Evaluation of boards could benefit from broader adoption of good practice

Out-Law News | 25 Jan 2021 | 4:54 pm | 2 min. read

The UK’s Chartered Governance Institute (ICSA) has published a voluntary code of practice for independent board reviewers, and voluntary good practice principles for listed companies.

After a review of the effectiveness of independent board evaluation (53 page / 460KB PDF) in the UK listed sector, carried out at the request of the Department of Business, Energy and Industrial Strategy (BEIS), ICSA concluded that broader adoption of good practice and greater transparency would benefit both reviewers and companies.

Corporate governance expert Tom Proverbs-Garbett of Pinsent Masons, the law firm behind Out-Law, said the dual-pronged approach aimed at both reviewers and companies reinforced ICSA’s view that the process was a two-way encounter.

“Reviewers should adhere to minimum standards, but it is up to the company – acting through its board – to pursue suggestions for, and implement, change,” Proverbs-Garbett said.

ICSA suggested that the Financial Reporting Council (FRC) should consider adopting the terminology “board performance review” instead of “board evaluation” when it next updated the UK Corporate Governance Code (UKCGC) and its guidance on board effectiveness.

“This is designed to underline the distinction between assurance and reassurance. The purpose of an evaluation is not to appraise the board, giving it some sort of pass or fail, but rather to consider its capabilities and behaviours and to make recommendations for improvement,” Proverbs-Garbett said.

“Whether this rather nuanced change is picked up and, if so, whether such revised terminology would have any demonstrable impact can only be a matter for speculation at the moment. However, focusing on external reviews as a barometer of board behaviour as opposed to any form of 'sign-off' is a sensible reflection of practice,” Proverbs-Garbett said.

ICSA said it was possible to capture elements of good practice in the way independent reviews are conducted, but it would not be appropriate to be overly prescriptive. It noted that external board reviewing was a developing area and excess prescription could deter innovation and competition.

The review found that there was nearly full compliance with the ‘comply or explain’ provision introduced in the 2010 UKCGC for companies to carry out an externally facilitated board performance review every three years.

Nevertheless, the 2018 revisions to the UKCGC developed this provision with additional requirements for companies to disclose how reviews had been carried out. ICSA recommended that the FRC introduces additional voluntary guidance on how to report against these provisions, and published a draft of this guidance (6 page / 281KB PDF).

Proverbs-Garbett welcomed the recommendation, but said reporting should be evidence-based.

“The idea that boards will rush to declare – and subsequently follow up on – areas deemed to be in need of improvement may be an overreach, likely to result in more boilerplate in the annual report. Corroboration of improvement to board capability should be ascertainable from increases in clear and evidence-based reporting against the UKCGC and other governance requirements in the annual report and through more frequent and better quality interactions between the shareholders and the board,” Proverbs-Garbett said.

The code of practice for board reviewers (10 page / 296KB PDF) includes guidance on the competence and capacity of reviewers, terms of engagement and how to ensure independence and integrity.

ICSA said all organisations conducting external board performance reviews for FTSE350 companies should be encouraged to become signatories to the code. It said BEIS should either issue the code itself or nominate a suitable organisation to become its ‘owner’ and maintain a public register of signatories.

ICSA also recommended that BEIS should also carry out a review of the impact of the measures three years after the register becomes active, to consider whether mandatory measures or enhanced oversight of the code of practice were required.

Meanwhile, the principles of good practice (4 page / 271KB PDF) for companies cover the selection of the reviewer, the scope of the review, and disclosure of whether the company has followed the principles.