More onerous responsibilities with paltry remuneration

CORPORATE GOVERNANCE (CG) is piling more responsibility and increasing work pressure on non-executive directors (NEDs), leading to growing tension. The gap between the traditional non- executive directors' function (ensuring that the firm has the right strategy and leadership) and the increasingly onerous policing and monitoring role demanded by higher levels of scrutiny is widening', according to a recent survey by PricewaterhouseCoopers in the U.K. The report adds that `whereas NEDs agree that their role has changed, many companies are failing to recognise the importance of this change when considering the appointment, remuneration, time commitment and evaluation of NEDs (Financial Management, London, March 2001).

That this problem is not confined to the U.K. and could become a contentious issue in India also, has bean pointed out, coincidentally in the March 2001 issue of Chartered Secretary. The authors, C. R. Shah and Komal Parikh, point out that ``companies generally pay only sitting fees to NEDs. Considering the profile of such NEDs, and the role they play through their intellectual contribution, there is a strong case for devising a proper system of adequately compensating such directors".

Corporate governance in India

Good Corporate Governance (GCG) has become the maha vakya in the boardrooms across the country, and as usual, many years after it became an accepted practice in the West, especially in the U.S., GCG received official blessings through amendments in 2000 to the Companies Act, 1956 (the Act), additional stipulations in the listing agreement and the institution of an annual award on excellence in corporate governance. Plans are also on the anvil to set up a Central Institute for Excellence in Corporate Governance, intended to tone up GCG mechanisms in tune with the emerging globalisation.

It will not be out of place to recapitulate the compelling factors for the acceptance and adoption of GCG in India, which are (i) compulsions for Indian companies to raise GDRs/ADRs abroad, and also getting their shares enlisted in foreign bourses, particularly at Nasdaq and New York stock exchanges; (ii) significant presence of a large number of FIIs who demand greater professionalism in Indian companies; (iii) integration of India with the world economy which entails following a standard set of international norms and standards; (iv) realisation by lending institutions which are now subject to rigorous accounting norms, particularly with regard to income recognition and provision against NPAs; and (v) assertion by shareholders of their rights.

Board of directors -the kingpin

of good corporate governance

It is now well established that the success or otherwise of GCG is greatly dependent on the role played/allowed to be played by directors especially the non-executive directors in the management of companies. A code of desirable corporate governance brought out by the Confederation of Indian Industry (CII) in April 1997 observed, ``Simply put CG refers to an economic, legal and institutional environment that allows companies to diversify, grow, restructure and exit, and do everything necessary to maximise long-term shareholder value. Thus NEDs and disclosures are parts and not the whole of CG. To most international experts on the subject, CG is an interplay between companies, shareholders, creditors, capital markets, financial sector institutions and company law".

Sir Adrian Cadbury, considered the guru of GCG in the U.K., explains, ``What is it that CG principles are trying to achieve? The basic governance issues relate to the effectiveness and the accountability of boards of directors. Effectiveness is measured by performance. How well do boards run their companies and how can they be encouraged to run them better? Effectiveness is, therefore, a measure of the quality of leadership which boards are giving to their companies and the text of effectiveness is the result which companies achieve".

NEDs defined

The term NED is not defined in the Act. In fact, it does not a find a place therein. Strange, the Act defines director as ``director includes any person occupying the position of director by whatever name called". However, from a reading and construction of relevant sections, one can conclude that NEDs are directors other than managing or whole-time directors. To clarify, NEDs are directors who are not in the whole-time employment of companies.

The listing agreement has no inhibition in using the term NEDs. It has also added another dimension, ``independent directors' and proceeds to define them as `those directors, who apart from receiving directors' remuneration, do not have any other material pecuniary relationship or transaction with the company, its promoters, its management of its subsidiaries, which in the judgment of the board, may affect independence of judgment of the directors".

Role and remuneration of NEDs

The function of NEDs, all these years, was simply to attend meetings of the board or committees thereof, and of course, general meetings. For attending each meeting of the board or its committees, they are eligible for sitting fees, on a graded scale, the maximum payable being Rs. 5,000 per meeting. No fees is payable for attending general meetings although usually a board meeting precedes or follows a general meeting. Of course, NEDs are reimbursed their travelling, hotel and other incidental expenses. There is, however, a provision in the Act that NEDs can be paid a percentage of the net profits although only a few companies seem to have used this route to remunerate their NEDs. But the imponderable is, no amount under this provision can be paid, unless the company comes out with profits.

The role, responsibility, and exposure of NEDs have increased significantly with the growing emphasis on GCG. The amendment to the Act and the additional elaborate clauses in the listing agreement, swear by GCG. Alas, the Act is silent on increase in remuneration for NEDs, commensurate with their additional responsibility. It is also a matter of concern that in cases of conflict between the stipulations in the Act and the requirements under the listing agreement, it is not clear which would prevail. For example, the Act lays down that only two-thirds of the audit committee members need be NEDs, whereas the listing agreement would have all members drawn from NEDs only.

Role under the Companies Act: In terms of the year 2000 Amendment to the Act, it has been made obligatory for directors to include in their report, `a directors' responsibility statement' regarding application or otherwise of prescribed accounting standards and accounting policies. If there is any deviation, ail directors, including NEDs, are liable to be hauled up.

Further, in terms of the year 2000 amendment, public companies having paid-up capital of Rs. 5 crores and above, should constitute audit committees consisting of not less than three directors of which two-thirds should be NEDs. As a rider, the board's report is to reveal the composition of the audit committee. The Act does not spell out clearly the functions of the audit committee. It, however, stipulates that the recommendations of the committee on any matter relating to financial management, including the audit report, shall be binding on the board. If the board does not accept the recommendations, it has to record the reasons therefor and communicate such reasons to the shareholders.

An unnecessary and half-baked requirement is that the chairman of the audit committee has to be present at annual general meetings, and if he fails to do so, he will be liable to imprisonment (maximum one year) or fine (maximum Rs. 50,000) or both. Can woes of NEDs be harsher?

Role under listing agreement: The listing agreement has thrust a whole lot of additional responsibilities on NEDs. However, these stipulations apply only to listed companies, whatever may be their paid-up capital. The areas of new responsibilities, particularly relevant to GCG, are constitution and function of audit committee and remuneration committee, management philosophy, and closer scrutiny and policing of the implementation of approved policies.

The role of the audit company, consisting of entirely NEDs, is onerous. It is empowered even to appoint or remove statutory auditors and fix their remuneration. A welcome role for the audit committee is ``to look into the reasons for substantial defaults in payment to depositors, debenture-holders, shareholders (in the case of non-payment of declared dividends) and creditors. A major lacuna is the silence as to whether the audit committee's recommendations are binding on the board or not.

The remuneration committee is to determine, inter alia, the policy on ``specific remuneration package for executive directors, including pension rights and any compensation payment".

NEDs cannot escape attending meetings of the board, its committees and general meetings. Their record of attendance has to form part of the directors' report. Alas, they cannot arrange for proxies!

NED's remuneration package needs revision

The directorship of a company used to have a glamour of its own and an incumbent, especially of big foreign companies, used to be looked upon as demigods! Not any more. In the opinion of this writer, directors including NEDs, sit on chairs of thorns, with the proverbial sword of Damocles, hanging over their heads. They are susceptible to numerous pulls and pressures and subject to extortion by powers that be. They are liable to answer for all acts of omission and commission.

Even for a minor infringement of some obscure statute, of which they may well be not aware of, they can be hauled up, arrested, harassed and prosecuted. Managing and whole-time directors have at least the `support of handsome remuneration'.

It is their poor cousins, the NEDs who require all support and encouragement, especially now in view of the numerous onerous responsibilities thrust upon them.

As mentioned earlier, managerial remuneration consists of two parts - for managing and whole-time directors, a monthly salary and perks and a commission based on available net profits and for NEDs, fees for attending meetings of the board or its committees (pegged at Rs. 5,000 maximum per meeting) and in a few enlightened cases, a commission on net profits.

With the growing acceptance of the concept of GCG, there is not much of a gap between the exposure and responsibilities of these two categories of directors.

Again, with emphasis on professionalism, selection of NEDs has necessarily to be from the learned professions of law, finance, IT and marketing and it will be difficult to attract men of requisite calibre for a measly sitting fee. These gentlemen (or ladies) have to sacrifice their usual earnings from their own avocation for 1-2 days and in the bargain, upset their own clientele as well.

There is thus every justification for early and urgent action on the part of the companies to recompense NEDs also for a start with commission, which the Act provides for. But this is dependent on companies coming out with profits, which as is well accepted is not in the hands of NEDs.

Companies, especially in their gestation period, cannot be expected to come out with an ideal bottomline and hence it is necessary that the Act is amended for NEDs to be paid a minimum commission by whatever name called irrespective of the operating results. Otherwise the quality and calibre of the boards will, willy-nilly, be just average, unequal to meet the challenges of the current dynamic globalisation.

S. Balakrishnan

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