'Paper'ing over the cracks - Part 2

The constituency of the independent director (ID) is vast and varied. When appointing an ID, what should shareholders look for?

Sebi’s Paper on IDs proposes that the skills and capabilities required for the appointment of ID, and the manner in which the proposed individual meets the requirement of the Board, should be disclosed to the shareholders prior to the appointment. Also to be disclosed is the channel used for searching for the appropriate candidates. What shareholders should be more concerned with is the number of Boards on which the proposed candidate already serves, and whether he/she would be able to devote adequate quality time to the affairs of this company. The assessment of skillsets is, in fact, so subjective that every company in the Nifty 50 list has indicated that it covers all skillsets on the basis of the requisite skillsets that they have identified for the Board members.

Some companies have been known to resort to the devious practice of appointing IDs one day after the annual general meeting (AGM), and to bring up the candidature of that ID for approval at the next AGM, which is close to a year after the appointment. This has been sought to be addressed by providing that IDs shall be appointed only with the prior approval of the shareholders at a general meeting. In the case of a casual vacancy, the approval of shareholders would be obtained within a period of three months. What follows is that at the time of initial appointment, a shareholder will have to consider the previous track record, in other companies, of the candidate proposed to be appointed, as also the skill­sets that he/she brings in relation to what “the job description” requires. If a person has not been an ID on any Board earlier, there will be no past track record as a director to go by, and only a theoretical matching of the job requirements and the skillsets will be possible. Going by this, the non-Board experience of distinguished persons being considered for appointment for the first time is fraught with danger, since past performance is no guarantee of future returns.

Resignation of IDs has also been addressed in the Paper. One of Sebi’s most salutary prescriptions in recent times is that in the letter of resignation, an ID should, in addition to indicating the reasons for resignation, confirm that there are no other material reasons, other than those already provided. This is as good a provision as it can get. To attempt to improve it is to gild the lily. The prescription of a cooling off period for IDs who are resigning is more procedural than substantive, since IDs will find a way to get back should they choose to do so. It is not as if there are several IDs who exit for short periods and return to Boards in the same capacity or in some other capacity.

Considering the importance of the audit committee (AC), “it is proposed that audit committee shall comprise of 2/3rd IDs and 1/3rd Non-Executive Directors (NEDs) who are not related to the promoter, including nominee directors, if any”. Firstly, the syntax needs to be improved. Secondly, while providing for the revised composition, it might have been worthwhile to mention that all members of the AC should be equipped in terms of financial knowledge and experience to do justice to their membership of the committee.

Any attempt to deal with the institution of IDs should necessarily look at how they are compensated. The proposal in the Paper does not tinker with the sitting fees payable to IDs. A concern that profit- or performance-linked commission may encourage short-termism, and lead to conflicts, has suddenly emerged. Profit-linked commission is subject to a statutory ceiling of 1 per cent of net profits for all NEDs taken together. There is no company, at least among the bigger companies, where the total commission paid to NEDs is anywhere near 1 per cent of the net profits. Therefore, to believe that IDs could function in a manner that would inflate the profits, in order to enhance their commission, is somewhat fanciful. If anything, shareholders who expect value from IDs should ask Boards and managements whether the compensation presently given to IDs is adequate, having regard to their role.

ESOPs to IDs (instead of profit-linked commission) with a long vesting period of five years, is proposed as a solution for the short-termism that profit-linked commissions allegedly bring. In the case of many companies, ESOPs given to employees are under water, and have ceased to be a worthwhile instrument to attract and retain talent. How an instrument of this nature can help to get and keep good IDs in the boardroom is worth thinking about? Further, even if this was seen as the instrument that would enhance boardroom quality, it is unlikely to pass the scrutiny of the Standing Committee and Parliament, which had discontinued ESOPs because they were led to believe that ESOPs promoted short-termism.

The Paper addresses the pro­blems at either end of the spectrum by saying that while “there are concerns that a large remuneration may compromise the independence of ID, lesser compensation may not attract competent IDs”. Mercifully, the focus is not only on the question — “How much is too much?”, but also on the corollary — “How little is too little?”. As for start-ups, a separate compensation formula could be considered in terms of deferred payments to directors, rather than stock options, when no certainty is attached to future value of the shares.

The question whether we need IDs should be addressed once and for all. With our inability to decide whether to swallow or spit, the fishbone remains firmly stuck in the throat.

The author is Chairperson, Excellence Enablers, and Former Chairman, SEBI, UTI and IDBI