August 2024 Newsletter

Executive Pay | Change In Non-Executive Directors’ Remuneration Limit At Private Sector Banks

To attract and retain qualified individuals and considering the varying role of NEDs on the Board and its committees, the limit has been revised.

In a bid to enable banks to sufficiently attract qualified competent individuals on their Boards, the Reserve Bank of India (RBI) has revised upwards the ceiling in respect of remuneration of Non-Executive Directors (NEDs), other than the Chair of the Board, to ₹30 lakh per annum from ₹20 lakh.

The aforementioned revised ceiling is applicable to NEDs of private sector banks, including Small Finance Banks (SFBs) and Payment Banks (PBs), as also the wholly owned subsidiaries of Foreign Banks. Instructions in this regard have come into force with immediate effect. “Considering the crucial role of NEDs in efficient functioning of bank Boards and its various Committees…it has been decided to revise the aforementioned ceiling to ₹30 lakh per annum,” RBI said.

The central bank emphasised that banks are required to have suitable criteria for granting fixed remuneration to their NEDs, with the approval of their Board before any review of the extant remuneration. The Board of the bank may fix a lower amount within the ceiling limit of ₹30 lakh per annum depending upon the size of the bank, experience of the NED and other relevant factors. “As hitherto, private sector banks would be required to obtain regulatory approval regarding remuneration to Part-time Chairman. Banks are required to make disclosure on remuneration paid to the directors on an annual basis at a minimum, in their Annual Financial Statements,” RBI said. Read More.

Board Diversity, Equity, and Inclusion| What The Board Needs to Change About DEI

Boards are taking extra care to reevaluate DEI efforts to avoid scrutiny. Leaders are considering working towards a more accountable vision of DEI.

As DEI work faces increasing scrutiny socially, politically, and legally, organizations are taking extra care to re-evaluate their DEI efforts. Leaders are right to consider change, not as a reaction to backlash, but to work toward a more accountable, transparent, and successful vision of what DEI could be. The author identifies three things that need to change: 1) Clumsy, jargon-heavy communication, 2) disconnected and decoupled DEI goals and programs, and 3) nonexistent or vanity DEI measurement. They also identify three things that should be maintained: 1) Responsiveness to broader society, 2) commitment to healthy organizations, and 3) the belief that we can be better.

Organizations and their leaders have endeavored to create more diverse, equitable, and inclusive organizations in one way or another since the mid-1960s, even as the sociopolitical climate around these efforts has fluctuated. Read More.

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Industry News | What Drove The Global Stock Sell-Off?

Global markets were on Monday hit with a bout of severe tumult as concerns swirled over the trajectory of the US economy and traders rapidly unwound bets that have dominated this year. Japan was at the centre of the late summer storm, with its Topix index tumbling more than 12 per cent in the biggest sell-off since the “Black Monday” crash of 1987. Selling spilled into US and European markets, with Wall Street’s S&P 500 falling more than 2 per cent.

What is behind the sell-off?
In short: recent economic data has punctured the widely held view that global policymakers, led by the US Federal Reserve, will be able to cool inflation without too much collateral damage. Friday’s US jobs report, which showed a much sharper slowdown in hiring than Wall Street anticipated, added to simmering fears that the world’s largest economy is coming under growing strains from high borrowing costs. Corporate executives signalled during the recent earnings season that consumers, who play a central role in the US economy, are beginning to cut back on spending.

“Entering this year, investor expectations were for a ‘Goldilocks’ outcome,” JPMorgan equities strategists said on Monday, adding that this narrative was now being “severely tested”. Goldman Sachs said at the weekend that it now believed there was a one-in-four chance of the US falling into recession in the next year, compared with its previous forecast of 15 per cent odds.

Signs of impending economic malaise are not limited to the US: Eurozone business surveys show the bloc has been hit by geopolitical tensions, weaker global growth and fragile consumer confidence. Activity in China’s dominant factory sector also eased in the three months through to July. Surveys last month of executives in the manufacturing sector were “consistent with a stall in global factory output gains”, said Bruce Kasman, global chief economist at JPMorgan Chase.

Japan has further complicated the situation with a continued shift away from its negative-rate policies, which began in March and accelerated last week. This has caused tumult in the currency market that has spread elsewhere.

Why are the ructions so severe?
Global equities markets had up until recently been on the rise, driven by hopes for a Goldilocks economic scenario and a rush into US tech stocks fuelled by enthusiasm for artificial intelligence technology. Wall Street’s S&P 500, the world’s most important equities barometer, rallied almost 20 per cent from the start of the year to a record closing high on July 16. Pullbacks tend to be swifter than melt-ups: the S&P 500 has fallen nearly 8 per cent since reaching its July peak.

The rise in equities this year also made stocks look more expensive, a factor that has been a consistent concern for investors. The S&P 500 was as of Friday trading at about 20.5 times expected earnings over the next 12 months, compared with an average since 2000 of 16.5, FactSet data shows.

The Vix index, often referred to as Wall Street’s “fear gauge”, on Monday shot up to 65 points compared with 16 points a week ago, its highest level since the 2020 Covid-19 pandemic and signalling that more tumult could be in store for markets. It subsequently fell back to 33. The volatility also comes at the beginning of August, a time when senior investors and traders pack up for their summer holidays. Generally, this “low liquidity” situation lends itself to exacerbated moves.

What is the role of the tech sector?
Many investors have been fretting about the outsized influence on markets of just a small handful of tech stocks — America’s so-called Magnificent Seven. Apple, Microsoft, Alphabet, Amazon, Tesla, Meta and Nvidia accounted for 52 per cent of the year-to-date returns on the S&P 500 through to the end of July, according to Howard Silverblatt, senior analyst at S&P Dow Jones Indices. These stocks are now under pressure, with their once-positive influence on markets morphing into a pivotal factor in the sell-off. The tech-heavy Nasdaq Composite index is down about 13 per cent from its July peak.

The gloom was accentuated by news this weekend that Warren Buffett’s Berkshire Hathaway cut by half its stake in Apple as part of a broader shift away from equities that led the billionaire investor to offload $76bn of stocks. Other tech-focused concerns have also surfaced. Intel, one of the US’s best-known chipmakers, tumbled about 30 per cent last week after it unveiled plans to cut 15,000 jobs as part of a sweeping turnaround plan. Other chip stocks fell as a result. Anxiety that an AI boom would drive huge demand for specialised chips and servers is overdone has also weighed on sentiment. Chipmaker Nvidia, which briefly became the world’s most valuable company this year, has fallen more than 25 per cent from its June highs.

Why are Japanese stocks being hit hardest?
Japan’s equities have erased all of their gains for the year following Monday’s plunge, stung by a rapid rise in the yen after the Bank of Japan last week raised its main interest rate to 0.25 per cent, the highest level since the global financial crisis in late 2008. The more hawkish stance in Japan has contrasted with expectations for a dovish shift in US monetary policy. This has caused an unwinding of so-called carry trades in which investors borrow in a country with low rates to invest in one with high rates. This interplay has sent the yen rallying more than 11 per cent against the US dollar — a seismic move in currency markets — since the end of June to ¥143.95. A stronger currency is a big headwind for the country’s exporter-heavy stock benchmarks.

Japan’s actively traded stock market, which is heavily exposed to the global economy, is also an obvious place to start taking risk off the table when big global funds switch into panic mode. Despite recent bullish “Japan is back” rhetoric, and the all-time highs hit by Tokyo stocks in July, the story only ever had fragile support. Domestic institutions and individuals were never buying into the market with strong conviction, meaning that the heavy lifting of the recent rally was largely driven by foreigners. It means these investment “tourists” can pull out of the market with extraordinary speed — and they have done so.

Is the Fed to blame?
When the Fed held interest rates last week at a 23-year high above 5 per cent, the US central bank was doing as investors expected.

But the weak July jobs report, which showed slower hiring and a rise in the unemployment rate, suddenly spread panic that the Fed might have left it too long to begin lowering borrowing costs, heightening the risks of a US recession. Fed chair Jay Powell may be put to the test if markets begin creaking over a sustained period. Markets are now pricing in four or five quarter-point reductions by the end of the year. Traders are also betting on the possibility the US central bank will be forced to react before its next meeting in September with an unscheduled emergency cut. “We see a possibility of a [0.5 percentage point] cut in September but want confirmation from other data,” said Steven Englander at Standard Chartered. “If other data confirm that the decline is as steep as the July labour data suggest, a sequence of sharp cuts is likely.” Read More.

Board Composition And Independence | Research on the Impact of Board Size and Independence on Corporate Performance

Corporate governance issues have attracted a good deal of public interest because of their apparent importance for the economic health of corporations and society in general, especially after the plethora of corporate scams and debacles in recent times. Corporate governance issues flow from the concept of accountability and governance and assume greater significance and magnitude in the case of corporate form of organization where the ownership and management of organizations are distanced. And, it is in this context that the pivotal role played by the board of directors in maintaining an effective organization assumes much importance. A major part of the debate on corporate governance centres around board composition, especially board size and independence. Various committees have mandated a minimum number of independent directors and have given guidelines on board composition. However, the relationship of board characteristics such as composition, size, and independence with performance has not yet been established.

This paper addresses this question: Does the board size and independence really matter in terms of influencing firm’s performance?

The findings suggest that:
– There is an inverse association between board size and firm performance.
– Different proportions of board independence have dissimilar impacts on firm performance.
– The impact of board independence on firm performance is more when the board independence is between 50 and 60 per cent.
– Smaller boards are more efficient than the larger ones, with a board size limit of six suggested as the ideal.
– Independent directors have so far failed to perform their monitoring role effectively and improve the performance of the firm.
– The guidelines on corporate governance should take into account the ‘cross-board’ phenomenon while defining the criteria for eligibility for appointment as an independent director.
– Lack of training to function as independent directors and ignorance of the procedures, tasks, and responsibilities expected of them could be reasons for the independent directors’ non-performance.
– A bad performance leads to an increase in board size, which in turn, hampers performance.

Guidelines are provided for future studies to include different variables to see which board composition is suitable for different companies at different stages of life cycle.

The corporate governance issues have succeeded in attracting a good deal of public interest because of their apparent importance for the economic health of corporations and society in general, especially after the plethora of corporate scams and debacles in the recent times. The US, Canada, the UK, other European countries, the East Asian countries, and even India for that matter have witnessed the collapse of or severe pressure on their economies and have faced grave problems including the demise of several leading companies in the last two decades or so. This has resulted in a greater emphasis and attention on the corporate governance issues (Dalton and Dalton, 2005).

The corporate governance issues flow from the concept of accountability for the safety and performance of assets and resources entrusted to the operating team; these issues of accountability and governance assume greater significance and magnitude in the case of corporate form of organization where ownership and management of the organizations are distanced. A variety of governance mechanisms have been suggested to overcome the agency problem arising from the separation of ownership and control. One of them is the inclusion of independent directors in the board of directors.

The board of directors is viewed as an important internal corporate governance mechanism. In the corporate form of business organization, the board of directors occupies a unique position. It governs all organizations big or small. To have a board of directors is a legal requirement mandated by a statute for all the incorporated entities. The Cadbury Report (1992) placed the corporate board at the centre stage of the governance system, and described it as one by which companies are directed and governed. Elected by the equity shareholders of the company, the board presides over the functioning and performance of the company, operates through the executive management, and is accountable to the shareholders and, in a broader sense, to the other stakeholders of the company also. The board can therefore be viewed as juxtaposed between the shareholders (owners) and the executive management (Cadbury, 1992).

The corporate governance literature in the US and the UK focuses on the role of the board as a bridge between the owners and the management (Cadbury, 1992). In an environment where ownership and management are widely separated, the owners are unable to exercise effective control over the management or the board. The management becomes self-perpetuating and the likes and dislikes of the Chief Executive Officer (CEO) largely influence the composition of the board itself. The corporate governance reforms in the US and the UK have focused on making the board independent of the CEO.

Given the fiduciary relationships that the corporate directors are subject to, there is always an overwhelming need to ensure that they discharge their responsibilities properly to protect and promote the interests of all shareholders as well as other stakeholders. It is in this context that measures to have independent directors on the board — who have no pecuniary relationships that may impair their judgments on matters relating to the company and its shareholders — are being stressed upon. The Cadbury Committee (1992), the Greenbury Committee (1995), the Hampel Committee (1998), the Higgs Committee (2003), etc., have mandated independent directors on the board.

In India, guidelines on the composition of the board of directors have been issued along the similar lines as abroad, mandating the appointment of a certain percentage of independent directors. The guidelines on independent directors pose a series of questions concerning their independence and the relationship of the board composition and independence with the firm’s performance. The justification of inferring a relationship between board composition and performance is implied by the impact of the decision-making authority of the board on firm performance. The question of how the board characteristics such as composition or size or duality are related to profitability has remained unresolved based on the studies done abroad.

REVIEW OF LITERATURE AND RESEARCH GAP

A number of empirical studies have been conducted in the US on whether there is any link between independent directors and corporate performance. Some researchers have looked for direct evidence of a link between board composition in terms of independence and corporate performance. They have studied the correlation between the independent directors and the firms’ performance as reflected by the accounting numbers. Baysinger and Butler (1985) and Hambrick and Jackson (2000) found evidence for the proportion of independent non-executive directors to be positively correlated with the accounting measure of performance. On the other hand, studies by Klein (1998), Bhagat and Black (1997), and Hermalin and Weisbach (1991) have found that a high proportion of independent directors does not predict a better future accounting performance. Using accounting measures, Agrawal and Knoeber (1999) found a negative relationship between board independence and firm’s performance.

Hermalin and Weisbach (1991) and Bhagat and Black (2000) used the approach of Tobin’s q as a performance measure, on the ground that it reflects the ‘value added’ of intangible factors such as governance (Yermack, 1996) and found that there is no noticeable relation between the proportion of outside directors and q. The study by Lawrence and Stapledon (1999) produced no consistent evidence that the independent directors either add or destroy value where corporate performance was assessed using accounting and share-price measures.

Hermalin and Weisbach (1988) found that the proportion of independent directors tended to increase when a company performed poorly. Therefore, any cross-sectional regression of performance on board composition will be biased because of changes in board composition resulting merely from past performance. Both Hermalin and Weisbach (1991) and Bhagat and Black (2000) have attempted to correct for this effect using panel data, which allowed them to control for biases due to the joint endogeneity of the variables and simultaneous equation methods. In particular, these papers used lagged performance as an instrument for current performance. Even after correcting in this manner, there did not appear to be an empirical relation between board composition and firm performance.

The firm value depends on the quality of monitoring and decision-making by the board of directors, and the board size represents an important determinant of its performance. Jensen (1993) opines that large boards can be less effective than small boards. He says that when boards get beyond seven or eight people, they are less likely to function effectively and are easier for the CEO to control. A similar view is advocated by Lipton and Lorsch (1992) who state that the norms of behavior in most boardrooms are dysfunctional because directors rarely criticize the policies of the top managers or hold candid discussions about corporate performance. Believing that these problems increase with the number of directors, they recommended limiting the membership of boards to ten, with a preferred size of eight or nine. They, in a way, suggest that even if board capacities for monitoring increase with the board size, the benefits are outweighed by such costs as slower decision-making, less candid discussions of managerial performance, and biases against risk-taking. The idea is that when boards get to be too big, agency problems increase and the board becomes more symbolic and less a part of the management process. The inverse relationship between board size and performance has been reported by Yermack (1996), Eisenberg, Sundgren, and Wells (1998), Mak and Kusnadi (2003), Alshimmiri (2004), and Andres, Azofra, and Lopez (2005). However, Dalton et al. (1999) came up with contrary results.

Weirner and Pape (1999) have shown that the system of corporate governance in a particular country is context-specific and is a framework of legal, institutional, and cultural factors shaping the patterns of influence that stakeholders exert on managerial decision-making.

Further, the board leadership structure outside of the US might be more varied and, hence, may have a different relationship with firm performance. This phenomenon is particularly true for transition economies experimenting with the Western forms of governance and market mechanisms. Nonetheless, firms outside of the US are composed of different individuals and have different institutional expectations than the American boards, and this institutional context may lead to a different relationship with firm performance. For example, in their study of the 50 largest firms in the US, the UK, and Japan, Dalton and Kesner (1987) found that the proportion of insiders on boards varied significantly between these three countries (30%, 34%, and 49%, respectively). The institutional context and the make-up of corporate boards vary considerably around the world. Also, each country has, through time, developed a wide variety of governance mechanisms to overcome the agency problem that arises from the separation of ownership and control (Maher and Anderson, 2001). Further, Verma (1997) opines that there is no reason to expect the Anglo-American models of corporate governance to work in the Indian context. In fact, India had a unique system of Managing Agency in force for a long period of time before it was finally abolished.

Balasubramanian (2005) documents that our own ancient texts have laid down sound principles of governance, which are very relevant to the modern-day corporate requirements. But, in India, the policymakers are aping the Western models and forming policies and regulations based on them without checking their applicability in the Indian context. To add to this, there is mixed evidence abroad on the value addition as a result of moving towards majority-independent boards. Within a country, different studies have produced conflicting results.

The question of how board characteristics such as composition, size, or duality are related to profitability still remains unresolved. Yet, the recommendations of the Securities and Exchange Board of India Committee on Corporate Governance under the chairmanship of Kumar Mangalam Birla (1999), the Confederation of Indian Industry Code on Corporate Governance (1999), the Naresh Chandra Committee (2002), and the Securities and Exchange Board of India Committee on Corporate Governance under the chairmanship of N R Narayana Murthy (2003) are in favor of majority-independent boards, while the J J Irani Committee has recommended 33 percent independence, which can also vary with the size and type of company. There is a need for stronger tests to discern whether board composition has any effect on a firm’s performance. Hence, this study examines the question of whether or not board composition has an impact on the firm’s performance.

RESEARCH DESIGN

Data-
The guidelines on corporate governance issued by SEBI (1999) made it mandatory for all listed companies to adopt them in a phased manner. The BSE 100, NSE 50 companies, and the Category A companies had to adhere to the guidelines by March 31, 2001. This classification virtually covers all BSE 200 companies. So, all the companies in BSE 200 were taken, as it provided data for at least three financial years after the adoption of the guidelines on corporate governance. In all, data for six financial years from FY 1997-1998 to FY 2002-2003 were included in the analysis. The data sources were the Annual Reports of the companies, databases like Prowess and Capitaline, and the reports filed by the companies with the NSE and the BSE as part of the listing requirements. From the 200 companies selected above, all the banking companies were excluded as being governed by the Banking Companies Regulation Act; hence, these companies were different from those governed by the Companies Act. Also, those companies which were not listed for all the six years under consideration were excluded. The exclusion of these, as well as the banking companies, left us with a sample of 164 companies.

Methodology
To study the relationship between board independence, board size, and firm performance, the following variables were used, which were endogenous or exogenous depending upon the hypothesis being tested:

Firm Performance
Data on four measures of firm performance — each with support in the finance and accounting literature as a respectable measure of firm performance — were collected as there is no single ideal measure of long-term firm performance (Healey,1985). The approach is akin to the approach adopted by Bhagat and Black (2002) with suitable modifications.

The measures are:

Tobin’s q: Computed as \[(MV of common stock + BV of preference stock + BV of borrowings + BV of CL) / BV of total assets as denoted by FA + INV + CA\] with all values computed at the year end. This is a slightly modified version of the computation \[(MV of common stock + BV of pref stock + BV of LTD) / BV of total assets\], given by Chung and Pruitt (1994) who report that this computation approximates the actual q to the extent of 96 percent. The modification was done to make it compatible with the manner of reporting in the Indian context. Tobin’s q is an unambiguous measure of value added by the management and can also capture the value of future investment opportunities.

Ratio of operating income (EBIT) to assets: Also known in literature as return on assets.

Ratio of sales to assets.

The accounting variables chosen were independent of the firm’s capital structure and its tax structure. Other measures are also there in literature, but they tend to be highly correlated (Jacobson, 1987), so the choice was limited to the above three.

Market-adjusted stock price returns (MASR): Computed by cumulating over the measurement period, monthly stock returns minus returns on market index (NSE 50) without adjustment for beta. For the multi-year periods over which returns are cumulated, MASR is better specified than abnormal return measures that include a beta adjustment (Kothari and Warner, 1997).

Director Independence
The directors of the companies were classified into four categories, namely executive (inside) directors, outside (independent) directors, directors who are non-executive but non-independent, and nominee directors (directors who are nominees of financial institutions). The measure for board independence was taken as the number of independent directors as a percentage or proportion of total directors. Also, to see the differences between boards that have 30 percent independent directors or boards that have 60 percent independent directors, the board independence was categorized as follows:
Category 1: where the proportion of independent directors with respect to the total board size was less than one-third, i.e., 33.33 percent.
Category 2: where the proportion of independent directors with respect to the total board size was greater than 33 percent and up to 50 percent.
Category 3: where the proportion of independent directors with respect to the total board size was greater than 50 percent and up to 60 percent.
Category 4: where the proportion of independent directors with respect to the total board size was greater than 60 percent and up to 74 percent.
Category 5: where the proportion of independent directors with respect to the total board size was greater than 74 percent.

Board Size
The measure for board size was the total number of directors on the board. Also, there was a need to see the differences between different board sizes. Large boards, as suggested in literature, may become dysfunctional. To check for this, the board was categorized as follows:
Category 1: if board size was of 3 to 6 members.
Category 2: if board size was of 7 to 9 members.
Category 3: if board size was of 10 to 12 members.
Category 4: if board size was more than 12 members.
Dummy variables were used for board size categories at the time of analysis.

Control Variables
The regression results between firm performance and board composition were subject to control for a number of factors that could affect firm performance, board composition, or both. These control variables are:
Outside director ownership: using a dummy variable which equals 1 if it exceeds one percent. Directors’ and shareholders’ interests get aligned when directors have significant holdings.
Firm size: measured by log of sales. Log transformation of this variable is used to correct for the high degree of skewness in the firm size, thus ensuring that the data is properly distributed. Log sales take care of heteroskedasticity.
Leverage: measured as long-term debt/ (debt + equity), to control for variations in capital structure and as proxy for default risk.
Industry control: for manufacturing/services/financial services with dummy variables for different categories.
Risk: as measured by beta.
Type of company: whether government-owned/Indian private sector/foreign-owned (MNC) by using dummy variables for different categories.
Age: measured as the number of years for which the company has been in existence since incorporation.
Number of outsiders who own at least 5 percent stock.
Diversification: measured as the number of business segments for which the company reports. Yermack (1996) reports that diversified firms are valued less highly in the capital market than stand-alone businesses. He also states that diversified companies are likely to have larger boards, because many boards grow in size when companies make acquisitions and because boards of conglomerates may seek outside expertise for a greater number of industries.
Ratio of capital expenditure over sales: as proxy for investment opportunities. Smith and Watts (1992) state that firm value depends upon future investment opportunities.

Use of Panel Data
Unobservable characteristics are likely to affect each company’s market value. Therefore, both OLS and Random Effects models were estimated. The Random Effects model was estimated to verify the main results obtained from the OLS models. Green (1997) maintains that panel data sets allow researchers to capture both time series and cross-sectional relations. There are both fixed-effects and random-effects panel models. Hsiao (1986) states, “when inferences will be made about a population of effects from which those in the data are considered to be a random sample, then the effects should be considered random.” That is what has been proposed to be done through this study and hence the Random Effects model has been used.

RECOMMENDATIONS

Board Size

Literature finds that smaller boards are more efficient than larger ones. A larger board impairs the performance of the firm. Larger boards are dysfunctional; their contributions get marred and are easily manipulated by the CEO. The board size should be large enough to have people with the required expertise and knowledge to efficiently run the company and yet be small enough to allow meaningful discussions. This is facilitated when the boards are small so that the members get acquainted well enough to have frank discussions, reach a consensus, and allow for every director to contribute. More often than not, in the case of large boards, the members get divided into sub-groups who are at loggerheads with each other, which does more harm than good to the company (Cadbury, 2002). The study recommends limiting the board size to 6 as advocated by Jensen (1993) (anything between 6 to 8) and less than the recommendations of Lipton and Lorsch (1992), who suggest limiting the board size to 8 to 9 members. Corporate governance norms may bring this issue to the attention of the firms instead of going for legislative changes.

Director Categories and Performance
The study found mixed evidence that independent directors add value and improve the performance of the firm. It is pertinent to mention that there was no conflicting evidence that they destroy value. These results suggest that independent directors have so far failed to perform their monitoring role effectively. This can be attributed to the fact that ‘board independence’ is something that has just started getting importance and is catching on in India. It will take some time for the effects to come.
Another reason for this can be that there is a limited pool of talent from where the independent directors can be taken. This is exhibited by the presence of the same person as the independent director on the boards of many companies. At the time of data collection, it was observed that the cross-board phenomenon was also prevalent — a person (say, Mr. X) may be an executive director (or CEO) in one company where some other person (say, Mr. Y) is an independent director. Now, Mr. Y, in turn, is an executive director (or CEO) of a company where Mr. X is an independent director. In such cases, it is doubtful that either of them will contribute as an independent director to the board on which they are appointed or will bring in independent judgments, and their lack of interference and monitoring will be proportional to what they expect others to do on the board where they are the executive directors (or CEO). Therefore, it is suggested that the guidelines on corporate governance should take into account the ‘cross-board’ phenomenon while defining the criteria for a person to be eligible for appointment as an independent director. Cadbury (2002) adds another dimension to this by saying that the practice of having executive directors of other companies on the board of the company needs to be discouraged as such people have a mindset similar to that of the executive directors who are already there on the board. He argues that people with different backgrounds and different perspectives required in today’s dynamic and global world should be added.
Lack of training to function as independent directors, and ignorance of the procedures, tasks, and responsibilities expected of them, can be other reasons why the study did not find independent directors contributing towards the performance of the firms. There is thus a need for training programmes for independent directors. Merely adding such persons to the board may increase the proportion of independent directors without improving the performance.
Some companies had no independent directors till the end of the financial year 2002-03. This shows that compliance with the guidelines or listing agreements left a lot of scope for improvement. Very recently, in 2005, a company (ONGC) was threatened with delisting if it did not add independent directors to its board to meet the minimum stipulated norms. This was one of the first cases where action was contemplated and it came four years after the deadline to implement the guidelines.
The findings of the study suggest that the proportion of independent directors should be between 50 and 60 per cent. The results do not support board independence beyond 60 per cent or below 33 per cent. The study thus suggests that there is an optimum proportion of board independence. The overall insignificant results with regard to board independence can be attributed to the presence of companies in the sample where the board independence was either below 33 per cent or more than 60 per cent.
Board size and performance as well as board independence and performance were found to be inversely related. This means that poor performance leads to an increase in both board size and board independence. Independent directors are added under pressure from stakeholders on the grounds of bringing in expertise and independent judgment as well as providing transparency at the time of poor results. This addition of independent directors need not be accompanied by the removal of a director in some other category; as a result, both the size and the proportion of board independence increase, which is what the results seem to suggest. The study found evidence of endogenous determination of board size and performance. Poor performance leads to an increase in board size, which in turn hampers performance. No evidence was found for endogenous determination of board independence and performance.

LIMITATIONS
There are a variety of mechanisms and market forces that reduce agency costs and complement or substitute board independence. Despite providing for controls in the analysis, the impact of governance mechanism is difficult to segregate.
The data has been collected from databases like PROWESS and Capitaline. Mistakes were detected in the data and were corrected. While care was taken to ensure that all corrections are made, some of them might have been inadvertently overlooked. The classification of the directors into different categories was as mentioned in the corporate governance reports which are a part of the annual reports. It was assumed that the companies are reporting fairly to the regulators and the stock exchanges, as misrepresentation would entice legal actions.
The data for performance measures tend to be noisy. Many factors influence the performance of the firm, and not all of them would have been controlled for in the study. Also, if the board composition effects are anticipated by the market, then the market-based performance measures tend to become irrelevant for an analysis to determine the impact of board composition.
This study has taken data for six financial years, as prior to that, corporate governance was not reported in the financial statements. Studies on board composition should be conducted for a longer time horizon.

GUIDELINES FOR FUTURE RESEARCH
The qualifications of the directors, their age, and whether the effect of board composition is moderated by these factors need to be looked into. The companies have now started disclosing information on these variables in their annual reports; therefore, further studies can be taken up with them.
Different companies can have different board compositions that are appropriate. Further studies can be taken up to see which board composition is suitable for different companies that are in different stages of the life cycle (starters, fast growth, mature, etc). Boardroom behaviour is also very important. Future researchers can observe and study boardroom behaviour by actually attending the board meetings.
Besides composition, other factors like the number of meetings, the duration of these meetings, the attendance records of independent directors, the number of agenda items in the board meeting, etc., are also important and can be included in future studies.
Strong substitution effects are present amongst the various aspects of governance conduct. Substitution between monitoring by the outside directors and the large shareholders, as well as monitoring by the inside directors in determining the performance, can be studied. Read More.

Board Effectiveness | Board Effectiveness A Practical Approach To Corporate Governance 2024

Boards are conducting annual director assessments in line with annual self-assessments to help individual board members assess their own and their peers’ value contributions and to resolve queries from shareholders for any incumbent and prospective nominees.

An effective board adds value. While this seems obvious and is widely known as an axiom in governance circles, being an effective board member and contributing to the effectiveness of the board at large is often misunderstood. Gaining a board seat has become all the rage in business circles globally of late. It’s often a highly lucrative career option, particularly when factoring in the hours required and the perquisites provided. I searched “board member” on LinkedIn recently and found that more than three million people list it as an “experience”—add to those the board members who do not maintain a LinkedIn profile. I recently came across a quote by Greek philosopher Plutarch, which prompted me to focus this piece on director effectiveness: what it means to be effective and why it is important.

“Holding office is not about power, except to the uneducated leader who is insecure and afraid of the people he [or she] governs…. Educated leaders, conversely, are primarily concerned with the welfare of their constituents, even at the expense of their own power or safety.” – Plutarch

Observations from the field: Characteristics of the effective board member

A board member’s primary roles are to add value when undertaking board responsibilities and duties and to set a healthy tone from the top. Anyone seeking a board seat should carefully consider the organization and ask oneself three questions:

• Do I support the organization’s vision?
• Do I support and use the organization’s products?
• Since total shareholder return (TSR) is of vital concern to the board, will I deliver value on behalf of shareholders and all stakeholders?

In my board advisory role of nearly 15 years, I have interviewed, worked with and advised well over 1,000 board members, chief executive officers (CEOs) and C-suite members specifically on the topic of board effectiveness. In my experience, the most impactful board members are those who:

1. Bring a broad understanding of the business.
2. Arrive at board meetings well prepared and focused.
3. Have led an organization or division and executed on strategy.
4. Possess an understanding of business psychology and social anthropology.
5. Maintain a specific skill, or set of skills, while also being well rounded and able to contribute insights on a range of topics.
6. Challenge assumptions with respect and emotion in check.
7. Seek continuing education outside the boardroom.
8. Possess and demonstrate a strong IQ (intelligence quotient) and EQ (emotional intelligence).
9. Know that the reason for aspiring to be a board member is service to the organization.

I would also add that effective board members understand how visions, missions, values and goals are communicated down through an organization so that the tone from the top leadership effectively signals through all organizational levels why the entity exists and how it delivers value.

Having provided a list of what contributes to being an effective board member, I am often asked to address the circumstances and characteristics of a less-than-effective board member. Avoiding these behaviors is certainly recommended:

1. Signaling entitlement over service.
2. Communicating self-importance versus checking his or her ego at the door.
3. Confusing the board member’s role with the manager’s operational responsibility.
4. Asking questions that are explained in detail in the board’s pre-read information.
5. Being verbose and dominating board discussions.

An addendum to this list is that while board tenure and effectiveness don’t directly correlate, many CEOs and chairs emphasize that board members should be more objective and put the best interests of the board and organization first when considering the right time to step down from their roles—similar to the axiom concerning one who has been invited to a house dinner party: Don’t overstay your welcome.

Adding value: The importance of continuous learning and active listening

Board members often ask me how to add value to topics and issues outside of their areas of expertise. Two helpful operative concepts are continuous learning and active listening.

Active listening and curiosity augment board members’ abilities to contribute to all board discussions and effectively carry out their duties of care, monitoring and loyalty. Active listening is the ability to keep an open mind while listening intentionally, with a goal focused on learning and understanding. When integrated as part of a board’s culture, active listening and curiosity promote inclusive, focused discussions, open and candid debates, and effective summarizations to help guide boardroom discussions.

The importance of continuous learning is impossible to overstate. With the development and implementation of groundbreaking new technologies, increased and changing regulatory and reporting requirements, and disruptions coming from every direction, risks and opportunities have never been so plentiful. It is imperative that a board collectively possesses a level of knowledge and understanding that supports effective oversight and governance. Board members who choose not to keep up risk being left behind or, worse, making bad decisions. Concerning technology, in particular, it is no longer sufficient to rely on the expertise of advisors or the bank’s IT (information technology) team; boards must assume responsibility for building functional levels of understanding.

In the fast-paced change environment of the business world today, the opportunity for ongoing executive education is replete. Universities globally sponsor programs for board members’ continuing educations.

Thinking beyond the basics: Risk oversight

Risk oversight encompasses a wide range of focus areas. For this discussion, I will focus on two key areas. It is generally agreed that hiring the chief executive is the board’s first and most important responsibility. Regardless of the board’s confidence in the chief executive or how long he or she has held the position, maintaining a succession plan should be a top priority on the board’s agenda. Even if a board believes it has the right CEO who will most likely serve for many years, the absence of a robust, formal CEO and management succession plan invites unnecessary risks to the organization. Developing a strong and deep bench for both planned succession and sudden departures must be strategic and viewed through an enterprise risk management (ERM) lens. Each board member has an important role to play here. Access to and regular engagements with the CEO and members of management at multiple levels provide insights into the status of the pipeline. Board mentorship can be an impactful practice in developing talent.

The average board comprises nine to ten members. The board’s number-one priority is being the stewards of the organization’s long-term sustainability. Hiring and supporting the CEO and maintaining a succession plan should be a top priority on the board’s agenda. CEO successes and failures over the past 20 years certainly point to the necessity of better, more dynamic CEO succession planning.

A second board priority is building and promoting a robust risk culture. A highly effective board is one that approaches risk, opportunity and succession together with an enterprise risk management approach, in other words, a wholistic approach.

Consider for a moment the Rubik’s Cube from the 1980s. The cube has 54 squares of different colors on its six sides. Without a mirror, how many sides can one person possibly see? Only three. Suspend the cube over a circular board table at an angle, and imagine 20 board members and managers at the table. Together, they can examine all sides of the ERM cube—all 54 risks. This team of 20 can then identify and prioritize each risk’s materiality and impact. Effective boards monitor these identified risks and probe areas of unpredictability and unintended consequences.

But what about the sides of the cubes that are not visible? The hard-to-predict aspects of risks? The unintended consequences?

Understanding AI

Consider for a moment artificial intelligence (AI), which is quickly becoming part of every board’s discussion. While artificial intelligence has been nurtured as an emerging technology since the 1950s with Alan Turing’s work Computing Machinery and Intelligence and later with the democratized access proliferated by OpenAI, coupled with processing power that is accelerating generative AI, board members once again have a ringside seat to a new era of human intellectual evolution, one that is likely to have a significant influence on boards’ risk oversight and oversight generally. As stated earlier, developing some level of understanding of this new technology is the responsibility of every board member.

For the simple reason that AI is already affecting banking, and to remain relevant, board members should attend events during which they can build their understandings of these technologies and their benefits and risks.

Moreover, board members should expect and even demand that AI improve their abilities to add value in the boardroom. Examples include developing more accurate methodologies for reviewing financial results, providing deeper insights into customer trends and sentiments, synthesizing board-meeting information to prioritize the most important elements and building better scenario understanding through trend-prediction analyses.

Corporate governance 2024 and beyond

Anyone who aspires to take a public-organization board seat today should consider this responsibility with care. The standards to which boards and individual directors hold themselves should be well understood.

Boards’ efforts to achieve continuous improvement and drive excellence in the boardroom are already being augmented with AI tools, meaning excuses for a board’s underperformance will be harder to defend, and scrutiny of governance performances and failures will increase. Boards are conducting annual director assessments in conjunction with their annual board self-assessments to provide individual board members with opportunities to reflect on their own and their peers’ continuing effectiveness and value contributions. Shareholders routinely challenge incumbent and prospective nominees. Board service requires firm and informed commitments.

A board’s corporate-governance journey towards excellence is best served by a leadership culture that embraces humility and continuous improvement. While Jim Collins’ book Good to Great and its underlying research found that the Level 5 leader embodies “humility and strength of will”, a highly effective board member reading this should recognize aspects of his or her ethos and board leadership reasoning within.

I am grateful for the leaders who have provided practical governance insights. Recently, a board chair commented, “What I despise is mushroom management” in response to my question to him about the relationship between the board and management. “What is mushroom management?” I queried back. “That’s where leadership leaves the board and others in the dark.”

A renewed commitment to board effectiveness

Effective boards and well-governed organizations aspire to maintain an open, transparent culture built on a solid foundation of trust (personal, financial and organizational), on which candor and respect are promoted and proliferated.

In that spirit of transparency, I offer aspiring and sitting directors an trusted advisor’s insight and a practical takeaway highlighting the following trends:

• CEO coordinates board and management interactions beyond direct reports.
• Annual “offsite” strategy gathering of the board and management.
• Clear understanding that surprise is an enemy.
• Ongoing succession planning.
• Development and implementation of board-level dashboards.
• Invite challenges of assumptions with openness and active listening.
• Robust risk culture that evaluates opportunity as a risk.
• Scenario planning/pressure testing.
• Understanding customer trends and competitive landscapes.
• Visiting and knowing the sites or facilities where the entity conducts business.
• Lifelong learning approach to self-education for the board’s benefit.
• Sufficient understanding of the entity’s stakeholders.
• Knowing the culture leaders.
• Seeking management’s candid input on the board’s effectiveness.
• Monitoring board and company cultures for consistency.

The effectiveness of a board and its members is observed by its stakeholders, particularly its shareholders, workers and vendors and the communities the organization impacts. The effective board’s foundation is trust, and the goal of board members, individually and collectively, is that the organization delivers positive results. Between these two is hard work, which includes accountability, constructive challenge and strategy. Read More. 

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The Evolving Role of Board of Directors and Management Teams