As the dust settles down on Sebi's announcement on the review of corporate governance norms for listed companies in India following its board meeting on February 13, and rationality slowly takes the better of the initial shock, it is time for saner analysis on the possible multidimensional impact.
There was a time not so long ago, when Clause 49 and its impact could be discussed without any reference to the Companies Act, because the old Act did not directly concern itself much with issues related to corporate governance. The position changed when the Companies Act 2013 was notified on August 31, 2013. We got a new Act which was robust and provided a modern regulatory framework for companies. But even nearly six months after the enactment of the new Act, it has remained largely ineffective, as most (372) of the sections of the Act, including those related to internal governance, have not come into force. If one were to examine the approved amendments to Clause 49 in conjunction with Sebi's Concept Paper on the review of corporate governance, and compared these with the provisions related to internal governance of companies strewn across various sections of the Companies Act 2013, one would discover that Sebi's review of Clause 49 has harmonised the provisions of Clause 49 with the relevant sections in the Companies Act 2013. Thus even if there is a further delay now in the issuance of the notifications under the Companies Act 2013 to bring in force the various sections of the Act, for listed companies it would hardly matter, because the new Clause 49 in any case effectively incorporates the essence of the relevant sections of the Act. This is why Sebi's announcement becomes significant.
Sebi's announcement is important on one more count. Many listed companies may have chosen to wait for formal notification of the various sections under the Companies Act, 2013, before taking steps to implement the provisions of the sections. Consequent upon the announcement, they would have to immediately get down to setting their houses in order, reconstitute boards, appoint new directors and institute systems and processes for the boards and committees, and be compliant with Clause 49 by October 1, 2014. Quite a bit of work will be involved, and going by the recent track record of Sebi on enforcement of the minimum public shareholding requirement, any postponement of the time line appears highly unlikely.
Among the 20-odd amendments, three in particular stand out in terms of the impact value on the boards of companies as well as on independent directors. It would behove good companies who pride themselves on their governance standards to consider these measures seriously.
The first one is the restriction in the maximum number of boards of listed companies an independent director can serve on to seven - and three in case the person is serving as a whole-time director in a listed company. The limit is lower than the permissible limit of ten in the yet-to-be-in-force Section 165 of the Companies Act. The cogent arguments about the soundness of restricting the number of directorships have already been articulated in an earlier article (Business Standard, February 8, 2014: Do multiple directorships matter?), and repeating these here would be superfluous. More important to consider is the likely manifold impact of this measure, especially when supplemented by the prohibition of stock options to independent directors. One, it should weed out the not-so-serious directors and second, good companies would have to reconstitute their boards and meaningfully search for serious directors which, contrary to popular understanding, there is no dearth of. Sebi's measure may be disconcerting for many directors and even a tad unsettling initially for companies, but the long-term effects of these steps should prove to be salubrious for board efficiency.
The second amendment which should influence board efficiency in the long run is board and independent director evaluation. The importance of this step has so far been downplayed by the corporate sector in India and there are strong reservations against the concept and its usefulness. But boards globally have recognised that it would be important for them to continually assess how effectively they are performing their roles against the objectives and the goals they have set for themselves.
The third amendment of importance concerns abusive related party transactions. When businesses are dominated by large business groups, or owned by a controlling shareholder with a large network of personal interests, abusive related party transactions pose one of the biggest corporate governance challenges. This is of course true for most businesses in Asia. The amendments approved by Sebi to curb such abusive related party transactions require adequate board oversight, a central role for independent directors for monitoring these transactions, designing board approval procedures, and setting up elaborate systems beyond the current processes employed by companies.
The sum total of these amendments and others approved by Sebi, such as the expanded role and consequential addition of new responsibilities of the audit committee, reconstitution of boards, risk management and compulsory whistleblower mechanisms, would certainly raise board oversight and increase the responsibilities as well as liabilities of directors.
The measures related to corporate governance are commonly viewed in India only from a compliance perspective and not from a business strategy viewpoint. Corporate governance measures then would seem like a dead albatross heavily weighing on businesses. A change in mindset will happen only when businesses begin to view corporate governance requirements as an integral part of business strategy to help to grow the business ethically.