Diversity in a corporate board has various perspective – diversity on account of education, experience, knowledge, functionality, gender, executive/non-executive, independent, international etc. Some of these ‘diversity’ components are also mandatory as required by the regulators. But the fundamental question is - Why should a corporate board have diversity and how a corporate gains with this theory? The probable answers would be: - · for diversified experience and opinions
- · for a non-biased, objective view on the functionality of the corporate – role of independent directors
- · to get external (non-executive) perspective of the functioning of the corporate
- · to access to the external network
- · to broad base the board
- · for legal compliance
There are certain provisions under the Companies Act 2013 and its various Rules and under Listing Obligation and Disclosure Requirements issued by Securities & Exchange Board of India.
While complying these provision, the spirit of the law is lost, sometimes even in bigger corporate. Few recent examples from the Indian corporate world are ICICI Bank, Sun Pharma, IL & FS, Jet Airways and so on. All the companies do comply with these provisions but they failed somewhere on the test of ‘corporate governance’ and consequently, shareholders lost huge value of their investments. (see the picture here as published in the daily financial Mint, Mumbai).Some time back, I read a research report about Lehman collapse. The work was done by Young Ah Kim and was published in Illinois Business Law Journal [1] in April 2016. I am sharing a certain portion from the said research relevant to corporate governance, which failed in Lehman and could be one of the reasons for the collapse, as understood in hindsight. The research says – “Lehman Brothers is often cited as an example of corporate governance failure largely due to poor oversight by the board.” “….On September 15, 2008, Lehman Brothers filed for bankruptcy. With $639 billion in assets and $619 billion in debt, Lehman's bankruptcy filing was the largest in history, as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron...”[2]
Lehman Brothers Holdings Inc. – Too big to fail?
Lehman Brothers Holdings Inc. (former NYSE ticker symbol LEH) /ˈliːmən/ was a global financial services firm. Before filing for bankruptcy in 2008, Lehman was the fourth-largest investment bank in the United States (behind Goldman Sachs, Morgan Stanley, and Merrill Lynch), doing business in investment banking, equity and fixed-income sales and trading (especially U.S. Treasury securities), research, investment management, private equity, and private banking. Lehman was operational for 158 years from its founding in 1850 until 2008.
On September 15, 2008, the firm filed for Chapter 11 bankruptcy protection following the massive exodus of most of its clients, drastic losses in its stock, and devaluation of assets by credit rating agencies, largely sparked by Lehman's involvement in the subprime mortgage crisis, and its exposure to less liquid assets. Lehman's bankruptcy filing is the largest in US history, and is thought to have played a major role in the unfolding of the late-2000s global financial crisis. The market collapse also gave support to the "Too Big To Fail" doctrine. [3]
The report questions “Why did Lehman’s board of directors not effectively oversee Lehman and leave it bankrupt? Their responsibilities are the oversight of and advisory to the company. After Lehman Brothers collapsed, many observers have pointed out that it should not have taken excessive debts, diversified product portfolio and the board of directors should have monitored its strategy and risk management more carefully. All of the root causes of Lehman’s failures can be traced back to the dysfunction of the board of directors and the agency problem.”
The report critically examines the role and failure of a well diversified board and its directors and says –
“In Lehman, 8 out of 10 directors met the independence of standards of the NYSE in 2006, but they lacked the financial expertise and failed to reliably monitor Lehman. For example, the finance & risk committee met only two times a year and the compensation committee met more times (eight) than the audit committee (seven). Berlind was a theatrical producer, and Evans was a career officer and Rear Admiral in the United States Navy. Retired CEOs’ professional experience include Sotheby’s, Vodaphone Group, IBM, Telemundo Group, which are not financial services areas. Until 2006, Lehman’s board included Dina Merrill, an 83-year-old actress. In addition, there were no current CEOs of major public corporations and former CEOs were well into retirement. Did the board properly understand the complexity and severity of financial markets well enough to weather the storms when the financial market slowed down? Could these “independent” directors who did not have most updated financial expertise represent the shareholders’ best interests? Did they exercise fully their fiduciary duty that they owe to Lehman and act in good faith in exercising their oversight responsibilities solely in the best interests of Lehman’s shareholders?”
It may happen that most of the public listed entities (all size) would comply with the regulatory requirement for the composition of the board of directors and committees but ‘irrelevance’ of such people or lack of training to such people may make the whole process redundant. It may be completely ineffective board as far as Independent directors are concerned when they are not ‘relevant’ or not trained for that board. Most of the boards are decorated with good names but they become ineffective or they have failed when it comes to corporate governance. In recent days, we have seen a large number of Non-Performing Assets (NPA) in the Indian banking system. To what extent the board of directors should be held responsible, for both the side – borrower and the lender, it’s a question to be examined in detail carefully.
Lehman didn’t fail due to noncompliance. In most of the cases, corporate governance is understood as a system of ‘legal compliance’ and not beyond that. But good corporate governance contributes to shaping a company and its business beyond compliance. For a well-diversified corporate board, take away from Lehman Brothers failure would include the following points:
i. There is no doctrine – ‘too big to fail’. In fact, when it is too big, the impact is also too big of something going wrong. Hence when the going is good, they (directors) need to be extra careful and most of the times, wrong decisions are taken during the best times.
ii. Directors must examine ‘risk’ for every business plan in depth and in case, they need some external assistance, they must seek the same to examine the plan. Risk, de-risk process is a must for every company.
iii. Directors must ask the executive management to build an information architecture – to get the right and accurate information at the right time and with the right periodicity.
iv. Directors must set up a process of information dissemination to the stakeholders which convey the necessary risk factors associated with the business of the company.
v. Board composition and recruitment of Directors – directors must have some relevance to the corporate’s business and not the sole criteria of the promoter’s familiarity.
vi. Independent Director must insist for a proper familiarization (business) program by the company in order to understand the business of the company. Such programs should be on regular basis.
vii. Independent directors must keep an eye on the information about the company in the public domain in general to sense the direction/perception and must seek the necessary information from the company executives.
In May 2017, Lubna Qassim [4], a Global Lawyer and Strategist, published a paper ‘How does corporate governance vary around the world’ and quotes Wharton professor Michael Useem [5] who predicts boards around the world will move to a standard model within 15 years [report 6] driven by globalization and the need to move huge sums of investment freely between countries.
He argues: “Put yourself in the shoes of Fidelity or Vanguard or other investors out there who are diversifying out of US stocks. You want to assure yourself that the companies you are going into are reasonably well governed — that they have acceptable accounting standards and are transparent.”
He says the central focus of corporate governance is the structure of the corporate board and that firms around the world are moving to create boards that are more independent from management, populated by non-executive members and organised around committees overseeing management, compensation and auditing. He adds: “All these factors point to good governance and thus the company becomes more attractive to investors and legitimate in the eyes of suppliers and customers. An investment manager anywhere in the world looking to put cash in the stock of a company in Lithuania or Italy will come at the company with an eye to whether it is following good practices.”
Corporate governance is the system of rules, practices and processes by which a company is directed and controlled. A well diversified corporate board with good corporate governance practices balances the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community.
With the changes happening, we all expect active well diversified corporate boards in next few years to minimize failure due to poor/bad governance.
References, reports and persons referred:
About the Author:
Pradeep Malu
A fellow member of the Institute of Chartered Accountants of India, he is a Business Advisor & Mentor, Independent Director, Corporate Governance Professional, Investor from Mumbai, Maharashtra, India. See detailed profile
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