Independent director: An oxymoron

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Independent director: An oxymoron

Wednesday, 10 January 2018 | Hima Bindu Kota

As the situation exists today, there is no independence for independent directors. The need of the hour is to make them active participants in board meetings

Strong independent directors make strong boards. The fiduciary board of independent directors of any listed company is to protect the interests of minority shareholders and ensure that the majority shareholders or owners do not while away their funds on private jets or yachts or invest in suboptimal funds from the investors’ perspective. After the catastrophic jolt to the trust and confidence of Indian investors by the Satyam scandal in 2009, where financial fraud was to the tune of Rs 7,000 crore, several committees were set up and eventually their recommendations paved way for India’s new Companies Act, 2013, which clearly established the responsibility and accountability of independent directors and auditors. But the question arises, whether the term independent director is an oxymoronIJ

As per Section 149(6) of the Companies Act 2013, an independent director is a non-executive director who does not have any pecuniary relationship with the company, its promoters, senior management or affiliate companies, and is not related to promoters or the senior management, and/or has not been an executive with the company in the three preceding financial years. It also says that an independent director should not have been a partner or executive director of the auditors/lawyers/consultants of the company in preceding three years or should not hold two per cent or more of shares of the company. Further, he/she should not be a supplier, service provider or customer of the company.

Independent directors are supposed to bring accountability and credibility by being trustees of good governance and play an important role in improving corporate credibility, governance standards and risk management of the company by taking unbiased decisions and checking various decisions taken by the promoters or the majority shareholders, But are they able to fulfil this responsibilityIJ

The answer lies in the structure of Indian companies, which is quite different from that of companies in the West. There is a clear difference between the owners/shareholders and management in companies in the US, with the ownership being diverse and not concentrated in few hands. The role of independent directors is to protect the interest of shareholders. If we take the example of Apple, a darling in the technology world, and listed in Dow Jones, 60.76 per cent of it is owned by various institutional investors and the remaining by some top leadership of the company, including CEO Tim Cook and former Vice President of United States, Al Gore.

Compare this with Wipro, another technology giant from India, 76 per cent of whose ownership is with the promoter/promoter group and 16 per cent with institutional investors. This shows that ownership and management are not separate in India, and are mostly dominated by families. Maintaining independence of independent directors is questionable, peculiar and challenging.

This brings us to the major challenge that is being faced by independent directors — the selection process. Will the monitoring role not hamper, given that a majority shareholders have a strong influence on selection and sustenance of independent directorsIJ

According to chairman, Securities and Exchange Board of India (SEBI), Ajay Tyagi, the regulator is planning to make changes to the appointment and removal norms of independent directors. Currently, it is easier to remove an independent director than re-appointing him/her. Removal requires an ordinary resolution, ie, the approval of at least 50 per cent shareholders, whereas re-appointment needs a special resolution, which is the nod from 75 per cent or more shareholders. This needs to be changed to help independent directors function independently. SEBI is weighing the possibility to make a special resolution mandatory for removal of an independent director, which will reduce arbitrariness and in turn empower them.

The second extensive problem faced by independent directors of controlled companies to exercise independent judgment, is inadequate knowledge about the organisation as ownership and access to information remain in the hands of controlling stockholders, which makes it challenging for them. This is the case in most companies and the presence of independent directors on the boards is mere ceremonial. These independent directors are generally luminaries in their fields and have a reputation to protect, which can get tarnished, because of wrong doings of companies. For example, the Satyam episode, that defamed the prestige of six of the famous corporate and academic personalities. The plight of independent directors is apparent from the fact that after the Satyam fiasco and confession by its founder B  Ramalinga Raju on January 7, 2009, some 115 independent directors on boards of more than 100 listed companies quit between January 7 and February 7 that year.

As per sub section 4 of Section 149 of the Companies Act 2013, at least 50 per cent of the board should have non-executive directors. If the chairman of the board is a non-executive director, then at least one-third of the board should comprise of independent directors. If the chairman is an executive director, then independent directors should make up at least half of the board. If an independent director resigns or is removed from the board, he/she has to be replaced by a new independent director within 180 days from the day of such resignation/removal.

With these changes, it is expected that India Inc will need an additional 5,000 independent directors by 2019, which is quite challenging in itself. Further to the Companies Act 2013, if the Uday Kotak-led SEBI panel on corporate governance recommendation, of inclusion of at least one “independent” woman director at all listed companies  were to be implemented, nearly 40 per cent of the companies listed on National Stock Exchange will have to appoint an independent woman director. This shows that there is a dearth of independent directors and steps need to be taken to minimise this gap. Although databanks are available from where independent directors can be selected, this experience has not been encouraging as companies prefer having a known than an unknown face on their boards.

Concrete steps need to be taken to improve the functioning of independent directors and it should start with the selection process. Apart from the controlling shareholder having a say in appointment and/or removal of independent directors, minority shareholders should also participate in the process. This will bring more transparency to the appointment process. In addition, SEBI should also create an ombudsman for independent directors where they can report malpractices. If independent directors have to truly fulfill their mission to monitor performance, advise the CEO and protect the interests of minority shareholders, they must unite and become a robust team, whose members are capable of extracting information for better decision-making. Finally, independent directors should not be held liable for any mismanagement by the companies unless they have power and knowledge to prevent the same.

Independent directors should have the power to be able to question the promoter group and dispassionately serve the interest of minority shareholders in corporate boardrooms. For this, the regulatory body, SEBI, has to take strong steps and create structures to make sure that independent directors are more than muted and passive participants in board meetings.

(The writer is Assistant Professor, Amity University)

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