Split CMD position: Medicine without ailment?
The Security and Exchange Board of India (Sebi) has deferred the date by which the top 500-listed companies are required to comply with the regulation to separate the roles of chairperson and managing director (Md)/chief executive officer (CEO) from April 1, 2020, to April 1, 2022. The Sebi regulation requires that the non-executive chairperson and the CEO should not be related according to the definition of a relative in the Companies Act, 2013. It is explained that Sebi has taken the decision to defer the applicability of the regulation in view of the demand from companies and to keep the compliance burden low in the wake of the current economic scenario.
When we see through the lens of agency theory, which assumes that the manager ignores the interest of the company and enriches itself unless monitored, separation of the two roles -- chairperson and CEO -- makes sense, albeit theoretically. Independent chairperson improves the oversight function of the board. The chairperson has clear authority to speak on behalf of the company and manage the board meetings. Separation mitigates the conflict of interest in the areas of performance evaluation, executive compensation, succession planning, and appointment of new directors. It allows the CEO to focus on strategy implementation and organisational issues, as the responsibilities related to management oversight, board leadership and governance-related matters lie with the chairperson. Crafting strategy is the joint responsibility of the board and the CEO.
When we see through the lens of the stewardship theory, which assumes that the manager is motivated to work in the interest of the company, separation of the two positions does not make sense. A manager who is self-motivated to work in the interest of the company does not require monitoring. On the other hand, separation of the two roles results in losing the benefits of “unity of command”.
The UK Code of Corporate governance, which is a soft law (comply or explain), mandates that the same individual should not occupy both positions. In the US, there is no mandate to separate the roles of chairperson and CEO. However, more and more companies in the US are now separating the two roles. In 2005, in 30 per cent of the S&P 500 companies, the role of chairperson and CEO were split. In 2013, the percentage increased to 40 per cent and now it is 53 per cent. The OECD Corporate Governance Fact Book 2019 reports that of 37 jurisdictions covered in the report, 30 per cent require separation, 30 per cent do not require separation, 35 per cent recommend separation, and 5 per cent have incentive mechanism to induce separation.
Research fails to provide conclusive evidence that the separation of the two roles improves performance. Research evidence suggests that benefits and drawback of separation of the two roles are situation dependent and depend on an array of factors. Two professors of Stanford University examined the leadership structure and the circumstances under which they changed over a 20-year period (1996-2015). Their sample consisted of 100 largest and 100 smallest of the Fortune 1,000 companies (2016). They reported that most separations (78 per cent) occur during orderly succession when the former founder, CEO or other officer continues to serve as chairperson temporarily or permanently. Research evidence suggests that the temporary separation provides stability. The vast majority of cases of combining the two positions (91 per cent) involve an orderly succession at the top. In a nutshell, changes in the leadership involved orderly succession. In some cases, companies separated the two positions to address corporate governance failures under shareholders’ pressure.
Indian family businesses dominate the corporate sector and will continue to drive economic growth. Stewardship theory better explains the behaviour of the controlling shareholder (the family). Mandating family businesses to separate the chairperson and CEO positions is like forcing someone to take medicine without an ailment, ignoring the ill-effect of the same. One complaint against family businesses is that the family expropriates the wealth of non-controlling shareholders through abusive related-party transactions (RPT), etc. This has already been addressed under the current dispensation by making the audit committee responsible to approve RPTS. Appointment of a lead independent director might be a better option than mandating separation of the positions of chairperson and CEO. If companies are forced to separate the two positions, they will prefer to appoint the nominee of the controlling shareholder as nonexecutive chairperson and an outsider as CEO, who will be subservient to the chairperson in the interest of the company and in his/her self-interest.
Appointment of a lead independent director might be a better option than mandating separation of the positions of chairperson and MD/CEO