Independent directors: Underpaid & unappreciated

Independent directors have been in the eye of the storm for their inability to guide companies or being able to stand up to controlling shareholders

A lot is expected — rather demanded — of independent directors. By regulators, through the Companies Act and the Securities and Exchange Board of India’s (Sebi’s) listing obligations, by shareholders and the other stakeholders, and by promoters and managements. Add to this the looming risk of regulatory action, and it is clear why being an independent director is not easy. 

To be an effective board member, you need both knowledge and judgement. As businesses have grown more complex, the knowledge quotient has gone-up exponentially.

Recognising this, the Ministry of Corporate Affairs mandated that to serve on a board today, albeit with some exceptions, you need to take an exam. Here, you will be questioned on aspects of the Companies Act, 2013 (say, that criminal liability for mis-statements will attract Section 447 of the Act), basics of accounting and accounting standards (knowing that AS4 deals with the treatment of events and contingencies after the balance sheet date), financial ratios, duties of directors (duty of care), board committees, corporate social responsibility, secretarial standards (directors will not participate through electronic mode for the approval of accounts), securities laws (say Sebi’s ESOP and sweat equity guidelines etc), listing disclosures etc. Potential directors will be expected to be familiar with board practices including topics relating to board effectiveness and culture, governance of board committees, board evaluation etc. One can debate whether such knowledge is neither necessary nor sufficient or it is necessary but not sufficient, but clearly a test can take you only so far.  

For example, if a media company wants to invest in an over-the-top or OTT platform, the board members will need to have some familiarity with the business itself, its market structure, understand choice of technology, what might upend or disrupt the business, how will you determine the addressable market size, and how it is evolving, how will you market the platform, the advertising and social media strategy, accounting standards for the business taking in revenue recognition, if subscriptions can be cancelled and content created up-front, cyber security, the kind of people to be hired. And at a base level whether to even invest in this business or not. Now you may have cleared the exam, but still not be sufficiently well-versed with all this, so what matters is judgement and behaviour.

 

 

Sanjay Kapoor of Russell Reynolds helpfully directs me to a survey his firm had undertaken a few years ago answering just this question of behaviour. Cutting through 18 traits, the ones that mattered to most and across geographies are (i) possess the courage to do the right thing for the right reasons; (ii) willing to constructively challenge management, when appropriate; (iii) demonstrate sound business judgement; (iv) ask the right questions; and (v) possess independent perspective and avoid “groupthink”. There are others like remain "fully present" in meetings, and communicate in a constructive manner, but there was a global consensus regarding the first five.

Unfortunately, these are skills that cannot be tested for, but these are what make the difference.

So, if individuals with knowledge and skills are needed in the boardroom, are companies compensating them adequately? For the most, no.

IiAS data for the BSE500 companies for FY18, finds that of the 2,880 independent directors, 540 were paid a sitting fee of Rs 100,000 or less, and 1,009 or one in three were paid Rs 2 lakh or less and 42 per cent were paid Rs 3 lakh or less. Were it not for the prestige of being on the board of a public limited company, I am not sure how many will even get out of bed in the morning. And more so if you see the regulatory risks associated with this. The independent directors of Nirav Modi’s firm found their bank accounts frozen, and the independent directors of Jaiprakash Associates from transferring any personal assets.

True, there are companies — Infosys, Tata Consultancy, Reliance Industries, just to name a few — who pay upwards of Rs 1 crore, but they do so as commission, which has its own limitations. For one, it is all paid to the directors upfront, though a lot of what the board does should continue to impact the company in the medium- to long-term. Ideally, you want the incentive to be deferred, else you risk companies cutting down on long-term investments. (Boeing is yet to recover from a cut in R&D spends.)

While welcoming these pay-outs, structure aside, it brings to the fore another issue that warrants a debate. Paying too much. True, independence is both state of mind and strength of character. Yet, as Mae West colourfully put it, “I generally avoid temptation unless I can’t resist it.” And believe me, it is easy, for the independent directors to convince themselves that the controlling shareholder knows what is in the company’s best interest, after all they are the ones who have skin in the game. The regulators briefly flirted with matter of board fees and its linkage to income/wealth. They proposed recommendation rewarding people by inversing Marx’s slogan popularised in his Critique of the Gotha Program, when he exhorted for each (to be paid) according to their need. They wanted the well-heeled to be paid more. Thankfully, this was scuttled but it points to how vexing this issue can be.

Based on this, two things need to be done. First, sitting fees needs to go-up. I will not be prescriptive and suggest a number, but companies will need to find the balance between paying too little and paying so much that behaviour alters. The second is doing away with commission and replacing it with stock options. Currently stock options are not permitted. We need to allow these. Options should be issued at market price so that there is alignment with the shareholder interest and can vest between one and three years from stepping off the board. Unlike commission, this can be clawed back. And it might even serve as an incentive for board members to step off the board.

Given the increased expectations from independent directors and take on the risk of serving on a board, we need to broaden the pool. And that will happen only if we provide the right incentive and make it worthwhile for an individual to serve on a board.

The author is with Institutional Investor Advisory Services India. Views are personal.

@AmitTandon_in