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excellence-12 · 3 months ago

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Reimagining Boardroom Dynamics: Moving Beyond Incrementalism

With the commencement of a new financial year, and with a new SEBI Chairperson in place, the context is appropriate for Boards to look at what they should be doing in the months and years ahead. To get companies away from the normal practice of incrementalism, and be on the road less travelled, Excellence Enablers organised a roundtable with participants of diverse experience and expertise, to come up with action points, milestones and methodology. What follows is an attempt to focus on some of the more significant suggestions.

While it is well understood that appropriate composition of the Board is the starting point of getting the company to move in the right direction, it is rarely that the specifics of this objective get addressed. What is often overlooked is the need to factor in what the company presently does, and what it wants to do in the future. Given contextual clarity, it will become easier to decide on the kind of persons who ought to be inducted on the Board. While some of them will have significant domain knowledge, and some others might be helpful in domain neutral suggestions for improved performance, the lowest common denominator should be that Directors should act independently, and be unafraid to express their views in a constructive manner. In this exercise, Nomination and Remuneration Committees (NRCs) should be actively engaged in identifying the gaps to be filled in Board composition, and creating the appropriate universe from which the right persons could be selected. NRCs should not be seen as mindlessly endorsing the views of the management on the selection of Directors.

It is often heard that the availability of good Directors is limited. Nothing could be further from the truth. If the net is spread wide, instead of focussing on a narrow catchment area as in the past, potentially good Directors could be identified, and brought on board. The possibility of engaging external specialist firms should not be brushed aside. Over time, Boards have become manifestations of gerontocracy. This should be consciously addressed by selecting younger persons, who might have knowledge, that is more contextually relevant to the company.

Suboptimal performance by Boards is often a function of absence of role clarity. Directors, especially those who have in the recent past held executive positions, are more inclined to get into management territory, forgetting that execution and operations are not the functions of the Board. The Board should act as a sounding board for management, and not get involved in the nitty gritty of individual transactions.

The related point to be remembered is that Boards do not run companies. Running companies is the responsibility of management. The Board’s function is to ensure that the managements run the companies well. Unfortunately, even Regulators, on occasion, task Boards with functions that belong entirely to management, and in the process, reduce the time available to the Board to discharge its basic functions of superintendence, direction and control.

One problem that has been mentioned in the recent past is the inadequate preparedness of senior management persons moving to Board level positions. It is erroneously believed that such persons, having been in the company for several years, hit the ground running when they get onto Boards. The transformation in roles will require handholding to ensure that the newly appointed Directors are schooled in the responsibilities and functions at the Board level.

Many Boards consistently underperform because of their extraordinary focus on the past, without setting apart enough time for discussions on the future. Spending disproportionate time on looking at the performance of the previous quarter or the previous year, makes Board meetings resemble the meetings of pathology departments, since the quarter or the year has gone by, and apart from throwing up some lessons, will have little contribution to what the company should be doing in the months and years ahead.

Related to this is the question of setting a value-adding agenda. It should not be left entirely to the management comprising the Company Secretary and the CEO, with an occasional input from the Chair of the Board, to design the agenda for the forthcoming meeting. Good Boards have recognised that the agenda must be set “with the Board”, and not “for the Board”. Boards must also focus on the timely flow of complete and correct information, so that decisions are not taken based on ill-informed discussions arising from inadequate information.

There are some specific areas that Boards have not focussed on adequately. To begin with, there is rarely, if ever, a review of the existing business model, and the changes that might be required for the company to remain relevant and ahead of competition. If the business model is taken as cast in stone, change, if any, would at best be incremental, and will not be fundamental.

Succession planning is often spoken about, but adequate time is not invested in this exercise by the Board or the NRC. It cannot be that only when a vacancy arises, even if it is a vacancy that should have been anticipated, the exercise commences by looking for suitable candidates within or outside the company. Successors should be identified and kept in a state of readiness to seamlessly move to the higher assignment that a vacancy gives rise to.

Diversity Equity and Inclusion (DEI) again is more spoken of than actually discussed or actioned. Much the same is the treatment accorded to ESG, with lack of clarity on which committee(s) of the Board should handle which aspects of ESG. Climate change is yet another item that gets bandied about in conversations, but rarely makes it to the Board agenda as a specific item. With floods, cyclones, earthquakes and the like affecting the physical infrastructure and the conduct of business of companies, inadequate time is being allotted in boardroom discussions to preventive measures, and the business continuity plans, that ought to kick in when a major event is about to take place. Much the same could be said about cyber security and the absence of AI and technology applications in the Board agenda.

In a competitive environment, it is necessary for companies to innovate on a continuing basis, lest they get overtaken by obsolescence or irrelevance. While there is token acknowledgement for the need for innovation as well as R&D, the overriding approach seems to be to treat these as expenditure items, and not as investments.

No company is an island unto itself. It is necessary to keep track of, and even anticipate, the changes in the global economy, so that when such changes take place, the company is not caught napping.

The spread and reach of social media, with its negative connotations, is a matter that does not seem to have attracted the attention of the Board or any of the Board committees. While social media policies might exist, they do not capture the entirety of the phenomenon. Resultantly, with negative posts in social media going viral, companies do not seem to be ready to respond in time, and to undertake damage control. Boards need to appreciate that the ecosystem has a disproportionate presence of social media, and it can be ignored only at the expense of the company.

Strategy is yet another matter which gets talked about, but not adequately addressed by Boards. While some companies follow the practice of having an offsite meeting for strategy, the agenda for such meetings often comprises several other items, which reduces the time available for meaningful discussions on strategy. Strategy being co-created by the management and the Board, it is essential that it becomes the central agenda, if not the only agenda item, for meetings that are described as strategy meetings. Such meetings, in addition to helping to craft and refine strategy, also enable the Board members to get a visibility of senior management persons, to assess their capability and competence for being moved to positions of higher responsibilities. This would also encapsulate the mentoring role that Board Directors have, even if such a role is not articulated in laws and regulations.

Given the responsibilities of Directors, no justice can be done to their role if they only attend the meetings of the Board and its committees. It is of paramount importance for Directors to interact with management persons between meeting dates, so that they not only get updated on a continuing basis, but are also able to help with advice and assistance where necessary.

The need for right-contenting the Board has been discussed. What should not be lost sight of is that Board members should be willing to serve on different Board committees, especially because the committees constitute the place where in-depth discussions take place. To address the possibility of asymmetry of information between committee members and Directors who are not on some committees, there should be a policy of inviting such Directors to be present during the committee meetings, so that they get to hear firsthand the issues that are being discussed. While the non-members might get some insights from the briefings by the committee Chairs, it does not adequately bridge the information gap between committee members, and persons who are not members of the committees.

In some companies, though the practice is mercifully not widespread, decisions of the committees are taken as final, with the Board either not considering them, or routinely endorsing them, without application of mind. This is inconsistent with the position that Board committees, no matter how well they are constituted, and irrespective of the time that they invest, are not a replacement of or a substitute for the Board. It should be possible for the Boards to revisit the recommendations and/or decisions of the committees, and make such modifications as the Board in its collective wisdom might consider desirable.

One forum which has not been taken advantage of, presumably because of the context and the cavalier treatment given by Schedule IV, is the separate meeting of Independent Directors (IDs). One meeting every year, limited to undertaking the process of Board evaluation, is a hopeless underutilisation of the forum. Progressive companies have put in place a practice where before every Board meeting, the IDs discuss matters on the agenda, as well as other matters that are relevant. This meeting functions as a clearing house of ideas. Giving it stepmotherly treatment is equivalent to scoring a self-goal.

Boards have also reluctantly recognised that a robust external Board evaluation exercise is far more value-adding than the routine box ticking exercise that in-house Board evaluation exercises have descended to. To rule out external evaluation on the ground that it has a cost element, is to be extremely shortsighted, and to shut the door on a value-adding exercise. Experience has shown that where external evaluation is undertaken, the areas for improvement are more easily identified, and acted upon, unlike in the case of internal evaluation, where the exercise becomes one of legitimising present practices.

Companies, especially Public Sector Undertakings, often have the problem of the owner/ promoter not being able to distinguish between ownership and management. If a Board is constituted with the right kind of members, it stands to reason that the Board should be trusted to function in a manner consistent with the interest of all shareholders. Continuous interference, and disproportionate influence being exerted on the functioning of the Board, will disincentivise and demotivate the Board, and reduce Board members to rubberstamps.

The tasks are clear and nearly everyone talks about them. What remains is the ability and the willingness to walk the talk.

Source: https://excellenceenablers.com/knowledge-centre/newsletters/april-2025/

#CorporateGovernance #BoardEffectiveness #Leadership #SuccessionPlanning #ESG #BoardComposition #Strategy #Innovation #RiskManagement #BoardEvaluation #SEBI #GovernanceReform

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excellence-12 · 5 months ago

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What makes a Good Audit Committee?

Audit Committee (AC) is the oldest, and one of the most important Board level committees. It is considered to be the most important committee because its key roles involve recommending of financial statements for approval, interaction with Statutory and Internal Auditors, ensuring existence of proper internal controls, and approval of related party transactions (RPTs). With changes in law and regulations, most ACs have seen an expanded role, with a number of mandatory and non-mandatory roles being added to their scope of work.

For an AC to add value, it is important to have the following considerations:

Composition – For a proper functioning AC, its composition plays a key role. SEBI LODR Regulations, 2015 (LODR) require at least 2/3rd of the members of AC to be Independent Directors (IDs), with the Chair of AC also being an ID. Given the important role played by this Committee, some companies proactively consider having an AC comprising all IDs as a positive. It is believed that such ACs are objective and independent in their discussions and decision-making.

Skillsets – LODR requires the Chair of AC to be an expert in finance, and other members to have knowledge of finance. It is important to have Directors with the right skillset and aptitude as members of the AC.

AC Chair – AC Chair plays an important role in ensuring an effective AC. He/she sets the tone for committee meetings. AC Chair has to be an ID, and has to be an expert in finance. His/her knowledge is often extremely important when it comes to steering the meetings, and communicating with the CFO and the auditors. He/she also has to ensure that management presents proper agenda for meetings. He/she should have the ability and willingness to ask the tough questions. Given the importance of the Committee, he/she is often considered to be the senior most ID, and is also tasked with the additional responsibility of chairing meetings of IDs. Attending Annual General Meetings, to answer shareholder queries, is yet another role assigned to him/her.

Induction of AC members – Given the role of the AC, it is a good practice to have a proper induction programme for newly inducted members of the committee. The focus of this programme should be on the role of the Director as an AC member, and the attributes required.

Number of meetings – LODR requires the AC to meet at least four times in a year. Increasingly it is seen that the quarterly meetings, as mandated, focus only on financial statements. Given the additional roles to be performed by the Committee, it is a good practice to have at least 2 additional meetings, in which the focus can be on items such as Internal Audit.

Pre-AC meetings with CFO – A number of companies have found the practice of the AC Chair having a pre-AC meeting/ call with the CFO beneficial. In such meetings/ calls, the CFO is able to brief the AC Chair about the agenda, the updates since the previous AC meetings, and any issues that the company might be facing.

Pre-AC meetings with Statutory Auditors – A number of companies have also find the practice of the AC Chair having a pre-AC meeting/ call with the Statutory Auditors beneficial. In such meetings/ calls, the auditor is able to brief the AC Chair about any item that he/she may want to bring to the attention of the Chair.

Interaction with Auditors – Most good ACs have started the practice of interacting with Statutory Auditors and Internal Auditors, without the presence of management persons. This forum gives the auditors the opportunity to mention any issues/ problems that might be faced. This also becomes a good forum to understand how the company can improve its existing practices. AC can also ensure that the Statutory and Internal Auditors interact with one another.

Interaction with Chief Risk Officer (CRO) – Risk management and Internal Audit go hand in hand. Some companies therefore have started the practice of inviting the CRO to the AC meeting, for interaction with AC members.

Internal Audit – It is the role of AC to approve the annual Internal Audit plan, and to have the Internal Auditor report to it every quarter on findings and the next steps. Good ACs ensure that Internal Audit function has the necessary independence that it requires to function. For this, it is important that Internal Audit reports to AC on functional matters.

RPTs – There are a number of stipulations with respect to RPT. The practice that a number of good ACs have found useful is to, on a random basis, ask for the working papers relating to 1-2 RPTs, to ensure that the management follows the correct process/ procedure for ensuring that the transaction is at arms length and in the ordinary course of business. This would also ensure that the management would be careful when it comes to putting through such transactions.

Whistleblower mechanism – AC Chair should ensure that a whistleblower can have access to him/her in exceptional cases. AC should also ensure that the mechanism functions independently.

Prohibition of Insider Trading – In the case of violation of Insider Trading regulations, AC must ensure that the penalty imposed is in accordance with the violation, and a soft treatment is not given.

Legal cases – A number of good ACs ensure that they have exposure to the material legal cases, along with a status update.

Oversight of subsidiaries – ACs of holding companies should invest time in interacting with the Statutory Auditors of the subsidiaries, to ensure that nothing of consequence is missed. This is especially important when the auditor of the subsidiary is different from the auditor of the parent.

The AC is the repository of trust of stakeholders. It cannot afford to underperform.

#CorporateGovernance #BoardCommittees #InternalAudit #RiskManagement #BoardComposition #IndependentDirectors

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