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  • Vishu Surana

The Insufficient Impact of Kotak Committee Recommendations on Indian Corporate Governance

[Vishu Surana is a third-year student at National Law School of India University.]

An independent director (ID) is a non-executive director without any kind of interest in the company that may affect his / her independence. The role of IDs is to improve corporate credibility and governance practices by acting as a watchdog and playing a vital role in risk management. In India, Section 149(6) of the Companies Act 2013 and Regulation 16(1)(b) of the SEBI Listing Obligation and Disclosure Requirement Regulations 2015 (LODR) set out the eligibility criteria for an ID.

The practice of appointing IDs started in 1990s in the USA, which follows the ‘outsider’ model of corporate governance. In this model, there is a separation of ownership and control of the company, and the individual interests of shareholders are secondary to those in-charge of a company. Due to this corporate structure, companies face the first agency problem. This problem has been identified by Kraakman in his book ‘The Anatomy of Corporate Law: A Comparative and Functional Approach, 2017’ as conflict between managers (agents) and owners or shareholders (principal). To keep a check on management, boards are filled with IDs who protect the interests of the shareholders.

Since then, there has been a rising emphasis on the ‘monitoring’ role of the board to ensure that the interests of absentee stakeholders are protected. However, the concept of IDs has been universally transplanted, without any reference to local ownership pattern.

India follows the ‘insider’ model i.e. owners have a controlling interest in most companies. These controlling shareholders have the single largest shareholding, thereby exercising dominance over the company’s affairs. At present, of the BSE 500 companies, at least 100 have a promoter stake above 65%, which means possessing the ability to influence the board constitution by virtually appointing preferred candidates as IDs. In such scenarios, the conflict is between the controlling shareholders (agents) and the minority shareholders (principal). Since the minority shareholders do not own enough shareholding to outvote the controlling shareholders, they are helpless if the decision is not in their best interest.

Thus, Indian companies face a different agency problem i.e. conflict between controlling shareholders and minority shareholders. The controlling shareholders dominate the company and can protect their own interests, and thus the agency problem faced in the USA does not exist in India. Nevertheless, Indian boards are also filled with IDs in the hope that it will bring about corporate governance reforms, without realizing that the IDs are usually being appointed by the controlling shareholders themselves.

Hence, the emulation and eclecticism of corporate governance norms in the USA is unlikely to have any major impact on corporate governance in India. This transplantation is clear by the fact that NYSE does not require a board to have a majority of IDs when the company is a controlled company as it is recognised that when there is a controlling shareholder, the other shareholders cannot be protected by IDs.

In this light, the Kotak Committee on Corporate Governance (Committee) was set up to suggest improvements to provisions related to IDs to improve corporate governance norms in India. This piece argues that since the difference between ‘outsider’ and ‘insider’ systems of governance has not been recognized by the Committee, its recommendations on IDs will have a limited impact on corporate governance in India. This is because the agency problem between controlling and minority shareholders remains largely unsolved as the appointment of IDs is itself subject to the controlling shareholders.

The rationale that IDs control functions involving ratification and monitoring of management actions to ensure a check on the company does not apply to India where there is an overlap between the owners and the management. To dilute the dominance of controlling shareholders in the appointment of IDs, the Committee recommended having a Nomination Committee, two-thirds of which would comprise of IDs, but this recommendation was rejected by SEBI. The current system of appointing an ID is to select a person to be appointed as an ID from a databank maintained by the Central Government, pass a board resolution and then have a direct election in a general body meeting of the company. However, since the votes are proportionate to the shareholding, the controlling shareholders control who gets appointed. Thus, the current system of direct elections, without any independent nomination process, will not lessen the influence of the controlling shareholders on IDs.

The Committee’s recommendations to exclude persons who constitute the promoter group of a listed entity from the definition of IDs and prevent board inter-locks were accepted by SEBI. While this will ensure that the controlling shareholders have lesser dominance on the board and IDs can take unbiased decisions, the problem of the presence of a promoter, who is not a director, in the board meetings and the indirect control exerted by him / her is not resolved. For instance, all IDs of JM Financial raised concerns over the presence of Vishal Kampani, CEO but not a Director, in all board meetings, yet nothing was done about it.

Having independent directors will not make much difference in improving governance if these voices are not truly independent. In practice, they generally have de facto allegiance to the controlling shareholders. They have a tendency to passively approve the actions taken by the company. The Satyam-Maytas fiasco demonstrates the inability of IDs to exercise unbiased judgement as even though they raised several questions regarding the proposed acquisition of Maytas by Satyam, they unanimously approved the deal in the board meeting.

The Committee’s recommendation of having at least one ID for quorum of all board meetings and Nomination and Remuneration Committee meetings will ensure involvement of IDs in the governance of the company and increase their accountability. However, SEBI did not accept the recommendation for exclusive ID meetings or appointing a lead director. Thus, the problem of lack of effective engagement and information asymmetry between IDs largely remains.

SEBI also did not accept the recommendation for having mandatory induction and training of IDs and left it to the discretion of the companies. The reasoning behind this recommendation was that IDs may have a diverse set of skills but may still not understand the company’s operations well. However, SEBI accepted the recommendation for disclosure of the expertise of the board of directors in the Annual Report. Even if this recommendation is successfully implemented, it will only have a limited impact as it does not address the problem of an ID being unable to exercise independent judgement due to lack of knowledge and access to information about the company. Even in the IL&FS fiasco, the ID did not raise any questions on why the money was lent, as long as the company got its money back. One of the IDs said that he was unaware of the extent of the crisis as he was not privy to the daily operations of the company.

This fiasco also raises the question of the role of IDs and to what extent they can be held liable for the company’s mismanagement. IDs are treated like other directors under Section 166 of Companies Act 2013. It is unclear whether IDs are advisors to the management or protectors of stakeholder’s interests i.e. employees, financial lenders and minority shareholders. Since the Committee made no recommendation on this, the ambiguity on the extent of their obligations remains.

If IDs are held liable for corporate fraud and severe penalties are imposed on them, it will become even more difficult to appoint right people as IDs. This is seen by the increasing instances of IDs rendering their resignations after any corporate fraud comes to light and courts impose personal liability on IDs for failing to discharge governance responsibilities (Jaypee Infratech case).

Even if a particular ID is highly committed, he alone cannot prevent any wrongdoing or management fraud, as he cannot stop a decision by himself or blow the whistle outside the board room since these meetings are considered confidential. Even when IDs choose to raise governance related issues, boards do not pay any heed to them, and they have no option but to resign to avoid being personally liable for any wrongdoings of the company. For instance, Anil Khandelwal resigned from the Board of JM Financial as ‘the company’s perception about governance issues were in wide variance of his understanding about a transparent governance issue’.

This brings us to the next recommendation of the Committee i.e. detailed reasons should be given by IDs on resignation before expiry of their tenure. Since 2014, out of 2703 IDs that resigned, no reason was given by 2046 of them, leaving the stakeholders with no clarity on the internal affairs of the company. For instance, since the revelations by Rana Kapoor of the increasing NPAs from loans given by Yes Bank, five board members have resigned without giving any relevant reasons, even as its Moody ratings and share price continues to fall. Even when reasons were given, most of them cite personal reasons but continue to remain on the board of other companies. If this recommendation is implemented, it will ensure wider disclosure and greater clarity for the external stakeholders.

India has traditionally relied on more regulation rather than improved implementation and enforcement. However, the promoter-led model followed in India has prioritized the promoter’s self-interests over minority shareholders, which has made enforcement of corporate governance norms more challenging yet equally imperative.

While the recommendations may increase transparency and information available with stakeholders, it may not improve corporate governance or prevent scandals significantly. Since India does not statutorily mandate the ‘comply or explain’ approach, most companies follow the tick-box approach rather than placing emphasis on what will be more impactful for the governance of the company.

While the recommendations may reflect well in firm value, they fail to take into account the vulnerability of minority shareholders in insider systems. Minority shareholders must be conferred rights such as proportional representation on the Board or cumulative voting rights. For instance, public sectors banks are mandated to have at least one director who is an employee-representative. Unless IDs in insider systems are appointed through a larger democratic process, the sole reliance on them as a check on management cannot be long-lasting.


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