Board self-appraisal, which includes appraisal of committees and individual directors, has evolved as an effective feedback mechanism for improving board effectiveness. Most Indian companies will carry out the exercise for the first time, as the Companies Act 2013 (Act) mandates board evaluation. The Act does not prescribe any specific method for evaluating the board. However, the provisions have been constructed in such a manner that compliance of the law to the letter might have significant dysfunctional effects.
Board evaluation is an elaborate process. Pre-evaluation process involves deciding the objective, criteria and method for evaluating the board. The board decides all those with inputs from the CEO. The most common evaluation method is to collect data by analysing governance documents (e.g., agenda and minutes), surveying directors through a questionnaire and interviewing directors.
The data so collected is analysed and a report is presented for discussion before the full board. Performance of individual directors is assessed through self-assessment and interview. Feedback is provided to each director on a one-to-one basis.
Usually, the chairperson of the Nomination Committee or the lead independent director supervises the whole process, interviews individual directors, provides feedback to each director and presents the report before the full board. Confidentiality is the hallmark of the evaluation process. Therefore, names of individuals are removed from all documents while collating and analysing the data.
The Act mandates that independent directors will meet separately at least once a year to review the performance of non-independent directors and the board as a whole; and to review the performance of the chairperson of the company, taking into account the views of executive directors and non-executive directors. Evaluation of the board and non-independent directors just by meeting once without getting into an elaborate exercise will only be an informal evaluation. This is not the intention of the law.
The Act requires the board to disclose in its report the manner in which the board has made formal annual evaluation of its own performance and of its committees, and individual directors. Therefore, independent directors will have to formally evaluate the board and non-independent directors.They may finalise the draft report in the separate meeting. Although, the law is silent on how the result of evaluation will be used, the draft report should be discussed with the full board to decide the actions for improving board effectiveness. Independent directors should involve the CEO and the full board in deciding the objective, criteria and method of evaluation. It will be a grave error to exclude non-independent directors from the whole process. They should consider the views of non-independent directors in board evaluation.
There is some strength in the argument that inclusion of the views of non-independent directors in board evaluation will distort the result, as non-independent directors might not be able to provide an honest feedback.
But exclusion of non-independent directors from the whole exercise will have huge dysfunctional effects. This will politically divide the Board. The board cohesiveness will be lost. The whole exercise will be a waste.
The Act requires the board to evaluate independent directors. It is problematic. Open discussion of individual performance in the Board breaches the principle of confidentiality. It also fails to achieve the purpose of providing an honest feedback to each director to enable him to improve his performance.
Discussion of report cards of individual directors with the full board is likely to be resented by directors and might drive away good directors. The best practice is to use self-assessment and interview method to assess individual performance and to provide feedback to each director (independent or non-independent) on a one-to-one basis. The reports of independent directors should be submitted to the chairperson of the Nomination and Remuneration Committee. It should consider the same while deciding the continuation of the independent director as a board member.
The Act requires that Nomination and Remuneration Committee of the Board to carry out evaluation of every director's performance. The law is not clear about the role of the Committee, as the law requires the board to evaluate independent directors; and independent directors, in a separate meeting, to evaluate non-independent directors. I suggest that the Committee should take the responsibility for the whole board evaluation exercise. Complying the law to the letter will have huge dysfunctional effects. Boards should comply with the law in spirit. They should adopt the global best practices.
I often face a question on whether the board evaluation and evaluation of individual directors will be meaningful in government companies and promoter-driven companies.
I hold the view that boards and directors in those companies will receive valuable feedback from a serious evaluation exercise even though the controlling shareholder (government or promoter) plays an important role in appointing directors and strategic decisions are taken at forums other than the board.
Only rubber stamp boards will not benefit from the exercise.