The Companies Act 2013 has given independent directors the pivotal role in ensuring good corporate governance. However, it will be interesting to see how independent directors in family businesses respond to the new challenges
The perception that minority (non-controlling) shareholders' interest is less protected in a family business than in a professionally-managed company is unfounded.
The concern about the opportunistic behaviour of managers came into focus when Berley and Means in their 1932 book (The Modern Corporation and Private Property) brought out the fact that in public-funded companies the control is divorced from ownership, as shareholders are a dispersed group. In those companies, the manager (executive management) has the temptation to enhance 'personal benefits of control'. Therefore, there is a need to establish a mechanism to protect the interest of dispersed shareholders against the opportunistic behaviour of the manager.
In contrast, in a family business, there is an 'anchor shareholder' (the family) who controls the company. The anchor shareholder in a family business has the temptation to maximise the 'private benefits of control'. However, there are checks on their endeavour to maximise personal benefits. Professional managers trade their service in the market and their market value depends on the performance of the company. The anchor shareholder is concerned with family reputation and family wealth, which is linked to the performance of the company. Thus, both the professional manager and the promoter-manager are restrained from increasing their 'personal benefits of control'.
Except in companies that are formed as a vehicle to deceive others, there is natural protection, albeit not full, to the interest of minority shareholders and other stakeholders from the opportunistic behaviour of the manager. For example, tunneling of funds may not be totally absent in a family business, but the factors discussed above put a limit on the same.
An independent director's prime responsibility is to ensure that the manager does not expose shareholders' funds to undue risks due to his aggressive stance and decision-making from the business group's perspective and that the company addresses reasonable expectations and concerns of other stakeholders (employees and community). It is not to protect minority shareholders from the opportunistic behaviour of the manager.
Risks flow from strategy. In a family business, corporate strategy is formulated taking into account aspirations of the family members.
Unfortunately, independent directors, except the one who acts as a 'friend, philosopher and guide', are not privy to family governance and therefore, cannot appreciate and understand family aspirations. As a result, their participation in strategy formulation can at best be at a superficial level. However, an independent director, who takes the pain to understand the business, and internal and external environment in which it operates, should be able to assess whether the proposed strategy exposes shareholders' fund to undue risks.
Another source of risk is poor succession planning. In a family business, succession planning cannot be delinked from family governance. Therefore, independent directors, in a family business, cannot play an effective role in succession planning. Fortunately, well-governed business families groom their children with utmost care to make them fit to take responsible positions in the company. This is quite evident in India.
The Companies Act 2013 requires independent directors to directly intervene in the appointment and remuneration of directors and senior management personnel. This might remain on paper. Often it is argued that family members occupying senior positions are paid much higher than outsiders occupying similar positions.
Shareholders should appreciate that a family member brings much higher value on the table than an outsider because he has access to both family governance and corporate governance.
The Companies Act requires independent directors to evaluate the performance of the chairman and executive directors. It is an excellent idea. But it can be implemented effectively only in those companies where the chairman is amenable to the idea. In other companies, it will be a mere paper exercise.
From the above discussion if we conclude that that in a family business independent directors only grace the boardroom, we shall err in our judgement.
Independent directors should articulate their concerns and force resolution of the same. For example, if a proposed strategy is likely to expose shareholders' fund to undue risk, or proposed compensation to a family member is at a level that it amounts to expropriation of shareholder value, the independent director should force discussion on his concerns. If the concerns remain unresolved, he should ensure that the unresolved concerns are recorded in the minutes.
An outright individual with courage and conviction and leadership quality can only perform effectively as an independent director.
The million-dollar question is who will ensure that such individuals are inducted as directors in boards of family-managed companies. The answer is none other than the anchor shareholder has qualities that drive an independent director to perform effectively are not discernible.
Anchor shareholder in most companies would avoid appointing upright and courageous individuals as independent directors. It will take time to understand the value of the presence of a 'loyal critic' in the boardroom.