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Rethinking Corporate Governance

11 Feb 2023

Corporate governance and its overall effective implementation have always been a challenge for India. India has witnessed several businesses reduced to rubble either due to lack of foundational strength or on account of poor management of internal affairs. Having seen very turbulent times in the past few decades, financial and management scandals in India do not seem to be slowing down, with India Inc. being witness to various scams in 2022.

While the government and other regulatory bodies such as the Securities and Exchange Board of India (“SEBI”) have mandated standards to ensure good governance practices, India Inc. continues to bear the consequences of scams resulting in huge financial losses to the banks, financial institutions and more so to the market itself.

There is a pressing need to rethink corporate governance, particularly in the established companies, by adopting good governance practices and keeping a check on the leakages resulting in losses.

The board room is the ultimate black-box in the corporate world. Board rooms pose challenges in terms of managing conflicts arising from a diversity of ideas, interests, individual personalities, and value systems. It is essential for a board to be composed of diversified set of members in terms of qualification, training and highly professional individuals who possess the relevant industry knowledge.

Boards need to identify and understand the key focus areas for improvement, Each key focus area is discussed and analysed below, specifically in the context of the Indian businesses.

Board’s Role

The Audit committee of a listed entity is typically responsible for overseeing financial reporting, audit processes, and company’s internal control and compliances. However, it is equally important that board members focus on making the board smarter, or more commercially aware, and more diverse in terms of expertise, skill sets and experience.

Members of the board must be able to understand their role and contribution and execute these with great care and diligence. The board is also required to understand complex transactions undertaken by company and analyse the impact of such transactions on the company’s future while managing stakeholders interests. Often, board members are just not equipped to do this effectively and trust the management blindly.

Companies must be cognizant of the fact that corporate governance is a direct reflection of the boards’ actions and in order to ensure good governance, companies need to actively engage in acts promoting the image of the company through discussion with its core management group and evaluate alternatives before taking such drastic steps Mass layoffs do not instill confidence in the investors or the public with respect to board governance and management.

Board composition

SEBI mandates disclosure of particulars of the composition of the board of directors in accordance with SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 (“SEBI LODR Regulations”). It is equally important to consider the board consists of members having diversified backgrounds. Diversity of a board can be judged on several metrics including gender, age, educational qualifications, industry experience, and presence of experts or people with specialized knowledge in a particular field.

SEBI has taken several steps to promote diversity on the board of directors including mandating the following:

Appointment of at least one independent woman director in select companies
At least one-third or one-half of the board comprised of independent directors depending on specific criteria.
Setting an age threshold for non-executive directors.

Role of Risk Management

SEBI mandates the establishment of a risk management committee in every listed company. Each listed company therefore formulates a risk management policy but there are no minimum standards prescribed, and no defined thresholds for identification and measurement of risks or any specific measures for mitigation of such risks.

SEBI LODR Regulations mandate that every risk management committee must have minimum of three members, with at least one independent director. The Company Law Committee Report 2022 recognised the urgent need for every company to have an active risk management committee to identify, mitigate and resolve risks. However, significant gaps exist in understanding the risk management function and how it relates to corporate governance.

Stakeholder Engagement

One of the most interesting parts of corporate governance is balancing the interest of all the stakeholders in the company. Apart from shareholders and directors, there are other stakeholders in a company such as the security holders, creditors, debenture holders, financial institutions, government, employees, unions of employees and/or prospective Investors. Protecting the Interests of all stakeholders forms an integral part of the governance strategy.

Reconciliation of all stakeholders’ interest through strategies capable of raising not only economical standards but also social and environmental standards is need of the hour, India initially focused on protecting the interests of only those parties who had a direct relationship with any company or organisation, however the scope of protection of interests has Increased to all such individuals or entities who have an indirect stake in business and are likely to be affected or impacted by the activities of such organisation. SEBI LODR Regulations have, in the recent past, included reporting requirements to notify the initiatives taken by a listed entity from an environmental, social and governance perspective.

Succession Planning

Many leading companies and conglomerates in India are family owned. Succession planning is one of the key aspects of risk that the board is required to address Investors backing such family-owned companies are required to be assured about succession planning. This should be done to ensure that adequate disclosures have been made to the investors for the purpose of smooth functioning of the company without any disruptions that could be caused by succession battles.

Earlier, succession planning used to take place in the background within the family. However, after the Introduction of SEBI (Listing Obligations and Disclosure Requirements) Regulaons, 2015, succession planning was formally introduced as a key responsibility of the board. The Kotak Committee on Corporate Governance in its report (October 2017) recommended that the boards should meet once a year at least to address succession planning and other governance issues.

Succession planning must not be only limited to finding successors for key managerial personnel. Boards should also work towards a strategic approach to succession planning. As investors continue to demand more information about the board’s operations in this area, the board needs to formalise a strategy to improve its effectiveness and provide long-term value to the shareholders. The Nomination and Remuneration Committee of every company should formulate a specific policy for board succession planning to assess board’s performance continuously and to ensure that any disruptions in business activities due to untimely departures of board members are avoided.

Conclusion

Identifying the issues in advance and ensuring proper resolution for them when they arise is the test of good corporate governance. It is imperative for boards to keep themselves updated and monitor the working of internal policies regularly. Directors will be required to channel their efforts in identifying areas where growth and change will be required to improve performance. Companies should look to optimize composition of the board in ways that can enhance long-term value. It is need of the hour to bridge the gap between the board and management to allow vigorous debates in the board room to come up with effective solutions.

Lastly, communication should be the key component of corporate governance and investor relations. The Board needs to develop a sense of trust with all the stakeholders Stakeholders will have confidence in a company only if its Board has frequent conversations with specific industry experts on risk mitigation and prevention and implements best practices The Boards should also be able to adapt and respond to the opportunities and risks in an agile manner, and this only be possibi through guided copies on pricnties risk management and strategy.

The article was contributed by Ms Kalpana Unadkat, Partner, Kaitan & Co., in the January 2023 issue of CII Pascheem.