Will screening test for independent directors improve corporate governance?

The government cannot and should not intervene in the appointment of directors in non-government companies, writes the author

Even after almost seven years of the enactment of the Companies Act, 2013, the corporate governance standard in the lower rung of listed companies has not improved significantly. Promoters and dominant shareholders who control family businesses still believe that having outsiders (read independent directors), who do not have skin in the business, is a necessary evil. Any new regulation to strengthen the institution of independent directors fails because of this attitude of dominant shareholders. They adopt the ‘tick-the-box’ approach. Often those companies appoint dummy directors to comply with the requirements of the Companies Act and Sebi regulations, and the ‘shadow director’ take the decisions. It is not uncommon that they appoint low-level employees and inexperienced family members.

 
The company law prescribes that an independent director shall possess appropriate skills, experience, and knowledge in one or more fields of finance, law, management, sales, marketing, administration, research, corporate governance, and technical operations, or other disciplines related to the company’s business. It does not prescribe the minimum educational qualification and rightly so, because business acumen and domain knowledge can be acquired through experience also. It is the board’s responsibility to appoint ‘fit and proper’ persons as directors and judge the suitability of individuals proposed to be appointed as directors. The government cannot and should not intervene in the appointment of directors in non-government companies.

 
The government has made it mandatory, effective from December 1, 2019, for every independent director of listed companies and unlisted public companies having a paid-up share capital of Rs 10 crore or more to get his/her name included in the data bank to be maintained by the Indian Institute of Corporate Affairs (IICA), which is an arm of the Ministry of Corporate Affairs (MCA), and to pass an online self-assessment proficiency test to be conducted by IICA with minimum 60 per cent marks within a year. An individual who has served for at least 10 years as a director or key managerial personnel in a listed public company or an unlisted public company having a paid-up share capital of Rs 10 crore or more is exempted from clearing the test. Boards of companies will have to disclose the results of the test in their annual report. There is no cap on the number of times an individual can appear in the test.

 

Presumably, the proficiency test aims at screening off those who do not have either the skill or the bandwidth (time) or inclination to pass the test. The test will be designed to evaluate the basic understanding of the company law, securities law and accounting. The success of this initiative will depend on the standard of questions in the question bank. They should neither lack rigour nor should be very technical. The 10-member panel to be constituted under the new rules shall take the responsibility to ensure that course outline, study materials and questions are of the desired standard.
 

Some commentators have expressed the opinion that the introduction of the test will shrink the pool of independent directors. It is in the interest of investors to weed out those who do not have or are not inclined to have basic knowledge of company law, securities law, and accounting. The new rules are likely to expand the pool of aspiring directors, as the professionalisation of the institution of independent directors will attract more qualified individuals to join the board. They will register their names in the data bank. Reduction in the existing pool of independent directors will induce companies to select directors from the data bank. However, disclosure of marks in the annual report might create some kind of inhibition in taking the test. The government should consider replacing this disclosure of marks with the disclosure that the director is listed in the data bank.

 
 New rules will not necessarily improve corporate governance practices in India significantly, as they will not be able to check the induction of independent directors, who are sympathetic to the dominant shareholder. There is a large supply of aspiring independent directors who are sympathetic to the dominant shareholder, as many young professionals see board membership as a way to improve their CVs. They do not join the board with the zeal to protect investors’ interest. Companies may not find it difficult to appoint such individuals on the board. However, this situation does not nullify the benefits of the new rules.

 
We should leave the habit of criticising a new law only because India is first to enact the same. We should evaluate every new initiative in the Indian context. 
 
The writer is director, Institute of Management Technology Ghaziabad. E-mail ID:  asish.bhattacharyya@gmail.com