One of my friends, who is an accomplished professional and acts as an independent director in a few companies, recently narrated his experience in a company, managed by a highly reputed business family. It is a 100-year company with a turnover of Rs 6,000-Rs 10,000 crore. The promoter group holds a little more than 40 per cent shares, institutions hold a little more than 20 per cent shares (including foreign institutional investors (FII) holding a little more than 10 per cent) and the public holds a little less than 40 per cent shares. The company performs reasonably well in the product market and capital market. The board of the company is a passive board or 'rubber stamp' board.
Most documents are placed on the table and the management expects the board of directors to approve all the proposals without any meaningful discussion. My friend thought the board process should improve. He wrote to the company secretary suggesting process improvements.
A surprise came in the next board meeting. The promoter separately invited him for a chat. During the meeting, he politely advised my friend to resign, as the company would not be able to meet his expectations regarding the board process. My friend obliged. When I talked to him last, he was looking for a plausible reason for resignation, as the Companies Act 2013 requires directors to state explicitly the reason for resignation in its submission to the Registrar of Companies. One cannot mention that he has resigned due to 'personal reasons'. My friend was not interested in mentioning the actual reason for resignation for two reasons. First, he has no evidence that he was asked to resign. Second, he is not sure whether the corporate affairs ministry can take any action to improve the board process, the objective that he desired to achieve.
My friend could have declined to resign. In that case, the company would have to take steps to remove him. Removal of a director requires a simple majority in the shareholders' meeting. The director gets a chance to represent his position. Therefore, the removal process would have given my friend an opportunity to present his case before shareholders. But, I know that like most professionals, he is not an activist. And in this case, perhaps, the promoter could get the resolution passed, as it holds 40 per cent voting rights and all shareholders seldom attend or vote (through e-voting) in a general meeting. Therefore, he must have considered resigning from the boards his best option.
The provisions of the Companies Act 2013 regarding removal of director cannot deter the management from removing an independent director in a company where there is a concentration of ownership. We have seen how independent directors of public sector enterprises were removed. An independent director, who is not an activist, cannot have the motivation to act as a crusader for improving the board process and effectiveness, because he is usually an otherwise accomplished person and he does not have a stake in the company. He loses nothing by quitting a board where he is uncomfortable.
The above incident shows that even today 'rubber stamp' boards exist. No outsider can find fault with the corporate governance practice of the particular company. All the disclosures and reports show that it complies with every requirement of the Companies Act and Sebi code of corporate governance. This is the difficulty in assessing corporate governance practice in a company. Nothing is observable from outside.
The government can do little to transform 'rubber stamp' boards into 'engaged boards', particularly in companies where there is a concentration of ownership. In a family-run company, key business decisions are taken at the family forum and therefore, the promoter may love to live with an ornamental board. Independent directors in such a company hold office at the pleasure of the promoter. The chairman of the board of directors and the promoter decides to which extent it will engage the board of directors in decision-making. Enlightened family-managed companies engage the board in decision making to take advantage of outside perspective and critical review of key decisions and systems by 'loyal critics'.
Independent directors who are members of a 'rubber stamp' board are exposed to the risks of being prosecuted for omissions or commissions of the company. It is difficult, or rather impossible, for directors to directly detect management misfeasance, frauds, abuse of related-party transactions and errors in financial statements. They have to depend on the statutory and internal auditors. Therefore, in the absence of an engaged and effective audit committee, directors might be caught in a surprise when a wrongdoing is detected and they may be prosecuted for not applying due diligence.
Both the management and independent directors are benefited when the board as a whole gets engaged with the management of the company. The mindset has to change.