Corporate governance code comes into force

WITHOUT CONTEMPT

It has finally happened. The turn of the year has brought in the new Clause 49 into the standard listing agreement binding stock exchanges and listed companies.

This signals the onset of the corporate governance code, which among other matters, regulates the composition of the board of directors.

At least half the board has to comprise non-executive directors. But if the board has an executive director as chairman, at least half the board has to comprise "independent directors". Should the chairman be a non-executive director, one-third of the board ought to comprise "independent directors".

Corporate India is scurrying for cover. Internet portals have gone out in the past several weeks enlisting professionals to act as independent directors for companies to choose from. Corporate boards are taking a hard look at who should sit on the board.

The sheer pressure of numbers could lead to a number of passengers belonging to families of promoters getting off the boards. While this churn is welcome and would hopefully lead to a better qualitative composition of corporate boards, the corporate ecosystem would find it a struggle to throw up independent directors who fit the bill.

Even a non-executive director who holds two per cent or more of the voting power in a listed company cannot be an independent director. There should be no problem with this requirement if it is restricted to the personal shareholding of the individual who acts as a director. However, there is a big debate in the system about whether a non-executive director nominated by any shareholder holding more than two per cent would qualify as being independent.

It is settled law that guidelines have to be purposively construed. The purpose of the Corporate Governance Code is to ensure that persons who can genuinely act as a check and a balance on persons managing the company should be available on the board to oversee the company's operations. As corporate managements get more and more professionalised, the biggest check on the management is the owner of the company i.e. the shareholder.

If every non-executive director nominated by a shareholder owning two per cent or more is disqualified from being an independent director, an inherent economic check and balance is being ruled out. The disqualification of every promoter-nominated director from the status of "independent directorship" is adequate to take care of the risk of persons in control of a listed company filling in positions of independent directors.

On the other hand, ruling out even non-promoter non-executive shareholders from independent directorship does not serve any real purpose. For instance, a director nominated by a substantial financial investor would be an excellent policeman over the company's operations, but would not qualify as an independent director. The only exemption from this restriction has been made in favour of directors nominated by public financial institutions and banks.

There is no reason why such an exemption should be refused to directors nominated by mutual funds, venture capital funds, private equity funds, and other such financial investors. The fact that a supporting vote of the nominating shareholder would be in favour of the nominee is of no consequence. Ultimately, even directors who are not nominated by shareholders still have to be voted onto the boards by shareholders.

A simple way to deal with the problem would be to provide that directors nominated by any shareholder who meets the definition of "qualified institutional buyer" would qualify for being an independent director, provided such an investor is not related to the promoters.

Else, filling corporate boards with directors who simply have no stake at all may lead to unintended consequences. We could have a spawn of directors whose only job is to sit on boards to fill independent director vacancies and therefore get so busy that they either do not attend board meetings (frustrating the very purpose of the law forcing companies to appoint them) or leading to inordinate delays in companies' ability to take corporate decisions with investor-friendly speed.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed are personal)