Recent scandals at some of the world’s largest and most respected companies are seeing corporate governance back in the headlines and a hot topic of discussion in boardrooms. These events have massive and potentially long-term ramifications on the industry, regulation, the economy, society, shareholders and of course the company’s hapless employees, most of whom are not complicit in the events. These global occurrences though thousands of miles away are a wake up call for board members in India. Incidents that discredit the reputation here would put the spotlight squarely on the board as much as management.
The mandate to the directors under the Companies Act 2013 is clear:
“A director of the company shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in best interests of the company, its employees, the shareholders, the community and for the protection of the environment.”
Regulatory requirements in India are fairly prescriptive in their expectations of the board in terms of its composition, role, functioning, reporting and now even require performance evaluations of the board and its members. Board members will need to introspect and ask themselves some hard questions. Are they implementing the requirements of the Act in spirit or have these been turned into checklists and form-filling exercises? Are the real issues being discussed in board meetings and its committees or is the agenda set to ensure compliance? Is the conduct of the board adhered to or has it become a document that is nice to have?[i]
A classic case of implementing regulatory requirements in letter but not in spirit is the appointment of a woman director to the board. Companies have recruited close female relatives of the organisation’s leadership to comply. This may be a tick mark on introducing gender diversity but the impact of this action on the quality of governance is a bigger question.
Board members need to make sure that they are engaging with the management in a constructive and meaningful manner. The board should not just agree with or ‘recommend’ course corrections to management actions but should provide the management with the right challenge, inquiry and get the job done. Given the regulatory implications board members cannot adopt the stand–we were not told, so we could not respond. The simple response is did you make an honest effort to find out and what did you do about it? Board members need to ensure that they upgrade their skills, knowledge and awareness to discharge their responsibilities in an effective manner. For example, if you are a member of the risk management committee:
- Are you aware of the risks in your industry and comparable players? How does this compare to what is presented to you by the management?
- Do you really understand how risk management has been operationalised in the company? Is this just an exercise for you or has risk management been embedded in the business rhythm?
- How comfortable are you with the responses identified by the management, do these really address the risks? How do you obtain comfort on the quality and implementation of the risk responses?
- Do you have the right specialist skills in your committee? Have you ever consulted an independent expert?
- Have you independently engaged with the head of internal audit or the head of risk management?
The regulator is clear that they cannot rely solely on the management to govern the company effectively. The Companies Act 2013 requires the board of a listed company to have at least one-third of the total number of directors who are independent. The directors have been given the clear responsibility to keep the management in check and make sure that the company is being run in the right and ethical manner. Given the responsibility resting on their shoulders and consequences of the failure to perform their duties, directors need to act as per the spirit of the law–decisively, definitively and urgently.
An argument is made by the companies in the manner in which the Companies Act 2013 was enacted by the regulator which has forced their hands into complying in letter over substance. Companies were unhappy with the phased implementation and rules were notified with short lead times for implementation. Leading global practice is to give companies a year or two before actual implementation so they are able to understand what the requirements entail. The new requirements are onerous and require guidance and change the management both from the regulator to the companies; and the company to its staff, management and even board to ensure effective implementation. This has scope for improvement for all parties involved. For example, section 143 requires the auditor to report if the company has an adequate internal financial control system in place and comment on the operating effectiveness of such control was notified in August 2013, guidance on audit of internal financial controls over financial reporting was published in September 2015. Anyone who has gone through SOX knows what a massive effort it takes to comply. There is still no guidance on how directors will sign off on Internal Financial Controls (IFC) under section 134 and IFC is way broader than financial reporting controls.
So what should you as a director of a board need to ask yourself as you discharge your responsibilities?
- Do we know how we compare to leading boards and what we need to do to bridge the gap?
- Do we have the right team and skills in place? This is beyond merely complying with the composition requirements, for example do we have the right diversity of experience, specialists’ skills and complete as a group?
- Do we understand what our responsibilities are as a board and as members of individual committees?
- Are we spending enough time to deliver on our agenda?
- Is our agenda for individual meetings sharply defined to discuss the right things?
- Are there healthy discussions between members allowing for healthy dissent and informed decision making? If not, why is this not happening? What are we doing to deal with this?
- Do we get the right information and have access to experts to make informed decisions?
- Do we understand how the performance of the board and its committees will be evaluated? Is the current process right for our board? Will it allow for continuous improvement?
The questions can go on and there are many schools of thought, publications and points of view which will tell you what needs to be done. Ultimately, everything boils down to doing the right thing in intent, commitment and action.
Also, stay tuned to our EY EOY website for live coverage of our business awards on 11th Feb.