Improving Corporate Governance

The Economic Times - February 27, 2012

It would help to reduce the familiarity quotient on boards and factor in business health beyond profits.

Corporate India has been calling attention to two issues: one, in the context of the proposed Companies Bill, is reasonableness in non-executive director liability and penalty for misdemeanours pertaining to day-to-day operational management of the company. The other is the call for better public governance. Suddenly, there is more open complaining to ministers in public meetings about extortion by government agencies and blatant rent-seeking behaviour.

This is probably a good time for corporate India to also look inward and improve its own corporate governance, moving it beyond regulatory compliances to better oversight (an unfortunate corporate governance term that means the exact opposite in the English language). There is enough low-hanging fruit to be taken advantage of in the form of improvements that can be quickly implemented.

The first area to improve is board composition. A lot has been said about the benefits of diversity in boards. Indian boards do have a fairly high diversity quotient (DQ) in terms of work experience and socio-cultural and values/attitude/lifestyle, because of the inherent diversity of India - even among people who went to the same colleges. However, they have a less visible, less-widely-discussed problem of high familiarity between board members. It is decreasing the familiarity quotient (FQ) of the Indian board that should be the first priority in improving governance, even ahead of increasing the DQ. FQ isn't the result of cronyism but because of birds of a feather tending to flock together, in a relatively small world.

Board members tend to have several shared workspaces at present, or have been connected in past workspaces, perhaps even in boss-subordinate or board member-CEO or customer-supplier roles and so on, and, hence, know each other very well or have a past established pattern of power or hierarchy. This high level of familiarity increases the risk that board deliberations become less rigorous than they could or should have been, and results in more quick 'negotiated' settlements on issues, even without the people themselves noticing the implicit negotiation process!

Nomination committees then compound this FQ in the way they often work: "Who do we know who has xyz skills/background/personal traits?" Sometimes, it is the CEO who proposes the shortlist of names for the nominations committee, or nom coms, to deliberate on, and an increased FQ between the CEO and the board further weakens governance. The starting point of nom coms asking "who do we know" is not wrong. Boards are a sensitive social system, and, of course, it is critical to have shared values and mutual respect among members, and new entrants to the team must have enough points of commonality with the rest, for boards to be effective. Personal experience and vouchsafing by present board members is a very good way to do this. But if we start with a board with high FQ, then this way we end up with even higher FQ.

A good working solution is to say that at given time intervals, one or more new members will be introduced into the board, who are not known to half the existing members, except maybe by name or reputation. The positive effects of 'outsiders' joining a board are, to name a few, that fresh questions get raised for deliberation and there are fresh articulations, hopefully leading to review, on the "doesn't everybody know these are the rules and thoughts of the house".

The good news also is that even if nom coms start with asking the "who-do-we-know" question, there will be ever-widening pools to fish from rather than being stuck with the same pool.

The second low-hanging fruit for improving corporate governance is to take on very seriously the tasks of evaluating the performance of the business and the CEO and key managers. Since the mandatory requirement is for a compensation committee of the board, all boards have one. But how can compensation be set or reviewed, truly and beyond competitive benchmarking, without an assessment of business and individual performance? And how can performance be assessed without first setting the performance contract between the management and the board? Any performance contract requires serious application of mind and time to generate both the right dimensions of performance and the right metrics to measure those dimensions.

With increasing top management compensation, and given that there is public money involved, the board is the 'non interested' party in this performance contract and has to play a lead role that needs to go well beyond a high-altitude review of what management sets down as key performance indicators (KPIs) or performance metrics, in any form. It must go beyond the financial performance into the health of the business (in markets such as ours, growth in financial performance doesn't always mean growth in business health). But for all this to happen, compensation committees have to define their role more broadly, introduce more rigour and formality into the process, and agree to spend more time.

The third improvement area is that boards could write their minutes more explicitly than many do today. Even as we demand that more and more government comes within the ambit of RTI, the less and less boards record their deliberations, and the process and logic of arriving at decisions. The board that minutes unanimity of views should no longer be the gold standard. The very act of writing down, perhaps for revisiting by someone some day, what the board thought will make for more informed board discussion, and fewer hastily-disposed-of table items, hopefully.