Why Are Independent Directors Not Allowed ESOPs?

Under Section 149(1)(c) of the Companies Act, 2013, independent directors in India cannot receive Employee Stock Options (ESOPs) to preserve their impartiality and ensure unbiased corporate governance. Granting ESOPs may create a pecuniary relationship with the company, potentially compromising their independence. However, independent directors can earn profit-based commissions alongside sitting fees, provided shareholders approve. This raises questions about the consistency of these financial incentives. Profit-based commissions, when tied to operating profits, are seen as less risky than ESOPs, which are market-driven and susceptible to short-term manipulation. Unlike ESOPs, commissions are auditable and less likely to influence immediate decision-making for personal gain. Globally, developed countries like the US, UK, and Singapore allow independent directors to receive ESOPs with safeguards, such as longer vesting periods, to align their interests with long-term company growth. This approach ensures fair compensation without compromising governance standards. The debate in India continues—could adopting such practices balance independence with appropriate rewards for independent directors?

Section 149(1)(c) of The Companies Act, 2013, prohibits independent directors from receiving Employee Stock Options (ESOPs). for the following reasons:

a. The fundamental principle behind an independent director is to ensure unbiasedness and fairness in corporate governance.

b. Granting ESOPs could create a material pecuniary relationship between the company and the independent director, which may restrict their independence.

But on Contradiction: Profit-Based Commission can be given to Independent Directors (IDs)

If financial incentives impact independence, why are independent directors allowed profit-based commissions while ESOPs remain prohibited?

Let’s Deep Dive:

• Independent directors may receive profit-based commissions alongside sitting fees, but only with prior shareholder approval.
• The key question: Does profit-based commission influence independence?

Risk Involved:

• If an independent director’s earnings are tied to short-term profits, won’t they be attracted towards immediate gains over long-term stability of the company?
• Accounting profits can be easily manipulated through non-operating income like:
• Premium on debenture issues
• Gain on sale of assets
• Investment returns
• Some companies counter this by linking independent directors’ commission only to operating profits, which provides a fairer representation.
• Why justifies the equation why was director appointed at first place

Operating gains = Independent director’s gain

So, Why Are ESOPs Seen More Risky Than Profit-Based Commission?

 The Global Perspective

• In developed countries, independent directors can receive ESOPs but with longer vesting periods.
• Countries like the United States, the United Kingdom, and Singapore allow independent directors to receive ESOPs with conditions ensuring long-term value creation and proper compensation to IDs.
• This ensures that independent directors focus on long-term growth of company rather than short-term stock price fluctuations.
• After a period, when the company genuinely grows, they can harness the benefits of ESOPs without compromising independence.

The Final Thought

The debate around ESOPs vs. profit-based commissions for independent directors highlights a core issue: How do we ensure corporate governance remains unbiased while still fairly compensating those who look after it?

Would India benefit from ESOPs with longer vesting periods for independent directors like other global economies? Let the debate continue!