Education

Independent directors and governance conundrum

Updated on: May 06, 2012
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Companies stand to gain from independent directors who are courageous enough to voice genuine concerns and constructively challenge executive decisions.

Independent directors are one of the most critical pillars of corporate governance. They are expected to act as an effective oversight body to protect the interest of investors, stakeholders, regulators, government and minority shareholders. They bring external and unbiased inputs which can bring a new and independent perspective, thereby giving a fillip to overall quality in governance.

The need to have independent directors is not borne solely out of regulatory compulsions. The growth story of the Indian economy fuelled by economic reforms has significantly contributed to a realisation that an independent check is needed to strike a right balance between growth and governance. In the zest to pursue all-out growth, corporate governance runs a risk of getting relegated to the sidelines.

A number of tests are enunciated in the listing agreement of stock exchanges for an independent director: he should not be an employee or a relative of the promoters, or a substantial shareholder, or have significant business dealings with the company. The Companies Act also mandates disclosure of interest by directors to identify potential conflicts beforehand. The underlying rationale idea behind all this is to stay clear of situations in which a director's other business dealings or relationships might pose a conflict, consequently impeding the board's ability to act impartially.

Appointment process

In the Indian capital markets, promoters have a controlling stake in the company. The provisions for appointment of directors under the Companies Act require a positive vote by a majority of shareholders, effectively making the promoter's nod in the appointment a prerequisite. Regulations in many countries mandate or suggest that boards have a nominating committee — preferably comprising non-executive and independent directors. In India, the proposed Companies Bill stipulates that listed companies have to constitute a nomination and remuneration committee consisting of non-executive and independent directors. The Committee shall identify candidates, recommend their appointment to the board and also carry out performance evaluation. Limiting the say on pay of promoters with regard to remuneration of independent directors could be a good way of insulating the latter from the influence of the executive management.

There is, however, a difference between being independent and unconnected. To be effective contributors, independent directors have to bring in knowledge, experience, insight and skill and industry expertise to enable them to ask the right questions. Companies can profit immensely from the presence of independent directors who are courageous enough to voice genuine concerns and constructively challenge executive decisions.

Having the right qualifications, experience and pedigree is only half the battle won. The time and, more importantly, the quality of time spent by independent directors is what makes a difference. Mere presence and participation in board meetings could best have an ornamental value. Interactions with executive management, reviewing industry publications and analysing data about the company's competitors are some of the ways to deliver value. Matured corporates follow a practice of prior circulation of pre-meeting material, focusing on quality rather than quantum. Right people need to be armed with the right tools in order to make the right impact.

Orientation and training programmes giving a background of a company's operations and organisational structure, its line of products and services, strategies, and key challenges and opportunities can tremendously shorten the learning curve of independent directors.

Current Liability Regime

The Indian law does not explicitly distinguish between executive and non-executive directors when it comes to determining penal consequences. The breather to independent directors given by the Ministry of Corporate Affairs gives them a shield in cases where contravention occurred without their knowledge or connivance and the directors have been diligent on their part.

This immunity, however, is limited only to offences under the Companies Act leaving ample scope for penal consequences under a plethora of other laws. The risk-reward proposition can act as a deterrent for independent directors while evaluating the option to join the boards.

While the burden of expectations on independent directors is huge, there is scope to improve the process of appointment, on-boarding, dissemination of information to help strengthen and empower the institution of independent directors. A clear and unambiguous liability regime that clears the grey areas can be a significant confidence-building measure. Clearly, there is considerable ground to cover before we can bridge the gap between what stakeholders and the government expect and what independent directors can practically deliver. The need of the hour is a paradigm shift in approach — from a tick in the box approach to a compliance with the law in spirit and in substance.

Satyavati Berera is Leader, Risk Advisory Services, PwC India. (With Inputs from Pankaj Tewari, Senior Manager)

Published on November 15, 2017

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