The Companies Bill stipulates that in every listed public company independent directors should constitute at least one-third of the board.

By Asish K Bhattacharyya

It is widely accepted that the presence of independent directors in the boardroom improves the quality of corporate governance. Accordingly, corporate governance mechanisms all over the globe, including in India, focus on ‘independent directors’. The Companies Bill 2011 includes number of new provisions related to independent directors. It includes a ‘Code For Independent Directors’ (Schedule IV).

According to the Bill an independent director is a director other than a managing director or a whole-time director or a nominee director, who is not a promoter and who fulfils certain conditions specified in the Bill. Primarily he/she does not have any pecuniary relationship with the company or he/she, with relatives, does not hold more than two percent of the voting power of the company.

The Bill describes an independent director as a person of integrity, who possesses relevant expertise and experience.

Role of independent directors

The government expects independent directors to bring an independent judgment to bear on the Board’s deliberations especially on issues of strategy, performance, risk management, resources, key appointments and standards of conduct; and to bring an objective view in the evaluation of the performance of board and management. As per the Companies Bill, their responsibility is to safeguard the interest of stakeholders, particularly minority shareholders and to balance conflicting interests of stakeholders. Balancing the conflicting interest is a tricky job and most experts believe that a company should not try to do that. Rather, it should focus on shareholder value while behaving responsibly to all stakeholders. Presumably, the government wanted to draw attention to CSR and therefore specifically mentioned that responsibility. In practice, it might not be possible for companies to balance conflicting interests of stakeholders.

Critical Role of an independent director

The Companies Bill stipulates that in every listed public company independent directors should constitute at least one-third of the board. Usually, every board endeavours to achieve consensus in taking decisions. In absence of consensus, the majority view prevails. Therefore, even if all the independent directors agree that a decision is against the interest of non-controlling shareholders or other stakeholders, they together cannot block the decision. At best, they can record their dissent. This might protect their interest, but fails to protect the interest of affected stakeholders. Minutes are accessible to auditors. But an auditor is not expected to comment on business decisions because evaluation of those is beyond the scope of audit. However, if the dissent note relate to a ‘related party transaction’, the auditor might take cognisance of the same.

Resignation of an independent director may not benefit

The only alternative is to resign from the board. Resignation of an individual with high stature will signal the market that something is wrong in the governance of the company. The market will not notice resignation of someone who does not enjoy the celebrity status. Moreover, market’s memory is short. Therefore, resignation of an independent director may not benefit non-controlling shareholders and other stakeholders.

Should we expect independent directors to play the role of whistle blowers? Should they inform regulators their reservations about decisions taken at a board meeting? It is a debatable question.

Independent directors cannot monitor the executive management

Let us accept that independent directors cannot monitor the executive management. At best they provide checks and balances and enrich boardroom deliberations.

For example, Mr. Keshub Mahindra, the highly respected industrialist, could not prevent the Bhopal disaster caused by negligence of the executive management, while he was the non-executive chairman of UCIL. Similarly, in case of Satyam, illustrious independent directors could not prevent fraud perpetrated by the management. J M Financial founder and investment banker Nimesh Kampani could not prevent the Nagarjuna Finance scam.

Gap between what independent directors can do and what stakeholders expect them to do

In the above scenario, independent directors should not be held responsible for the misdeeds of the company, provided they have applied due diligence in carrying out their responsibilities. The public rage against directors in the cases of AMRI and UCIL reflects that there is a huge expectation gap – the gap between what independent directors can do and what stakeholders expect them to do.

This gap is created because we have hyped the role of independent directors. We presented them as semi-god, who is not ordinary person. Fact is that most independent directors are ordinary persons with competencies to manage companies. Therefore, they cannot improve corporate governance by magic touch.

In case of UCIL, the Court found Mr. Mahindra guilty of causing death by negligence (section 304 A of IPC). Courts should review such decisions. If, the present position continues, it will be difficult to get experts willing to join boards as independent directors.