Clause 49

Less than a week before the Clause 49 amendment to the listing agreement comes into effect, mandating the induction of specified percentages of independent directors on to company boards, managements are sacrificing their year-end holidays to rush and meet this new regulatory requirement. On the Bombay Stock Exchange's corporate announcements pages, there is a sudden burst of activity on the appointment of independent directors. Some companies may miss the deadline, necessitating another extension of the last date, but the objective will have been substantially achieved by month-end, since almost all the large firms would have complied.

While the Clause 49 deadline is a domestic one, it is part of the global trend of strengthening corporate governance, after the Enron scandal and the US response in the form of the Sarbanes-Oxley Act. Sebi's Clause 49 draws on this Act in some areas, and covers several corporate governance issues, including the appointment of independent directors. From January 1, 2006, non-executive directors should make up at least 50 per cent of a company's board. If the chairman is a non-executive director, a third of the board members should be independent directors, and if the chairman is an executive director, the requirement goes up to 50 per cent. Sebi stipulates that these directors cannot be relatives of the promoters or senior management, or have any financial relationship with the company or its management.

While most of the larger companies already comply with the revised requirements for independent directors, many smaller companies will just about manage to meet the deadline. Not all boards are likely to toe the line voluntarily, but Sebi's threat of punitive action, in the form of de-listing from stock exchanges or a hefty fine (which can be up to Rs 1 crore), is a strong motivator. De-listing is the least efficient solution as it will harm the minority shareholder the most, exactly the opposite of Sebi's intention. The danger of unintended consequences therefore exists. Of the over 7,000 companies that are listed on the BSE, barely a third are traded frequently. For the rest of the companies, this could end up being a good reason to get de-listed. It is not clear that independent directors can help very much in improving corporate governance, especially if that is not the end result desired by the controlling shareholder(s) or the company management. Determined company managements can pull the wool over the eyes of any board, especially since non-executive directors have only a marginal stake in the fortunes of a firm and as a result make very limited time commitments for board meetings-which are usually held once in two or three months. Indeed, non-executive directors have themselves acknowledged their limitations by asking for exemption from the purview of penalties for events like the dishonouring of cheques. In recent times, there has also been the practice of directors resigning en masse before a company defaults on its loans, and then coming right back on the board soon afterwards. In other words, stipulating the number of non-executive directors tends to emphasise the process rather than the substance. This may be unavoidable when regulating a large number of companies with substantial variations in standards of corporate governance. But it is as well to recognise the limited efficacy of the exercise. Indeed, to the extent that Clause 49 comes in the way of a company's legal advisor or management consultant sitting on the board, it may even be counter-productive.

The more effective part of the new regulation would be the Sarbanes-Oxley idea, borrowed here, to ask the CEO, CFO and other functionaries like the company secretary, to personally certify the authenticity of various declarations made to the board and to shareholders. Even in the US, it is this which has been the most effective among the many new rules. As far as the independent directors are concerned, many companies will observe the new rules in letter but not necessarily in spirit.