Coming straight to the key point, a high-profile Committee of the Securities and Exchange Board of India (SEBI) on October 5 recommended a slew of measures, including increasing the number of directors on boards of listed companies, the appointment of at least one woman independent director, and a higher frequency of board meetings to enhance corporate governance standards at India Inc. It is widely anticipated that this panel will usher in the much needed corporate governance overhaul. But right now it would be premature to guess how effective it will be in ushering corporate governance overhaul. Uday Kotak who is the head of SEBI's panel on corporate governance presented the report to SEBI Chairman Ajay Tyagi on October 5.
While craving for my esteemed readers exclusive indulgence, let me inform them that the 25-member panel on corporate governance, headed by Uday Kotak who is Vice Chairman and Managing Director of Kotak Mahindra Bank has also called for separating the roles of chairman and managing director and creating a formal framework for sharing sensitive information between the board and entities not part of the board. Pushing strongly for greater transparency, the panel said that sound corporate governance helped companies generate 'significantly greater returns', compared to companies, which exhibited poor corporate governance standards. It further said that well-governed companies could command a premium between 10 and 40 percent over not-so-well-governed companies.
For my esteemed readers exclusive indulgence, let
me also inform them that the panel headed by eminent banker Uday Kotak also suggested
the government assess an 'independent holding structure' for public sector undertakings
(PSUs). The panel in its 178-page report submitted to SEBI said that, 'The government
should consider consolidating its ownership and monitoring PSUs into independent
holding entity structures by April 1, 2020.' I am sure that the government will
seriously consider this recommendation as well as other recommendations.
Let me hasten to add here that the move, the panel
said, would help remove conflicts between the government and the regulator. The
panel also said that an autonomous environment would enhance the shareholder value
and act in the best interests of all stakeholders noting several public sector undertakings
(PSUs) were trading at a sharp discount to their private peers. It is thus incumbent
that an autonomous environment should be created soon so that it can help in more
ways than one.
To put things in perspective, while suggesting a
major overhaul of corporate governance norms for listed companies, the Kotak panel
rightly recommended limiting chairmanship to only non-executive directors and appointing
at least one woman as independent directors. Presently, we see that 637 companies
(38.1%) don't have a single independent woman director. This is certainly most concerning!
It also must be added here that the panel has recommended
that the requirement to have at least one woman director should exclude promoter's
relative to be truly independent. M Damodaran who is former Chairman of SEBI says
that, 'My view has always been that there should be at least two women directors
on the board, with at least one being independent. There is nothing wrong with a
promoter's relative being one of the women directors since no such question is raised
when the promoter's son or nephew is appointed to the board.' While the proposal
for only non-executive director being allowed to be made chairman would eventually
lead to a split in the posts of chairman and managing director, the panel also suggested
increasing the minimum board strength to six members and the number of board meetings
to five in a year. Earlier the minimum number of board members were three and minimum
number of board meetings were four.
As things stand, the current rules require that
there must be one woman on board, irrespective of her being on board, irrespective
of her being an independent or executive director. They also call for having at
least half of board members as independent directors, up from one-third currently.
The suggestions assume immense significance when considered in the backdrop of alleged
corporate governance-related issues at Tata Group and Infosys and the ugly slugfest
that broke out between those persons who are in the helm now and those who were
earlier in the helm which even saw many heads rolling!
Simply put, the panel also suggested a minimum remuneration
of Rs 5 lakh per annum for independent directors and a sitting fee of Rs 20,000
- 50,000 for each board meet. It also sought to make it mandatory to seek public
shareholders approval for annual remuneration of executive directors from promoter
family if the amount exceeds Rs 5 crore or 2.5 percent of the company's net profit.
No doubt, this would check arbitrary actions and act as a safeguard against misuse
Briefly stated, in case of more than one such director, the same condition would apply for aggregate annual remuneration exceeding 5 percent of the net profit. The approval of shareholders will be required every year in which the annual remuneration payable to a single non-executive director exceeds 50 percent of the total annual remuneration payable to all non-executive directors. The companies would be required to disclose the list of competencies/expertise that its board members actually possess. This will ensure increased accountability and compliance with rules which will undoubtedly be good for the system. Besides, public shareholders nod would be mandatory for non-executive directors over 75 years of age. 972 non-executive directorship positions occupied by directors who are more than 75 years of age.
As it turned out, the capital markets regulator
SEBI has sought public comments till November 4 on the panel's recommendations which
runs into 178 pages and covers a plethora of issues. The panel has suggested at
least half of board members to be independent directors at listed companies, while
all directors must attend at least half of board meets. Presently, a board needs
to have at least a third of its directors as independent.
What is of immense significance is that the panel
also called for a better compensation for independent directors in order to balance
the 'risk-reward' and make it attractive for 'competent people' to become independent
directors. It also called for exclusive meetings of independent directors. It suggested
for new disclosure norms, where listed entities would have to give detailed reasons
for resignation of an independent director. This without doubt would strengthen
the position of independent director.
As of now, according to the figures obtained by
Prime Database, till date 851 independent directors would resign from various companies.
Going ahead, many companies may even find it hard to find independent directors.
In the last two years, many independent directors have been resigning from companies
they feel could land them in trouble.
It is laudable that the panel recommended to disclose
detailed reasons for resignation of independent directors while earlier there were
no such specific rules. This will ensure that independent directors before quitting
would lay bare the stark truth of all what was going wrong due to which he/she had
to resign! So no one can take them for granted. We all know fully well how in the
aftermath of Cyrus Mistry's ouster as Chairman of Tata sons, Nusli Wadia - an independent
director on the boards of three listed Tata companies had asked SEBI to inquire
into unpublished material and price sensitive information shared by the companies
with Tata trustees and Tata sons. Wadia showed how an independent director can assert
himself and work without getting influenced by anyone!
Also, interestingly enough, where chairperson is
not independent, the panel recommended that independent director should be the lead
while earlier there was no such provision. Now, independent directors could face
more scrutiny which will ensure that they work more transparently and sincerely.
It is also laudable that the panel has proposed a minimum remuneration in the case
of independent directors depending on the size of the economy.
Truth be told, the panel which submitted so many
of its landmark recommendations was set up by SEBI in June 2017 with a view to enhancing
the standards of corporate governance of listed entities in India. The committee
consisted of officials from the government, industry, professional bodies, stock
exchanges, academicians, lawyers and proxy advisors. The panel was asked to submit
its report within four months which it did on October 5.
Truly speaking, the terms of reference of the committee
were to make recommendations to SEBI on various issues including ensuring independence
in spirit of independent directors and their active participation in functioning
of the company. Besides, the suggestions are aimed at improving safeguards and disclosures
pertaining to related party transactions. They also cover issues in accounting and
auditing practices by listed companies and seek to improve effectiveness of board
evaluation practices. The report also seeks to address issues faced by investors
on voting and participation in general meetings, and disclosure and transparency
Needless to say, the panel also suggested that all
listed entities which have public shareholding of 40 percent or more at the beginning
of a fiscal year should ensure that the chairperson should be a non-executive director
from April 1, 2020, while chairperson should be a non-executive director for all
the listed companies from April 1, 2022. It is commendable that it also recommended
that the top 100 companies by market capitalisation should webcast their shareholder
meeting. It also suggested that the minimum number of audit committee meetings be
increased to five every year from the present four.
Be it noted, the panel also recommended the adoption
of a transparent framework for exchanging unpublished price-sensitive information
(UPSI) with promoters or any significant entity not part of the board. It called
for the creation of special agreements enabling the management to share any UPSI
with designated persons. Under the current framework, such information can be shared
with members only if they are part of the decision-making process.
It is a no-brainer that this issue had assumed immense
significance during the no-holds-barred tussle at Tata sons between their erstwhile
chairman Ratan Tata and Cyrus Mistry and the latter had to quit under unrelenting
pressure exerted on him by the former. Panel member Keki Mistry who is Vice Chairman
and Chief Executive Officer HDFC said that, 'These measures would bring clarity
and create a pathway where promoters can access sensitive information, subject to
It must be brought out here that addressing the
issue of high royalty payments by domestically listed multi-national companies (MNCs)
to their parents, the panel recommended that payments amounting to over 5 percent
of the revenues would require the approval of public shareholders. It also recommended
high frequent disclosures of related party transactions (RPTs), often a bone of
contention between public shareholders and promoters.
Of course, it called for the presence of at least
one independent director at every board meeting. It further suggested the separation
of the roles of the chairperson and the CEO and managing director for listed entities,
with public shareholding over more than 40 percent by April 2020 and extend it to
all companies by April 2022. The move could impact companies like Reliance Industries
where Mukesh Ambani holds the post of both Chairman and MD. Same is the case with
Pawan Munjal at India's largest motorcycle maker Hero MotorCorp and RD Shroff at
the country's largest agrochemicals producer United Phosphorus. Of the 50 companies
on the benchmark Nifty, at least 12, including Reliance Industries, ONGC and Wipro,
have the same person occupying both posts.
To be sure, the Kotak panel also made several proposals
for effective functioning of board committees which includes audit, remuneration
and stakeholder relationship committee. It also advised setting up of information
technology committee to focus on digital and technological developments.
In a bid to improve transparency among group entities,
the panel suggested revising the definition of a 'material subsidiary'. It said
an entity will be termed as a material subsidiary if its income or net worth exceeds
10 percent, up from the current 20 percent, of the consolidated income or networth
respectively of the listed entity. This also apply to unlisted foreign subsidiaries.
Going forward, the panel stipulates that the maximum
number of directorships held by a person will be capped at 8 by April 1, 2019 and
7 by April 1, 2020. It also stipulates that the auditor shall have the right to
independently obtain external opinions from experts. It recommended that for listed
entities in India, the auditor of the holding company should be made responsible
for the audit opinion of all material unlisted subsidiaries.
Let me bring out here that the panel has recommended that chartered accountants apex body ICAI (Institute of Chartered Accountants of India) should have powers to punish audit firms and impose a fine of up to Rs 1 crore on erring auditors. This would go a long way in deterring them from erring intentionally. Presently, the ICAI can only impose a maximum of Rs 5 lakh fine on its members for violations.
Let me also bring out here that it also stated categorically
that, 'On the audit firm - punishment or impose penalties of up to Rs 5 crore in
case of repeated violations (that is where the number of violations exceed three).
Besides, it has suggested that the institute should make increased disclosure about
actions taken against members which would ensure more transparency and act as a
deterrent. Another suggestion is for the institute to have a separate team for enforcement
pertaining to listed entities in order to reduce the turnaround time for disciplinary
It cannot be lost on us that the panel proposed
stricter rules and disclosures for related-party transactions. It stated that, 'All
material related-party transactions shall require approval of the shareholders through
resolution and no related parties shall vote to approve such resolutions whether
the entity is a related party to the particular transaction or not.' It also said
that, 'All entities falling under the definition of related parties shall not vote
to approve the relevant transaction irrespective of whether the entity is a party
to the particular transaction or not.'
It also has to be borne in mind that the panel suggested
companies should disclose in the annual report key financial ratios or sector-specific
equivalent ratios. It also proposed the release of consolidated results every quarter
and cash-flow statements every six months.
It is noteworthy that the panel proposes to put
in place a common stewardship code that might compel Life Insurance Corporation
(LIC) and top mutual funds (MFs) to play a more active role in this regard. Sai
Venkateshwaran who is partner and head of accounting advisory services at consultancy
KPMG India says that, 'The (proposed) code will make it a formal mandate for institutional
investors to play a stewardship role, rather than remain silent spectators with
respect to the affairs of their investee companies'. Several countries such as the
UK, Japan and Malaysia have prescribed detailed Stewardship Codes to be followed
by institutional investors voluntarily. These include principles which require that
institutional investors have comprehensive policies on -
1. Discharge of their stewardship responsibilities;
2. Management of conflicts of interest in fulfilling stewardship responsibilities;
3. Monitoring of investee companies;
4. Intervention in investee companies;
5. Collaboration with other institutional investors;
6. Voting and disclosure of voting activity;
7. Periodical reporting on their stewardship activities.
It is also noteworthy that the panel has also recommended that the market regulator, SEBI, will have the right to pull up auditors for any lapse in corporate governance norms and penalize them. In the past, we saw how some of India's top auditors, including some from the Big Four firms, were found clearing annual reports despite companies being accused of corporate governance violations as the case of United Spirits. This recommendation would undoubtedly make sure that auditors, who are seldom taken to task by their self-regulated body, do a thorough job while certifying accounts as not doing so would land them in a deep trouble.
Be it noted, the panel has proposed a formal framework for listed companies to share unpublished price sensitive information with promoters and large shareholders as this issue hit the headlines with the recent boardroom battles at Tata Group and Infosys. The Infosys Board had criticized its founder Narayana Murthy of inappropriate interference. The panel now entails that a listed entity may enter into the agreement in relation to providing access to material information, including unpublished price sensitive information, to the promoter or someone with more than 25% shares.
It also makes it clear that is the duty of the promoters and large shareholders to maintain strict confidentiality of all material information, under the terms of agreement. Safeguards to be put in place in respect of procedures of communication and procurement of information. The promoters and large shareholders will have to provide an undertaking that it will use the information received in accordance to the securities laws and access of information does not undermine the independence and autonomy of the board of directors of the listed entity in any manner.
It must be noted here that the listed entity shall have the right to unilaterally terminate the agreement with the consent of majority of directors of the listed entity representing three-fourths in number, provided that the counterparty on the board of directors of the listed entity shall abstain from such voting. The panel also said that the business reality in India is that a majority of the listed entities are controlled by a single promoter where the lines of control, influence and information flow do not necessarily follow the formal and distinct corporate structure. The listed entity shall have the right to withhold communication and access to material information in case the board of directors determines that it is not in the interests of the listed entity or there is a conflict of interest in it sharing the material information with the promoter or there has been a breach of the agreement by the promoter.
It is quite troubling to see that even though currently there are no provisions to grant leniency by SEBI but the panel has proposed to provide powers to the Central Government based on recommendations by SEBI to grant immunity both from prosecution and imposition of penalty under the SEBI Act and the SCRA for the alleged violation subject to certain conditions. One only hopes that this is reviewed and even if not changed is not misused to favour wrongdoers.
It is also proposed that the top 100 companies by market cap would hold annual general meetings (AGMs) within five months and the same may be extended to other entities in a phased manner. Over time, this timeline would be reduced to four months. Presently, companies hold AGM within six months from the end of the financial year.
All said and done, it needs no rocket scientist to conclude that the panel led by Uday Kotak has really submitted laudable recommendations. We have discussed here just few of them. There may be a few shortcomings but overall it seems to be a very good and carefully drafted report in which about 25 experts have tried to bring in the best. So it would not be proper to just dismiss it as yet another report! It still remains to be seen how many recommendations are finally accepted by the SEBI. But it is certainly a watershed moment which promises many changes for the better in corporate governance if they are finally accepted!