In this brand new report, The Conference Board looked at several of the less glitzy areas of board governance to identify some evolving best practices for attaining board excellence, such as board continuing education. From AI to ESG, corporate boards are bombarded by new and important issues about which they must attain some level of understanding and fluency. But how? Is there anything new in best practices for continuing education? Other areas of focus in the report are board self-evaluations, director overboarding and committee rotation. Are there any developments in best practices in those areas? TCB has some data and some advice, discussed below.
The data for the report was collected, in collaboration with data analytics company ESGAUGE, from TCB's database as November 10, 2023 and reflects practices in place as of the companies' most recent SEC filings.
Board orientation and education. TCB found that the percentage of companies relying, at least in part, on external resources for board education has increased. The report showed that 37% of companies among the S&P 500 relied on a blend of internal and external education programs in 2023, up from 25% in 2018. Among Russell 3000 companies, the percentage increased from 12% in 2018 to 23% in 2023. Although, for most public companies, board education is still conducted exclusively in-house, that percentage has declined from 67% in 2018 to 61% in 2023 among S&P 500 companies and from 66% in 2018 to 64% in 2023 among Russell 300 companies.
TCB advised that boards "consider increasing their use of external resources for board education programs....Enlisting third-party experts, especially when their presentations are tailored to address a company's particular circumstances, can be an efficient and objective way to increase board fluency in key areas where the board may not have deep experience, such as the digital and sustainability transformations of the business, and other areas as needed." External programs can not only supplement management's knowledge, but also expose the board to diverse perspectives, which "can enhance its ability to make informed decisions, adapt to changing circumstances, and avoid institutional groupthink." Although boards can certainly request presentations on topics that they identify, TCB recommends that management "ensure it has sufficient informal interactions with the board and individual directors, so it can identify and address any gaps between what the board knows (which might be more than management realizes) and what it should know."
Board evaluations. TCB also found that boards were conducting more comprehensive self-assessments, frequently incorporating individual director evaluations into their annual board self-assessment process. According to TCB, in 2023, 56% of S&P 500 companies reported that their board self-assessments included a "combination of full board, committee, and individual director evaluations (including both peer assessments and self-assessments)," reflecting an increase from 37% in 2018. The proportion of companies conducting only board and committee evaluations declined from 58% in 2018 to 48% in 2023. A similar increase occurred among companies in the Russell 3000, with the percentage of companies conducting full board, committee and individual evaluations jumping from 18% in 2018 to 38% in 2023; over the same period, the percentage of companies conducting only full board and committee evaluations declined to 50% from 65% in 2018. In addition, increasingly, companies were engaging independent facilitators for board evaluations, particularly larger companies. In 2018, only 14% of S&P 500 and 5% of Russell 3000 companies disclosed that they used an independent facilitator, but that percentage grew in 2023 to 36% of S&P 500 companies and 17% of Russell 3000 companies.
TCB offered several recommendations on conducting the evaluation process and addressing the results. First, TCB suggested using a "multifaceted approach that incorporates both surveys and the nuanced insights gathered through interviews with individual directors." To augment the process, boards and committees can engage in group discussions during board and committee meetings to address "the results of the self-assessments and creat[e] action plans for the issues raised." It's worth noting that not everything is required every year. For example, individual director evaluations may not be necessary every year; instead, TCB advocated conducting them every two or three years, in conjunction with regular annual board and committee evaluations. Individual evaluations can help to provide
"detailed insights into individual performance; identif[y] strengths, opportunities, and skill gaps; and enable[] the formulation of targeted development plans. This approach strengthens accountability and can lead to changes in board composition, resulting in a well-rounded board that has critical competencies for long-term performance and the ability to navigate the complexities of the current business environment. In between formal evaluation cycles, management should take note of which directors are engaged, ask probing questions, and effectively challenge management—and which ones don't. Management should bring this to the attention of board leadership, so issues around individual director performance can be addressed informally on an ongoing basis. These are sensitive discussions and require a strong level of trust between management and board leadership."
Independent facilitators can provide relatively neutral listeners who may elicit more "candid feedback" from directors and "may also be better equipped to benchmark the board's performance against external standards and best practices, as well as identify areas for improvement." But, according to TCB and governance professionals, outside facilitators are not necessary every year; rather, engaging facilitators "every few years not only prevents the erosion of trust among directors but can also balance the benefits of external expertise with practical considerations (e.g., resource efficiency and meaningful implementation of changes based on the evaluation results)." TCB cautions that, with outside facilitators, the company will need to be sure to protect legal privilege and provide "an environment conducive to open and honest feedback."
Overboarding. Most public companies now have policies on overboarding. TCB indicated that, among companies in the S&P 500, 75% have overboarding policies applicable to all directors (i.e., independent non-executive directors), up from 64% in 2018; in the Russell 3000, that percentage increased from 45% to 53%. (TCB noted that, typically, directors who are also CEOs or other executive officers are subject to narrower restrictions, for example, a limit of one additional board seat.) For 60% of S&P 500 companies and 49% of Russell 3000 companies with overboarding policies, the limit on the number of additional board seats was set at three, reflecting increases from 2018 when only 36% of the S&P 500 and 33% of the Russell 3000 used a limit of three. A declining percentage of companies permitted four additional board seats: only 33% of S&P 500 companies and 38% of Russell 3000 companies (in both cases, with overboarding policies) permitted directors to hold four additional seats in 2023, reflecting declines from 50% among S&P 500 companies and 45% among Russell 3000 companies in 2018. A number of companies limited their overboarding policies to audit committee members, but those percentages have declined somewhat. Among the S&P 500, 13% applied the policy only to audit committee members in 2023, a decrease from 21% in 2018; for the Russell 3000, those percentages were 20% in 2023, a decline from 22% in 2023.
SideBar
Why audit committees? One reason may be that many have expressed concern about audit committee overload, with ACs are now sometimes referred to as "kitchen sink of the board." Last year, SEC Chief Accountant Paul Munter, quoted here, cautioned his conference audience about the potential for audit committee overload. "More demands are being put on audit committees, sometimes on topics outside their core responsibility," he said. "Audit committees need to be continually vigilant that they have enough time to focus on their core mission—protecting investors—and don't let other topics cloud that out." While the AC's primary responsibilities are generally thought to be oversight of financial reporting, including the audit of a company's financial statements and internal control over financial reporting, these days, the AC often becomes the default committee of choice for oversight of other emerging risks, such as cybersecurity and even ESG. As a result, questions have arisen as to whether the burdens on the AC impair its ability to perform its main function related to audits, financial reporting and internal controls.
In "Audit Committee: The Kitchen Sink of the Board," from the Center for Audit Quality, the authors discuss how ACs "can manage their evolving responsibilities." With regard to the question of how boards can effectively allocate oversight responsibilities to the audit committee, the key findings were:
- "Perpetually assigning emerging risks to the AC (i.e., the 'kitchen sink' approach) can lead to suboptimal oversight due to overworked ACs and a 'check the box' mentality.
- Traditional AC skill sets relate to financial reporting and internal controls. As AC responsibilities evolve, it is important that AC skill sets evolve as well.
- Some AC members individually advocate for the AC to oversee these emerging risks because of their personal skills and interests. In these cases, AC members should be careful not to succumb to overconfidence bias and ensure that a clear succession plan is in place without them.
- To effectively allocate oversight responsibilities, ACs may need to consider situations when it makes sense to push back on the board."
With regard to the question of how audit committee members can keep up with an ever-evolving workload, the CAQ advised that:
- "AC members should be purposeful about developing skill
sets that match oversight responsibilities:
- Actively assess the committee's key risks when planning for continuing education opportunities and use specialists where needed.
- Regularly evaluate whether AC refreshment is needed to keep up with the necessary skill sets to properly oversee evolving risks.
- Carefully manage the AC agenda by mapping out risks to allow for deep dives on a rotation of topics throughout the year."
- "ACs can free up time for additional responsibilities by
managing the agenda and relationships:
- Work with management to fine-tune the types of materials delivered in advance and hold AC members accountable for reading them.
- Reflect on whether meetings allowed for sufficient time to evaluate management's response to key risks, and schedule meetings so that they can go long or continue at an additional time when needed.
- Maintain a collaborative relationship with management to foster transparency.
- Adopt leading practices to manage shared governance across board committees."
(See this PubCo post.)
With the proliferation of board responsibilities into new and diverse areas, such as AI, supply chain issues and ESG, TCB observed that overboarding policies help ensure that directors have sufficient time to devote to their burgeoning set of board responsibilities. Ensuring that directors have adequate time to perform their responsibilities can "enhance board performance and engagement," and "promote board refreshment by prompting a dialogue with board members as to whether the director should resign from a particular board." In some circumstances, even a limit of three additional board seats can lead to overboarding. TCB advised that "while adopting an overboarding policy can be useful, it is more important for boards to have candid conversations about their evolving time requirements and the ability of directors to devote the time necessary to the role." TCB noted that the proxy guidelines from State Street Global Advisors provide that, in 2024, for companies in the S&P 500, the determination of overboarding will be based, not on numbers, but rather on assessments by nominating committees of their directors' time commitments.
Committee rotation. TCB found that, in 2023, 33% of S&P 500 and 26% of Russell 3000 companies (compared to 24% and 16%, respectively, in 2018) had policies on committee rotation. These policies "may include elements such as term limits, rotation criteria, the reappointment process, and exceptions." A small percentage of companies reported that they had term limits for committee members (9% of S&P 500 and 6% of Russell 3000 companies in 2023), with most set to five terms.
Coming full circle, TCB suggested that rotation and committee term limits can serve to help educate the board by allowing directors a "more comprehensive view of the company" and facilitating "the sharing of knowledge and expertise across the board." In addition, rotation can enable new and different perspectives to be introduced and "contribute to positive board dynamics by promoting a sense of equal opportunity to serve on committees and in leadership positions."
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