Reinforcing the Corporate Governance Framework on Director Competence

[Tushar Oberoy and Rishabh Sharma are 4th year BA.LL.B. (Hons.) students at NALSAR University of Law, Hyderabad]

A director of a company has manifold duties and responsibilities that include ensuring that the interests of all shareholders are protected and that healthy management practices are put in place. For effective fulfillment of these responsibilities, a competent director becomes an invaluable asset for a company. The board of directors of a company must comprise of directors who have the knowledge, skills and experience required to fill particular gaps in the board and to effectively steer the company in the desired direction. The importance of having a diverse and skilled board has also been highlighted in the Report of the Committee on Corporate Governance, known as the Kotak Committee Recommendations, released in 2017.

This post analyzes the provisions aimed at ensuring that only competent persons feature on the board of a company and recommends modifications in the same for building a more robust disclosure framework to enable an adequate analysis of the board’s competency by all the stakeholders, present or prospective. Given below is a brief description of the existing appointment process and disclosure framework for directors in comparable jurisdictions.

Law in India

Under section 178(2) of the Companies Act, 2013, the task of overseeing the process of appointing a director rests in the hands of a company’s nomination and remuneration committee. The committee formulates the criteria for determining qualifications of potential candidates and identifies individuals eligible for becoming directors on Indian companies. It is also required to carry out evaluation of the performance of every director. In addition to this, the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”) state that a company has to disclose a matrix of skills/expertise/competence identified by the company, as required in the context of its business and, with effect from March 31, 2020, the names of directors who possess them.[1] Such a requirement was introduced in 2018, by way of an amendment, based on the Kotak committee recommendations for bolstering the existing disclosure framework.

Law in Australia and Singapore

The corporate governance requirements in Australia (“ASX Principles”) and the corporate governance code in Singapore (“Singapore Code”) have also focused on the expertise of directors for effective discharge of duties. The norms of these two jurisdictions also require the nomination committee of a company to lead the appointment of directors. The ASX Principles recommend that companies disclose a skills matrix, setting out the skills that the board would be looking for in an incoming director. Similarly, the Practice Guidance 4 complementing the Singapore Code requires disclosure of the criteria used to identify potential directors along with disclosure of how the board’s skills will help in meeting the needs of the company. These are also supported by the requirement of periodic assessment of a director’s skills and professional development activities in the respective jurisdictions.

Law in the United Kingdom

The UK Corporate Governance Code of 2018 (“UK Code”) stipulates that the board should have a combination of skills, experience and knowledge. The UK Code also specifies that a nomination committee should lead the appointment process. Along with this, an annual evaluation of the board’s performance needs to be carried out and the nomination committee is required to disclose the process for appointment as well as evaluation in the company’s annual report.

Analysis

The foregoing discussion reveals that the regulatory framework ensuring expertise of directors is broadly the same in all the jurisdictions discussed above, with the exception of a few provisions. However, it is necessary to realize that the subject of director expertise and the process of determining it cannot be laid down in concrete and objective terms in light of the subjective considerations involved. One of the disadvantages associated with the use of a skills matrix is that it is only required to be disclosed to the investors for their satisfaction and, hence, the company might only disclose skills that match the investors’ expectations of its present or future ventures. A company might also try to avoid disclosure of domain specific skills to circumvent the possibility of giving a hint about its future endeavors or expected risks to the market. Moreover, the matrix can contain very general and vague qualities like ‘leadership’ or ‘financial expertise’, etc. The company can back its choice of directors by showing a remote connection between the qualifications of the company and its relevance in the business context.

Having said that, the authors are of the opinion that India’s corporate governance framework pertaining to disclosure of director’s skillset, in its present form, is insufficient to win confidence of the company’s stakeholders and present them with adequate knowledge about its directors’ competence. However, the same can be reinforced and made more robust by requiring more expanded disclosures of a director’s competence. For instance, a disclosure requirement could be drafted similar to that laid down in section 407 of the Sarbanes Oxley Act of 2002 in the United States which deals with “disclosure of audit committee financial expert”. The parameters should be formulated in a manner that enables all the stakeholders to ascertain whether an individual’s past education and work experience is in tune with the current or upcoming requirements of the company and whether the board in toto has the skills and the competence to do justice with the strategy of the company. Another disclosure requirement, which is present in the Singapore Code, of how a director’s attributes would benefit the company can also be added. This would help the investors in better assessing the value a particular director adds to the board of a company.

To conclude, the authors submit that it is not enough to disclose the particular skill, expertise or competency possessed by a director; the same should be backed by an expanded disclosure of the director’s past education and work experience. Moreover, the board must also explain how the concerned attribute is beneficial to the company. This would allow the stakeholders to have a more intricate understanding of whether the directors represented on the board are aligned with company strategy, and are adept at managing future risks and creating investor value.

Tushar Oberoy & Rishabh Sharma

[1] Sub-clause (h) of Clause (2) of Para C of Schedule V of the LODR Regulations.

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