Board Effectiveness - Issues and Challenges

 

 A.  Management and Board Governance

 The Board of Directors has to exercise strategic oversight over business operations while directly measuring and rewarding management’s performance. Simultaneously the Board has to ensure compliance with the legal framework, integrity of financial accounting and reporting systems and credibility in the eyes of the stakeholders through proper and timely disclosures.

2. Board’s responsibilities inherently demand the exercise of judgment. Therefore the Board necessarily has to be vested with a reasonable level of discretion. While corporate governance may comprise of both legal and behavioral norms, no written set of rules or laws can contemplate every situation that a director or the board collectively may find itself in. Besides, existence of written norms in itself cannot prevent a director from abusing his position while going through the motions of proper deliberation prescribed by written norms. Therefore behavioural norms that include informed and deliberative decision making, division of authority, monitoring of management and even handed performance of duties owed to the company as well as the shareholders are equally important.

3. However in a situation where companies have grown in size and have large public interest potential, it is important to prescribe an appropriate basic framework that needs to be complied with by all companies without sacrificing the basic requirement of allowing exercise of discretion and business judgment in the interest of the company and the stakeholders. The liability of compliance has to be seen in context of the common law framework prevalent in the country along with a wide variety of ownership structures including family run or controlled or otherwise closely held companies.

B. Board of Directors

4. Obligation to constitute a Board of Directors :- 4.1 The Board of Directors of a company is central to its decision making and governance process. Its liability to ensure compliance with the law underpins the corporate governance structure in a company, the aspirations of the promoters and the rights of stakeholders, all of which get articulated through the actions of the Board. There should be an obligation on the part of a Company to constitute and maintain a Board of Directors as per the provisions of the law and to disclose particulars of the Directors so appointed in the public domain through statutory filing of information. 4.2 Such obligation should extend to the accuracy of the information and its being updated regularly as well as on occurrence of specific events such as appointment, resignation, removal or any change in prescribed particulars of Directors.

The objective of appointment of Independent Directors are

1.      Independent functioning of the board

2.      Protect interest of minority shareholders and stakeholders

3.      Independent monitoring of the performance of the company

4.      Enhance the quality of Corporate Governance

The achievement of these objective poses several challenges The TopTen Issues in Corporate Governance Practices in India are as follows:

·         Getting the Board Right. 

·         Performance Evaluation of Directors.

·         True Independence of Directors.

·         Removal of Independent Directors. 

·         Accountability to Stakeholders. 

·         Executive Compensation. 

·         Founders' Control and Succession Planning. 

·         Risk Management.

·         Privacy and Data Protection

·         Board's Approach to Corporate Social Responsibility (CSR)

 

With the efforts made by regulators to avoid another Satyam incident through the introduction of various reforms, the challenges for India remain in implementation and enforcement. For the companies, they need to follow corporate governance practices not just in letter but also in spirit. Board evaluation will need to be taken seriously and the recommendations be looked at as areas for improvement rather than as criticism. In other words, make it a constructive process. Efforts should be made to avoid it being just a box-ticking exercise, especially regarding performance of independent directors, who need to be more aware of their role. Ensure that the process is value-accretive and provides strategic guidance; ensure that it is seeking to identify areas that will genuinely enhance the Board’s performance collectively and the effective contributions of its directors individually. It should not be used as a witch hunt.

Shri M. Venkaiah Naidu, Honourable Vice President of India at the gathering after presenting Mints Corporate Strategy Awards, in Mumbai on March 23, 2018 put forth what is known as  SWEET PHILOSOPHY.

This means Segregation of ownership and control, Wealth creation of which profits will be a by- product, Efficiency of decision-making and resource use , Ethical & Environmental commitments and also Transparency through accountability

Listed companies thrive on a vast pool of hope and trust of the large number of shareholders. All the shareholders need to be treated fairly and equally without any discrimination. The well-being of the society depends upon creation of wealth for larger benefit than on the profit concerns of a privileged few.

Higher corporate governance standards need to be propelled by the larger ethical and environmental concerns as well. Climate change has emerged as a major concern which we cannot afford to ignore. Every investment decision sets in certain processes with demonstrated impact on the climate. So, environmental audit of corporate decisions is essential.

In our country, transparency and accountability in all matters of governance, including corporate governance need to be accorded top priority for ensuring credibility and enhancing the confidence of all the stakeholders including the shareholders. This applies more to constitution of Boards of Directors, performance evaluation of Directors, ensuring independence of Directors, compensation for Executives, succession planning, appointment and rotation of external auditors, putting in place a whistle blowing mechanism, etc., which are critical for effective corporate governance.

Corporate Social Responsibility (CSR) norm is a laudable initiative which India proudly shares with only a few other countries. This underpins the responsibility of corporations towards the larger society and this needs to be effectively executed on ground.

More innovative firms now include a diverse range of individuals, who work in collaboration with the firm’s CEO and other senior managers, to develop new business strategies. Directors help the firm to stay relevant by including diverse perspectives that are directly relevant to the company. A more collaborative model of the relationship between board and senior management (and the companies’ investors) ensures that these perspectives are incorporated into the decision-making processes in ways that can add genuine value to a firm’s business operations. 

 

It is in this context that policymakers and regulators seek to better understand the factors that impact the effectiveness of boards. So far, however, the discussion has focused on a number of legal formalities and requirements, including gender balance, optimal board size, remuneration, and the role of the chair of the board. 

 Recently Board Evaluation and Evaluation Processes have been added to the list. In particular, many boards have recognised the importance of frequent evaluations and assessments of their performance. This has resulted in more attention to board evaluations in both rules-based, as well as in principles based jurisdictions. For example, the G20/OECD Principles recommend inclusion of regular board evaluations in a country’s corporate governance framework. The New Paradigm recommends that the board of directors evaluate its own performance, as well as assessing the performance of its directors and board committees.

The Board Effectiveness in India

The Companies Act 2013 requires listed companies and public companies with paid-up share capital exceeding 250 million rupees, to disclose the manner in which formal annual evaluation has been undertaken of the performance of the board, the committees constituted by the board and individual directors in the board’s report.

The NRC and the IDs have been made responsible for carrying out the evaluation of each director’s performance; however, the Companies Act does not provide for the mode, manner and process to be followed for such evaluation.

The Listing Regulations additionally require the board of listed companies to undertake an evaluation of the performance of the IDs on the board. Such evaluation shall include the performance of the directors and fulfilment of the independence criteria as specified in the Listing Regulations and their independence from the management. The entire board is required to participate in the evaluation of each ID, except for the individual ID being evaluated.

The NRC of listed companies has been tasked with formulating the criteria for evaluating the performance of IDs, as well as the board as a whole, and the evaluation criteria are to be disclosed by the company in its annual report. The board of listed companies is requiredto monitor and review the evaluation framework for the board.

The Securities and Exchange Board of India issued a guidance note in January 2017 to guide listed entities on various aspects of board evaluation. Further, the Institute of Company Secretaries of India published a ‘Guide to Board Evaluation’ in June 2017 to provide guidance to companies on how to evaluate the performance of its board with suggested parameters and sample models for evaluation.

 

India has moved to the forefront of this governance challenge with its new Companies Act of 2013, which states that the Board of every listed company and other public companies with paid-up capital of Rs 25 crore or more (approximately US$ 4 million) shall report the annual performance evaluation of individual directors, the Board and its committees

Amendments made by the Securities and Exchange Board of India (SEBI) to Clauses 35B and 49 of the Equity Listing Agreement issued in April 2014 mention “Monitoring and reviewing Board Evaluation framework” as a key function of the Board

The Companies Act, 2013, has introduced norms on board diversity, independence and tenure of independent directors. The aim is to make Indian boards richer in skills, experience and expertise for effective governance. The Act mandates all listed companies to appoint at least one woman director on their board.

 The two specific issues related to board composition and structure:

 • Professionalism and workload of independent directors It is surprising to read that 95% of independent directors report that their letter of appointment does not mention the workload expected from them. Also on average an independent director commits less than nine days per year to board work. This compares very unfavorably with recent research results by McKinsey that identified the average work commitment in top international companies at 40 days!2 If Indian companies are to expect higher levels of professionalism from their boards, surely the input from directors needs to increase substantially

• Board diversity Around the world, the diversity of boards is becoming increasingly valued as a mechanism for challenging ’group think’ and stimulating innovation in strategies. The Companies Act requiring a woman on every board is a welcome step towards achieving greater diversity

In India, the Companies Act, 2013 laid down greater emphasis on good governance through the boards, board processes and enhancing board’s effectiveness, and performance evaluation is one of them.

The performance evaluation is a qualitative factor certainly facilitates transition from good to great boards which if implemented in true letter and spirit would definitely take good governance in India to greater heights.

In April 2015, the Institute of Company Secretaries of India (ICSI) released A Guide to Board Evaluation based on the provisions of the Companies Act, 2013 and related best corporate practices.

The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 which came into existence later in 2015, also contains detailed provisions on board evaluation.

In the year 2017, the SEBI has released a Guidance Note on Board Evaluation, considering all these developments, this publication is being revised. To facilitate the board performance evaluation, the Institute has brought out this revised publication. This publication discusses the need and importance of board evaluation, international trends, legal framework in India, methodologies, steps involved, post-evaluation activities and barriers to board evaluation.

It also contains the Parameters and Sample models for evaluation of Chairperson, Managing Director, Executive Director, Non-executive director, Independent Director, Board as whole and the Committees and also provides guidance on how to conduct evaluation of Board.

Board Effectiveness-Issues and Challenges

One reason for Board’s ineffectiveness is that corporate governance has been overly focused on regulatory design of “checks-and-balances” in listed companies, rather than on the equally important issue of how governance structures can add strategic value to a firm.

In the conventional checks-and-balances model, authority and empowerment flows from the shareholders (the legal and moral owners of a company), through the board of directors/supervisory board, to management, and eventually, staff. Corporate governance mechanisms, which initially targeted executives, were intended to curtail agency problems, notably those that arise between potentially self-interested management and investors.

Policymakers emphasised that the monitoring and oversight role of “independent” or “outside” directors is crucial in maximising shareholder wealth and preventing self-interested transactions. In countries with controlling shareholders, which is common in Europe and Asia, board members are also expected to protect the interests of “minority investors” and other stakeholders in the company. This is necessary because controlling shareholders may engage in self-interested transactions. 

Following the 2008 global financial crisis, a predominantly independent board was considered essential to serve as a necessary and dynamic “wedge” between the company and its insiders, on the one hand, and the capital market and the short-term investors on the other. Such an arrangement reduced the three-way agency problems between executive managers and the varying types of investors and stakeholders.

 

There was a widespread view that the board of directors should be insulated from shareholder influence and interventions. Board independence was deemed necessary to offer resistance to the short-term mentality that prevailed (and often still prevails) in the investor community and capital markets.

Board directors handle a difficult set of responsibilities — needing to remain loyal to a business and ensure that it’s performing for stakeholders, while not exercising direct control over the business's functions.

Still, despite greater emphasis on the long-term prospects of a company, the dominant view has been to treat the board as a supervisor/monitor of senior managers. Consequently, the board of directors tends to focus on the control of management behavior and monitoring of the company’s past performance and sustainability. 

 Also, many companies, as well as their investors, now recognise that the “monitoring” role is no longer sufficient and constitutes a missed opportunity.

While every board will face its own unique set of circumstances, there are some obstacles that almost every director will need to handle during their time on a business or nonprofit board.

Here are 5 challenges commonly faced by board directors and how they can be overcome by any organization.

·         Guiding business communication. ...

·         Balancing risk and opportunity. ...

·         Following board duties. ...

·         Managing board-CEO communication. ...

·         Shareholder activism.

In a survey by McKinsey (2015) of Boards around the world, it was revealed that of the 772 directors surveyed only 34% indicated that they “fully comprehended” their companies’ strategies. Even more alarming was the indication that only 22% stated their Boards were “completely aware” of how their firms created value and an even fewer 16% of the directors surveyed indicated that their Boards had a “strong understanding” of the dynamics of their firms’ industries [Where Boards Fall Short, Dominic Barton and Mark Wiseman, Harvard Business Review, January 2015].

The Companies Act of 2013 mandates that the code of conduct for independentdirectors include: “Bring an objective view in the evaluation of the performance of Board and management.

Board’s leadershipculture, the tone at the top, is an essential feature of an effective assessment process. Board evaluation is driven by the values and performance expectations of senior leaders in Tata Group, Infosys and other well-known Indian companies.

The survey report (2016)  from Forbes Insight, in association with KPMG finds a number of key current and ongoing governance challenges faced by organisations. The biggest issue is found to be ‘risk management and oversight’, cited by 28% of respondents. ‘Assessing innovation and emerging competition’ comes in second, also at 28% - however, this category is particularly an issue for $1 billion plus organisations, at 34%, while in the size category down 23% cite it as an issue. The third most cited issue is ‘confirming/establishing company strategy’, which is cited, on average, by 23% of organisations – in this category it is particularly boards of smaller organisations that face this challenge, at 29%. 

The areas of least concern to the board members surveyed are ‘divided ownership group’ at 10%, ‘overreliance on management’s information’, at 13%, and ‘director time and workload’ at 16%. ‘Board effectiveness’ is cited as an issue by 17% of responding directors.

 

The key area of challenge is in ‘budget/resource constraint’, at 36%. The second biggest area of concern was found to be ‘conflicts of interest/related party transactions’, at 28% - although this was considerably higher at financial services firms (41%) and organisations of $1 billion and up (39%). The phenomenon of ‘overrepresentation of controlling shareholders’ came in third equal (25%) with ‘board serves in advisory capacity only’.

Of least concern to the executives that participated, at 19% and 21% respectively, are ‘lack of formal structure’ and ‘underutilisation of third-party resources/research’.