On the road to effective Board evaluations in India

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By Mathew John – Board Practice, Amrop India

 

 

 

The corporate governance story in India over the last two decades has been one of promise, path-breaking initiatives and occasional heartbreak.

On the regulatory front, governance reforms are taking place at a breakneck speed. The most recent tend to display greater focus towards instituting checks and balances that are designed to enhance overall company governance structures and addressing the agency problem prevalent in India. That is characterised by the omnipresence of promoter-run, promoted-owned companies in both the listed and the unlisted space (i.e. potential conflict between promoters and minority shareholders). While this is certainly a cause for celebration and optimism, the frequency of governance failures and instances of fraud continue to be status quo with major institutions like the Punjab National Bank (PNB) and Infrastructure Leasing and Financial Services Limited (IL&FS) leading the race to the bottom in 2019.[1]

In this context, board evaluations are seen as an important element in a firm’s strategy for improving the quality of its top-level decision-making and for developing its operations. Over the last few years, the Indian regulatory environment has transitioned from merely encouraging voluntary adoption of evaluation of the board of directors of a listed company to a regime that strongly mandates listed and public entities (with paid-up capital of INR 250million or more) to undertake periodic evaluations of the board and its various committees. While the intent behind mandating periodic evaluations is commendable, the actual implementation is fraught with many challenges.

How evaluations contribute to board effectiveness

Spurred on by waves of technological disruptions and corporate crises across the globe, reforming governance structures, including novel ideas on improving the performance and effectiveness of boards, now takes centre stage in academic and professional discourse focussing on corporate governance. Strengthening board effectiveness is a high priority for many leading companies and their shareholders. Consequently, it is no longer sufficient to have directors who are only ‘good enough’.

Globally, corporate boards conduct regular evaluations to assess their strengths and weaknesses, with the objective of building high-performing boards capable of anticipating and overcoming the challenges ahead. Well-structured evaluation processes provide an important conduit for reform as companies require new skills, perspectives and strategies over time. For this reason, evaluation of board behaviour, effectiveness and its disclosure are increasingly being regarded by investors as a key opportunity to enhance shareholder value.

An OECD study published in 2018 notes that boards in countries with more detailed principles and guidance adopt a ‘more substantive and accessible board evaluation practice than their peers in jurisdictions with little or no detailed requirements’.[2] The jury is still out on whether or not evaluations mandated by legislation are actually effective in encouraging companies to move beyond a ‘box-ticking’ compliance exercise. It goes without saying that meeting compliance standards is not the single qualifying criteria determining board effectiveness. An effective board is characterised by having the right skill diversity in composition and an innate desire among members to work together to improve the quality of decision-making to ensure equitable benefits to all stakeholders.

In many leading companies, robust board evaluation and honest undertaking of consequent remedial measures often turn out to be the key ingredients that enable the transformation of a good board into an effective board.

Board evaluations in the Indian context

Unlike the US or the UK, board evaluation in India is still an emergent concept. It was only in April 2014, with the enactment of the Companies Act 2013 and the SEBI Listing Obligations and Disclosure Requirements Regulations, 2015 (SEBI LODR) that India mandated periodic evaluations for the board of directors of listed entities and its various committees. However, diving deep into the mechanics of mandated evaluations reveal a tangled mess.

Section 178(2) of the Companies Act 2013 necessitates the boards of directors of listed entities to form a nomination and remuneration committee (NRC), which is tasked with establishing criteria; and, finally, making for the evaluation of performance of independent directors and the board of directors; carrying out these evaluations based on the established criteria and finally; making the determination to continue or revise the term of appointment of the independent director based on each of their assessment reports.[3] Meanwhile, Schedule IV of the Act requires review of the board and the chairperson to be done in a ‘separate meeting’ of independent directors without the attendance of other board members. In the same breath, Schedule IV also stipulates that the performance of each director is to be evaluated by the board.

So finally, the question arises: who is really supposed to conduct the evaluations?

When it comes to the practice of board evaluations, in a study conducted by one of the three proxy advisory firms in India, it became fairly apparent that very few Indian companies recognise the value of conducting credible evaluations beyond fulfilling compliance obligations.[4] Since the first iteration of the mandatory evaluation exercise issued in March 2015, many companies are content to follow oversimplified processes to conduct evaluations and the range of compliance varies wildly between them.[5] Evaluations are being conducted in an arbitrary manner with some companies relying on questionnaires with Likert style rating scales, some relying on one-to-one interviews and peer reviews and others relying on in-house processes and/or external consultants.

While the main goal of any review process is to identify areas for improvement that can potentially improve board effectiveness, the fact remains that almost no Indian company discloses areas for improvement flagged by the board during the evaluation process. In an attempt to address these issues, in January 2017, the Securities and Exchange Board of India (SEBI) released a ‘guidance note’ with the objective of providing clear directions to listed entities on the various aspects and nuances involved in the evaluation process.[6]

The SEBI note says that in addition to the aforementioned statutory requirements, listed companies can voluntarily opt to provide additional disclosures, including the outcome of the evaluation, actions taken, and current status of the outcomes that require engaging various stakeholders. For SEBI, the guidance note is a departure from the standard practice of establishing norms and procedures to one that recognises the need for encouraging a board culture that fulfils its perceived moral obligations towards all stakeholders.

“It goes without saying that success of any evaluation exercise is contingent on ensuring feedback is given to all those who have been evaluated”

While it remains a truism that adherence to the ‘guidance note’ is not mandatory, it would be difficult for companies to claim good corporate governance performance without it. Ongoing reforms in India prove that the quality of performance of Board of Directors in India is under greater scrutiny than ever before. They are a response to the growing importance of effective Board evaluations internationally as a key instrument for assessing board effectiveness and efficiency.

Way forward

With the board rising in prominence as a key determinant of a company’s destiny, it is all the more important that it should be dispassionately assessed. Evaluation is to be a formal, closed-door, comprehensive process which considers all issues faced by the board, including the hard ones. When measuring performance, it must be in the context of alignment with strategic objectives of the company and fiscal performance without compromising the principles of stakeholder democracy. A good evaluation exercise is also underpinned by its nuanced understanding of the social dynamics of board interactions and, as David Nadler reflects in the May 2004 issue of the Harvard Business Review, ‘in the competence, integrity, and constructive involvement of individual directors’.[7]

Just as a robust evaluation exercise can contribute to strengthening board effectiveness, poor evaluations can lead to governance failures. Reluctance of board members to accept their shortcomings when highlighted should not result in the board shying away from working on areas for improvement in the interest of preserving any collegial atmosphere within. An external evaluator in this context can be very useful in facilitating an honest, objective assessment in terms of board roles, dynamics and individual performance. Following a clear articulation of the objectives and scope of the exercise, and a careful selection of parameters and tools used for evaluation, external consultants can also be leveraged to drive the process of adequately apprising the board before the implementation phase itself.

Once the board evaluation process reaches its conclusion, any specific recommendations for implementation should be brought up. It goes without saying that success of any evaluation exercise is contingent on ensuring feedback is given to all those who have been evaluated.

Sustainable evaluations

At Amrop, our global board practice in concert with leading academicians and industry practitioners has developed a robust ‘3-phase’ process that goes beyond a cursory compliance exercise. The process achieves this by holistically assessing all aspects influencing board effectiveness in the 21st Century, ranging from composition and individual board members’ contributions and results, to ethical conduct, sustainability and stakeholder communications.

GETTING THE RIGHT ANALYSIS – Evaluations done poorly will lead to governance failures

In the Summer 2019 edition of Ethical Boardroom, Andrew Woodburn, managing partner at Amrop South Africa, recommended a ‘Multi-year Sustainable Evaluation Programme’ approach designed to generate actionable insights on the key determinants of board effectiveness over the short, medium and long term.[8] Rather than following a specific template of evaluation every year to meet compliances, Sustainable Evaluations encourage Boards to take an in-depth look every year to measure their performance at specific levels and also to figure out exactly what works and what doesn’t when it comes to following through on the on the action items covered in the preceding year. Paraphrasing Andrew’s reflections in the Indian context and considering the issues enumerated earlier, this model of sustainable evaluation will go a long way towards promoting investor confidence by extending stakeholders the opportunity to observe and measure the board’s commitment to active, ongoing evaluations and improvements in board practice.

It is worth reiterating that no amount of legislation can ensure ‘good corporate governance’. It has to come from an innate desire to maximise shareholder value while at the same time fulfilling the company’s moral obligations to all stakeholders. Evaluation can serve as a powerful tool towards mapping the governance landscape with the objective of correcting any deficiencies, but success of any such exercise is contingent on the board buying in on the idea and viewing it as a constructive initiative.

Exhaustive studies done over the years demonstrate time and again that good corporate governance leads to superior firm value and is consistently associated with lower cost of capital, effective capital allocation and risk management, among other benefits. Echoing the views of global experts and trend observers, it would not be long before investors begin placing a premium on evaluation reports – which means a well-designed process which includes actionable reporting is paramount. In this context an effective, sustainable evaluation exercise contributes positively towards improving efficiency of the board as a whole and should be seen as such.

 

About the Author:

Mathew John is a member of the Corporate Governance and Board Advisory practice at Amrop India. He is a Corporate Governance and Public Policy professional with multi-sector experience working with National Governments, Law Enforcement Agencies, Media Houses and Statutory & Non-Statutory Professional Bodies. Prior to his tenure at Amrop, he was responsible for leading the Centre of Excellence for Sustainable Development (CESD), Department of IP&CC and was associated with the School of Corporate Governance and Public Policy (SoCGPP) at the Indian Institute of Corporate Affairs – think tank for the Ministry of Corporate Affairs. His prior associations include International Criminal Police Organization (INTERPOL HQ, Lyon, France), Times of India, Association of Independent Directors of India (AIDI) and Centre for Legislative Research & Advocacy.

Footnotes:

1.https://economictimes.indiatimes.com/industry/banking/finance/banking/scam-exposes-management-lapses-at-pnb-say-experts/articleshow/62934503.cms  2.https://www.oecd.org/daf/ca/Evaluating-Boards-of-Directors-2018.pdf  3.http://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf  4.http://www.ingovern.com/wp-content/uploads/2016/05/Board-Evaluation-Practices-in-India-26-05-2016.pdf  5.https://www.icsi.edu/media/webmodules/companiesact2013/Final_LODR.pdf 6.https://www.sebi.gov.in/legal/circulars/jan-2017/guidance-note-on-board-evaluation_33961.html 7.https://hbr.org/2004/05/building-better-boards  8.https://ethicalboardroom.com/the-case-for-sustainable-board-evaluation/