A transformation of corporate governance

A transformation of corporate governance

Protecting the interests of minority shareholders is a must—and that means fixing accountability

The preface to the Kotak Committee report on corporate governance refers to the need to move from the monarchial model to the custodial model—two styles of running a company. The latter would translate to protecting the minority and instilling a greater sense of accountability for majority shareholders managing the business affairs.

Performance evaluation of board/directors

The Kotak Committee report lays emphasis on enhanced accountability. This includes capping the number of directorships, minimum attendance of board meetings and specified skill profile of independent directors. Even the existing Section 134 of the Companies Act, 2013 specifically charts out a long list of conditions to be implemented by the board, including compliance with sub-section 3p with respect to performance evaluation of all directors, including committees of the board.

Notwithstanding the intention to fix the accountability of the board, the word “performance” has not been elaborated anywhere. Failing this, the exact purpose of compliance remains ambiguous. For instance, if we take a sample of the annual reports of companies classified as non-performing assets by banks or companies carrying seriously negative notes to accounts with questionable performance and vice-versa, the reference to board performance carries a standardized response on parameters used for assessing and evaluating the performance of the board/committees. What this conveys is that the board always functions well, notwithstanding the erosion in shareholder value and future uncertainty.

Paragraph 13 of the report acknowledges performance evaluation of the board being in a nascent stage in India and urges the Securities and Exchange Board of India to address this as per their convenience. In order to make governance more objective as well as to do justice to the role envisaged for independent directors, the committee should propose following insertions:

1. Non-independent directors should not be assessing the performance of independent directors by suitably amending the Companies Act.

2. The dissenting views of independent directors should be published for decisions taken with respect to capital investments, acquisitions, related-party transactions and breach of risk prudence in any manner.

3. The board should declare its accountability on key business parameters (present and future) at the beginning of the year to shareholders to instill objectivity in board performance.

Separating management from shareholding

In this emerging age of rapid technological advancement and growing complexities around business corporations, the custodial model of governance warrants a code of minimum qualification/experience for any individual being appointed managing director. The legacy succession of young family members from the promoter group carries several negative repercussions. It would be advisable to begin by at least sensitizing promoters to the need to separate management from shareholding. Defining minimum criterion for being eligible for top managerial positions for companies with a certain size and scale of market capitalization is also important.

Disclosure of key changes in financial indicators

Since the intent of adding additional financial information is to help investors better comprehend significant or key developments in the company’s business, it would make sense to elaborate this to include subsidiary companies—and, in the case of multiple businesses in one company, elaborate business-wise capital deployment along with explanations for changes along prescribed lines proposed in the report. Financial indicators should be supplemented with some non-financial lead indicators to allow investors to make better assessments.

Special codification for NPAs and potential NPAs

Effective corporate governance gains added significance in the case of companies undergoing financial distress, since management attention is shifted to managing creditors rather than maintaining business performance. The key challenges in a stressed company revolve around liquidity crunch and the absence of borrowing power and working capital. Employee morale and overall work atmosphere become challenging, resulting in unrest, conflict and the difficulty of hewing to the right codes of governance. This would merit writing a special code of governance to protect shareholder interest inter alia the Insolvency and Bankruptcy Code, 2016.

Challenge of jurisdiction

The revised code of governance necessitates amendments in the Companies Act, reformulation of the internal policies of the Institute of Chartered Accountants of India and several other autonomous bodies. They have already gone on record with their objections, terming the recommendations as ultra vires the terms of reference. The government should enforce the recommendations by special amendments to coherently administer the revised framework, leaving no room for turf protection.

Author : Vipin Agarwal