Companies Bill, 2011...Governance!
Hello & Welcome to The Firm. The Parliament may not find it worth its while to debate the Companies Bill, 2011 but we do. And so we are continuing our analysis of this crucial proposed legislation, which on becoming law, will bring about big and lasting changes to the way companies are incorporated, funded and governed. Last week we discussed key commercial proposals from corporate structures to restructuring. This week we focus on governance- joining me this week Ė Nawshir Mirza, formerly with E&Y and now Independent Director on several boards; Bharat Vasani of the Tata Group and Mohandas Pai, Chairman, Manipal Universal Learning.
Doshi: The first topic that I would like to bring up and that has to do with several changes that impact Key Managerial Personnel. Mainly, limits on remuneration and the separation of the Chairman and Managing Director or CEO posts? If I remember correctly, the 2009 version of this Bill had done away with any government imposed limits on remuneration to key managerial personnel. The parliamentary standing committee in its report said no, we must impose some limits in the light of the Satyam scam and therefore we now have limits making a come back in this 2011 Bill Ė What do you make of the limits- they seem to be liberal, are they liberal enough?
Vasani: Certainly itís more liberal than what was there in the 1956 Act which is currently there but unfortunately lot of ambiguities are there for example while they have introduced those overall limits, if the company is not making a profit, we have to go back to Schedule V which was earlier Schedule 13 and there they have provided effective capital based limits starting from Rs 30 lakhs to 60 lakhs and they have said that if the shareholders approve it by special resolution, it goes to twice that amount. Also, there is a proviso which is very interesting that if the person is not a shareholder or a director or an employee for the previous two years, then the limits can be as high as 2.5% of the current relevant profit and that term is defined.
The most interesting part is that if the person is doing exceedingly well and is a Vice President, he is elevated to the Board as an ED or MD, then he cannot get this benefit. If a person is already a Non-Executive Director and he becomes an Executive Director, he cannot get the benefit and if the person is just holding 10 shares or 1 share even two years before, he cannot get this benefit. So what is the rationale- are you punishing efficiency that the person is extremely bright and he is Executive Vice President and the Board feels he should be elevated on the Board, then he cannot get the benefit of 2.5%... (Interrupted)
Mirza: I think it is limiting particularly in the context of what Mr. Vasani just said because if the company is not making enough profits, indeed, the people running the organization are far more challenged and they have much more difficult jobs to deal with and they deserve a better remuneration for what they are doing. It is not related to what the profit is but itís related to the effort they need to put in.
Doshi: One can also argue this from a governance point of view- we have seen several instances in corporate India where companies are not doing very well and yet their top management is paid exceedingly well and maybe this is trying to strike a balance saying that you can get remunerated through ESOPs or something like that, something which is linked to the future performance of the company but today you are not making profits then there is limitation on how much you can get.
Mirza: You have just raised an interesting point. I think the ESOPs shouldnít be out of the entire remuneration structuring, currently ESOPs is left entirely out of all remuneration limits, measures... (Interrupted)
Doshi: Even for key managerial personnel? I donít think so; only for Directors right?
Mirza: No, even key managerial personnel because how do you value the ESOP. So currently it doesnít figure in any calculation.
Pai: I think the section that is there is slightly misconstrued- it should have been made liberal where the board is authorized to do that and shareholders have to vote on it in special resolution except for one caveat- I would add that if any member of the board holds more than 3-4% of the company, directly or indirectly or his family holds something, there should be some limitations because all the cases of corporate abuse that you saw are in companies where promoters have a large stake directly or indirectly or through the family and take huge compensation for themselves irrespective of performance. In such cases, there is a need for the government to come in. But when it comes to professional directors, when it comes to loss making companies, I think it should be a matter between the board, the remuneration committee and the shareholders. Otherwise we need a change in the law as it is today; it is not the right thing to do for corporate India.
Doshi: The other half-baked or quarter-baked proposal in this Bill is the separation of Chairman and CEO or the Managing Director post and it seems like they wanted to push it through till some corporate lobbying came in and forced them to change the wording of that Clause because they have said. Ď it is mandatory unless the article of the company provide otherwiseí, which gives company such an easy exit clause Ė what do you make of this because we have debated this earlier on this show and most promoter run companies in this country are opposed to the separation of those two posts?
Pai: There has to be a separation because it is time that India started a better governance system. You have many companies where the promoters are Managing Directors, they are Chairman that means they are executive people who manage the company can also manage the board and they manage the Board. I think there has to be separation of powers; it has to come in the Statute. What has been done is totally wrong, against all spirits of governance and is oppressive of the minority. I am very clear in my mind, I would like a non-Wholetime Chairman and a Wholetime Managing Director and these two to be separate posts and if you are a Chairman, you should not be a significant shareholder because if you are a Chairman and a significant shareholder, you could set the agenda for the board and you could do many things to make sure that your interests are protected.
Doshi: Moving on to the next issue in terms of Independent Directors Ė lots of changes Ė the Tenure is fixed, remuneration includes no ESOPs- so limited in terms of the fact that ESOPs have been ruled out, a whole new guide book to what the functions and responsibilities and duties of the Independent Directors are and an attempt to limit the liability of Independent Directors Ė what do you make of all these changes, will it make Independent Directors more Independent on Indian Board?
Mirza: At first sight, it might appear to be so but the biggest concern I have and the biggest issue of this Bill which perhaps at a first reading people donít realize is that there are three places in the Bill where the Board and particularly Independent Directors are made responsible for balancing the interest of all stakeholders. This is a profound change, which requires a huge amount of social debate that perhaps should take 10-20 years to determine that are we now putting aside the capitalists system in how corporations are governed and the objective of corporations and the purpose of the firm is now made as for all its stakeholders. I am all for this but I am not for it in the way it is has been brought in.
Doshi: The one place that I noticed it was mentioned is in Schedule IV which is what they are referring to that the Code is a guide to professional conduct. I donít know how mandatory Schedule IV is? Is this Schedule IV just a guide book on how independent Directors should behave and what should their functions be or does it accept you to safeguard the interest of all stakeholders, particularly the minority shareholders?
Vasani: In my reading, the word Ďshallí - the way the Clause 149 which will eventually become Section 149- it is mandatory and the wording of Schedule IV at several places says Independent Directors Ďshallí and doesnít say Ďmayí.
Doshi: Yes, but the introduction says the Code is a guide to professional conduct to Independent Directors?
Vasani: A mandatory guide.
Doshi: What do you make of that Schedule IV because if all of Schedule IV is applicable, I cannot see a single Independent Director wanting to continue on any board in this country. Some of the clauses are absurd and I will read one Ė ď ..moderate and arbitrate in the interest of the company as a whole, in situations of conflict between management and shareholderís interest.Ē there are several such clauses in that Schedule IV?
Pai: I think this is the ghost of Satyam talking, the ghost is very evident in this and the government has developed cold feet and they are trying to legislate good behavior into law which is totally wrong because if you read the Code and understand everything, you just cannot work in the company. Every decision that you make is up to question, people can ask you why you are doing this, why you are not doing this and there is no end to this debate. I think we should abandon this Schedule IV and make sure that we normalize what is there in the Companyís Act and donít put too much of a burden on Independent Directors.
Yes, Independent Directors have to balance interests of all stakeholders- the direction is correct but doing it right now, mandating it right now is not very good. I think Schedule IV should go lock, stock and barrel because itís not well construed. You cannot put all that liability on somebody who comes and attends 5 meetings a year. For 5-6 days a year you come, you donít have enough information, you are not giving briefing, and you donít get compensated for your efforts in most companies- I donít know why anybody should become an independent Director.
Doshi: I thought that this is a battle Mr. Mirza would be fighting but you have taken up on his behalf.
Mirza: It is also actually in Clause 166 (2) that, ĎA director of a company shall act in good faith in order to promoter the objects of the company for the benefit of its members as a whole, and in the best interest of the company, its employees, the shareholders, the community and for the protection of the environment.í
It goes a little beyond because suppose a company has a very high PE, obviously the PE is high because people assume it is going to be making super profits and that is why they are willing to pay much more. Some a vendor to the company can turn around and say look this company has been squeezing me almost to near death and as result itís got this high PE, its not acting in the interest of its vendor stakeholders or customer can come in and say you should cut prices, why should they have such a high PEÖ(Interrupted)
Doshi: And that becomes the liability of Independent Directors?
Mirza: In Clause 166 it becomes of the whole Board, in Schedule IV it becomes of Independent Directors- so there will be no end to this defense. Because we are saying the capitalist system will no longer regulate the purpose of the companies; it is a more social purpose that companies exist for. We must have a proper debate on this; not introduce it in this surreptitious fashion.
Vasani: Tata Management Training Centre did a study last year on the Independent Directors and why they donít speak their mind at the Board meeting and they came out with a very interesting issue that in India, we have a huge cultural issues because of which the Independent Directors either speak before the Board meeting or after the board meeting but not during the Board Meeting.
Doshi: But that cannot explain away why they donít do what they are meant to do which is speak at Board meetings?
Vasani: But unfortunately, it is not going to happen by legislating it as Mr. Pai rightly pointed out; you cannot legislate governance and ethics.
Doshi: But you have to force something top down because bottom up is not working in this country.
Vasani: You can create an enabling architecture but you cannot compel. Will this guarantee high quality deliberations and decision making at the board level, I am not so sure.
Doshi: I want you to come in on the fact that it doesnít seems to me that the governmentís intentions are wrong or poor because they have made this effort to limit liabilities saying ĎIndependent Directors are liable only in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently.í so they are being sensitive to the needs of the Independent Directors except that there is this vague wording that is going on in the Bill and that makes it look otherwise?
Pai: The key challenge that we faced in governance is that a dominant shareholder who is also the manager, who is also the Chairman of the company- there can never be good governance; there is conflict of interest and that problem has to be solved. And unless you solve the problem through other means, to say where there is a dominant shareholder he cannot be the Chairman of the company, the Chairman has to be independent, you will never have independence. So I think you have a problem, the basis of the problem is that.
Doshi: Since we do need to move on to the next topic I want to give the last word on this to Mr. Mirza - remuneration, no ESOPs, fixed tenure which I am guessing all of this seems minor when you bring up the other big issue of behavior, roles and responsibilities. What do you make of all the changes?
Mirza: I think I make of all the changes that while some of these are good improvements or they are improvements.....
Doshi: For instance?
Mirza: For instance I think removing ESOPs from independent directors. I am in favor of that.
Doshi: Fixed tenure?
Mirza: Fixed tenure, I have nothing against it but I donít think I have anything for it. Indeed there is some confusion in the wording here itself that it says upon the retirement, the 1/3rd to be retiring every year does not apply to independent directors.
Doshi: So you get appointed for a fixed term of five years and the second five year term is a special resolution; non-independent directors?
Mirza: Correct. So itís not clear that retirement provision then applies to which director because the others are nominated directors, they are not subject to retirement. It doesnít apply to independent directors
Vasani: There is a dichotomy between two clauses in the sense that you will not have a board which will have not more than 1/3rd non-retiring directors. But leave aside that issue. I want to correct one factual issue which says that they have been given immunity; immunity is only under the Companies Act. They can still be prosecuted for violation of PF Regulations or any other law. So tomorrow if there is an IPC offense, they will go inside irrespective. The immunity is confined to the violation of the Companies Act.
Doshi: I wanted to come to that because it looks like an umbrella immunity but its umbrella when it comes to this Act because this cannot supersede other acts and most often independent directors are harassed or bothered by those Acts as opposed to Companies Act.
Mirza: Negotiable instruments.
Doshi: Yes all of that. I want to wrap this point up because we do have to move on to audit and I know thatís an equally interesting point to talk about. You are accepting of most of the changes except for the vagueness with which they have defined roles, responsibilities, functions and thatís what we need clarity on. Throw Schedule IV out lock stock and barrel or make it just a guide.
Mirza: And Clause 166.
Doshi: Let me move on to audit committees and audit. Let me refer to it as the broad function of audit and the interface between companies and their auditors. Here too Mr. Pai - there have been fixed tenures, several changes, liability has been upped, supervision of auditors and audit firms is likely to change now because the National Advisory Committee on Accounting Standard (NACAS) could be renamed and re-empowered. What do you make of the changes that are going to come in with regards to the interface between audit firms and companies?
Pai: I think many of the changes are very good. Having a regulator like the PCAOB in the United States - that National Regulatory Authority is very good. I fully support that except that it should be made more stringent. Rotating the firms, I support that now. I didnít support it earlier. Now I think about it. I support it very well. Rotating partners, obviously it happens. Fastening some liability on them, I think it happens because of many important issues. You have seen in the case of Satyam how the auditors behaved. They went and made a deal with SEC, admitted to culpability and said, yes there has been a bad audit. But in India, they have not done it. There double standards are being followed. They are not even getting punished, they are going to courts and taking stays in many areas and showing their disdain for good governance. For good audit, I think its time that some kind of regulation is brought.
Vasani: In fact, I think one important change which people should not miss out that now the auditors cannot be removed by the shareholders alone, it requires central government approval. If an auditor resigns, he has to give a detailed letter to the CAG which was essentially for public sector. Now they have brought it to the private sector that why is he resigning. I am in favor of the changes made because there was too much of clubbiness between the management and the auditors.
Doshi: So you approve of rotation, you approve of the fact that audit firms cannot provide conflicting non-auditing services to an audit client, you approve of the fact that there will now be enhanced liability not just on the audit partner but on the firm as well and this new body NACAS which may become NFRA will have the power to debar firms as well?
Vasani: Now auditors have no excuse for not doing the job. Let me put it this way. There is no need for them to oblige the promoters.
Mirza: Having being an auditor for 36 years let me have my say. Indeed on the rotation thing let me start with that- I donít know why the Act restricts it only to listed companies. If it is such a good thing, why deny it to all the other lakhs of companies. I would say that all they need to do is to remove the word listed. Every company should rotate its auditor. I see no reason why it should be denied..... (Interrupted)
Doshi: Yes; why not? Some of the largest companies in this country are unlisted companies.
Mirza: There maybe small companies, so what? Is it that small companies, we donít get the benefit of the new auditors? So I should say rotation should be right across the board, I am all for it. Every 10 years, let all the six lakh companies change their auditors. I think itís a great idea.
Doshi: Do you believe it will mean less clubbiness and therefore a more scrutinized efficient audit?
Mirza: Indeed. If there is this threat of rotation, I will offer to such so-called promoter managements which have been denigrated continuously- I will come and tell them, you know I am a very clubby auditor, please appoint me now that the rotation has come up. See in the normal course, I couldnít go along to one of these managements and say appoint me. He will say I already got a nice auditor. Now I will go around selling myself not on the basis of my professional skills but on my ability to suppress my professional competence.
Doshi: Thankfully you can be clubby only for two consecutive five years.
Mirza: 10 years is long enough.
Pai: In listed companies, public interest is involved - thatís the crucial thing. Unless your companyís public interest is not enough. Public interest entity is very clear. They are public interest entities; it is very clear- I think on that issue, the debate is closed for a long time. Itís not that private companies have public money.
Doshi: Are you opposed to the idea that this should be extended to all companies including unlisted?
Pai: I think we are making unnecessary arguments because the unlisted companies have a very different governance structure and I think we should let them be and not try to impose many rules on them.
Mirza: Unlisted companies borrow public money, they pay taxes
Vasani: Substantial borrowing from public institutions.
Doshi: So where do you stand on this debate?
Vasani: I think the auditor related provisions are fine.
Doshi: Listed and unlisted?
Vasani: I think it should apply to certain large unlisted companies also particularly which are taking recourse to public borrowings.
Doshi: I do want to move to the other equally important issue of shareholder democracy and I think two big points here. In several places in this Bill, they have proposed an exit for dissenting shareholders by the controlling shareholder or the promoter. So if you disagree with a change in objects with regards to unutilized funds raised in a public offer or if you disagree with amalgamation scheme, they have proposed an exit. We donít have the full details of how this exit works but it could be one step forward in shareholder democracy. The other step and a big step forward is the enabling of class action suits at the tribunal level. Again I donít know how effective thatís going to be. It depends on how effective the tribunal will be but both of these mark a big change.
Vasani: Significant change but more importantly, now also they are going to allow the shareholders to participate through electronic voting.
Doshi: So third step forward in terms of shareholder democracy.
Vasani: But only thing I have a concern is that the several provisions of the Bill contemplate management being required to approach to the shareholders far too frequently. That may create a problem particularly when it comes to inter-corporate loans, investment guarantees, and related party transactions. So I donít know will it increase the cost, will it reduce the speed. These are all balancing factors but principally I am supportive of shareholder democracy principles and the way the current Bill is worded, the provisions relating to that.
Doshi: Mr. Mirza where do you stand on this because I think the issue that Mr. Vasani raised is with regards to having to go back to shareholders for inter corporate loans or even related party transactions where they have now finally taken heed of the SEBI suggestion and said that a related party cannot vote in the special resolution where a related party transaction is put to vote. I think thatís a step forward because that includes more shareholders, it gives them a stronger voice in important matters like this and they can now vote electronically as well.
Vasani: But there is a potential to misuse also. The minority group of shareholders can try to say that I will not approve of a particular transaction unless I am taken care of. In every system in India, there is always a potential..... (Interrupted)
Doshi: But every system is open to that flaw, right?
Vasani: But here I donít know whether it is advisable to go so frequently to the shareholders for everything which is now being contemplated.
Doshi: Have we hit an extreme?
Mirza: My only issue on related party transactions is that in Clause 177, the audit committee has been charged with approving them and I think thatís a dangerous practice. The audit committee should not make any executive decisions like approving related party transactions. Its job is to protect the auditors and to make sure the financial statements prepared are reliable. Now if the audit committee has approved a certain transaction and the consequences of that transaction financially later prove not to be so good, the audit committee might be biased or influenced into trying to suppress..... (Interrupted)
Doshi: So barring this audit committee point, do you believe that the steps taken to strengthen shareholder democracy are positive steps?
Mirza: I think yes; I think so.
Doshi: Where do you stand in this conversation?
Pai: I stand for third party liability suits because I think it is fine that this has come. That has a very good effect on bad governance. Two, I stand for this related party transactions going to shareholders and related party is not voting on such transactions because there have been wise spread abuse.
Doshi: I think we have covered the broad key areas of change that we wanted to. There are several other important Clauses that have changed but we are entirely out of time and I do want quick wrap up comments from each one of you. I am going to start first with you Mohandas Pai.
Pai: I think itís a very positive change in the way it looks at corporate India and governance. I wish they will go further like separating the Chairman and the Managing Director posts, making sure that the role of the dominant shareholder in management is reduced so it becomes much more democratic and much more open. Obviously independent directors should have stock options otherwise why should good people come and spend the time especially when the company makes losses, we will not be able to get good directors to come. So I support stock options unlike one of the panelists. But overall, I think the direction is very good. Schedule IV should be put in the backburner- just made a code that you follow but you are not liable for. Overall I support this.
Doshi: Alright, voluntary code. Mr. Mirza if Schedule IV was done away with along with that one Clause that you wanted done away with, do you think this Bill takes the right steps towards trying to enforce better governance top down because bottom up is taking way too long in this country?
Mirza: I would make two or three points. One point is that the Bill, in several Clauses on governance, deals with listed companies. I always thought the regulation of listed companies was the prerogative of SEBI. Now we have two organizations or two regulators who are going to tell listed companies how to behave. Indeed we may end up with situations where there is a conflict between the two. Even today, it says here for example, what proportion of independent directors there should be which is different from what the SEBI requirement is. My other point is the government continues to behave like a fabian socialist nanny state because in many things, the government believes that the shareholders and the board are incapable of reaching a fair decision and that most managements or promoters are crooks and so we must approve this, we must approve that. They have even defined what corporate social responsibility- is so itís the kind of Bill written by somebody who was living 40 years ago.
Doshi: It may have defined a lot many more things but has it reduced the number of trips you will have to make to the government or to the MCA in order to get approvals because it has moved a lot of those approvals now upon shareholderís shoulders?
Mirza: I donít think so because there are few hundred places where they are going to still write the regulation. God knows what they are going to write and how often they are going to change that and what amount of lobbying people will be doing in Delhi. So Delhi continues to have its hands on all the levers of power to keep pressing corporates.
Vasani: There are 377 items on which they prescribe Rules.
Doshi: Last word to you in this debate.
Vasani: Except for the clause which doesnít compel the separation of CEO and the Chairman, I think their heart is in the right place.
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