How to revive corporate governance

Independent directors are considered to be effective deterrents to fraud and mismanagement in an organisation but roles keep changing. Tougher measures are needed to prevent corporate disasters

Recent bank scandals have shaken India Inc to the core and have raised several questions regarding the governance of these banks and other corporates. The board plays a key role in providing direction to the management in terms of strategy and also ensuring that the companies operate in the best interests of shareholders and other stakeholders. Board independence is seen as a cornerstone of accountability and the presence of independent directors in the boardroom has been hailed as an effective deterrent to fraud, mismanagement, inefficient use of resources, inequality and unaccountability of decisions.

Regulators in India have taken several steps over the years; and after several committee recommendations, they amended the corporate governance norms to give more importance to non-executive directors. But clearly, much more has to be achieved and the change has to be more qualitative in nature rather than being quantitative. Corporate governance norms in the international arena were triggered by scams such as Enron, WorldCom, Qwest, Global Crossing and the subsequent milestone Sarbanes-Oxley Act of 2002. India also followed the global cues and made the definition of an independent director more precise under the leadership of the finest policy-makers and industry stalwarts like Naresh Chandra and NR Narayana Murthy.

Although independent directors do not take part in day-to-day operations of the company, they are expected to raise appropriate red flags, by asking right questions at the right time and, therefore, playing a fundamental and critical role in bringing transparency, accountability and credibility to the board process and practices. However, recent scams show that independent directors may not be performing and taking their monitoring roles to the hilt. So, why are independent directors — assuming that they are committed to ethical practices — not effective in their responsibilities? The answer is isolation. Independent directors may not play an effective role to stop fraud at the highest level.

However, collectively, they can form a voice that is hard to stop and can make a huge difference by identifying the signals of fraud and mismanagement; and then try stopping them. These directors will get more teeth and their collective strength will enhance if their number is increased in the board. At present, one-third of the board members in Indian public listed companies are independent or non-executive directors but it should be increased to at least half of the board members.

The role of an independent director has to be much more qualitative in nature, with more emphasis on offering strategic, specific and objective advice at board meetings. They should help in providing long-term vision and also act as mentors to the senior staff. They should be networkers looking for new opportunities and useful contacts; and must act as relationship builders, in and outside the company. To be a part of the solution, instead of being a part of the problem, boards must exercise real power, they must have more power to say “no more” and provide tough oversight.

Since knowledge is power, independent directors can become more powerful by possessing enough knowledge to exert their power effectively on essential issues. An independent director should invest time in understanding intricate issues of today’s business, like complex acquisitions, especially those in new product markets or into new and unfamiliar territories; major expansions in either existing or newer businesses; and understanding the compensation structure of a senior executive, to name a few.

At present, this important role is performed by non-executive directors, at best on a part-time basis; and due to this, it risks the loss of some of its cachet. How can one expect the non-executive directors, who visit the company during the board meetings, to stand up to tall expectations? At present, a person is serving as an independent director in maximum seven listed companies with maximum directorships in aggregate (including alternate directorships),  being 20 companies. In addition, an independent director can be a member of a maximum 10 committees or act as a chairman of more than five committees across all companies in which he is a director.

This practically gives no time to the independent directors to be effective monitors and get an in-depth understanding of the functioning of the company, which in turn defeats the very purpose of having them in the first place. To contribute more significantly, the directorship of these directors should be limited to about three or four companies.

Another precarious situation is that the board of directors is headed by a chairman, who has a significant influence over the direction of the board. In many companies, the CEO/MD, who holds the top management position, also serves as the chairman of the board. This is often the case with companies that have grown rapidly and still retain the initial founder in those roles. It is a debatable topic which suggests that non-separation of both these positions can reduce the overall effectiveness of the board and can compromise on the overall integrity of the company.

According to the recommendation of the Uday Kotak Committee, the time is right for India to introduce a separation of roles of a chairperson and a CEO/MD for listed companies. The committee observed that such separation may be more relevant where public shareholders constitute a large portion of shareholding of a company. In this regard, the committee considered various thresholds and concluded that at least 40 per cent of public shareholding would be at an appropriate threshold.

Further, in view of the fact that this would require a significant transition from the existing requirements, the committee believes that the listed entities should be given sufficient time to undertake such a transition and recommended that from April 1, 2020, all listed companies that have public share-holding of 40 per cent or more, should have a chairperson who is a non-executive director.

Once implemented, this will remain in effect even if the public share-holding of the company falls below the threshold level of 40 per cent. By investing more time in their important roles in corporate governance and ethics, understanding the multi-faceted and complex business issues of present-day business and by harnessing their collective power, independent directors can red-flag serious concerns, like reckless over-expansion, misguided acquisitions at foolish prices, short-term strategies, unwarranted levels of executive compensation, cooking accounting books, outright fraud and bankruptcy and take steps to stop them before they spiral into major scams and scandals.

Gaining an in-depth knowledge about the industry and company in this fast-moving world is extremely time-consuming. So, the role of a non-executive or an independent director is changing from part-time to full-time in the future. Hence, tougher measures are needed to prevent corporate disasters that we are seeing around us. Is a full-time chief governance officer, much like a CEO or a CFO, the need of the hour for India Inc?

(The writer is Assistant Professor, Amity University)