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Wanted for India Inc: Independent
directors
By Kunal Kumar Kundu
MUMBAI - The ownership battle between the
Ambani brothers - Mukesh and Anil - of Reliance
Industries has probably done for India's corporate
governance what the Kumarmanagalam Birla and
Narayana Murthy committees constituted by the
Securities and Exchange Board of India (SEBI) and
the Naresh Chandra Committee set up by the
previous government could not - upgrade it as the
top corporate concern. The unraveling of the
intricate web of investment companies and
cross-holdings that late Reliance founder Dhirubai
Ambani crafted - and which now muddles the
succession and ownership issues - would not have
been possible even if SEBI were to launch an
independent inspection. Only an insider could have
blown the whistle.
Corporate governance is
the system by which companies are run and the
means by which they are responsive to their
shareholders, employees and society. It is
concerned with holding the balance between
economic and social goals and between individual
and communal goals. Authority, it is said, isn't
very good at enforcing morality. Ever since the
labyrinthine cross-holdings in Reliance have come
to light, shareholders have been asking themselves
if good corporate governance has been enforced in
India at all. One thing that has found repeated
mention in this regard is the role of the board of
directors.
The Birla Committee and the
SEBI have put in place the basic framework for
corporate governance in India through the
institution of boards of directors. They have
defined independence and the stipulated structure
and composition of the boards, among other things,
to support corporate governance. The regulations
require that the board of a company must have an
optimum combination of executive and non-executive
directors with no less than 50% of the board
comprising the latter. According to the Birla
Committee, good corporate governance dictates that
the board has individuals with certain core
competence, such as awareness of the importance of
the board's tasks, integrity, a sense of
accountability, track record of achievements, and
the ability to ask tough questions. Besides
possessing financial literacy, the requisite
experience, leadership qualities and the ability
to think strategically, the directors must show a
significant degree of commitment to the company
and devote adequate time for board meetings,
preparation and attendance. The committee was also
of the view that adequate compensation package be
given to the non-executive independent directors
so that these positions attract talent.
Reliance, which was - wonder of wonders -
recently awarded for best corporate governance,
now finds itself in the doghouse for just the
opposite. Unwittingly, the Ambani brothers have
shifted the spotlight to the role of independent
directors as the battle heats up over Reliance's
control. It is an open secret in India's corporate
world that most independent directors find seats
on the boards on the basis of their proximity to
the promoters. Leaving aside the dramatic
resignation (which was subsequently withdrawn) of
M L Bhakta from the board of Reliance, there have
been no cases where independent directors have
differed on the direction of the company.
An independent director interfaces with
shareholders through audit committee reports. But
the scope for comments is restricted to the
veracity of the figures and maintenance of the
account books. Is there a way for the shareholders
to know how many independent directors expressed
misgivings about the company's expenditure plan,
or how many had reservations about the company's
resource-mopping exercise or bonus issue? As long
as the board has a majority of votes, these sorts
of discussions never even take place.
In
the framework of corporate governance, the role of
non-executive independent directors assumes great
importance. Independent directors are those who,
apart from receiving a director's remuneration, do
not have any material relationship with the
company or its subsidiaries. But this definition,
with its open discretionary caveat, undermines the
concept of independent directors. International
practice has been quite forthright and objective
in defining independence, however. According to
the Guidelines of the Commonwealth Association for
Corporate Governance (1999), "Independence is more
likely to be assumed when the director does not
have an actual or potential conflict of interest.
That is, the director is not retained as a
professional adviser by the company, is not a
significant supplier or customer to the company,
has not been an employee in any executive capacity
in the recent past and does not participate in any
share-option scheme within the company."
In today's context, the role of
non-executive and independent directors is being
met in India in four distinct, possibly not so
perfect, ways. The first is to take on
board-retired civil servants or private
sector/public sector functionaries. The second is
to accept non-independent directors of chosen
companies as independent directors. The third is
to induct working professionals such as lawyers,
doctors, consultants and professors as independent
directors. The fourth, resorted to by relatively
high-profile companies, is to have on board
executives, professors and consultants from other
countries. The Indian system, thus, has bank
customers serving on the boards of banks,
founders/chief executives and professionals
serving as mutual independent directors in each
other's group entities, professionals whose firms
or associates undertake work for the companies
being on the boards of such companies and
directors of other nationalities (including
non-resident Indians) helping in business
development and networking.
What India
requires are boards with senior personnel who
possess the requisite skills and attributes, and
are economically independent to be able to analyze
complex issues and voice their opinions without
fear or favor. SEBI has recently brought about a
change in the Clause 49 listing agreement between
companies and stock exchanges, which deals with
qualifications of independent directors. The
clause was originally incorporated in February
2000. Subsequently, on October 29, 2004, SEBI
amended the original clause and issued a new one.
All existing listed companies will have to comply
with the provisions of the new clause by December
2005. But it has already come into force for
companies that have been listed on the stock
exchanges after October 29, 2004.
The new
clause lays down tighter qualification criteria
for independent directors. It disqualifies
material suppliers and customers from the board.
It also disallows a shareholder with more than a
2% stake in the company from being an independent
director, as well as a former executive who left
the company less than three years ago. Partners of
current legal, audit, and consulting firms, as
well as partners of such firms that had worked in
the company in the preceding three years, too,
can't be independent directors. A relative of a
promoter, or an executive director or a senior
executive one level below an executive director,
too, cannot be an independent director.
Another important difference is that while
the original clause gave the board the freedom to
decide whether a materially significant
relationship between a director and a company
affected his independence, the new clause takes
this discretionary power away from the board. In
the original clause, the maximum time gap between
two board meetings could be four months. The new
clause has reduced this time gap to three months.
The original clause had stipulated that the audit
committee must meet at least three times a year
and at least once every six months. The new clause
makes it mandatory for the audit committee to meet
a minimum of four times a year with a maximum time
gap of four months. Moreover, unlike the original
clause, which was silent on the qualifications of
audit committee members, the new clause states
that all members should be financially literate
and at least one should have financial or
accounting management expertise. The new clause
also defines "financially literate" and
"accounting or related financial management
expertise", and widens the role and responsibility
of audit committees.
The new Clause 49
necessitates that:
The board will lay down a code of conduct for
all members and senior management.
The chief executive officer and the chief
financial officer will certify the company's
financial statements and cash flow statements.
At least one independent director of the
holding company will be a member of the board of a
material non-listed subsidiary.
The audit committee of the listed company
shall review the financial statements of the
unlisted subsidiary, in particular its
investments.
If while preparing financial statements, the
company follows a treatment that's different from
that prescribed in the accounting standards, it
must disclose this in the financial statements and
the management should also provide an explanation
for doing so in the corporate governance report of
the annual report;
The company will have to lay down procedures
for informing board members about risk management
and minimization procedures.
Where money is raised from the public, the
company will have to disclose the
uses/applications of funds according to major
categories (capital expenditure, working capital,
marketing costs, etc) as part of quarterly
disclosure of financial statements. Further, on an
annual basis, the company will prepare a statement
of funds utilized for purposes other than those
specified in the offer document/prospectus and
place it before the audit committee.
The company will have to publish in its annual
report its criteria for making its payments to
non-executive directors.
Though these are
steps in the right direction, there is also a case
to amend the Company Law so that independent
directors can establish direct communication with
shareholders via annual reports. Also, if chairman
and managing directors are held responsible for
the balance sheet they have signed, the same
should extend to the independent directors as
well. If independent directors get the platform to
voice their concerns rather than parrot the
executive directors' views in the board rooms, it
will boost the quality of debate, corporate
supervision and accountability. In family-run
businesses such as Reliance, this will also ensure
the induction of professionals does not stop
outside the board rooms.
Kunal Kumar
Kundu is a senior economist with a leading
bilateral Chamber of Commerce in India. He has a
Masters in Economics with specialization in
econometrics from the University of Calcutta.
(Copyright 2005 Asia Times Online Ltd. All
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on sales, syndication and republishing.) |
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