When Boards Forget Their Custodianship Role

The unfortunate turn of events at the helm of Tata Sons raises questions about the role of the board in situations such as a proposal to expel its chairman. More specifically, the manner in which this was done raises serious questions about board governance at Tata Sons. At a broader level, this raises questions about the role of a board of directors as the custodian of the interests of all the stakeholders.

Role of a Board

The board serves as the corporations apex governance body. It defines the organisation's purpose and frames broad policies to achieve it. The board oversees the conduct of the business and is supposed to effectively supervise the actions of the chief executive and the management. Good corporate governance demands that the boards oversight must take into account the impact of all the executive decisions that could have a bearing not only on shareholders but also on all the other stakeholders. As the custodian of the company, the board must ensure effective organisational planning and efficient management of its resources. The board is required to take notice of any deviations to the norms and advice the executives on remedial action needed. Then, why do we have governance challenges at the board level?

Instances of Board Misgovernance

There have been several instances when corporate boards miserably failed to discharge their duties. In 2002, when the erstwhile US energy major, Enron, failed, its board was blamed for failure in oversight. Enron's board had an illustrious set of independent directors but they were 'unaware' of the firm's risky financial deals or were 'unwilling'to ask tough questions. The Sarbanes-Oxley Act of 2002 further tightened board level governance requirements.

Still, when Lehman Brothers collapsed in 2008, eight of its independent directors, who were great in their own fields, were found to have very little expertise in finance! The same year, American insurance giant AIG was found to be suffering from excessive risks that reached the brink of collapse. The board tried to protect the CEO until the US government intervened, sacked the CEO and a few directors and took charge of the firm after a $180 billion bailout deal. There were cases of the board conniving with the majority shareholder to the detriment of the organisation. In 2011, Michael Woodford, CEO of Olympus Corporation, was fired by the board when he found something amiss in the companys financial dealings and pressed for an investigation. Later investigations found that the company was glossing over its losses for many years using bogus transactions.

Closer home, in the Satyam case the board approved reverse merger of the profitable IT firm with the groups infrastructure firm Maytas in 2008. Later investigations found that the promoters had forged documents and shown inflated asset value on papers. The board members failure to provide effective oversight and ask tough questions led to a change in the Indian norms for independent directors. Similarly, in 2013, Daiichi Sankyo, the Japanese acquirer of Indian pharma major Ranbaxy alleged that the erstwhile Ranbaxy promoters and the board did not disclose the extent of risks involved in on-going USFDA investigations in drug trials. Ranbaxy was heavily fined for fudging the drug trial data and Daiichi later sold off Ranbaxy at a loss. In 2015, Diageo, after acquiring a controlling stake in United Spirits, alleged that its chairman Vijay Mallya had diverted huge funds from the firm. Its board members, either knowingly or unknowingly, did not raise any alarm against such activities due to Mallyas overarching persona.

Why Exactly Do Boards Fail?

There are several reasons why corporate boards fail in the prudent discharge of their fiduciary duties. A major cause is the board members' familiarity with the promoter(s). Many boards of Indian companies are simply filled with the promoter's family members, relatives and friends. They often do not wish to hurt their personal bonds by asking tough questions. Even the independent directors keep serving on the boards for several years during which they develop familiarity with the key management personnel. This makes their oversight difficult as negative exchanges have an emotional cost to bear. Another reason for board misgovernance is the lack of definition of 'degree of freedom.' Often the board members are unsure about the freedom they enjoy in raising objections or holding the management to account. Even in cases where it is defined on paper, this freedom may not actually translate in practice.

The lure of incentives that come attached with the board position make it attractive for independent directors to toe the management's line. Raising questions and objecting to the management's ways of functioning may be costly to them! Hence, very few directors are in a position to take a firm stand or ask the difficult questions. They often keep tolerating the management's deviations from the norms and continue to postpone voicing their concern. In some other cases the directors are so busy with their multiple responsibilities, at times in multiple companies, that they do not devote adequate time and attention to discharge their oversight duties. Another reason that compels boards to toe the management line is the promoter's desire to keep strong control over the company. Their assertiveness keeps the independent directors in check. Board selections are also done to ensure that promoter's control over business decisions is not seriously challenged. As a result of all these pressures, board members falter and corporate governance suffers.

Need of the Hour: Redefining the Governance Frontier

Board misgovernance is a complex problem to deal with as it cannot be solved by passing legislations. There should be a multi pronged approach to address it. Fundamentally, regulatory authorities like SEBI should insist on comprehensive audit of board function to ascertain its independence and quality of oversight function especially for organisations of certain size and/or history. Also, there should be norms for reappointments. Promoters should be motivated to adopt best board governance practices. Unless promoters get involved to set matters right, it is difficult to improve board governance. Promoters can be incentivised through tax or other regulatory benefits to adopt the accepted global norms of board governance. They need to be educated on how the markets place a premium on better corporate governance. It is critical to convince them about why it is in their interest to raise the bar and improve board governance. It is critical for them to develop value compatibility between themselves and the board members.

Finally, efforts should be made to develop and produce high quality independent directors who not only bring the right set of capabilities to the company but also have an impeccable value system. This would give them the courage to ask tough questions and improve board governance. Unless concerted efforts are made by all stakeholders, corporate boards will remain paper tigers and continue to fail the litmus test of independence. Board membership is a responsibility and it is only for those with strong custodianship values to ornament.

The authors are Executive Director and Research Associate respectively at the Thomas Schmidheiny Centre for Family Enterprise, ISB