Two decades of corporate governance law

Indian corporate governance reforms have kept pace with those in advanced nations, but the quality of corporate governance, in terms of compliance, has not improved

This year marks the 20th anniversary of the first corporate governance initiative in India. In 1998, a voluntary code was devised under the aegis of the Confederation of Indian Industry. Subsequently, the Securities and Exchange Board of India (Sebi) opted for a hard law and enacted the Corporate Governance Code to be complied mandatorily by listed companies. The Code has evolved over the years through various amendments. The law is now incorporated in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, and is much more robust than the voluntary code introduced in 1998. The Companies Act, 2013, incorporated various corporate governance norms and Sebi aligned its Corporate Governance Code with those norms. Sebi went a step ahead and introduced stricter norms. However, the institution of independent directors remains the fulcrum of corporate governance. 

Many believe that audit is the weakest link in corporate governance. India, in line with the global trend, has brought many audit reforms such as rotation of auditors and constitution of the independent regulator (the National Financial Reporting Authority, or NAFRA). These reforms are expected to improve the audit quality.

The focus of corporate governance reform was to balance the power of the controlling-shareholder/CEO and the board, by enforcing the accountability of independent directors. Recently, we have seen a shift in the judiciary’s approach towards the accountability and liability of independent directors. In some recent cases, the judiciary held every director, including independent directors, responsible for every omission and commission of the company, and this blurs the boundary between the policy decisions and operational decisions. Even personal assets of independent directors of a company have been frozen. This has created significant uncertainty about the interpretation of law and expectations from independent directors. The consequence might be that right individuals would be discouraged to join the board of directors of not-so-reputed companies. It is the time that regulators evaluated whether in our zeal to strengthen the institution of independent directors, we are weakening the same. 

The IL&FS case demonstrates that independent directors do not fully understand the complex business models of the company. In a VUCA (volatile, uncertain, complex, ambiguous) world, companies are continuously in the transformational phase and adopt complex business models. Moreover, the opening of the economy and globalisation have raised the level of aspiration to grow and internationalise. All these have increased the business risks. Independent directors fail to completely understand the business model and associated risks, because they often do not spend the adequate time required to play their role effectively.  In order to address the issue, Sebi has imposed a cap on the number of companies in which an individual can be an independent director. But, this will fail to solve the problem unless the issue of ‘lack of motivation’ is addressed. That is challenging. 

The experience of the last two decades shows difficulties in monitoring the compliance of corporate governance regulations. Companies comply with regulations ‘in letter’, rather than ‘in spirit’. An example is the functioning of the nomination and remuneration committee (NRC). In most companies, the NRC nominates independent directors only with the approval of the promoter or controlling shareholder or the incumbent management. Therefore, even today, the question ‘how independent are independent directors’ remains valid. However, over the last two decades, the investment of institutional investors in large Indian companies has increased. Those companies present a more sophisticated corporate governance structure. They communicate regularly with large investors. In some cases, institutional investors lead the shareholder activism. These have resulted in the emergence of proxy advisory services. All these, to an extent, have improved corporate governance in such companies. However, shareholder activism in India is at the nascent stage. The ICICI Bank episode involving its former CEO Chanda Kochhar shows that media activism is more powerful than shareholder activism. Unfortunately, media activism enhances reputation risk to companies without improving corporate governance.

The Indian corporate sector is dominated by family businesses. The Indian Corporate Governance Code aims to control the power of promoters. But the Infosys episode showed us that powerful promoters can influence company operations even when they do not have significant shareholding and are not directly involved in the governance of the company. Promoters drive the governance of companies. Perhaps the number of ‘rubber stamp board’ has been reduced significantly, but ushering into the regime of ‘independent boards’ is a distant dream. 

Over the last two decades, Indian corporate governance reforms have kept pace with reforms in advanced countries. But due to difficulties in implementation, the quality of corporate governance, in terms of compliance with rules, has not improved. Regulators and commentators are more bothered than the capital market. 

The writer is director, Institute of Management Technology, Ghaziabad

Email: asish.bhattacharyya@gmail.com