SEBI’s Rules on Separating Chairperson and CEO Roles, Explained

They say two is company and three is a crowd.

But what happens when a company gets a little too crowded?!

In efforts to de-clutter the crowded and conflicted top brass of Indian companies, SEBI came up with a set of norms in January last year requiring the top 500 listed companies by market capitalisation to split the roles of chairman and managing director (MD)/chief executive officer (CEO) with effect from April 1st 2020.

Later, the deadline to comply with these norms was pushed to April 1st 2022. Yesterday, SEBI Chairman Ajay Tyagi prompted a reminder for the same saying that the separation of these roles will improve corporate governance, reduce concentration of authority in one individual and avoid conflicts of interest.

These norms being spoken of are a result of the Uday Kotak Committee Report which recommended separating the CEO/MD and chairman roles to ensure a structural advantage for the board to act independently. Interestingly, there is an existing provision in law that already mandates separation of these two roles. So, what’s with the renewed fuss?

We’ll get to that eventually. But before that, time for some context.

Who Comes First — The Chief or the Director?

These two titles are used interchangeably in many countries. As per Section 2(18) of the Companies Act, 2013, a CEO is an officer of the company who has been so designated by it. On the other hand, Section 2(54) defines an MD as essentially a director entrusted with “substantial powers of the management and affairs of the company”. Note that both CEO and MD are included within the ambit of “Key Managerial Personnel” of a company.

In the scheme of things, as long as the goal is to frame common business goals and consolidate affairs of management, assimilating both the CEO and MD titles into one is actually plausible (as is the practice in many countries). Which brings us to the issue at hand.

Chairman or CEO — Who is the Boss of Whom?

The word “chairman” hasn’t been defined anywhere in the Companies Act, including in the list of key managerial personnel. But after the 2017 Amendment, it was clarified that under the exception of Section 2(51)(v), a chairman can be included in the list.

Unlike the CEO/MD, a chairman may not be a statutory position but he can be appointed under the Article of Association (AoA) of a company. His job is to preside over the general meetings, set the agenda of board meetings, order polls, oversee committees etc. Most importantly, he has the right to make a casting vote at board meetings. This indicates that a chairman’s role is more focused on the governance of the board as compared to a CEO/MD who focuses on the smooth running of the company’s business.

One could ask, where does the conflict come in? Historically, many successful companies have had the same person as both the chairman of the board and the CEO/MD — Steve Jobs of Apple, Jamie Dimon of JP Morgan Chase, Rex Tillerson of Exxon Mobil, Kenneth Chenault of American Express etc.

Separation of Powers Not So Separate

One thing to understand is that the democratic set up of corporations flows from three sources: the board of directors, the management and the shareholders. Tomorrow, if the shareholders allege mismanagement of the company, it is the board’s prerogative to acknowledge these allegations and resolve them. How do they do that if the same person heads the board as well as the management?

Also, since the chairman has influence over the board of directors and the board votes to increase executive pay, if X is the chairman and also the CEO, he is effectively voting in favour of his own compensation.

When the goal is to uphold the charter and protect the interests of the company, some would agree that separating these titular roles at least makes it look like it is above scrutiny. The responsibility of corporate governance is one that requires highest regard for convention and authority. Which made sense when Elon Musk was made to step aside as the Chairman of Tesla after 14 years because that would provide a “critical check on the possibly dysfunctional group dynamics” of the company.

Is the Separation Anxiety Valid?

India has a plethora of family-owned companies. Here, usually the senior member of the family transitions into the chairman position and the junior manages the company as CEO. Although they are different entities and strictly don’t conform to the separation formula, whether the formula would trump years of hereditary coordination and result in better governance is uncertain.

Again, how credible is this iron curtain of separation? If Chanda Kochhar could sanction illicit loans to the Videocon Group without being the chairman of ICICI Bank in theory, it shows she exerted enough influence over the board in practice. How do you circle that square?

Suffice it to say, the real and tangible benefits that could accrue from separating the roles of chairman and CEO/MD is highly situation dependent. It also may not be completely wise for SEBI to get carried away by a spirit of corporate activism and introduce an artificial separation of leadership roles without actually addressing the essence of conflicted interests.

Existing Legal Framework

Let’s reiterate the existing provision in law that already mandates separation of roles anyway, as mentioned in the intro. The law spoken of is Section 208 of the Companies Act which says that “an individual shall not be appointed or reappointed as the chairman as well as the CEO/MD at the same time”.

But, the validity of this law is questionable owing to its inconsistency with other laws.

First, the exemptions, which say companies can do otherwise if they are engaged in one common business or if their AoA says otherwise.

Second, this requirement is limited only to a listed company or other public companies which have a paid-up share capital of ₹100cr ($13.6m) and annual turnover of ₹1,000cr ($136.3m) or more.

Third, under the SEBI LODR Regulations, the requirement of separation between the roles is not binding for listed entities.

Fourth, under the Banking Regulation Act, 1949, regardless of their listed status, the chairman of a banking company can also exercise the role of an MD when he has been appointed on a whole-time basis.

So, is a clarity on these laws urgently required? It would seem so. Although the implementation of the separation rule has been delayed by two years, it is not completely air-tight and could certainly benefit from reconsideration.

In addition to a hard line of separation, it could also be worthwhile to improve governance via other mechanisms, such as increasing the role of independent directors. Alternatively, perhaps, only those companies could be fire-walled which have been prone to misgovernance in the past or present.

Either way, the push towards heightened corporate governance in India is foremost and while the way to lift the standards can perhaps be debated, the need can hardly be.

(Originally published April 12th 2021 in transfin.in)