No corporate governance issue in India in recent times has stoked as much emotional fervour as whether companies should have separate unrelated individuals holding the positions of chair and chief executive officer (or managing director, as referred to in India). The market regulator Securities and Exchange Board of India’s answer is a resounding yes, but the market’s battle cry is a no. A temporary truce has postponed the quandary by a couple of years.
Regulatory Nudges Globally
World over, the question of whether one person can hold the positions of chair and CEO or whether two individuals must each hold them separately has evoked a great deal of controversy. There is great merit in separating the roles to ensure a proper balance of power on corporate boards. At the same time, such a distinction can be a contrived one as it can lead to inefficiencies such as duplication in leadership. Available research is equivocal about the benefits of separation of the roles. In their study ‘Chairman and CEO: The Controversy over Board Leadership Structure’, Stanford researchers David Larcker and Brian Tayan summarise findings that “the independence status of the chairman is not a material indicator of firm performance or governance quality”.
Despite the lack of clinching evidence demonstrating the net benefit of the separation of chair and CEO roles, leading jurisdictions around the world, including the U.K. and the U.S., are applying pressure on companies to give effect to the separation. Activist shareholders are following suit. However, companies are not legally obliged to separate their roles. In case there is a valid reason to consolidate them in a single individual, companies need only to explain their stance to the market.
Hence, while separation is desirable, it is not mandatory, as companies enjoy the freedom to choose the option that fits their circumstances the best.
Legal Compulsion In India
Although India has been a relative latecomer to this debate, recent developments have introduced a great deal of stringency in requiring the separation of the roles. The discourse gained considerable traction in the aftermath of the Satyam corporate governance scandal, and the concept ultimately found its way into the Companies Act, 2013. Section 203 provides that the same individual cannot be the chair and CEO of a company. This is, however, only a default provision as companies are entitled to deviate from this through clauses in their articles of association. Moreover, the separation requirement does not apply to companies with a single line of business, where it would understandably amount to overkill. Despite the explicit recognition of separation, the Act rendered sufficient flexibility to companies to determine whether to implement it.
Matters acquired a great deal of severity when in 2018, SEBI—triggered by the recommendations of the Kotak Committee report—introduced a mandatory separation requirement for the top 500 listed companies to take effect on April 1, 2020. More importantly, SEBI introduced a condition that the chair and the CEO must not be ‘related’, as judged by the definition of ‘relative’ under the Companies Act. The requirement of separate chair and CEO was made inapplicable to companies without promoters, i.e., those with dispersed shareholding. Although SEBI provided a nearly two-year window for companies to comply with the requirements, the industry began exhibiting its resistance to the rule, and that too only as the date for implementation drew closer. Capitulating to immense pressure, SEBI appears to have had little choice but to defer the implementation until April 1, 2022.
Voluntary Versus Mandatory
Experience has shown that the Indian legislators and regulators distrust the voluntary ‘comply-or-explain’ approach to corporate governance for Indian companies. This is evident from the fact that corporate governance norms that constitute ‘soft law’ in most other jurisdictions are enforced in India through either the Companies Act or SEBI’s regulations in the form of ‘hard law’. The present trend to impose a legal mandate to separate the chair and CEO roles is characteristic of this trend.
However, it is not the idea of separation itself, but its form as a mandate for all manner of large listed companies that resulted in the miscarriage of SEBI’s present attempt.
It is nobody’s case that separation is undesirable, but given it operates beneficially in the context of specific types of companies and that too in specific circumstances, the decision to adopt that path must lie in the hands of companies and their shareholders, and not the regulators.
As Larcker and Tayan note, research shows that the benefits of separation of chair and CEO roles are “situation-dependent”. It would be imprudent to paint every large company with the same brush. For example, the separation of chair and CEO roles may be beneficial in companies that are facing governance crises, especially due to the consolidation of power in an individual’s leadership. In such cases, regulators elsewhere have intervened as well.
For example, when Tesla’s then Chairman and CEO, Elon Musk, launched a failed bid to acquire his company, the U.S. Securities and Exchange Commission settled charges on the condition that he relinquish his position as chairman in favour of an independent director.
Conversely, it is conceivable that if one introduces an artificial separation of leadership roles in an otherwise well-performing and well-governed company, any accompanying discord on the board may send the company into a downward spiral.
There is a risk that SEBI’s mandate to Indian companies might result in compliance in form rather than in substance. It matters less what the precise structure of the board is; greater emphasis needs to be placed on the qualities, capabilities, and credibility of the individuals populating it. Matters of business ethics and governance are innate qualities that boards must develop, and there are limitations on the extent to which microscopically prescriptive regulation can engender those qualities.
Moreover, SEBI would do well to adopt a risk-based approach rather than a universal approach.
Rather than stipulating a separation of roles to all large companies, SEBI can mandate it to companies that carry governance risks, such as where the company is facing audit issues or is the subject matter of regulatory action from SEBI or other market regulators. In other companies, the focus must be on lead independent directors, who can play the balancing role of modulating the powers arising out of a consolidated leadership position. Instead of mandating a separation of roles when there is insufficient evidence of success, functional substitutes such as the lead independent director might fill in the gap. Ultimately, micro-level governance structures are company-specific as well as situation-specific. All-encompassing prescriptive mandates are likely to be counterproductive.
A Family Affair
SEBI’s separation formula has touched a raw nerve among India’s family-owned companies, as the rule explicitly targets them. The requirement that the chair be unrelated to the CEO stands in the way of succession plans of family firms, whereby senior family members usually transition into chair roles while junior members manage the companies as CEO.
Now, family firms are left with only two choices: induct a non-family chair, or professionalise the executive management of the company.
Whether such a straitjacketed formula would result in better corporate performance and governance is anybody’s guess.
Curiously, the separation requirement evolved in countries like the U.S. and the U.K. where companies with dispersed shareholding and a large body of institutional investors are prominent. Family firms in India have disputed the utility of such ‘westernised’ notions into the Indian milieu. In the circumstances, it strikes as somewhat odd that the separation rule in India spares companies with dispersed shareholding when the requirement originated initially in countries like the U.K. for precisely those types of companies. Its applicability to family firms and not to dispersed firms effectively turns the rule on its head.
Going Forward
In the current dispensation, SEBI has merely postponed the implementation of the separation rule by two years, and has not displayed any inclination to review it. However, given the complexities involved in what superficially appears to be a minor technicality in corporate governance, SEBI would do well to undertake a cost-benefit analysis and fine-tune the mechanism to take on a meaningful shape that is capable of implementation in the Indian circumstances. If not, there is a grave risk that the current scenario will play out again, and the regulator would only have moved the clock back by two years.
Umakanth Varottil is an Associate Professor of Law at the National University of Singapore. He specialises in company law, corporate governance and mergers and acquisitions.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.
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