In June 2017, the Securities and Exchange Board of India [SEBI] had set up a committee under the chairmanship of Uday Kotak, Kotak Mahindra Bank to advise it on issues relating to corporate governance in Indian companies.
In its report submitted on October 5, 2017, the committee has recommended (i) more active ‘role’ and greater ‘autonomy’ for independent directors; (ii) at least half of the board of a listed entity be constituted of independent directors and increase in their number in the board to a minimum of six in every listed entity, with at least one woman independent director; (iii) promote ‘transparency’ in their functioning via listing ‘competencies’ of every independent director and disclosure of the detailed ‘reasons’ for their resignation; (iv) make formal induction of a new independent director mandatory and (v) top 500 companies by market capitalization to undertake D&O [Directors and Officers] Insurance for them.
The committee has also recommended that (vi) board of directors be updated on regulatory and compliance changes at least once in a year; (vii) frequent interaction between non-executive directors and senior management, at least once a year; (viii) splitting the Chairman and MD-CEO roles of the listed firms (ix) increase in Audit Committee meetings to minimum five every year and (x) discussion on succession planning and risk management at least once a year.
The committee has also proposed (xi) establishment of a framework/institutionalized mechanism for sharing of information on deliberations in the board meeting with the promoters in a transparent manner.
The recommendations of the Committee need to be viewed in the backdrop of corporate governance in India reaching a new low in recent years more so at the two large industrial houses viz. Tata Sons and Infosys. Both the houses have witnessed flexing of muscles and interference by the promoters/owners in the functioning of companies not just in policy formulation and giving broad direction but also, in their day-to-day affairs.
At Tata Sons, last year, this muscle flexing degenerated to such low that its then Chairman, Cyrus Mistry was removed in a surreptitious manner. This was followed by his removal from dozens of companies controlled by Tata Sons. While, taking such decision, the views of independent directors were ignored [in fact, some directors who opposed removal were punished]. At Infosys, its owners ran a sustained vilification campaign against the then CEO and MD, Vishal Sikka thereby forcing him to submit his resignation.
While, happenings at these two conglomerates have hogged media limelight, there are numerous other instances of democratic norms being thrown to the winds in corporate board rooms to the detriment of shareholders particularly, minority shareholders who have heavily invested in those corporate. Therefore, it is only apt that independent directors who are custodians of public interest are empowered and given greater say in management decisions. The committee has also proposed safeguards to ensure that they are made accountable for their actions and there is transparency in their appointment and removals. Commensurate with their increasing role and responsibilities, the provision of D&O insurance for them makes eminent sense.
Further, to ensure that independent directors are well informed and able to take right decisions, they need to have frequent interaction with the senior management who is also expected to update them on changing regulations and compliance thereof as also developments having a bearing on critical performance indicators such profit, return etc . Increase in number of audit committee meetings is aimed at enhancing the accountability of the management. The committee has made appropriate recommendations in this regard.
A board dominated by independent directors and its proactive engagement with audit committee and senior management can also help prevent siphoning off/diversion of funds to entities related to the promoters – a practice widely prevalent in corporate world.
A serious malady afflicting the corporate sector including public sector undertakings [PSUs] relates to merger of the posts of Chairman, Managing Director [MD] in to one or CMD in short. In a fundamental sense, the two positions have entirely different set of functions associated with each. While, the former in his/her capacity as leading the board of directors formulates policies, gives directions and exercises a supervisory role, the latter implements the policies and conducts the day-to-day affairs of the company.
When, these two fundamentally different positions get merged to create a single CMD post, this leads to an anomalous situation whereby the person who formulates policies is also in charge of their implementation; a person who is expected to supervise only, also runs the affairs of the company; a person who is expected to hold the management accountable, sits in judgment over himself/herself.
Invariably, the Chairman of a company is either the promoter himself [e.g. in Reliance Industries, it is Mukesh Ambani] or a person nominated by him. For a PSU, it is a nominee of union government in case of central PSU and state government for a state PSU. If, the owner/promoter is also in-charge of running the company, the operations are bound to get biased towards advancing his own interest which may be out of sync with the interest of investing community at large.
In PSUs, this results in interference by bureaucrats and politicians in concerned administrative ministry [and other relevant ministries such as finance or home] to curry favors albeit at the cost of national exchequer. Even though, with separation of Chairman from MD post, there is no guarantee that interference will stop, but CMD dispensation is clearly much more vulnerable.
In this backdrop, recommendation of the committee to split the post of Chairman and MD will galvanize the concerned persons to focus exclusively on their respective roles, enhancing accountability of the management and reducing intervention by the promoter/owner thereby ensuring more rewarding outcomes for all stakeholders including minority shareholders.
In a nutshell, the package offered by Kotak committee will help immensely in improving corporate governance standards. Having taken the initiative, SEBI should not drag its feet and immediately act on these recommendations.