Companies have to make money. They need to generate surplus for sustainability and growth and to ensure adequate return on capital and return of capital to attract capital. Therefore, it is not surprising that shareholders’ interest gets priority over interests of other stakeholder groups. Accordingly, the primary role of independent directors is to protect the interest of non-controlling shareholders.
There is a wind of change. The new paradigm on corporate governance is evolving.
More and more companies are adopting sustainable reporting guidelines issued by the organisation called Global Reporting Initiative (GRI). The government has issued voluntary guidelines on social, environmental and economic responsibilities of companies. The Companies Bill 2011 requires independent directors to safeguard interests of all stakeholders and to balance the conflicting interests of the stakeholders. Every company is engaged in some CSR activities.
The new paradigm, while maintaining the supremacy of shareholders, pushes the interests of non-core stakeholders by a few notches. Companies are expected to meet the reasonable expectations of all stakeholders and address their concern. They are also expected to create positive externalities and reduce negative externalities. Ideally, they should absorb all the costs of operation, including social costs.
There are two ways to look at the sustainability issue. One is to take it as a constraint within which to create shareholder value. The second is to consider participation in improving the living of this and future generations as a corporate responsibility and to embed sustainability in decision-making processes. Responsible companies are expected to adopt the second approach.
In the extant corporate governance model, the primary role of independent directors is to protect the interest of non-controlling shareholders. In the new paradigm, independent directors are expected to take two additional responsibilities. They have to ensure that the executive management is making serious endeavour to meet the societal expectations and to act as arbitrator in a dispute between stakeholders groups. In the present formulation independent directors might not be able to discharge their existing and additional responsibilities effectively.
The Companies Bill 2011 requires that at least one-third of the board members should be independent directors. Thus, a company has the option to constitute a board with majority of functional directors. For example, if the board has ten members, the minimum number of independent directors required by law will be four. The company can fill up six positions with functional directors. In this board structure, independent directors can bring objectivity to board room deliberations but, they cannot stop the board from taking decisions, which will hurt the interests of one or more stakeholder groups. At best, independent directors can ensure that their dissent is recorded in the minutes of the meeting. But most independent directors would not like to press for the same as that goes against the boardroom decorum. If an independent director does not get support from other non-functional directors, he/she will feel shy even to pursue his/her point.
Some experts argue that the current corporate governance model will be more effective if the board is barred from taking decisions without the presence of independent directors and if decisions on certain critical issues can be implemented only if approved by majority of independent directors. Experts who bring such propositions assume that all independent directors are individuals with higher level of integrity and enjoy higher professional or social stature than the CEO, who is usually the Chairperson of the board, and that they are more knowledgeable than functional directors. Those are simplistic assumptions. Therefore, such models are not workable.
The board should be independent. It should act without bias towards shareholders or any other stakeholder group. The board can function independently only if all the directors, including functional directors, are committed to sustainability. This will happen only when the principles of sustainability are embedded in decision-making processes. Board’s review of various decisions should be similar to the peer review process. The chairperson should empower the board by providing full information and encouraging open discussions. A committee of independent directors may be formed to ensure implementation of voluntary guidelines and sustainability reporting. It should post-audit decisions with the support of outside consultants. The audit findings should be discussed in the board and with senior executives freely. This will help to strengthen systems and to create awareness across the organisation.
Those CEOs, who are ignoring various voluntary guidelines issued by the government and other institutions will be caught napping when the new paradigm will gain momentum. Ultimately investors will suffer.
Affiliation: Chairman, Riverside Management Academy