By Rajesh Chakrabarti, Professor, Indian School of Business
Quality independent directors are hard to find today. Ask Azim Premji. India’s third-largest IT company, Wipro, is about to join the horde of companies violating Sebi norms by keeping independent directors beyond the suggested nine-year maximum tenure.
The independent director situation in India has indeed become tighter in the last two-and-a-half years since the Satyam scandal shook India Inc. While the Satyam crisis did not bring any regulatory changes in its wake, research seems to indicate that, combined with the near-concurrent persecution of Nimesh Kampani, the episode has left a significant imprint in corporate boardrooms across the country.
In a recent paper*, we compare the composition, characteristics and compensation of boards before and after the crisis for close to 2,500 firms to study the broader impact of the event on corporate boards in India. The findings are quite illuminating. Boards have become larger but controlling for other things, less independent (have fewer independent directors) after the crisis. Much of this seems to be the result of a “supply shock” in which independent directors have become more aware of the risks associated with board positions. In the three weeks of January 2009 after the Satyam fraud came to light, independent director exits soared to 109 from a monthly average of about 30 before the crisis. Over a longer horizon, independent director exits per year have risen by 20% in the post-Satyam period as compared to the three years before the crisis.
The paucity of independent directors is reflected in the pay as well. The average pay of independent directors in the post-Satyam period has shown an increase of over 30%. Also the proportion of fixed pay has increased in their compensation packages. But even the pay rise does not seem to have been able to attract quality to board rooms. Independent directors are now less likely than before to be professionals (including lawyers/consultants, financial experts, and retired executives, civil servants and government officials). Also, notwithstanding the quality drop, independent directors have become busier, sitting on more boards than before.
As a reaction, many companies have now turned to executive directors. Executive director appointments have more than doubled in the post-Satyam period than before. Their proportion on boards has risen by 16%. This does not automatically follow from fewer independent directors, there are some directors who are neither. Non-executive chairmen have become more common – a move that brings down the minimum independent director proportion from half to a third. Among other things that have changed, board committees became more punctual and meetings are being better attended than before.
What to make of all these changes? They can all be seen as results of the crisis affecting a more or less efficient market for independent directors. As the media and investigative agencies hounded the directors, a virtual exodus of independent director resignations followed immediately. The independent directors reassessed the risks of a board seat – that a lifetime’s reputation can be tarnished because of the hard-to-detect actions of an unscrupulous promoter.
As a result, the existing and potential independent directors demanded a higher price for their presence in the boards. Realising the extent of the risks, they also want more certainty in compensation. At the same time, to the extent that it matters, they want to monitor the promoters for their own safety. Hence, attendance in meetings has gone up.
But not all independent directors are the same. The ones with the most reputation to protect simply exited the market bringing a drop in quality. More firms are now left vying for a smaller pool of independent directors, raising the number of directorships per head.
But there is probably more to it than just a drop in supply of independent directors because of the now-more-obvious risks. India Inc itself may have started doubting the efficacy of independent directors in the boardroom. Firms are now opting for a non-executive chairman, which reduces the independence requirement and packing boards with more executives. That signifies a paradigm shift about the value of the much bandied about board independence. India Inc may have very well just started walking away from the idea, something it was anyway never too comfortable with. And the move is not wholly without logic. In a recent paper, Raghuram Rajan and his co-authors have argued that internal governance may well provide a viable alternative to the present system. Indian businesses may well agree.
The issues involved also assume particular importance as the government mulls over the new Companies Act. The Indian legal system currently draws no distinction between the responsibilities of independent directors and those of the “inside” directors. More importantly, all directors have an indefinable fiduciary liability that extends to any offence the company may commit, like issuing a cheque that bounces or allowing delays in employee provident fund payments. The independent director has virtually no control over such actions and yet is responsible to an equal degree with other board members for such offences. Therefore, one not only risks a lifetime’s reputation by serving on a board, even one’s liberty and property.
(Co-authored with Krishnamurthy Subramanian, who teaches finance at the Indian School of Business, Hyderabad)
*Chakrabarti, Rajesh, Krishnamurthy Subramanian and Naresh Kotrike, After the Storm: The Unregulated Effect of a Corporate Governance Crisis on Corporate Boards, Working Paper, ISB
Professor Rajesh Chakrabarti is an Assistant Professor of Finance at the Indian School of Business. Prior to joining the ISB, he was with Georgia Tech College of Management. He received his PhD from the University of California at Los Angeles. He also has an MBA from the Indian Institute of Management, Ahmedabad, India and a bachelor’s degree in Economics from the University of Calcutta, India. Before joining Georgia Tech, he had taught at the University of Alberta, Canada and had previously worked for a major financial institution in India. Professor Chakrabarti’s areas of teaching and research interests include international financial markets, exchange rate movements and informational issues in financial markets. His research papers have been published in the Journal of Financial Economics and the Journal of Financial Markets.