Good corporate governance can help improve accountability, business performance, employee retention and shareholder value. Good governance practices can help both large publicly listed companies as well as family run businesses.
Governance of an enterprise encompasses several aspects such as the composition and role of the Board of directors, decision making process, oversight of management, compliance and compensation practices.
Good governance practices and management accountability are easier to establish at professionally run businesses. Boards of such companies generally have seasoned directors and management teams are experienced in facilitating constructive engagement with Board members. Promoter driven or family businesses often struggle in this area and an experienced, and independent Board of directors can make a meaningful difference to the long-term trajectory of such businesses.
Independent directors are critical to good governance. While private companies are not required by law to appoint independent directors, management teams of ambitious young companies should consider constituting a Board of Directors that include a combination of executive, non-executive and independent directors.
Recruiting independent directors alone will not ensure good governance. Directors should have the right experience and stature. The most effective Board members are generally the ones with prior corporate leadership experience. Running a business is a unique experience and individuals with prior C level experience (CEO, CFO, CMO) are better able to understand the challenges of a growing business. They will also have the credibility and stature to challenge management teams.
The promoter group and the management should encourage the Board members to speak freely and establish a culture of open discussion and feedback. In the absence of such an environment, directors are reluctant to speak out and act as rubber stamps. Compensation for independent directors should be aligned with the long-term success of the company. Equity related compensation, preferably with long tenured vesting schedules, can achieve the purpose. Regulation should be improved so that these compensation practices are permitted.
The Board of Directors and management team should agree on a list of key decisions that require Board consent. Decisions such as approval of budgets, capital raising, large capital expenditure items, launch of new product lines and hiring of senior management and compensation policies are examples of such decisions. The goal is not to micromanage the executive team, but to improve decision making and accountability.
The two most important board committees are audit and compensation committees. The statutory auditors should be directly accountable to the audit committee. In addition, the audit committee should consider appointing special internal auditors for specialized audits – examples are review of procurement audit for manufacturing firms and audit of underwriting and collection processes by lending firms. The compensation committee should oversee and approve the compensation of the senior management team and help establish compensation policies for the entire company.
Board directors should also help design incentive plans for senior management. ESOP’s or other equity related compensation schemes are important instruments for alignment of senior employee and shareholder interests. Unfortunately, these equity related awards have been ineffective in India for several reasons including lack of awareness among employees and poor design of ESOP schemes. The effectiveness of these instruments can be improved by better alignment with shareholders. Some possible design improvements include: (i) Incorporating equity awards as part of core compensation (ii) Large and meaningful allocations of equity to key members of the management team and (iii) Use of Restricted Stock units instead of ESOP’s.
Finally, the Board of directors should help improve the culture of the organization and develop opportunity and accountability from the bottom up. In family run businesses, decision making is often centralized with the family members of the promoter group. The leadership teams are sometimes oblivious to the negative consequences of centralized top down management. These organizations suffer from low employee morale and productivity. Talented and ambitious employees often leave these businesses and the ones who remain are afraid to challenge management or propose new ideas. Experienced directors and a well-functioning Board of Directors can help family run businesses improve in these areas.
Mukul Gulati is the Co-founder and Managing Partner of Zephyr Peacock India. Since the start of operations in India in 2006, Zephyr Peacock Funds have made investments in more than 20 SMEs in India.