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Performance evaluation of independent directors
Professor Krishnamurthy Subramaniam
State-run Oil and Natural Gas Corporation (ONGC)’s initiative to evaluate the performance of independent directors (IDs), as reported in the ET on August 28, deserves commendation. This initiative comes in the wake of concerns expressed by former chairman RS Sharma that some IDs do not even read the agenda for the board meetings. To improve corporate governance in India in general, and to strengthen the institution of IDs in particular, this initiative needs to be lauded.
Though the idea is conceptually a sound one, the devil lies in the details. How should performance be assessed? Would it work if the CEO/managing director/chairman assess performance of IDs? Presumably not, because the CEO/managing director/chairman may end up rewarding those IDs that toe his/her line. Can IDs be expected to perform when often, material information relating to board meetings is not provided to the directors in time and in an amenable format? By examining some of these questions, I attempt to sketch out the details for evaluating the performance of IDs and thereby correlating their remuneration to performance. My hope is to initiate a debate that can eventually lead to policies that The Securities and Exchange Board of India (SEBI) can implement in this area.
First, though obvious, it needs to be reiterated that unless remuneration of IDs is tied to their performance, the exercise of evaluating performance of IDs would remain an academic one. The remuneration of IDs needs to be tied not only to firm performance, which can be, for example, substituted using stock performance; but also to the relative contribution made by the ID to such performance. It is to measure this relative contribution made by the ID that the performance evaluation system needs to be put in place.
Since the directors in a board resemble a team of peers where no individual is supposed to have a superior position compared to another, performance evaluation techniques employed to assess relative contributions in teams comprised of peers need to be adapted. Therefore, the performance evaluation techniques typically employed in a corporate scenario, where a superior assesses the performance of a subordinate, will not work well to evaluate the performance of IDs. In particular, even if we were to argue that the chairman of the board represents the first among equals, the chairman should not be entrusted the responsibility of assessing the performance of IDs. This is because such a scheme may lead to IDs not speaking their mind and opposing the chairman when needed for fear that the chairman may reward disproportionately those IDs that toe his/her line.
Instead, the performance evaluation techniques employed in academic environments to assess team members’ individual contributions to group work could be adapted to the ID scenario. For example, significant portions of academic credit in an MBA program is based on group projects, where the concern exists that particular individuals may free ride on the work of others in the group. To avoid such free riders, which the former chairman of ONGC is concerned about in the ID context, faculty use rankings provided by the peers in a group. For example, say a team comprises of five members – A, B, C, D and E. In this case, each of the five members is asked to rate the contribution of the other four members. Thus B, C, D and E rate A’s performance; A’s score equals the average of those provided by B, C, D and E. Similarly, A, C, D and E rate B’s performance and so on. Such peer ratings assigned to an individual director by all the other directors on the board of a firm can be employed to assess the performance of an individual director.
It is quite critical to mention here the need for regulation that mandates timely and accessible information to IDs before a board meeting. Often, IDs receive material documents as late as 10 PM the day before the meeting. Moreover, usually the documents run in to several hundreds of printed pages, which make it practically impossible for an ID to search for relevant information and thereby get informed before the board meeting. Such tardiness in providing information may not be an accident: after all, if an ID is not informed, how can he/she ask uncomfortable questions or raise uncomfortable issues? If IDs performance is to be assessed, it is critical that SEBI enacts regulation where all the relevant documents for a board meeting are put up in a soft copy format in a “board portal” that can only be accessed by directors. Moreover, all listed firms must be mandated to put up the relevant documents at least a couple of days before the board meeting. Once IDs are provided the relevant documents in a soft copy format in a timely manner, they cannot offer any excuse for having come unprepared for the meeting. Performance evaluation then acquires a significant bite, which can improve ID performance and thereby corporate governance in India.