Managing an independent director’s career

R Anand/V Ranganathan | Updated on June 08, 2020

In focus: Director’s actions in question   -  Getty Images/iStockphoto

Transiting from an independent director to a whole time director can be a tricky affair. It’s about both optics and the law

The evolution of corporate governance, more so after the 2013 Act, has been a roller coaster ride. The short supply of independent directors (ID) in relation to the demand is largely on account of the risks associated with the post, and rewards not being commensurate with said risks.

Generally, the candidates for ID are retirees who want to transfer their knowledge and experience. Interestingly, there are some cases where IDs are appointed on boards and then made whole-time directors (WTD) before completing their five-year tenure. In a situation like this, how can the Nomination and Remuneration Committee (NRC) and the Board deal with the matter within the framework of the Act and the Regulations, and also manage perception, since the position of the ID is generally felt to be the final destination and not a stepping stone?

Corporate India is largely driven by family-owned and managed companies, and the requirement of appointing IDs was forced down their throat in 2013. The learnings in the last seven years have been a mixed bag, and IDs are at the receiving end in every corporate failure or debacle. The promoter identifies the ID, who is appointed as per the Act. IDs now have to empanel on the data base and also pass the online proficiency test. But the real test is acting independently at board meetings.

When an extraordinary talent is spotted and taken in as ID, and has age on his side, can he be considered for the role of a WTD? The law, as it stands, is clear on this. The process of ID appointment is undertaken at the NRC, and then a recommendation is made to the board.

In fact, even if the transition from ID to WTD is uncommon, it is fortunate, as the company will gain from the expertise and knowledge of said director. This transition will be justified since the director would have made an impact in his role as ID at Board meetings.

Perception challenges

The key issue is whether such a process passes the optics test. This is more relevant today, since one has to comply with not only the letter but also the spirit of the law. If an ID knows he is in for a larger role in the company in the near future, can he act independently in the capacity of an ID? The answer could be yes — one can erect a Chinese Wall in both the roles. But it would optically pose a challenge. The Code of Conduct states in Section I (7) that an ID shall refrain from any action that would lead to loss of independence, and I(8) states that in circumstances where an ID loses his independence, he must immediately inform the board.

A combined reading of these two clauses places the ball in the court of the NRC and the board, to come to a categorical conclusion that the ID in question had acted independently. Even if the papers and documents do not show any instance wherein the ID compromised his role, the sequence of events before and after could pose a challenge of perception.

There is the expectation that an ID act as a watchdog of the non-promoter and exercise vigilance on matters like related party transactions, which normally carry a presumption of conflict for the promoter-directors or executive directors. While the larger debate on whether IDs are performing the expected role looms, more so in the context of recent corporate scams, the transition of an ID to the role of WTD is an action that may cause qualms in the minds of the non-promoter shareholder and trigger an unease.

Cool-off time

While the board should be trusted to have exercised all care and diligence in taking the decision, it is only in the fitness of things that the explanatory memorandum for appointing an ID as WTD adequately captures the background, reasons and logic that prevailed in arriving at the decision. The shareholders should give the benefit of doubt to the board and trust its wisdom in deciding what is best for the company.

Interestingly, there is no cooling off period for the transition from the role of ID to WTD. It can happen immediately, and hence the question of optics stares at our face. On the other hand, there is a three-year cooling off period from WTD to ID in the same company, largely relevant if the WTD in question retires. Likewise, there is a three-year cooling off period if an auditor is to be appointed as an ID in the company audited by him.

With corporate India facing talent crunch, we need to ensure that regulations do not come in the way of sourcing the right set of people at senior levels, both as IDs as well as WTDs. The situation described above may be rare now, but could become quite common as we go along. There are some cases in the Indian and global contexts where such a shift has occurred, but largely in the context of crisis and to keep the ship afloat. In the case of Boeing, for example, the chairman of the board shifted to being President and CEO.

The ideal solution could be to prescribe a three- year cooling off period and restore parity, and thereby optics. After all, managing perception is as important as managing the law. As in the context of the judiciary — justice should not only be delivered but also appear to be delivered.

The writers are chartered accountants

Published on June 09, 2020

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