Will Sebi guidance improve board evaluation?

Ornamental boards do not have an urge to improve performance, says the author

The Companies Act, 2013, and the Securities and Exchange Board of India’s (Sebi’s) Listing Obligation and Disclosure Requirements Regulation, 2015, mandate board evaluation, which is the evaluation of the functioning of the board of directors (hereafter board), evaluation of the chairman, individual directors and the board process. The Companies Act requires that every listed company and every other public company having a paid-up share capital of Rs 25 crore or more at the end of the preceding financial year shall include in the report a statement indicating the manner in which annual board evaluation has been made.

Board evaluation is an effective tool for improving board performance. It is a kind of self-evaluation. Like any other knowledge group, the board evaluates its performance periodically to identify areas for improvement and develop an action plan to improve the performance. Another objective of evaluating individual directors is to identify under-performing directors and to weed them out. A weak chairperson should also be removed. 

In January 2017 Sebi issued a Guidance Note on board evaluation. The preamble says that the objective of the Guidance Note is to provide guidance to those listed companies that do not have much clarity on the process of board evaluation. Board evaluation is new in India, but it is decades-old in the US, Europe and some other parts of the world. Literature on board evaluation is easily available. Any company that is serious about board evaluation can develop and implement the process by going through the available literature. Moreover, there are professionals who advise companies in developing and implementing the process of board evaluation. Therefore, the lack of clarity cannot be a reason for not implementing board evaluation in the right spirit. Companies that have not implemented board evaluation in the true spirit are not serious about it.

Board evaluation is meaningful only if the board is empowered to do what it is expected to do — to guide and advise the executive management (the CEO and his/her team), monitor it in order to protect the interests of non-controlling shareholders (also called minority shareholders) and facilitate net working with external resources. Board evaluation improves the performance of even those boards that focus on the advisory role rather than the monitoring role.

It is wrong to assume that every public company is motivated to develop and implement an effective board evaluation process. In family-managed companies the dominant shareholder monitors the executive management closely and does not require the board to monitor it. In most of those companies, the dominant shareholder appoints and, if necessary, removes the CEO, the Key Management Personnel (KMP) and the members of the senior management team. The Nomination and Remuneration Committee (NRC) does not play any significant role in this regard although the 

Companies Act has made NRC responsible for the same. Similarly, NRC does not play any significant role in the appointment and removal of directors and in succession planning. NRC approves the decisions of the dominant shareholder. In those companies the dominant shareholder takes strategic decisions, as he/she understands the business and its environment much better than independent directors and relies on his/her entrepreneurial spirit and business acumen, rather than on the collective wisdom of the board. Minority shareholders expect the board (read independent directors) to protect their interest from the opportunistic behaviour (for example, tunnelling of funds for self-enrichment) of the dominant shareholder. But in those companies, independent directors are not independent as they are selected by the dominant shareholder and enjoy office at his/her pleasure. The dominant shareholder does not want an effective monitoring by the board.

In most family-managed businesses, the board is an ornamental board. The dominant shareholder selects independent directors from professionals drawn from diverse fields to add to the ornamental value of the board. The board discusses routine matters (for example, performance evaluation) at great length, spends less time on important issues (for example, strategic issues) and ultimately approves whatever proposal is presented before it. Ornamental boards do not have an urge to improve performance. The dominant shareholder does not see any value in board evaluation. The focus is on family governance and family values. 

Some family businesses which operate in a volatile, uncertain, complex and ambiguous (VUCA) business environment or want to attract institutional investors and foreign capital are motivated to adopt good corporate governance practices and build an effective board. Sebi Guidance will help them to improve the board evaluation process. Others will use it as a reference point just for preparing the disclosure in the board report without implementing board evaluation seriously.

The writer is adjunct professor in IMT Ghaziabad and chairman, Riverside Management Academy 

E-mail: asish.bhattacharyya@gmail.com