Corporate governance: More rules won't help

Strict enforcement of independent director's accountability for omission and commission of company drives away 'good' independent directors

On April 1, 2014, most of the new provisions (relating to corporate governance) of the Companies Act, 2013, came into force. The objectives of the new provisions are to strengthen the institution of independent directors, improve the effectiveness of the board, empower the shareholders and improve the audit quality. Over this period (2014-2018),  proxy advisory firms have emerged, the Insurance Regulatory and Development Authority of India (IRDAI) issued stewardship code and the Securities and Exchange Board of India (Sebi) mandated mutual funds to disclose their position on resolutions placed before general meetings of companies. 

In 2018, Sebi tightened the regulations on corporate governance. In January 2018, Sebi announced stringent action against Price Waterhouse (audit firm) for its failure to detect fraud in Satyam and the National Financial Reporting Authority (NFRA), an independent regulator of accounting and auditing profession, came into existence. Although the above has created an expectation that corporate governance in India will improve, it is quite unlikely that companies, barring a few, will comply with the regulations in spirit. There are many reasons for the same. 

The speed with which regulatory changes have been brought in, the enforcement machinery has not been strengthened with that speed. As a result, still, the oversight by regulators is weak. Moreover, it is difficult to ensure that the companies are complying with the regulations in spirit. Consequently, companies adopt ‘tick-the-box’ approach to comply with the regulations. 

Promoter’s emotional attachment to the company acts as a blinder and he/she cannot take the right decisions at the right time in the interest of the company. Examples are Naresh Goyal’s reluctance to relinquish control of Jet Airways, and turbulence in Infosys due to Narayana Murthy’s emotional attachment to the company even after creating an independent board and distancing himself from the management of the company. Promoters and controlling shareholders will continue to call the shots in companies where there is a concentration of ownership. They will continue to induct management-sympathetic independent directors and will weed out shareholder-sympathetic independent directors. Tata Group episode (the removal of Nusli Wadia from group companies) demonstrated how easy it is to remove dissenting independent directors. The Nomination and Remuneration Committee does not nominate individuals for appointment as directors without the tacit approval of the promoter. 

One more concern is that companies induct as independent directors individuals known to the promoter or the top management or those who are highly successful professionals and entrepreneurs, ignoring the capability gap in the board.  Consequently, most independent directors do not have a complete understanding of a complex business model, organisation structure and contexts. A recent example is IL&FS. As a result, boards fail to provide guidance to the CEO, participate in strategy formulation and engage with the CEO in crisis situations in order to find solutions to problems. Independent directors ensure compliance with laws to mitigate their individual risks. An independent board tempts to control the CEO rather than encouraging innovation and entrepreneurship because if it gives free hand to the CEO, it is considered a weak board (example, Infosys). If it protects the CEO from media trial and does not sacrifice the CEO without proper investigation, it is criticised as an incompetent board (example, ICICI Bank). 

Strict enforcement of independent director’s accountability for the omission and commission of the company drives away ‘good’ independent directors.  Independent directors exit whenever they smell trouble. Recently, we have seen the exit of independent directors from YES bank, JM Financial Asset Reconstruction Company Limited and many other companies. During 2018, 743 independent directors of NSE-listed firms had quit the board. This does not help improve corporate governance. 

It is unlikely that the promoter or dominant shareholder will give control of the business to independent directors, who have no stake in the company and whose understanding of the business, and its environment is shallow. However, recent trends show that corporate governance in family businesses has improved because of improvement in family governance. Families have started appreciating that sustainability of the business, and protecting and creating family wealth requires appropriate and timely succession planning and protecting the interest of all the family members without involving everyone in managing the business. More and more business families are transferring shares to a family trust and creating family offices to manage family wealth. There is an emerging trend that promoters are transferring the management of their businesses to professional managers while guiding them and overseeing their performance. 

Average corporate governance will improve, because the Indian corporate sector is dominated by family businesses, many of which are now focusing on better family governance, and not because of more regulations.
 

The writer is director, Institute of Management Technology, Ghaziabad

Email: asish.bhattacharyya@gmail.com