Asish K Bhattacharyya: Independent directors: Are they lame ducks?

The Government of India has recently used its power under the Constitution to issue a Presidential directive to compel Coal India Limited (CIL) to sign fuel supply agreements (FSAs) with power producers. An FSA will bind the state-owned miner to supply as much as 80 per cent of the fuel requirements of power plants or pay penalties if it doesn’t meet the commitment. The government has issued the Presidential directive in the sovereign interest – to increase power production in order to reduce the gap between demand and supply.

Earlier, independent directors of CIL had rejected the request from the PM’s office for signing the FSA. They argued that such an agreement would harm the interest of shareholders. Their argument has merit because the price at which CIL supplies coal is not linked to global coal price and the company is facing hurdles (e.g. environmental issues and issues relating to land acquisition) in increasing coal production. However, on the positive side, CIL will be motivated to improve productivity.

The government holds 90 per cent of the voting rights in CIL, which is a listed company. Issuance of the Presidential directive has triggered a debate on whether the government intervention, ignoring the interests of non-controlling shareholders, conflicts with the principles of good governance. On the face of it, it is an example of bad governance. But, such government interventions are not unexpected. Often, the government uses state-owned enterprises (SOEs) to achieve certain sovereign objectives. Therefore, the Presidential order to CIL is not a shock to the market. The market price, which is determined by the trade between non-controlling shareholders, must have captured this possibility. Non-controlling shareholders have no reason to complain against the government intervention.

The government response to the board’s refusal to approve signing of FSA leads to the question whether independent directors in SOEs are lame duck. The position of independent directors in SOEs is no different from that in companies, which are controlled by a family or a particular shareholder group.

The literature on corporate governance and various codes emphasise that the board of directors should provide direction to the company, evaluate and approve strategies, appoint and remove the CEO and decide the compensation for the CEO and other members of the top management. In SOEs and companies in which a family or a shareholders’ group hold the controlling right, the board does not carry out any of the above functions. For example, in case of SOEs, the government provides direction to the company, appoints and removes the CEO, approves the strategy and decides the compensation package to the CEO and other top management personnel. This is natural. The government does not invest in commercial activities with the single objective of making money. It keeps the option of using SOEs for achieving certain social goals, even if it results in sacrificing profit. Therefore, the government provides restricted autonomy to companies.In family business too, strategic such decisions are taken by the promoter, who holdsthe controlling right.

We cannot ignore the dominance of the promoter in the decision making process. Financial institutions recognise the special status of the promoter among shareholders. Therefore, in corporate debt restructuring, lending institutions ask the promoter to inject fresh equity in the company. Lending institutions often ask for a personal guarantee from the promoter. Therefore, it is not appropriate to raise hue and cry that the corporate governance in family businesses is weak. Investors, including foreign institutional investors (FIIs), invest in family businesses with the full knowledge that family patriarch calls the shots.

Does it mean that independent directors are lame duck? The answer is definite no. Independent directors should not hesitate to audit the strategy presented before the board for approval and asks uncomfortable question. This helps the promoter to receive objective feedback on the strategy. An independent director should focus on the adequacy and effectiveness of the internal control and risk management systems.It must critically review the strategy implementation and operating performance.

Independent directors are expected to protect the interest of non-controlling shareholders. They should be watchful to identify weaknesses before they surface in the product market. But they should not be over-reactive. They should not develop animosity towards the promoter or the CEO. They should act as friend, philosopher and guide. They should act tough only when required.

Independent directors should not consider themselves as lame duck only because there is a gap between what they can do and what they are expected to do under the code of corporate governance. In order to be effective, they need to understand that they can effectively protect the interest of non-controlling shareholders even when the board is devoid of certain critical responsibilities.

E-mail: asish.bhattacharyya@gmail.com