Rule-based corporate governance: Does one size fit all?

Regulators prefer principle-based regulations when ‘one-size does not fit all’. For example, across the globe, regulators prefer principle-based accounting regulations (Generally Accepted Accounting Principles). The Securities and Exchange Board of India (Sebi) has adopted rule-based regulations, while the contexts of different companies are different. Most rules are aligned with best practices evolved in the US and other advanced economies, while Indian contexts are different. Therefore, they may not benefit companies.                                              

A recent amendment to the SEBI (LODR) Regulations requires companies to seek the approval of the three-fourth majority (special resolution) of shareholders (voted for the resolution) for appointing of a person or continuation of a person who has attained the age of 75 years as a non-executive director. The voting at the AGM of HDFC held on July 30, 2018, on resolutions to appoint Deepak S Parekh and J J Irani as non-executive directors tells a story worth pondering. 

HDFC has no identified promoter. Foreign institutional investors hold 72.89 per cent of total outstanding shares and institutional investors (including FIIs) hold 88.90 per cent of the same. 

As many as 22.6 per cent shareholders voted against Parekh's continuation as a director beyond October 2019, when he will turn 75. Only 5.42 per cent shareholders voted against former Tata Steel managing director J J Irani, who is 82 years old. It may be inferred that 78.76 per cent of those who voted against the continuation of Mr Parekh (primarily FIIs) decided against his continuation considering factors, other than his age. It is reported in the media that some foreign proxy advisory firms advised foreign institutional investors to vote against the continuation of Parekh because he is a director in eight public companies, which is higher than the general norm of five public companies adopted by many foreign proxy advisory firms. The SEBI (LODR) Regulations prescribes that an individual cannot be director of more than eight listed companies effective from April 1, 2019, and seven effective from April 1, 2020. Moreover, a person cannot serve as an independent director in more than seven companies. The rationale is that it is challenging for an individual to devote adequate time to each company in which he/she is a director if he/she is a director in a large number of companies. 

Analysis of the voting results in the AGM of HDFC shows that institutional investors and public shareholders are not concerned about the age of directors. They overwhelmingly voted in favour of Irani, who has attained the age of 82 years. The ’75 years of age’ criterion is arbitrary. Whether physical agility is more important than cognitive ability depends on the contribution expected of a non-executive director. If the board expects the non-executive director to provide guidance on complex and critical issues, the cognitive ability and wisdom are more important than physical agility. The age does not matter. 

In HDFC AGM, most institutional investors and public shareholders did not care whether the individual is the director of more than seven companies, so long as the individual, in the past, demonstrated his/her commitment to contribute and has earned the reputation of a competent director. ‘Seven listed companies’ criterion is also arbitrary. Listed companies are of different sizes and operate in environments with different levels of complexities. The demand on the time and attention of individual directors often depends on the size and complexity of the business. Therefore, to mandate that an individual cannot be an independent director of more than seven companies is again an application of the thumb rule, which is evolved in the US and other advanced economies, where the average size of the companies is bigger than the average size of companies in India. Moreover, most multinational companies, whose business models are relatively more complex, are located in those countries. Therefore, the magic number of ‘seven’ may not be appropriate for India while limiting the number of directorship. 

The decision on retirement age, etc should be left to the board of directors. The board should decide its composition and the desired profiles of individual directors. The Sebi regulations should not create avoidable constraints for companies which value good corporate governance and adopt good corporate governance practices. HDFC is an example. Those who do not value good corporate governance adopt ‘tick-the-box’ approach in complying with regulations.

‘Comply or explain’ approach in corporate governance regulations is most appropriate, as companies differ in size, ownership, and complexities in the business model and the business environment. As one size does not fit all, the ‘comply or explain’ approach provides the desired flexibility.

The author is director, Institute of Management Technology Ghaziabad

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