Giving some teeth to independent directors

By: |
November 27, 2020 7:00 AM

Having Independent directors on the board will remain mandatory. the way forward is to strengthen the system surrounding their appointment & functioning

This should be put on the websites of the stock exchanges for public comments for 21 days.This should be put on the websites of the stock exchanges for public comments for 21 days.

In the article on Thursday (bit.ly/2V7yBzf), I had argued since independent directors (IDs) are substantially a myth, the focus needs to be on other entities, and some harsh measures. This is simply because, in listed companies, monies of crores of investors is at stake as also the growth of the economy, which significantly depends on the health of the capital market and mobilisation of household savings.

However, as the institution of IDs shall continue to remain mandatory, and if they are to play at least some of their expected role, the way forward is to strengthen the system surrounding their appointment and functioning. Some of the measures are outlined below. The caveat, though, is that none of this will significantly improve IDs bringing better governance.

One size does not fit all: In the existing context, one cannot have a single recipe for all companies: big and small, private and government, closely-held and widely-held, and professionally-managed and promoter-driven. ID requirements for each of these types should be carefully prescribed.

Minimum qualifications/experience: An appropriate business education qualification and/or a minimum experience in the corporate world has to be an essential eligibility criterion for all IDs.

Change the appointment process of IDs: One suggestion has been that the government should nominate IDs. This idea is fraught with several dangers and also impinges on corporate freedom, and thus, will also be strongly opposed by the promoters. On the other hand, since the corporate law is generally designed to give the largest shareholders the largest voice in choosing directors, it is hard to see how directors representing minority shareholders (or employees) could be elected to the board in the first place.

Appointment of IDs is a responsibility best vested with the board of directors. They should, however, be appointed only on merit and objective criteria. Non-promoter shareholders should be permitted to recommend names to the NRC, and reasons for rejections should be provided.

Importantly, there should be a public disclosure on how an ID has been shortlisted, his detailed profile and why is he being proposed, along with all his past and present relationship of any kind with the company, promoters, directors, major shareholders and management, all his present significant commitments as also the proposed remuneration. This should be put on the websites of the stock exchanges for public comments for 21 days. Public comments would only help the cause as any negative information will help prevent the appointment of inappropriate persons and consequential damage. Incidentally, prospectuses are also put up for public comments as are the shareholding patterns, financials et al. If so much importance is attached to the board, let its composition be governed by a good starting point.

Bring in demutualisation: The functions of the owner, chairman and CEO should vest in three different persons, with the chairman being compulsorily an ID.

Not wait for AGM: The present law provides for the appointment of a new ID as an additional director and to then obtain the shareholders’ approval, which could technically be 364 days later at a general meeting. So, a person is allowed to be a director without shareholders’ approval for almost a year! The postal ballot should be made mandatory before the appointment of an ID requiring approval by a majority of the minority.

Limit the number of directorships: To provide for the requisite attention, no person, including retired people, should be allowed to hold ID positions in more than two listed companies, including their subsidiaries. Promoters of listed companies or persons who are full-time employees in any listed company should not be permitted to hold even one ID position, as they have an existing responsibility, and shareholders deserve their undivided attention.

Revise the definition of relatives: The term ‘relatives’ needs to be expanded significantly, to include several levels of relatives, and include ones from the mother’s as well as wife’s sides as well.

Recognise relationships among IDs: If two IDs in a company are related to each other, only one of them should be deemed as an ID.

Ban payment of commissions: A cap on sitting fees is not desirable, and should be left to each case. However, the sharing of profits should be banned as it can lead to compromising independence. In fact, people, especially post-retirement, who offer to become IDs should see it more of a public service. If they are looking at remuneration, they should join as consultants, and thereby, also avoid liabilities, or still better, move to ‘vanaprastha’.

Do away with tests for IDs: The value of a compulsory test for IDs, not existing anywhere in the world, is also being increasingly questioned; is knowledge of some basic company law and Sebi regulations, and that too with a 60% pass mark, enough for corporate governance?

Do away with performance evaluation of IDs: This again has become another tick-box exercise. All evaluations have standard parameters like participation and contribution by a director, commitment, effective deployment of knowledge and expertise, integrity and maintenance of confidentiality and independence of behaviour and judgment. Almost all companies do self-evaluation; which becomes a non-exercise. External evaluations in any case are difficult as you cannot have an external evaluator to sit through a few board meetings. The annual reports of companies do not talk of what specifically emerged out of such evaluations; there is not a single case where a director was rated poorly.

Reduce the liabilities of IDs: As most IDs are ignorant of the deep functioning of the companies, they should be held accountable only if they have an explicit role in the commitment of any fraud, and should then be also debarred from holding any ID positions in the future. For all malpractices, as argued earlier, punishment should be meted out to the promoters/management.

Hold exit interviews of the IDs, especially those who resign prior to the expiry of their terms: There has been a spate of resignations of IDs in recent times. We have no clear answers as to why IDs resign. Despite the requirement of providing real reasons, most cite personal, health or pre-occupation, which we know is not true in majority of the cases. Anecdotally, professionals and retired bureaucrats resign when they see anything amiss as the fear of reputation loss and legal cases looms large.

No such resigning ID has ever played the role of a whistleblower. In reality, no one will give the real reason or cite improper action, when in discomfort; she will open up herself for investigations. She would also not like to be unkind to her friend—the promoter. Alarm bells should start ringing at such resignations, and the regulator needs to interact with IDs to identify the ills affecting the companies from which they have resigned.

Mandate negative impact analysis: For every agenda item at the board meeting, there should be a “Negative Impact Analysis on Minority Shareholders”. Each agenda item should also expressly list out direct/indirect benefit to the promoters/majority shareholders. The IDs should discuss these impact analyses and offer their comments, which should be recorded in writing.

Mandate a compliance committee: Each company should be required to have a board-level compliance committee whose sole mandate is to ensure compliance of all laws and regulations.

Prescribe/encourage the greater role of institutional investors: The Indian investment world has changed dramatically. From being retail dominated, we now have institutional investors emerging as dominant minority shareholders. Institutional investors have to play the governance role; they should be required to take proactive decisions on company agendas and disclose the same.

Make proxy advisory firms more relevant: When domestic institutional investors, which represent public monies (like mutual funds, insurance companies, pension schemes, etc), vote on an agenda item contrary to the advice of a proxy advisory firm, they should be required to make their reasons public.

Or …just make ID requirement voluntary: As a new model, it may be worthwhile to consider if the requirement for IDs can be made voluntary. Let the companies, who hire IDs, demonstrate the value these IDs will bring, especially to the minority shareholders.

PS: Incidentally, I recently asked promoters of ten companies whether governance had improved after IDs were mandated. Not surprisingly, the universal answer was “it is business as usual; only the costs on account of IDs have gone up”. Promoters will continue to have their say; they will always be smarter than IDs.

The author is Founder-Chairman , Prime Database Group
Views are personal

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