Board Evaluations a Nightmare for Independent Directors?
October 2, 2019
Next on the list of dilemmas relating to corporate governance issues for independent directors (ID) of a listed company is Board Evaluations. These are 360-degree reviews of the performance of a board of directors, conducted by the Nomination and Remuneration Committee (NRC). In a formal board evaluation process, each director reviews the other.
Interestingly, based on such evaluation, the NRC has to determine (amongst other things) whether an ID should continue holding his directorship or not. Earlier on, such evaluations were voluntary and some companies have been making generic voluntary disclosures in the annual report stating that the evaluation was conducted and recommendations were absorbed for improvement of board functioning. Going forward, the content of this disclosure will change.
The new Companies Act and SEBI’s Listing Regulations make such evaluations compulsory. SEBI has issued a detailed Guidance Note in January this year to help listed companies better comprehend the evaluation requirements. These legislations require the companies to disclose the manner of evaluation and criteria used for evaluations. However, the details of outcome of evaluation can be kept confidential. From this, three important issues arise. Firstly, whether outcome of the evaluation should be confidential? Secondly, whether it puts more pressure on the IDs on how to conduct themselves in family controlled businesses with the sword of legally required evaluation hanging over their heads (though the evaluation process applies to other directors as well), and a possible ousting through a disguised evaluation process? Thirdly, irrespective of such recommendation by the NRC, should people (who in all probability will be the ones who own the business) who call for an ID to be ousted, have any vote in the shareholder resolution proposing such an ousting?
For the first question, one may defend the issue by saying that the law develops with time and slowly law will require the outcome to be made public. Confidentiality of outcome defeats the very purpose of disclosure relating to board evaluations as any public shareholder would need to know what the evaluation process led to.
For the second question, there is no perfect answer as the NRC may make a recommendation based on the first-hand experience of dealing with the ID, which experience the public shareholders may not have. For the third question, indeed the more robust and popular approach for making IDs more confident and, therefore, independent, the answer would be that voting on the ousting of IDs should be treated the same way as law treats voting on related party transactions, i.e. interested persons should not vote. Some countries like Italy and Israel, controlling shareholders do not vote on appointment and removal of IDs.
Since controlling shareholders can arguably influence votes, interested persons for such resolution should cover people who proposed such a resolution, relatives of such people and people from whom votes could be managed through a history of business dealings or close ties. This would ensure that only those truly interested in the long-term interests of the company would vote to determine in whose hands the oversight of the company’s functioning should lie. Since the concept of IDs was introduced to bring in checks and balances at board level to ensure effective corporate governance, law should also strengthen the independence of IDs meaningfully rather than allowing people to find ways to blame the ID for not being truly independent!