Board evaluation: A step towards greater governance

By Shruti Rajan and Rohan Banerjee, Cyril Amarchand Mangaldas
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Quis custodiet ipsos custodes? (Who will guard the guardians?) – Juvenal

Since the introduction of clause 49 in the Listing Agreement more than a decade ago, the Securities and Exchange Board of India (SEBI) has paid a lot of attention to the issue of corporate governance for listed companies. A company’s board of directors acts as gatekeeper of the company’s conduct and must ensure that the company operates in a manner that is fair and not prejudicial to its stakeholders, especially the retail investors. Who then stands guard over the directors and the manner in which they function?

Shruti Rajan Partner Cyril Amarchand Mangaldas
Shruti Rajan
Partner
Cyril Amarchand Mangaldas

On 5 January this year, SEBI issued a Guidance Note on Board Evaluation to make the assessment and performance review of directors more transparent and increase accountability to the public stakeholders.

While previously the board evaluation process was voluntary, the Companies Act, 2013, and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, have made it mandatory for listed companies and public companies with paid-up share capital of ₹250 million (US$3.8 million) or more. Such companies must prepare a statement (to be included as part of the report of the board of directors) regarding the manner in which evaluation of the board, its committees and each individual director was carried out.

The regulations also assign specific roles to the nomination and remuneration committee to formulate the criteria for evaluation of directors, while independent directors are required to review the performance of non-independent directors and the board as a whole.

However, a report prepared by InGovern Research Services and CimplyFive Corporate Secretarial Services in May 2016 noted that only about half of the top 100 Indian companies reviewed reported both the evaluation criteria and the evaluation process. Of these, only five disclosed the results of the evaluation. Nine of the companies had engaged an external consultant for the board evaluation.

The guidance note recognizes that despite the regulatory provisions, the implementation and practice of board evaluation by Indian companies is far from ideal. Therefore, it provides certain guiding principles on board evaluation for companies to “improve their overall performance as well as corporate governance standards to benefit all stakeholders”.

The guidance note divides the board evaluation process into three stages: (1) the pre-evaluation stage, when the objectives and criteria of evaluation may be determined; (2) the evaluation, being either an internal assessment by way of questionnaire and/or oral interviews, or a review by an external entity which is unrelated and independent; and (3) post-evaluation action steps, such as providing feedback to directors, formulating an action plan identifying areas for improvement, etc.

The guidance note suggests criteria for the evaluation of directors, both collectively, as members of the board or committees, and individually. It also specifies factors that may be considered for evaluation of independent directors. The criteria are based on the need to ensure a balanced, diverse and experienced board which is competent to oversee and govern the affairs of the company.

Rohan Banerjee Associate Cyril Amarchand Mangaldas
Rohan Banerjee
Principal associate
Cyril Amarchand Mangaldas

The guidance note observes that globally, many entities disclose to various stakeholders the results of their board evaluations and the actions taken by the company. Companies in India are not specifically required to make such disclosure. However, the guidance note makes clear that SEBI’s intent is to urge companies to adopt a culture of additional disclosure, and publish the results of the board evaluation so as to comply with the spirit and not just the letter of law. This principle was reiterated at the meeting of the International Advisory Board of SEBI (IAB) on 13-14 January, where it was noted that it “would be a good practice if the result of the evaluation of the board as a whole is disclosed to the shareholders”.

At the same meeting, the IAB also noted that board evaluation is “a very important element in corporate governance”. The evaluation of the board coupled with adequate disclosures being made to the public shareholders is a critical process to ensure complete transparency and accountability of the board to the stakeholders in the company.

While the guidance note is not legally binding, it is a step in the right direction to assist companies in prioritizing governance issues. It also reflects SEBI’s efforts to move towards a principle-based regulatory regime. The corporate governance framework in India is now a healthy combination of principle-based and rule-based legislation, to tackle concerns on transparency and effective governance in a holistic manner. It will be interesting to observe how companies adapt and evolve their internal practices in line with this structure.

Cyril Amarchand Mangaldas is India’s largest full-service law firm. Shruti Rajan is a partner and Rohan Banerjee is a principal associate at the firm.

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