Column : Abolish independent directorship

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: The board of directors is one of the instruments designed to ensure good corporate governance. When the management is led by the promoter, the board is required to ensure that the promoters and management do not compromise the interest of other sharesholders. To enable this, one-half of the members of the board are independent.

In reality, companies abide by this requirement only in letter and not in spirit. Independent directors are chosen by the promoters and almost invariably fail to think or act like watchdogs. Sometimes, promoters choose them to be polite and in the rare cases where the promoters genuinely desire to have an actively critical set of independent directors, they face a paucity of directors with skills and guts. As a result, independent directors mostly cooperate with the promoters. Often, they suggest that the company hire more auditors, lawyers and consultants to suggest solutions to problems. This partly reflects their lack of expertise on all matters that go into the running of a company and also because it is safe.

At the far end of the spectrum are the entrepreneurs that systematically cheat. We need to save the minority shareholders from these sharks. But they know how to manage a board half full of respectable independent directors. Good entrepreneurs would do none of this. But, they do not require independent directors because they do not indulge in fraudulent practices. Thus, the stipulation that one-half of the directors on the board of a listed company should be independent serves no purpose. Worse still, it provides a false sense of protection to shareholders. Thus, the Sebi mandated stipulation that one-half of the board should comprise of independent directors should be dispensed with.

The board of directors should consist principally of representatives of the various stakeholders in the company—essentially, the equity shareholders and it should have a representation of independent professional accountants and lawyers. Here is a set of proposals to constitute the board in the absence of independent directors.

1. The pattern of the board of directors should reflect the pattern of ownership of equity shares. For a beginning we may use the groups by which the shareholders are classified in the regular quarterly disclosures to the Exchanges. The groups include: promoters, institutions, non-promoter corporates and individuals. Institutions include mutual funds, banks, FIIs and VCs. Each of these groups should be allowed to separately nominate their director to the board such that the final board composition reflects the share of each group in the overall ownership of the total equity shares. With this, each nominee to the board would represent a stake in the company and this would ensure that the management or the promoter does not compromise the interest of the various shareholder groups since they are all represented on the board.

2. Nominations from non-promoters should necessarily include a professional accountant and a professional lawyer. These two professions are the most important in ensuring that the company maintains proper books of accounts and is compliant with the provisions of the law.

3. Any owner group that has 10% or more of the equity should have a representation on the board. Remainders from ownership groups of less than 10% should be aggregated at the sub-group levels. With this, the broad distribution of the board would reflect the distribution of ownership.

4. Owner groups may engage professional directors and pay them to represent their interests on the board. This would bring in greater professionalism into the board. Each owner group may decide the kind of expertise it would like to bring into the board. So, typically, a large private equity investor would not only provide the financial capital to the company but also some human capital on the board. However, representatives of non-promoters should include a professional accountant and a professional lawyer.

Such a board would not be a reflection of merely the promoter group as is the case currently. Election to such a board would now be stratified according to the ownership. Currently, a promoter with a 51% ownership of equity (often even lesser) can dictate the entire board. In the proposed dispensation, such a promoter necessarily dictates only 51% of the board.

If we apply the above rule to a standardised board size of 11 members, the Raju family could have elected only one person to the board. The rest would all have been nominated by non-promoter groups. Of these, FIIs would have elected five. If some of these were professional and independent accountants and lawyers, it would have possibly saved the country from a major disaster.

A quick study of the Nifty 50 companies reveals that on an average, promoters would elect six of the eleven members and non-promoters would elect the remaining five. This is a healthy mix of representation of promoters and non-promoter stake holders rather than promoters and promoter-appointed (independent) directors. The expertise of independent directors can be obtained through consultancy retainerships.