The Pitfalls of an Improperly Constituted Board of Directors
The Board or Governing Body of is the nerve centre of any organisation, responsible for strategic decision-making. In the realm of corporate governance, the composition of a board of directors plays a pivotal role in steering the direction and success of a company. An improperly constituted board, however, can lead to a myriad of challenges and potential risks that can significantly impact the organization’s performance and reputation. Let’s delve into the key aspects and consequences of an improperly constituted board of directors.
Understanding Board Composition: How It should Look Like
A board of directors typically comprises individuals with diverse backgrounds, expertise, and experiences relevant to the company’s industry and operations. This diversity ensures a broad spectrum of perspectives and insights, contributing to robust decision-making and strategic planning. Key elements of a well-constituted board and the strategies thereof include:
Independence: Independent directors bring objectivity and impartiality to board discussions, ensuring that decisions are made in the best interest of the company and its stakeholders, rather than being influenced by personal or professional affiliations. Independent directors are supposed to maintain high standards of ethics and integrity while performing their duties. Inadequate independence on the board increases the risk of conflicts of interest, where directors may prioritize personal or conflicting agendas over the company’s interests, compromising transparency and accountability. Persistent governance challenges stemming from an improperly constituted board can erode trust among investors, customers, employees, and other stakeholders, impacting the company’s brand reputation and long-term sustainability. Boards that are not properly constituted may fail to comply with regulatory requirements or corporate governance standards, exposing the company to legal and reputational risks.
Diversity: Diversity in terms of gender, ethnicity, age and background promotes inclusivity and reflects the varied perspectives of customers, employees and communities served by the company.
The Indian Companies Act, 2013 mandates listed companies and other public companies with paid-up share capital of > ₹ 100 Cr or turnover of ₹ 300 Cr to have at least one (1) women directors.
Expertise: A mix of expertise in areas such as finance, legal, technology, sales & marketing and operations enables the board to comprehensively assess and address various aspects of the business, fostering innovation and effective risk management. Without the right mix of skills and experiences, boards may struggle to provide strategic guidance and oversight, leading to missed opportunities or misguided decisions that hinder the company’s growth and competitiveness. A homogeneous or inexperienced board may struggle to embrace innovation and adapt to market changes, limiting the company’s ability to innovate and stay ahead of competitors.
Active: The board should meet frequently and its members should actively participate in the decision-making. Conducting evaluations of the board and its committees’ performance, composition, and effectiveness will ascertain the activeness of the board and identify the areas for improvement. The Indian Companies Act, 2013 mandates every listed company and every other public company having a paid-up share capital of > ₹ 25 Cr to disclose in its board’s report, a statement indicating the manner in which formal annual evaluation has been made by the Board of its own performance and that of its committees and individual directors. The Act also mandates the Nomination & Remuneration Committee of the board to specify the manner for effective evaluation of performance of Board, its committees and individual Directors to be carried out either by the Board, by the Nomination and Remuneration Committee or by an independent external agency and review its implementation and compliance.
Frequent or Weak Leadership: Another Sign of an Improperly Constituted Board
An improperly constituted board often arises when a company has a managing director who is frequently replaced or lacks strong leadership skills. Every board typically has a managing director appointed for a longer tenure, as outlined by the Indian Companies Act, 2013, which envisages a five-year term. However, when a managing director is frequently changed, it paralyzes the decision-making process and leaves the company directionless. This instability prevents the managing director from giving their full effort, knowing they might be replaced soon. This scenario is common in public sector companies where managing directors are often appointed on deputation from other government departments. By the time they start understanding the organization and its business, they are transferred to another department.
Another significant issue arises when the top leadership, such as the managing director, lacks a strong governance, risk, and compliance (GRC) focus. Without this tone from the top, the entire organization becomes complacent, leading to poor decision-making and a lack of accountability.
Frequent leadership changes or weak leadership are slow poisons that gradually erode the company’s effectiveness, causing it to fail in achieving its objectives.
