In recent years, ASX-listed companies have increasingly chosen to disclose their board skills matrix, providing transparency regarding the skills, background and experience of those on the board. However, as contemporary organisations grow increasingly complex, a board skills matrix may not provide the degree of evaluation required to ensure the board is best equipped to fulfil its directors’ duties.
In their recent research paper for the Actuaries Institute, former Australian Prudential Regulation Authority (APRA) deputy chair Ian Laughlin and former president of the Actuaries Institute Barry Rafe considered whether the misconduct revealed by the Banking Royal Commission was enabled by directors who failed to understand the businesses they directed.1
Their discussion reflects the importance of ensuring directors are equipped with the appropriate skills into the spotlight. While the primary focus of their research paper was complex financial services businesses, it is becoming clear that ensuring that a board has the ‘right’ mix of skills to undertake their duties is relevant to all boards.
In their paper, Laughlin and Rafe suggest that in the complex financial services industry directors must:
- understand how the organisation makes money i.e., be financially literate; and
- understand the financial and non-financial risks inherent in the business.
These observations are absolutely aligned to the directors’ duty to act with care and diligence, contained in section 180 of the Corporations Act. In a practical sense this means each director must:
- become familiar (and maintain familiarity) with the fundamentals of the business of the organisation; and
- maintain familiarity with the organisation’s business and monitor its financial status.
The observations by Laughlin and Rafe are further aligned with the directors’ duty to prevent insolvent trading (Corporations Act, s. 588G), under which each director must apply their own minds to the organisation's financial statements and situation, rather than relying solely on advice.
How a skills matrix can limit a board’s ability to fulfil directors’ duties
Beyond the complex financial services industry, however, the underlying question Laughlin and Rafe’s paper poses are relevant to all organisations covered by the Corporations Act – do the directors possess the skills necessary to effectively meet the obligations imposed upon them by their directors’ duties?
In a practical sense, this leads to two key questions:
- What skills does the board need to ensure they can deliver upon their directors’ duties?
- How does the board know if they have these skills?
Many boards we deal with contend that they have answered these questions as they have developed a board skills matrix. This approach can fall short for a number of reasons:
- Put simply, boards don’t know what they don’t know. Research suggests that people are not aware of their errors of omission.2 If an individual is not aware of all options, they will base their assessment only on those things of which they are aware. The recent papers and outputs from inquiries and Royal Commissions have redefined the skills required by directors of a contemporary board. This list of required skills has evolved and continues to evolve. Few directors will have informed themselves about the changes in the skills identified in a contemporary board skills profile. This weakness in self-assessment is often compounded by the fact many boards do not take the time to actively consider the skills profile which they desire.
- Self-assessment is often based upon the perception of individual directors. It has been argued that if people make self-judgments in the absence of agreed criteria they are free to judge themselves in a flattering way.3
Best practice for evaluating a board’s skills
Boards should regularly undertake an independent skills assessment that addresses these deficiencies inherent with self-assessment, through:
- An externally facilitated board discussion that supports the development of a desired board skills profile reflecting both skills prioritisation and the number/level of capability of directors with those skills. This workshop should draw upon the knowledge of the entire board and provide the board with contemporary guidance on how the board role is evolving.
- A self-assessment process that provides well-researched skills definitions and criteria to facilitate an informed self-judgment. The definition of skills should provide clear guidance in relation to what defines each level of competence.
The key message is that the skills required of a modern board have evolved and an internal skills matrix is not sufficient to ensure the board is equipped to deliver upon its directors’ duties. Only through taking the time to commit to an independent skills assessment process built upon clear, rigorously-researched skills definitions can a meaningful assessment be completed.
1 Laughlin, I. & Rafe, B. 2021. ‘Was the misconduct revealed by the banking Royal Commission enabled by directors who did not understand the business they directed?’, paper presented at 2021 All-Actuaries Virtual Summit, viewed 20 October 2021, https://actuaries.logicaldoc.cloud/download-ticket?ticketId=a7e04fbf-c13c-4cc9-ad72-3541760b6b86.
2 Caputo, D. & Dunning, D. 2005. ‘What you don't know: The role played by errors of omission in imperfect self-assessments’, Journal of Experimental Social Psychology, 41(5), 488-505.
3 Carter, T. J. & Dunning, D. 2008. ‘Faulty self-assessment: Why Evaluating one's own competence is an intrinsically difficult task’, Social and Personality Psychology Compass, 2(1), 346-360.