Corporate governance – Do we require new rules?

The Indian Corporate Governance Code is incorporated in the Sebi (Listing Obligations and Disclosure Requirements) Regulations, 2015. The Companies Act of 2013, which came into force from April 1, 2014, stipulates many provisions aimed at improving corporate governance. A 21-member panel, set up by the Securities and Exchange Board of India (Sebi) to suggest measures for improving corporate governance of listed companies, under the chairmanship of Uday Kotak, vice-chairman and managing director of Kotak Mahindra Bank, submitted its report on Thursday. The committee looked into issues related to functioning of independent directors (IDs), related-party transactions, accounting and auditing practices by listed firms, board evaluation practices, voting and participation in general meetings, and disclosure and transparency. All these were examined while formulating the Companies Act and global best practices were supposedly adopted. Therefore, the task of the committee was quite challenging.

Many believe IDs as an institution have failed. The concept of IDs is an excellent one, to make the board of directors independent of the management. In practice, it is not producing desired results in India and across the globe. The Companies Act has provisions to strengthen the institution of IDs. For example, it includes a code for IDs, which is a guide for their professional conduct. An ID shall be liable if it is established that he/she had not acted diligently. Similarly, board evaluation and evaluation of the chairperson and directors have been made mandatory.

Going by the roles and responsibilities delineated in the corporate governance code, one may argue that IDs of real estate major Unitech had failed in applying due diligence while approving its business strategy. About 80 per cent of its equity share capital is held by the public, including financial institutions, and the rest by the promoters. It has been dragged to court for cheating, as it was yet to deliver apartments to 16,300 people in 61 projects, after collecting ~7,816 crore from them. The Supreme Court has refused bail to Sanjay Chandra and his brother Ajay Chandra, managing directors of Unitech.

IDs are expected to understand and evaluate, among other things, the ethical dimension of a business model and reputational risk and other risks from business strategy. They should provide checks and balances to ensure the management does not adopt unethical practices or expose shareholders’ investment to unwarranted risks. In the case of Unitech, they failed in this regard. There are many other instances.

In the case of Unitech, the founder (promoter) is executive chairman and his two sons are managing directors. Obviously, power is tilted towards the executive management, and therefore, the board was ineffective. The situation is no different in most family businesses. In most family businesses (irrespective of size), someone from the promoter or controlling shareholder or his/her nominee is chairperson and the chief executive officer, even if he/she is a professional, is also a member of the business family or a nominee of the promoter or controlling shareholder or is selected by the promoter/controlling share. Therefore, in most family businesses, power is tilted towards the controlling shareholder or management. Consequently, the board is ineffective. The issue of ‘independence of IDs’ is important but more important issues in family businesses are the promoter’s willingness to ‘empower the board’ and capabilities of IDs. Rules cannot change the mindset of promoters. In the present context, IDs, at best, can only protect investors and depositors from direct fraud on them by the promoter or management.

Sebi might in forming the committee have felt the necessity to examine corporate governance issues debated after the governance crises at Infosys and Tata Sons. Ajay Tyagi, before taking charge of Sebi in May 2017 had expressed his concern about the independence of IDs and general state of corporate governance. He wanted stakeholders to have a serious re-look at current practices and rules. Whatever the reasons, it is too early to lose patience, as corporate governance evolves over time and the recently formulated (2013/2015) rules will take time to have an impact.

It is unlikely that new regulation, which Sebi might formulate, based on the committee’s recommendations, will immediately improve corporate governance practices, particularly in the family businesses which dominate the corporate sector.

In most family businesses, power is tilted towards controlling shareholder or management. So, the board is ineffective. This can’t change soon