Introduction :
It’s been some time now since Corporate Governance became
mandatory for listed companies in India vide Clause 49 of the Listing Agreement.
The post-Enron era has evidenced significant development in Corporate Governance
across the globe, though it is still evolving. The raison d’etre of
‘governance codes’ is the Agency Theory on which, the edifice of companies is
built. To what extent the existing model of Clause 49 has been successful in
addressing this Agency theory in India, is yet to be seen. However, there are
still certain areas where there is scope of improvement.
This article identifies and highlights areas wherein Clause
49 is in variance with international governance practices and also tries to
bring out certain inherent limitations in the existing clause. It tries to
highlight potential areas of improvement and articulate the next stage which
Clause 49 needs to embrace in order to improve the governance practice in India.
Splitting the roles of Chairman and CEO :
The basic objective of corporate governance is to segregate
the functions of governing the company and managing the company. This is done by
establishing a governing body (alias the Board) and giving it adequate
independence to direct and supervise the actions of management. To strengthen
its independence, the governing body is constituted through a mix of internal
and external parties. Board’s independence is a sine qua non for
effective governance.
Clause 49 does make demarcation between Governing Body and
Managing Body; this ensures independence to an extent. But at the end of the
day, the leader of both the bodies is the same person i.e., the CEO.
Unlike the Combined Code in the UK, Clause 49 does not mandate splitting of
roles of Chairman and CEO. So in effect, the person responsible for managing the
company is also responsible for managing the Board — which further implies that
the functions of managing and governing are effectively in the hands of the same
person, thereby violating the basic principle of independence and concept of
corporate governance.
In theory, the Board and the Chairman are responsible to
critically evaluate and challenge the actions of the management and the CEO. But
in a scenario where the Chairman of the Board and CEO of the company is the same
person, the Chairman becomes responsible for evaluating his own performance and
challenging his own decisions, which at first instance sounds grotesque, if not
impudent. Albeit, there are other members also on the Board along with CEO, who
are responsible for ensuring independence — combining or not splitting two roles
does jeopardize and weaken the Board’s independence, particularly in Indian
context, where the Board Meetings are largely influenced and driven by its
Chairman making Board Meetings person-driven instead of process-driven. It has
been often evidenced that such meetings are largely led by the Chairman,
undermining and suppressing the roles of other independent directors who often
are fairly new on the Board and thereby putting the Chairman-cum-CEO in further
advantageous position.
Clause A.2 of the Combined Code succinctly provides that –
‘There should be a clear division of responsibilities at the head of the company
between the running of the Board and the executive responsibility for the
running of the company’s business. No one individual should have unfettered
powers of decision’.
It further states — The division of responsibilities
between the chairman and chief executive should be clearly established, set out
in writing and agreed by the Board. A chief executive should not go on to be
chairman of the same company. If exceptionally a Board decides that a chief
executive should become chairman, the Board should consult major shareholders in
advance and should set out its reasons to shareholders at the time of the
appointment and in the next annual report.
While the UK law makers do endorse that splitting of roles is
an indispensable component of Board’s independence, they further go to criticise
the consolidated model on the grounds that management might be more tempted, and
more able, to withhold information (which generally means bad news) from the
Board, thereby reducing its ability to assess the company’s performance.
Independence apart, many argue that one person can’t carry out two such
increasingly difficult jobs. Separating them frees the CEO to focus on running
the business and the Chairman to discharge the board’s expanding
responsibilities.
In the United Kingdom, about 95% of all FTSE 350 companies
adhere to the principle that different people should hold each of these roles.
In the United States, by contrast, nearly 80% of S&P 500 companies combine them
— a proportion that has barely changed in the past 15 years.
Clause 49 partly addresses the issue of independence by
mandating that if the Chairman is an executive director, at least fifty percent
of the Board members shall comprise of ‘independent directors’. In case, the
Chairman is a non-executive director, then the minimum number of independent
directors shall be one-third. However, the clause does not mandate that only an
independent director shall be chairman of the Board and that there should be a
clear division of responsibilities between the running of the Board and running
of the company’s business.
Suggestive prescription :
Separating the two roles in itself, is not the panacea for
making Boards more effective and even after such separation there is no
guarantee of improvement in the Board’s performance; however, such separation
will indubitably add to the Board’s independence and empower it to critically
challenge the actions of management and CEO. Clause 49 should mandate the
separation of the two functions; in other words, the Chairman of the Board and
CEO of the company shall be two distinct persons.
Mandating whistleblowing and empowering whistleblowers :
Whether one agrees or not, whistleblowers have a
crucial role to play in corporate governance and can save a corporate
titanic from hitting an ice berg by striking the bells at the right
time. The Enron saga and its downturn started with whistleblowers.
Clause
49 does have a provision for a whistleblower policy, but the provision
is recommendatory in nature. While many of large cap companies have
voluntarily formulated a whistleblower policy, not many companies listed
on stock exchange have a ‘whistleblower’ policy.
Even in those
companies which have implemented a ‘Whistleblower’ policy, it is evident
that the Policy, akin to many other policies, becomes a mere paper
document posted on company’s website. The Policy therefore, is
implemented in letter and not in spirit. There are very few instances on
record wherein the policy has been able to bring out the issues buried
underground and take apposite actions. In majority of companies, the
employees are either oblivious of such a policy or are not willing to
take its recourse and have selected silence as an option.
To boil down, there are two reasons for whistle-blowing not being effective in the Indian scenario
Firstly, having a formal whistleblowing policy is still not mandatory.
Secondly,
the existing corporate culture does not support or rather empower an
employee to stand up and blow the whistle – it is cultural and other
soft factors that impede an employee from coming forward and blowing the
whistle despite formal protection available under the policy.
Whistle
blowers normally lose their jobs and find difficult to get employment
elsewhere. Even in the U.S. Government, whistleblowers get shunted
(source: Financial Express, 12-5-2008).
The cultural deficit
exists because there is lack of adequate commitment and communication
from the Board and management who are reluctant to empower its employees
– in some cases, the reluctance is deliberate while in other cases it
is due to the fact that implementing such a policy requires change, and
any change, particularly cultural change, is difficult to implement.
While latter cases can be pardoned, the former cannot be; deliberate
reluctance from management and Board might be due to fear that such a
policy may act as a key to ‘Pandora’s Box’ and may become’ Achilles
Heel’ of the management by exposing its wrong deeds.
Suggestive prescription:
Following is the suggestive prescription to make whistleblowing an effective tool of corporate governance in Indian scenario.
Giving regulatory hue:
At
the outset,’ prescribing a ‘whistleblower’ policy should be made
mandatory. This will at least initiate formal adoption of the policy and
its implementation, at least in letter, if not in spirit. The auditors/
company secretary, while issuing certificate on corporate governance,
should be required to comment on the adequacy of such a policy.
Allow Anonymous Whistle Blowing:
Despite
the existence of formal policy and conducive culture, employees don’t
consider this tool as a preferred option to highlight wrongdoing within
the organisation. One way to overcome this impediment is to allow
anonymous whistleblowing. Under anonymous reporting, the whistleblower
is not required to disclose his/her identity at the initial stage. Being
anonymous provides an innate protection to the complainant.
This
mechanism however has a risk of impudent issues being reported to Board
and the Board may find itself being mingled among trivial issues which
could have been easily resolved by the management. Also, anonymous
whistleblowing is feasible only at the initial stage of screening of the
issue; once the investigation begins, the anonymous whistleblower
should be willing to come out and testify as a witness. As a matter of
fact the anonymous whistleblower in an anonymous complaint should offer
to do so. In the absence of his willingness, unless a prima facie case
exists, it is likely that the enquiry would be dropped.
Allowing external whistleblowing :
Enact
a law as in the Philippines, where there is a separate law called
‘Whistleblower Protection Act’, which provides legal protection to
whistleblowers for voicing against corruption practices within an
organisation.
Raise the issue with external independent agency,
like company’s auditors who whilst conducting their audit would take
cognizance of such an issue. However, the problem with the above model
is – once a fraud/corruption issue is reported to an external agency, it
becomes rhetoric and has the risk of sabotage to company’s reputation.
Extending Whistleblower policy to other stakeholders:
Whistleblowing,
as a tool to disclose misconduct and graft, is used in a restrictive
sense and embraces only employees within the company including
directors. Under the existing model of whistleblowing, it is only the
employees who are empowered to blow whistle.
An organisation
constitutes of several other stakeholders apart from employees and
includes suppliers, customers, government and local community. Quite
often these stakeholders are confronted with an act of corruption or
misconduct while dealing with the company, especially the suppliers and
customers. Such transactions are not reported by internal employees to
conceal their unscrupulous deeds. In such a scenario the external
stakeholders, say, suppliers or customers should have an opportunity to
disclose such scheming conduct to company’s governing body. There should
be some mechanism whereby even the external stakeholders have an
opportunity of blowing whistle to the Board of Directors.
The
mechanism suggested is akin to ‘grievance cell’ found in many companies,
where the customers have a right to file a complaint in case of any
dis-satisfaction. However, unlike a grievance cell, under this mechanism
an external stakeholder has the right to report any misconduct on the
part of company to the Board of Directors.
It is hoped that
extending the whistleblower mechanism to other stakeholders will promote
greater transparency in company’s conduct of business and improve its
value among the stakeholders at large.
Cons of the idea:
Despite
its benefits, the idea of extending whistle-blowing model to other
stakeholders has not been widely acclaimed. One contention is – what
would an external stakeholder gain by whistle blowing particularly when
he himself has benefited from such fraudulent conduct. However, the
argument against this contention is that corporate governance is meant
to protect interest of all the stakeholders and not just the
shareholders or employees; by disclosing solecism conduct he not only
benefits the company, but also protects his own interest and long-term
value; in fact, it becomes his ethical responsibility to make such
disclosure, as he is also economically associated with the organisation.
It
is also argued that the above mechanism may lead to trivial issues
being escalated and may in fact become a mode to express dissatisfaction
rather than expose misconduct. Embedded therein is also the risk of it
being deliberately misused by external stakeholders whose relationship
with the company has soured.
Evaluating performance of non-executive and independent directors:
The
primary role of non-executive and independent directors on the Board is
to critically challenge the actions and decisions of Executive Board
and management. Apart from maintaining independence and integrity, they
are also expected to provide fresh insights and bring their
competencies, thereby enhancing the value to stakeholders.
Evaluation of NED under Clause 49 is currently recommendatory. Such evaluation is necessary for the following reasons:
1. To determine whether a non-executive director has delivered on his/her expectations.
2. To determine whether he has contributed to enhance overall effectiveness of the Board.
3. To determine whether a particular director should continue on the Board.
4. To link remuneration of non-executive directors to their performance.
In
the current scenario, majority of the Indian companies do not have a
formal process in place to evaluate performance of non-executive
directors. The primary reason is that:
- having a formal evaluation process is not currently mandatory
- it is difficult to define/prescribe performance criteria objectively.
Suggestive prescription:
The
evaluation can be done by establishing a peer review committee which
should consist of Board members other than the director whose
performance is being evaluated. The peer review committee can meet on
periodic basis (say, on bi-annual or annual basis) to evaluate
performance of directors.
The following are the suggestive
criteria for evaluating performance of non-executive and independent
directors. The criteria are only illustrative and may vary depending on
requirement of each Board:
Practical Case: Infosys Technologies Limited
Currently,
there are very few companies in India which have voluntarily instituted
a formal mechanism for evaluation of non-executive members. For
instance – In Infosys, the performance of NED is evaluated through ‘peer
evaluation process’, wherein each external Board member is required to
present before the entire Board on how he has performed or added value;
the performance is evaluated on a scale of 1 to 10 based on set
performance criteria. The criteria used by Infosys are:
- Ability to contribute to and monitor corporate governance practice
- Ability to contribute by introducing international best practices to address top management issues
- Active participation in long-term strategic planning
- Commitment to fulfilment of director’s obligations and fiduciary responsibilities – this includes participation and attendance.
Conclusion:
The
aspects covered present potential pitfalls and areas of improvement in
existing Clause 49. While the suggestive prescriptions are not foolproof
and exhaustive, the purpose is to trigger a thought process and
initiate ‘deliberation’, which can lead to strengthening of corporate
governance.
