Institutional EYE

Commentary on Corporate Governance Issues

The elephant in the boardroom

December 4, 2019

India Inc needs to fight the real elephant in the boardroom:  the requirement that the chairman and managing director not being related. Regulations, in doing so is forcing families to make choices that they are not quite prepared to make - chairman versus managing director and choosing between different family members.

 

A few week ago, FICCI, an industry body, wrote to the Finance Minister, asking her to reconsider the decision to separate the role of the chairman and managing director/CEO for companies. This separation was bound to be contentious from when it was first mooted as it demanded not just separation, but that the chairman and MD/CEO not be related. What surprises is that it has taken two years for industry to formally raise this issue, given that this is the one topic that has been on everyone’s mind.

 

What has SEBI said and why

The CG Voluntary Guidelines issued by the Ministry of Corporate Affairs, had mooted this separation between the role of the chairman and the CEO of a company in 2009. This was immediately buried, till it was resuscitated by the  Report of the Committee on Corporate Governance aka the Kotak Committee in October 2017.

 

The Kotak Committee proposed that listed entities with more than 40% public shareholding should separate the roles of Chairperson and MD/CEO (with effect from April 1, 2020). And if this had merit, it was be extended to all listed companies in 2022.

 

The report saw the role of the chairman as the leader of the board, and that of the CEO a leader of the management. Separating the roles provides for a “more balanced governance structure by enabling better and more effective supervision of the management” since the separation will enable the board to act independently. It eliminates conflicts in performance evaluation thereby paving the way for fairer executive compensation. It allowed the CEO to concentrate on strategy, execution and the day-to-day running of business. This greater role clarity was seen as a way of ensuring that boards tasks are not neglected due to lack of time. Importantly this was also as a way of reducing excessive concentration of authority in a single individual.

 

The Kotak Committee report was placed for public comments, and when SEBI’s board met on 27 March 2018, they proposed that ‘separation may be initially made applicable to the top 100 listed entities (by market capitalization) w.e.f. April 1, 2019. Further, in such entities, Chairperson and MD/CEO should not be related to each other in terms of the definition of “relative” as defined under the Companies Act, 2013.’ When this was  notified in May 2018, it was extended to the top 500 companies.

 

The pushback

FICCI in its letter to the finance minister, referred to above, has argued that India is ‘different’ given the family ownership of business from the largest to the smallest corner grocery store. They highlight the role of the family and family patriarch in the Indian ethos. And finally, that Indian family business has shown stronger top-line growth than non-family business – citing global research to bolster this claim.

 

Given that such separation takes away from efficiency in decision making (- takes away from a unified chain of command), the letter states that there is no evidence of separation leading to better governance (- true) or better financial performance (- also true).

 

It goes on to argue, whether to separate the two roles or combine them, whether the chairman should be executive or non-executive are decisions that are best left to the company’s and its shareholders. There are, ofcourse, safeguards that are already in place: the provision of having 50% independent directors, when the chair is executive is one example. And finally, there are less disruptive idea’s like a lead-independent director if the role of the chairman and CEO are combined.

 

How many companies are impacted?

FICCI is battling a trend. Addressing media on 20 November, SEBI’s chairman said that only about a third of the companies still need to separate the two roles – implying that companies, for the most have begun acting on this.  This is in line with data Russell Reynolds/Prime database/Conference Board have, showing that 345 of the 500 companies have this separation. The data is not explicit in whether the separation excludes executive chairman or ‘relatives,’ even so, it suggests that the issue is not as widespread as it is being made out – atleast not for the top 500, by number.

 

This data is no different from what we see in other geographies. More than 90% of the Stoxx Europe companies have separated the two roles. In UK this split is for all practical purposes, mandatory. Even in the US, which for the longest have seen no merit in this, is changing. A recent article in WSJ finds that as of October 2019, there were 266 companies, or 53%, in the S&P 500 index that have definitively split the two roles, according to a recent article in WSJ, up from 35% in 2009.

 

What now

India Inc needs to fight the real elephant in the boardroom:  the requirement that the chairman and managing director not being related  The regulation, in doing so is forcing families to make choices that they are not quite prepared to make – choosing a role: chairman versus managing director and choosing between different family members. Families must articulate what is the causing them anxiety. Perhaps then, the regulators can help them arrive at a workable solution. Riling against separation per se, is regurgitating yesterday’s debate.

 

To read the full report click Here

 

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