In the present corporate ecosystem, we can witness many corporations fail and wind up because of internal mismanagement of the company. In the normative sense, the Board of director’s actions should be in line with the interests of the shareholders and should be devoid of any personal gains but in the contemporary world this seems to be more of a teasing illusion.

A whole range of reforms have been bought about in order to inhibit such corporate scams and in maintaining independent functioning of corporate boards. The objective of this paper is to analyze issues in relation to the working of an independent board in India and the international practices to improve the quality of governance.

AUTONOMY OF BOARD & CORPORATE GOVERNANCE- 

According to the Financial Aspects of Corporate Governance Report (The Cadbury Report), Corporate governance is the process by which companies are regulated and guided. The Board of directors are acting in the capacity of an agent for the shareholders but the lack of motivation to monitor the decisions of the directors creates an opportunity for the managers to make poor decisions and unprofitable transactions which reduces the value of the company and in turn the shareholders gain.

In India, majority of the companies are family owned businesses with it’s board comprising of family members which allows mismanagement of the internal affairs of the company for personal gain. The problem with autonomy of board can also be seen in corporations with a “horizontal governance” structure in which the majority and the discrete shareholders both play a role in the management.

Due to the independent board playing an active role in supervising the workings of the corporation, there has been a significant shift towards having a higher percentage of independent directors. The “independent director” in the board of a company is expected to be indifferent to the opinions of any other employee of the company including the CEO. In reality, the “directors seem paralyzed in the presence of powerful CEOs.

PSYCHOLOGICAL ANALYSIS-

The Board independence can be analyzed using the Milgram experiment. It analyses how human behavior like faithfulness can effect the decision making of an individual. This experiment had proved that individuals act in a way that appeals to an authoritative figure, completely ignoring their own decision making. By drawing an analogy to the board independence, it can be observed that the independent director is most loyal to the CEO of the company (as CEO plays a major role in electing them). Therefore, as it owes fidelity to the CEO, the so called “Independent director” is reduced to just a sham.

In the recent times, sterner rules have been levied according to which an independent director should not have any pecuniary relationship with the internal management and his/her return from the corporation should only be limited to the salary. This provision may not be enough to tackle the issues of internal mismanagement as it only reduces faithfulness towards the CEO but does not take into account any social ties or relationships with the senior managerial position. The probability of a biased “independent director” is high, as approximately 33% boards have CEO duality and there has been an increasing number of promoters playing the role as a chairman.

BOARD INDEPENDENCE IN INDIA AND ITS ISSUES-

The policy of independent directors in India was guided by its implementation and experiences in other jurisdictions like the US and the UK. In both the countries the institution was created to curb the agency problem between the shareholders and the management of the company. On the contrary in India the problem was different and focused more on the majority-minority. The majority-minority problem is a major cause of concern in India. The regulations concerning an independent board is laid down in the Companies Act and the SEBI rules. All around the world, the autonomy of a board has been determined objectively by creating a mandate of a minimum percentage of independent directors in the board of a company. The problem of internal mismanagement cannot be addressed by this objective standard as the true essence and limitation of the word “Independent” is not defined.

Some of the other issues that contribute to the poor functioning of the independent directors are-

  • The workload of the appointed independent director is also a factor for the quality of corporate governance. The independent directors that have directorships at many corporations fail to keep a proper check on the internal workings of the company.
  • CEO duality – When the post of a CEO is occupied by the same individual as the chairperson of the company it leads to internal mismanagement. This individual solely manages the functioning of the board and also the daily actions of the company.
  • The inclusion of controlling stockholders on the company’s board which leads to dissenting interests.

Therefore, board independence is generally considered to be a necessary condition for effective monitoring, there is a growing recognition that it s not board independence per se but rather board quality that is important for governance.

THE SATYAM SCAM-

The founder and CEO of Satyam Computers B. Ramalinga Raju admitted to the fraud of investing $1.6 billion in Maytas infrastructure and Maytas Properties, two firms which are controlled and sponsored by his family members.

The proposed investment in the two Maytas firms gave the impression to be ethical on the first sight but in my opinion the independent directors should have taken due care as a family connection existed. As an independent board member, one should have carefully analysed whether it was the right decision for the company and its stockholders. The Stockholders of Satyam were the victims of internal mismanagement and prejudiced decisions taken by the board. From these experiences, it is clear that the institution of the independent director has not been able to keep a check on the excesses of controlling shareholder even if the promoter does not hold a substantial stake. For example, in the Satyam scam, 5% of the stocks were held by the family but despite of a minority shareholding it managed to deceive a superficially independent board.

The effectiveness of independent directors can be simply determined by the dynamics inside a board room once its doors are closed. There is a traditional thinking of some Indian companies that the board members actually work for the people who have brought them onto the board, this is a definitely a misguided thinking, “The real strength of a healthy board is when a consensus gets overturned by a dissenting view”

An individual independent director cannot play an effective role in isolation. Even if a particular independent director is highly committed, she can only ‘watch’ wrong doing and at best initiate a discussion, but alone she cannot stop a decision even if it is detrimental to the interest of shareholders or other stakeholders. Neither can she blow the whistle outside the board room (e.g. to regulators) because board proceedings are considered confidential.

SAFEGUARDS & REFORMS TO ADDRESS THESE ISSUE-

The fall of major corporate firms has paved a way for reformatory policies to cater to the issue of oppression and mismanagement of the company. Some of these reformatory policies are-

  • An appointment committee has to be formed comprising of independent directors who are responsible for deciding upon the appointment of members of the board and their internal management.
  • “In discharging its responsibility of ensuring adequate and effective internal control the board must depend on other institutions of corporate governance such as internal audit, external audit, and legal counsel. Independent directors may not be in a position to stop management fraud perpetrated at the highest level, but with high level of commitment and due diligence they should be able to identify signals that indicate that everything is not hunky dory.”
  • A Senior Independent Director has to be employed who would provide an additional safeguard to mismanagement by conducting meetings with the board without the CEO and would also be responsible for keep the functioning of the CEO in check.
  • The non-management director of the corporation should hold meetings at a regular basis without the board member holding managerial positions.

These practises have created a more active role for the independent board, making it responsible to inspect closely and supervise the day to day activities of the corporation. This has increased accountability of the CEO and board of directors towards the stockholders.

REFERENCES-

1. The Financial Aspects of Corporate Governance (The Cadbury Report). 1992

2. Morck, Randall. “Behavioral Finance in Corporate Governance: Economics and Ethics of the Devil’s Advocate.” Journal of Management & Governance, vol. 12, no. 2, 2008, pp. 179–200., doi:10.1007/s10997-008-9059-4.

3. Sarkar, et al. “A Corporate Governance Index for Large Listed Companies in India.” By Jikun Huang, Ruifa Hu, Scott Rozelle, Fangbin Qiao, Carl E. Pray :: SSRN, 11 May 2012, papers.ssrn.com/sol3/papers.cfm?abstract_id=2055091.

4. Morck, Randall. “Behavioral Finance in Corporate Governance: Economics and Ethics of the Devil’s Advocate.” Journal of Management & Governance, vol. 12, no. 2, 2008, pp. 179–200., doi:10.1007/s10997-008-9059-4.

5. Indian Journal of Industrial Relations

6. 44, No. 4 (Apr., 2009), pp. 576-592 (17 pages)

7. America, Asia-PacificIndiaNorth. “Scandal at Satyam: Truth, Lies and Corporate Governance.” Knowledge@Wharton, knowledge.wharton.upenn.edu/article/scandal-at-satyam-truth-lies-and-corporate-governance/.

8. Bhattacharyya, Asish K. “Satyam: How Guilty Are the Independent Directors?” Business Standard, Business-Standard, 11 Jan. 2009, www.business-standard.com/article/economy-policy/satyam-how-guilty-are-the-independent-directors-109011201009_1.html.

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Company: Jindal Global Law School
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