Between 1991 and 2016, India’s listed companies increased their gross income 11times, their post-tax profits 25 times and their market cap 118 times.
By Rahul Bajaj & Omkar Goswami
The first corporate governance code for companies in India — ‘Desirable Corporate Governance: A Code’ — was released by the Confederation of Indian Industry (CII) in 1997, and won kudos from the press. One of us (Rahul Bajaj) chaired that task force; the other drafted the code. From 1998, some of the more progressive companies started to voluntarily adhere to the CII code.
Soon enough, the Securities and Exchange Board of India (Sebi) got into play. In 1999, a Sebi committee under Kumar Mangalam Birla drafted a code of corporate governance remarkably similar to the CII’s. In 2000, Sebi used this to introduce the first official corporate governance code through Clause 49 of the Listing Agreement. It was subsequently updated in 2005, based on recommendations of the NR Narayana Murthy Committee, in which one of us (Omkar Goswami) was a member.
Then came the ministry of corporate affairs (MCA). In 2009, it drafted a new Companies Bill. After active debates over different versions of the Bill, it was finally passed as the Companies Act, 2013 (CA 2013). The new law, while improving some areas of governance, also carried several draconian provisions and restrictions. In any event, it became the law of the land for Indian companies.
Thereafter, Sebi came out with a detailed Listing Obligations and Disclosure Requirements Regulations (LODR), 2015. Then, on October 5, 2017, the report of the Sebi Committee on Corporate Governance chaired by Uday Kotak was released. This article is about the Uday Kotak Committee. Before going further, we must state that we respect Kotak as a banker, a thinker and a corporate citizen of substance. Regrettably, we are constrained to criticise some key recommendations of the report.
We begin with a fundamental question. What were the particularly galling shortcomings in corporate governance in the Companies Act, 2013 and Sebi’s LODR that required yet another committee? If we compare our key governance requirements, as well as our accounting and financial disclosure standards with those of listed companies in Britain, the US, Australia, France, Germany and other OECD nations, we are in the top decile. Why, then, another committee?
Mismanagement
Do our regulators inherently distrust the promoters and directors? If that were so, it would be a terrible bias. Moreover, do they believe crafting a ‘perfect’ set of regulations that can invariably ensure that everything shall occur exactly in line with what is designed? That hasn’t happened anywhere in the world.
Now to some specifics
Our fundamental criticism relates to regulatory micro-management. Consider the following examples:
CA 2013 and LODR provide that a company must have a minimum of four board meetings every year and there cannot be a gap of more than 120 days between two consecutive meetings. There is a clear rationale for four — one after each of the first three quarters, followed by one for the annual accounts. Why should the Kotak Committee micro-manage to recommend five? Parenthetically, the authors serve on boards that have more meetings, ranging from five to eight. But that’s the choice of the boards.
Micro-managing doesn’t stop here. The Kotak Committee recommends what topics should be discussed at the board, such as strategy, succession planning, risk management, environment, sustainability and governance. Good boards discuss all of these subjects at length. Bad boards don’t. But what purpose does this serve, other than to have companies make a meaningless disclosure in their annual reports that these have been indeed discussed?
The Kotak Committee recommends that a listed company must disclose the competencies of its board members in a matrix form vis-àvis every identified competency/expertise the company or the sector might need. The outcome: in over 90% of the cases, it will be the preparation of a useless matrix, with form dominating substance.
Annual board evaluations are prescribed by CA 2013 as well LODR. The Kotak Committee goes further and recommends that all listed entities disclose observations of board evaluation of the year and proposed actions to be taken; and the previous year iss observations and what actions were taken. Does the committee believe that such a recommendation will enhance the substance of corporate governance? Or cause another mandated ticking of a check-list?
Here is another insufficiently thought out recommendation: for listed entities where public shareholding is at least 40% of the voting stock (and for all listed companies from 1 April, 2022), the chairperson must be a non-executive director.
Corporate Governance
Forms of corporate governance vary across regions. In Britain and much of Western Europe, chairs of listed companies are independent directors. Not so in the US, where the chairman is often the CEO. There is little hard evidence to suggest that one works better than the other. This recommendation serves no real governance purpose, and confuses a preferred form in some geographies for universally relevant substance.
Consider the recommendation relating to disclosures on long- and medium-term corporate strategy. The Kotak Committee suggests there be a guidance to listed entities to disclose their medium- and long-term strategy in their annual reports under Management Discussion and Analysis, and also articulate a clear set of long-term metrics specific to the company’s strategy to allow for appropriate measurement of progress. Which company will discuss its real corporate strategy at any level of detail in the annual report, all for the benefit of its competitors?
Increasing the minimum number of audit committee (AC) meetings from four to five is, again, micro-management. Some listed companies have five AC meetings; banks and nonbanking financial companies (NBFCs) have more. But that is the choice of the AC and the board. Should we now expect Sebi to promulgate the number of hours that must be spent for each AC meeting?
Regulatory Overkill
There are other such instances of micro-management. Let us end with two observations. The first is that the outcome is a mixed bag with some good and many bad recommendations. The good in the Kotak Committee has been regrettably overwhelmed by the bad — resulting in even the ministries of corporate affairs and of finance critiquing various recommendations.
Our second observation is more serious. The Satyam scandal created a milieu for putting in severe measures in CA 2013. Sebi probably wants to demonstrate it can do even better. This unrelenting process of competitive State interference in the working of corporates is a dangerous trend that has been intensifying over the last few years.
We don’t want to return to the control and permit raj. We need corporate development, not an increasing burden of controls.
Between 1991 and 2016, India’s listed companies increased their gross income 11times, their post-tax profits 25 times and their market cap 118 times. If this government truly believes in ‘ease of doing business’, should it asphyxiate the goose laying the golden egg with reams of paper for making meaningless disclosures that lay primacy to form over substance?
Instead of catching and punishing those promoters and directors who are guilty of wrongdoing, does Sebi want to make doing business more difficult for all companies and hurt their competitiveness through regulatory overkill? Surely, the Kotak Committee did not intend this.
(Bajaj is Chairman, Bajaj Auto. Goswami is Chairman, CERG Advisory)
(19 November 2017)
