The Companies Bill 2009 has dealt with independent directors quite extensively. The Standing Committee has spent significant time on issues relating to independent directors as evident from the report of the Committee. This shows the criticality of the effectiveness of independent directors in corporate governance. In the words of the Standing Committee “It is important that Independent Directors play their designated role to nurture the financial health of the Company and to protect the interests of various stakeholders, particularly the minority shareholders”. It is a general belief that the presence of independent directors in the board improves the effectiveness of the oversight function of the board. Independent directors bring objectivity in board room deliberations, and skills and experience required for proper functioning of the board.
Independent directors are expected to play two important roles. The first is to monitor the executive management; and the second is to enrich board room deliberations leading to right decisions. While, the executive management focuses on the second role, regulators focus on the first role. A reading of the report leads to the inference that the Standing Committee views the failure of Satyam as a failure of independent directors. Many experts subscribe to this view. However, independent directors performed the second role effectively and that is the reason why Satyam could be brought back on rail so fast.
According to the Companies Bill 2009, any company having a specified amount of paid up capital shall have at the least one-third of the total number of directors as independent directors. Any fraction contained in such ‘one-third number’ shall be rounded off as one. Thus if the size of the board is twelve directors, which is the maximum size proposed in the Companies Bill, four board members should be independent directors. Usually, in board meetings efforts are made to reach to a consensus on an agenda item. However, in case of disagreement among board members, majority view prevails.
Therefore, if a company maintains the proportion of independent directors at one-third, it can get any agenda item approved by the board. Independent directors will not be able stop any decision, which they consider detrimental to the interest of shareholders. They can only record their dissent. Minutes are expected to record the names of dissenting members of the board. Practically, we may not find any significant number of dissenting directors in the board room. Most independent directors would not like to be labeled as dissenter. Therefore, independent directors cannot be effective in their monitoring role, unless a whistle blowing mechanism for directors is put in place.
At the insistence of the Standing Committee, the Ministry of Corporate Affairs has agreed to introduce a provision requiring companies to establish a whistle blowing mechanism. It is difficult to guess whether independent directors will effectively use this mechanism. Companies, in general, will be happy with the proposed provision of one-third independent directors. But, companies committed to improve corporate governance may have larger proportion of independent directors than that proposed in the Companies Bill.
The Standing Committee has expressed concerns about the independence of internal auditors. On the suggestion of the Standing Committee, the Ministry of Corporate Affairs has agreed to introduce a clause on the tenure of independent directors. It is proposed that no independent director shall have a tenure exceeding, in the aggregate, a period of six consecutive years on the Board of a company. A period of three years shall elapse before such an individual is inducted in the same company in any capacity. No individual shall have more than two tenures as independent director in any company in the manner provided in this clause.
A cap on the tenure of independent directors is pro-posed on the assumption that proximity with the executive management impairs the independence of an individual. This assumption may not be correct. Even if this assumption is correct, the provision may prove counterproductive. Effectiveness of independent directors depends, to a large extent, on the confidence of the executive management on independent directors, particularly, in a family run enterprise. Indian corporate sector is dominated by family run businesses. Therefore, a short tenure (six years) of independent directors will be a constraint in developing a relationship of trust between independent directors and the executive management.
