The Hindu Business Line : Two-tier board structure

It is hoped that the Government's decision on the proposal for a two-tier board for public sector companies is realistic. Not only is it difficult to get qualified and experienced persons to man both levels of the structure, there is also no guarantee that such a system will guarantee better performance.

A RECENT news report tells us that the Securities and Exchange Board of India (SEBI) is thinking of prescribing a two-tier board structure for public sector companies that have a wieldy board consequent to the fulfilment of the corporate governance remit on appointing an adequate number of independent directors.

SEBI is considering a first-level, consisting of functional directors, which will be overseen by a policy-making board — a structure resembling the two-tier board operating in European countries.

Though this proposal is seemingly innocuous it needs fuller debate for it will entail burdening the public sector undertakings, which have a host of problems on their hands, as it is.

Solution worse than problem

The proposal, in effect, seems to offer a solution worse than the problem. To meet the regulatory prescription of independent directors, a more difficult requirement of a two-tier board is sought to be imposed on PSUs. The owner — the government — has difficulty finding suitable personnel, even for a single board. A two-tier structure will only add to its difficulties.

The future is uncertain for PSUs — whether they will continue to be under government ownership or opened up to significant private equity participation.

It is hoped that the `focused internal group' will consider the various aspects and elicit the views of a cross-section of management experts and academics before forming their views.

First to be considered should be the justifiable grievance of discrimination. Corporate governance standards and regulatory and statutory requirements should, as far as possible, be the same for both private and public sector companies.

When the former seeks a level playing field, there cannot be one rule for the structure and constitution of PSU boards and another for the private sector.

Second, the issue of inclusion of adequate number of `independent directors' on company boards is under consideration and the government is expected to reach its decision some time this month. It is better to wait for this decision and not rush to create a cumbersome board structure.

Recent developments

Sir Derek Higgs' report (UK-2003) is the most recent expert public exercise on the issue of independent directors and related issues. He is a strong advocate for including a sufficient number of independent directors.

His recommendations, however, met with resistance from the British corporate sector.

The trend of appointing an adequate number of independent directors is, however, spreading.

In the 1990s, 66 per cent of all directors in American companies were outsiders; in 2000, this percentage rose to 78. The picture in the other leading Western economiesis much the same.

The corporate sector has difficulty finding suitably qualified independent directors with the appropriate status and seniority to occupy a position on company boards.

Naturally, most companies want persons who have been CEOs or senior executives with experience of running divisions exposed to profit and loss. But such persons are already in board positions with other companies.

Bernard Black, of Stanford Law School, found that companies where at least half the directors were independent did not seem to perform any better than companies where that was not the case. He also found that boards with only one or two insiders actually performed worse, financially, than other firms.

Such a careful study does not seem to have been carried out in India, either by the government or the regulatory agencies, or the apex business chambers and their consultants. We seem to be pursuing this concept to blindly follow western standards.

Some Western researchers have also observed that the "rise of independent directors is too recent for much of the research to be relevant".

Some believe that a director's financial involvement in the company of which he is a director is closely correlated with performance.

A study by Donald Hambrick and Eric Jackson of Columbia University Business School argued that the outside directors of companies that outperform their business sector hold more equity than those of companies that under-perform.

Hermes — Britain's top fund manager — insists on share ownership by outside directors. Nell Minow, an American shareholder activist, agrees with this line of thought: "The single most important requirement" for an effective board, she believes, is "that all directors have a significant personal stake in the company".

Another study which may help our authorities to firm up their view in the matter is neatly summed up by The Economist in its essay on `Outside directors' thus: "Most of the evidence suggests that a stake is much more likely to influence directors' behaviour". It quotes the view of an independent director: "I've always held small, token amounts. But now I'm on board where the CEO encouraged us to buy and hold significant shares. I'm in for about half a million dollars, and I can tell you I'm a heck of a lot more attentive to this company than I have been to the others. If this company faces a challenge, I lose sleep at night."

We need not blindly import corporate governance from the West. These need to be evolved by every country depending upon the level of development of the corporate sector and its level of economic development and availability of appropriate human resources.

The corporate scandals of the West have given impetus to corporate governance reforms resulting in a spate of recommendations by management consultants and corporate governance specialists.

Roger Raber, head of the National Association of Corporate Directors raises the problem of the very definition of independent directors and points out that "there is big difference between being independent, according to the rules and being independent-minded. He says that too many companies are putting people on the board, which may not challenge powerful executives. Mr Raber points out that the key thing is transparency and if independent directors don't get the information they need, they are dead."

Listen also to this opinion written by The Economist on the deliberations of Sir Derek Higgs who perseveringly advocated the case of independent directors: "One of the oddities of corporate governance is that what looks like a sound structure in one country is anathema in another. Create two boards, German style, with one to supervise and one to manage?

"Give us unitary boards every time, say the English-speaking nations. Put only non-executive directors on the board, apart from the chief executive, to maximise the number of supposedly independent voices, as most American companies do?

"No thanks, say the British, who prefer to see plenty of executives around the mahogany table too. But all three countries have had their share of corporate scandals — suggesting that good governance is driven more by the climate of acceptable behaviour than by board structure."

In India, it is going to be difficult, not only to find enough suitable independent directors but also to split the CEO's post into two — a non-executive chairman and a CEO, if this is made a regulatory and statutory requirement.

Give up the two-tier board idea

The proposal for creating a two-tier board for public sector companies thus needs to be critically examined in this light.

Whatever may be the government's decision on the issue of independent directors, it is hoped that it will be realistic, keeping in view the difficulties in getting qualified and experienced persons.

If the authorities are not able to structurally reform the public sector in consonance with the objectives of the reforms and economic liberalisation and make them effective enough to compete with the private sector, one hopes they will at least exercise caution in experimenting with apex structures without the guarantee that it will lead to better performance.

(The author is a former Executive Director of the LIC.)

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