Board Evaluation
– Real Opportunity for Self-learning and Improvement
September 20, 2023
All listed companies and most large public companies (even if un-listed) are legally abided to conduct an Annual Board Evaluation exercise. It is also an excellent opportunity for boards of companies to assess themselves and set in motion practices to help improve their own effectiveness as the final decision-makers of the corporations on whose boards they serve.
A. Mandatory Statutory Requirement
Annual Board Evaluation is a mandatory Statutory requirement, under The Companies Act 2013 (CA 2013), for all companies with a paid-up capital of Rs 25 crores or more, and all listed companies regardless of how much is their paid-up capital.
Section 134(3) of CA 2013 states:
There shall be attached to statements laid before a company in general meeting, a report by its Board of Directors, which shall include— (p) in case of a listed company and every other public company having such paid-up share capital as may be prescribed (given below), a statement indicating the manner in which formal annual evaluation of the performance of the Board, its Committees and of individual directors has been made;
There shall be attached to statements laid before a company in general meeting, a report by its Board of Directors, which shall include— (p) in case of a listed company and every other public company having such paid-up share capital as may be prescribed (given below), a statement indicating the manner in which formal annual evaluation of the performance of the Board, its Committees and of individual directors has been made;
Rule 8, Sub-rule 4, of the Companies (Accounts) Rules, 2014 states:
Every listed company and every other public company having a paid up share capital of twenty five crore rupees or more calculated at the end of the preceding financial year shall include, in the report by its Board of directors, a statement indicating the manner in which formal annual evaluation has been made by the Board of its own performance and that of its committees and individual directors.
Every listed company and every other public company having a paid up share capital of twenty five crore rupees or more calculated at the end of the preceding financial year shall include, in the report by its Board of directors, a statement indicating the manner in which formal annual evaluation has been made by the Board of its own performance and that of its committees and individual directors.
Further, Section 178(2) of the Act says:
The Nomination and Remuneration Committee (NRC) shall identify persons who are qualified to become directors and who may be appointed in senior management in accordance with the criteria laid down, recommend to the Board their appointment and removal and shall specify the manner for effective evaluation of performance of Board, its committees and individual directors to be carried out either by the Board, by the (NRC) or by an independent external agency and review its implementation and compliance.
The Nomination and Remuneration Committee (NRC) shall identify persons who are qualified to become directors and who may be appointed in senior management in accordance with the criteria laid down, recommend to the Board their appointment and removal and shall specify the manner for effective evaluation of performance of Board, its committees and individual directors to be carried out either by the Board, by the (NRC) or by an independent external agency and review its implementation and compliance.
It is clear from the above that CA 2013 mandates companies to conduct a formal annual assessment of all directors, all committees and the board itself. It stops short of mandating the involvement of an external agency to facilitate the process. Clearly the law does not intend it to be a check-the-box exercise. Involvement of an external agency indicates the desire to implement the spirit of the law, and will provide a much better quality of validation thereof.
B. Regulator’s focus on Independent Directors
SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, Regulation 17(10) reads thus:
The evaluation of independent directors shall be done by the entire board of directors which shall include –
(a) performance of the directors; and
(b) fulfillment of the independence criteria as specified in these regulations and their independence from the management:
Provided that in the above evaluation, the directors who are subject to evaluation shall not participate.
(a) performance of the directors; and
(b) fulfillment of the independence criteria as specified in these regulations and their independence from the management:
Provided that in the above evaluation, the directors who are subject to evaluation shall not participate.
Further, relevant parts of Regulation 25 read thus:
Reg. 25(3):
Reg. 25(3):
The independent directors of the listed entity shall hold at least one meeting in a financial year, without the presence of non-independent directors and members of the management and all the independent directors shall strive to be present at such meeting.
Reg. 25(4):
The independent directors in the meeting referred in sub-regulation (3) shall, inter alia-
(a) review the performance of non-independent directors and the board of directors as a whole;
(b) review the performance of the chairperson of the listed entity, taking into account the views of executive directors and non-executive directors;
(c) assess the quality, quantity and timeliness of flow of information between the management of the listed entity and the board of directors that is necessary for the board of directors to effectively and reasonably perform their duties.
(a) review the performance of non-independent directors and the board of directors as a whole;
(b) review the performance of the chairperson of the listed entity, taking into account the views of executive directors and non-executive directors;
(c) assess the quality, quantity and timeliness of flow of information between the management of the listed entity and the board of directors that is necessary for the board of directors to effectively and reasonably perform their duties.
C. Responsibility for Conduct of this Activity
There are various people responsible for the conduct of various activities in compliance with the above requirements. However, the two critical role players appear to be – the NRC (or the NRC Chairperson) and the Chairperson of the Board itself. These 2 individuals need to drive the conduct of this activity, to ensure the benefit of the company.
As per our study, almost nowhere else in the common law world is there a statutory provision that mandates conduct of formal, annual Board Evaluation. Both, our Companies Act and our market regulator SEBI, are in that sense clearly ahead of the rest of the world in this regard. The impact is bound to be favourable on the decision-making and fortunes of investors in Indian companies. Also, good management will find itself rewarded more than those who merely tick boxes.
SEBI’s Guidance Note on Board Evaluations says this about “Assessment by external experts:
Use of external experts imparts an independence to the evaluation process and therefore is used by many entities globally. However, care must be taken to ensure that the external assessor is not a related party or conflicted due to closeness of the Board to ensure impartiality.
Such external assessment may be done based on questionnaires/interviews or a combination of the two and done on a regular basis. Such external assessment complements the internal assessment and adds an objective aspect to the evaluation process.
Effective use of Information Technology through use of board evaluation software, applications, etc. can also play a facilitating role.
D. Desired Outcome
Taking the LODR requirements together with the CA 2013 mandate, it is obvious that the MCA and SEBI together wish to ensure that all board members are evaluated by the other board members. That should lead to the desired outcome of ensuring improvement in the effectiveness and efficiency of the board’s functioning.
One key specific outcome would be validation of the selection and continuity of Independent Directors – as is made clear in SEBI’s own Guidance Note on this regulation.
Also, by requiring disclosure in the Board Report (a part of the Annual Report), the law indicates the desire to ensure that the company’s shareholders and other stakeholders, obtain an insight into the functioning of the Board.
This is, therefore, also, a key input to investors for assessing the quality of a company’s top management – which is an input for decision-making on further investment in the company.
Obviously, the best way to ensure realization of the above outcomes is to conduct the entire process in a completely confidential manner, with oversight by a trusted independent and competent facilitator.
E. Going Forward
To promote good governance and continually improve the board’s activities, it is important to conduct regular board evaluations. More than any other specific activity, it appears best to find reliable, impartial, competent and experienced Facilitators who cannot be influenced by board seniors, and entrust them with the job of conducting the board evaluation process.
Finally, and most importantly, the board will need to be open to learning and to disclosure. This is far easier said than done, but this is the necessity of the day! The Facilitator will need to be entrusted with the following:
–
Running the software infrastructure for board evaluation without any access to it by officers of the company, other than the Directors
– Interaction freedom with Directors during the entire process
– Report presentation to individual directors, the NRC and the Chairperson of the Board
– Interaction freedom with Directors during the entire process
– Report presentation to individual directors, the NRC and the Chairperson of the Board
This will lead to improved excellence and effectiveness in board governance!