Introduction :

It’s been some time now since Corporate Governance became mandatory for listed companies in India vide Clause 49 of the Listing Agreement. The post-Enron era has evidenced significant development in Corporate Governance across the globe, though it is still evolving. The raison d’etre of ‘governance codes’ is the Agency Theory on which, the edifice of companies is built. To what extent the existing model of Clause 49 has been successful in addressing this Agency theory in India, is yet to be seen. However, there are still certain areas where there is scope of improvement.

This article identifies and highlights areas wherein Clause 49 is in variance with international governance practices and also tries to bring out certain inherent limitations in the existing clause. It tries to highlight potential areas of improvement and articulate the next stage which Clause 49 needs to embrace in order to improve the governance practice in India.

The basic objective of corporate governance is to segregate the functions of governing the company and managing the company. This is done by establishing a governing body (alias the Board) and giving it adequate independence to direct and supervise the actions of management. To strengthen its independence, the governing body is constituted through a mix of internal and external parties. Board’s independence is a sine qua non for effective governance.

Clause 49 does make demarcation between Governing Body and Managing Body; this ensures independence to an extent. But at the end of the day, the leader of both the bodies is the same person i.e., the CEO. Unlike the Combined Code in the UK, Clause 49 does not mandate splitting of roles of Chairman and CEO. So in effect, the person responsible for managing the company is also responsible for managing the Board — which further implies that the functions of managing and governing are effectively in the hands of the same person, thereby violating the basic principle of independence and concept of corporate governance.

In theory, the Board and the Chairman are responsible to critically evaluate and challenge the actions of the management and the CEO. But in a scenario where the Chairman of the Board and CEO of the company is the same person, the Chairman becomes responsible for evaluating his own performance and challenging his own decisions, which at first instance sounds grotesque, if not impudent. Albeit, there are other members also on the Board along with CEO, who are responsible for ensuring independence — combining or not splitting two roles does jeopardize and weaken the Board’s independence, particularly in Indian context, where the Board Meetings are largely influenced and driven by its Chairman making Board Meetings person-driven instead of process-driven. It has been often evidenced that such meetings are largely led by the Chairman, undermining and suppressing the roles of other independent directors who often are fairly new on the Board and thereby putting the Chairman-cum-CEO in further advantageous position.

Clause A.2 of the Combined Code succinctly provides that – ‘There should be a clear division of responsibilities at the head of the company between the running of the Board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision’.

It further states — The division of responsibilities between the chairman and chief executive should be clearly established, set out in writing and agreed by the Board. A chief executive should not go on to be chairman of the same company. If exceptionally a Board decides that a chief executive should become chairman, the Board should consult major shareholders in advance and should set out its reasons to shareholders at the time of the appointment and in the next annual report.

While the UK law makers do endorse that splitting of roles is an indispensable component of Board’s independence, they further go to criticise the consolidated model on the grounds that management might be more tempted, and more able, to withhold information (which generally means bad news) from the Board, thereby reducing its ability to assess the company’s performance. Independence apart, many argue that one person can’t carry out two such increasingly difficult jobs. Separating them frees the CEO to focus on running the business and the Chairman to discharge the board’s expanding responsibilities.

In the United Kingdom, about 95% of all FTSE 350 companies adhere to the principle that different people should hold each of these roles. In the United States, by contrast, nearly 80% of S&P 500 companies combine them — a proportion that has barely changed in the past 15 years.

Clause 49 partly addresses the issue of independence by mandating that if the Chairman is an executive director, at least fifty percent of the Board members shall comprise of ‘independent directors’. In case, the Chairman is a non-executive director, then the minimum number of independent directors shall be one-third. However, the clause does not mandate that only an independent director shall be chairman of the Board and that there should be a clear division of responsibilities between the running of the Board and running of the company’s business.

Separating the two roles in itself, is not the panacea for making Boards more effective and even after such separation there is no guarantee of improvement in the Board’s performance; however, such separation will indubitably add to the Board’s independence and empower it to critically challenge the actions of management and CEO. Clause 49 should mandate the separation of the two functions; in other words, the Chairman of the Board and CEO of the company shall be two distinct persons.

Whether one agrees or not, whistleblowers have a crucial role to play in corporate governance and can save a corporate titanic from hitting an ice berg by striking the bells at the right time. The Enron saga and its downturn started with whistleblowers.

Clause 49 does have a provision for a whistleblower policy, but the provision is recommendatory in nature. While many of large cap companies have voluntarily formulated a whistleblower policy, not many companies listed on stock exchange have a ‘whistleblower’ policy.

Even in those companies which have implemented a ‘Whistleblower’ policy, it is evident that the Policy, akin to many other policies, becomes a mere paper document posted on company’s website. The Policy therefore, is implemented in letter and not in spirit. There are very few instances on record wherein the policy has been able to bring out the issues buried underground and take apposite actions. In majority of companies, the employees are either oblivious of such a policy or are not willing to take its recourse and have selected silence as an option.

To boil down, there are two reasons for whistle-blowing not being effective in the Indian scenario —

Firstly, having a formal whistleblowing policy is still not mandatory.

Secondly, the existing corporate culture does not support or rather empower an employee to stand up and blow the whistle — it is cultural and other soft factors that impede an employee from coming forward and blowing the whistle despite formal protection available under the policy.

Whistle blowers normally lose their jobs and find difficult to get employment elsewhere. Even in the U.S. Government, whistleblowers get shunted (source : Financial Express, 12-5-2008).

The cultural deficit exists because there is lack of adequate commitment and communication from the Board and management who are reluctant to empower its employees — in some cases, the reluctance is deliberate while in other cases it is due to the fact that implementing such a policy requires change, and any change, particularly cultural change, is difficult to implement. While latter cases can be pardoned, the former cannot be; deliberate reluctance from management and Board might be due to fear that such a policy may act as a key to ‘Pandora’s Box’ and may become ‘Achilles Heel’ of the management by exposing its wrong deeds.

Following is the suggestive prescription to make whistleblowing an effective tool of corporate governance in Indian scenario.

At the outset, prescribing a ‘whistleblower’ policy should be made mandatory. This will at least initiate formal adoption of the policy and its implementation, at least in letter, if not in spirit. The auditors/company secretary, while issuing certifi-cate on corporate governance, should be required to comment on the adequacy of such a policy.

Despite the existence of formal policy and conducive culture, employees don’t consider this tool as a preferred option to highlight wrongdoing within the organisation. One way to overcome this impediment is to allow anonymous whistleblowing. Under anonymous reporting, the whistleblower is not required to disclose his/her identity at the initial stage. Being anonymous provides an innate protection to the complainant.

This mechanism however has a risk of impudent issues being reported to Board and the Board may find itself being mingled among trivial issues which could have been easily resolved by the management. Also, anonymous whistleblowing is feasible only at the initial stage of screening of the issue; once the investigation begins, the anonymous whistleblower should be willing to come out and testify as a witness. As a matter of fact the anonymous whistleblower in an anonymous complaint should offer to do so. In the absence of his willingness, unless a prima facie case exists, it is likely that the enquiry would be dropped.

Enact a law as in the Philippines, where there is a separate law called ‘Whistleblower Protection Act’, which provides legal protection to whistleblowers for voicing against corruption practices within an organisation.

Raise the issue with external independent agency, like company’s auditors who whilst conducting their audit would take cognizance of such an issue. However, the problem with the above model is — once a fraud/corruption issue is reported to an external agency, it becomes rhetoric and has the risk of sabotage to company’s reputation.

Whistleblowing, as a tool to disclose misconduct and graft, is used in a restrictive sense and embraces only employees within the company including directors. Under the existing model of whistleblow-ing, it is only the employees who are empowered to blow whistle.

An organisation constitutes of several other stakeholders apart from employees and includes suppliers, customers, government and local community. Quite often these stakeholders are confronted with an act of corruption or misconduct while dealing with the company, especially the suppliers and customers. Such transactions are not reported by internal employees to conceal their unscrupulous deeds. In such a scenario the external stakeholders, say, suppliers or customers should have an opportunity to disclose such scheming conduct to company’s governing body. There should be some mechanism whereby even the external stakeholders have an opportunity of blowing whistle to the Board of Directors.

The mechanism suggested is akin to ‘grievance cell’ found in many companies, where the customers have a right to file a complaint in case of any dissatisfaction. However, unlike a grievance cell, under this mechanism an external stakeholder has the right to report any misconduct on the part of company to the Board of Directors.

It is hoped that extending the whistleblower mechanism to other stakeholders will promote greater transparency in company’s conduct of business and improve its value among the stakeholders at large.

Despite its benefits, the idea of extending whistle-blowing model to other stakeholders has not been widely acclaimed. One contention is — what would an external stakeholder gain by whistle blowing particularly when he himself has benefited from such fraudulent conduct. However, the argument against this contention is that corporate governance is meant to protect interest of all the stakeholders and not just the shareholders or employees; by disclosing solecism conduct he not only benefits the company, but also protects his own interest and long-term value; in fact, it becomes his ethical responsibility to make such disclosure, as he is also economically associated with the organisation.

It is also argued that the above mechanism may lead to trivial issues being escalated and may in fact become a mode to express dissatisfaction rather than expose misconduct. Embedded therein is also the risk of it being deliberately misused by external stakeholders whose relationship with the company has soured.

The primary role of non-executive and independent directors on the Board is to critically challenge the actions and decisions of Executive Board and management. Apart from maintaining independence and integrity, they are also expected to provide fresh insights and bring their competencies, thereby enhancing the value to stakeholders.

Evaluation of NED under Clause 49 is currently recommendatory. Such evaluation is necessary for the following reasons :