This article has been written by R M Vinod Kumar pursuing an Executive Certificate Course in Corporate Governance for Directors and CXOs from Skill Arbitrage.
This article has been edited and published by Shashwat Kaushik.
Table of Contents
Introduction
Corporate governance is characterised as the framework by which organisations are coordinated and controlled. As part of this corporate culture, directors are in charge of the administration of their organisations. Indian corporate entities prior to independence and almost four decades after independence were bound by colonial guidelines.
The concept of independent directors was conceived in the United States in the mid-20th century and popularised further in the United Kingdom in the 1990s. The reforms in corporate governance were initiated by the Chamber of Indian Industries in 1996 and in 2003, SEBI constituted a committee to study the role of independent directors in India.
Why independent directors
On a wider spectrum, large corporations and listed companies are characterised by the presence of a large controlling shareholder, while the rest of the shares are distributed among a wide range of smaller shareholders. These large controlling shareholders are either the promoters or their families and can have control over the board and the management. Many of the companies have a history of having family representatives in key senior managerial roles. A shareholder imbalance was found to have been created here.
As a result of this imbalance, mega scandals have rocked the corporate world and thereby led to soul searching in policy circles around the world, resulting in a consensus that large companies must be subject to Non-Management supervision, called non-management directors and later termed independent directors.
The independent directors are technically a part of the board of directors but are divorced from the internal workings of the management and expected to monitor the board with a sense of detachment. Having an independent director who sits in the same room as the senior managers but remains untouched by management dynamics will ensure management accountability and weed out boardroom corruption. It also brings an outside perspective to boardroom discussions.
Trends of independent directors
In the intricate landscape of corporate governance, independent directors play a prominent role. The expectations of an independent director have been evolving from being a watchdog in the boardroom to becoming a passive participant and adding value to the transformation of the company.
Independent directors have been shouldering the responsibility of upholding transparency, enforcing accountability and bringing ethical conduct to the companies. As the corporate landscape undergoes a transformation, the role of the independent director is deemed for a transition, symbolising a collective realisation that their expertise serves as a compass in steering the companies towards their transformation.
In today’s competitive world, companies have been focusing on excelling in every field and technology over their competitors by recalibrating their governance strategies. This has intensified the need for board members with excellence in governance, expertise, foresight and principled stewardship.
Independent directors are now looked upon as members with an intricate understanding of corporate laws and regulations, industry trends, market forces and global economic shifts. Their contributions extend to long term organisational success by participating in strategic planning, risk assessments, bolstering accounting controls, enhancing regulatory frameworks and ethical standards, and arising from the need to be part of various board committees.
Board committees
Board committees are generally formed to perform some expertise work, particularly to improve the board’s effectiveness and efficiency, in areas where more focused, specialised and technical discussions are required. In India, the Companies Act 2013 mandates the formation of key committees like:
- The Audit Committee;
- The Risk Management Committee;
- The Nomination and Remuneration Committee;
- The Corporate Social Responsibility Committee; and
- The Stakeholder relationship committee.
In the United States, the US stock exchanges have mandated three core committees – the audit, compensation and nominating governance committees.
As we see corporate boards evolve in response to changes in business environments,. Accordingly, the structure and responsibilities of the board committees evolve as the board adapts to changing priorities. Boards keep adding new committees or expanding the purview of the existing key committees to deepen their focus in areas such as talent, technology, sustainability, etc., and also to meet the different phases of their business.
A brief analysis of the structure and the committees in the board of NTPC (National Thermal Power Corporation), an Indian Central Public sector undertaking, reveals that the company had formed about seventeen board committees for ease of functioning of the board and the companies business. These Committees include (i) the audit committee; (ii) the corporate social responsibility and Sustainability committee; (iii) the stakeholder relationship committee; (iv) Risk Management Committee, (v) Nomination and remuneration committee, including PRP (vi) Contracts subcommittee; (vii) Committee of functional directors for contracts (viii) Project Subcommittee; (ix) Committee for allotment and post allotment activities of NTPC’s securities; (x) Committee for Vigilance Matters; (xi) Committee for Guidance Acquisition of Power Assets; (xii) Exchange Risk Management Committee; (xiii) Committee on Management Controls; (xiv) Committee of the Board for considering proposals having financial implications beyond the provisions of the contract. (xv) Committee for supervising Legal matters (xvi) Committee of directors on fuel Management, Development, and Operation of Coal blocks (xvii) Subcommittee of the Standing Committee of the Board regarding ensuring wholesome compliance with rules and regulations of the government of India
Changing landscape of board committees
Corporate boards continue to enhance their board committee structure based on the changing trend of the business environment and to address oversight of talent and culture, including diversity, equity and inclusion (DEI), environmental and social matters, cyber security and digital trust.
The analysis showed that the number of S&P 500 companies with a separate technology committee increased to 12% from 9% in 2019. The key responsibilities of this committee include innovation, strategy, transformation or investment. Similarly, the standalone corporate responsibility and sustainability committee saw a rise to 11% from 7% in 2019. The key responsibilities of this committee include a primary focus on environmental, social and governance (ESG) risks and opportunities.
Another approach the boards take to strengthen oversight is to broaden the purview of the existing core committees. In the above analysis of the S&P 500 companies, the audit committee has emerged as the primary committee overseeing cybersecurity. Beyond this, more audit committees are now overseeing other non-financial risks. Notably, the environment, ESG, sustainability and climate are now other topics being taken up by the audit committee in more than 13% of the S&P 500 companies.
Similarly, the analysis showed that the compensation committee embraces oversight of talent matters, which include talent recruitment, development and retention, workspace environment and culture, health and wellness, pay equity, employee engagement and external surveys.
The clarity around corporate governance now dwells on what the investors or stakeholders of the company would want to know. Accordingly, more focus is thrown on key subjects like:
- Environment
- ESG
- Sustainability
- Political
- Climate
- Social responsibility
- Technology Competence
- Agility and crisis management
- Shareholder activism and engagement
- Human Capital Management
Mandatory appointment of independent directors in India
The Companies Act, 2013, introduced a number of significant changes to the corporate governance landscape in India, one of the most important of which was the mandatory appointment of independent directors. Independent directors are those who are not related to the company, its promoters, or its management in any way. They are expected to bring an objective and independent perspective to the board of directors, and to act in the best interests of the company and its shareholders.
There are a number of reasons why the mandatory appointment of independent directors is a positive development. First, it helps to improve the quality of corporate governance in India. Independent directors are more likely to be objective and independent in their decision-making, and they are less likely to be influenced by personal or political considerations. This can lead to better decision-making and improved performance for the company.
Second, the mandatory appointment of independent directors helps to protect the interests of minority shareholders. Minority shareholders are often at a disadvantage when it comes to making their voices heard in the company. Independent directors can help to ensure that the interests of minority shareholders are taken into account in the decision-making process.
Third, the mandatory appointment of independent directors helps to promote transparency and accountability in Indian companies. Independent directors are more likely to ask tough questions and to hold management accountable for its actions. This can help to prevent corruption and mismanagement, and it can also help to improve the overall performance of the company.
The mandatory appointment of independent directors is a significant step forward for corporate governance in India. It is a positive development that is likely to have a number of benefits for companies, shareholders, and the economy as a whole.
Specific examples of the benefits of mandatory appointment of independent directors
The mandatory appointment of independent directors brings several benefits to a company, including:
Enhanced corporate governance:
- Independent directors provide an objective perspective, free from conflicts of interest, ensuring that decisions are made in the best interests of the company and its shareholders.
- They contribute to effective boardroom dynamics, fostering robust discussions and challenging management assumptions, leading to more informed decision-making.
Improved risk management:
- Independent directors bring diverse experiences and expertise, helping the board identify and mitigate potential risks.
- They strengthen the company’s risk oversight function, ensuring that management has adequate risk management systems and processes in place.
Increased investor confidence:
- The presence of independent directors signals to investors that the company is committed to transparency and accountability.
- It enhances the credibility of the company’s financial statements and other disclosures, attracting and retaining long-term investors.
Compliance with regulations:
- Many countries have regulations that require the appointment of independent directors.
- Compliance with these regulations ensures that the company is operating within the legal framework and avoids potential regulatory penalties.
Better access to capital:
- Lenders and investors are more likely to provide financing to companies with strong corporate governance practices, including the appointment of independent directors.
- This can lead to improved access to capital and lower costs of borrowing.
Enhanced stakeholder engagement:
- Independent directors can facilitate effective engagement with stakeholders, including shareholders, employees, customers, and suppliers.
- They help the company build trust and credibility with its stakeholders, leading to improved relationships and long-term sustainability.
- A study by the National Foundation for Corporate Governance (NFCG) found that companies with a higher proportion of independent directors on their boards have better financial performance.
- A study by the Institute of Chartered Accountants of India (ICAI) found that companies with a higher proportion of independent directors are less likely to be involved in corporate scandals.
- A study by the Securities and Exchange Board of India (SEBI) found that companies with a higher proportion of independent directors have higher levels of investor confidence.
Powers and duties of independent directors in corporate boards
Independent directors play a crucial role in corporate governance by providing objective oversight and guidance to the company’s management. Their powers and duties include:
- Overseeing the company’s strategic direction: Independent directors are responsible for reviewing and approving the company’s strategic plan, ensuring that it is in the best interests of all stakeholders. They provide input on major business decisions, such as mergers and acquisitions, and monitor the company’s performance against its strategic goals.
- Monitoring the company’s financial performance: Independent directors review the company’s financial statements and ensure that they are accurate and transparent. They also oversee the company’s internal controls and risk management policies, ensuring that the company is financially sound and compliant with all applicable laws and regulations.
- Assessing and managing risk: Independent directors are responsible for assessing and managing the company’s risks, including financial, operational, legal, and reputational risks. They ensure that the company has adequate risk management policies and procedures in place and that these policies are effectively implemented.
- Protecting the interests of minority shareholders: Independent directors represent the interests of minority shareholders, who may not have a significant voice in the company’s decision-making process. They ensure that the rights of minority shareholders are protected and that they receive fair treatment from the company’s management.
- Reviewing and approving major transactions: Independent directors review and approve major transactions, such as mergers, acquisitions, and divestitures. They ensure that these transactions are in the best interests of the company and its shareholders, and that they are conducted in a fair and transparent manner.
- Holding management accountable: Independent directors hold the company’s management accountable for its performance and conduct. They review the performance of the CEO and other senior executives, and provide feedback to the management on areas where improvement is needed. They also ensure that the company’s management is acting in accordance with ethical standards and applicable laws and regulations.
- Providing independent advice: Independent directors provide independent advice to the company’s management and board of directors. They offer a fresh perspective and challenge the management’s assumptions and decisions, helping to ensure that the company makes well-informed decisions.
- Promoting corporate social responsibility: Independent directors promote corporate social responsibility by ensuring that the company considers the interests of all stakeholders, including employees, customers, suppliers, and the community. They ensure that the company operates in a sustainable manner and that it is committed to ethical business practices.
By fulfilling these powers and duties, independent directors play a vital role in ensuring that companies are well-governed, transparent, and accountable to all stakeholders.
Conclusion
Board committees are the pillars of corporate governance. As the responsibilities of directors have become more demanding, boards have increasingly formed committees to deal with some of their more detailed work. Boards are more effective when they can delegate authority to well-run and well-functioning committees that have clarity on their roles and responsibilities. Committees play a critical role in allowing boards to meet evolving business needs and the changing environment relating to strategy, risk, talent, culture, technology and climate change. There is no fixed structure for the board committees; instead, they evolve based on the division of responsibilities and changing priorities and needs.
References
- https://www.scconline.com/blog/post/2019/11/13/evolution-of-corporate-governance-in-india/ https://www2.deloitte.com/content/dam/Deloitte/lu/Documents/risk/corporate-governance-trends.pdf
- https://www.icsi.edu/media/webmodules/companiesact2013/BOARD%20COMMITTEES.pdf
- https://www.ey.com/en_us/board-matters/
- https://www.ntpc.co.in/corporate-governance/Committees-of-the-Board
