'Dependent' independent directors

Corporate governance, or “making boards more effective”, ranks right up there in executive training programmes. It’s in the august company of such timeless topics such as leadership, team work and strategy. If programmes on corporate governance have been going on for decades and we still need them, it’s a fair bet they haven’t been making much of a difference on the ground.

That’s also true of committees on corporate governance. There have been more committees on the subject worldwide than one would care to count. And yet the clamour for better governance refuses to die down. The Uday Kotak committee on corporate governance, constituted by the Securities and Exchange Board of India, has recently proposed a fresh set of norms. Expect another committee to be set up in a few years’ time. 

The Kotak committee asks for more directors and independent directors. It lays down requirements for the minimum number of board meetings and attendance requirements. It specifies a minimum compensation for independent directors. These recommendations are fine. But they amount to little more than ticking more boxes. They are not going to make boards more effective. 

That’s because there’s a basic contradiction at the very heart of boards of directors. Directors on boards, especially independent directors, are expected to be watchdogs on behalf of the shareholders. However, while directors are supposed to act on behalf of shareholders, dispersed shareholders themselves have little say in who acts on their behalf. 

In the Anglo-Saxon world, “independent” directors, who are supposed to represent ordinary shareholders, are chosen not by shareholders but largely by the management. True, in recent years, the nominations committee that chooses independent directors does not have the CEO on it. However, in practice, it’s almost unthinkable for the nominations committee would induct anybody as independent director without the CEO’s approval. That’s the culture of today’s boards. Don’t antagonise the CEO. Don’t rock the boat. Don’t disturb the clubby atmosphere of the board.

In India, the contradiction is even more acute. We have very few companies run by professional managers. Most companies are run by the dominant shareholder, also known as “promoter”. The dominant shareholder is either an industrialist or the government. There’s no way that any independent director would be chosen without the approval of the promoter. What we have here are not independent directors but what has come to be characterised as “dependent” independent directors, that is, independent directors who are beholden to the promoter for their places on the board. 

In public sector enterprises, the appointment of independent directors is at least independent of the CEO because it’s the ministry concerned that appoints independent directors — mostly, without even consulting the CEO. Independent directors can question and challenge the CEO because they don’t owe their jobs to him. They have to be careful not to antagonise the promoter, the government. However, on most matters that go to the board, the government does not have a strong opinion and often looks to the independent directors for a point of view. Those who have served on the boards of public sector undertakings (PSUs) will testify that independent directors have considerable freedom to express themselves. 

This is not true of the vast majority of private companies where promoter and CEO are effectively the same. For an independent director to seriously question decisions would be quite a challenge. Not that some conscientious professionals don’t. But, in the very nature of things, this is not common. 

The Kotak committee dwells on the eligibility criteria for independent directors, their induction and training and the rest. These are all useful. But boards are ineffective not because they lack people with the necessary background and training. It’s hard to imagine a more star-studded board than that of the Royal Bank of Scotland. The stars could not prevent RBS from the becoming the biggest banking disaster ever in the UK. 

The problem with the RBS board was that it just could not bring itself to challenge a star CEO. Boards are ineffective not because they lack expertise but because they cannot bring themselves to ask the CEO basic questions. For instance, don’t you think it’s time for you to move on? And this sort of questioning cannot happen as long as independent directors are all chosen by the CEO or the promoter — and handsomely rewarded for not asking awkward questions. As economists would say, there’s no incentive to question. 

It should be clear what we need to do to make boards truly effective. We need to radically change the process of selecting independent directors. We need at least some directors to be chosen independently of the promoter. Institutional investors, minority shareholders, employees — all these constituents should be given the right to choose at least one independent director each. Then, we would have at least a few directors who are independent of the promoter. Boardroom diversity must mean diversity in selection of independent directors. Such a radical reform, alas, is nowhere in sight. 
 

The writer is a professor at IIM-Ahmedabad 

ttr@iima.ac.in