June 27, 2020
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Parsley On The Fish

Majority of outside directors on boards of Indian companies are mere rubber stamps.

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Parsley On The Fish
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One day at work, you get a call from a CEO friend who requests you to be a non-executive director (NED) in his company. A quick check on the number of directorships you already hold (10) and your work schedule and you agree. After all, your friend is a good chap-you were in college together-and his company is well known. Besides, the board meetings will be in Bangalore, where your daughter is studying. Five-six round trips per year by J-class, night stays at Taj Westend, two hours in a ritualistic board meeting followed by an excellent lunch, and the rest of the afternoon with your daughter. What's wrong with that? You've earned it, haven't you?

By and large, this describes the so-called 'independent' NEDs gracing the boards of listed companies. An NED is technically independent insofar as he is not (a) a former executive of the company, (b) a large customer or vendor, (iii) the company's legal advisor, solicitor, management consultant or chartered accountant, (iv) a relative of the promoter or any ED, and (v) holding a significant stake or representing a major shareholder or creditor. But is he 'independent' and does he know what it's to be a 'fiduciary'?

Fiduciary means 'of a trust, trustee, or trusteeship' or 'held or given in trust'. What most NEDs quickly forget (if they know it at all) is that they are fiduciaries of those who appointed them and who really own the company, namely the shareholders. The job of any director-most of all independent NEDs-is to ensure the company performs efficiently to maximise long-term value for the shareholders, while respecting the interests of other stakeholders. Unfortunately, this fiduciary responsibility is discharged by far too few. Often, NEDs are rubber-stamps of the management.

The purpose of appointing NEDs is two-fold: to provide a company with knowledge, objectivity and judgement of a kind that may not be available if the board has only full-time executives; and to ensure that the performance of EDs and the management are up to standard. Independence doesn't mean adopting non-collegial and adversarial positions. NEDs should assist management in moving the business forward, enhancing reputation and raising corporate value. But such support shouldn't be uncritical. NEDs must be independent enough to face contentious issues, and professional enough to assess them properly. The acid test of the balance of any board is whether it can, when the chips are down, stand up to the CEO and, if necessary, replace him.

Such independence is a rarity on the boards of our companies. The most important reason for this has to do with the demand side-the majority doesn't wish to have professionally competent, independent people on their boards. Legacies of the managing agency system continue to influence corporate India. Till the early '90s, the growth of private listed companies was driven more by debt than equity. Since term-lenders were generous public financial institutions (FIs) with high tolerance for mismanagement, most companies were run by promoters with insignificant ownership. So that, promoters (Indian or foreign) wielded far more control over 'their' companies than they deserved.

As a result, hardly any management had the incentive to appoint top professionals as independent directors. Instead, boards were visualised as legally necessary constructs that had to be packed by friends and relatives, executives from group companies, a few retired bureaucrats (to help in Delhi) and dormant FI nominees. Resolutions were to be passed, not questioNED; the agenda was a matter of form, not substance; meetings began at 11.30 to conclude with lunch; and all was well.

Admittedly, things have changed under pressure of competition and liberalisation. But, like many aspects of economic reform, the change has been glacial. I reckon that no more than a dozen blue-chips have really professional boards, where truly independent NEDs enjoy numerical superiority and question the management.

There is also a demand side reason that explains the paucity of independent NEDs-remuneration. The Companies Act stipulates a maximum sitting fee of Rs 2,000 per meeting attended-hardly the stuff to attract first-rate talent and induce them to become active directors instead of passive observers. While the Act also allows paying 1 to 3 per cent of net profits as commission to directors, not more than 20 listed companies do this. Not surprisingly, many NEDs attend less than half of the board meetings. And since attendance is rarely ever disclosed in the annual report, they generally get re-elected by shareholders in the annual general meetings.

And we get what we deserve: pliant and passive directors who think that their job is ceremonial-trivially honourable and hardly ever accountable.

Can we expect more and more companies to have first-rate directors who are active participants in boards, who understand the nature of their fiduciary duties and are willing to devote 10 working days for each company? Yes, provided there's a sea change in attitude. Company chairmen and directors must realise the importance and sanctity of the phrase "Your company". It means "you", the shareholders, are the owners of the company, and we, the directors, are "your" fiduciaries, appointed by "you" to look after "your" long-term interests. Such a change won't happen only through enlighteNED altruism. It'll need much greater shareholder activism and a demand from them and the stock exchanges for greater corporate governance disclosures and transparency. It required the US pension and mutual funds to force changes in boardroom practices in corporate America. When such pressures build up here and companies realise that good corporate governance is essential to access capital at competitive rates, then we'll see the real separation of the wheat from the chaff. Until then, most NEDs will be like 'parsley on the fish'-decorative and decorous but with no real purpose.

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