How independent are independent directors?

Boardroom battles at Tata group and Infosys have put spotlight on their role and responsibilities

Though there are hundreds of eminent independent directors from various walks of life — bureaucrats, accountants and lawyers — serving on the boards of listed companies, it took a senior businessman and a promoter of a large firm himself to test the limits of the rights and powers of an independent director.

The adversarial position taken by Bombay Dyeing Chairman Nusli Wadia against the Tata group promoters following the sudden removal of then Tata Sons’ chairman Cyrus Mistry and his open campaign for corporate governance, which reached the courts, are unprecedented in the history of independent directors in India. Wadia’s eventual removal from the boards of Tata Motors, Tata Steel and Tata Power, in which he had served for decades, has triggered a regulatory review of the framework governing such actions.
 
In a different set of events, Infosys, which had been long considered the benchmark for good corporate governance practices in India, has seen its board come under attack. It is the promoters, led by co-founder N R Narayana Murthy, who have accused the board of being less transparent and have sought its reconstitution. Infosys’ 10-member board has seven independent directors, apart from Chairman R Seshasayee.
 
The independent directors have largely been quiet and have not offered any separate comments on the ongoing issues. Experts feel that such events affect perceptions about the institution of independent directors and raise doubts that other companies might also be facing similar pressures in the boardroom to compromise with high standards of governance.
 

N R Narayana Murthy Co-founder, Infosys

Arun Kumar Rath, who heads the Centre for Corporate Governance at the International Management Institute, Delhi, said, “The recent developments in a few reputed companies well-known for their high standards of governance and ethics do raise doubts in the minds of stakeholders and general civil society about a possibility of any impairment of such long-established standards. If any questionable decision has been taken by the board and/or board sub-committees with the participation of such eminent outsider independent directors (IDs) without any note of dissent by them, the public perception about their independence is likely to suffer.”
 
Rath, a retired IAS officer who has served as an independent director on the boards of large companies, added, “If well-known ethical corporations of India are seen to get involved in such questionable decisions, despite the presence of respected IDs on the board/board sub-committees, then the credibility of the institution of IDs is bound to suffer.”
 

Nusli Wadia Chairman, Bombay Dyeing

The institution of IDs is a key construct of a company’s corporate governance framework. These directors have a fiduciary responsibility towards minority shareholders and are expected to act independently, irrespective of the directives of the controlling shareholders.
 
The regulatory provisions in India, including the Companies Act 2013 and Sebi’s Listing Obligations and Disclosure Requirements, require listed companies to institute balanced boards with an adequate representation of IDs. The overarching objective behind this requirement is that it will help strengthen the internal control mechanism and foster greater trust between the company and its stakeholders.
 
To carry out their duties efficiently, independent directors need to be able to exercise strong oversight on the actions of the company. The regulations have therefore tightened the definition of independent directors and have provided them additional powers while scrutinising related party transactions, executive compensation and financial statements of subsidiaries.
 

Cyrus Mistry Former Chairman, Tata Sons

According to Sumit Agrawal, partner, Suvan Law Advisors, “Regulators want them to be clinical, while the promoter or management expects them to be sympathetic or practical. That’s the tightrope they walk on. As observed in the recent past, if an independent director does not toe the line of businesses, the ease with which an ID is removed could set a dangerous precedent. If the promoters can remove an independent director at their whims and fancies, then it would be foolish to expect such directors to act as a check mechanism.”
 
Agarwal feels that it is time Sebi’s listing regulations are amended to clarify that the promoters who move the resolution for removal of IDs and their related parties should not be allowed to vote on their removal. “Also, there is the need for a special resolution. This does not require waiting for the Companies Act to be amended, as far as Sebi’s jurisdiction is concerned.” On the other hand, there is a perception that though designated “independent”, a majority of these directors are often close to or familiar to the promoter/management and often do not go against their view. Also, there are several directors who have an association with the promoter/management dating back several decades.
 
The law now allows IDs to be appointed for five years, and they can be reappointed for a further five years. This ten-year period is too long to retain the “independence” and arms’ length relationship of the IDs. However, since it is applicable prospectively, there may not be any respite until 2023. Some directors feel that such long associations of IDs with the company must be reduced by amending the legal provisions.
 

R Seshasayee Chairman, Infosys

Given that independent directors sit in judgment on the actions of the company, their (re)appointment or removal from the board must be ideally driven by the Nomination and Remuneration Committee (NRC). To lend credibility to the process, the decision of the committee must be backed by a rigorous board evaluation exercise and the results of the evaluation must be tested and benchmarked against some pre-defined criteria, proxy advisory firm Institutional Investor Advisory Services (IiAS) said in a recent note.
 
Section 169 of the Companies Act 2013 provides that any director on the board can be removed by passing an ordinary resolution at a general meeting. This does not make any distinction between independent and non-independent directors. The resolution may be proposed by the company or by the shareholders. For shareholders to propose such a resolution, they must collectively own 10 per cent of the equity and call for an EGM by giving a special notice under Section 100 of the Companies Act 2013. This automatically gives most Indian promoters, who typically have large shareholdings, the power to remove independent directors at will.
 
Agrawal of Suvan Law Advisors, who was with Sebi earlier, said, “This is a unique problem in India, since the shareholding of corporates is concentrated in the hands of large promoter groups. When an independent director raises some concerns, which are serious governance issues, there needs to be a policy for a time-bound fact-finding investigation for such cases in future, perhaps for Nifty-50 or Sensex companies to start with.”
 
“Allowing controlling shareholders to remove independent directors from the board undermines the integrity of the entire process and the institution of independent directors itself. Having said so, there may be mitigating circumstances under which their removal is sought. To give just two examples: When there is evidence of fraud and misconduct or when the director is being a disruptive force on the board. Regulators no doubt are closely watching these developments and we expect them to take meaningful steps to address this issue,” IiAS said in a note at the time.
 
Experts like Rath suggest that a constitutional or statutory body insulated from the promoters/dominant shareholders can be created to select and recommend names for IDs to the company. Another suggestion is to give a committee of IDs of the board greater say in the matter of selecting new IDs. The corporate governance code has come a long way in the last 15 years.
 
Though there is always room for improvement, there are concerns that too much prescription can escalate compliance costs and be counter-productive.

Some suggestions for improvement

• A committee of IDs should meet regularly, without the management, and bring to the board instances of violations of law and ethics in corporate affairs.
• Any payment and benefit to IDs should be strictly in accordance with the law. It must be transparent and the information should be available to the public, to remove any chance of influencing their independence in the boardroom.
• Shareholder activism must improve. Currently, most shareholders are silent spectators to happenings in corporations, which are actually owned by them. 
• The corporation should emerge as a social institution, with the directors having duties and responsibilities towards society, observing not only the letter of the law but also the spirit of ethics.