Corporate Regulator’s Decision to Split MD and Chairman positions: Once Again Deferred | Nand L. Dhameja

The Corporate Regulator, SEBI, has announced deferment of its decision to split the post of MD and Chairman with effect from March 31, 2022, the date extended date by two years in 2020.

Sebi had announced in 2018, on the suggestions of the Uday Kotak Committee on Corporate Governance to amend provisions of the SEBI (Listing Obligations and Disclosure Requirements (LODR) Regulations, 2015. As per the recommendations:

a). positions of the chairman and managing director (MD/CEO) or chief executive officer (CEO) were split;
b). chairman and MD/CEO must not be related to each other, and;
c). position of chairman be held by a non-executive member.
The above regulation was applicable to the top 500 listed entities by market capitalization and was to be effective from April 1, 2020, the date was extended by two years to March 31, 2022.

As per legal provision, Section 203 of the Companies Act, 2013 provides that an individual shall not be appointed as the chairperson of a company as well as the MD/CEO at the same time unless

a). the articles of such company provide otherwise, or
b). the company does not undertake multiple businesses.

Rational of the amendment by SEBI was to improve corporate governance as many companies had merged the two positions managing director and chairman (CMD) which led to overlap board and the management and conflict of interest. Objective was to provide a better and more balanced governance structure by enabling more effective supervision of the company’s management by reducing excessive concentration of authority in a single individual.

Idea behind the separation of two posts was to have a “better and more balanced governance structure“, as a chairperson is the head of the board, while the MD/CEO works under the supervision of the board; and so common position of the chairman and MD would lead to potential conflict of interest. As there are three levels of control in a company: shareholders, board, and management; shareholders and board cannot interfere in the day-to-day operations of the company. If the board leadership and the management leadership are vested in the hands of the same person, there is overlap and boundaries get blurred.

International practice

The Organization for Economic Co-operation and Development (OECD) has recommended that the two posts of chairman and managing director should be separated as a good corporate governance practice. Germany and Netherlands have a two-tier board structure that separates the roles of the board and management. In Europe, more than 90 percent of the Financial Times Stock Exchange (FTSE) 100 companies have distinct roles defined. In the US, there is an increasing trend of organisations favouring this split. Countries including UK, large parts of Europe, Japan, Australia, and South Africa, etc. support the practice of separating the two roles. However, the matter is contested in some countries like, the US and France.

Germany has a two-tier system of Board - Supervisory board and management board. The supervisory board has the power to appoint and dismiss members of the management board, as well as to supervise the management board’s activities. The supervisory board must have at least three members, higher number up to nine, 15 or 21 members, depending on the share capital of the company, but the total number must be divisible by three. There is no minimum number of the members of the management board unless the articles provide otherwise.

Corporate Position in India

Some of the Indian companies having split the two roles included, Mahindra and Mahindra, Asian Paints, Sun Pharmaceuticals, HUL, Ultra Tech. As of the end of December 2020, only 53 percent of the top 500 listed entities had complied with this provision; and there is barely four percent increase in compliance by top 500 listed firms.

Various Industry associations have shown reluctance to the provision of separation of the post of chairman and MD. The Confederation of Indian Industry (CII), in its recent letter to SEBI, has reiterated its opposition to this amendment, citing concerns of over-regulation and that would act as an impediment to a conducive business environment. Chandrajit Banerjee, Director General CII said, “The provision that chairman and MD/CEO should not be related, could be onerous and may not be required, especially in the light of sufficient checks and balances present in the existing regulations to counter any potential ill-effects of such a situation,”

Similarly, Arun Chawla, director general, FICCI, expressed gratefulness to the regulator for appreciating industry’s issues concerning splitting the posts of chairman and managing director, the move that might weaken entrepreneurial spirit and hamper the business environment of the country. To quote, Arun Chawla, “FICCI had highlighted this particular issue multiple times and true to the spirit of the current dispensation, Sebi has heeded to our suggestions and given a huge relief to industry, which is struggling to revive economic growth amidst multiple waves of the pandemic. Responsible self-regulation with adequate disclosures and accountability is the mantra,”

Family-run-businesses which make a significant contribution to GDP, employment and economic growth and account for about 60 percent of the top 500 listed companies in India, are among entities that are most impacted by SEBI’s proposed MD/chairman split. The move will affect succession planning as the MD’s position is often a preparatory one for the next generation family member before the person becomes the chairman.

Many business entities too have shown reservations against this provision. According to Bajaj Finserv chairman and MD, Sanjiv Bajaj, the provision to split two posts will weaken India’s competitiveness; as most businesses in India are family owned, where knowledge and experience is passed from one generation to another. Sangita Reddy, Jt. MD Apollo Hospitals opined that such a move could act as counter balance where independent directors will be more inclined towards choosing the best candidate, much in line with the company promoter’s interest.

Considering unsatisfactory compliance to the provision of split of the two posts of MD and chairman, representations from industry, constraints posed by the prevailing pandemic situation, and also with a view to enable the companies to plan for a smoother transition, as a way forward, the SEBI decided that this provision may not be retained as a mandatory requirement and instead be made applicable to the listed entities on a voluntary basis,”

The reprieve is expected to benefit hundreds of companies, having the same individual as chairperson and MD/CEO. Such companies include Reliance Industries, Bajaj Finserv, Adani Ports.

Thus, the Sebi decision to split MD and Chairman role among top 500 listed companies has been deferred and compliance by companies has been made voluntary. To strengthen it, following issues need consideration:

• Provision for split of two roles would lead to over-regulations and abrogation of the shareholders democracy and over-ride their authority to determine how does the company leadership function. Further, it would hinder the ease of doing business by interfering in the company’s internal operations? This is particularly so for the functioning, and to smoothen succession planning among family-owned businesses.
• Rather, efforts should be to strengthen the system of board of directors and also the system of independent directors. For strengthening of the corporate governance system, functioning of the Audit Committee and the Committee for the Protection of Investors’ interest, norms for inclusion of independent directors should be streamlined so as to oversee the management of the company and to put a check on concentration of power in a single individual. Institutional shareholders have a bigger role in making the system of directorship and company management by overseeing their operations.
• In cases, the two roles are with a single person, has it led to weakening of their system of corporate governance? Findings and observations of the 21-members Panel constituted by the Sebi for the purpose could be a useful indicator.
• Certain companies abroad favouring split in two positions, has such practice of split been done voluntarily or under some regulation?
• Policy of role split among state public sector banks and public corporations is certainly of relevance because of government ownership and control, and also as they do not involve the practice of succession-planning, a normal practice among family-owned companies

(Author: Dr. Nand L. Dhameja, Professor Emeritus, FMS, Manav Rachna International Institute of Research & Studies, Faridabad)