Board Composition and Evaluation
Given the number of financial institutions that have closed in the United States in the last two years, not to mention all of the financial institutions that have closed around the world, the real question is, “Where were the boards?”
Having spent a big part of my life observing, speaking for and conducting educational sessions for boards, it is not surprising to me that the board is often the last one to know that there are serious problems. Among other reasons, I believe that bank and credit union boards are often composed of the wrong people, they fail to evaluate themselves adequately, they spend next to no time thinking about or working on board succession, and there is no formal process for recruiting new, competent members. This article will address board composition and evaluation.
In most financial institutions this would take some dialogue, and I’m afraid that if an objective analysis was done the answer would be no. That doesn’t mean that some and perhaps many of the board members aren’t doing a good job and aren’t qualified to face future challenges, it simply means that the board’s composition, while possibly adequate in the past, is not the optimum for the future. To begin, a matrix could be drafted which would list each individual board member and each of the skills that he or she brings to the table. Some of those skills might include financial knowledge, business development opportunities, knowledge of banking, understanding of strategy and risk management. If the bank or credit union has a significant amount of problem assets and is located where the economy is especially bad, then different skills will be needed on the board.
As a long-time member and a current faculty member of the Board Advisory Services program offered by the National Association of Corporate Directors, the most requested programs by publicly traded companies this year have been on board composition and evaluations. While some banks and all credit unions are not publicly traded, the idea that there are directors who bring different skills to the table is every bit as germane. The four roles of a board member are:
- Serving as a fiduciary;
- Being an advisor on strategy, risk, etc.;
- Overseeing compliance, risk, management and strategy, etc.; and
- Business development.
If you believe these four roles to be accurate, then doesn’t it stand to reason that the board members collectively need to have enough of the skills necessary to fill those roles adequately? In my experience, many financial institution boards lack the diveristy and skill sets that are needed. This is often a mistake, and one that is difficult to change even when it is necessary.
Many boards in the past have been picked largely by the CEO, and many board members assume that they will serve for life. That might have been great 50 years ago, but it is not the optimum for the future. There is one thing of which I am certain, and that is that the composition of most bank and credit union boards needs to change.
While publicly traded companies, in the wake of Sarbanes-Oxley, have no choice but to evaluate the board and board members individually on an annual basis, most banks and all credit unions are not required to do so. But, I would submit that they should do so. The place to start is to make sure that every board member clearly understands his/her responsibilities. In other words, give them a written job description when you bring them on the board (and if they have been on the board and don’t have a job description, get them one today). In my estimation, it is unfair to evaluate someone without that person’s clear understanding of what is expected of him/her. Once those expectations are set, then the evaluation process can take place a few months later. The evaluation process should be either out-sourced or headed by the Nominating and Governance Committee or similar committee within the company. The process should ask and answer at least the following questions:
- What is the purpose of the evaluations? – Other than by members voting one off the board, there is no other place for boards to be evaluated except through a self-assessment. Evaluations are conducted primarily to encourage good performance and occasionally to get rid of a non-performing director.
- Who should do it? – Whether the Nominating and Governance Committee does it themselves, hires an outside firm or expert or uses inside or outside general counsel, the process should be driven by a board governance system and should be done on an annual basis.
- Should the board as a whole be evaluated or should individual directors be evaluated? – The answer is both. While it is much easier to evaluate the board’s effectiveness as a whole, it can get a little touchy when it comes to evaluating individual directors. The need for confidentiality is critical but a desire for candor is just as critical. Again, the evaluation is not designed primarily to replace people, but rather to point out weaknesses in individual or board performance and to get those weaknesses addressed and improved.
- What about financial literacy? – The need for financial literacy is certainly more important today than ever before, and this is true whether the company is a financial institution or a company for which financial literacy is less an issue. While not every board member needs to be a CPA, the test that I have given board members over the years on their understanding of the financial statements, ratios, etc., indicates that the majority of board members do not have an adequate understanding of financial statements.
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Dennis McCuistion is a “recovering bank CEO” who works with banks and credit unions on developing competent boards of directors. He can be reached at email@example.com or at 903-464-9555. He also hosts a television program on PBS which can be viewed online at www.mccuistiontv.com.
Dennis will be presenting ”The Board as a Competitive Advantage” at RFG’s annual CEO Forum being held at the Broadmoor in Colorado Springs, Colorado August 11th to the 13th. For more information on the CEO Forum, visit http://www.raddon.com/forum or call 800.827.3500 ext 6582.