The efforts to strengthen the corporate governance framework through enhancing the effectiveness of Independent Directors are welcome. These directors are essential for monitoring the agents [firm executives] and protection of all stakeholders, including, minority shareholders. But what about Nominee Directors?
On June 29, 2021, the board of Securities and Exchange Board of India (SEBI) approved amendments to the regulations pertaining to Independent Directors (IDs) on the boards of listed companies. It, however, remains mum on strengthening the role of Nominee Directors (NDs) who represent a very significant group of shareholders. As per data from Primeinfobase, institutional investors account for 33.9 per cent of the shareholding in NSE-listed companies, by value of shares, as on March 31, 2021. Directors nominated by the Life Insurance Corporation of India and other insurance companies, asset management companies, banks, private equity firms, other companies, and the government of India or state governments on the boards of companies is common.
Concerns with respect to independence of IDs have led SEBI and the Ministry of Corporate Affairs (MCA) to frequently enhance the regulatory requirements with regards to the composition, conduct, role, and eligibility of such directors. The efforts to strengthen the corporate governance framework through enhancing the effectiveness of IDs are welcome. IDs are essential for monitoring the agents [firm executives] and protection of all stakeholders, including, minority shareholders. What about NDs?
NDs must act like IDs
The reforms are inadequate if they leave out a significant player like the NDs. NDs represent investing organisations that are public, whose source of funds is public money. Hence, the NDs must play a vital role in upholding the highest levels of governance at the company on whose board they serve. Yet, governance anomalies have emerged in the past in institutions such as the ICICI Bank and Larsen and Toubro that had NDs on their boards.
In this article, we argue that NDs must act like IDs. The significant investment in the company should ensure that they play the role of a steward. More than the IDs, the NDs have a direct and bigger stake in the company. Yet, why do they fall short in monitoring and safeguarding the interests of the investor as well as the other stakeholders? What are their strengths and weaknesses? How can the NDs tap their potential and create opportunities for elevating the governance standards of the company?
Strengths, Weaknesses and Opportunities
Expertise: NDs are non-independent, often non-executive, experienced and highly qualified members. But do they have the relevant experience and qualification to be a good board member? Given the significant stake that the investor has in the company, it will be worthwhile to make well thought through nominations such that there is a fit between the firm needs and the nominee. Many a time, a firm may look for help from the nominee of a private equity firm for expansion into another market, access to networks, and advanced technical knowhow. On the other hand, a nominee from a bank may be looked up to for guidance on raising funds for another project.
Incentive: While the investor has the incentive to ensure that the company performs well, the ND may perceive the board position as an additional responsibility without any incremental incentive. The rewards and remunerations of the ND are not tied to the performance of the company. The ND must be treated as an ID by the company and compensated for their time and efforts to make it worthwhile for the ND to contribute.
Multiple Directorships: Many NDs are members of multiple boards. It is imperative that they do so without compromising on the time spent to prepare for each board meeting. The management of the company should also demand that the NDs contribute to the discussions at the board level.
Conflict of Interest: NDs may find themselves at crossroads in certain situations as they represent the investor, but it is their fiduciary duty to act in the interest of the company. In any such situation where a conflict arises, the ND must fulfil her duties towards the company that she serves as a director. An example of conflict of interest can be in the context of a banker serving as a ND in a company. Incentives of bankers are mostly linked to the quantity of lending, rather than the quality of lending. This in fact enables the promoters to control the firm with very little skin in the game by borrowing heavily. The ND in such a situation should be concerned more with monitoring and ensuring that there is no tunnelling or misappropriation of funds rather than facilitating more loans to the company.
Muscle Power: NDs have their organizational infrastructure behind them to aid them in asking the right questions to the management of the investee company with regards to their long-term investment strategies. They have the voting rights, access to information and the incentive to discipline the managers. The investor must encourage the ND to use the available eco-system, in-house expertise, and technical knowhow.
NDs can and must take on greater responsibility to ensure better governance in the companies they serve. While there is a lot of stress on improving the quality of IDs, equal stress must be put to improve the quality and contributions of NDs. History has proven that leaving the complete onus of NDs only to the institutional investors create major agency costs resulting in lower quality decision making and poor governance. The regulators, investors and the NDs themselves need to realise their potential and take their role more seriously.
The authors are with the Thomas Schmidheiny Centre for Family Enterprise, Indian School of Business.