A reform measure cannot be held hostage to the whims and fancies of those who decide not to comply with the reform order

Based on the recommendations of Uday Kotak committee on corporate governance (2018), the stock markets watchdog, Securities Exchange Board of India (SEBI) had asked listed companies to separate the positions of Chairperson and Managing Director (MD)/Chief Executive Officer (CEO). The requirement was mandatory.

The companies were required to implement the order by April 2020. However, based on representations received from the industry, an additional two years was given for compliance. In April last year, SEBI chairman Ajay Tyagi goaded them to ensure that the April 2022 deadline is not missed. Now, that even this deadlineis barely a month away, the regulator has done a volte face. 

On February 15, 2022, the SEBI decided to implement the requirement on a voluntary basis for now. The substitution of ‘mandatory’ by ‘voluntary’ tantamount to saying good bye to the order as an entity who is not comfortable with it; hence, unwilling to comply is no longer under any compulsion to do it.

While, handing out its latest decision, the regulator has made the following observations:

“Considering rather unsatisfactory level of compliance achieved so far, with respect to this corporate governance reform, various representations received, constraints posed by the prevailing pandemic situation and with a view to enabling the companies to plan for a smoother transition, as a way forward, SEBI board at this juncture, decided that this provision may not be retained as a mandatory requirement and instead be made applicable to the listed entities on a voluntary basis”.

Three considerations prompting SEBI to bend backward are (i) unsatisfactory level of compliance achieved so far; (ii) constraints posed by the prevailing pandemic situation; (iii) enabling the companies to plan for a smoother transition.

Why did the regulator come up with this order in the very first place?

A listed company by nature is an entity whose ownership or shareholding (a jargon that represents ownership; a certain number of shares - each of specified value say `10 - held by a person give him/her ownership right in the company proportionate to his/her holding of company’s total share capital) is publicly held; those shares are listed and traded on the stock exchange.

Normally, a significant chunk of shares are held by a person or a group of persons - call him ‘promoter’ (for instance, the Ambani family, holds approx. 49.38% of the total shares in the Reliance Industries Limited or RIL whereas the remaining 50.62% shares are held by public shareholders, including foreign institutional investors or FIIs and corporate bodies). By virtue of this, he/she has also the prime responsibility of running the company.

An ideal structure of running a firm (call it ‘corporate governance’) is one in which there is a management headed by the MD/CEO and a Board of Directors (BoD) headed by the Chairperson. While, the MD/CEO runs the day-to-day affairs of the company, BoDacts as the supervisory authority and gives policy directions - consistent with set goals for the company - to the former. The BoD is accountable to the shareholders. Each centre of authority is expected to carry out its responsibilities as per the mandate assigned to it and refrain from interfering in the functioning of the other.

This provides a fairly balanced governance structure and helps in steering the company in a manner so as to ensure its sustained health and growth and protect the interests of all shareholders. But, the situation on groundzero is far from it.

Many companies have the post of CMD. As the designation suggests, the Chairperson is also MD. This is bizarre. Acting as MD, this individual takes orders from himself whereas, in his incarnation as Chairperson, he gives orders to himself. In short, there is excessive concentration of authority in one person.

This scenario holds particularly for family-owned businesses where the promoter has a fundamental interest in keeping his own interest above those of other/public shareholders. Prima facie, this could be bandiedasbeing out of sync with conventional wisdom that gives credence to’convergence of interest between the two’; for instance, when the company makeshigher profit, all shareholders, including promoter and public shareholders, gain. But this is anover-simplified view of a situation which is far more complex.

Invariably, a family-owned promoter has a number of diversified businesses and there are numerous instances of a companysay ‘A’ in the conglomerate transferring surplus funds to another ‘B’ wherein also he has a major stake or the latter taking loan from a financial institution on the strength of formers’ balance sheet. ‘A’ could also be used to favor ‘B’ in matters of assigning contracts or procuring materials etc. In several instances, the management of ‘A’ diverts funds to the so called shell companies whose beneficial ownership rests with the promoter of ‘A’.

A governance structure where the Chairperson and MD is the same person (read: CMD) is amenable to such decisions which undermines the interest of public shareholders of ‘A’. On the other hand, if these two positions are segregated, this will result in a better and more balanced governance structure which will enable more ‘effective’ and ‘objective’ supervision of the management. It will help avoid all undesirable scenario of the type mentioned above and protect interests of all shareholders without discrimination. 

This will also be consistent with the global practice in countries such as the UK, Australia, Germany, Netherlands and so on who have opted for  separation of the Chairperson and CEO roles.

In this backdrop, the recommendation of Kodak Committee was apt and SEBI had initiallymade the right move to implement it. The about turnnow is retrograde. The three reasons advanced by the regulator are bizarre.   

On (i), SEBI posits that as on September 2019, the compliance level which stood at 50.4 percent amongst the top 500 listed firms has progressed to only 54 percent as on December 31, 2021 - a four percent incremental improvement in two years. Hence, it goes on to say ‘expecting the remaining 46 percent to comply with these norms by the target date would be a tall order’.

If, non-compliance by 46 percent is the criteria for abandoning the ‘mandatory’ requirement then by the same logic with 50.4 percent of firms having complied - that too within a year of enforcing the order - SEBI should stay with it. Dispensing with it (read: mandatory) just because 46 percent have not complied will be ‘unfair’ and ‘discriminatory’ to the companies who have already complied.

A reform measure has to viewed in terms of what it is intended to achieve. It cannot be held hostage to the whims and fancies of those who decide not to comply with the order. The reversal will also send a wrong message that ‘lobbying by some powerful groups’ can always force theregulator to backtrack.

As for (ii), it is hard to fathom any linkage - even remotely - between a ‘mere change in the structure of running a firm’ with the prevailing pandemic situation. Moreover, to see this link now when Covid is waning makes it laughable. As for invoking ‘a smoother transition’ argument (reason iii), this is just a ploy to let the violators forget this advisory with passage of time.

To conclude, following SEBI’s volte face, corporate governance in India has received a big blow.

 (The writer is a policy analyst. The views expressed are personal.)