bstracted from: The Case For Privileged Board Self-Evaluation Programs
By: Lois Herzeca and Christian Herzeca  Fried Frank Harris Shriver & Jacobson, New York, NY (LH);

Corporate Governance Group, New York, NY (CH)

Corporate Governance Advisor - Vol. 11, No. 5, Pgs. 1-11

Overview: Illuminates the backdrop of judicial skepticism toward management self-governance against which corporations should design self-evaluation programs. Sketches the normative and descriptive processes by which companies should operate their programs. Recommends enacting a privilege against disclosing how the board designed the self-evaluation and what results it obtained.

The unexamined life no longer gets a pass. Corporate self-examination is no longer a luxury. Proposed NYSE listing standards mandate listed companies to conduct annual self-evaluations of the audit, compensation, and nominating/governance committees (and advise the same for the entire board). Courts criticize boards for failing to provide meaningfully independent oversight, Lois Herzeca and Christian Herzeca point out, as in the 2003 Delaware Chancery Court case of In Re Oracle Derivative Litigation. The special litigation committee investigating whether to pursue derivative claims against several directors was, according to the court, tainted by its close links with Stanford University. Two committee members were Stanford professors, while one of the directors under investigation was also a professor and two others were major contributors. Similar judicial rejections of board actions that required independent judgment include the same court's decision in In Re Walt Disney Co. Derivative Litigation (2003), because the board had rubber-stamped the chairman's selection of (and subsequent sweet termination package for) his close personal friend, the president. In these and other recent cases, the courts excoriated boards that accepted clubby arrangements without seriously questioning management conduct. These are actions the courts equate with bad faith sufficient to overcome the business-judgment rule, actions that boards would not undertake had they been regularly evaluating their own effectiveness.

Self-evaluation goals and methods. One purpose of self-evaluation is to strengthen the directors' genuine independence and the effectiveness of their oversight, the authors explain. The process should contain both descriptive and normative components: first describe how the board is organized to perform its functions, then evaluate how well that system has addressed important events since the prior self-evaluation. The authors insist that these two components must occur separately and in order, if the board is to understand what it does well, how it needs to improve, and what action plan accomplishes the necessary changes. Delegating the self-evaluation process to a committee of independent directors, who should enlist professional advisors, is reasonable. The action plan, the fruit of the process, is also the seed for the next year's evaluation, by altering the descriptive background and providing a fresh basis for performance evaluation.

Description and proscription. The first job of the self-evaluation is to describe the board's responsibilities under the law (now especially including the Sarbanes-Oxley Act) and the corporate charter. Next, assess the resources available to meet the board's duties. Resources covered by the authors include board members themselves and their skill sets, as well as senior executives with both their skills and their cooperation with and candor towards the board. Evaluating management requires an assessment of individuals' motivation through compensation design, their responsiveness, approach to risk, and personal and financial interactions with the company and board. Other significant resources include institutional investors; auditors and other professional advisors; and the board's procedures for self-refreshment through the nomination process, as it relates to interaction with shareholders. After describing the board's functions, resources and processes, develop a governance scorecard that measures how well the board performs. List actions to improve measurable results, including references to outside assessments of corporate performance, such as governance rating agencies.

A privileged position. The authors stress that for boards to conduct effective self-evaluation-for the ultimate benefit of shareholders-directors must be able to critique themselves without fear of penalty for having done so. Delaware law does not recognize any privilege or discovery exemption for records and reports of board deliberations, nor has any Delaware court recognized a privilege for the board's self-critical analysis. Nevertheless, federal courts and some other state courts have concluded that self-evaluations, especially the normative components, differ from other factual and business-related board output and should be shielded from discovery in litigation. The self-evaluative process, the authors argue, differs from the deliberations of special litigation committees, the context in which Delaware courts have rejected privilege, since special committees address specific shareholder demands. Delaware would provide necessary clarity and encourage corporate self-examination if it enacts protections for self-critical analysis.

Abstracted from Corporate Governance Advisor, published by Aspen Publishers, 1185 Avenue of the Americas, New York, NY 10036. For information on subscribing, call (800) 234-1660 or (800) 638-8437; or search


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