Developing an effective Governance Self-Assessment Instrument

Dr. Simon Grima [1] and Dr. Rebecca Dalli Gonzi [2]

Stakeholders’ (of both private and public organisations) trust in the effectiveness and ability of the Board of Directors (‘BOD’) depends on factors such as transparency and clear accountability. Therefore, measuring the effectiveness of these factors is essential. However, how can we do this and against what benchmark/s? Should we consider a one-size-fits-all or should we consider proportionality?

Following the 2008/09 financial crisis and the current pandemic crisis (COVID-19), politicians and regulators have imposed, and are imposing, stricter regulations and intensified supervision in relation to governance, especially on the financial services sector within the EU. They believe that the failure in governance, especially in the financial sector, has led to past and current problems.

This has brought, and is having, an adverse effect on the economy, stifling creativity, the ability to ensure continuity, and innovation. More responsibility is being placed on the BOD, especially the non-executive board members, who need to oversee the organisations and its management, with the aim of ensuring that none of these are taking excessive risks beyond the appetite and tolerance of the stakeholders (Grima, 2012).

However, risk-taking is essential for development and sustainability whilst over-emphasis on inflexible prescriptive requirements/policies may constrain their risk appetite to a lower threshold. Therefore, it is vital to ensure (but not abuse) the application of the principle of proportionality when assessing BOD effectiveness (Grima, 2020) (Grima et al. 2020)

Board Effectiveness Practices and Instruments
Various academics have attempted, based on best practices, to answer these questions, and to develop, and validate  “Governance Self-Assessment Instruments (GSAI)”, to help BODs in evaluating their own performance. For example, Bradshaw, et al. (1992a) suggested that effectiveness depended on “three objective measures” 1) “input effectiveness”: the ability to obtain essential resources, 2) “throughput effectiveness”: the efficient use of resources and 3) “output or outcome effectiveness”:  successful achievement of objectives. They found the best BOD effectiveness predictors to be “engagement in strategic planning, a CEO-led common vision, meeting management, a pro- change core group, and low levels of internal conflict”. Stone, et al. (1999), from a broad review of literature, found that having a Formal Planning Process results in better BOD effectiveness.

Cutt et al. (2000), identified “two basic kinds of evaluation standards: absolute standards and relative standards” (p. 33). The first is a measure of the ability of the organization to reach objectives and the latter is a comparison of the results to similar benchmark organisations. Gill et al. (2005), uses an instrument of 144 items organized into twelve subscales, designed to determine the relative strengths and weaknesses of the BOD effectiveness. BOD involvement in Policy formation, strategic planning, program monitoring, financial planning and control, resource development, board development, and dispute resolution” were highlighted by Green et al. (1996) as predictors of strong performance in organisations. This as Herman, et al. (1997) note, the more effective the BOD is and the larger number of commended BOD practices used, the more effective is the organisation. Jackson, et al. (1998) noted a high correlation between the BOD effectiveness scores on the contextual, educational, interpersonal, analytical, political, and strategic competences and financial performance. Nobbie et al. (2002) found a significant relationship between abiding by recommended governance practices issued by the National Centre for Non-profit Boards (1999) and the Policy Governance model (Carver, 1990) and five organisational effectiveness measures (i.e. goal achievement, financial ratios, resource acquisition, internal processes, and CEO job satisfaction).

The Organisation for Economic Co-operation and Development (OECD, 2004) highlight that, in order to provide a structure and roadmap for setting, attaining and monitoring objectives, governance within any organisation, must involve some kind of relationships between the BOD, the management, and any stakeholders. They note that an effective governance framework calls for an “appropriate and effective legal, regulatory and institutional foundation” which will normally include binding (regulations) and voluntary limits and parameters (standards and internal policies). The latter, would usually vary by company and usually as corroborated by Arnwine (2002), is the result of a behaviour, culture, experience and tradition of an organisation, because failures are mostly caused by unwelcome behaviour and morals rather than bad structures.  He argues that operating within guidelines of values and responsibilities requires that one has respect for the organisation, the management, the employees, other board members, is transparent about any conflict of interest, being proportionate in decisions and supporting majority opinions and decisions.

The Financial Stability Board (FSB), (2017), note that an effective BOD will monitor a company’s governance practices and make changes where necessary. They also highlight that most regulators’ effort and enforcement focusses on the BOD themselves and thereby miss the objectives put in place through the overall governance framework. They tend to micro manage using a one-size-fits-all approach and ideology about BOD member suitability. They also believe that putting the responsibility for a governance framework on the BOD is enough incentive for them to ensure effectiveness. They show that effectiveness results if the BODs oversee and ensure “(a) ‘Succession Planning’, (b) that there is a nomination and appointment process, (c) the management of and addressing of potential conflicts of interest, (d) the integrity of accounting and financial reporting systems and (e) objective and independent judgement” (FSB, 2017) (Grima et al. 2020).

The issue of appropriate behaviour is often discussed in matters relating to BOD effectiveness. Arnwine (2002), defines this concept as operating in accordance with the roles and responsibilities of the BOD, implying having respect for the company, the management, the employees, and other board members, being transparent about any conflict of interest that any board member might have, being able to distinguish in a timely manner between what matters and what is trivial and supporting the majorities opinion and decision taken to meet objectives.

Becht et. al., (2005) suggest that that there is no evidence to prove that one form of governance is superior to the other in ensuring effectiveness. Moreover, they explain that even though the financial and regulatory systems show superiority over what are the best guidelines for efficient governance, the effects are still puzzling and a one-size-fits-all governance regulation would definitely not be appropriate. They contend that diverse types of governance requirements for different industrial sectors and stages of their development are necessary. Similar views were expressed by Baldacchino (2013),Baldacchino et. al., (2017), Bezzina et. al., (2014a), Bezzina et. al., (2014b).

The Development of the GSAI
After delving into both academic and grey literature, discussions with practitioners and analysing the pros and cons of the findings and suggestions, two GSAI instruments were developed by the authors together with others. These are the FORTE Model developed by the Public Risk Management Organisation (PRIMO) (Kruf, et al. 2019) and the DALI Model developed by Dalli Gonzi, et al. (2019). They are designed to include a set of governance best practices to serve a self-diagnostic of good and effective governance practices and to serve as a tool for educational and governance improvement purposes. Also, with these tools the BOD members and Management would be able to benchmark their effectiveness in a timely manner.

Moreover, in addressing these GSAI instruments as suggested by Gill et al. (2005), care was taken to ensure that the instruments were “simple, easy to use, transparent, comprehensive, relevant and provides interpretive reporting”.

The FORTETM Model

This model is structured around the FORTETM acronym as themes, ‘Financial and compliant design’, ‘Object orientation and delivery’, ‘Responsibility and stewardship’, ‘Tools and processes for creation’ and ‘Environmental awareness and interaction’, with 5 statements under each theme to which participants are required to assess themselves using a 5-point Likert-scale ranging from “Strongly Disagree” to “Strongly Agree” (Kruf, et al. 2019). Vide Appendix 1 for Model.

Element 1: Financial and Compliant Design – relates to the finances being focussed on the creation and delivery of values and on this being in line (compliant) with voluntary and mandatory requirements (procedures, policies, rules, directives, rule of law and regulations).

Element 2: Object Orientation and Validation – This relates to the orientation of the actor on its object and validation of its state in connection with the value to be delivered.

Element 3: Responsibility and Stewardship – This relates to trust building and security by empowerment, communication and team approach as opposed to the silo approach.

Element 4: Tools and Processes for Creation – This relates to understanding the needs of the organisation and ensuring that there is the capacity to achieve objectives.

Element 5: Environmental Awareness and Interaction – This relates to the understanding and awareness of the internal and external (wider) environment of the organisation.

FORTETM can be used for understanding, diagnosis and corrective action and governance redesign. That is to design or improve the governance related to a specific value. “This can be a concrete output target, an outcome, a state of resilience of the object involved, the process of governance itself or even the position of the actor itself”.

However, one should ensure that before setting the model, an introductory set of questions need to be asked “in order to frame the problem, the actor, the value and the object and the main focus of governance:

  1. What is the actual issue? Is there a problem? And what is the problem leading to? Why should we act?
  2. Who is the actor in charge of the value?
  3. What is the value, which should be delivered?
  4. What is the expected risk (deviation from desired value)?
  5. Who is the object the value should be delivered to?”(Kruf, et. al. 2019)

The DALI Model
The DALI model is a tool for financial institutions and most sectors in commerce, to identify the appropriate risks and effectively manage them to reach their company objectives. Using four thematic elements presented in the form of a Preparedness Index, the tool addresses your ‘Network and Policy Feedback’,  ‘Service and Process Improvement’,  ‘Resource and Governance’ and the ‘Connection to the system’ (Dalli Gonzi et al., 2019) which is the immediate awareness of crisis internal to any department.

When tested, higher DALI Model scores were recorded for those financial firms who were better able to identify the appropriate risks (Dalli Gonzi et al., 2019). In getting towards desired objectives, one should address the following questions:

  • Can management practices continue to exist and support operational environments, even when unexpected circumstances affect their day to day operations and processes?
  • Can the firm promote a just-in-time response?
  • Can the firm identify the strain under which it is operating?

It is critical to recognise when a limit is reached. Building situational awareness is key to any responsive change plan. In a time-urgent situation, an approach which requires achieving balance between control and autonomy is needed within a constant demand for satisfactory performance. The problems that will warrant recovery in this case are leadership (at different layers in the organisation), integrity in financial transactions and maintaining stability through fast changing markets (Vide appendix 2 for Dali Model).

Conclusions
Both these models were validated by statistical analysis on the responses to the model statements by a sample of 433 participants from organizations within small EU Jurisdictions (that is jurisdictions with a population of under 3million) in the case of the FORTETM model (32.6% Public Organizations, 67.4% Private Organizations) and on 2343 participants from financial services firms in the case of the DALI model ( 16.5% worked in credit institutions (banks) and 83.5% worked in other institutions).

Further research on the connection between these GSAI models and BOD effectiveness needs to be encouraged, even in different sectors of the economy, especially given the precarious situation we are currently in due to COVID-19. The elusiveness of the quest for standard, practical, and validated measures of governance effectiveness suggests that it is expressly rewarding to also use these models in organizations that are already using some kind of other models for testing and validating Governance effectiveness.

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[1] Head of the Department of Insurance, Faculty of Economics Management and Accountancy, University of Malta, Malta. simon.grima@um.edu.mt

[2] Department of Construction & Property Management, University of Malta, MSD 2080 Msida, Malta; rebecca.e.dalli-gonzi@um.edu.mt