Exodus of good independent directors?

The Companies Act, 2013, and the new Code of Corporate Governance have made independent directors jittery

Interacting with independent directors who take their job seriously, I found a kind of uneasiness among them. They are apprehensive about whether the existing corporate structure will allow them to effectively perform their duties, which are stipulated in the Companies Act, 2013, and the new Code of Corporate Governance issued by Sebi on April 17, 2014.

The new provisions might expose them to the high risk of being accused of not carrying out their duties diligently, even if they do perform diligently in the given corporate eco system. The Companies Act and the new Code of Corporate Governance have made independent directors responsible for protecting the interest of minority shareholders and other stakeholders. There is nothing new in it. However, new penal provisions to enforce accountability and expanded responsibilities have made independent directors jittery.

Concentration of ownership is a rule, rather than an exception, in the Indian corporate sector. It is dominated by family businesses, public sector enterprises and joint ventures and subsidiaries of multinational companies. In companies that are controlled and managed by the promoter or a shareholder group, independent directors, at best, can provide checks and balances, but cannot shoot down proposals put forward by the dominant shareholder, except those that are fraudulent, or are blatantly against the interest of minority shareholders. Therefore, the premise that the institution of independent directors will get strengthened with the codification of duties and enforcing accountability may not be correct.

We shall take two examples to demonstrate how difficult it would be to implement some new provisions in companies that have concentrated ownership. One, is the provision concerning related party transactions (RPT). It is quite common for companies to enter into RPTs. Abusive RPTs hurt minority shareholders. Therefore, it cannot be over emphasised that independent directors must review RPTs to protect minority interest. The new Corporate Governance Code, which is applicable to listed companies, requires every RPT to be approved by the Audit Committee. The Companies Act stipulates that the Audit Committee's approval will be required if the RPT is not entered into in the ordinary course of business and on an arm's length basis. Thus, the Audit Committee has been made responsible for an executive function. Even if we leave aside the question whether the Board should have any executive function, we need to examine whether the responsibility is onerous for independent directors.

Sometimes, it is difficult to form a judgment on whether an RPT is abusive. In those situations the controlling shareholder will take the position that is favourable to it and an MNC will take a position that is favourable to the parent company. It would be difficult, rather impossible, for independent directors to induce the management not to enter into those RPTs, which are borderline. Moreover, on hindsight an RPT might appear abusive while in earlier evaluation it was considered non-abusive. If, at a later date, a court takes the view that a RPT was abusive, the Audit Committee members might be held guilty of not acting diligently while approving the RPT.

The provision also has the potential to develop an adversarial relationship between the independent directors and the management. This harms the company and minority shareholders. The second example relates to succession planning. The new Code of Corporate Governance stipulates that one of the responsibilities of the board is to oversee succession planning. It also stipulates that the board will satisfy itself that plans are in place for orderly succession of appointments to the board and to senior management. This is again an onerous responsibility. In family-managed business, succession plans for board-level appointments are formulated at the family governance forum and those are usually kept secret to avoid dysfunctional effects on family governance and corporate governance. Similarly, the parent usually manages board level appointments in the subsidiary of an MNC. It is unlikely that these practices will change.

Even in appointments at senior levels, the dominant shareholder would like to have the final say and might not allow the board to intervene in succession planning. If, at some point in time, it is found that the company was hurt due to lack of proper succession planning, independent directors would find it difficult to defend their position. Obtaining an assurance from the controlling shareholder that succession plans are in place might not be considered adequate. These are just two examples of how well intended provisions would expose independent directors to the reputation risk. There are a number of such provisions in the new Companies Act and the new Code of Corporate Governance. Apprehensions of independent directors cannot be ignored. Such apprehensions might drive away good independent directors, particularly those who have nothing to gain from directorship, except continuing learning and self-satisfaction. The government should address the issue to avoid exodus of good independent directors.

Email: asish.bhattacharyya@gmail.com
Affiliations: Professor and Head, School of Corporate Governance and Public Policy, Indian Institute of Corporate Affairs; Advisor (Advanced Studies), Institute of Cost Accountants of India; Chairman, Riverside Management Academy Private Limited