Real board independence is elusive

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: Company affairs minister Prem Chand Gupta has recently said that instead of a stipulation in the company law, companies must be free to decide on the number of independent directors. Though the corporate sector is pleased, corporate governance enthusiasts from the Anglo-Saxon school are aghast. One part of the minister’s view implies that aspects of independent directors need not be part of law as such—this is the position in most countries. The international standard regarding independent directors is mostly stated in the listing agreements, or remains as best practice—not as law. Clause 49 of Sebi’s listing agreement, which calls for 50% independent directors in the case of chairman-cum-CEO and 30% in other cases, arises from such international thinking. In countries where the standard is merely a best practice, companies are expected to comply or else explain and justify.

The other part of the statement is radical. It implies that the judgment of the promoters, financial institutions and shareholders is better than a uniform standard on the number of independent directors. On this, the minister may eventually prove to be wiser than the critics. The definition of independence has not prevented companies from choosing ‘independent’ directors who willingly collude with dominant shareholders. In some public enterprises, government nominees who represent the owners have been categorised as ‘independent’, relying on the ‘judgment of the board.’ Private firms have been picking up celebrities through a crony system that ensures their loyalty to the benefactor.

Further, there are no stipulations on the competence, qualifications or relevance of the independent directors. The ‘fit and proper’ tests are not validated and standardised. Only a few countries have gone to the extent of insisting (Malaysia, for example) or, at least, preferring directors’ accreditation, or similar hurdles. In the absence of such criteria, companies can fill their boards with ‘independent’ directors who may take temporary leave of their reasoning or voice during the board meetings.

The independence and competence of directors is wholly dependent on the vision and wisdom of those in control. There are three broad approaches evident from the companies in inducting independent directors. The first is that the obligation enjoined by Sebi has to be fulfilled, but without actually changing any part of the board practices.

The third approach is adopted by wise companies that wish to leverage on the independent directors to elevate their strategic thinking to fight risks and gain competitive advantage. They value independent directors as a strategic resource—not as publicity material. They profile their boards and induct fit, proper and competent independent directors, who can contribute to making unique choices that competition is not capable of. They do not indulge in cronyism while selecting independent directors. They would also enter into appropriate contracts that would include non-disclosure pacts, non-compete pacts, and transparent compensation contracts. They will be transparent and justify conflict of interests, where they become essential for shareholders approval.