One could put efforts to introduce good corporate governance as just one of the seemingly endless efforts to bring company management to book in terms of their accountability to the shareholders for whom, shedding away the corporate veil, they work. Several scams have heightened the cynicism in the capital markets over the benefits of the corporate entity having a large public share holding. It was felt thatlaws are followed only to the letter and hence were inadequate to deal with issues where management act to the prejudice of the shareholders and other stakeholders. Encouraged by the good response and experience in the West of measures for good corporate governance, a formal effort is now taking place in India.

Sebi, will soon lay down guidelines which will have to be followed by listed companies of a particular size. The draft report by the committee appointed to study this matter and make recommendations is worth considering.

A fundamental issue rightly discussed by the committee is what would be the nature of the guidelines and how should they be approached and followed. It has been realised that framing the guidelines as a formal law would not be the right approach since they would be followed only in the letter and not in spirit. At the same time, guidelines which are merely recommendatory or optional will have no meaning in the larger context. Hence, firstly, it has been provided that theguidelines will have a legal status.

However, it has been emphasised that the guidelines will have to be observed in their spirit and substance will have to prevail over form. Having said this, the report makes most of the recommendations mandatory and some voluntary. Further, a timetable has been given for companies to gradually implement the guidelines. A cut-off limit has also been laid down and companies having a paid-up capital of less than Rs 5 crore will not have to mandatorily comply with the guidelines.

An important mandatory requirement is that relating to composition of the board of directors and, in particular, to the extent to which it will have non-executive and independent directors. In all cases, it has been required that 50 per cent of the board should comprise of non-executive directors. The objective appears to be that the executive directors who are concerned with the day-to-day management of the company should be balanced by non-executive directors many of whom may beprofessionals.

Apparently, keeping the percentage as 50 would be to ensure that decisions cannot be taken where all the non-executive directors are against the proposal. Of course, if this is really the intention, it may be defeated by a simple provision that the chairman, who may be an executive director, has a casting vote whereby he would defeat any resistance by even all the non-executive directors acting together. An appropriate amendment in the law would be necessary to avoid this.

Further, one may ask the question that what stops the management from putting its own supporters as non-executive directors. A partial though unsatisfactory answer lies in the second part of this recommendation regarding the inclusion of independent directors in the board. It has been provided if the chairman is also an executive director, at least half of the board should consist of independent directors. If the chairman is a non-executive director, it will suffice if one-third of the board consist of independentdirectors. Here again, the casting vote which the chairman usually has may defeat this requirement.

Further, the logic of having a far lesser number of independent directors when there is a non-executive chairman is not clear. Note also that it is also not required that the chairman should be an independent director and the distinction is made on whether or not he is an executive director. However, from a reading of the definition of an independent director, the intention appears to be that executive directors would not be independent directors.

As regards the issue that the non-executive and even the independent directors may be really stooges of the promoter or management, the report does not further deal with this matter. Interestingly, practically all international corporate governance reports, on which the report in India is largely based, specifically address this issue by having a nomination committee whose purpose is to decide who would be appointed as a director. The whole concept of nominationcommittee is conspicuous by its absence in the draft report.

One of the most controversial and perhaps unwarranted recommendation is as regards nominees of financial institutions and other major shareholders on the board. The report recommends that such major shareholders should not nominate their persons as directors on the board. Rather, they are asked to merely have an active interest in the company and should make only make use of their voting power in general meetings. One can understand the peculiar history of financial institutions in India who as the sole provider of finance ended up holding large chunks of shares in many leading companies.

Hence, companies are unwilling to grant them the full role their shareholding demands. But, with the greatest of respect, it is submitted that this is one issue which needs to be resolved separately and has nothing to do with corporate governance. Asking such financial institutions and other large shareholders such as mutual funds not to seek a position in theboard would defeat shareholder activism that has played such an important and successful role in protecting the interest of the shareholders as a whole in the West. It must be realised that institutions hold a very large percentage of shares in the West and this trend is also taking place in India.

It is submitted that the issue regarding what should the institutional shareholders do and what they should not do should simply not be dealt with and the recommendation be simply dropped.

(To be concluded)
The author is a Mumbai-based chartered accountant