The Parliamentary Standing Committee on Finance has reviewed the Companies Bill, 2009. Some of its recommendations underpin the importance of independent directors as a critical instrument to nurture the financial health of a company and to protect the interests of various stakeholders, particularly the minority shareholders. The Committee rightly emphasised that safeguards should be put in place in the Bill, so that the independent directors can play their designated role in the boards and help improve the board governance. Two of the Committee’s suggestions that the ministry of corporate affairs, the chambers of commerce and boards of the companies would do well to recognise are: First, “the role of independent directors should be distinguished from other directors in the Bill” and, second, “the appointment of independent directors should not be a case of mere technical compliance reduced to the letter of the law” (source: press release of the Press Information Bureau).
To implement these, the government would need to prescribe the mode of appointment, qualifications, extent of independence from promoters/management, roles and responsibilities and liabilities of the independent directors. What remains to be seen is the manner in which these useful recommendations would be translated into the letter of law, the way the companies would implement these and the direct or indirect monitoring mechanism that the ministry of corporate affairs would put in place.
It is possible that these recommendations may not go down well with a large segment of companies and those who consider the position of independent directors an ornamental post-superannuation perk. These may even give rise to protestations from different quarters that there is a dearth of good people in the country to become independent directors; if these recommendations are implemented, the numbers of willing candidates will decline further. Set in the context of our professed dalliance with GDP numbers and our “all-round growth story”, these refrains would perhaps seem a trifle trite and pedestrian.
But why this emphasis on independent directors? Is this emphasis rational or misplaced? Is it an issue that is being given undue importance? This is clearly a subject of considerable debate with equivocal responses across economies. India is a late entrant in this debate, perhaps after the Satyam episode.
This focus on the role of the boards and the independent directors is the consequence of corporate failures and corporate governance scandals particularly in the US, the UK and Italy — the boards in these countries have been found to be central to the governance failures. External expectations about the accountability of the board have risen. Boards’ responsibilities in response to these expectations have grown. Directors continue to be overwhelmed by a slate of responsibilities that is only becoming more complex. But the sheer complexity of today’s businesses and the practicality imposed by availability of time, knowledge and skills in understanding different businesses would also mean that boards simply cannot achieve everything that is expected of them, even if they devote more time to their board duties.
Legally, directors are responsible for the company even if they delegate almost completely to management. However, the scope of this responsibility is hard to reconcile with the limits of time and knowledge that the independent directors must live with. Boards that clearly understand their roles will have to use their limited resources better because their efforts will then become more focused. Thus, there is a growing gap between society’s expectations and what a board can truly achieve. Many companies in India may not be feeling this pressure yet. But as the economy matures, the pressure would only increase and the sooner the companies realise this the better it would be for them.
Several initiatives worldwide have been taken to drive board performance. Regulatory changes have affected the composition, role and responsibilities of boards worldwide and stronger frameworks for directors’ fiduciary responsibilities have resulted. Consequently, boards are trying to find a balance between increased scrutiny and regulatory reforms imposed from outside and the efforts made by the boards themselves.
Embodied in the recent regulatory requirements in several countries is the notion and confirmed catechism that independent directors provide a particular type of objective, shareholder-minded monitoring and it has been argued by the governance advocates and regulators that independent directors improve corporate decision-making and business performance. Listing standards of many stock exchanges requires that boards have a majority of non-executive or so-called “outside” directors.
The reforms imposed from outside tend to focus only on those characteristics of the board that are visible to outsiders, but they say little about what should actually happen inside the board room. Nor do these reforms recognise the aforesaid dilemmas. Significantly, there is increasing international recognition that giving independent directors responsibilities is not a panacea, because they can do only this much.
Good-governance regulatory recipes don’t necessarily produce good boards merely because of their structure and composition. One of the root causes of the problem seems to be the inadequate attention being paid to the way each board is designed to handle its responsibilities. The most involved, diligent, value-adding boards may or may not follow every recommendation in the hand book. Professor Sonnenfeld of Harvard Business School, a noted scholar on the subject, says boards are “essentially social systems and what distinguishes exemplary boards is that they function as robust, effective social systems, in a virtuous cycle of respect, trust and candour”. Where team members develop mutual respect, they develop trust and because they have trust in one another, they have the ability to share difficult information. Since all of them have the same information, they can challenge one another’s conclusions cohesively. It is not the number of independent directors or the proportion of independent director that determine the effectiveness of the board but the environment inside the board room. The availability of information and the free flow of information between the management and the board members are important ingredients for developing a climate of respect, trust and candour. Good board governance cannot be fully ensured by external legislation alone but has to built over time and the best bet for success according to Professor Sonnenfeld lies in: (1) building a climate of trust and candour in the board to share important information with directors in time; (2) encouraging a culture of open, positive dissent that is not regarded as disloyalty, and allows a director to leave a board without being pressured to do so; (3) building systems to ensure individual accountability of directors within the board and (4) introducing measures for evaluating board’s performance in terms of integrity of the directors, quality of the discussions, degree of knowledge and interpersonal relationships.
Professor Sonnenfled’s contextual quote would be a good way to end this article. In the Harvard Business Review (September 2002) he says: “We will be fighting the wrong war if we tighten the procedural rules for boards and ignore their pressing need — to be strong, high functioning work groups whose members trust and challenge one another and engage directly with senior managers on critical issues facing corporations”. Nice if the companies recognise this, if the Chambers of Commerce advocate this; if the policy makers and the regulators keep this in view while framing and implementing policies.
The views expressed are personal
The author is a former executive director of the Securities and Exchange Board of India and is currently associated with International Finance Corporation’s Global Corporate Governance Forum and the World Bank
