The Companies Bill is hazy on reappointment of independent directors and network audit firms

Of course, as a voting advisory firm, we ask shareholders to vote against merging unlisted companies belonging to the ?promoter family? with a listed company, with the sole object of increasing the families? control. Of course, we ask shareholders to vote against resolutions where the family wants the 23-year-old princeling not just on the board, but as a working director. Of course, we ask shareholders to vote against the increase in royalty payments being hoovered by the global owners despite competitors in the Indian market growing at a more furious pace and more profitably. And while this list of corporate transgressions we caution against is a lot longer, for the most part we have advised shareholders to vote against the reappointment of auditors and against the reappointment of independent directors.

This should not surprise. Related party mergers, appointment of successors, royalty increases happen only on the odd occasion for each individual company. But each year companies propose reappointing auditors and each year they propose appointing new and reappointing existing directors. It?s the frequency of such resolutions which accounts for our statistics; it?s this same routineness that ensures these resolutions are taken least seriously. So you find directors who have remained independent for 26 years, directors in all four listed group companies being called independent, accountants who started a practice only to audit a firm and in one instance one who has audited the books for over 50 years.

Why do companies carry on with existing auditors? Companies argue that the replacement costs for auditors will become significantly high and far outweigh any transparency benefits that may result from the change. They maintain that businesses nowadays are far more complex and the audit process requires a fair degree of familiarity with the internal processes, systems and key risk areas of the company. Periodic rotation, therefore, will not achieve the intended results and, conversely, may end up reducing the audit quality. But if audit integrity is desirable, so should the need to change auditors. Vintage auditors tend to develop a certain level of comfort with the company management, thereby compromising the integrity of the audit process. Mandatory rotation will not only bring a fresh perspective on the financials, it keeps the existing auditors on their toes as they will be aware that a new auditor may detect any irregularities in the accounting process.

In a survey regarding governance, investors indicated that quality of financial reporting is the most important parameter while deciding whether to invest in a company. Hence, any doubts regarding the integrity of the audit process creates a negative perception in the minds of investors. Breaking this existing relationship between companies and their auditors will be a critical step towards raising the corporate governance standards in India.

No one questions the need for non-partisan directors. Yet while reappointing independent directors, companies prefer to remain within their comfort zone. But this rationalisation rests on fragile foundations?there are no quality people to join the board? Further, given the ownership overhang, investors choose to go with the controlling shareholder largely because they see a strategic alignment of interest between the controlling and public shareholders. But as the interest of the controlling shareholder may at times diverge from the other investors in the company, the board needs to safeguard minority investors. And this precisely is why the independence of the board is crucial. At the risk of generalising, it?s safe to assume that the length on the board is inversely proportionate to a directors? independence.

The good thing is that both?lengthy occupancy of the board and extended audit tenure?are set to change. The new Companies Bill has defined independence and said that directors who have served for more than 10 years on a board can no longer be considered independent. If companies nonetheless value their advice, they can continue with them on the board, but must not classify these directors as independent. To maintain the statutory mix of independence and non-independence, boards will need to infuse fresh blood. Regarding long serving auditors, the Bill advocates rotation after five years with the flexibility to extend it to 10, after which there is a mandatory cooling off for five years.

Before we conclude change is here to stay, it?s worth remembering that the Companies Bill is yet not law. And then there is the matter of small print. For reappointment, the Bill is silent on the existing tenure. So an independent director on the board for 12 years can end up with serving on the board for another 10 more as an independent director. As regards the auditors, the Bill does not recognise ?network audit firms?. For example, Price Waterhouse & Co, Lovelock & Lewes, RSM & Co, Dalal & Shah are all under the Price Waterhouse Coopers? audit network, but are treated as independent. So auditors and board appointments can continue happening within the owners? comfort zone.

The author is managing director, Institutional Investor Advisory Services India, an advisory firm dedicated to providing participants in the Indian financial markets with voting recommendations on shareholder resolutions, independent opinions, research and data on corporate governance issues