Don't threaten independent directors

We need a revolution in thinking beyond the legalities of board decisions. Good governance is a product of teamwork!

The large-scale resignations of independent directors in 2017 as reported in Business Standard seems a manifestation of the pent-up anxieties that have been building up in the light of the notifications of the Ministry of Corporate Affairs (MCA) about independent directors. Coming in the wake of cases against Nirav Modi and the Rotomac promoters and mounting non-performing assets (NPA) of banks, the authorities seem to pass over the oversight responsibility entirely to independent directors. With extended liability for any untoward happenings in organisations, capable outside directors are more likely to avoid accepting such positions unless they know the promoters very well and are willing to risk their own reputation for promoters' sake. 

Limitations of an outside director

In most Indian companies, boards meet once a quarter, with very limited structured interactions otherwise. Even such interactions get limited to specific areas where only the particular director's opinion is sought. With board level discussions limited to a prefixed agenda and prioritisation of items for discussion and discretion of what specific inputs need to be provided to the board decided by the management, in most cases, the discussion takes a course that is designed by the promoters and management. Also, given that most board meetings do not go beyond a few hours of deliberations, it is difficult to expect a non-executive independent director to know anything beyond what the management wants that person to know. Even efforts made by independent directors to gather further information may not make a lot of progress beyond the purdah of information the management is ready to share willingly. More often than not, first time independent directors notice that the "way the game is played" is different from the way it was envisaged in corporate governance principles!

There are activist and otherwise independent directors playing the watch dog role in some of the advanced western economies. New roles and expectations defined by regulators in such societies have made some positive impact. However, importing such approaches as panacea for our governance challenges, being oblivious to yeomen differences in the institutional and socio-cultural realities, will be myopic, to say the least. We need to remember that most independent directors in India are handpicked appointees of promoters. Our own research on some of India's largest companies had clearly shown that promoters look for polite advisors and not forceful decision-makers / influencers in independent directors. They tend to do adequate background check to see the individual's "need for independence" and style of functioning before inviting to be a board member. They will get rid of individuals who try to cross the Lakshman Rekha in different ways. 

Illustration by Binay Sinha

For many independent directors, visibility, status and connections are also attractions beyond the sitting fee. Our research shows that in NSE listed firms, the average age of independent directors is 66 while that of executive directors is only 56. While age is necessarily not an indicator of competent independence, but social and economic perks do matter for some beyond their prime productive age. Also, friends and relatives who fulfill the conditions of “independent” are natural choice to fill the quota of independent directors. So much about the “independence” of independent directors in India!

The concept of a lead independent director has been getting wider acceptance in the US. By designating one independent director as the lead director, the expectation in the US is that company boards will function more independently. 

Unfortunately, none of these will work in an environment where promoters continue to be operating managers or hold sway over operations, with the freedom to appoint independent directors of their choice. Promoters' attitude towards corporate governance is also a vital issue. An enlightened promoter can attract better independent directors and allow them to function independently. Hence, any substantial change at the fundamental level of corporate governance should begin with a change in the mindset of Indian promoters. 

What will make independent directors effective

Some of the current initiatives such as making directors aware of their fiduciary responsibilities and legal implications of any wrongdoing by the company are timely and important. But that is not good enough. Actually, much of the tone of the governmental messaging is highly threatening, making people think several times before agreeing to be board members. In fact, there is an increasing trend of such people agreeing to be advisors (and not directors) so that while the organisation benefits from their expertise, they do not have the uncertainties of the legal shadow following them.

Most boards tend to find common ground among varying viewpoints of their members. It is rare that voting is taken or dissent expressed and minuted. Hence, while it is easy to say that independent directors should record their dissent to insulate themselves from prosecution, it is unlikely to have any such thing happening in the Indian context easily.

We should go beyond the mindset of compliance and “somehow” meeting the regulatory requirements of governance. We need a revolution in thinking beyond the legalities of board decisions. Good governance cannot be legislated, it is a product of teamwork! That will mainly depend on the promoters' enlightened actions and not by threatening to take the heads of the independent directors. 

Ramachandran is professor and executive director, Thomas Schmidheiny Centre for Family Enterprise, ISB and Ray is professor, IIM Calcutta