Adding heft to weak corporate boards
Shareholders and taxpayers are currently paying the price for weak corporate governance during the previous economic boom
The ongoing spectacle starring battered banks and overleveraged companies in parallel roles is as much a result of weak corporate governance as it is of the vagaries of the business cycle. In this context, the Securities and Exchange Board of India (Sebi) has done well to accept about 40 recommendations made by the Uday Kotak committee on corporate governance, which submitted its report in October 2017.
Several listed companies have already been referred to the National Company Law Tribunal under the Insolvency and Bankruptcy Code. It is reasonable to assume that if the boards of these companies had asked tougher questions at the time of the borrowing binge, at least some of them would have avoided destroying shareholder wealth. The government and regulators need to work at multiple levels to strengthen the overall governance framework. This is necessary not only to protect faith in the system but also to make the allocation of capital more efficient.
Some of the broad recommendations of the Kotak committee are worth noting here.
First, the eligibility criteria for independent directors would be expanded. The institution of the independent director is extremely important for protecting the interest of shareholders. Therefore, it is important that independent directors are actually independent of the management, which is not necessarily true today. It is likely that the management of a listed company takes decisions that suit the promoters or the management group at the cost of other shareholders. The Kotak committee had recommended that apart from excluding members of the promoter group, an independent director would need to give an undertaking that they are not aware of any situation that could affect their ability to make an independent judgment. This would be assessed and put on record by the board. Further, the committee recommended excluding “board inter-locks”. This means that if a non-independent director of a listed company serves as an independent director in another firm, then a non-independent director of the second firm would not be able to become an independent director in the first company. The idea is that independent directors should be truly independent to be able to protect the interests of shareholders.
Second, the market regulator has decided in favour of separating the position of the chairperson and the chief executive officer or managing director, which will initially be applied to the top 500 companies by market capitalization. The issue is being debated in various parts of the world, and the committee recommended this with the idea of reducing the concentration of power and achieving a better governance structure. This will enable better supervision and allow the board to act more independently.
Third, auditors play a critical role in the governance structure and ensure that the reported financial statements are accurate. To improve transparency, Sebi has accepted the recommendations regarding disclosure of the auditor’s credentials and fees, among other things. The committee had recommended that the notice of the annual general meeting where an auditor is to be appointed should have details like the credentials of the auditor and the proposed fees. The company should also provide the reason in case there is a significant change in fees compared to the outgoing auditor. Further, the committee had recommended that the company should disclose the reasons in case an auditor leaves before completing its term. Similarly, an audit firm should also be encouraged to disclose the reasons for its resignation. Besides, acceptance of the Kotak committee recommendations would lead to more disclosures regarding related-party transactions and enhance the obligations of listed companies regarding subsidiaries.
Finally, apart from improving the corporate governance regulations, Sebi would also do well to pay attention to what the Kotak committee had noted about the regulator itself. The committee, for instance, highlighted the difference between the way the US Securities and Exchange Commission and Sebi are staffed. It is important that the regulator is adequately staffed. It should prepare to regulate the securities market of a growing economy, which would perhaps double its size in less than a decade, increasing levels of financial sophistication. In fact, economic growth itself, to a large extent, will depend on how well markets are regulated and how efficiently savings are channelized into investments. India, in general, lacks institutional capacity in implementing laws and regulation, but filling this gap in the securities and financial markets could have a disproportionate impact on growth outcomes.
Corporate boards will have to rise to the occasion to protect shareholder interest, especially since India neither has enough activist investors nor short sellers who can bring change from outside the cosy system. Shareholders and taxpayers are currently paying the price for weak corporate governance during the previous economic boom.
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