The following is a guest post by by Sonia Jaspal from her blog, Sonia Jaspal’s RiskBoard, originally posted on June 12, 2012. I’ve added a few links, a couple of ads and reformatted the post slightly.
The board of directors have the responsibility for steering the organization in the right direction and guiding the CEO and senior management. However, worldwide they are lambasted for catering to the manifested interest of CEO and senior management at the expense of shareholder interest. The criticism is that boards’ failure to maintain independence results in under-performance.
A prime example is the decision of Satyam board to acquire Matyas. The board approved a deal of USD 1.6 billion to acquire Maytas Infra for USD 300 million and Maytas Properties for USD 1.3 billion. Ramilanga Raju after admitting the Satyam fraud stated that deal was to fill Satyam with real assets instead of fictitious assets. The scandal came out as shareholders refused to approve the deal and Raju didn’t have a way to cover the fraud. The recent case of Kingfisher Airlines debacle clearly shows that the board was not asking the right questions.
Mr. N. R. Narayan Murthy, founder of Infosys, in his book A Better India: A Better World succinctly describes the prevailing trends. He wrote – “A a result, the 1990s was the era of the stock-option-fattened, superman-superwoman CEOs who could do no wrong in the eyes of their admiration-heavy boards, and who were seen as demigods. Lax oversight by the boards made these CEOS more or less omnipotent.” He has lead corporate governance in India by walking the talk and his scathing comments are right on target. He has given a number of suggestions to improve corporate governance and board performance.
Let us see, whether Indian boards are up to the task. To analyse the performance of the boards, I have taken the best practices of the board from the report of Trinity Group and Mr. Narayan Murthy’s book. The statistics are from India Board Governance report 2011 and the relevant laws are from the New Companies Bill 2011.
1. Constitution of the board
Corporate governance practices mention ideal board size of 8-12 members with around one-third to half the members being non-executive and independent directors. Indian boards on an average had 9.6 directors of which 5.2 were independent directors in 2010 and 60% of the boards have separate roles for CEO and Chairpersons. On the whole, this sounds good, however, in light of the additional information given below, the perspective changes.
a) In 2010 in India, board chairpersons were members of 9.5 external boards though majority of the memberships were of private companies. According to the survey “the maximum public board memberships held by an individual was 12, and the maximum private board memberships a whopping 37″.
b) The CEOs & managing directors were on an average board members of 7 external boards. “The highest number of public company board memberships held by a CEO was 10, whereas it was 32 for private company boards.”
c) Non-executive directors, on an average held a total of 6.7 total board memberships, with 2.1 public and 4.6 private memberships.
d) 56% of the directors surveyed identified the limited talent pool as an impediment, with 38% perceiving it as a major hindrance. Yet, less than 10% used search firms or other 3rd party sources to locate suitable talent.
The lack of experienced and trained directors is the key reason for a few directors available in the talent pool holding multiple memberships. When most independent directors are selected from the social circle of the CEO or Chairperson, there are very few who would not toe the line stated by the CEO. With the multiple holdings, a conflict in one board may impact the relationship in another board. Hence, instead of independence, diplomacy and self-interest prevails.
2) Strategy review by the board
According to the best practices given in the Trinity report, “the board’s primary responsibilities include : (a) reaching agreement on a strategy and risk appetite with management, (b) choosing a CEO capable of executing the strategy, (c) ensuring a high-quality leadership team is in place, (d) obtaining reasonable assurance of compliance with regulatory, legal, and ethical rules and guidelines and that appropriate and necessary risk control processes are in place, (e) ensuring all stakeholder interests are appropriately represented and considered, and (f) providing advice and support to management based on experience, expertise, and relationships.”
On the other hand, the Companies Bill mentions the board’s power as: “ (a) to make calls on shareholders in respect of money unpaid on their shares; (b) to authorise buy-back of securities under section 68; (c) to issue securities, including debentures, whether in or outside India; (d) to borrow monies; (e) to invest the funds of the company; (f) to grant loans or give guarantee or provide security in respect of loans; (g) to approve financial statement and the Board’s report; (h) to diversify the business of the company; (i) to approve amalgamation, merger or reconstruction; (j) to take over a company or acquire a controlling or substantial stake in another company; (k) any other matter which may be prescribed“
The theoretical legal powers given are quite different from the actual working of an effective board. On an average in India in 2010, board members met 6.5 times during the year. The minimum number of meetings were four, that is a statutory requirement and maximum were 19 board meetings by a company. The boards met on an average three times during the year for strategic and business review.
Considering the number of meetings conducted by the board, with the legal responsibilities and practical requirements, it is not feasible for the boards to do a constructive strategic review of the business or provide regulatory oversight. Too big a mandate has been given, while the time spent on it is relatively small. It is not surprising that most boards are acting as rubber stamps to the senior management plans. It is a case of imbalance between power, responsibility and time commitment.
3. Focus on risks
After the Satyam scandal and financial crises, the board focus on risk management has increased. The boards ideally need to determine the risk appetite, review internal audit reports and external auditors reports, understand various strategic, financial and operational risks, and maintain compliance oversight. In India, the Company Bill mandates an audit committee for listed companies, with majority being financially literate independent directors.
In 2010, in India, 69% of the board members respondents stated that boards are considering risks as top priority. However, 31% mentioned that boards are not involved in systematically addressing corporate risk management.
My view is that the focus on Indian boards is more on risk of misreporting financial statements rather than others. Risk management field as such is still in young stage in India, and board members are ill-geared or untrained on the various aspects.
4. Information availability
The decision-making of the board is subject to the information available with it. As per law, board members are ideally required to receive all relevant information about board resolutions and decisions, seven days before the meeting. However, board members responded that most of the documents are given prior to the meeting or just a couple of days in advance.
Moreover, “a vast majority of boards depend largely on management reports (90%) and informal management discussions (79%) for business information. Third party reports and stakeholder views are used as tools only by 23% of the companies.”
With such limited information, and high dependability on company sources, the directors may not be in a position to make informed decisions. The directors don’t even have sufficient time to study the presented information to make independent decisions and cross question the senior managers. Hence, this could be a key reason for poor performance.
5. Performance Review of CEO & senior management
The compensation committees recommend the CEO and other senior managers. In India, around 80% the respondent companies had a compensation or remuneration committee. The issue of CEO compensation isn’t as big as the western world, however, it is fast gaining prominence. Some high earning CEOs in the top 100 list are being evaluated on the basis of returns to investors.
The board as such has to evaluate CEOs performance. In the west, the “star” CEOs are in the limelight and are paid high salaries in relationship long-term company performance. However, India scenario is different. Most of the critical positions in family organizations are held by family members and relatives. In such a scenario, the board or compensation committee are hardly in a position to evaluate the performance or recommend salary.
6. Performance review of board
As per law, the nomination committee reviews directors performance , and recommends removal. However, two-thirds of the independent directors stated the roles and responsibilities of non-executive directors are not defined clearly. Hence, without the clarity in role, the evaluations can hardly be constructive.
As such, the boards in India have the following three priorities: “ensuring overall corporate and statutory compliance (90%), monitoring business and operating performance (87%), and establishing and monitoring financial standards and internal controls (82%). Leadership development, succession planning, CSR and risk management continue to be low on the board priority list.”
The professionally run organization do claim for independent evaluation. For instance, Tata and Infosys succession, the nomination committees were said to be doing independent evaluation. However, in both cases, questions were raised on the final selection. Though Mr. Murthy in his book mentioned that – “At Infosys, the chairman of the board sits with each board member, discusses his/her evaluation, and suggests remedies and course-corrections. The chairman’s performance review is handled by the lead independent director.“
In my opinion, the practice of evaluating board performance only exists in some companies in India.
Unless the mindset changes to compassionate capitalism where business is done with integrity, decency and in a principled manner, boards will continue to be tutorial heads without much power and say. To ensure boards perform better, shareholders and investors need to become more active. The regulators need to ensure governance codes are followed in spirit and not just tick box mentality. A more elaborate role can be defined by regulators with mandatory requirement of time commitment and reporting requirements.