SEBI has decided to
come out with a major consultative paper reviewing the corporate governance
norms in India as it applies to listed companies. It merges its own
developmental philosophy with the thinking of the Companies Bill which is
pending passage in Parliament. Of course the Companies Bill has governance
provisions for all public limited companies (private limited companies are
broadly exempt) and surprisingly, several enhanced standards for listed
companies. Some of the proposals in the Bill are tougher than those contained
in today's corporate governance norms set in the SEBI mandated listing
agreement.
This author broadly
supports most of the reforms sought to be introduced by SEBI with this paper.
However, on going through the vast number of recommendations and proposals, two
broad problems also arise. One, that the huge incremental changes will be
costly and will require substantial changes in the way companies are run today.
Second, while each proposal is sound, on a collective basis, these proposals
might be crossing the limit of corporate governance and getting into the
territory of over-regulation. The proposals all but state everything a company
needs to do except the time it should wake up in the morning. This may look
good at first blush, but over-regulation will also keep more companies from
being listed. Exhibit A to this point is America's Sarbanes Oxley Act which has
stunted the growth of the public listed company in that country.
This article looks at
most if not all of the two dozen recommendations critically. For the sake of
analysis, let us divide them into the good, the bad and the ugly.
The
good
Black
and white terms.
SEBI proposes a formal letter of appointment be issued to directors, which should
explicitly state the rights and obligations of the directors and this letter be
disclosed to all. This is a good thing.
Rights and fiduciary duties should be stated in black and white and directors
should know both their duties and their rights so that a shareholder can
protest in a shareholder meeting or otherwise if he or she crosses the
contractually stated lakshman rekha
of what is agreed. Psychological studies have shown that these kinds of firm
written commitments have an impact on behaviour. Similarly, it is good to recommend
continuing director training. As all of us learn through our lives and creating
a classroom where directors can learn from each other and in an institutional
framework would clearly be progressive and keeping it disclosure based rather
than a mandatory provision is a good move.
Term.
The term of independent directors has been proposed to be limited to two terms
of 5 years with a 3 year cooling off. This is a much needed move as dirctors
who hang around for a period longer than 10 years are highly unlikely to be
independent of entrenched interests. For the truly qualified and independent,
there are many other opportunities. Working at one company as independent
director for thirty or more years compromises independence. Though, only a few
people have abused their stay beyond reasonable welcome, this was a necessary
prophylactic for better governance. Similarly, a proposal to limit independent
directorships to 7 listed companies may be a bit extreme, but should not impact
most high quality independent directors. To be
sure, 7 listed company directorships for one person is a lot of work.
Role
of IDs. There have been several new proposed roles for
independent directors including leadership roles in the company where they meet
in the absence of the non-independent directors and review the performance of
the others. On the same lines, introduction of performance evaluation of
directors is a good move and would put
pressure on boards to work on tangible outputs and well established processes
to achieve those targets instead of propounding abstract theories and dilbertisms.
Noisy
withdrawal. Another great development is the direction to
directors, particularly the independent ones, from resigning for ‘personal
reasons’. SEBI has played this with nuance. It has not proposed forcing
directors to make a 'noisy withdrawal', but seeks to create an environment where
appropriate disclosure has to be made to shareholders explaining the
resignation. A subtle pressure is put on directors resigning on personal
grounds to explain why those same personal grounds are not reason enough to
withdraw from all companies where they sit as directors. This is a great move
without tipping over into micro-management.
Whistleblowing.
Mandatory provisions for whistleblowing rights would be a step in the right
direction. The current status of optionally protecting those who uncover fraud
is unacceptable. Protection to those who uncover fraud must be a law given
right and those who victimise such people must be the ones facing the wrath of
law.
Related
party deals. The non-regulation of pay is a step in
the right direction, though runaway pay has been tackled through proper
disclosures. The ratio of top management pay to the median worker is to be
provided. In addition, shareholder approval of non-interested shareholders
voting for the pay of promoter-directors is a good move. There is an extensive
portion rightly dedicated to related party transactions which have been the
bane of corporate India's image of rapacious promoters. Several hurdles have
been put in the way of self dealing - through approval of non-interested
shareholders, disclosures, restriction of superior rights, approval of audit
committee and a new fiduciary duty of majority shareholder towards minority
shareholders. These are bold moves and are likely to be opposed by many a
powerful promoter. But they are a move in the right direction given our history
of problems in this area.
Proxy
advisors. The paper also seeks to grant some sort of
recognition to proxy advisory firms which advice investors on how to vote in
the interest of the company. These are firms whose time has come and they will
clearly impose substantial burden, both real and through the press, on those
companies who take excessive liberties with their shareholders.
Institutions’
duties. Finally, without deciding, the paper disccusses
the role of institutional shareholders and their role and duty in playing a
somewhat more active role in acting as a check and a balance to the untrammeled
power of the promoters.
The
Bad
Nominee
director independence. Nominee directors are proposed to be
branded as congenitally non-independent. This is a departure from the current
position where nominees from certain financial institutions are not considered
non-independent. While, there are problems with the current regime, the
proposed regime would bring its own problem – i.e. branding nominees of
creditors as interested in more than the repayment of their loans on time.
Something which they clearly don’t represent. Their role begins and ends with
ensuring repayment of interest and capital. Clearly, the current regime is more
nuanced and appropriate, though some black sheep do wander in the guise of
independent nominee directors. On the whole, the status quo is probably better as the exemption providing the
clothes of independence is only given to certain financial institutions and
banks.
ESOPs
to IDs. If the company will prosper its key stakeholders
should do well. Many employees will get greater pay and employee stock options.
Similarly, top management can also be rewarded with higher pay and stock
options. It is not clear why independent directors are not deemed suitable
enough to be awarded stock options. Shouldn’t they do well if the company does
well and also lose some investment when the company doesn’t do well. The bar on
awarding stock options to independent directors needs to be lifted and they
should have an interest with skin in the game as well. This will be good for
the performance of the company as the directors collectively drive the
strategic vision of the company.
Micro-regulation.
There are other areas of micro-management of what ought to be a good practices
code, like having a proper succession planning, a risk management framework,
appointing nomination and remuneration committees, supervision of the internal
auditors to name a few. These are best left to the wisdom of the company's
directors rather than be introduced as legal obligations.
Class
no-action. On a separate note, there is a provision for class
action suits, which is a non event because these are permitted even today under
the civil procedure code for any corporate case - though unused for reason of
delay in justice rather than because the right doesn't exist.
The
Ugly
Minority
representation. SEBI discusses at some length the
appointment of directors representing minority shareholders. And it seems it
comes to no firm conclusion. It finds that appointment by ‘majority of
minority’ may create an abusive system in which a rival can acquire shares and
sabotage the company. However, the alternate system it comes up with also does
not pass the same test. SEBI has proposed one director appointment from those
shareholders who own say shares worth not more than Rs. 20,000. This gives
power to those who hardly have any skin in the game and thus may not be the
best counter-balancing force against a problematic majority. In addition this
would give power to those shareholders who are the least affected and are
therefore most likely to be fronts for other interest groups. It may instead be
better to push for cumulative voting which gives a better voice to minority
shareholders.
70
is the new 50. There is discussion about the age of
directors and approvals and minimum and maximum ages. These are quite pointless
micro-management. There are many young savants and many people in their prime
even after they cross 70. Anyways if you can be a prime minister of the country
of over a billion at 70, why should good people be disallowed from director
roles at that age. Let good people be on the boards of companies rather than
decide it on such factors as age. If age restrictions were implemented in
California's corporate laws, I'm sure Silicon Valley would be the poorer. In
fact the story of India's youngest CEO starts tragi-comically (he was featured
in Time magazine as the world's youngest CEO at 14) with Indian law prohibiting
him from being a director in the company he founded and he was forced to
incorporate in the US. Clearly it is time to make that concept history.
Conclusion.
Overall, I would give the paper high marks, particularly, if it avoids in its
finality areas of over-regulation and dumps them in favour of innovation,
disclosures, checks and balances and the right level of regulation.
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