Pressing ahead for change

The Kotak Committee has made wide-ranging recommendations and sees the boards and auditors as the two critical gatekeepers

Thanks to seven corporate governance committees, a new Companies Act and new listing regulation, all over the last two decades, India ticks most boxes with regard to protection of minority investor rights. The World Bank’s Doing Business 2017 report ranks India at #13 out of 190 countries (India’s overall Doing Business rank, in sharp contrast, is 130).

Yet, every few quarters there is a governance event — an outlandish related party transaction, or compensation that has no bearing on the job, or a CEO defenestrated, which put companies under a fresh bout of scrutiny. A series of such events creates a nagging sense that something is amiss and regulators feel compelled to act. Their expectation always is that a bit more transparency will provide for better oversight and, ultimately, shareholder value. A three-year gap after the Companies Act, 2013, was enacted and recent market events, crucially, two high-profile boardroom dramas, which raised fundamental questions about the role of the boards, were strong signals that practices don’t quite square up with India’s high rank. This, and the realisation that if India is to attract capital, changes are needed. Against this background, the Securities and Exchange Board (Sebi) set up a committee on corporate governance with Uday Kotak as chair (Kotak Committee, hereafter, committee).

The committee was asked to make recommendations to Sebi “with the aim of improving standards of corporate governance of listed companies in India”, on seven fronts — role of independent directors, related party transaction disclosures, accounting and audit practices, board evaluation practices, investors and their participation in shareholder meetings, disclosure and transparency and other aspects relating to corporate governance.

Twelve meetings and four months later, the committee has presented its recommendations to Sebi. The committee has made wide-ranging recommendations and see boards and auditors as the two critical gatekeepers. 

Corporate governance practices are driven by the board. Therefore, facilitating a strong board composition and bolstering the institution of independent directors are crucial. The board has been asked to review the skill sets it possess and disclose competencies. This will help identify gaps and as boards refresh themselves, it will lead to a more wholesome board composition. 

A complaint one often hears is about the risk-reward ratio for board members. The committee has taken a small step in addressing this by prescribing minimum sitting fees. It has also introduced the concept of lead independent director in promoter-controlled firms and for the first time brought in board interlocks where directors/executives sit on each other’s board. 

Illustration by Ajay Mohanty

Separation of the role of the chairman and that of the managing director has far-reaching implications: It separates running the board and running the company. Often, the two are seen as being the same. They are not.

Larger boards, the board and board committee mix, more meetings, minimum attendance thresholds and knowledge upgrades also find mention — all signalling the importance of the board’s role in establishing the company’s corporate governance practices.

Audit and auditors are a critical area. Auditors have been signing balance sheets relying on the work done by fellow auditors. As the number of subsidiaries has increased, the part that they actually “audit” has come down: In a recent case it was just 11 per cent of the total balance sheet size. The committee has now proposed that group audits be governed by global audit standards (“group” is a string focus for the committee, as discussed later). Auditors can seek external independent opinions when their view differs from that of the company. And, as is with the Reserve Bank of India, Sebi should have veto powers on who can audit a listed company.

The audit committee’s role in fortifying the corporate governance culture emanates from its responsibilities to appoint auditors — and approving related party transactions. The Kotak Committee has therefore increased the disclosure responsibilities of the audit committee, with a view that greater disclosure will compel more thoughtful decision-making.

There are two aspects regarding disclosures. One, what is disclosed, and second, to whom. The committee has recommended revised thresholds for disclosing related party transactions, sought very basic disclosures in valuation reports (those that are obvious, yet generally ignored), material changes in financial indicators and a discussion on strategy.

A unique requirement put forth is information access. Moving beyond legitimate purpose, the committee recognises that promoters have access to information, and has put forward a framework for sharing information. The idea is that information can now legitimately move from one “safe container” to another one. In the years ahead, this proposal will help business families that want to step back from operating businesses, but fear losing access to information and thereby, control.

A discretionary recommendation of the committee is the creation of a group governance unit. Independent of whether a group governance unit is created, the committee recognises that subsidiaries and group companies need strong oversight and has sought to address this by focusing on consolidated accounts, disclosure of subsidiary accounts on the website, recommending greater audit committee scrutiny, review by auditors of internal controls of subsidiaries.

A big grouse with compensation has been that promoters vote for their own salary. As a simple majority has been easy to reach, compensations have skyrocketed. Promoters will now need super majority voting for their compensation increase, if it exceeds some redefined thresholds.

The committee’s recommendations cover a lot of ground (governance of public sector undertakings, focus on cyber security, an IT Committee) and the above is only some of what is new. The benefits of these recommendations will come to nought if Sebi is not able to monitor how effectively these are applied. So even as companies are stepping up their game, Sebi needs to run faster. Fittingly, the final chapter of the report focuses on capacity building at Sebi.

Disclosure: The author served on the Kotak Committee

The author is with Institutional Investor Advisory Services. Twitter: amittandon_in