Independent directors should be able to question the promoter group and serve the interest of minority shareholders in boardrooms. For this to happen, the SEBI has to empower them

A strong independent director is an asset to an organisation if he/she has the ability to objectively analyse affairs to bring about a convergence in the views of different shareholder groups and works towards protecting the interests of minority stockholders and the company as a whole. Such a person increases the transparency and accountability of the board and can pave the way to making it strong.

After the Rs 7,000 crore 2009 Satyam financial fraud, several committees were set up and their recommendations paved the way for India’s new Companies Act, 2013, which clearly established the responsibility and accountability of independent directors and auditors. Over the years, there has been a sea change in their duties and obligations, with an increased expectation to play an active and vigilant role in the decisions that are being taken by the company at the board level.

In order to make the corporate governance structure stronger, the Government has tightened the norms and taken the relatives of independent directors under its ambit and amended the Companies (Appointment and Qualification of Directors) Rules, 2014. It has ordained that no relative of an independent director should be in any way “indebted” to the company, its holding, subsidiary or associate company, promoters or directors. Additionally, relatives cannot give guarantee or provide any security in case of indebtedness of any third person to the company or its promoters and subsidiaries. The new rules would govern all transactions involving an amount starting from Rs 50 lakh in the preceding two financial years or even the current year.

Now the question arises, whether independent directors are caught in a catch-22 situation with stringent regulations on one side but do not have enough power to govern company operations as they are not involved in day-to-day functioning?

It is common knowledge that many boards are more of a “friends club” with directors rarely raising any contentious issues. According to the theory of critical mass, any person, being in minority in a group, would not be able to exert his/her point of view and generally tends to go with the decisions of the majority. So, any independent director with a divergent view may not be comfortable in expressing his/her views and may choose to follow the crowd. This may have been quite prevalent, considering the fact that many corporate governance mismanagements, like the liquidity crisis among the NBFCs due to the unexpected default by IL&FS, have come to light recently and the independent directors were also caught unawares.

Now, a majority of independent directors are finding it difficult to discharge the stringent statutory duties that have been thrust on them by the changes made to the Companies Act. Consequently, the number of resignations this year went up by 30 per cent and many eligible and experienced members of business and bureaucracy refused to accept positions as independent directors. Although almost all have cited personal reasons for quitting, it’s clear that they are resigning because of some inkling of corporate mismanagement. However, Anil Khandelwal, former Chairman and Managing Director of Dena Bank and Bank of Baroda and also independent director of JM Financial Asset Reconstruction Company, boldly proclaimed the lack of transparent governance in the company to be the cause for his leaving.

 Some departures are appropriate if the board failed in its basic fiduciary duties, especially where the independent directors fail to exercise their liberty. However, on the downside, honest people may be forced to abandon boards, undermining a system that was meant to bring balance to the boardroom.

One cannot expect independent directors to function at their best with possible information asymmetries, which stems from the fact that the structure of Indian companies is quite different from that of firms in the West. In the US, the ownership is diverse and not concentrated in a few hands and the role of independent directors is to protect the interests of shareholders. For instance, 61.1 per cent of Dow Jones-listed technology major Apple, is owned by various institutional investors, 27.89 per cent by mutual funds and 1.06 per cent by individual stakeholders like Arthur Levinson, Chairman and CEO Tim Cook and so on and 9.95 per cent by other investors. Compare this with Indian technology giant Wipro, 74 per cent of whose ownership is with the promoter/promoter group, 16 per cent with institutional investors and a mere 5.66 per cent with the general public or retail investors. This shows that ownership and management are not separate in India, mostly dominated by families and maintaining freedom of independent directors is questionable, peculiar and challenging.

This brings us to the major difficulty that is being faced by independent directors — the selection process. Will the monitoring role not be hampered, given that the majority shareholders have a strong influence on selection and sustenance of independent directors? In an attempt to enhance their eligibility criteria and role, the Securities and Exchange Board of India (SEBI) has accepted the recommendations of the Kotak Committee that an independent director must provide an undertaking of his/her liberty and this declaration must be taken on record by the board of directors of the listed company after duly assessing its veracity. In addition, there must be no “board inter-locks”, which means that if A, being a non-independent director of a listed company X, is an independent director of company Y, then any non-independent director of company Y cannot be an independent director of the listed company X.

The second problem faced by them in exercising wisdom is inadequate knowledge about the organisation, as ownership and access to information remain in the hands of the controlling stockholders. This is the case in most companies and independent directors just have a ceremonial presence. They are generally luminaries in their fields and their reputation can get tarnished because of the wrongdoings of firms. For instance, the Satyam episode defamed six famous corporate and academic personalities.

Their plight is apparent from the fact that after the confession by Satyam founder B Ramalinga Raju on January 7, 2009, some 115 independent directors of more than 100 listed companies quit within a month.

As per sub-section four of Section 149 of the Companies Act, 2013, at least 50 per cent of the board should have non-executive directors. If the chairman is a non-executive director, then at least one-third of the board should comprise 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 one within 180 days. With these changes, it is expected that India Inc. would need an additional 5,000 of them by 2019-end, which is quite challenging in itself. According to the Kotak Committee, there must be at least one independent woman director on the board of the top 1,000 listed companies by April 1, 2020. With the slew of recent resignations, there is a definite gap here. 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. First, apart from the controlling shareholders having a say in their appointment and removal, minority shareholders should also participate in the process for the sake of transparency. Second, SEBI should also create an ombudsman where independent directors can report any malpractices. If they have to honestly monitor performance, advise the Chief Executive Officer and protect the interests of minority shareholders, they must unite and become a robust team capable of extracting information for better decision-making.

Finally, they should not be held liable for any mismanagement by firms unless they have power and knowledge to prevent the same. Independent directors should have the power to question the promoter group and dispassionately serve the interest of minority shareholders in boardrooms. For this, SEBI has to create structures to ensure that they are more than mute and passive participants in board meetings.

(The writer is Assistant Professor, Amity University)