Background
The norms relating to corporate governance in India see periodical revisions and thus have come a long way. From being recommendatory at one time, to forming part of the Listing Agreement, some provisions relating to corporate governance now form part of the Companies Act, 2013. To review the requirements, particularly in the light of several recent developments, a Committee was set up. The Committee has made several recommendations which, whilst mostly being largely incremental, have already become contentious. Considering the past, where after considering, the recommendations are fast tracked and finally implemented, and hence the proposed changes need to be highlighted. The Report itself, however, recommends a phased adoption with extra time being given in appropriate cases. The recommendations are numerous. However, considering paucity of space, only some of the important ones are highlighted.
Requirements relating to accounts/auditors
Several recommendations have been made in the area of accounts/audit. The Committee is of the view that there is a need to improve disclosures in financial statements and also enhance the quality of financial statements and audit. Important recommendations are summarised below :
Presently, a company is required to quantify the impact of audit qualifications on various financial parameters such as profits, net worth, etc. The Report recommends that the management shall mandatorily make an estimate of impact of qualifications, where the impact on financial parameters of qualifications is not quantifiable. However, such estimate need not be made on matters like going concern or sub-judice matters. But in such cases, the management shall give reasons and the auditor shall review them and report thereon.
The Report then recommends that where the auditor is not satisfied with the opinion of an expert (lawyer, valuer, etc.) appointed by the company on an issue, he is entitled to obtain, at the cost of the listed company, opinion of another expert appointed by him.
The Committee noted that, presently, the auditor of the holding company may place reliance on audit performed by respective auditors of subsidiaries while reporting on the consolidated financial statements. He may, however, decide that supplemental tests on the financial statements of the subsidiary are necessary and he may send a questionnaire seeking information to the auditor of the subsidiary. Whether this was enough or whether the auditor should have more active role was the question. In line with global standards, the Committee recommended that the auditor should be made responsible for the audit opinion of all material unlisted subsidiaries. Thus, the auditor of the holding company would have more control over how the audit of the subsidiary is conducted.
The Committee has recommended that both quarterly consolidated and standalone statements, should be published. Further, half-yearly cash flow statement should also be published. The quarterly limited review should now include review also of the subsidiaries in such a manner that at least 80% of the consolidated revenue/assets/profits are covered in such review. In the last quarter, regulations currently require that the last quarter figures would be the balancing figures of the whole year’s figures minus those of the preceding three quarters. For this purpose, the Committee recommends that material adjustments made in the last quarter but relating to preceding quarters shall be disclosed.
The Committee recommends that the detailed reasons given by the auditor for his resignation before the end of his term shall be disclosed.
A recommendation that could have far reaching effect relates to power of SEBI to take action against auditors. Presently, a decision of the Bombay High Court (Price Waterhouse & Co. vs. SEBI (2010) 103 SCL 96) affirms the power of SEBI to take action against the auditors in case of fraud/connivance. The Committee recommends that this power be taken one step ahead and SEBI should be allowed to take action also in case of gross negligence. However, the ICAI has opposed this recommendation stating that “the regulation of chartered accountants is covered under the Chartered Accountants Act, 1949” and also “to avoid jurisdictional conflict and other issues.”
The Committee has made recommendations regarding the Quality Review Board (“QRB”) in relation to review of audits including strengthening this Board, enhancing its independence, etc. The ICAI has dissented with this recommendation stating that it was outside the scope of reference of the Committee. Further, it has stated that QRB has already applied for membership of International Forum of Independent Audit Regulators (IFIAR).
Changes regarding board/independent directors/women directors/Chairman
One of the pillars of good governance is sufficient number of independent directors. The principle is to balance the promoter/management dominated board with independent directors who have no connection or relationship with the promoters or the Company. Hence, the present law requires a significant number of independent directors on the board and at least one woman director on the board.
The Report now recommends certain changes. Firstly, it recommends that the minimum board size be increased from the current three to six. The intention clearly is to have a larger board having diverse expertise, which would help in better governance. While boards having only the bare minimum 3 directors may be rare, several companies have boards in the range of 3-6 directors. Companies will now need to find more directors. Importantly, since the number of independent directors is calculated as a fraction (one-third or half) of the Board size, more independent directors would also have to be appointed. Liability of independent directors (and even directors generally) under the Companies Act, 2013, as well as the SEBI Regulations is already very high.
Remuneration of independent directors
Remuneration, particularly of independent directors, remains low and limited. The Committee has recommended increase in remuneration. The irony is that a higher remuneration to independent directors may supposedly result in dilution of independence. It would thus be tough to find directors who are really independent directors.
Remuneration of independent directors is a tricky area. Give too less they lose incentive to put in the efforts required. Give too much, they become dependent on the company for getting substantial remuneration and compromise their independence. At same time, the increased remuneration will also be a burden on the Company, even if for a valid purpose.
Presently, the law requires that at least one-third of the Board should consist of independent directors, but if the Chairman is from the promoter group or an executive director, the said proportion is one-half. The Report recommends that :
– the Chairman should not be an executive director.
– the number of independent directors should at least be 50% of the Board size.
– Woman director should be an independent director to comply wih the spirit of the law.
The objective is to strengthen further this pillar of corporate governance. Needless to emphasise that the demand for independent directors will increase.
But perhaps the most curious of requirements relates to who should be Chairman. Presently, there are already some restrictions on appointing a promoter/executive director as Chairman. However, now, the Report goes much further, noting the already existing similar requirement under the Companies Act, 2013, and proposes a blanket prohibition and recommends that the Chairman shall not be an executive director. The rationale provided is that this would avoid in excessive concentration of powers in the hands of one person. I submit that this is a western concept where promoter holding is scattered and hence the CEO has vast powers without any counter balance. In India, companies are largely promoter dominated who typically hold controlling interest. The CEO, even if professional, is easily balanced by the promoter group along with the independent directors. Further, the post of Chairman, at least in India, is largely ceremonial unless executive power is specifically granted. The Chairman conducts the meetings as per law and not arbitrarily. It is reiterated that he does not have ipso facto any executive or overriding powers. On the other hand, he does represent the face and image of the Company. Shareholders do know that a promoter driven company has usually the senior family member of the promoter family in the forefront. In such a case, seeking to replace him with a non-executive person does not make sense. It may only result in a member of the promoter group being appointed as Chairman but without being an executive director. But it will not change the position that the promoters control the company. The Report does clarify that initially the requirement be made only for companies with at least 40% public shareholding. But even that is too low since this may require even a company with 51% promoter holding to have such a non-executive Chairman.
The Report now suggests that it would be fair to provide at least a certain level of minimum compensation to independent directors. This is suggested to be worked out as a mix of their actual role in terms of work done and also in terms of performance of the company in terms of profits. The Report recommends at least Rs. 5 lakh (if profits permit) should be provided as minimum remuneration (including sitting fees) to independent directors for the top 500 listed companies. The minimum sitting fees should be Rs. 50,000 for board meetings, Rs. 40,000 as sitting fees for Audit Committee meetings and Rs. 20,000 for other Committee meetings, for top 100 companies (with half of that for next 400 top companies).
This will clearly incentivise the directors. However, considering that this increase is also together with overall increase in number of independent directors, the burden on companies in terms of costs will also increase.
Sharing of information with Promoters, etc.
Finally, the Report deals with an issue having special relevance to India. And that is sharing of unpublished price sensitive information in listed companies in India with its promoters and generally also with significant shareholders who have rights under an agreement of access to such information.
The issue is detailed and complex and would require a full length article to even cover the main points. But suffice here to say that the Report makes certain recommendations to ensure that the information that the promoters and others get is not misused. In particular, they face restrictions on their use/distribution, etc. similar to insiders under the Regulations relating to insider trading.
Conclusion
There are other recommendations too. However, the Report has faced controversy on some issues, not just from outside but within the Committee itself with certain members/representatives openly and strongly expressing their dissent. It will be beyond the scope of this article to analyse the merits of such objections.
But one can conclude that some of the important recommendations may either get dropped or substantially modified and perhaps get delayed in implementation till a broader debate is conducted and a consensus arrived at. Nevertheless, the path of future corporate governance leads is visible and it is a tough call for independent directors.
