Values, Integrity and Good
Governance, Not Valuations, Should Drive Indian Business in the Future |
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If a leading organization in India that
had a five-star Board - which was
supported by leading professional
service firms, and had been known
for exercising good corporate
governance standards - can mislead
the world, what signal does it send to
global markets?
Recent events in India clearly demonstrate that
social responsibility is not always on the minds of
some CEOs as firms are being accused of falsifying
revenues and earnings in an effort to meet analyst
and shareholder expectations and demands.
Such sentiments are reflected in a recent comment
by a leading Chairman in India who suggested, "It
was like riding a tiger, not knowing how to get off
without being eaten".
The deception, hubris, and possible criminal fraud
that has led to the decline and collapse of multiple
firms around the world is bad enough; but just as
disturbing is the lack of business judgment and
oversight exercised by some boards of directors.
We hope the recent corporate governance scandal
involving a major IT firm in India will redouble the
efforts by other Indian firms to improve corporate
governance practices.
As the ripples from recent scandals in India spread,
what should Indian-listed companies be doing in
response to the corporate governance issues that
have been raised?
The reviews being undertaken by legislators and
regulators in India will no doubt give rise to
regulatory changes covering corporate governance,
accounts, and auditors.
However, directors of listed companies should not
simply wait for these regulatory reviews.
This article highlights key corporate governance
issues that have arisen recently and outlines the
range of matters that we think boards should be
review more actively.
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1. Board organizations and operation
Boards across the globe should focus on three main
areas as it pertains to the Board organization and
operations: Board independence; Effectiveness of
Board meetings and group dynamics; and Board
and Committee structure.
As shown in Figure 1, each of these areas involves
topics that are crucial for a Board to uphold its duty
to protect and represent shareholders' interests.
Today, much of the focus is on maintaining an
effective balance of executive and non-executive
directors. In particular, the combined role of
CEO/Chairman has come under increased scrutiny.
As Boards begin to review the basics of the board
structure, we suggest thinking about the following
questions:
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Is the balance and division of responsibility at
board level clear and appropriate? |
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Is the balance between non-executives and
executives right? |
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Does the board have a sufficient number of fully
independent non-executive directors? |
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The focus is shifting from the technical concept
of independence to the need for non-executives
to also be truly independent and capable in the
sense of a willingness to make contrary views
known and to stand up to management.
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Are the skills and experience of the
non-executive director's right for the
company's business? |
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Has a senior independent non-executive director
been nominated and is that person a strong
force within the board who takes the lead on
important issues of concern to the non-executive
directors (Lead Director role)? |
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Does the Board regularly hold executive
sessions without management present? |
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2. Board role and responsibilities.
To ensure maximum effectiveness in today's
business environment, the Board needs to go
beyond its traditional advisory role and actively
oversee the company's strategy development and
risk management to minimize business uncertainties
and promote the creation of long-term shareholder
value.
A major challenge for the Board is to establish the
right balance of responsibilities between the role of
non-executives and role of management, especially
the CEO.
There are five main areas of responsibilities for
Boards to focus on:
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First, directors regularly review and approve the
strategic direction of an enterprise. The Board
needs to ensure that corporate resources are used most effectively and efficiently
to achieve the strategy. |
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Second, the Board plays an
essential role in selecting, monitoring,
counseling, and advising the senior executive
team, including the CEO. |
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Third, directors are watchdogs for
uncompensated or excessive risk and guardians
for compliance around major financial issues. |
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Fourth, Boards are responsible for ensuring that
the company gets a fair return for the
compensation paid to the executives of the firm. |
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Fifth, Boards are responsible for evaluating
themselves relative to governance standards
and objectives set at the beginning of the
performance period. |
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Figure 2 below highlights these five areas of
responsibility and suggested activities relative to
each.
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3. Board compensation.
In the most simplistic way, Board compensation
should reflect the critical accountability of the Board
members.
Historically, Board directors have been
compensated through a combination of retainer
and/or meeting fees and annual or periodic stock
option grants.
There has been little differentiation between those
with leadership and general membership roles.
Cash compensation has been set to pay for the
activities and services of the board members. Stock
option awards have attempted to align board
decisions with shareholder interests, and provide the
competitive total compensation necessary to attract
new members. However, in leading industrialized
nations, we have seen a shift away from stock
options and towards full value shares for
independent director pay.
While Board compensation is philosophically similar
to executive compensation, there are some
fundamental differences. They are similar in that
each program includes cash and usually some form
of equity-based compensation for services rendered.
It is different because there is often little
differentiation between members, the amount one
receives is not based on performance, and there are
concerns about inherent conflicts between current
pay programs and the fiduciary responsibility of the
Board.
It is critical that a Board seek the help of a neutral,
independent, and competent advisor while reviewing
the compensation programs of its directors.
While the overall role and
responsibilities of Boards have not
changed, the work they perform and the
consequences they face for their decisions have
changed dramatically.
"Social responsibility other than to
make...money for stockholders.is a
fundamentally subversive doctrine."
Milton Friedman
The requirements and roles for directors have
increased significantly. Investor and shareholder
advisory groups are closely scrutinizing governance
practices and how board members are compensated.
As part of the re-examination of corporate
governance for the organization, Boards need to
assess the philosophy, basic architecture, actual
amounts, and decision process for compensating
directors.
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There are three primary aspects to be covered while
determining the appropriate compensation.
These areas are:
I) Define the framework for determining the
structure, mix, and levels of compensation for
directors.
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Should the board be compensated for its
activities (e.g., meeting fees) or their
responsibilities (e.g., retainers)? |
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Should the total compensation for the chair of
the committees be different from that of others
on the board? |
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Should directors receive equity-based
compensation for their services (and, if so, what form of equity) or should they receive only cash
compensation? |
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What mix best reflects their services as well as
their fiduciary responsibilities to the
shareholders and executive management? |
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Should there be any special conditions related to
a director's compensation? |
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ii) Determine the frame of reference for the
appropriate amount of compensation.
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What should constitute the "marketplace" from
which the corporation needs to draw directors,
and what is the desired level of
competitiveness? |
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Should there be a difference between new
members and well-established members;
between current shareholders and board
members with limited holdings in the company? |
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Should corporate performance
impact director compensation, and if,
so how? |
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iii) Provide on-going reviews and support to
decisions that fulfill legal, ethical and strategic
requirements.
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Should the current director compensation
programs be modified in light of the emerging
changes in governance requirements, the board
structure, and the membership of the board? |
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How should these changes be implemented and
in what timeframe? |
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How often does the board need to examine its
own compensation, and how should it make and
document these decisions without being seen as
self-serving? |
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Companies in India have made great strides in addressing the need for good corporate governance practices.
We believe that the recent governance scandals in India will serve as a signal for organizations to conduct a strict
due diligence on their current governance programs and process and will accelerate the adoption of best
principles in governance across the country.
We should remember that, when corporate governance is effective, it helps safeguard shareholders, customers,
and employees without hindering appropriate risk-taking.
But when it is ineffective, it can have a disastrous impact on these key stakeholders and on the long-term viability
of the enterprise.
Shekhar Purohit, Principal, Asia Pacific Leader for Executive Compensation and Corporate Governance.
shekhar.purohit@hewitt.com |
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Hewitt Quarterly Asia Pacific
is made possible through the combined skills and experience of Hewitt consultants from across the Asia-Pacific region.
For further information please contact:
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editor-hqap@hewitt.com |
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