Moving towards better corporate governance
Many Indian companies are groaning under the weight of excess debt. Almost every bank has a mountain of bad loans on its balance sheet. Few of the expensive acquisitions made in the previous decade have paid off for shareholders. Most corporate boards have maintained a studied silence about these issues. The problems in the Indian economy right now are as much about corporate governance as they are about the vagaries of the business cycle.
The recommendations that the committee headed by Uday Kotak submitted to the Securities and Exchange Board of India (Sebi) last week should be seen against this backdrop. The committee has recommended sweeping changes that will make corporate affairs more transparent as well as improve the standard of corporate governance in listed companies. As committee member Krishnamurthy Subramanian told this newspaper, the way to achieve this is by strengthening the three gatekeepers—the board, the auditors and the regulator.
To be sure, improving the standard of governance is an ongoing process, and India has made progress over the years. Committees in the past, such as those led by Kumar Mangalam Birla and N.R. Narayana Murthy, contributed to the process. The Kotak committee has extensively examined the current state and has made recommendations that will help improve governance and enhance investor confidence.
The committee has delved into areas such as the size and composition of the board, number of independent directors and their role, and disclosure and dissemination of information. The committee, for example, notes that since the board has a significant role in the functioning of a listed company, it should have an appropriate number of directors. It has recommended that a listed company should have a minimum of six directors, at least one independent woman director, and a minimum 50% of the directors should be non-executive.
The role of independent directors on the board is extremely important as they protect the interest of all stakeholders, especially the small investors. The committee has laid down the path for greater presence and role of independent directors. No board meeting can be conducted without the presence of an independent director. The committee has recommended that at least half of the board members should be independent directors. It has also suggested measures so that independent directors inducted in the board are truly independent. Given their importance in governance, it has been recommended that listed companies should have to give detailed reasons if an independent director resigns. These recommendations need to be welcomed. Independent directors will now be in a much better position to objectively protect the interest of different stakeholders, including the small shareholder. However, it may not be easy for companies to find good independent directors. The committee has also recommended the separation of roles of chairperson and managing director, and the chairperson should be a non-executive director.
Interestingly, the committee has suggested that the number of board meetings in a year should be increased from four to five and aspects such as succession planning, strategy and broad evaluation should be discussed at least once a year. This seems to have been inspired by recent boardroom battles, but it’s not clear if one more board meeting would actually help avoid such problems.
Further, the committee has advocated several changes that will help small investors. For instance, it has recommended that disclosures by companies to stock exchanges and on their own websites should be in a format that allows investors to find information with ease. It also recommended that companies explain significant changes in select financial ratios in the annual report. Additionally, the committee has recommended that all listed companies should publish cash flow statements on a half-yearly basis. All this will help the common investors—who normally don’t have access to financial databases—understand and track companies with relative ease.
The reliability of financial statements is extremely important, and this makes the role of auditors crucial. Here also, the committee is of the view that if an audit firm leaves before the expiry of its term, the company should give reasons for this as it could be a cause of concern for investors. It has also recommended that Sebi should have the power to act against auditors if the need arises.
Overall, the recommendations of the Kotak committee will enhance transparency and effectiveness in the way boards of listed companies function. Since some of the proposed changes are structural in nature, it has provided timelines for implementation. However, effective implementation and regulation remains an issue. The securities market regulator will need to develop capabilities to be able to regulate listed companies more effectively and protect the interests of small shareholders.
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