Changes herald new era for corporate governance

By Manoj Kumar, Hammurabi & Solomon
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Be it the Infosys turnaround on Narayana Murthy’s allegations on Panaya, the Tata-Mistry stand-off, the Satyam-Maytas scam or the Kingfisher-Mallya turn of events, each time the functioning of boardrooms has put the need for transparency and accountability in corporate governance in India at centre stage. The recent acceptance of numerous recommendations of the Kotak Committee by the Securities and Exchange Board of India seeks to make way for an inclusive functioning of company boards to keep the interests of stakeholders above the interests of promoters as a “custodian”.

Manoj KumarFounder and managing partnerHammurabi & Solomon
Manoj Kumar
Founder and managing partner
Hammurabi & Solomon

Among the key changes coming up in the area of corporate governance, the offices of chairperson and chief executive officer or managing director (CEO/MD) cannot be held by the same person with effect from April 2020. Listed companies will need to rework their organizational structures to make way for two separate power centres, to avoid conflicts of interest in the governance of companies and functioning of boards.

The practice of promoters of listed companies sitting as independent directors on each other’s boards through board interlock structures has now been effectively done away with. Hence a promoter will no longer be able to borrow an independent director from another board where the promoter is sitting as an independent director.

The maximum number of directorships of listed companies that any individual can hold has now been reduced from 10 to eight. However, an individual who is a managing director or whole-time director of a listed company cannot serve as an independent director of more than three listed entities.

All boards of listed companies must now have at least one female independent director, a change from the earlier regime which required that any one director be a woman.

The minimum number of directors for listed companies has now been increased to six with at least half being independent directors. The quorum for board meetings will be one-third of the strength of the board or three directors, whichever is higher.

Subsidiaries of listed companies that have a net worth or income exceeding 10% of the consolidated net worth or income of the listed company will be called “material subsidiaries”. It will now be necessary to have at least one independent director of the listed company on the board of a foreign material subsidiary and it will be compulsory to carry out secretarial audits of Indian material subsidiaries of a listed company, which must be disclosed in the company’s annual report.

The scope of “related parties” will now include all promoters and promoter group entities that hold 20% or more in a listed company for the purposes of related-party-transaction compliances. Transactions with promoters and promoter group entities holding 10% or more will be required to be disclosed on a consolidated basis at half-yearly intervals. Further, all payments to related parties in excess of 2% of consolidated turnover towards brand usage will need to be approved by shareholders.

While increased oversight should improve the quality and composition of boards, there is also a need to have at least one-third or more directors who have direct industry experience and expertise.

The separation of the chairman and CEO/MD roles should enable long-term value creation to supersede short-term gain as the driver of decision making. However, for the CEO/MD to be able to take the path of sustainable value creation, it will be necessary for independent directors with a similar history to find a place on the board. Further, finding independent directors with relevant skills and sufficient time to dedicate to the board may be hard unless effective compensation regimes are put in place for independent directors similar to incentive compensation structures to drive desired employee behaviour.

Globally, a lack of institutionalized functioning of boards has been seen in Brazil, where an institutional regime of corporate governance is yet to evolve. In the EU, faced with a rising sentiment among member nations to safeguard important companies from potential takeovers, corporate governance has taken a reverse flow, with an increase in chairperson and CEO/MD roles getting combined. Even Japan, where the number of companies signing up to the Japan Engagement Consortium has grown to 300, led by Governance for Owners Japan, improving gender diversity in boardrooms remains a challenge.

An increased transparency on promoters in Indian boardrooms along with more effective oversight by independent directors and stakeholders is a welcome step, but the transitions may not be easy, as has been the case in many key jurisdictions.

Manoj Kumar is the founder and managing partner at Hammurabi & Solomon.

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