How to get truly independent directors

R Anand | Updated on September 20, 2019 Published on September 19, 2019

Best interest An independent director must check any unfair move on the company promoter’s part   -  AdrianHillman

To allow independent directors to work effectively, they should be freed from all conflicts of interest with the company’s promoters

‘I am the boss of this house — and I have my wife’s permission to say so’. This is a familiar placard in most houses. In this sentence, if we substitute independent director (ID) for the ‘I’ and the promoter of the company for ‘wife’; we have the present scenario. The Kotak Panel Report on Corporate Governance has made a sincere attempt to revamp the role and responsibility of IDs. At best, the Report skims the surface, and avoids dealing with ground-level problems and issues. Corporate India embraced the forced presence of IDs in board rooms with considerable discomfort and uneasiness, but have now reconciled to live with this forever. The Kotak Panel’s recommendations have suggested that half of the boards of listed companies should be IDs, as against the present norm of one-third.

The demand for IDs will therefore increase substantially; but, supply is woefully inadequate. More importantly, the existing pool of talent among IDs is a mix of experience and new entrants struggling to come to grips with the new normal of overdosage of regulations. The question often being posed is: How effective are the IDs in the overall scheme of things, and have they served the purpose for which they have been inducted into corporate boards? If it is merely a tick in the box, then we do have a serious problem to deal with.

What is independence?

Legislating the concept of ‘independence’ is a Herculean task, since the word depicts the behavioural streak of an individual. It is a state of mind. What is expected from an ID is independence that allows him to speak his mind freely on issues that are confronted at the board meeting, with no axe to grind. There are two potentially extreme situations. An ID is so fiercely independent that he opposes every move at the meeting and becomes a virtual speedbreaker. This is not what is expected.

The other extreme is an ID nodding his head for every issue and functioning as an employee of the promoter. This defeats the very concept. The ideal is the middle path — which is easy to preach, but difficult to practice. The crux of the problem is that an ID is spotted and appointed by the promoter. Hence the loyalty of the ID is tilted towards the promoter. Here lies the starting problem. The best recourse is to have a panel of IDs with the MCA/RBI/SEBI, as the case may be, and the regulator allocating IDs to the boards of various companies.

This will take care of the vexatious issue of the promoter/ID nexus. It will also avoid the tendency of placing relatives and friends in corporate boards, which is seen with scepticism, notwithstanding the meritocracy the persons so appointed. The background and upbringing of the individual and the experience he has gained over a period are important ingredients that determine the extent of independence. While he may be independent in his thinking, it requires courage and conviction to put across frank issues during board meetings. More often than not, IDs prefer to live in a comfort zone than test the waters of discomfort. There is empirical evidence that quality decisions suffer on account of directors taking the safer middle path approach.

Relationship with company

The remuneration of an ID consists of essentially two components — sitting fees and commission. There is always a feeling that the risk to reward ratio is disproportionate, considering the remuneration paid to IDs today. The question to ask is whether IDs join boards of companies for pecuniary gains or for passion towards the job? Clearly commissions, and in some cases stock options, jeopardise the spirit of independence so vital in the functioning of IDs. That being said, there has to be a reasonable sitting fee, as rightly prescribed by the Kotak Panel. Further, the said fees can be paid directly by the Regulator to the IDs. This will completely eliminate the company-ID relationship from the financial angle. The pecuniary part and the way it is paid is critical, since it has close linkage to the behaviour of the IDs.

Recent instances of corporate frauds have sent shivers down the spine of IDs. When and how are IDs responsible for lapses is still evolving with every corporate failure? The answer is clearly not there in the regulations. The director’s liability insurance in some sense provides partial security.

There is now a tendency to equate whole-time directors and IDs for all types of lapses — major or minor — which is totally unfair. How can an ID be responsible for a remote non-compliance of some provisions of Factories Act? It is here that various types of audit, extent and quality of documentation and manner of structuring meetings’ agenda notes and the ‘minutes’ of meetings become important. This is a large subject requiring separate discussion.

It is in times of crisis that the role of IDs becomes critical and also nebulous. They cannot take sides, but only deal with issues in an impartial manner. The only criteria in mind should be that whatever needs to be done is in the best interest of the company and all stakeholders. This is where the collective maturity of IDs is put to test. If the situation requires change of management and control to set right matters, so be it.

As they say, the crunch situation brings out the best in cricket (Ben Stokes being a recent example), and it also brings out the best in the performance of IDs. Undoubtedly, the learning curve in handling tough situations is in its nascent stage, but whatever is currently available in the public domain can be captured as reference points for existing and future crop of IDs on how to handle these tough situations.

The watchdog role

Nothing succeeds like success. Corporates perform well largely because of a strong business model, dedicated workforce and a competent and transparent management. It has nothing to do with presence of absence of IDs. Successful and profitable companies may not be the best governed, just as unsuccessful companies may not be the worst governed.

The main role that an ID has to play is to ensure that the promoter does not enrich himself at the cost of other stakeholders. It is in this area that the real value addition of an ID is required. There may be enough checks and balances in the system to ensure that funds are not diverted for the personal gains of promoters, but still, the ID has to play an effective role of a watchdog. With too many regulators hovering around corporates, much of the time of ID is spent on compliance with regulations rather than on discussion of core strategic issues. Merely adding to the number of IDs on the Board will not solve the problem in entirety.

The Kotak Panel on this score has clearly missed the wood for the trees. Finally, the ID’s courage and conviction will leave an indelible imprint on corporate boards in the long run. Questions like ‘Will I be misunderstood?’, ‘Will I be sidelined?’ will crop up now and then. But then, The ID has to answer it by saying “I have been mandated to do a job by the regulator and I have to do it in the best possible manner — come what may!”

The writer is a chartered accountant

Published on September 19, 2019
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