Board Effectiveness: Challenges and Opportunities

[Bharat Vasani is Senior Advisor – Corporate laws at the Mumbai office of Cyril Amarchand Mangaldas. An earlier version of this post was published on the Cyril Amarchand Mangaldas Blog]

It is the board’s responsibility to successfully run a company, as set out in terms of section 179 of the Companies Act, 2013 (“Act”). Hence, it is imperative that the boards function effectively to ensure that the company’s interests are always kept at the forefront while protecting interests of all stakeholders.

Boards under Intense Public Scrutiny

Currently, boards of public companies are functioning under intense public scrutiny, with an activist judiciary, media and shareholders’ groups being aided by equally activist proxy advisory firms. The legal and regulatory changes affecting the corporate world over the last decade have further increased the level of public disclosures and transparency in the functioning of corporate boards. A listed company is now required to make extensive disclosures under regulation 30 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”). Obtaining shareholder approval for certain transactions, too, has become further complicated, with promoters or controlling shareholders of a company getting disenfranchised in matters, including approval for related party transactions, certain types of schemes of mergers and de-mergers, de-listing of securities, and for business transfer agreements undertaken outside the “scheme of arrangement route”, by virtue of the recently introduced regulation 37A of the LODR Regulations.

E-voting facility at annual general meetings of companies has further increased the level of shareholder participation in the decision-making process. All these developments have increased the pressure on corporate boards. With instant media reporting of board decisions, a mere allegation of bias or arbitrariness can cause severe reputational harm to the corporate brand, which is built carefully over the years. A single instance of lack of oversight can tarnish reputations built over centuries. The Supreme Court’s decisions such as cancellations of 2G licences in 2012, allocation of coal blocks, and electoral bonds are examples demonstrating that corporate actions are now also subject to intense judicial scrutiny, if there is any arbitrariness in the process followed by the Government in grant of license or if it lacks transparency and disclosures.

Obstacles to Board Effectiveness

Given the above backdrop, the business environment has become extremely challenging, with business models becoming rather complex. The pressure on the boards is mounting, with SEBI mandating quarterly accounts for listed companies. As a result, four annual board meetings are consumed by quarterly results, leaving very little time for the boards to discuss broader business issues and strategic plans. Given the fact that Indian law mandates a uniform financial year, board meetings are usually conducted over one or two weeks during the announcement of quarterly results, resulting in very little time for the board members to prepare for the board meetings.

The challenges facing the board get further complicated when operating management is not willing to share the required information with the board; on many occasions, very vital information on key proposals is shared at the very last minute. The boards are also finding it difficult to find the right balance between their oversight role and the need to get involved in the operational matters of the company, given that certain confirmations on operational matters like effectiveness of internal financial controls are required to be given to the shareholders by the boards in the Directors Responsibility Statement under section 134(5) of the Act.

Should Boards Get Involved in Operational Matters?

Finding the right balance for the board’s oversight role is always challenging, for which different board members adopt varying approaches depending on their background. It has been observed that non-executive directors (who were previously or are currently holding positions such as CEO) tend to get overly involved in operational issues, implying that they are yet to transition into their non-executive roles from their executive ones. Also, some independent directors tend to be over-cautious in matters involving potential legal liabilities and would prefer seeking external legal opinion on various issues to use that as a defence from potential liability implications. Such an approach is undesirable as businesses function in a dynamic environment, and one cannot run a company on the basis of legal opinions. In any case, regulators like SEBI are now taking a view that reliance on legal opinions cannot absolve the board members from their liability for a failure to exercise adequate oversight on key matters, such as approval of the annual accounts and related party transactions.

Intense public scrutiny on the functioning of boards has also led to boards being ultra-cautious, resulting in disproportionate time and attention spent on regulatory and compliance issues rather than focusing on the business of the company and its strategic long-term objectives. Excessive involvement of the board in various operational matters is a clear sign of a weak CEO and management team. It is the chairperson’s responsibility to ensure that the board does not cross the “Lakshman-Rekha” in its oversight role and let the CEOs and management team run the company.

Board Effectiveness – Practical Challenges

In an ideal world, the board should function as one homogenous body, which takes informed decisions by consensus after due deliberations. However, directors are divided under various categories:

  1. CEO/ Executive Directors;
  2. Nominee Directors;
  3. Independent Directors;
  4. Non-executive, Non-Independent Directors (Promoters nominee); and
  5. Women Directors.

There is also asymmetry of information at the board level, which poses many practical challenges. The degree of knowledge of different board members about the company and its business and the business environment is very different. Such knowledge is significantly higher at the CEO and executive directors’ level, while independent directors at times are ill-informed about many such issues. It is also true that the promoter’s nominee on the board generally has higher knowledge of these aspects as compared to independent directors.

Relationship Dynamics

A healthy and functional relationship between the CEO and the chairperson and the board is key to ensuring effective and positive board dynamics. If there is an element of distrust, it invariably results in the chairperson asking penetrating questions on various operational matters, which ideally the board should not get involved in. A board relying heavily on the CFO on strategic issues rather than the CEO is also an indication of trust deficit. A board that trusts the CEO would rather focus on long-term strategic issues and vision of the company, rather than the day-to-day operational matters. The relationship between a CEO and independent directors is also crucial. If the independent directors are of the view that the CEO is selective in sharing information with the chairperson and promoter’s nominee, and they too are being kept in the dark, there is a greater likelihood of independent directors asserting their muscle and demanding more information on operational aspects. It is the chairperson’s job to ensure that there is trust between board members and the CEO, to avoid untoward experiences at board meetings. A regular flow of communication between the CEO and the board members is key to a healthy relationship. The CEO must share “bad news” as candidly with the board as “good news”.

Opportunities for Improving Board Effectiveness

In the Indian context, cultural issues play an important role in board dynamics and board effectiveness. In India, the promoter plays an important role in the management of the company. The promoter or his/her nominee is generally the chairperson of the board, and most directors would not like to challenge the chairpersons’ views or  decisions at the board meeting. If independent directors are uncomfortable with the proposed agenda, they invariably speak to the chairperson either before or after the board meeting.

The chairperson plays a vital role in making boards function effectively: he or she has to play the role of a “statesman” or “stateswoman” in giving fair opportunity to every board member to put forth their views effectively, while also ensuring that no board member dominates the discussion.

The chairperson needs to support the operating management and ensure that there is a healthy relationship between the CEO and board members. This can be achieved in two ways: (i) CEO providing required information to the board from time-to-time on operational matters, which instills board members with confidence, particularly if the CEO is also giving bad news along with good news and the board feels comforted that there is no suppression of any crucial information by the management team; and (ii) the board also needs to engage extensively with the management team outside of the board meetings. Communication between board members outside board meetings should also take place regularly. It would be useful if board members have direct communication channels with the CFO, General Counsel, Company Secretary or any committees or sub committees. They are important pillars in the corporate governance architecture and direct communication could prevent misunderstandings.

It is also advisable for the chairperson of the Audit Committee to have private sessions with statutory auditors, internal auditors, and the CFO to discuss issues relating to accounts and accounting treatment. For high-profile litigation having reputational implications, board members must engage directly with the General Counsel’s office, and if necessary, also meet external lawyers advising the company. The Audit Committee should particularly pay attention to liability provisions if profitability of the company is under challenge. The board’s critical oversight over the key risks faced by the business is important. In such a situation, there is a tendency to under-provide for liabilities. The board can also do well to focus on contingent liability to ensure no real liability is suppressed. For mergers and acquisitions transactions, it may be advisable for the board to form a sub-committee, which can work closely with the management team to review and provide inputs on key deal terms, until the transaction matures for execution. Continuous dialogue between the board and management team eliminates communication gap and prevents misunderstandings between the board and CEO.

The Nominations and Remuneration Committee (NRC) can also play an important role in ensuring that the board comprises of members with complimentary skill sets and experience. Diversity in the board is also crucial to bring in different perspectives. The NRC is also expected to implement an effective process to evaluate the performance of the board and individual directors.

Keeping in mind the roles and responsibilities, the board should ensure that it remains focused on the long-term objectives of the company. Pressures of quarterly results have forced many boards to view every decision made at the board meeting from the prism of how it will impact the share price. Such an approach can hamper the long-term interests of the company. In fact, several advanced countries have moved away from the requirement of declaring quarterly financial results so that the boards can remain focused on the long-term economic interests of the company.

Concluding Thoughts

The role of the board is to inspire and guide the CEO and management team and not to run the company by itself. The board should allow the CEO and the management team to run the day-to-day affairs of the company under its careful oversight. The board should focus on long-term strategy, succession planning and focus on its own effectiveness by institutionalising strong performance evaluation processes. Board effectiveness is not a mirage; it can certainly be achieved.

Bharat Vasani

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