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GOOD PRACTICES BETTER GOVERNANCE

Proxy advisory firms (PAF) are independent advisory firms that advise institutional investors on how to vote on resolutions. For this, and in order to maintain consistency in their advice, they prepare voting guidelines, that objectively mention the basis on which they would arrive at the recommendations. While firming up these voting guidelines, these firms evaluate matters on the basis of pros and cons of the decision on the company, its shareholders, and other stakeholders. The aspects on which they have guidelines include mergers, acquisitions, appointment and compensation of Directors and KMPs. These are items on which shareholders are expected to vote in AGMs, EGMs and Postal Ballots. These firms, on the basis of public disclosures made by a company, as also the voting guidelines issued by them, produce detailed reports advising shareholders, usually institutional shareholders, on how they should vote on resolutions, and the reasons therefor. 

Some of the guidelines mentioned in the voting guidelines of PAFs are good corporate governance practices. As a result, companies can voluntarily adopt them. Some of these are:

Appointment of Directors: PAFs recommend to vote against the appointment of any Directors if:

  • the company has not provided any profile of the Director. This is because in the absence of a profile, it would be difficult to comprehensively gather the Director’s experience. 
  • the Director is a former employee who joins the Board where his / her previous supervisor / significant shareholder, is on the Board. This is because it could impact independence of thought. 
  • the Director has been on the Board of two of more companies that have failed on account of poor governance and oversight.
  • the Director is also the CEO of a company where a serious and material restatement occurred after the CEO had previously certified the pre-restatement financial statements.

All these are important parameters that cannot be ignored while choosing a new Director, or approving re-appointment of a Director.

Director’s reputation: PAFs also pay attention to the past experience of a Director, and recommend voting against him/her if he/she is, or has been, involved in any transaction(s) that is prejudicial to the interest of minority shareholders, or he/she has served on Board or as an executive of a company with records of poor performance, over-remuneration, audit or accounting-related issues and/or other indicators of mismanagement. As per the PAF, such a Director carries a reputation risk and it would not be in the interest of the company to appoint/ re-appoint such a Director. 

Companies too should pay importance to reputation while selecting a Director. 

Age of the Director: A special resolution is required for a Director to continue post attaining the age of 75. As a result, a number of companies usually seek shareholder approval to retain a Director till he/she attains the age of 75. PAFs recommend that companies should evaluate Directors, and their continuing on the Board, based on their contribution to the Board, and not their age alone. 

Independence: PAFs are of the opinion that an Independent Director (ID) loses his/her independence if he/she continues as a Director for a very long time. They recommend to vote against the his/her re-appointment post serving the Board of the company or its parent/holding/subsidiary for more than 10 consecutive years. They also recommend a cooling off period of 3 years before the Director seeks re-appointment, as it would enable him/her to completely detach himself/herself from the Board, the company, and the promoter group.

While independence is a state of mind, too long a tenure can blunt independence. 

Composition: As per Section 149 (1) of the Companies Act, 2013, a company cannot have more than 15 Directors, provided the company gets a shareholder approval for the same through a special resolution. However, PAFs recommend to vote against the Chair of the NRC if a company has more than 15 Directors as the presence of too many voices would make it difficult to reach a consensus, and make timely decisions. 

Too large a Board can become unwieldly and detract from value. 

Director’s Commitment: PAFs recommend that a Director should not sit on the Boards of more than 6 publicly listed companies (as opposed to 7 publicly listed companies as provided under SEBI LODR Regulations 2015). PAFs are of the opinion that sitting on Boards of more than 6 publicly listed companies would become very time consuming for the Director, and he/she would not be able to commit quality time to the affairs of the company.

While artificially reducing the number, and second-guessing the Regulator is not good, it would be worthwhile for companies to check the time commitment of Directors, before they are appointed on the Board. 

Conflict of Interest: PAFs recommend to vote against a Director who has himself/herself or whose immediate relative has provided any professional services to the company, or who has himself/herself or whose immediate relative has engaged in any airplane, real estate or similar deals, to avoid potential conflict of interest which may adversely affect the company’s interest in the future. PAFs also recommend to vote against Director(s) who are involved in interlocked directorships (sitting on each other’s Boards), since they pose a possibility of conflict. 

The problem of conflict of interest is real. Companies should give it a lot of importance, not only at the time of appointment of a Director, but throughout the tenure of each Director. 

Attendance: While law provides for attending at least one Board meeting in a year, PAFs recommend to vote against the re-appointment of Directors if their attendance falls below 75% in any year. A Director’s commitment to the company is shown in his/her actions, and his/her past conduct is often indicative of future conduct, and performance. 

Inadequate attendance could be reflective of lack of commitment.

Removal of Director: PAFs believe that the proposal for removal of any Director, executive or non-executive, should be supported by adequate disclosures, giving inter alia the rationale for the removal, and its long-term implications on the company. 

Shareholders deserve to know why a Director is being removed, especially since they were the ones to appoint him/her. 

Committee Chairs: PAFs are of the opinion that Chairs of Board level committees should be voted against if the composition of the committee is not as per law, and/or if the number of meetings in a FY are less than those prescribed by law and/or if the committee has not performed the functions mandated by law. The PAFs also recommend to vote against the NRC Chair if gender diversity criteria for the Board is not fulfilled. 

The role of Chairs of committees is often ignored. Increasingly, as more work is done through committees, the role of Chairs of committees cannot, and should not, be ignored. 

Compensation: With respect to compensation of Non-Executive Directors (NEDs), PAFs recommend to vote against Director’s remuneration if he/she is being rewarded for poor performance, or if his/her remuneration is higher than that of the senior leadership, or if the amount seems excessive, when compared with other companies of similar size. Further, the PAF considers the following factors to decide on matters related to the compensation of Directors:

  • Remuneration paid to NEDs in past years
  • Whether the proposed remuneration is commensurate with the size and scale of the company 
  • Remuneration paid to one Director relative to remuneration paid to other NEDs 
  • Whether aggregate remuneration is higher than or largely in line with that of any other Executive Director (ED). 
  • Whether there has been a linkage of NED remuneration to company performance
  • Overall family remuneration (for promoter family members)  

PAFs also discourage a Director from receiving additional remuneration from unlisted subsidiaries/holding companies, since this goes against transparency.

Compensation to Directors is an important matter, and NRCs should start focussing on performance linked compensation for Direct ors too.

Disclosure regarding compensation to EDs: PAFs believe that the Board/ NRC should give adequate information with respect to compensation paid to the EDs, including the various components of salary, to promote transparency. NRCs should provide clarity on the following aspects of compensation

  • If increase in median employee remuneration is lower than that of an ED, the reason for this.
  • Basis for calculating annual increase in fixed pay. 
  • Parameters considered while arriving at the variable pay (i.e. return on capital employed, market share, successful closure of transaction etc).

Pay for performance is important, and NRCs should focus on it. 

Auditor appointment: In PSUs/PSBs, shareholder approval is required only for approving the remuneration paid to the Statutory auditors, and not for their appointment. PAFs believe that this denies the shareholders the opportunity to voice their opinion on the suitability of the chosen audit firm(s). Shareholder approval must be sought for appointment too, and the company should make adequate disclosures regarding the size/experience of the firm and its partners. PAFs recommend to vote against auditor appointment / reappointment if –

  • Non-audit related fee is in excess of audit fee or is in excess of 50% of the audit fee. 
  • The company failed to disclose the auditors fees paid for the previous FY or a break-up thereof, in either of the financial statements, standalone or consolidated.         
  • There are serious concerns about the accounts presented or the audit procedures used. 
  • Profile of auditor/ audit firm is not in public domain.  
  • Size of audit firm is not commensurate with that of the company / experience of audit partners is not adequate. 
  • Audit firm/partner(s) have a poor track record/reputation. 
  • There is an affiliation/association of the new firm/partner(s) with the rotated firm. 
  • There is no peer review conducted for the audit firm. 
  • There are consulting services provided by network partners of the audit firm.

Auditors are gatekeepers of governance. Transparency in their appointment, as also the compensation paid to them, is the starting point of good governance.  

Removal of Auditor: If a Board proposes to remove an auditor, PAFs recommend that this proposal be supported by a detailed disclosure explaining the rationale for such a removal. PAFs recommend to vote against such a removal if the previous audit reports contained adverse remarks. 

Since auditors are appointed by shareholders, it is important that their removal, along with the reasons thereof, should come to the shareholders. This is particularly important since auditors perform on behalf of the shareholders. 

Related Party Transactions (RPTs): PAFs generally recommend to vote against the approval of RPTs, if the approval is sought for an indefinite/ undefined time period, or if the transaction seems perpetual, as if approved, this would prevent a periodic review of such transactions. 

RPTs are not necessarily bad. They should however not be misused. 

Social/Environmental Issues: PAFs recommend to vote against a Board member, as and when he/she comes up for re-appointment, when it is clear that the company has not properly managed or mitigated environmental or social risks, and this could be detrimental to shareholder value. 

ESG issues are important, and cannot be ignored. The Board needs to have focus on this matter. 

Appointment to office of profit: PAFs do not support appointment of too many family members in similar roles across a company, as this could create conflicts of interest. 

The problem of conflict of interest is real. Boards need to focus on it. 

Amendment of Article of Association (AOA): PAFs would not recommend any clauses or changes in the AoA which provide special/overriding powers to a particular individual or group, as it would lead to potential misuse, and would be prejudicial to the interests of minority shareholders.

All shareholders, minority or otherwise, are important. Their rights should be protected. 

Clawback of compensation: PAFs recommend that companies should implement clawback provisions wherein any bonus awarded to an employee may be recouped by the company in the event of material fraud or misconduct by the recipient of a bonus award.

A company should not pay the price of a fraud. Any management person who is responsible for it, should pay the price. 

Severance pay: PAFs are of the opinion that severance payments should be limited to no more than one year of fixed salary and should not be paid in the event of inadequate performance or voluntary departure.

Severance pay should not be excessive.

Shikha Shah