Government Mulls A New Voting Process To Appoint Independent Directors

Recent corporate governance scandals in India have prompted the government to consider measures to strengthen board independence. One way of doing that is to ensure independent directors are truly independent. Hence, the government is mulling giving more powers to minority shareholders for appointment of independent directors on company boards.

The Ministry of Corporate Affairs is considering a dual voting system in which the election of an independent director must be approved by public shareholders, a senior government official told BloombergQuint requesting anonymity. The official cited a similar practice being followed in the U.K.

As per the U.K. listing requirements, in the case of companies with a controlling shareholder (more than 30 percent voting power), the election or re-election of an independent director has to be approved by shareholders and independent shareholders. If both the sets of shareholders don’t approve the director appointment and the company remains desirous of appointing that person, it must propose another resolution after 90 days.

The U.K. method gives prominence to independent (non-promoter or public) shareholders’ votes by forcing the company to put the resolution to vote again in case it didn’t win their approval in the first vote. The imposition of a 90-day “cooling off” period also allows shareholders to engage in discussions to reach a solution acceptable to both the controlling shareholder/promoter and public shareholders.

What’s The Prevalent System

Currently in India, appointment of a director starts with nomination and remuneration committee identifying candidates for approval by the board of directors and subsequently by shareholders. A resolution to appoint a director needs a simple majority—over 50 percent of votes cast—to succeed. While at least half the NRC should constitute independent directors, experts have often pointed out that promoters can influence the selection of candidates at that stage and then use their majority shareholding to ensure the director is elected. This may often compromise the independence of the director even if he otherwise meets the definition of “independent” as laid down in company law.

If a dual voting framework is implemented in India, and minority shareholders vote against the appointment of independent directors, but the promoters still appoint the same candidates, there will be a stigma that the company has crushed the voice of minority shareholders, the official cited earlier said.

Of course, any change in appointment of directors would require an amendment to the Companies Act, 2013. Introducing such a change would require some time and detailed deliberations, the official said. If approved, such a voting system would be made mandatory for all public companies and later extended to large private companies, the official said.

This review seems to be prompted by the several questions raised regarding the board’s role in the collapse of infrastructure financier IL&FS Ltd. and in governance scandals at private banks, such as ICICI Bank Ltd. and Yes Bank Ltd., as well as non-banking financial services companies like Dewan Housing Financial Ltd.

Over the last decade Indian laws and SEBI regulations have mandated that at least 50 percent of the directors on a public company board be independent, and if the chairman is independent then at least 30 percent of the board constitute independent directors. The effort has been to reduce the influence of the majority/controlling/promoter shareholder and ensure the interests of all stakeholders are considered in the governance of the company.

But the current arrangements undermine the effectiveness of independent directors’ oversight, the official quoted above said. The official said the time has come for a dual voting system where there will be a calibration between promoters and minority shareholders, and those directors appointed by the promoters are made more accountable.

Governance experts are not sure these changes would achieve the desired results. “Government has to look at this issue in a holistic manner,” said JN Gupta, founder of proxy advisory firm Stakeholder Empowerment Services. He said the government should instead ensure that there are more number of candidates than the position, and also ensure all the retail investors participate in the voting.

Calling it a good move by the government, Prithvi Haldea, chief executive officer of Prime Database, said this will give more confidence to minority shareholders, and a say while appointing independent directors. “If the minority shareholders vote against the independent director, there will be a moral pressure on the management to not go against them,” he said. “In that case the management will have to do something to ensure that minority shareholders are also on board.”