Two agencies regulate companies in India: the Ministry of
Corporate Affairs (MCA) through The Companies Act, and the
Securities and Exchange Board of India (SEBI), whose writ covers
all listed entities. Until January 2009, SEBI was the clear
winner. The companies that really mattered were listed and,
therefore, in SEBI’s jurisdiction; the key clauses of the
Listing Agreement clearly defined the norms for financial
disclosure and corporate governance; most importantly, SEBI was
considered a more transparent and professional body compared to
Satyam changed all that in January 2009. As a stunned corporate
world was figuring out how half a dozen felons led by Ramalinga
Raju stole monstrous amounts of company money with neither the
statutory auditors nor the non-executive directors having a
clue, the MCA assumed charge. It played the lead role with the
investigators, the new Satyam Board, the press and the
politicians. In the process, it consigned SEBI to purgatory.
Since then, the MCA has been determined to define a new control
raj and hold the aces.
The Companies Bill, 2009, is a particularly gross example of the
MCA calling the shots. The original bill has been significantly
modified by the MCA and the Parliamentary Standing Committee (PSC)
chaired by Yashwant Sinha. The PSC report — including the
altered bill — was presented to the Lok Sabha on 31 August 2010.
It will be debated in the winter session of Parliament. Given
how little parliamentary debate occurs in matters such as
competition and corporate law, it will be almost certainly
passed during the session.
This article critiques certain terrible provisions of the bill
which relate to corporate governance, boards and auditors. I
certainly believe that The Companies Act, 1956, needed changing
to the 21st century. But in doing so, the MCA has displayed some
terrible aspects of licence-control dirigisme and excessive
over-reach of law. Here is a small sample.
Board size. Clause 132(1) of the bill states that every public
limited company must have a minimum of three and a maximum of 15
directors, excluding nominees from lending institutions. A
company wishing to appoint more directors can only do so after
obtaining prior approval of Central Government and passing a
special resolution. Every sensible country’s corporate law
prescribes the minimum, as it should. But why should it impose a
maximum? Isn’t that a matter for the company’s shareholders to
decide? And if the shareholders agree to such a special
resolution, why does a company need “prior approval of Central
Government” to increase its Board size beyond 15?
An independent director’s term. According to a new clause 132(7)
introduced by the MCA and approved by the PSC, (i) no
independent director shall have a tenure exceeding, in the
aggregate, a period of six consecutive years on the Board of a
company; (ii) three years must elapse before such a person is
inducted in the same company in any capacity, and (iii) no
individual shall have more than two tenures as independent
director in any company in the manner provided in this clause.
Clause 132(7) has appeared thanks to a clever ploy by the MCA.
It wasn’t in the original bill. In December 2009, the MCA
released a document called Corporate Governance: Voluntary
Guidelines, where it stated:
“a) An individual may not remain as an independent director in a
company for more than six years.
b) A period of three years should elapse before such an
individual is inducted in the same company in any capacity.
c) No individual may be allowed more than three tenures as an
independent director in the manner suggested in (a) and (b)
Impossible to tell apart, right? When various organisations and
bodies seriously critiqued this provision, MCA responded that it
is ‘voluntary’ — and no different in spirit to the voluntary
recommendation in SEBI’s Clause 49 that an independent director
ought not to serve for more than nine consecutive years.
In subsequent discussions with the PSC, the ministry
successfully introduced it as a new sub-clause. The PSC has not
only agreed, but has also stated that it “would like the
Government to formulate a code of Independent Directors [to]…
include their mode of appointment, role and responsibilities…
their remuneration and extent of their liability”. With the MCA
convincing the PSC that various elements of its ‘voluntary’ code
should be incorporated in the Bill, it has made ‘voluntariness’
No corporate law in any country worth the name legislates the
maximum number of years that a director can serve on a Board.
Not in the USA; in the UK; in Australia; in Canada; in
Singapore; in Hong Kong; and many more. Such a ceiling, if it
exists at all, is in the Memorandum and Articles of Association
of a company, or as a Board practice. Legislation does not
prescribe a ceiling.
Consider this. Is there a law that states the
maximum number of terms for a Lok Sabha MP? If political
representatives have no ceilings on the number of terms that
they can be elected, why is it imposed on corporate fiduciaries?
How can law decide the maximum tenure of an elected appointee of
the shareholders? It is for a company’s shareholders to choose,
not the State.
Such a clause seriously impairs the working of Boards and
corporate governance. Consider multi-product, multi-location,
multi-service companies, or businesses with substantial
regulatory interface such as banks, mutual funds and insurance
companies. Even with serious training, it normally takes a new
independent director a year and a half to properly understand
nuances of the businesses. Hence, what is proposed is that the
effective tenure of being an informed and sensible fiduciary be
four and a half years. After that the Nomination Committee of
the Board will have to hunt for a replacement.
What great corporate governance is this? Where is it to be found
in law? Where is the hard evidence that independence in judgment
ends after serving six years on a Board? None whatsoever. How
then did it come to pass? Because the MCA found it ‘worthy’ for
Number of directorships. A new clause 146 inserted by the MCA
states that no person can be a director of more than 15 public
companies, and within these, in no more than seven listed
companies. That is probably fair. But the PSC has tightened it
further. The maximum number of public companies has been reduced
to 10; and for listed companies, it has reduced to five. To
reduce the number of listed companies where a person can serve
as a director to five is extreme. A person can, with full
diligence, serve on seven to nine listed Boards, especially if
these are not as meeting-intensive as those of banks. I’m
willing to bet that limiting it to five won’t improve
governance, while it will certainly increase the stress of
finding new directors. And if this clause is about getting
directorships for those who don’t normally make the cut, it
still won’t. Let me state an honest truth. Today, there aren’t
even 250 people who are genuinely competent to be independent
directors of major corporations. The law won’t suddenly increase
this to 500 or 1,000.
Ban on stock options. A new clause 132 (6) states: “Subject to
the provisions of section 176, an independent director shall not
be entitled to any remuneration, other than sitting fee,
reimbursement of expenses for participation in the Board and
other meetings and profit-related commission as may be approved
by the members.”
Thus, stock options have been omitted in law “to allow
independent directors to remain independent in decision making”
(PSC). Here are four questions:
· Which significant nation’s (USA’s, UK’s, Canada’s,
Australia’s, Singapore’s, Hong Kong’s to name some) corporate
law bans stock options for independent director? Answer: none.
· Where is the irrefutable evidence that stock options given to
independent directors systematically encourage corporate mis-governance
and self-seeking behaviour at the cost of long term shareholder
value? Answer: none.
· How can one expect to attract best-in-class independent
directors on Boards of start-ups without getting stock options?
· How can one attract good independent directors to sit on
Boards of financially distressed but sound companies without
getting stock options? Answer: can’t.
One can impose constraints. For example, listing
norms can state that stock options, even if converted to shares
by an independent director, cannot be sold until six months
after the director exiting from the Board. Such constraints are
worth debating. But to ban stock options is seriously
Statutory Auditors. The big firms have had it! Clause 123 (1A)
states that no company shall appoint/re-appoint an individual or
a firm as auditor for more than five consecutive years.
Moreover, such a firm or individual auditor shall not be,
respectively, eligible for re-appointment as auditor in the same
company for five or three years thereafter. In addition, where a
firm is appointed as an auditor, the auditing partner of the
firm must be rotated after three consecutive years and shall not
be eligible to be re-appointed as auditing partner of the same
company for the next three years.
These are absurd. Only Italy has compulsory rotation of auditors
by law — and Italy is hardly the model for corporate governance!
No sensible common law or civil law country has these
This clause is due to pressure from the Institute of Chartered
Accountants of India (ICAI). The large mass of ICAI members want
to audit large corporations, even if they don’t have the
requisite skill sets. They have now changed the law to get
entry. Have no doubt that such short period rotation will harm
the quality of audit. And even the small firms will lose their
few marquee clients!
I can state many more. But here’s the piece de resistance. The
PSC has recommended that the maximum percentage for political
contributions per year be raised from 5% to 7.5% of average net
profits during the three immediately preceding financial years!
That’s brilliant corporate governance, isn’t it?