Leveraging the power of an independent board

This article was first published in the Financial Express on March 14, 2023, Co-authors: Navneet Bhatnagar, Sougata Ray; https://www.financialexpress.com/industry/leveraging-the-power-of-an-independent-board/3008998/

Governance failures often jeopardise businesses, including family-owned firms. Family businesses are often blamed for poor corporate governance and oversight. In India, well known and established family firms have come under the regulatory scanner for opacity in financial dealings, related party transactions, and appropriation of minority shareholders’ wealth.

For corporate governance and monitoring issues, the buck stops at the apex governing body of the company, that is, its board of directors. The board of directors of a company determines its purpose, broad policies, and oversight mechanisms. An effective board ensures that executive decisions are made in the company's best interest. It is critical for the board oversight mechanism to assess the impact of executive decisions on shareholders and other stakeholders.

Aimed at improving corporate governance, the Companies Act 2013 stipulates the appointment of Independent Directors as non-executive members who can objectively scrutinise executive decisions and management performance. While monitoring the firm's reporting mechanism, independent directors are expected to evaluate and check the robustness of financial controls and risk management systems. They must uphold high ethical standards, integrity, and probity. Independent directors are not supposed to receive any monetary benefits except their fees. They are appointed for a five-year term and can not hold more than two consecutive terms.

Corporate governance standards were expected to be elevated through these legal provisions. However, various corporate governance debacles continue to hit the headlines in India. In 2015, Diageo alleged misappropriation of funds at United Spirits, which they had acquired from Vijay Mallya. Malvinder and Shivender Singh's fraudulent loan transactions at Religare and loan fraud at Gitanjali Gems were the other cases that poorly reflected the governance in Indian family businesses. So was the case of the Dhoot family-owned Videocon's loans obtained from ICICI Bank by questionable means and alleged kickbacks. In all these cases, the role that independent directors played as the custodians of stakeholder interest was wanting.

Our research on these cases of corporate governance failures of independent directors reveals some key insights.

Proximity to Promoters: One of the reasons why independent directors fail to discharge their fiduciary duties is their proximity to the promoters. Due to this, they often do not hold management to account and avoid asking tough questions. Independent directors who continue to serve the companies for a long time develop an affinity with key management personnel, making oversight difficult as the emotional costs of a negative exchange escalate. Hence, independent directors impose self-restraint.

Power equation: In several cases, we observed that the aura and assertiveness of the promoter family's leader kept the independent directors constrained to voice concerns. Board selections were made so that the independent directors could not seriously challenge executive decisions.

Incentives: Another reason for this oversight was the lure of the incentives attached to the board position. Independent directors follow what pleases the management or postpone raising their concerns due to the significant monetary/non-monetary incentives they gain from the company.

Overworked: In some other cases, we observed that the independent directors were so occupied with multiple responsibilities across different companies that they failed to devote sufficient time and attention to their oversight responsibilities.

As a result of the above factors, independent directors are rendered “rubber stamps”, corporate governance falters, and the respective businesses suffer a significant loss of monetary and brand value.

The need of our times is to make independent directors “truly independent.” Several measures can be adopted to empower independent directors with the authority to intervene through more effective checks and control mechanisms.

Selection: First and foremost, it is vital to improve the independent directors' selection process. They must be chosen on merit and have an impeccable value system.

Induction: They must be appropriately inducted and familiarized with the business and its key challenges. They must be eager to learn and update their knowledge and skills. They must be able to assess the internal and external environments in which the business operates and be vigilant of the motives that drive executive decisions.

Promoters' Buy-In: The most crucial factor that may make the role of independent directors more effective is the promoters' realization of the genuine need to raise the corporate governance standards of their company. If promoter families embrace good corporate governance in its true spirit, they will see the value in fostering vocal, expert, empowered, and truly independent directors.

Family firms and promoters must realise that when boards fail to exercise effective oversight, deviations from governance norms go unchecked. Ineffective governance eventually results in bigger violations and the destruction of value. Therefore, the boards must be diligent in objectively assessing executive decisions and providing timely advice when remedial measures are required, and they must be 'allowed' to do it. 

Managing Differences in the Family to Prevent Destruction of Business and Wealth

This article was first published in the Economic Times on March 08, 2023, Co-authors: Navneet Bhatnagar, Sougata Ray; https://economictimes.indiatimes.com/news/company/corporate-trends/managing-differences-in-the-family-to-prevent-destruction-of-business-and-wealth/articleshow/98481901.cms?from=mdr 

Recently, the Hinduja brothers decided to put an end to their long-standing dispute over family wealth. The Singhanias, owners of Raymond, have also shown signs of a reconciliation after a bitter dispute between the father and son. Managing a family business is often more challenging than steering a non-family enterprise. This is because family businesses are an amalgam of two inherently distinct subsystems. While business is an economic system, the family is a social system. In the initial phase both the family and business are simple systems. As time passes by both grow to become complex and complicated. While businesses expand in size and enter new segments and markets, families increase in size, extend into branches, or forge new relationships (in-laws). New generations emerge, often with distinct ways of thinking and analysing than the previous generations. Therefore, it is very natural for differences to emerge within the family. If these differences are not addressed properly, they turn into deep discontent and surface later as full-blown conflicts. Repeatedly, Indian family businesses have seen bitter feuds in the past, which has ruined large business groups and their legacy- the Modis, the Mafatlals, and the Singhs of Ranbaxy group- to name a few.

Many a times, the roots of such differences lie in the family sub-system. The socialist nature of the family accords equal rights and status to all its members. However, business, rooted in capitalism, rewards the more meritorious members. Differences arise when some family members feel that they are not being equally rewarded, or their opinions are not valued, or their needs remain unmet. Differences emerge when the roles, rights, and responsibilities are not clearly understood by the members. This happens due to lack of clear policies, that leads to decisions being made in an ad-hoc and inconsistent manner. When left unaddressed, these differences turn into a deep sense of ‘perceived’ injustice and bitterness. Often, these pent-up emotions get triggered into outbursts at a tipping point that ‘breaks the camel’s back’, leading to a cascading effect of deviations in action, poor decisions, and destruction of wealth and family legacy.

Is there a way to avoid this ‘differences to destruction’ trap? The answer lies in robust governance and clear communication mechanisms. It is important to create effective governance structures and mechanisms both for the business and family. Governance mechanisms must be embraced in true spirit and not just to meet regulatory requirements. High quality governance based on strong values can resolve most issues right at their emergence. Some measures that could help family businesses minimize the impact of family differences include: adopting the policy of fair treatment to all family members, clear and transparent communication within family and with all stakeholders, decoupling critical business and family issues, establishing fora for communication and raising concerns (such as a family council or forum), adhering to policy-based family governance rooted in a family agreement, charter or constitution and developing shared-clarity on ownership rights. A well-defined conflict resolution mechanism can ensure that the differences are resolved before they turn into a major problem and the business interest is not affected.  

Two examples that may be cited here are: the structured succession planning initiated by Mukesh Ambani-led Reliance group and the recent amicable restructuring of the TVS group. Reliance is adopting a holding entity model that will own and control the family's businesses-refining and petrochemicals, retail and e-commerce, telecom, and green energy. The family members will own stakes in this entity and serve on its board. However, operations will be managed by non-family professionals. This planned shift from operations to ownership and governance will keep the next-gen family members focused on strategic issues. This decision will minimise differences that may emerge in the family due to operational issues of the business.

In the TVS case, the four family branches decided amicably to re-align the ownership of their group companies. Earlier all the TVS group firms were grouped under three holding firms and there were lot of cross holdings among the four family branches. The family decided to merge all three holding firms and then demerge into four holding companies, one for each family branch. Each resultant holding firm will own the businesses managed by that branch. Besides this, the agreement also envisaged to included clear terms of the use of TVS brand, and non-compete agreements among the family members.

In the Indian context, which continues to witness fierce battles for rights over control of business and family wealth, the proactive planning and implementation of structured mechanisms adopted by both Reliance and TVS groups are inspiring examples of ringfencing the business from potential family disputes.