Will independent directors speak up?

In his 2019 letter to shareholders, famed investor Warren Buffet wrote, “I’ve seen a lot of corporate boards operate. And the independent directors, in many cases, are the least independent…When seeking directors, CEOs don’t look for pit bulls. It’s the cocker spaniel that gets taken home.”

Replace (or add to) CEOs with promoters, and you get the gist of the problem SEBI is attempting to tackle in its recent proposals on independent directors. The main proposal, a dual-approval by shareholders and non-affiliated minority shareholders for the appointment and removal of independent directors, is modelled on the UK’s rules for premium listed companies. Other proposals pertain to the process and disclosures for nomination committees, resignation of independent directors, and remuneration, among others.

On balance, SEBI’s recent reforms to independent director regulations are thoughtful, balanced and address the right issues. The dual-approval process for selection and removal strikes a balance between majority shareholders’ right to final decision, and minority shareholders’ ability to influence.

Allowing ESOPs for independent directors, in lieu of the current regulations which allow remuneration to be linked to net profits, would correct an anomaly where directors’ remuneration was linked to an accounting figure they have an ability to influence at the margin, even while long-term ESOPs were eschewed in the name of independence. Improving the processes and disclosures while short-listing candidates may improve professionalism in the hiring process, and increase diversity.

A few other proposals may have only a marginal impact. The proposed cooling-off period of one year before a person can transition from an independent director to whole-time director is one such example. Apparently, there was just one instance last year when an independent director was appointed to an executive director position in the middle of his term. While the proposal seeks to plug a gap, it might normalise a marginal and questionable practice. It would be better to tackle such lacunae through other means, such as engaging with specific companies on the circumstances surrounding the appointments.

Regulations only scratch the surface when it comes to some of the most pressing issues around IDs, and needs to be complemented with best practices. Let’s consider three such issues — disclosures around independent director resignations, chair-CEO role separation, and gender diversity.

Reasons for resignations

The increasing number of resignations by independent directors in recent years have put the spotlight on disclosures of reasons for resignations. SEBI has tackled this issue in the past by requiring an affirmation from the resigning director that there is no other reason for the resignation beyond the one provided by the company.

The current proposal, which requires the disclosure of other directorships held by the resigning director, and a cooling-off period before being appointed to other boards, seeks to plug the gap between directors’ words and actions, and allows investors to better gauge if there may be nefarious reasons behind the resignation.

However, this issue is hardly unique to India, and there are many reasons for directors disguising their true motives for resigning, such as not wanting to damage business relationships and potentially future employment opportunities, or to suffer material consequences from adverse market reaction if they own stock options.

A long-term solution is to increase engagement between independent directors and investors. That way, investors would’ve a better sense of independent directors, their priorities, and what may have transpired when independent directors resign mid-way.

Separation of chair and CEO roles, expected to be mandatory for the largest 500 companies with identified promoters, effective next year, is a good corporate governance practice. However, appointing a lead independent director to serve as a liaison between other independent directors and the CEO, chairing non-executive directors’ meetings, and acting as a focal point of contact for institutional investors must be encouraged across all companies where the roles of chair and CEO are not separate.

Board diversity rules may lead to a baseline level performance, but without an egalitarian setting where the views of all members are actively solicited and equally valued, and including members with relevant qualifications in important committees, the rules might lead to tokenism and box-checking. According to CFA Institute calculations, nearly half of the Indian companies in a sample of 318 companies (market cap over $500 million) had just one female director, the legal minimum, as of August 2020.

According to a recent study that appeared in Harvard Business Review , while female independent directors in India are considerably more educated than their male counterparts, they are less likely to sit in prominent committees.

Lastly, there is a fundamental issue of lack of role clarity that need to be addressed, especially in promoter-dominated and group-companies. Beyond the traditional debate around monitoring versus advisory roles, more nuanced issues are coming to the fore, such as the conflicts of interest faced by an independent director, when she serves two group companies and is expected to weigh in on business decisions which impact both, such as apportioning contracts and related-party transactions.

Boards must have periodic conversations on whom they owe their primary duty to, and how they balance their responsibilities among various stakeholders. Training, which focusses not only on regulations and skills, but also on fiduciary duty and ethical dilemmas faced by directors, is needed.

Boards and independent directors provide their greatest value guiding companies during times of disruption. As companies navigate an increasingly turbulent world, the importance of good leadership, strategic insight, and monitoring that boards provide have never been greater. The best companies would embrace the diversity and contributions from independent directors and seek to maximise the benefits they generate.

A holistic approach which focusses on independent directors’ effectiveness, which goes beyond well-intentioned regulations, is the need of the hour.

The writer is Director of Capital Markets Policy (India) at CFA Institute

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