Agenda Item of the Month: Nomination of Board Members - Part II

The objective of AABD's Agenda of the Month is to expand the discussion of the Board of Directors beyond the routine monthly subject matter.

This month's agenda is a follow-up to our October 2002 agenda. In that agenda, AABD suggested considerations that the board should take into account relating to the nomination of board members at the upcoming shareholder meetings.

This agenda addresses board evaluations. If your bank does not have in place a board evaluation process and standards, this is a good time to consider one. By adopting one at or near the beginning of next year, your bank will be able to apply the evaluation standards at the end of next year for purposes of deciding on the slate of directors to be nominated.

For many banks, the board will renominate all of its incumbents, unless they are retiring or not standing for reelection on their own volition, and shareholders will almost certainly reelect them. Yet, as we pointed out in our October agenda, there is more to it than that.

The board or one of its committees evaluates senior management and external auditors; senior management evaluates other employees. Part of life is being subject to evaluation. Why shouldn't board members also be evaluated?

But who should evaluate board members?  Shareholders elect board members. Therefore, they should be the ones to evaluate them. But in companies that are not closely held, the shareholder base seldom is in a position to influence the result of the nomination process. The shareholders are given a right to vote for or against the persons that the board nominated; they infrequently undertake an expensive proxy fight to appoint directors of their own choosing.

The only other body in the position of evaluating and choosing directors is the board itself. But most boards do not have any formal process of evaluating the performance of their members. Most do not even have criteria with which to evaluate individual directors. Most board members are nominated because they are incumbents, not based on what they did or did not do as a director.

To have an effective nomination process, it is advisable to have a Nominating Committee consisting largely or entirely of independent directors. If your bank or bank holding company is listed on one of the stock exchanges, it may be required, if proposed rule changes are made final, to have a nominating committee consisting solely of independent directors. The Nominating Committee can be the entity that considers the development and implementation of a director evaluation process, subject to Board approval.

There are two basic types of evaluation systems. One is a self-evaluation, which calls for each director to complete a questionnaire each year on his or her performance. This self-evaluation can be useful in encouraging a director to pay more attention to his or her duties, but it is seldom used to decide whether the director should be renominated.

The other type of evaluation system is where each director evaluates each of the other directors. Many companies, out of fear that the process will be disruptive, view this system with caution. Nevertheless, some institutions will find this system effective and useful.

For some community banks, the willingness of a director to do business with the bank and effectiveness in referring business to the bank is the person's most valuable attribute. If business development is considered an important element in the performance of a bank director, such performance is easily tracked and reportable to the board.

Other attributes are more subjective, but can be equally, if not more important. These include thoroughness of preparation for meetings; participation at the meetings; ability to work effectively with other board members and the CEO; willingness to further one's education and information base to serve more effectively as a director; and knowledge of the market, business of the bank, accounting principles, regulatory rules, corporate governance, and other aspects of overseeing the affairs of a bank.

Negative attributes should also be taken into account. Financial difficulties or negative publicity is not desirable for a member of the board. Any defaults or risk of default on any direct or indirect loans made by the bank to a director or his or her interests may require a director's resignation. Targeting by bank regulators of a director in any investigation or enforcement action may also provide grounds to a board to not renominate the person. Conflicts of interest with the bank that the board has not satisfactorily resolved may also cause a board not to renominate the person. Frequent absences from meetings of the board or any of its committees, or lack of engagement or participation may also justify not renominating the person.

Another entirely different approach is to evaluate the effectiveness of the board as a whole. This may be useful in deciding the proper level and forms of compensation paid to bank directors. A white paper on bank director compensation prepared by the benefits consulting firm of Clark/Bardes for AABD will be issued shortly and will be made available to AABD members without charge.

For a more detailed analysis of the nomination process, you should consult your copy of the September 1997 issue of Bank Director News, or order a copy from AABD on its website at www.aabd.org. You may also call AABD at (301) 320-0643.