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Institutional EYE

Commentary on Corporate Governance Issues

Boards should be tasked with saving promoters from themselves

This article is the fourth of a series on ‘Board Failures’ that appeared in Bloomberg Quint.

Being an independent director on a board is a challenge. Doubly so in India. From names on the masthead aimed at attracting capital, to councillors to families and managements, the role of independent directors has changed, as the law has steadily burdened them with more responsibilities. Just as independent director narrowed down their role to being arbitrators between the controlling shareholder and public shareholders, legislation has now tasked them with providing oversight and exercising control eg. the audit committee needs to approve related party transactions. I expect the role to continue to evolve, as the duty of the director itself has changed. For the longest this was to promote the interest of the company and by extension its shareholders. Directors are now expected to promote the interest of all stakeholders – employees, suppliers, the community and the environment. From maximizing value while balancing between two sets of shareholders, their role is now to balance multiple agenda’s.

Even as the law has changed, the market expectations have soared. For the longest, it was the controlling shareholder who took the blow for governance failures. Now each misstep by a company is seen as a failure of its board and independent directors. Investors are quick to judge directors for their inability to rein-in strong CEO’s, for their failure to push back on high salaries, for their inability to hold-off on related party transactions. Independent directors face these and similar dilemma’s in each board meeting. Described as the hand that feeds syndrome, it cannot always easy to go against the person who invited them to join the board. But they must.

Compounding this is how the law is now being interpreted by the courts. Last November the Supreme Court restrained not just the promoters of Jaiprakash Associates, but the independent directors and their family members from transferring any personal assets or property without the court’s permission. Earlier this year, three independent directors on Nirav Modi’s firm - Sanjay Rishi, president of American Express for South Asia, Gautham Mukkavilli, a former PepsiCo India president and Suresh Senapaty, a former chief financial officer of Wipro - were restrained from freely accessing their bank accounts as part of an ongoing investigation by the ministry of corporate affairs. The real danger is that the lower and district courts now cite these as precedents to penalize independent directors. Only a thorough check of the promoters and the business before joining the board, can mitigate this risk – but not wholly.

How have independent directors dealt with being on boards and these changes? Drawing on Alberto Hirschman’s framework, they have always had three choices - exit, voice or loyalty. Till recently most chose to stay loyal. With the passage of the new companies act, we have seen a spate of exits from boards. Resignations, from a public shareholders perspective - specially from boards of beleaguered companies, is a suboptimal outcome. We have lately seen R Chandrashekar resign from Yes Bank and Vikram Mehta from the board of a Jetairways. Investors would rather they stay back and help companies navigate through troubled times. Board members need to factor this into their decisions but for them to do so, regulations need to draw a line between culpability of owner-managers and others on the board.

Regulations may now have pushed voice to the forefront: directors are articulating why they have left the board. We have seen two such instances in quick succession – Yes Bank and JM Financial ARC. Whether these are an aberration or the beginning of a new trend, we will know soon.

It is said that the best way to contribute on a board is to imagine you are the owner; but how does a director argue with someone who has skin in the game, when they themselves have no stake in the business? But clearly for directors to give their unqualified support has not been working? Look around and you will see that the corporate landscape is littered with failed companies and many more with anaemic performance. Expansions funded by debt, since promoters want to maintain their control. Acquisitions stapled through double leverage because promoters don’t have equity funds to bring in. A high salary for the family members, because they believe this is where the value is, and not in the market capitalization. Moving funds between group entities till the money is tunnelled-out. Auditors singing to the promoters tune till the absence of liquidity bares all. How can independent directors keep track of all these? Lawyers can no doubt draw-out a checklist to help directors steer through all this and more. But there is one thread that runs through all this and it is of promoters over-reaching themselves. This gives directors a pointer. Directors should task themselves with protecting the promoters from themselves1 (- and in professionally managed companies, managements from themselves). This alone will help directors earn the trust of the company, its stakeholders, the regulators and investors, and to play the part that they are elected to play.

A modified version of this blog appeared in Bloomberg Quint on 5 December 2018. This is the fourth in a series on Board failures. You can read the article by clicking on this link or typing the following url:

You can read the earlier pieces in the series, by clicking the links:

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