Shrinking Board Sizes and Corporate Governance: Key Insights

Shrinking Board Sizes and Corporate Governance: Key Insights

Subject: Economy

Section: Financial market and money market

• Trend in Board Size:
  • In recent years, corporate boards are facing scrutiny over governance issues, leading to a trend of shrinking board sizes.
  • A new report by Excellence Enablers, backed by former SEBI Chairman M Damodaran, reveals the evolution in board sizes.
  • In FY18 and FY19, the range of board members varied from 4 to 22, but by FY23, the maximum board size has reduced to 16.
• Committee Requirements:
  • With the mandatory establishment of five board committees, it is crucial to have an adequate number of members for effective functioning.
  • The aim is to ensure proper constitution of committees, avoiding scenarios where the same members serve on multiple committees.
• Definition of Good Governance:
  • The essence of good corporate governance lies in doing the right things, at the right time, and for the right reasons.
  • Entities that proactively practice good governance for stakeholder interests often influence the creation of laws and regulations.
• Companies Act, 2013:
  • Section 149 (1) of the Companies Act, 2013, mandates a board of directors with specific minimum and maximum director requirements.
  • Public companies must have a minimum of three directors, private companies require a minimum of two, and one-person companies need at least one director.
  • The Act sets the maximum limit for directors at fifteen, with additional provisions for independent directors in listed public companies.
• Optimal Board Composition:
  • Effective boards often boast a balanced mix of executive and non-executive directors, providing diverse insights and experiences.
  • The report emphasizes the importance of this mix for better decision-making and governance effectiveness.
• Concerns on Combined Roles:
  • The report raises concerns about combining the roles of Chairman and MD/CEO, which may compromise corporate governance principles.
  • When both positions hold executive responsibilities, it could hinder the oversight and checks expected in good governance practices.
• Non-Mandatory Separation:
  • It is noted that the separation of Chairperson and MD/CEO roles is not mandatory, posing challenges for maintaining governance standards.
  • The report highlights the need for this separation to ensure adequate checks and balances within corporate structures.
• Conclusion:
  • As corporate governance continues to evolve, the focus on board sizes, composition, and role separation remains crucial.
  • The ongoing scrutiny underscores the importance of aligning board structures with best practices to uphold transparency, accountability, and stakeholder interests.
  • The report calls for a deeper examination of these governance aspects to drive sustainable and responsible corporate conduct.

Section 149 (1) of the Companies Act, 2013

• Minimum Number of Directors:
  • Every company incorporated under the Companies Act, 2013, is required to have a board of directors.
  • The section specifies the minimum number of directors that different types of companies must have.
• Public Company:
  • In the case of a public company, the minimum number of directors required is three.
• Private Company:
  • For a private company, the Act mandates a minimum of two directors.
• One Person Company (OPC):
  • In the case of an OPC (One Person Company), which is a unique type of company designed for single entrepreneurs, the requirement is for at least one director.
• Maximum Number of Directors:
  • The section also provides for the maximum number of directors a company can have, setting the limit at fifteen directors.
• Requirement for Independent Directors:
  • Additionally, the Act stipulates that every listed public company must have at least one-third of the total number of directors as independent directors.
  • This requirement ensures a level of independent oversight and governance in listed companies.

In summary, Section 149 (1) of the Companies Act, 2013, establishes the foundation for the composition of boards of directors in Indian companies.

It sets out the minimum and maximum numbers of directors based on the type of company, ensuring a structured and balanced governance framework. Additionally, it emphasizes the inclusion of independent directors in listed companies to enhance transparency and accountability.

Corporate Governance and Recent Controversy at NSE

Corporate Governance encompasses a comprehensive set of rules governing the affairs of a corporation. A lapse in governance not only impacts investors but also stakeholders, the public, and the government.

Corporate Governance as the system by which companies are directed and controlled. It involves a set of rules, practices, and processes governing a firm.

Balancing Stakeholder Interests: Corporate Governance ensures a balance between the interests of stakeholders such as shareholders, management, customers, financiers, and the community.

Ethical Business Conduct: It ensures that business operations are ethical, compliant with laws, regulations, and industry best practices.

Structure of Corporate Governance in India

• Companies Act 2013: Provides a formal structure with provisions for Independent Directors, Board Constitution, General and Board Meetings, Audit Committees, etc.
• Other Legislations: Acts like the Competition Act 2002, Foreign Exchange Management Act 1999, and Industries (Development and Regulation) Act 1951 impact corporate governance.
• SEBI Guidelines: Mandates adherence to best practices through various guidelines for investor protection.
• ICAI Accounting Standards: Accounting standards and mandatory financial disclosures are issued by the ICAI.
• Listing Agreement: Stock exchanges have listing agreements with detailed provisions on audits, disclosures, and annual statements.
• ICSI Secretarial Standards: Standards on board and general meetings issued by the ICSI also contribute to governance.

Committees for Improving Governance

• Rahul Bajaj Committee (1995): Developed the ‘Desirable Corporate Governance’ code.
• Kumar Mangalam Birla Committee (2000): Focused on investor protection and transparency.
• Naresh Chandra Committee (2002): Covered corporate audits and auditor-company relationships.
• Narayana Murthy Committee (2003): Reviewed and recommended improvements in corporate governance.
• Uday Kotak Committee (2017): Proposed measures to enhance governance, including gender diversity on boards.

Conclusion

Robust Corporate Governance is essential for restoring trust, preventing scams, and ensuring investor protection. India needs a concerted effort to enhance governance practices, making them inclusive, efficient, consensus-oriented, and rule-based. These steps are crucial for fostering a healthy corporate environment and attracting both domestic and foreign investments.

Uday Kotak Committee Recommendations on Corporate Governance

The Uday Kotak Committee, constituted by SEBI, focused on improving Corporate Governance practices. Its mandate included:

• Independence of Independent Directors: Enhancing the independence and active involvement of independent directors in the company’s functioning.
• Related Party Transactions: Improving safeguards and disclosures concerning related party transactions.
• Investor Participation: Addressing issues faced by investors regarding voting and participation in general meetings.
• Board Evaluation: Enhancing the effectiveness of board evaluation practices.
• Disclosure and Transparency: Suggesting measures to improve disclosure and transparency practices.

Key Recommendations

• Separation of Roles:
  • Chairman and MD Roles: Listed firms should separate the roles of Chairman and Managing Director. Chairmanship should be limited to non-executive directors only.
• Minimum Board Strength:
  • Board Size: Increase minimum board size to 6 members.
  • Gender Diversity: At least one woman to be appointed as an independent director.
  • Board Meetings: Listed firms should conduct at least five board meetings annually (up from the current four).
  • Discussion Topics: The board should discuss succession planning and risk management at least once a year.
• Independent Directors:
  • Proportion: At least half of the board members should be independent directors in listed companies.
  • Attendance: All directors must attend at least half of the board meetings.
  • Age Limit: Public shareholders’ approval required for non-executive directors above 75 years of age.
• Shareholder Meetings and Disclosures:
  • Webcasting: Top 100 firms by market capitalization should webcast shareholder meetings.
  • Cash Flow Statements: All listed firms should disclose cash flow statements every six months.
  • Quarterly Earnings: Mandatory disclosure of quarterly consolidated earnings by listed firms.
• Credit Ratings:
  • Transparency: Listed entities should provide an updated list of all credit ratings obtained in one accessible place for investors.
• Minimum Remuneration:
  • Independent Directors: Minimum remuneration of Rs 5 lakh per annum.
  • Board Meeting Fees: Sitting fee of Rs 20,000-50,000 for each board meeting.
  • Approval: Public shareholders’ approval required for annual remuneration of executive directors from promoter families exceeding specified limits.
• Risk Management and IT Committee:
  • Cyber Security: Top 500 listed companies should have a risk management committee focused on cyber security.
  • IT Committee: Listed entities must constitute an IT committee focusing on digital and technological aspects.

These recommendations aim to strengthen governance, enhance transparency, and align practices with global standards, ultimately benefiting investors and ensuring sustainable corporate growth.