The Board Can Sedate Or Enthuse!

Written by YRK Reddy | Updated: May 3 2004, 05:30am hrs
Warren Buffet has castigated independent directors in his letter to the shareholders in February 2004, wondering whether the board atmosphere sedates their fiduciary genes. In most countries, independent directors have been defined under law by the stock exchanges and by leading institutional investors. These definitions strive to ensure that independent directors do not have existing, past and potential relationships that are likely to impair independent judgement.

Yet, the reality is that there can never be a truly independent director if those in control do not want him/her to be one. Legal, regulatory or recommendatory definitions cover just one facet of independence. There are two others that make independence demonstrably beneficial competence and a culture/atmosphere that encourages independence.

Competence is a composite term that includes domain knowledge, functional expertise, board skills and, most importantly, the attitude and inclination to apply these actively. Thus, a highly reputed professional may not necessarily be a competent one if he/she does not apply them well. Dominant shareholders determine both competence and the board atmosphere. Companies which do not wish to provide a board atmosphere that supports independence, will not risk selecting truly competent and ethical directors. Our studies reveal companies may have one of three types of culture which, in turn, determine the scope for director competence and independence.

First and the most prevalent type of culture treats independent directors as an obligation and hence an additional burden on the time and resources of the company. Most private sector companies are controlled by business houses or families, which have dominant presence both on the Board as well as in the management. Several among these go through the motions of filling the slots of independent directors without risking embarrassing behaviour from them.

Promoters will want to be assured of their loyalty, which can be demonstrated well if the independent directors, at the very least, avoid wasteful and inconvenient debate, dialogue, and suggestions. Public enterprises also nurture a belief that directors are indeed a political baggage than a corporate requirement.

The second type of culture, which has particularly arisen during the last decade in most modern companies, is to look upon independent directors as reputation material that has to be worn well. Thus, individuals who are able to impress market analysts and investing public are invited to the Board. The promoters hope that these personalities will add lustre to the companys stock in the market. There is also hope that they are good channels to reach higher powers, and provide the extra oil for smoother and respectable external relations.

In this type, independent directors are allowed space during the meetings for suggestions and interaction to satisfy their bloated egos. The agenda, meetings and the minutes will be smooth and the independent directors will be shown respect even as they reciprocate by promoting the companys owners wherever and as often as they can. The general idea is to gain from the potential upside of reputation and connections of the independent directors.

The last variety is indeed rare but may be evident amongst companies which are start-ups, or undergoing severe financial crisis, or in a turnaround situation. In these companies, independent directors often ask critical questions that challenge the assumptions behind management proposals; bring about a new perspective to risk management; generate fresh strategic choices and competitive strategy. Their intervention results in widening the alternative courses of actions and debating costs, benefits and trade-offs. Typically, board meetings appear more like brainstorming sessions than breezy business. They last the whole day than end with a fine lunch.

In such a culture, independent directors would apply their competence fully and add value to the companys future prospects. The upside benefits of this culture arise from new ideas and suggestions and generation of fresh options from the independent directors who can bring an outside-in expert perspective. These independent directors also cover the downside risks, as they would have contributed in flagging and managing a variety of contingencies.

If there are serious differences or ethical concerns, such a director would have his/her opinions recorded, press for a dissenting note or call for voting. Voting will be the very last in the exercise of independence as a competent director should be in a position to influence the Board processes and its decisions by analytical debate, logic, and persuasion in the interests of shareholders and the larger good.

Independent directors would indeed be comatose in the first type of culture. In the second, they would be sedated, if not seduced, against activism and independent judgement. The true scope for independent directors to be competent and to excel in fulfilling their fiduciary duties would arise only in the last type.

The author can be reached at yrk@yagaconsulting.com