CNV3-I1-11-Identity
Introduction
Corporate Governance is been a topic of discussion since a decade and had witnessed lot of challenges in the last few years. The need for the Corporate Governance standards was realized soon after the economic reforms in 1991. The communication between countries has become easy due to globalization. Good Number of Indian Companies are registered on International Stock Exchanges. The investment by the International companies in Indian Companies necessitates a code of corporate conduct. Corporate Governance is a process which helps to maximize value for all stake holders, shareholders, investors, employees, customers, suppliers, environment and community at large.
In 1998, Confederation of Indian Industries came out with a voluntary code on corporate governance titled “Desirable Corporate Governance”, based on the recommendations of the task force under Rahul Bajaj. Corporate Governance defines the systems, rules, procedures through which the company is directed and controlled and helps to work in the best interests of the various stakeholders involved in the company. It rests on the key values of transparency, accountability and independence.
In 2000, SEBI came up with clause 49 of the listing agreement, which all the listed companies on a stock exchange need to sign, that dealt with issues of corporate governance based on the recommendations of the Kumaramanagalam Birla Committee. The clause dealt with issues such as protection of investor’s interests, promoting transparency, adhering to international standards of information disclosure etc. among others. It was subsequently amended under the recommendations of various expert committees like Naresh Chandra Committee and Narayana Murthy Committee.
The corporate governance procedure in the companies ensures more transparency, inclusivity, equity and responsibility. The present article focuses on the following:
§ Emergence of Corporate Governance in India
§ Role Independent Directors as per Companies Act, 2013 and Clause 49 of the Listing agreement
§ Are the Independent Directors really independent?
Emergence of Corporate Governance in India
Lot of Indian Organizations are family owned organizations and family members occupy the various managerial positions and take the key decisional roles. Hence the difference between the owners of the company and the company finances has disappeared. This created a necessity for the separation of management and owners. Corporate Governance ensures the protection of all the stakeholders involved without any personal interest of the promoters. Companies with good corporate Governance standards enjoy greater confidence in the stock market and customers eyes.
History of Corporate failures dates back to stock market scams of Harhshad Mehta, Ketan Parekh, Satyam Scandal, UTI scam etc which were seen as the outcomes of the failed corporate governance. Corporate Governance is necessary to build public confidence in the corporation which was shaken due to the above-mentioned corporate frauds. Reviving the confidence of the investors is the utmost priority.
Hence, the new companies Act, 2013 introduced several provisions to safe guard the investors and other stake holders involved. It has provisions related to Independent Directors, Board constitution, Audit committee etc. It is made mandatory that one-third of the board should comprise of Independent Directors, the board should have at least one woman director, constitution of the audit committee within the board.
Independent Director
In order to increase the effective functioning of the Board and having seen the yester year’s failures, recommendations of the committees have been focussing on the effective ways to maintain transparency and honesty in the corporate functioning.
The role of Independent Director asper Section 149 (6) of Companies Act, 2013 mentions that the person appointed should be a person of integrity and should not be associated with promoters’ holding or subsidiary company and should not have any pecuniary relationship with its holding or subsidiary company. The Law states that the independent director should take the moral burden of the company and protect the best interests of the company. He is the entrepreneur with no expectations and returns.
Role and functions listed under Schedule IV of the Companies Act, 2013 are as under:
The independent directors shall:
1. Help in bringing an independent judgment to bear on the Board’s deliberations especially on issues of strategy, performance, risk management, resources, key appointments and standards of conduct;
2. Bring an objective view in the evaluation of the performance of board and management;
3. Scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance;
4. Satisfy themselves on the integrity of financial information and that financial controls and the systems of risk management are robust and defensible;
5. Safeguard the interests of all stakeholders, particularly the minority shareholders;
6. Balance the conflicting interest of the stakeholders;
7. Determine appropriate levels of remuneration of executive directors, key managerial personnel and senior management and have a prime role in appointing and where necessary recommend removal of executive directors, key managerial personnel and senior management;
8. Moderate and arbitrate in the interest of the company as a whole, in situations of conflict
Independent Director under Clause 49 of the Listing Agreement
Clause 49 prescribes the following definition “Independent Director”. The expression ‘independent director’ shall mean a nonexecutive director of the company who:
a. Apart from receiving director’s remuneration, does not have any material pecuniary relationships or transactions with the company, its promoters, its directors, its senior management or its holding company, its subsidiaries and associates which may affect independence of the director;
b. Is not related to promoters or persons occupying management positions at the board level or at one level below the board;
c. Has not been an executive of the company in the immediately preceding three financial years;
d. Is not a partner or an executive or was not partner or an executive during the preceding three years, of any of the following:
I. The statutory audit firm or the internal audit firm that is associated with the company, and
II. The legal firm(s) and consulting firm(s) that have a material association with the company.
e. Is not a material supplier, service provider or customer or a lessor or lessee of the company, which may affect independence of the director.
f. Is not a substantial shareholder of the company i.e. owning two percent or more of the block of voting shares.
g. Is not less than 21 years of age
Independent Directors - Role Effectiveness...?
While we examine the Independent Directors roles in the above sections reiterated, they are expected to enhance the accountability of the board to the shareholders. They have to play the role of a watchdog and ensure to improve the credibility and standards of governance. The law states that Independent Directors should act in accordance with their fiduciary duties and protect the best interest of the company as they see fit in their individual judgement.
The challenge here is if the promoters will be able to listen to the independent directors who are criticising the Board performance. While the Tata Mistry Spat[1] happened, and the independent directors of Indian hotels came in support of Mistry, the Board was not in support of Independent Directors. The independent directors are expected by the law to take an independent judgement on issues of strategy and performance and key decisions. But the acceptance of the independent director’s independent judgement is still not clear. On the other hand, law also lays down the removal of independent directors by an ordinary resolution requiring a simple majority (at least 50 %).
The recent report on the Kingfisher Airlines case, the Serious Fraud Investigation office (SFIO) remarked on the independent directors who were a part of the audit committee for not questioning the Kingfisher’s accounting policy and they were unaware of their impact on profitability and financials. The Law states that the independent director’s role is to satisfy themselves on the integrity of the financial information, controls and systems of risk management are robust. The discharge of the duties by the independent directors here may not have been fully in compliance with law and its understood the precautions weren’t taken and hence the situation of the day with so many stakeholders affected. Are the independent directors acting as independent directors but were not really independent?
Independent Directors are rarely held liable in corporate frauds, but in the recent investigation of the Billionaire Jewellery Designer Nirav Modi, the assets of the Independent Directors were seized and the NCLAT dismissed the appeal by the Independent Directors of the Company who were high profile executives. The Law states that independent directors should help in bringing the integrity to the financial controls and safeguard the interest of the stakeholders. The magnitude of the financial fraud and the intervention by the independent directors to safeguard the interests of the stakeholders and risk management seems to be a failure here. The next question to ponder on is if the Independent Directors are appointed for only doing lip service? The responsibility to act with reasonable care, skill and diligence is defeated.
Independent Directors are expected to balance the conflicting interest of the stakeholders and safeguard the interest of the stakeholders as a priority. Jet Airways was grappling with the financial losses and turbulent situation and at the same time, two independent directors have resigned attributing the reason of inability to spend more time in the discharge of the responsibilities. The objective of the section is to enhance the role of the board s accountability to the shareholders which is defeated in the recent happening of the Jet Airways.
Another thought here is to understand the promoter’s readiness to accept the criticism of the Independent Directors on the Promoter Company’s Performance barring the fact that these are appointed by the promoters and paid by them. The appointment of the independent directors is by the promoters and pay the fees to them for becoming the critic on their performance. This demands a lot of acceptability, listening skills and reflective ability for the promoters and the key members of the business. If the Independent Directors fail to respond and stand up for the faulty reports, then the whole of the objective of the section is defeated.
It is a true fact to understand that the Independent Directors fail to stand up to the promoter’s decisions even they are against the interest of the majority stakeholders. On the other hand, there may be a fear of removal by the majority shareholders and hence they are not able to perform their duty with full conviction and confidence. The key challenges here for the road travelled and ahead are:
§ The knowledge and expertise of the independent directors in the promoter’s line of business and the impact of the performance is difficult issue to handle the responsibility of the stakeholders first. There are no guidelines as per this in the Section
§ The expectations on the performance of the Independent Directors is far exceeding with their zero role in day to day operations of the business of the promoters.
§ The magnitude of the role of independent directors on monitoring of the board performance versus the time availability to them is to be considered. The Independent Directors are also having their own profession /business and that was ignored. The responsibility here is as good as running his own business and as a consequence for; their reputation may also be at stake.
§ It’s worth to understand that if the independent directors were acting as “yes men” to the promoters or be able to justify their role defined in law.
§ Having one-third of the Board of Directors in the board and half of them do not show up for the meetings and the rest do not speak their mind, will not be helpful for the honest corporate governance standards.
§ Their role appears like sitting on a multi-edged sword with so many constraints to exercise their independent judgement.
Exit before the tenure
The recent data collected by Prime Database[2], a primary market research tracking firm, 743 Independent Directors have quit of the boards of Nifty-listed firms in 2018. 561 Independent directors stepped down without adequate reasons before the end of their term. The number of independent directors exiting without citing adequate reasons has been growing year on year. Also, we have witnessed a considerable number of Independent Directors resignations immediately after a fraud is reported in their serving companies. Unless the directors are truly independent, the collective wisdom of the board will improve the quality of the performance.
The Road Ahead …………
We have seen a bumpy road in the journey of corporate governance since the last few years. It’s the time for us to relook at the independent directors’ role with the new Companies Act, 2013 and its effective functioning. The objective was to safeguard the interests of the investors, shareholders and the community at large. However, we have seen the failure of the same and loss of investor’s confidence. The introduction of the provision fails to meet the practical reality. Time has come to audit the success and failure of the provisions and should try introducing the effective provision where there is no escape for the wrong doing. How far are we successful with the enhanced role independent directors to safeguard the interests of all the stakeholders involved? The law abiding and respecting corporates are falling short in the Corporate India and the obvious reason for so many failures.
As Mr. Narayana Murthy[3] mentioned in one of his interviews,” Good Corporate Governance is the foundation on which strong companies are built, if we lose transparency, fairness and accountability, that is the path to quick destruction”
[1] https://www.bloombergquint.com/opinion/indias-corporate-governance-problem-continues
[2] https://www.livemint.com/Companies/bntAau6XcAhPfTZ5yCVx7O/Why-independent-directors-arerushingfortheexit-door.html.
[3] https://www.economictimes.indiatimes.com/articleshow/60131531.cms?utm_source=contentofinterest& utm_medium=text&utm_campaign=cppst.
Prof.Vasantha Lakshmi and Dr.Snigdharani Mishra
Faculty ITM Business School, Navi Mumbai