Separation of board and management; a boon for professionalized management and shareholders democracy, bane for promoter- owned, family-owned companies

LegalitySimplified

The foundation stone of Corporate democracy and managerial and supervisory efficiency is the interconnected arrangement amongst the board, the shareholders and the management, where the board supervises the management and reports to the shareholders. Proper separation and balance of powers between the board, the shareholders and the management enables a balance between shareholder democracy and professionalized management.  The issue of whether to separate the roles of the chairperson and the CEO/MD, is a long-drawn issue in Indian as well as global corporate law as well as a growing concern in corporate governance worldwide.

Countries like UK, Australia, Germany and Netherlands have tilted in favor of separating the two posts. The US also witnessed the strong trend of organizations moving towards the separation of the posts despite strong opinions for both the sides. In the early 2000s around 16% of large listed entities in the US had separate roles but this increased to more than 50% in two decades. In Europe, more than 90 percent of FTSE 100 companies have distinct roles defined.

Moreover, The Organization for Economic Co-operation and Development (OECD), the international standard setter for corporate governance, recommends that these two posts should be separated as a good governance practice. Institutional Shareholder Services, the proxy shareholder firm also advocates for a split in the Chairperson and CEO roles.

Kotak committee report and legal reforms

Section 203 of the Companies Act, 2013 (2013 Act) provides that an individual should not be appointed/reappointed both as the chairperson of a company, and its Managing Director (MD) or Chief Executive officer (CEO). However, the companies are entitled to deviate from this provision if their articles of association permits it. This provision also does not apply to companies with a single line of business.

SEBI formed a committee on corporate governance in June 2017 under the Chairmanship of Mr. Uday Kotak with a view to enhancing the standards of corporate governance, shareholder democracy, managerial efficiency and supervision of listed entities in India. Kotak committee report provided following recommendations in this direction:

  1. Listed entities with more than 40% public shareholding should separate the roles of Chairperson and MD/CEO with effect from April 1, 2020.
  2. After 2020, SEBI may examine extending the requirement to all listed entities with effect from April 1, 2022.

The committee provided following reasoning for the recommendation:

  • Providing a structural advantage for the board to act independently;
  • Reducing excessive concentration of authority in a single individual; c) clarifying the respective roles of the chairperson and the CEO/MD;
  • Ensuring that board tasks are not neglected by a combined chairperson-CEO/MD due to lack of time;
  • Increasing the possibility that the chairperson and CEO/MD posts will be assumed by individuals possessing the skills and experience appropriate for those positions;
  • Creating a board environment that is more egalitarian and conducive to debate.

The recommendation was implemented by SEBI with modifications through SEBI (Listing Obligations and Disclosure Requirements)(Amendment) Regulations, 2018 issued on May 2018, (Listing Regulations), which specifies that the chairperson of the board of top 500 equity listed entities should be a non-executive director and not be related to the MD or CEO. This amendment provided for a mandatory separation of the two posts which shall take effect from April 1, 2020. However, the requirement of separate chair and CEO was made not applicable to companies without promoters, i.e., those with dispersed shareholding.

Implementation and resistance

The legal reform was not welcomed by the industry and as it began exhibiting its resistance to the rule, SEBI deferred the implementation of the above-mentioned provision. SEBI further amended LODR Regulations on 10 January 2020 to postpone the date of implementation till April 1, 2022.

As SEBI noticed that only 53% of the top 500 listed entities had complied with the said provision by the end of December 2020, on April 6, 2021, SEBI asked listed companies to work towards splitting the roles of chairman and managing director and to be prepared for the change before the April 2022 deadline. At a virtual event organized by the Confederation of Indian Industry (CII) on corporate governance, SEBI chairman, Ajay Tyagi stated that the objective behind such a separation is to provide a better and more balanced governance structure by enabling more effective supervision of the management. It is not to weaken the position of promoters. The separation of the roles is to reduce excessive concentration of authority in a single individual. When CEO/MD and chairman are the same person, conflict of interest is likely to arise.

In February 2022, SEBI, in its board meeting took a note of the fact that as of 31 December 2021, only 54% of the top 500 companies had complied with the MD / CEO split requirement.

Considering the compliance levels, industry representations and constraints posed by the pandemic, SEBI vide its amendment to LODR dated 22 March 2022 (“2022 Amendment”) has made the split a discretionary requirement under LODR. It shall remain a good corporate governance practice and not a mandatory requirement.

The stiff opposition could have been averted if SEBI implemented the transition of governance structure through incremental reforms. The separation requirement might not have met with resistance, had SEBI not also insisted on the chairperson and CEO not being ‘related’ (this was not a recommendation of the Kotak Committee either). This rule presents an obstacle to the succession plans of Indian family-run businesses, which include more than half of top 500 listed entities.

Conclusion

Many companies in India, especially the family-owned or promoter owned companies have the two posts merged as CMD (chairman-cum-managing director), leading to overlapping of the Board and management. The requirement that the chair be unrelated to the CEO stands in the way of succession plans of family firms, whereby senior family members usually transition into chair roles while junior members manage the companies as CEO. As a result of this regulatory requirement, companies are now compelled to start looking at long term succession planning.

This separation provides a more balanced governance structure, which eliminates a potential conflict of interest if the same individual occupies both the CEO and chairperson roles, especially for the larger promoter-led companies. With regard to the family run companies, this can lead to professionalizing the executive management of the company.

Upon revocation of the move, market analysts and investors have expressed genuine concerns about continuing weak corporate governance practices in India that range from related party transactions to concentration of power and executive authority in promoter-executives. India has lately seen an increasing focus on governance issues, shareholder activism and dilution of promoter holdings in favor of institutional investors. As such, it could only be a matter of time before institutional investors here begin demanding separation of the chairperson-CEO post. Thus, in future we can expect a voluntary transition in governance structure stimulated by a parallel transition in ownership structure.

An alternative to separation of roles, as per the US model, is to appoint a Lead independent director to monitor the performance of chairman-CEO. the Kotak Committee has recommended introducing the LID position in India, which SEBI might consider implementing in future given the failure to mandate separation of roles.

Authors:

Alby Stephan. K, Legal Executive at Legality Simplified.

Ester Princy. P

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