Boards should Focus on Disclosures and Auditors’ Independence

When, in the recent quarter, performance of Infosys failed to meet the market expectations, the media reported it as the first failure of Vishal Sikka, who is the CEO of the company. The media gives total credit for the consistently excellent performance of ITC to Yogi Deveswar, who is the Chairman and CEO of the company for quite a long time. Cyrus P Mistry had revised the strategy of the Tata Group, when he took over as the chairman of the Group. It is obvious that the media and the market believe, and rightly so, that the Board does not contribute significantly in the performance of the company. The leadership qualities and managerial capabilities of the CEO (and his team) determine the performance. In case of companies, where the controlling shareholder runs the company directly or through its nominee, the performance of the company reflects the quality of decision-making by the controlling shareholder. The board of directors (Board) gives free hand to the CEO to manage the company not only because it is right to do so, also because independent directors’ understanding of the business is not adequate to give directions to the CEO. Therefore, in ‘good times’, the Board plays the game to give a semblance of some serious boardroom deliberations on strategy and other critical issues. Of course, competent directors provide some valuable inputs. When, product/service-market performance of the company shows continuous decline, the Board asks certain persuasive questions, to the best of its capabilities. Even in those situations, solutions come from an external consultancy firm appointed by the management or from the management itself. The Board adds some value while deliberating alternative solutions, only if the Board is diversified and capable. Although, the Board remains passive, without intensive engagement with the CEO, when the going is good, it is worth building a diversified and capable Board, which can provide support to the CEO when needed. And in a crisis situation, advantage of collective wisdom can be obtained.

As the he Board gives freehand to the CEO, it is expected to play an important role in the selection of the CEO and his/her team. In this regards, the role of the Nomination and Remuneration Committee (N&RC) of the Board cannot be overemphasised. The Companies Act requires that every listed company, every public company with paid up capital of ten crore rupees or more or turnover of one hundred crore rupees or more and every public company having, in aggregate, outstanding loans, or borrowings, or debentures, or deposits exceeding fifty crore rupees shall constitute a N&RC. The committee consists of at least three non-executive directors, out of which not less than one-half should be independent directors. N&RC has the responsibility of identifying persons who are qualified to become directors and who may be appointed in Senior Management. It is also responsible for developing remuneration policy for directors, key managerial personnel (KPM) and other employees. SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 further requires, among others, that the Committee should devise a policy to diversify the Board. Unfortunately, companies, except some large and good companies, have adopted the tick-box approach in complying with provisions related to N&RC.  Therefore, in practice, engagement of N&RC, and consequently the Board, in the selection and appointment of directors, CEO, KMPs and employees in the Senior Management is minimal.

In practice, the Board does not have substantive involvement either in people management or in the formulation and implementation of strategy. Therefore, it should allocate its time to corporate governance issues, rather than spending more time to review strategy and performance in appearance only.

Investors and other stakeholders are not so much concerned about what is happening within the Board. In any case, that is unobservable. They evaluate the quality of corporate governance by catching signals and symptoms. For example, they evaluate the level of transparency accountability and equity adopted by the management; quality of family governance (e.g., dispute resolution and succession planning); leadership quality of the CEO and the leadership pool within the company; legal proceedings against the company; qualifications in the audit report; relationships between the CEO, promoter and the Board; relationships of the management with stakeholders; reported management fraud; and company’s resilience to quickly respond to the changes in the business environment. Boards should focus on those issues.

Unfortunately, Boards do not pay the desired attention to the quality and level of disclosures in various internal and external documents; and independence of statutory auditor and internal auditor. Boards are required to shift the focus.