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K. Srinivasan

K. Srinivasan on the company law proposal on independent directors

THE winds of change have been so frequent and their velocity has been so high in the area of company law that there seems to be a danger of good and essential things also being swept away along with decrepit structures and junk.

Every committee usually has one or two forceful personalities. Their convictions and their conclusions based on their individual experiences and perceptions leave their impress on any report with which they are associated. This is a defect of the very virtue of the committee system. The report of the Naresh Chandra Committee suffers from a few such demerits.

Independent directors

The new concept of `independent directors' is a case in point. It appears that there is a general cynicism about the integrity and dedication to their companies of the existing tribes of promoters and the professional executive directors and managers.

The old notion was that those who had personal stakes in a company or an institution would give it their best. Stock option schemes originated from the view that a sense of belonging would always be conducive to the maintenance of the highest standards in the management of a company. There could not conceivably be a surer incentive for improving productivity in a company than allotment of some shares in it to those engaged in productive activities so that they would not merely work harder but also extend the maximum cooperation to the management.

The Enron fiasco showed, on the other hand, how easily a stock option scheme could be exploited for personal gains and abused to the detriment of the permanent employees of the company and the investors in the company outside the narrow management coterie. Enron had an impressive audit committee but it would appear that the committee was not aboveboard; it was, in any case, utterly ineffective as it turned out.

Do these allegations prove that pride in the organisation that employs you will not get more and better work out of you than from one who has no stake in it? Since those who were responsible for the quick fall of Enron were not its promoters or those who had a controlling interest in its capital, any suspicions about the independence of directors who were among the original promoters of a company will not be warranted in India. If the members of a particular audit committee have had some skeletons in their cupboard or were not immune to influence or pressures, does it follow that the system is useless?

The solution to this kind of problem, as suggested by the Naresh Chandra Committee, is recruitment of a new breed of `independent directors' from the open market. It will not be a regular cadre or service such as the all-India services — Indian Administrative Service and the Indian Police Service — or the Central Services, such as the Indian Revenue Service or the Indian Audits and Accounts Service.

It may not even be all-India or State-wise panels drawn up periodically on the basis of prescribed qualifications and experience. No private or even public company can be compelled to restrict all its appointments in the ranks of directors to panels drawn up by the Central and/or State Governments or even by recruitment boards constituted by them jointly. Competent and independent directors who will rise above all temptations and who are as efficient as they are honest may not be available in adequate numbers in any part of the country.

The disqualifications for an individual's treatment as an independent director of a company have been determined mostly with reference to his previous and existing connections with, or interest in, the company which he is to serve. They proceed on the assumption that if he has any relatives working in the company or holds any shares in the company, his objectivity and his independence in taking business decisions will be adversely affected.

It is amazing that there should be a change in policy and in the law on an individual's fitness for the post of a director based merely on a reversal in the evaluation of a person's reliability and independence on the same facts and in the same circumstances. It is obvious that the level of a person's initiative, resourcefulness and business acumen will remain constant. The worst that can happen is that they may be biased or otherwise adversely affected by his financial interest in the company. Neither the case of Enron nor the other cases of the other large companies which have declined or fallen during the last few years in the US or in India would justify such a conclusion. The recommendations of the Committee thus appear to be subjective and not supported by any evidence or ground for the changes in view they reflect.

The assumption that it is only a person who has nothing to gain or lose in a business deal who can strike the best bargain for the company is, to say the least, a very odd one for two reasons. If he has no personal involvement, he can be bought for a consideration — by a kickback or slush-funds. There have been so many `scams' in India and elsewhere which show that even in a case where the goods procured were indisputably satisfactory, intermediaries got away with commission for services which never came to light.

Ownership of an establishment has never been a relevant factor in all such cases. The proposition that independent directors cannot be found for a company from within its existing establishment or from others connected or associated with the company, is an untested one. But this is not to say that in a listed company, the audit committee should not be manned by outsiders, who will be able to hold the balance even between the company's interests and the interests of the public at large, and that the audit committee should not be put in a position to do any whistle-blowing that may be necessary either on its own initiative or on information from within or outside the company's establishment.

sIt is to be noted that a senior official did attempt to blow the whistle in the Enron case but felt frustrated without any dependable avenue or forum from which effective action could be reasonably expected. Any intervention by any regulatory authority in all such matters may not be warranted in a company which is not listed and in the securities of which no active trading is done. The law has imposed a statutory auditor and a company secretary on almost every large company.

Compelling the company to experiment with a majority of independent directors would be the height of folly. The constitutional validity of such a requirement is also open to doubt, though most companies may not care to challenge the proposed provision because it is so vague. There is a feeling that it may actually facilitate political patronage/influence without serving any other useful purpose — more and more directorships for people less and less qualified for corporate governance.

(By arrangement with Corporate Law Adviser,

New Delhi.)

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