SEBI must ensure effective management, good governance are valued in board composition – The Economic Times

Clipped from: https://economictimes.indiatimes.com/news/company/corporate-trends/view-sebi-must-ensure-effective-management-good-governance-are-valued-in-board-composition/articleshow/81854476.cms

Synopsis–Over the past decade, IDs have grown in stature and voice. Most well-run listed companies have IDs who add genuine value to the business through their managerial or subject expertise. A host of governance measures and regulatory interventions by Sebi have made the board processes fairly robust

On March 1, the Securities and Exchange Board of India (Sebi) released a new consultation paper on independent directors (IDs). That it has adopted an industry-friendly approach of building consensus before making changes in its laws is welcome.

A significant fallout of the greater emphasis on transparency and corporate accountability has been the emergence of the ID and the value attached to them. In the 1980s-90s, company boards were typically filled with friends and well-wishers of the promoters, with board meetings being largely ceremonial affairs. Business was rapidly dealt with affirmative votes on every point on the agenda, and they were more social gatherings with no queries raised, and all matters adopted without discussion.

Declaring Independence

Fast forward to the present, and it’s the same conglomerate, some of the directors still remain. But there are many new faces now, many of them women. The board meeting begins with the usual pleasantries exchanged, but that’s where the similarity with the past ends. Meetings last hours, and every single item on the agenda is discussed threadbare, policies are formulated, proposals are discussed.

Over the past decade, IDs have grown in stature and voice. Most well-run listed companies have IDs who add genuine value to the business through their managerial or subject expertise. A host of governance measures and regulatory interventions by Sebi have made the board processes fairly robust. IDs now constitute 50% of most boards. The audit committees with a majority of IDs exercise close scrutiny over all material transactions and decisions. IDs even have their own mandatory meetings where they critique the management and assess the overall board process and conduct.

Invaluable as they have become, the search for suitable IDs can be an arduous exercise. In trying to achieve a balance between strategic focus, domain expertise, commercial acumen and financial knowledge, boards often find it difficult to align various features and find the right person. It is also important to find candidates who can devote time to develop a deep understanding of the business. Moreover, there is a reluctance among senior professionals to take up the onerous responsibilities IDs cast on them. The requirement of a director to also have the ‘right cultural fit’ adds to making the search of this species never-ending.

It is in this light that one must assess the new consultative paper. It deserves serious scrutiny to understand its feasibility, and the difficulties that may be faced in its implementation.

One important proposal is the provision of a cooling-off period before an associated person can be classified as independent. This period of three years is a healthy practice that should be continued for employees and relatives. However, the existing two-year cooling-off period for others who have had any sort of material or pecuniary relationship with the company is already impacting selection from a cross-section of potential candidates like auditors, lawyers, strategy consultants and technical experts.

Extending this to three years seems uncalled for. Not getting their services on the board during their best years would be a loss to industry. Adding them as non-IDs would often not be possible, as it would upset the statutory requirement of 50% ratio of IDs.

Perhaps the most radical recommendation is the one pertaining to the shareholder approval for appointment and removal of IDs. A dual voting mechanism in which minority shareholders will vote separately, and would need a 50% majority of the minority to appoint has been proposed. This suggestion is fraught with many practical problems. The effort and time put in by the chairman and nomination and remuneration committee members to scout, shortlist, interview and select a candidate takes months.

There is a good possibility that the qualities of the person for directorship are not sufficiently appreciated by shareholders who have no prior knowledge of the person, and may opt to vote against him or her, merely because they are not aware of their competencies or ‘have not heard’ of the candidate earlier. Second, it is also a loss of reputation for a candidate not voted in for reasons that may not be sound. Third, compliance difficulties would continue to increase if meetings have to be conducted again after 90 days for fresh selections.

An alternative solution would be to have the existing IDs hold a meeting only among themselves for approval of a new ID, after which it follows the existing system of all shareholders voting. A similar system could be followed for removal of IDs, instead of the dual system as proposed in the consultative paper.

Seeking Accommodation

The appointment of directors as additional directors and for filling casual vacancies is also proposed to be changed. This takes away a very good process currently followed. The ability to appoint additional directors subject to approval of shareholders at the next annual general meeting (AGM) enabled immediate strengthening of boards and in filling up casual vacancies. With these requiring prior shareholders’ approval as suggested in the Sebi draft, the options available to companies are to either wait till the next AGM, or incur additional burden of holding a shareholders’ meeting in the interim. In the current already-packed scheduling of board meetings, this could become cumbersome.

The suggestions for composition of an audit committee with no relatives of promoters is welcome. It will improve governance standards without impeding efficiency. Also, the process for resignation of IDs is sought to be made more robust. Usually, directors resign for 3-4 reasons. One, when they aren’t happy with the level of corporate governance being practised. Two, when moving on to a larger and more remunerative company. Sometimes, it’s due to paucity of time or for health reasons. However, far too many directors cite personal reasons and offer no further explanation. The new proposals are intended to bring greater transparency into reasons behind resignations.

The new provisions, however, seek to add a one-year cooling-off period for transitioning from an ID to a whole-time director. This is too restrictive.

Remuneration to IDs is presently done in the form of sitting fees and commissions. The system is transparent and working reasonably well. There are caps for sitting fees and shareholder approval thresholds for commissions. A new suggestion of employee stock ownership plans (Esops) has been mooted. While Esops can be effective, its drawback is it becomes unduly long-drawn. Directors should be remunerated in the short term for time spent. So, a better solution would be to add the option of Esops to the existing remuneration mechanisms, rather than making it the only option. There is also a case for increasing the limit for sitting fees from ₹100,000 to ₹300,000.

Sebi’s efforts have gone a long way in improving governance in the past. One can be sure that many fora of industry will suitably represent their views so that effective management and good governance are equally weighted.

The writer is chairman, RPG Enterprises

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