It is a global practice that the board of directors (Board) of companies functions through sub-committees. Majority of members in Board sub-committees are independent directors. In India, at present, a listed company is mandated (under clause 49 of the Listing Agreement) to constitute Audit Committee and Investors' Grievance Committee. Clause 49 recommends a listed company to constitute a Remuneration Committee.
There are three advantages in working through committees. The first advantage is that experts in a specialised subject handle issues related to that subject. The second advantage is the optimum utilisation of directors' time and efforts through distribution of work. Directors' time is the most scare resource. Independent directors, who are usually busy professionals or senior executives in full-time employment in other companies or institutions, cannot spend significant time to perform duties assigned to independent directors by law. The third advantage flows from the fact that a majority of members of the committees are independent directors. Committees can take an objective view on the issues placed before them. The performance of a committee hinges on the ability of independent directors to protect their independence.
The Companies Bill 2012 (Bill) stipulates that listed companies and some other classes of companies (to be notified by the government) shall constitute Audit Committee, and Nomination and Remuneration Committee. The Audit Committee will have a minimum of three members. A majority of members will be independent directors.
Unlike the requirement under the clause 49, the Bill does not mandate that the chairperson shall be an independent director. The duties of the Audit Committee, as delineated in the Bill are:
- To recommend appointment, remuneration and terms of appointment of auditors of the company
- To review and monitor the auditor's independence and performance, and effectiveness of audit process
- To examine the financial statement and the auditors' report thereon
- To approve transactions of the company with related parties if those are not entered in the normal course of business on an arm's length basis
- To scrutinise inter-corporate loans and investments
- To estimate the value of undertakings or assets of the company, wherever it is necessary
- To evaluate internal financial controls and risk management systems, and monitor the end use of funds raised through public offers and related matters.
The auditors of a company and the key managerial personnel will have a right to be heard in the meetings of the Audit Committee.
In a way, the Audit Committee deals with contentious issues that might arise from the conflict of interests between the dominant shareholders and minority shareholders. The Bill requires that the Board's report shall disclose the composition of an Audit Committee and where the Board had not accepted any recommendation of the committee, the same will be disclosed in the report along with the reasons for not accepting the recommendation.
Some hold the view that this provision makes it almost mandatory for the Board to accept the recommendations of the Audit Committee. This is not correct. The Board, which is the larger body, can always overrule the recommendations of one of its sub-committees. A sub-unit is always subordinate to the larger body. The full Board discusses the recommendations in the presence of the members of the Audit Committee and it examines the issue, if required, afresh. It is only in a rare situation that the difference between the Board and Audit Committee persists. Ultimately, it is the Board, which is accountable to shareholders and regulators. Therefore, it has the authority to take the final decision. Accountability demands that it should defend its position in public on a particular issue.
The provision in the Bill only enforces accountability of the Board.
The Bill requires that independent directors should meet separately, at least once in a year, without the attendance of non-independent directors and management. The purpose of the meeting is to review the performance of non-independent directors, the Board as a whole, and the chairperson of the company, and to assess the quality, quantity and timeliness of flow of information between the company management and the Board.
Audit Committee members, being in the most advantageous position to see the big picture. They are expected to contribute significantly in the review process. This makes the Audit Committee as the most powerful constituent of the Board. It might emerge as a separate power centre within the Board.
It is the responsibility of the members of the Audit Committee to ensure that this does not happen. Emergence of a separate power centre within the Board will harm stakeholders rather than benefitting them.
The author is a Professor and Head, School of Corporate Governance and Public Policy, Indian Institute of Corporate Affairs; Advisor (Advanced Studies), Institute of Cost Accountants of India; Chairman, Riverside Management Academy Private Limited
