“Citizens never support a weak company and birds do not build nests on a tree that does not bear fruits- Chanakya

Introduction:

With the increased focus on shareholders’ wealth maximisation as the key corporate objective, regulators worldwide have understood the role independent directors can play to safeguard the interests of minority shareholders. 1  While, in principle, it is a good idea to have many independent directors on the board, this in itself does not guarantee that minority shareholders’ interests are protected. At the end of the day, independent directors are appointed by executives of the company. 2Academic research finds companies largely appoint independent directors who remain loyal to the management. So even if these directors are competent, they do not question the management. This, therefore, raises questions regarding the wisdom in according increasing focus on the number of independent directors. There can be possible reasons why academic research does not find any link between independent directors and financial performance.

Myth of Independence of Independent Directors:

“Independent directors are nominated by the management and are at the mercy of the promoters. So, the independence of the directors is more a myth than a reality.”-Prithvi Haldea

The independence of independent directors is one of the questions which have come to the forefront time and again.3 It has been a subject of heated debate as to whether the independent directors are to contribute to the development of corporate strategy, reviewing the performance of management or whether their primary role is to protect the interests of the public shareholders by opposing questionable management policies and establishing adequate controls against the promoters and the management. The institution of independent directors was supposed to act as a bulwark against any opportunistic indiscretions that could be committed by the promoters and the management. This was done to promote investor protection through integrity and accountability. However, looking at the provisions relating to independent directors especially in the Listing agreement, the independence of independent director is highly jeopardized. This can be seen by looking at the various aspects with regard to the independent directors.

The first factor is with regard to the selection of the independent directors. As far as appointment of an independent director is concerned there is no selection procedure which has been spelt out by any committee or statutes worldwide. The committees have made an attempt to identify the number of independent directors who can be designated as the independent director in the board but to question as to how these members are selected was not addressed. 4There has been a lot of importance given to the word ‘independence’ of an independent director but the selection of the independent directors lie in the hands of the owners of the company or they are directly handpicked by the promoters. It is seen the promoters in control take decisions that they may not be in the interest of small shareholders, an independent director must keep in mind the interest of all stakeholders. Therefore, there needs to be proper criteria’s which needs to be laid down and such criteria must be disclosed at the annual report for the shareholders to have a view regarding it.

Failure of Role of Independent director:

Due to complex corporate structure, heavy pressure from stakeholders, government pressure, scams are the main reason due to creditability of the independent director are questioned and to avoid these things they are quitting their post. During the period of 2018-2019 approximately 2000 independent directors have resigned. Recent scams cases in top Indian corporate organization forces SEBI to tighten corporate laws and made amended wherever require to tackle such mishappening. For example- Scams like IF&LS, PNB, IDBI-AIRCEL and Nirav Modi where involvement of independent directors are clearly found by the enforcement directorate. One major thing which commonly found among the many organization that having more independent directors will give a strong message that they have high ethical and moral regarding corporate decision but honestly speaking by appointing more no of independent directors will lead to fall in both company performance and operation. Looked at the financial performance of 5,317 companies and 20,999 directors to know the value created by independent directors in India. The former companies have actually reported marginally lower return on equity in all the three years that we studied.

Lack of Accountability:

The most and foremost reason behind the failure of independent director concept was a lack of accountability because independent directors have no idea regarding anything happen in the organization because during the 5Board Meeting they are just informed by the top brass of the organization. An independent director doesn’t any right to interfere in the day-to-day operations of company. They are supposed to support the management in getting the delivery of what the objectives of the company are to its shareholders. If a director cannot get into a company’s day-to-day operations, he cannot understand how it is governed and will not be in the position to fulfill his responsibilities. The main source of information is the CEO and it is his performance they are supposed to be monitoring. There is no separate law under which an independent director operates. In other words, he has no legal protection from the management so that he can raise his voice fearlessly

Corporate Literacy:

There is no specific qualification that is laid down for the appointment of independent directors. The only eligibility criterion which has been laid down in the clause 49 of the listing agreement is based on negative prescriptions. The criteria which have been laid down is that they should not have a material or pecuniary relationship or should not be related to the promoters or be an executive in the company for the preceding three years. Therefore, there is not a list of positive qualification that has been laid down which would be considered appropriate for the role. The definition also ignores the fact that even eminent persons who are normally selected are associated with the board. In the Case of 6Dr. Sambit Patra (National Spokesperson, BJP) was chosen for the position of independent director of Oil and Natural Gas Corporation (ONGC) in 2017. This decision was challenged in court on account of his want of financial expertise necessary to discharge the duties of a director of a company. The Court took note of the varied interests that need to be accounted for when a corporation is working in society and the importance of knowledge regarding the same varied spaces. It was held by the Court that in this context the appointment and further relevance of a medical expert to the board of directors cannot be overlooked. Many independent directors are not technically and professionally qualified to head the committees they chair in the companies. Secondly, independent directors suffer from having inadequate knowledge about the company. Satyam is a case in point. So, one cannot expect much from these directors. Third, independent directors may indeed be inefficient. Even when they are efficient, as they are appointed by the management, they may prefer to support the management

Recommendations:

Independent directors can play a more important and useful role in the functioning of the board if they ensure protection of the interests of minority shareholders. Indian companies started recognising the importance of independent directors only in this century and it is probably too early to expect them to really play the role they are expected to play.

The following moves can make a difference:

  • Section 165 of the Companies Act can be ensure that other companies can benefit from the experience of independent directors. Probably, the law can be clearly in terms of a maximum number in each ownership category of company that an independent director can serve to ensure that majority of the minority shareholders get benefited.
  • Corporate literacy was totally unrealistic because the skills needed to be in the board of a company vary significantly.
  • Each and every organization should prefer those experience individuals who have specific knowledge regarding the industry so, it can be easily to manage its affairs.

But unless independent directors give their independent views at board meetings, it will not serve any purpose in having them. That is probably why we find companies that hire more independent directors report lower Return on equity than companies that don’t.

Though on paper, shareholders decide whether a particular person should be appointed as a director or not, usually, all resolutions get passed in the AGM. Since not much information is available about most independent directors, minority shareholders also cannot take an independent view. In such a case, the view of proxy firms or some independent rating agency would prove to be useful to all the minority shareholders in the country.

References

1. Ahmad, Dr. Tabrez, Malawat, Tabrez, Kochar, Yashowardhan and Roy, Ayan , “Satyam Scam in the Contemporary Corporate World: A Case Study in Indian Perspective” August 23, 2009. available online at SSRN: http://ssrn.com/abstract=1460022.

2. Kumar Vikas, “Corporate Governance: The Myth of Independent Directors”, available online at http://www.dehnenblog.com/corporate_governance/?feed=rss2&p=5

3. Venugopalan, S., “Role of Independent Directors in Listed Companies”, (2002) 2 Comp LJ 97.

4. Yadav, Neetika and T. Priyadarshini, “Clause 49 under the SEBI Listing Agreement: A Step Towards Corporate Governance”, (2007) 5 Comp LJ 97

5. Sampath K.R., “Law of Corporate Governance: Principles and Perspective”, Snow White Publications, Mumbai, 2006. at pg. 3.

6. Energy Watchdog v. Union of India & Ors., W.P.(C) No. 9269/2017 (India)

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