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What are the key provisions in voluntary guidelines around enhancing board independence and empowering independent directors?
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Which of these regulations could be codified into law and in what form?
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How can regulatory oversight and enforcement be enhanced to ensure that these regulations are complied “ in spirit ” ?
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Offices of Chairman and CEO
• Clear demarcation of the roles and responsibilities of the Chairman of the board and that of the
Managing Director/Chief Executive Officer (CEO)
Nomination
Committee
• A nomination committee comprising a majority of independent directors and independent Chairman drives the selection of non-executive directors (NEDs)
• Disclosure of guidelines followed and roles and responsibilities in the Annual Report
Attributes and independence of independent directors
• Policy specifying attributes of independent directors and disclosure of this policy to stakeholders
• ‘Certificate of Independence’ to be obtained and posted on the company’s website, as well as on the website of the stock exchange
Appointment of independent directors
• Formal letter of appointment specifying roles and responsibilities of NEDs, including independent directors
• Should be disclosed to shareholders through company’s website, as well as on the stock exchange
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Number of directorships
• Limit the number of outside directorships to 7.
Tenure of independent directors
• Cap on tenure of independent director to six years
Enabling powers for independent directors
• Empowerment of NEDs – Access to information, resources, company personnel and external advice
Remuneration of
NEDs/IDs
• A choice of fixed and variable remuneration
• Restriction on stock options
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Multiple existing regulations/guidelines will govern listed companies
Clause 49 of SEBI’s
Listing Agreement
Corporate
Governance
Voluntary
Guidelines
Companies Bill,
2009
Legal Sanctity
Regulatory
Oversight
Harmonization
Suggested Improvements
While the MCA’s guidelines may remain voluntary, the need to “comply or explain” should be made legally binding with strong punitive action for those who do not explain
The Bill should identify the relevant authority for regulatory oversight which will act as monitoring agency for quality of practices and disclosures
Need for harmonization between the various existing regulations
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Indian Scenario
• Promoters in Indian Companies have substantial shareholding and are directly involved with the business
• Segregation of board chair and CEO roles may potentially cause tension in the Board room
Scenario in Developed nations such as US and UK
• Institutional investors such as pension funds hold over 80 per cent of shareholding and hence ownership is separate from management
• Segregation seen as essential for effective oversight of management actions (e.g excessive risk taking, exec comp etc).
• 84% of European companies split the function of chairman and CEO
Our recommendation
• Instead of mandating companies to segregate board chair and CEO roles, it should be mandated that companies appoint a
Lead Independent Director. Some Companies have implemented this in practice.
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• The responsibility of the lead independent director should be to work with the promoters and oversee the functioning of the board
• The Lead Independent Director should act as an advisor to the board Chairperson, be involved in determining the board charters, agendas and information requirements and also bring to the fore concerns of the independent directors as a whole.
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Indian Scenario
• It may be difficult for smaller listed companies to constitute a nomination committee due to resource constraints. Expertise needed on the Nominations Committee would differ from that required on the Board
• Availability of independent directors with relevant experience may also act as a constraint.
Global Scenario
• In Europe, increasingly companies are segregating remuneration and nomination committees amidst growing awareness that remuneration and nomination are major talent challenges, requiring the commitment of a dedicated and expert group of directors.
• Combined committees are not found in the UK, Sweden, Germany, Italy and Denmark.
Our recommendation
• Mandate only large, listed companies (based on market cap and extent of public shareholding) to establish a nomination committee, requiring smaller organizations to have structured director appointment and evaluation processes overseen by the board.
• In case of smaller companies, regulators, institutions and stock exchanges should work together to develop a database of suitable independent director candidates for smaller companies to choose from.
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Indian scenario
• Independent director selection process is not very transparent and an overwhelming majority of the companies use the personal network of their promoters to search for new directors.
• As per recent Audit Committee Institute survey, a significant proportion of the prominent independent directors in India
(45%) serve on “5 or more” public company audit committees.
• 43% independent directors have had tenures of 6 years or more.
Global scenario
• Typically, companies in UK and US utilize the services of an executive search firm for appointing directors and disclose their director selection process to all stakeholders for scrutiny.
• Following the financial crisis, companies are required to make detailed disclosures about their board composition practices
(e.g.SEC disclosure requirements in US and amendments to the new Corporate Governance Code in UK)
• As per the 2010 Audit Committee Institute survey, 95% global respondents indicated that they served on “3 or less” public company audit committees (this is significantly lower than the Indian average highlighted above)
Our recommendation
• As per CGVG, the nominations committee/board should establish objective and transparent set of guidelines for searching, evaluating and appointing independent directors and disclose this to shareholders.
• There must be a limit on the number of outside directorships held. Going by the global norm, the limit should be no more than 5 and for those independent directors who are board / committee chairs, it should be 3.
• As per CGVG, there should be an upper limit of 6 years on the tenure of an independent director. Further, there should be a cooling-off period of 3 years before such an individual is inducted in any capacity
Source: India Board Report, 2009; Hunt Partners, AZB and Partners
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Indian scenario
• The Companies Act prescribes a ceiling on total remunerations paid to non-executive directors at 1% (or 3%) of the company’s stand-alone net profits for the year
• The structure of the compensation, including payment of sitting fees, commissions on profits, stock options, etc, are subject to approval by shareholders.
Global scenario
• The UK corporate governance code suggests that levels of remuneration for non-executive directors should reflect time commitment and responsibilities of the role and remuneration should not include share-options or other performance-related elements
• If, in exceptional cases, options are granted, the code suggests that approval should be sought in advance and any shares acquired by exercise of the options should be held until at least one year
• Remuneration structure in other parts of Europe varies vastly with countries such as Sweden, Denmark and Switzerland having over 95% of the total remuneration as fixed fees and countries such as France and Germany having less than 60% of the total remuneration as fixed
Our recommendation
• A significant proportion (up to 50%) of independent director’s compensation should be variable. This component should be determined based on attendance, time commitment, quality of advice and value added to company performance as measured by an objective board evaluation. Chairman of the Board and committees should be entitled to a higher remuneration due to the larger responsibilities that the role entails.
• As per CGVG, companies should be allowed pay stock options with delayed vesting rights to NED
• Companies should seek shareholders approval on “executive compensation policy”
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The need for director induction and continuous training
• Boards with a formal on-boarding process can help directors contribute sooner than boards without a formal on-boarding process.
Global scenario
• Both the NYSE and NASDAQ standards recognize the importance of initial and ongoing education through internal and external programs.
• Under the NYSE rules, companies must address their policies concerning director education in their corporate governance guidelines.
• Further, rating agencies such as ISS are factoring director training into their governance ratings/assessments.
• Institutions such as such as National Association of Corporate Directors (NACD) and Directors Institute are facilitating director education and training.
Our recommendation
• It is not sufficient to just mandate director induction and training, it is important to also mandate companies to disclose adequate information to enable stakeholders to monitor whether the companies are complying it in “in spirit”.
• It is also necessary to establish dedicated research and training institutions for independent directors
Source: Corporate Governance Handbook, The Conference Board
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Liability of the Independent Director
• Should Independent directors be as liable as the Executive Director? The ambiguity around this area is resulting in good candidates reluctant to take on independent director responsibilities.
Global Scenario
• UK Corporate Governance code observes that although both executive and non-executive directors have the same statutory duties, there are differences in time devoted to the company’s affairs by these directors.
• There is also information asymmetry which is an accepted fact.
• The code further adds that these differences in time spent should be considered while arriving at expectations from nonexecutive directors, implying a difference in liability
• In the US, companies are permitted to indemnify their directors and officers for certain types of liabilities, provided that these are in line with state incorporation laws and company by-laws.
Our recommendation
• There needs to be a differentiation between the liability of the non-executive director and that of an executive director
• Since independent directors spend lesser time with the company compared to executive directors and are not involved in day-to-day functioning, they should not be unduly held accountable for operational matters.
• The liability of the independent directors needs to be defined based on their roles and assigned responsibilities
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Policy makers and market regulators should collaborate with industry bodies, professional bodies, institutions and institutional investors to enhance regulatory oversight and enforcement
Regulatory ecosystem
Professional bodies
(ICAI, etc)
Industry bodies
(CII, NASSCOM, etc)
MCA &
DPE
SEBI
Institutions (IICA)
IRDA RBI
Institutional investors
(Private equity, mutual funds, etc)
Enhance the quality of regulatory oversight, by being proactive
Case in point: NASDAQ and NYSE Surveillance
Enhance enforcement framework
Case in point: SEC’s zero-tolerance to regulatory enforcement
Establish institutions that can play multiple roles of industry watchdogs, undertakers of governance research and training aimed at disseminating good practices
Case in point: NACD and Director Institute
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