Military working dogs. (Photographer: Luke Sharrett/Bloomberg)

Board Failures: There’s No Such Thing As A Part-Time Watchdog

BloombergQuintOpinion

“In India it’s less about board management and more about ‘managed’ boards.”

That comment by a veteran lawyer succinctly describes the corporate governance fiascos of the last several months.

From grave incidents of alleged fraud and mismanagement to underperformance, conflicts of interest and culture clashes – Indian companies have put every flaw on display.

Each time investors were left asking – “what in heavens was the board doing?”

Tata Sons
The board, aligned to the majority shareholder, gave Cyrus Mistry a glowing performance review only to sack him a few months later.
Infosys
The board first played supplicant to chief executive officer Vishal Sikka, then to former promoter NR Narayana Murthy. Investors paid the price for unstable leadership. And even today, investigations into certain acquisitions have not been shared with all shareholders.
Axis Bank
The board seemed unquestioning of managing director and chief executive officer Shikha Sharma. But the regulator wanted her gone.
ICICI Bank
The board appeared like a deer in the headlights, dazed by the celebrity of MD and CEO Chanda Kochhar, allowing her continued presence in the company, even as she was being investigated for alleged nepotism.
Fortis
Promoters held sway, the board turned a blind eye to many suspicious transactions, and finally shareholders booted them out.
Yes Bank
Yet another board seemed unaware of the regulator’s unflattering assessment of the MD and CEO Rana Kapoor. And then was found wanting a succession plan.
IL&FS
The board was either kept in the dark by an entrenched management or struggled with the complexity of hundreds of subsidiaries. And slept through a liquidity crisis.

Smaller companies like Vakrangee and Manpasand may have less recognised board members but they too watched silently as financials turned murky, auditors resigned and investors fled.

How Did It Come To This?

To be sure, over the last decade and more India has put in place one of the most rigorous corporate governance frameworks in the world, one that has often been ahead of changes in other countries.

For instance – it is only this year the United Kingdom, in its Corporate Governance Code, provided for at least half the board to be independent, a measure India imposed on listed companies several years ago. Audit firm rotation became part of European Union law in 2014, after India legislated the same in its company law. India mandated rotation of independent directors four years ago, many developed countries still don’t.

So before a government committee gets itchy to change the law or add one...that’s not what needs changing.


But a few other things do...

1. Culture

Behaviour can never be legislated. Behaviour is strongly influenced by the culture and culture takes a very long time to change. 
Former General Counsel

Culture and behaviour are not easily altered by legislation. At least not in the medium-term. And India’s corporate governance regime is just two decades old.

The challenge in India has been two-fold. To dial down the overwhelming influence of promoters and their anti-minority actions, and to turn up the independence quotient of directors.

The aggressive legal framework has had some success in restraining promoters, curtailing related party transactions and empowering shareholders. Curiously though, governance issues have now cropped up in non-promoter-led companies or those with dispersed shareholding, such as IL&FS.

“Promoter capture has been replaced by CEO capture,” is how the former general counsel put it.

It’s the second part, on independent directors, that’s proving trickier.

2. Selection Of Independent Directors

The most effective cure to a star-struck board is the induction of fiercely independent directors. But that spine is taking time to strengthen.

Again, not for the lack of a robust legal provision. To be clear, both company law and SEBI regulations have a detailed, stringent definition of what makes a director ‘independent’.

But the law can only draw boundaries, the rest must be supplied by people of quality and independent spirit.

And, while on paper the appointment of independent directors is to be independent of management and determined by shareholder vote, in reality the candidates are often handpicked by the promoter or the CEO.

As a result many boards continue to run like old boys clubs where camaraderie ranks high and dissent causes discomfort.

Some of this may change when the rotation of independent directors truly kicks in and the club is forced to cast the net wider and admit new members. That may take another five to six years.

Because when the rotation rule became effective in 2014 previous terms of independent directors were not counted towards the new mandate of maximum two terms of five years each.

There’s also been a debate on whether the process of selection and appointment of independent directors should change. That they should be selected by an independent nominating committee and approved by a majority of non-promoter (public) shareholders. The first has been somewhat achieved by mandating that the nomination and remuneration committee should be independent. The second is a contentious point as it undermines the majority shareholder and “control”.

3. Shareholder Activism

In the last decade, shareholder activism has increased aided by an increase in institutional ownership of Indian equity, voting disclosures by institutional investors and the rise of domestic governance and proxy advisory firms.

In 2012, KV Kamath, who served as managing director and chief executive officer of ICICI Bank till 2009, was designated as an independent director on the same board. While this was in conformity with the law it didn’t quite meet the spirit test. Yet no one demurred.

In 2014 mutual funds and governance advisory firms opposed Maruti Suzuki’s plan to allow parent Suzuki to build a manufacturing facility in Gujarat which would contract manufacture cars for Maruti. This, even though independent directors had approved the plan. It took the carmaker a year and several changes to get institutional shareholder approval.

This year, former RBI Governor Bimal Jalan and well-known accountant Bansi Mehta stepped down as independent directors of HDFC after proxy advisory firms recommended voting against a proposal to extend their directorships. In the same shareholder meeting, veteran business leader and HDFC Chairman Deepak Parekh retained his seat on the company’s board by the skin of his teeth.

In May when institutional shareholders of Fortis Healthcare moved a resolution to remove four independent directors from the board, it marked a first in India. Three quit. One was booted out.

More such shareholder actions will create a demand pull for directors who are independent.
(Source: BloombergQuint)
(Source: BloombergQuint)

Also read: India Inc.’s Corporate Governance Agenda Starting 2019

4. Expectations

Are independent directors supposed to play trusted strategic advisors to the management/promoter or serve as watchdogs for the company’s public shareholders?

This confusion in roles was highlighted in a 2010 paper by Vikramaditya Khanna and Shaun Mathew. “These roles are not easy to balance and indeed may run at odds with each other at times,” the authors noted.

Further, the time needed to be a strategic advisor may differ considerably from that needed to be a “watchdog”. The latter likely requires more ongoing and consistent oversight, whereas the former may require only more limited and discreet time commitments. Despite the general perception in the public that independent directors ought to serve as watchdogs, it would appear that the strategic advisory role may be more suited to the actual functioning of boards, given that few boards meet more than once every two months.
The Role Of Independent Directors In Controlled Firms (Courtesy: Manupatra)

Those words ring truer today as business and financial complexity puts more demands on the time of independent directors.

5. Board Engagement

The IL&FS audit committee met five times in financial year 2017-18. Only two of the five committee members attended all five meetings, the other three attended one each.

The company’s risk management meeting didn’t meet even once in the year.

Even when meetings are held and attendance is full, time is short.

A random check on the duration of recent board meetings held to approve October-ended quarterly earnings suggests that members spend between 2-5 hours on deliberations.

Most boards meet between five and eight times a year.

No doubt there are board committee meetings as well.

But is it enough to grasp operational and financial complexity of large businesses and their numerous subsidiaries?

More importantly, given the time spent, is it realistic to expect independent directors to fulfil the role of watchdogs?

6. Weak Enforcement

Given their limited engagement independent directors face disproportionately high liabilities...on paper. It is nobody’s case that independent directors should be punished for a company’s misdeeds, unless they were actively complicit in them.

But what about instances of negligence or ineffective oversight?

In February this year the U.S. Federal Reserve board issued an unprecedented enforcement action against Wells Fargo & Company following revelations that the leading American bank opened dummy customer accounts and other “pervasive and serious compliance and conduct failures”.

Besides imposing restrictions on growth and replacing four board members, the Fed board also made public letters of reprimand not only to Wells’ former CEO and chairperson but also to the former Independent Lead Director.

The letters are unsparing and directly address the failures.

Board Failures: There’s No Such Thing As A Part-Time Watchdog
Board Failures: There’s No Such Thing As A Part-Time Watchdog

“...the Federal Reserve’s enforcement action and public letters of reprimand are a striking reminder of the persistently rising expectations on boards of directors,” said a client memo published by law firm Paul Weiss.

Meanwhile shareholders of Axis Bank and Yes Bank are still trying to figure out when and how their CEOs lost the confidence of RBI and outlived their utility.

This column is the first in a series on board governance in India. It serves to raise questions that expert columns will hopefully hereafter answer.

Menaka Doshi is Managing Editor at BloombergQuint.