Monday, March 21, 2011

Nomination Committees of Corporate Boards

The recent episode relating to the nomination of directors for appointment on the board of Hewlett-Packard Co. brings to the fore the role of the nomination committee. Institutional Shareholder Services (ISS), a shareholder advisory group, recommended a vote against certain nominees on the ground that HP’s nomination committee was heavily influenced by the HP CEO, Leo Apotheker. While HP’s actions have been strongly defended, there is also a belief that the nomination committee’s actions can never be removed in practice from involvement by the CEO.

The position and role of nomination committees gives rise to a different set of issues in the Indian context. At the outset, constitution of nomination committees is not mandated by the corporate governance norms in India. It is not one of the committees boards are obligated to establish under Clause 49 of the listing agreement. However, several leading Indian companies have constituted nomination committees as a matter of good practice, and the Corporate Governance Voluntary Guidelines, 2009 exhort boards of listed companies to set up nomination committees. The process of nomination acquires great importance in selecting independent directors. I have had occasion to consider this issue elsewhere and simply provide an extract of the discussion (footnotes omitted):
Although the [Voluntary] Guidelines do not significantly alter board structure, they continue the prevailing trend of re-emphasizing board independence and strengthening the role of independent directors. One of the significant drawbacks of board independence in the Indian context has been the pervasive influence of controlling shareholders (known as “promoters”) in the nomination and appointment of independent directors. In order to address this situation, the Guidelines call for the establishment of a nomination committee comprising a majority of independent directors, including its chairman, for evaluating and recommending to the board appropriate candidates for directorships, with transparency being key.

(i) Efficacy of the Nomination Committee

While the nomination committee requirements have been introduced in Indian corporate governance for the very first time by means of the Guidelines and hence are noteworthy, it is doubtful whether they constitute giant strides towards effective board nomination and appointment. An independent nomination committee may be effective where shareholding in companies is dispersed (such as in the U.S. and the U.K.) whereby it removes the director nomination process outside the purview of management. However, as I have argued elsewhere, such a system may not achieve its intended goals where shareholding in companies tends to be concentrated (such as in India). Although a nomination committee may recommend candidates to begin with, the election of such candidates is still subject to voting at shareholders’ meetings where controlling shareholders can wield significant influence. Due to this reason, the nomination committee is likely to pick candidates who have the tacit acceptance of the controlling shareholders so that the successful outcome of election of such candidates is not in doubt. In that sense, although the nomination committee system is superior to the existing model of director nomination and elections, it does not abate the influence of controlling shareholders in election of directors, particularly that of independent directors (who are expected to be independent monitors of management as well as controlling shareholders).

Arguably, the Guidelines provide cosmetic comfort, and a more radical approach is warranted to deal with issues of independent director nomination and appointment. There is a need for altering the process of election of independent directors by increasing minority shareholder participation. This can be achieved through processes such as (i) cumulative voting, and (ii) voting by a “majority of the minority”, in which the controlling shareholder is excluded from the voting process. At the outset, these notions may appear somewhat outrageous, but proposals of this nature are beginning to gather a fair amount of steam, particularly in the wake of recent episodes involving governance failures in controlled companies.

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