’ independent assessment. However, in India, there seems to be an apparent apprehension about the engagement of external consultants at least in this first year of reporting after the Act. Sebi’s latest guidance note on board evaluation also highlights the need to have an external expert to carry out the board evaluation process. The note highlights “Hiring an external expert imparts independence to the evaluation process and therefore is used by many entities globally. However, care must be taken to ensure that the external assessor is not a related party or conflicted due to closeness of the board to ensure impartiality. Such external assessment may be done based on questionnaires/interviews or a combination of the two and done on a regular basis. Apart from the need to hire an external expert, the note also stresses the need to infuse technology into the traditional board evaluation process to provide more rigour and efficiency to the process.

Disclosing manner of board evaluation- Only 37 percent of the companies in the sample have disclosed the manner in which they had carried out the board evaluation process. The term ‘manner’ here refers to the criteria laid down by the companies for the performance evaluation along with the method used for such evaluation viz questionnaires, forms, surveys, rating sheets, 360 degree feedback, evaluation templates, interviews, etc. The guidance note reiterates this point and also observes that many entities worldwide voluntarily provide additional disclosures, including the results of the board evaluation, action taken on the basis of the evaluation, current status, etc to various stakeholders as a practice aimed at greater transparency.

Results of board evaluation- The survey results show that 67 percent of companies in the sample did not give any quantitative or qualitative comment on the results of the board evaluation. Disclosure of the results of the board evaluation is not mandated by the Act, but overall comments on the results and the actions undertaken by the boards to further improve on the inadequacies, if any, can be seen as an extra mile that can attain stakeholders’ trust. The results of the performance evaluation is a crucial part of the entire evaluation process and although it may have gained complete deliberation on part of the board, the disclosure of the same in the annual report can be crucial to obtain stakeholder confidence. While the guidance note doesn’t address aspects on disclosing results but underpins feedback to individual directors, the board and the committees as a crucial success factor of board evaluation. It is suggested that the active role of a chairperson is desirable in providing unbiased and honest feedback to all parties.

Not only in India but also worldwide, board evaluation is approached with a certain amount of caution and restraint. Most nations which lead the governance changes have only introduced board evaluation in the past 12 years. Globally, board evaluation practice is still at a nascent stage and it may take some time before its long-term benefits are well comprehended. Conflicts of interest, legal and procedural concerns, and perceived business risks could be some of the key challenges faced while undertaking performance evaluations of the boards, directors and the committees.

Nonetheless the barriers and resistance to the process of board evaluation, there is no denying the fact that such periodic evaluations are significant parameters considered by institutional investors for rating the governance of companies. The time when investors start asking for board evaluation reports, including the manner, methodology, results and the corresponding curative actions in the annual report is impending.

- By Abhay Gupte, Partner, Deloitte Touche Tohmatsu India LLP

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