Myth of independent directors: They can only be effective if they are independent of promoters

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October 14, 2020 4:30 AM

Independent directors can only be effective if they are independent of the promoters; else, having them just creates a false sense of good corporate governance

Clearly, therefore, if IDs are to perform their role, they have to be independent of the promoters; otherwise, the entire concept becomes meaningless, and expectations get misplaced.Clearly, therefore, if IDs are to perform their role, they have to be independent of the promoters; otherwise, the entire concept becomes meaningless, and expectations get misplaced.

Globally, a major theme in corporate governance has been the institution of independent directors (IDs), which is created only to prevent the growing incidence of promoters/management enriching themselves, through unfair means or outlandish remunerations, at the expense of the minority shareholders. Clearly, therefore, if IDs are to perform their role, they have to be independent of the promoters; otherwise, the entire concept becomes meaningless, and expectations get misplaced.

A key issue in India has been the appointment of IDs. While regulations specify who cannot be an ID, they are almost silent on qualifications or experience. The field is wide open for the appointment of people who can be described as ‘home directors’—friends, school/college mates, ex-colleagues, relatives (not covered by definition), neighbours, etc. It is not difficult at all for any company to find 3-4 such persons to achieve numerical compliance.

In any case, which promoter in his senses, would ever induct a stranger, however, qualified she may be and get exposed to unwanted roadblocks. And, conversely, no sensible person would ever join an unknown company and expose herself to potential liabilities. Little wonder, given that over 95% of the companies are promoter-driven where the stranglehold of the promoter is near-total, ‘home directors’ are omnipresent.

Of course, some companies do induct eminent people like professionals and retired bureaucrats (‘value directors’), but this is done to either “open doors” or get advice or to give positive signals to the potential investors that they are willing to be monitored. The problem here is that most ‘value directors’ get paid so handsomely that independence tends to get compromised. Compensations run in lakhs and crores. At the extreme end, imagine a retired professional making, as an ID, Rs 5.07 crore from a single company in a year or another one, a retired PSU banker, making a total of Rs 5.45 crore across four companies, which would be far more than the aggregate of her lifetime’s remuneration! Would such people ever bite the hand that feeds them, and feeds them so lavishly? Almost all IDs, with no investments, play along with the promoter, who has money in the game and help prevent obvious non-compliances.

This conflict becomes more acute as a high majority of ‘value directors’ are retired people, who are significantly dependent on the ID remuneration, thus, becoming dependent independent directors. Paradoxically, to become eligible, a person cannot have any pecuniary relationship with the company. But, what about the pecuniary relationship that gets established after becoming an ID?

The nomination and remuneration committees that have been mandated to identify persons for ID positions have, by and large, become a mocking formality. In reality, these committees recommend only such persons as are suggested to them privately by the promoter.

So, the biggest paradox is that an ID is appointed by the very promoter whose “wrongdoings” the ID is supposed to prevent. In Indian culture, guests are always polite to their hosts. In this case, these guests are also paid by the hosts. As such, IDs, who are expected to “deliver us from evil”, are a myth.

Another moot point is whether even the ‘value directors’ have been of help in preventing frauds. What made and still makes Satyam relevant, even today, is that a huge scam could be perpetrated, and that too for several years, under the very eyes of some of the most reputed and competent persons serving its board as IDs (four highly successful and renowned academics, an accomplished retired cabinet secretary of the Union government and a world-renowned technology genius).

It is clear that since IDs typically have no forensic skills, and many do not even have deep knowledge of finance. Besides, they attend just 5-6 meetings in a year where the promoter sets the agenda. So, expecting them to detect frauds, or even smell them, is utopian. Corporate scandals have been erupting with worrying regularity. All one hears from the ‘value directors’ is the need to reduce the liabilities of the IDs; of course, this again is for self-preservation.

What purpose, then are the IDs serving? There is only a finger-count of insightful ‘value directors’, and of well-governed companies. But that is more because the DNA of the promoter is good. Governance cannot be valid only for such 50-75 companies, but for all 1,800+ listed companies.

It is amusing to see how ‘value directors’ keep arguing, surely in self-interest, that the role of IDs is much more; their function is of a brain trust or a consultant, and surely they add value even for the minority shareholders. But then, would it not be better for a company to hire them as consultants, instead of on boards? Unfortunately, such redefinition continues to dilute the rationale of IDs and, therefore, leads us to find weak solutions.

Little wonder, we have been struggling for over 15 years with regulations to define the role of IDs, and have been tinkering with these. The important elements of the concept of and rationale for IDs remain curiously obscure and unexamined, leading to inappropriate and inconsistent rules. If in reality, there are no real IDs, what use is any regulation, and why place any expectations on them?

There is another disturbing development, that of rising resignations of IDs, especially of ‘value directors’ who have been the first to resign when they see anything amiss as the fear of reputation loss and legal cases now looms large. In just the last five years, as many as 4,088 IDs left boards according to primeinfobase.com. The ‘value directors’ who still are on boards, even in safe, reputed companies, find themselves vulnerable, clueless and angry when a fraud gets unearthed, which then leads to more resignations across many boards. It is an irony that boards are getting emptied of qualified people. Of course, no resigning ID has ever played the role of a whistleblower. Even in the reasons for resignations, just three have cited disagreement with the promoters.

Why are we continuing to be in denial mode? Why are we expecting a pet lamb to act as a watchdog? It is fatal to continue to expect corporate governance through IDs. Global experience also is now increasingly questioning their role. They are only creating a false sense of security for the public. It is time we reject emulation of international practices, which are at best valid only for widely-held companies and different cultures, and rather have a localised version of norms suited to the Indian environment.

Since IDs cannot be wished away, only a totally new paradigm may help. At the core of this is the appointment process and in having different regulations for different type of companies. And, in changing our focus for governance on the right entities; it is unfair that IDs are being made scapegoats being soft targets. Await my next article.

The author is Founder-Chairman of PRIME Database Group, which has been researching directors for the last 15 years. Views are personal

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