Resignation By Independent Directors Not A Solution, Says Mohandas Pai In Conversation With R Gopalakrishnan

With India Inc. seeing a spate of independent director exits in the past few months, to go or not to go seems to be the latest question they are faced with. Independent directors have received flak for taking or not taking certain decisions, and have shared the blame along with managements.

Do people have very high expectations of independent directors? Former Infosys chief financial officer Mohandas Pai thinks so and suggests we should temper them. But in a freewheeling chat with R Gopalakrishnan, former executive director at Tata Sons Ltd., Pai also says that resignation is not the solution.

The panel discussion on ‘Two-Tier Boards- The Way Forward?’ was held as part of an event hosted by former SEBI Chairman M Damodaran—Gatekeepers Of Governance.

Pai said overregulation was the real problem, and whether it was Saytam Computers or IL&FS, there were enough regulations at both times to identify problem areas. Regulation can’t be fixed by more regulation.

The discussion highlights the importance of the “mental make-up” of an independent director, why mistakes are unavoidable, and why clarity of intent is important in any business plan.

The main points discussed were:

• Should India have a two-tier board system?
• Improving the social dynamics of board.
• How independent are independent directors?
• Importance of consensus building in board dynamics.
• The power game: how much is enough?
• Assessing board failure and success.
• The problems of overregulation.

The panel went on to assess the problem of power play at work between managements and independent directors, and how this can weaken consensus building. R Gopalakrishnan said independent directors need to be taught to “disagree without becoming disagreeable”, and why conflict resolution is an integral part of decision making.

Watch the full discussion here:

Read the edited transcript of the conversation here:

Mohandas Pai: What is the route of the debate of one- and two-tier board and what do you think we need to look at?

R Gopalakrishnan: I am not sure who is having the debate other than you and I. There is literature. All forms of governance like public governance, corporate governance, family governance, school governance, they all must have roots in cultural soil of that society. If you look at two tier and one tier boards, they have Anglo- American roots in case of one tier and 9 countries including China which have two tier boards. The cultural influence behind it is UK and US model has evolved at a time when they said the capitalist system is best system. You are supposed to respect the market the most and you must reward the entrepreneur disproportionately. The rest of the stakeholders don’t matter. We go back to old Milton Friedman stuff. The German model which have gone to Netherlands, Finland and now to China comes out of German model soon after the WWII when they felt that number of stakeholders in a company, the social factors behind it was brewing for a long time. It manifested itself in two tier board. Both have run it and each one thinks theirs is better system and we will tweak it and do it better.

There are lots of flaws with both of it. In my career, I have worked in two tier board, except it wasn’t called two tiers. If I am on board of Tata Power, Tata Steel or Tata Motors and there is Tata Sons, conceptually and not legally, it is two tier board. If Tata Power or Tata Motors want more capital to do something hairy, Tata sons is expected to involve, for example, raising more capital. If I am at Hindustan Lever, then Unilever Board. So, we got experience for two tier board. However, we are legally operating with one tier board where both independent and executive directors sit together.

I don’t think there is great virtue of two-tier board. Argument that we can have free and more discussions among the independent directors as executive directors are not there. If you are scared of them and can’t have discussion, then you should re-think that whether you should be on board. I am not a great fan of two-tier board because this is like canning your wife because you are unhappy with this wife. You have to find how to settle your marriage here rather than keep looking for new wife.

Mohandas Pai: Do you believe that having the same voice in the same board will reduced the asymmetry of information within two set of players who is supposed to run the co-operation? The management which have all the information and independent directors and labors who can sit at a distance and take decision very differently. Do you think this suppression of power at distance makes a bug difference?

R Gopalakrishnan: Distance makes a difference, whether it is positive or negative depends on that context. The management board can get so obsessed with their domain, business and their competitors and they make loose wood for tress when there is development happening outside. The independent directors can bring that move. Conversely, independent directors are living in cuckoo land and they are sitting in supervisory board and say this people has no idea of what is happening in our company, I am not a great fan of distance thing. I believe that human ingenuity and innovativeness get promoted by interaction, dialogue, convergence, communication and collaboration. I am great fan of these three Cs. Those are the three steps that we need. To do that, you must sit around the same table.

My experience is when we shift the focus from governance, watchdog, hang the auditor, instead of that approach we say how will we change the social dynamics we will have far better outcome. That is being my experience.

R Gopalakrishnan: Instead of obsession with corporate governance and laws in accountancy, can we not have focus on board dynamics? What has been your experience?

Mohandas Pai: Our experience was good. We decided that in the time of listing it was very different from what it was. I played key role after the listing. We wanted to have set of people who bring to the board what we lack. I was not part of the board then but management. We lacked the overall understanding of groundless on bringing outside investors and large shareholders. We wanted the check and balance with the management and someone who sees it at a distance. We wanted someone to step into crises in case we get into crises. We were very clear in what we wanted. We wanted people which had this expertise. At that time, we had a small company. So, we got people who ran big companies compared to us who is reputed and doing this for many years. We have class number of people including from outside like Mazda, Maytree and others who came in and did well. We decided that we have to make it work and it is up to us. Give them space, all the information, give full independence, let them have meetings independently and you must not interfere. We must trust their views. Over a period of time, it worked very well except there was tension between two groups. It was around same table. We wanted governance, oversight. We were very eager. We wanted acceptance from this people to say that we are running it very well and complying it law. They wanted inside into strategy. They wanted to push strategy that why you are not doing this. Operation is okay, but they question strategy. We tell them that we knew this business, we report to you. Otherwise sack us. That was the only role of tension otherwise it worked very well.

The board’s role is strategy is to have oversight about strategy. Give feedback to management and decide based on what they see as the options. Management have to come with options and decide. When the strategy has risk, the board has to step in and say whether it is acceptable. The board cannot write and decide on the strategy. It has to be a two-way work. It worked very well over certain period of time. Then we had a particular issue. The earlier set of people retired. This company became very big. The new set of people who run much smaller business never understood the business.

The culture has to be open, transparent, collegial. We have to make it work, give them space, control them. Management has to resist and drawback. Management are the people who full time run the company. Otherwise, it will not work.

Mohandas Pai: Do you think between supervisory model of two-tier board and single tier board, there is congruence of interest coming together?

R Gopalakrishnan: I want to take inspiration from nature. If you leave various plant species together some of them will hybridise. Therefore, in human nature the human instinct and thinking is also like that plant species. You put a bunch of people together and they will hybridise. I didn’t know that Germany is moving to one tier board. The question is the intent. What the clarity of intent was and what they tried to do? That worked for some time, people move on and things change. All entrepreneurship is like a wild horse. You are

trying to put saddle and governance on it. the word manager has come from Spanish word manager which means taming a horse. There are number of steps taken institution wise for taming a horse. If you expect a horse to sit quietly and follow all your instructions, then he is not a horse anymore but an ass. If there is entrepreneur who has got the mall intent, I don’t think anything gets in.

The true instinct of individual director or any other person is watching the movements of CEO and picking up early signals. 95 percent of weddings in India are arranged. It has been going on for long time and it broadly worked. By looking at the attributes which the person is surrounded by, you come to a conclusion that this is worth progressing further. When you see CEOs, some of them have blatant movements. It is in your face every day. And yet there are boards which say that we have done nothing about it.

R Gopalakrishnan: Are we failing to bring human psychology, social behavior? Don’t you think that should be the independent director’s training?

Mohandas Pai: In all corporate boards, there have been failure. Show me one single board which is around 25-30 years and not failed. Globally, in every company there is failure because the human being is an emotional person. We create like, dislikes and we are not coldly logical. We react very emotionally. We operate in a dynamic market. We don’t create signals in market to change. We get carried away by success. Jack Well was there for 20 years but he has spoilt the company.

R Gopalakrishnan: They have found that he spoilt the company after he retired.

Mohandas Pai: Citi blew up at particular point of time. Deutsche bank was running by itself. Failure is inherent in the system. Expectation of independent director should be tempered. Panacea for all this should come down. Expectation that any model will change should come down. What is the bare minimum we expect? So that the bare minimum is there, we evaluate and accept it. Bare minimum will be the make up of the human being as an independent director. The board which had good people, intent and spend sufficient time are successful board. Everybody has good intent and good people, but have they undergone test of independence in standing up and saying no. if they are not then they compromise, and it goes on. In boards, we build consensus otherwise it cannot work. Like the dysfunctional political system, we have today which didn’t work as there is no consensus and everybody has to give something. The consensus may not be perfect solution and consensus building in good board over a period of time leads to failure. Everybody there is failure for long time and it will continue.

R Gopalakrishnan: Do you think that academic research on why failure happen? You cannot eliminate failures, but you can mitigate its extent. My argument is you mitigate the probability of failure by behavioral pattern rather than legal methods.

Mohandas Pai: I agree. Failure is reality and it happens, will happen and continue to happen. The thing is what is acceptable and non-acceptable level of failure. Acceptable failure is when you make judgments and when we fail. Non-acceptable is when there is lack of integrity and lack of process. On judgement, there will be failures.

Bigger challenge is what is the regulator reaction. In every case of failure, regulators put more rules and burden. Then we have SC, leave that corporate level in JP case and say that all the personal assets will be hogged as they have been on board. They over rule the law and SC makes the law. This is most ridiculous thing where an independent director is treated as same as management and you are reliable on personally for details which you never did. The problem today about corporate governance is regulator and excessive regulations. Market failure is there, you punish. Make simple corrections and you go on. We had Satyam case and now we have IL&FS. Satyam case did not make IL&FS better.

R Gopalakrishnan: My sense is if you don’t know how to tame this horse then somebody catches from this and that side. This is the case of regulation. It is easy as you have attacked in parliament and you will make a law. But I have no method to enforce a law.

I am aware of an individual who bought an arrest warrant, non-bailable warrant for exceeding 10 directorships. It became 11-12. This guy is unimpeachable. He went through the record and found that he has not exceeded. It was school board, and all added. He gets the notice from special economic offence court. I asked myself that is its criminal act of exceeding 10 directors assuming the guy did so. He went to court, sat for 5 hours. We had companies act in 2015. I was unaware. I don’t think it wanted a non-bailable warrant if you exceeded and become director for 11th company.

You can have regulation stacked one on the other and then a regulatory body which is unable to cope with it. there is no mischief in this, somebody has ticked a few boxes and sent off. Did you know that in Companies act, if you exceed 10 you will criminal? It is shocking. This person comes back with surety, bonds, 50,000 bucks, he gets a phone call from station saying I am carrying a piece of paper for you. But he said I have just been yesterday.

It is this kind of misdirected direction and implementation. In Bombay and Bangalore, people don’t stop at red light.

R Gopalakrishnan: If you don’t want to have piecemeal regulation a knee jerk reaction, how can we go about it?

Mohandas Pai: The SEC in U.S. has a different way of doing it. Any transgression, they catch the person and make sure that he goes to jail. He has to plea and pay a fine and the message is we will accept this but don’t go beyond the line. The emperors of China have very good way of governing the mandarin as they used to govern the empires. If mandarins were corrupt, every year they cut 4-5 of them and cut their neck. You will have enough examples of this, there will restrain of abilities and fear. We live in a fearless society. UK is fearless society as they wink and nod. You get right people, you get knock on knuckles and it is gone. In India, court makes sure that it will take 15-20 years. There has to be some fear that you have to be careful. If you will cross the line, you will be penalised. There has to be some kind of action but not over regulation. Regulations think their job is to have lot of regulations, put in surveillance and when it comes to implementation, they are constraint for various reasons as it is legalistic system unless they have the power like SEC and court system in US.

R Gopalakrishnan: You can blame the lawyers, then you can grab the accountants, then company secretary, the independent directors and then you say the whole corporate sector is bad. So, there are layers and each one takes its picking. I took cases and found out that the root cause of this is that power damages the brain. That is why I harp back that we want psychological and social methods rather than legal and accounting methods. We all have powers and we are brain damage survivors. The good news is when power is removed your brain restores to normalcy.

If that is the case, it is like saying there is pollution in Delhi. How can I protect myself? I can’t stop breathing. There are certain things which you can do. I have served on board where directors thought that the CEO is very miserly imparting with information and if you ask him too many questions, he sent lot of documents which is impossible to go through. Before some disaster happens, he spoke to him and eased him out. Directors said that we don’t understand what is happening in company. Once it got eased out, it worked, and the company survived. I am not saying that is the only solution, but we are moving to a time when directors say that we tried everything. The fact that the guy is powerful is not a problem but if his behavioral pattern does not change, then that is good cause to consider whether you need a CEO change.

Mohandas Pai: When is it the good time to have change in board composition? What is tyranny of board? s

R Gopalakrishnan: Corporate structures today are successors. In a family system, the independent director is the uncle and family members. He supposed to be a mentor. I will ask my relatives to mentor my son. Socially, our expectation of independent directors is that they should be mentors. The legal expectation is that they should be watchdogs. This is fundamental, social split in mind of people. Like if you need women director, they why not my wife or sister. We are getting into these situations.

In our system, we also need CEO mentoring. Your point is they are becoming alike. You have laws which says retire at 70. Nowadays, institutional advisors are becoming very active. I am less worried than the fundamental diversion between the legal and accounting and professional part and the human part. I think they are going in opposite direction. That is big challenge of corporate governance.

Mohandas Pai: The other big challenge is various stakeholders are not paying a role. If you look at structures of two-tier board or single tier board, there are shareholders to hold the stock, they appoint the independent directors. Then they appoint the management, the management run the company, the directors have oversight on management, they control, superintendence and guidance, they report back to shareholders and they voted back to power. It is beautiful structure. Then there are independent directors. The shareholders are not playing a role because institutional shareholders are not assessing themselves and making their views heard. They are weak. Even in US some of them are activist. UK it is becoming much better. In Germany, I don’t think it exist. Also, for Japan.

R Gopalakrishnan: Do you think India needs shareholder activism?

Mohandas Pai: Yes. Class action suits to happen to say that to be careful. Auditors just resign and go. So, where is the lack of care? Resigning and going is not a solution. You have been appointed to solve a problem. You are unable to solve problem and you go. You must stand up and take decisions. In two or single tier

board, various stakeholders are not paying their role that they are supposed to. The pulls and pressures are not there to create a much better situation than what it is.

Mohandas Pai: Do you agree with it?

R Gopalakrishnan: I agree. But what is my agreement worth, if I can’t put a solution on table?

Mohandas Pai: We need more activist shareholders. Not by individuals but by institution which has a large stake. Otherwise we will get NGOs type people which is not good as they don’t have a stake.

R Gopalakrishnan: Do you think it will work for our society?

Mohandas Pai: It should work. In Mumbai, when it comes to board matters, it worked to some extent. Even in two tier board the fundamental challenge remains, lack of shareholder activism. In Germany, there is no shareholder activism. There is no shareholder who takes an interest. It is there is UK and US in big way.

R Gopalakrishnan: In U.S., company directors tell me that, it is absolute nuisance. But it keeps them on their toes.

Mohandas Pai: If you have good set of regulators who take action, you have good set of large activists who is large shareholders who demands performance, therefore put pressure. Then you have auditors who play the role of being straight and not compromising because of various issues. You have analyst who point out things going wrong. Some of the analyst in US was very good. You have independent directors to oversee it. That will be better balance than a two tier and single tier board. The systemic influences will have greater and better impact and corporate governance then there is single- or two-tier board.

Mohandas Pai: Do you agree with this conclusion?

R Gopalakrishnan: It is difficult to say that I don’t agree to it. How to construct that cordon sanitaire is something I need to think about.

Mohandas Pai: if you look at two tier board and single tier board, you will see a morphing coming together. So, is there time come for two tier board? It is moving towards it, but it is not a panacea or solution as it doesn’t make too much of difference. Because the failure has been on both sides. We always need better independent directors, but they don’t exist.

R Gopalakrishnan:- Are we expecting independent directors to train in right methods?

Mohandas Pai: there is personal input that you can give about ethics, background. There are good people in world. There is level of competence and there is not enough competence. The ability to take a stand and financial standing which is one has to see.

R Gopalakrishnan: We need to train people in how to disagree by not being disagreeable.

Mohandas Pai: Is that to be trained or personal character?

R Gopalakrishnan: No. It is specific training of how to disagree without being disagreeable. We need it in public governance system too.

Mohandas Pai: Regulations has to be lighter in both models because we have over regulations being a checklist and there is no spirit and principle and it becomes a checklist. You see false sense of security. Bank people has not recognised NPAs earlier because accounting standard were reduced to checklist and you can game the checklist. What is your conclusion?

R Gopalakrishnan: NASA put up in challenger in 1970 certain mirror which can take pictures of moon in special angle which will be rare and giving lot of knowledge. Once the challenger went up, every test has been done but it failed. They mechanism on which the null connected did not work. When they did the whole research, they found that suppliers knew as it was not giving consistent results. They asked why you didn’t tell people. He said that the atmosphere was so scary, there was targets, time. It happens in every company. The director of astrophysics resigns saying that it is leadership failure. He went to university and to say that what is the behavioral things that they missed. We need that in corporate governance. If we can have what he calls the 4D mechanism, we need it in corporate and public governance. Corporate governance is mirror of public governance.

Mohandas Pai: There is blurring of lines between single chair board and double chair board and both sides is moving together. But the fundamental issue is the ability of set of people to look into issues which come, limited by human experience, it works or not. We must accept it as label of failure, lower our expectations and make sure we are able to manage.