Tick-Box Culture: The Lacuna Between Corporate Governance and Legal Compliance

It is commonly opined that the Companies Act, 2013¹ (Companies Act) must be credited as the source of what is driving future-oriented corporate governance in India.²

As under Section 149(4) of the Companies Act, at least one-third of the directors of every public listed company must be independent in nature.³ Schedule IV to the Companies Act prescribes the code for independent directors⁴, which can be applauded only for its idealistic crafting.

Although no company would have the audacity to leave the requirement of having one-third of independent directors unmet, which is easily within the eyeshot, the latterly addressed code of conduct is not what the corporate world subscribes to. With the nitty-gritty of the functioning that provides life to the compliance of such appointments slip through the cracks, the result is not compliance, but a façade of compliance i.e. ticking the box.⁵

The paper, which is analytical in nature, will employ the aforementioned discrepancy as an aid in examining the difference between compliance and tick boxing and how the approach of the law has played a role in the latter being the more prevalent phenomenon. In doing so, the author will turn to primary sources of law in the form of legislative stipulations, the narrative around which will be unpacked and critiqued through secondary sources.

The said paper is divided into four segments. The first section, by way of examples, demonstrates business activity that is inconsistent with the law despite continuous efforts to curtail it. In pursuance of such lapses, the second section analyses the inappropriateness of attaching condemnation to a particular actor without acknowledging the overpowering market culture to which they are subject. The third and fourth sections argue the ineffectiveness of regulation without first taking steps towards mitigating the gap between the said market culture and the law.

Gaps created in an attempt to fill the gaps

To be able to dwell on the unaddressed aspects of corporate governance, which can be attributed to the ineffectiveness and almost stagnation of the law in this domain, it is critical to first inspect some of the effects that the simplistic application of the law has had so far.

Yes men

Independent directors have been introduced on account of the need for diversification; such need was recognised in light of India’s concentrated shareholding pattern, whereby there is a very high probability that the executive directors will start acting as yes men.⁶

Furthermore, the remuneration of executive directors, as under Section 197 of the Companies Act, can go up to 11% of the company’s profits.⁷ Thus, as an executive director, one would have their eye on the net profits of the company. Consequentially, the prospective motive of wanting to keep drawing high remuneration raises the danger of the director concerned resorting to unethical activities to create an impression before the member body that the company has made high profits in that year; such working is but obviously not in the best interest of the shareholders.⁸

In speculation of such corporate misgovernance, there has been a thorough attempt to outline independent directorship in terms of the individuals concerned not being promoters or related to them, not sharing any pecuniary and remunerative relationship with the company, etc.⁹ Unlike executive directors, independent directors have nothing to do with Section 197 of the Companies Act; as under Section 149(9) of the Companies Act, they only receive sitting fees and reimbursement of expenses, while not being entitled to stock option plans.¹⁰

Therefore, independent directors have been introduced to primarily address two concerns pertaining to executive directors i.e. them serving as yes men and cooking the books to seek a higher remuneration.¹¹

The latter concern regarding executive directors furthering their remunerative interests has been addressed through the differentiated monetary arrangement prescribed under Section 149(9) of the Companies Act, which appears to have now driven independent directors into the arms of the formerly mentioned concern of being yes men.¹² In recognition of the preceding feelings of deprivation that may have ensued, SEBI has proposed a change to this structure by allowing stock options to be granted to independent directors.¹³ Even if such implementation does in fact do away with reliance on the controlling group, the issue regarding aligned interests, which was intended to be tackled through the introduction of independent directors, would now be the one to crop up.

To sum it up, every tunnel ultimately runs into the previously crossed one, which traps the outcome pertaining to independent directors within the same landscape as executive directors.

Flower directors

Historically, the independent directors in England were termed as flower directors i.e. individuals brought in to lend colour to the room¹⁴, without having them add anything to the discussion.

In a system of governance, it is understood that the Board plays a crucial role. However, owing to diversification, whereby executive and non-executive directors have differing degrees of involvement, the understanding of the law is that the quantum of liability cannot be painted with a broad brush across the Board.¹⁵ In this light, Sections 2(60)(vi) and 149(12) of the Companies Act serve as safe harbour provisions for independent directors.¹⁶ In consistence with what the said provisions extend, the Ministry of Corporate Affairs (MCA) issued a circular that states that independent directors would be saved from prosecution upon proving that they were unaware of the fraud.¹⁷

Such knowledge of any wrong, based on which the liability concerning an omission or commission is determined, would be derived from the minutes of the Board meeting. In other words, independent directors are merely expected to be aware of explicitly deliberated matters, which is counterproductive. If executive directors are, in fact, the yes men that they are ventured to be, they will continue protecting the skeletons in the company’s closet during interactions across the Board. Relieving independent directors of their liability withdraws the yearning to examine and poke into covert matters, which is further aggravated when this position serves as a passive source of income, owing to the monetary arrangement prescribed by the law.¹⁸

Thus, even if independent directors do not descend into the previously addressed phenomenon of becoming yes men through the negotiable nature of their pay, it is highly likely that they will sit back as flower directors, enjoying some income and no liability in exchange for doing nothing but turning a blind eye to the ongoings behind closed doors, while not being garbed as a whistleblower, which in turn would preserve their market reputation and future opportunities.¹⁹

Accountability of actors involved in the circumvention

In a technical sense, the aforementioned lapses stem from independent directors since the compliances concerned pertain to them. However, independence is a state of mind that the corporate environment has been unable to facilitate. Owing to how deeply ingrained such misconduct has become in practice, it has almost gained legitimacy amongst the workforce. While the law continues to theorise its code in failed attempts of its pragmatic applicability to the real world, it is palpable that the corporate space has parallelly developed an unsaid and unextractable piece of legislation, which is less fictional and envelopes more fear as compared to the letter of the law.²⁰

In light of this divide from the law, whereby market norms have failed to intersect with formal compliances, it is neither appropriate nor sufficient to zero in on the culpability of a particular actor, which in the current case would be that of the independent directors. In the capacity of working professionals trying to sustain in this cut-throat space, it is ineludibly human frailty to be sucked into the culture created by the corporate world²¹, which is what, in fact, demands further understanding and dealing with.

In the quest of investigating the inception of this background, corporations would be the next obvious choice for scrutiny, given the previously discussed command that they hold over the functioning of individual roles. However, corporations driving a narrative that is inconsistent with the principles of corporate governance, in the alleged course of what they believe furthers their interest, has been no secret. Following the long-drawn formal efforts to target such state of affairs, without much to show for it, it is safe to conclude that there is more unpacking left to do; the chain of corporate evil does not end at ascertaining who the doer is but understanding what the trigger is.

Cart before the horse

Man cannot be directed until the spirit is created. The current approach of the law is contrary to this naturally effective sequence of events.²²

In the present case, the law was rightly endeavouring to tackle the issues of the domineering nature of concentrated shareholding and that of directors looking out for their monetary gains.²³ However, as already evaluated, the law running interference has led to no redressal of what continues to persist; while the intention was to curb the occurrences pertaining to executive directors, there has been a duplication of the implications that this solution carries. The aforementioned phenomenon exemplifies the law being caught up in a loop, whereby the approach adopted has led the original impediment back to where it began. Nonetheless, this must be deemed a case of inadequate application of complementing jurisprudence, as opposed to the failure of law altogether.²⁴

In the immediate aftermath of any crisis, there is an understandable rush to adopt regulations that respond to the immediate symptoms, with the expectation that they can solve the underlying problems and prevent new ones.²⁵  The fallaciousness of the aforesaid has made itself glaringly apparent, especially in cases of corporate governance, the subject-matter of which pertains not to an artificial person i.e. a company, but to the natural persons that the said entity comprises. In this light, authorities concerned must hit the brakes on the mindless application of power and, before continuously diving into a myriad of regulations²⁶, acknowledge and capitalise on the highly overlooked human drive that can serve as the foundation of the much-aspired compliance.²⁷

The challenges revolving around executive and independent directorship cannot be deciphered through clear-cut instruction. Instead of equating legal compliance with corporate governance, it must be understood that the issues stemming from the theme concerned are not one of an objective nature that can be resolved by imposing a legally engineered moral compass.²⁸ While the command of the law will play a role, it certainly cannot take the lead in a space as fragile and humane as corporate governance; compliance will bear its fruit only when corporations see value in doing things the right way.²⁹

Therefore, the answer lies in revamping the trajectory followed. In other words, it is not suggested that compliance as a concept must be done away with. However, the law must initiate the process concerned by enabling the corporate world to develop a positive attitude towards corporate governance instead of directly subjecting them to regulations and sanctions in the utopic hope of achieving the said governance.³⁰

The subsequent section will further elucidate upon this proposed approach.

The power of perception

As addressed previously, the market is functioning in the shadows of its self-proclaimed customary law.³¹ Until compliances and market norms do not intersect, the former will never assume a form that is anything more than tick-boxing.³²

To achieve the said intersection, the law must serve a dual purpose, which includes setting a conducive environment and the deliverance of direction and uniformity. While in the traditional sense, the law is perceived through the lens of the latter purpose alone, it would be grossly inaccurate to believe that change is more effective when imposed from the outside than when carried out from the inside.³³ Therefore, instead of initiating the process with its conventional command, the law must purposefully engage in the act of creating a conducive environment. Subsequently, the corporations would take it upon themselves to amend the market culture as a byproduct of having undergone a high degree of enlightenment towards corporate governance. In doing so, the law’s burden of forcing the function of direction would reduce significantly, which, as already established, was never truly a successful endeavour.

The author is neither suggesting any unrealistic overhauls in terms of regulatory strategies, nor raising questions regarding the ultimate objective of checks and balances, which is an integral part of any civilised society.³⁴ As evaluated through the course of this paper, the act of insubstantial compliance that amounts to tick-boxing does not stem from flaws in the provisions themselves, but from the lack of capitalisation on human drive.³⁵ At present, the law has been portrayed as a mechanism of policing, given that the system has been founded upon a suspicion-driven perception.³⁶ Therefore, the first step towards effective compliance would be to alter the reasoning around it in a way that it does not treat the corporate world as offenders offhand; corporations cannot be expected to change their perspective towards corporate governance until the perspective that they are beholden to see a change.³⁷ In this light, it is up to the system to get the ball rolling by tweaking its undertone.

At present, the legal fraternity heavily relies on the ideology of agency problem i.e. the presumption of self-interest overriding duties towards the interests of others.³⁸ Without claiming ignorance of the aforementioned reality, the author believes that generalisation to the extent that there develops a deep-seated and dangerously irreversible aversion towards the corporate world will result in a highly poor relationship between the formal system and the corporations. The former cannot seek respect for its command unless it reflects its alliance with the corporations as well. Therefore, the narrative around regulations must not always be based on the agency model by default; other avenues that provide a positive context to regulation and its compliance must be explored.³⁹

To bring the proposed jurisprudence to life, an example is deemed to be fit at this stage.

Revisiting the first section of the paper, independent directors have been extended safe harbour provisions, which also draws from the conversation around the single-focused attachment that executive directors share with a particular company or a particular group, or companies belonging to one group.⁴⁰

Such affiliation being employed for the sole purpose of determining liability is of a narrow and biased nature that grossly overlooks its scope for also recognising the devotion that executive directors have towards a particular entity. There existed an opportunity to go beyond creating an antagonistic divide between executive and independent directors through an alternative narration based on the same fact.

Involvement in the company’s day-to-day functioning may enable emotionally driven decisions by the executive directors, thereby landing them into serious trouble. For instance, in the cases of Howard and Eclairs, it was observed that directors being of the view that their actions are in the company’s best interest would not be of any relevance to the ultimate decision.⁴¹ In other words, the right intention does not always amount to the right results. At this stage, the presence of independent directors may be explained through the spectator objectivity that they can offer; while this is not an unknown function of the said actor, the emphasis here lies on an empathetic narrative that strives to safeguard the executive directors from the implications that their own commitment to the company may unfortunately and unknowingly render, which can be conveyed without demeaning or attaching a negative connotation to the dynamic between the executive directors and their respective companies.

It is true that crooks can never completely cease to exist, which may justify precautionary narratives driven by the stick. However, its predominance that has resulted in an omission of preceding attempts towards nipping such misgovernance in the bud is what the author raises a concern regarding. As anticipated in the example above, a balanced dialogue would signal that the law is looking out for the executive directors and not just preparing for their downfall, which replaces the sense of fear with that of trust. It does not matter how well equipped the formal system is; its mechanisms, which in this example would be the independent directors, would have any prospect of success only if the relationship between the law and the target audience stands mended.

Conclusion

“Strict parents raise effective liars.”⁴²

In prejudice, there is a lack of perusal as to what corporations are at the receiving end of. At the very face of it, the rationale behind regulatory provisions reeks of distrust towards the actors involved in business, be it the shareholders or the directors. Demonising corporations from the very outset may trigger the instinctive retaliation of pushing back upon being provokingly challenged. On the other hand, a morale-boosting approach, distanced from the vexation of regulatory pressures, would not only allow the bodies concerned the space and time to develop a deep comprehension of the benefits they shall reap from good practices, but would also instil the profound aspiration to live up to the faith that the society has placed in them.

While this paper has the scope of entering the larger debate pertaining to the extent of regulation, the emphasis at present remains upon the pre-natal stage of regulation i.e. the necessity of positively redesigning human interaction within the corporate landscape, which is not premised on disparagement; there is a fine line between caution and accusation, and the latter should not be unreasonably projected until the time truly arrives.

There are an end number of tactics that enable the circumvention of statutory provisions. Preventing such conduct from becoming a recurring phenomenon is not possible unless and until compliance comes bearing the appeal of long-term benefits. There must be utmost caution exercised in the course of conveying the message concerned, which if administered through the isolated arm of the letter of the law, may be perceived as hostile or paternalistic. In this light, the opposition between the rule of law and the rule of custom must be softened by refining the conventionalist position.⁴³

At this stage, the immediate goal should be that of a rejuvenated zeal towards corporate governance. Upon the development of such willingness to engage in redemption, compliances will no longer attract the feeling of disgruntlement, an effect that meaningless requisites would ordinarily have.

In conclusion, a more positive approach towards corporate governance, grounded in trust and aspiration, can foster a culture of compliance that goes beyond mere legal requirements and promotes long-term benefits for all stakeholders involved. This requires a delicate balance between caution and accusation, and a willingness to engage in dialogue and redemption rather than confrontation and punishment.