Sunday, April 26, 2020

The Security and Exchange Board of India (SEBI) has deferred the  date by which the top 500 listed companies are required to comply with regulation to separate the roles of the chairperson and the CEO from April 1, 2020 to April 1, 2022. The SEBI regulation requires that the non-executive chairperson and the CEO should not be related to each other as per the definition of relative in the Companies Act 2013. It is explained that SEBI has taken the decision to defer the applicability of the regulation in view of the demand from companies and to keep the compliance burden low in the wake of current economic scenario. 
When we see through the lens of agency theory, which assumes that the manager ignores the interest of the company  and enriches itself unless monitored, separation of the two roles -  chairperson and CEO makes sense, albeit theoretically.  Independent chairperson improves the oversight function of the board. The chairperson has clear authority to speak on behalf of the company and to manage the board meetings. Separation  mitigates the conflict of interest in the areas of performance evaluation, executive compensation, succession planning, and appointment of new directors. It  allows the CEO to focus on strategy implementation and organisational issues, as the responsibilities related to management oversight, board leadership and governance-related matters lie with the chairperson. Crafting strategy is the joint responsibility of the board and the CEO. 
When we see through the lens of the stewardship theory, which assumes that the manager is motivated to work in the interest of the company, separation of the two positions does not make sense. A manger, who is self-motivated to work in the interest of the company, does not required monitoring. On the other hand,  separation of the two roles results in losing the benefits of ‘unity of command’.
The U.K. Code of Corporate governance, which is a soft law (comply or explain) mandates that the same individual should not occupy both the positions. In U.S.A. there is no mandate to separate the roles of the chairperson and the CEO. However, more and more companies in U.S.A. are now separating the two roles. In 2005, in 30 per cent of the S&P 500 companies the role of chairperson and the CEO were split. In 2013, the percentage increased to 40 per cent and now it is 53 per cent. OECD Corporate Governance Fact Bok 2019 reports that out of 37 jurisdictions covered in the report, 30 per cent require separation, 30 percent do not require separation, 35 per cent recommend separation and 5 percent have incentive mechanism to induce separation. 
Research fails to provide conclusive evidence that the separation of the two roles improves performance. Research evidence suggests  that benefits and drawback of separation of the two roles are situation dependent and depend on array of factors. Two professors of Stanford University examined the leadership structure and the circumstances under  which they changed over a twenty-year period (1996-2015). Their sample consisted of 100 largest and 100 smallest of Fortune 1,000 companies (2016). They reported that most separations (78 per cent) occur during orderly succession when the former founder, CEO or other officer continuing to serve as chairperson temporarily or permanently. Research evidence suggest that the temporary separation provides stability.  The vast majority of cases of combining the two positions (91 per cent) involve an orderly succession at the top. In a nutshell, changes in the leadership involved orderly succession. In some cases, companies separated the two positions to address corporate governance failures under shareholders’ pressure. 
Indian family businesses dominate the corporate sector and will continue to drive the growth of the economy. Stewardship theory better explains the behaviour of the controlling shareholder (the family). Mandating family businesses to separate the chairperson and CEO positions is like forcing someone to take medicine without an ailment, ignoring the ill effect of the same. One complaint against family businesses is that the family expropriates the wealth of non-controlling shareholders through abusive related party transactions (RPT) etc. This has already been addressed under the current dispensation by making the audit committee responsible to approve RPTs.  Appointment of a lead independent director might be a better option than mandating separation of the positions of the chairperson and CEO.  If, companies are forced to separate the two positions, they will prefer to appoint the nominee of the controlling shareholder as the non-executive chairperson and an outsider as CEO, who will be subservient to the chairperson in the interest of the company and in his/her self-interest.  

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