The Satyam mess has understandably raised concerns about scaring away independent directors. Indeed several independent directors have actually quit in the wake of the scam.
A likely reaction on the part of companies in this situation would be to raise compensation of independent directors so as to cover the additional ?risk premium? necessary to recruit and retain them. That would be a mistake. In fact, on the contrary, it is perhaps time the regulators cap the independent directors? pay, and even throw them out of boards every few years.
In principle, boards serve two purposes?guidance and monitoring. In reality, at least in India, independent directors are selected not really for these abilities (which are hard to measure anyway) but for their credibility?read titles, current or former?and connections. The second duty?monitoring?however, is a fiduciary responsibility and is quite a problematic one given crafty promoters, compliant managers and pliable auditors and consultants. The Satyam imbroglio is indeed, an independent director?s worst nightmare.
Less risk, not more returns ought to be the target. More clarity about the independent directors? responsibilities and liabilities, rather than broad over-arching objectives would help. Clear definitions of legal liability and standards of acceptability of information provided by management would reduce the risk. That said, reputations are more fragile than legal positions and trial by media can be swift and quite independent of legal niceties. The job, by its very nature would involve some risks.
That said, a Satyam-type fraud is less likely to be at the heart of most board failures in India than the capitulation of independent directors. Along with risk reduction should come a few measures to keep the independent directors that way, i.e. independent.
Term limits come to mind immediately. Given that it is cumbersome and costly in terms of reputation to remove an inconvenient director, the stick with the management is rather limited. The carrot, however, is re-appointment. If there are limits on how many terms an independent director can serve (not exceeding 5-6 years) in a company and in any other company of a group, that would reduce the effectiveness of the carrot.
There may be two objections to this: it would be costly for the company to look for new directors every so few years and that there would be little to induce a director to work hard. These are, however, not on solid grounds. For one, while an individual company will have to let go its old independent directors, so will other companies and the search, though not costless, will not be impossible. Essentially it would create more ?churn?. Independent directors would not stay with the same management for too long to develop the clubby, mutually supportive relationships. Further, given that an individual director will have to face the ?market? periodically, it would be important for him or her to maintain a track record, so the incentive for effort would not disappear either. The same applies to the companies as well.
Independent directors currently enjoy substantial pay?in cash and stock or stock options?in many major companies. The logic behind this is that unless appropriately compensated, they would not take their jobs seriously enough. In reality it is just the price of the director?s reputation and connections. Higher pay is probably not necessary and certainly not sufficient to create better monitors out of independent directors. If anything, it just makes the position too lucrative to lose, enhancing the independent director?s likelihood of ?playing along? with management. Having decided to play along, there is little incentive to sink in further efforts at verifying management action.
An independent director?s pay should be capped at a fraction, say 25%, of the respective director?s regular income (i.e. total income from all activities other than board positions elsewhere). Naturally this would mean different pay for different independent directors on the same board, but it means equity in the sense of opportunity costs?value of time spent?rather than in terms of actual pay. The value of the next lakh to a corporate executive is likely to be less than that to a retired civil servant. The effect would be that at any time, for an independent director at serious odds with management, confrontation or even resigning is not such a difficult choice. Currently many professors and former civil servants earn, from their board positions, a multiple of what they make in their day jobs (or from their pensions). It is impossible for most individuals to overlook this effect when considering a dissenting vote vis-?-vis management.
At the end of the day, a supervisor?s job will always be risky; particularly when he is at an informational disadvantage vis-?-vis his charge. It will however, benefit all to reduce the stakes in this gamble.
The author teaches finance at the Indian School of Business, Hyderabad