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Corporate Performance: The Governance Factor

by Kimberly Ortiz, Examiner

Strong corporate governance is essential not only for operating
performance, but also for maximizing shareholder value. Here we will explore how governance affects shareholder value and how practices such as the board of director's self-evaluation can be a rewarding endeavor.

Periodically, McKinsey Quarterly surveys investors to quantify whether they are willing to pay more for the stock of a well-governed company than they are for shares of a company with similar financial performance but poor governance practices. A 1996 survey found that 66 percent of respondents were willing to pay a premium for the shares of well governed companies,1 and by 1999, over 80 percent of respondents were willing to do so.2 Although the 1999 survey did not address why more respondents were willing to pay a premium, the stock performance of companies with poor governance practices over the past two years leads us to believe the figure may be even higher in today's environment.

It is interesting to note that in 1999, respondents, on average, were willing to pay 18 percent more for the stock of a well-governed U.S. company and 28 percent more for the stock of a well-governed company in Venezuela. The survey concluded that investors were willing to pay a smaller premium for well-governed U.S. companies because they believed that many domestic companies had "already addressed fundamental governance issues."

A Process for Improvement
A survey conducted by Korn/Ferry International in 2002 found that board practices are not keeping pace with directors' sentiments regarding good corporate governance.3 For example, 72 percent of directors indicated that the performance of individual directors should be evaluated regularly. However, only 21 percent of boards currently conduct such evaluations, and 59 percent of directors on those boards believe the evaluations are ineffective.

Although most companies conduct annual employee evaluations to assess their performance and effectiveness, it is not yet commonplace for directors and boards to do so. However, because of today's corporate environment, boards of directors should anticipate closer examination as to how they measure their performance and, ultimately, the effectiveness of each director.

Self-evaluation is one of the best methods for boards of directors to identify their strengths and weaknesses and to improve their performance and effectiveness. The self-evaluation process should encompass two steps. Because each director has an equal fiduciary and legal responsibility, the first step is to provide for an assessment of each director. The second step is to evaluate the board of directors as a whole in order to assess how the group functions together.




Is the size of the board of directors conducive to effective discussion?


What percentage of directors should be independent?
Do directors have the appropriate skills and experience to carry out their duties?

Meeting schedule

Is the number of board meetings adequate to accomplish objectives?
Is the length of board meetings appropriate to foster in-depth discussions?

Quality of

Is the format appropriate and sufficient time allotted for discussion of important strategic issues?
Are board discussions meaningful?
Do board members abstain from decisions when they are incapable of providing objective advise?


Is appropriate information received to monitor progress toward corporate objectives?
Is information organized so that directors can understand it?


Are practices for evaluating the CEO formal and useful to the board?
Does the process provide feedback and advise to the CEO for development?


Is committee membership appropriate?
Do existing committees function as intended by the board?

When instituting a self-evaluation process for the entire board of directors, boards may wish to consider a number of topics when evaluating their process and structure (see table).4

In addition to evaluating the board's process and structure, self-evalation should be used to determine whether the board is meeting their goals and objectives. Because goals, objectives, and board processes differ among companies, the evaluation criteria should be established by the board and based on their duties.

A Success Story
In 1995, Campbell Soup Company's board of directors conducted a selfevaluation. The evaluation revealed that directors felt more time should be devoted to long-range strategic planning; that some directors did not speak up enough during meetings; that the quality of some committee reports needed improvement; and that directors needed and wanted to broaden and diversify their skills. The self-evaluation resulted in corrective actions that improved the board's effectiveness.5

Four years ago, investors assumed that U.S. companies were following fundamental corporate governance practices. Since then, corporate governance failures have resulted in increased scrutiny of board of directors' ability to measure their performance and effectiveness. One way to demonstrate this ability is through the use and application of self-evaluations.

Korn/Ferry International's 2002 survey found that 37 percent of boards already have a formal process for evaluating their performance. With evidence that investors are willing to pay a premium for companies with good governance practices, shareholders could see improved returns as a result of board self-evaluations and subsequent corrective actions.



1. Robert F. Felton, Alec Hudnut, and Jennifer van Heeckeren, "Putting a Value on Board Governance," McKinsey Quarterly, no. 4 (1996), pp. 170- 75.

2. Paul Coombes and Mark Watson, "Three Surveys on Corporate Governance," McKinsey Quarterly, no. 4 (2000), pp. 75-77.

3. See Korn/Ferry International, U.S. 29th Annual Board of Directors Study.

4. Jay Lorsch, "Should Directors Grade Themselves?" Across the Board, vol. 34, no. 5 (1997).

5. See www.businessweek.com/1996/48/b35031.htm.




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