Will SEBI Guidance Improve Board Evaluation?

The Companies Act 2013 and the Securities and Exchange Board of India’s (SEBI) (Listing Obligation and Disclosure Requirements) Regulation 2015 mandate Board evaluation, which is the evaluation of the functioning of the board of directors (hereafter Board), evaluation of the chairman, individual directors and the board process. Companies Act requires that every listed company and every other public company having a paid up share capital of twenty five crore rupees or more at the end of the preceding financial year shall include in Board report a statement indicating the manner in which annual Board evaluation has been made.

Board evaluation is an effective tool for improving Board performance. It is a kind of self-evaluation. Like any other knowledge group, the Board evaluates its performance periodically to identify areas for improvement and develop an action plan to improve the performance. Another objective of evaluating individual directors is to identify under-performing directors and to weed them out. A weak chairperson should also be removed.

In January 2017 SEBI has issued Guidance Note on Board Evaluation. The preamble says that the objective of the Guidance Note is to provide guidance to those listed companies, which do not have much clarity on the process of Board evaluation. Board evaluation is new in India, but it is decades old in USA, Europe and some other parts of the world. Literature on Board evaluation is easily available. Any company that is serious about Board evaluation can develop and implement the process by going through the available literature. Moreover, there are professionals who advise companies in developing and implementing the process of board evaluation. Therefore, the lack of clarity cannot be a reason for not implementing Board evaluation in the right spirit. Those companies that have not implemented Board evaluation in true spirit are not serious about it.

Board evaluation is meaningful only if the Board is empowered for doing what it is expected to do – to guide and advise the executive management (the CEO and his/her team), monitor it in order to protect the interest of non-controlling shareholders (also called minority shareholders) and facilitate net working with external resources. Board evaluation improves the performance of even those Boards, which focus on the advisory role rather than the monitoring role.

It is wrong to assume that every public company is motivated to develop and implement an effective Board evaluation process.

In family-managed companies the dominant shareholder monitors the executive management closely and does not require the Board to monitor it. In most of those companies, the dominant shareholder appoints and if necessary, removes the CEO, Key Management Personnel (KMP) and the members of the senior management team. The Nomination and Remuneration Committee (NRC) does not play any significant role in this regard, although the Companies Act has made NRC responsible for the same. Similarly, the NRC does not play any significant role in the appointment and removal of directors and in succession planning. NRC approves the decisions of the dominant shareholder. In those companies, the dominant shareholder takes strategic decisions, as he/she understands the business and its environment much better than independent directors and relies on his/her entrepreneurial spirit and business acumen, rather than on the collective wisdom of the Board. Minority shareholders expect the Board (read independent directors) to protect their interest from the opportunistic behaviour (e.g., tunneling of funds for self-enrichment) of the dominant shareholder. But in those companies, independent directors are not independent, as they are selected by the dominant shareholder and enjoy the office at his/her pleasure. The dominant shareholder does not want an effective monitoring by the Board.

In most family-managed businesses, the Board is an ornamental Board. The dominant shareholder selects independent directors from professionals drawn from diverse fields to add to the ornamental value of the Board. The Board discusses routine matters (e.g., performance evaluation) at great length, spends less time on important issues (e.g., strategic issues) and ultimately approves whatever proposal is presented before it. Ornamental Boards do not have an urge to improve performance. The dominant shareholder does not see any value in Board evaluation. The focus is on family governance and family values.

Some family businesses, which operate in a volatile, uncertain, complex and ambiguous (VUCA) business environment, or want to attract institutional investors and foreign capital, are motivated to adopt good corporate governance practices and build an effective Board. SEBI Guidance will help them to improve the Board evaluation process. Others will use it as a reference point just for preparing the disclosure in the Board report without implementing Board evaluation seriously.