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Will Sebi’s proposal on independent directors improve corporate governance?

Independent directors are seen as a pillar that balances interests of all stakeholders with a primary emphasis on that of minority shareholders vis-à-vis promoters 

March 04, 2021 / 09:29 AM IST

SEBI has proposed several changes to the rules relating to corporate governance, mainly to strengthen the status of Independent Directors. The major changes include giving a bigger role to minority shareholders in appointment/removal of such directors, proposing a higher remuneration for them, strengthening the Audit Committee/Nomination and Remuneration Committee (NRC) even further, etc. Views are sought from the public at large through a consultation paper.

Independent Directors are seen as a pillar that balances interests of all stakeholders with a primary emphasis on that of minority shareholders vis-à-vis promoters.

The first of these important proposals looks at how Independent Directors are appointed and removed. Currently, they are recommended by the NRC, then appointed by the Board and finally confirmed by approval of majority of shareholders. Their removal is also by majority shareholder approval.

It is seen that the promoters with their controlling stake can influence — perhaps decisively — the process in every step. Hence, it is proposed, adopting almost wholly the UK model, where the appointment at shareholder level should pass two tests. One is the approval by a majority of all shareholders. The second is approval of the majority of the minority shareholders. Let’s understand this better by an illustration.

Say, the promoters hold 60 percent equity shares. The first test would be achieved when 50.01 percent of all shareholders approve. Since the promoters hold 60 percent, they would control this outcome. The second test is that more than half of the shareholding public (say 20.01 percent) would have to also approve. If either of these tests fail, the appointment is rejected.

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Then the recourses for management are two. It can suggest a new person and put them through these tests again. Or, put the same candidate through a slightly different ‘agni-pariksha’ of sorts after a cooling period of 90 days, but before 120 days. If at least 75 percent of total shareholders approve, the appointment would be through.

A similar process is proposed for removing Independent Directors. This ensures a significant role to the public shareholders and the strong influence of promoters is mitigated to an extent.

Even the shortlisting of Independent Directors is given a fillip by requiring more disclosures on how they were shortlisted. Moreover, the NRC that recommends Independent Directors will now have a higher two-thirds of Independent Directors, instead of just a majority.

Appointment of Independent Directors are currently made first by the Board and it is only at the later annual general meeting that shareholders approve. During this period the Independent Director functions in office. To avoid this even interim say of the promoters on such appointments, it is now proposed that the appointment of Independent Directors shall only be by shareholders. If an Independent Director resigns/dies, their replacement has to be done by shareholders within three months.

Further, if an Independent Director resigns stating ‘personal reasons’, ‘other commitments’ or ‘preoccupation’, they won’t be able to join any other board for a year. Resignation will not be allowed to be the route to become a whole-time director. A cooling period of one year is proposed.

The audit committee has an important role in approving related party transactions, accounts, etc. Currently, it is required that two-thirds should be Independent Directors and the rest can be any director including promoter directors. Now, this balance one-third can only be non-executive directors not related to the promoters. The influence of both the promoters and the management is sought to be removed.

Then, there is the proposal to enhance remuneration of Independent Directors. The dilemma here is if you pay too less, the director has less incentive to devote sufficient time and if you pay too much, the concern is of they being influenced. Currently, a maximum Rs 100,000 per meeting is permitted as sitting fees. Commission based on profits is allowed but this has issues for loss-making companies. Also, commission linked to profits has obvious concerns of conflict in approving accounts.

A compromise of sorts is proposed by two ways. One is by increasing the sitting fees but this would have to be decided by the Ministry of Corporate Affairs. The second is by permitting grant of ESOPs with at least five years vesting period. Thus, those who stay on for five years can possibly be rewarded through the appreciation in value of shares. However, this solution will not resolve the issue well. ESOPs are generally not widely common in companies. Also, a waiting period of five years could be too long and many may not benefit.

In all, the changes are positive. However, more is clearly needed. Powers and liabilities of Independent Directors are not touched on. Individually, Independent Directors have very little power. Liability, however, is significant and, ironically, the enhanced status may raise it even more.

The remuneration of Independent Directors is still resolved unsatisfactorily on at least two counts. First, the amount would still be decided by the Board and thus the promoters would still have a significant, often decisive, say. Second, the amount and manner may still be found to be insufficient to attract the best of talent. The proposal of dual approval tests giving minority shareholders a bigger role could also be applied for appointment of auditors who represent another pillar of safeguard.

It will also have to be seen how companies are required to transition to the new requirements. Will the provisions be effective immediately? Whether only large companies will be required first to change, with later dates being given for successive categories of companies? Will the existing directors be allowed to complete their terms or will they have to be subject to this test immediately?

Many principles of corporate governance are borrowed from the West, including few significant ones from the UK even in these proposals. India is different in a vital way though. The promoters typically hold a very significant stake, often more than 50 percent. Investors traditionally invest on the faith of the reputation and entrepreneurship of the promoters, though there would be cases where this trust is broken. While a check on them is always advisable, it should not happen that adopting a relatively alien concept tilts the balance so much that it actually becomes a hindrance.

Jayant Thakur is a chartered accountant. Views are personal.
Jayant Thakur is a chartered accountant. Views are personal.

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