Jayant M Thakur: Do we need independent directors in India?

When promoters own over half a company's equity here, it is foolish to import solutions from countries where owners' share is below 10%.

Are independent directors really required and relevant in India? This relevant question surprisingly has come not from the industry or an academician but from our own minister for company affairs.

He was quoted recently to have said that, in the context of need of independent directors, companies are best run by promoters and shareholders.

Knowingly or otherwise, he has finally given fuel to a spark of insight that was raised many years ago by academicians and researchers but perhaps the dazzling names of Cadbury and others had suspended our thinking and we thought that what is good for the West should automatically be good for us.

So, again, the moot question is, how far are independent directors relevant in India particularly considering our peculiar ownership holding structure? Should we adopt blindly from the West the same principles and methods of determining the eligibility of independent directors, their minimum strength, their powers and duties?

This question has even more relevance when one realises the impending crisis of a mismatch between demand and supply of independent directors.

Training institutes, bonafide and dubious, are mushrooming all over the country promising to train people, usually in exotic places in and outside India, to become independent directors.

The core contrasting factor is that, give or take a few percentage points, western countries such as the US have holding by owners or promoters of around 8 per cent while in India, the holding of promoters is in the range of 35 to 50 per cent and more.

Often, this percentage goes to 70 to 80 per cent also. The question then arises is, whether it is appropriate to require that at least half of the board strength should consist of independent directors.

In a country such as the US with an average promoters/management holding of 8 per cent, there is obvious conflict of interest.

Remuneration to management conflicts with shareholder profits. Other such examples include employee stock ownership plans (ESOPs), bonuses, corporate perks such as planes, and so on.

It is apparent that if only 8 per cent holding is of the management and that too scattered amongst several unrelated people, there is no direct interest in boosting shareholder profits or corporate value.

Thus, there is a need of an independent person to ensure that there are no unhealthy excesses and that shareholder and company value is not sacrificed.

In an Indian company, with, say, a 60 per cent promoter holding, the promoter would naturally be keen to increase the value of the company since more than half goes back to him.

In such a case, an outside director may actually be obstructive or even harmful, more so an independent director who usually attends a few meetings a year and professes expertise to give directions on formulating policies of the company.

In a DFID/Oxford University sponsored research on corporate governance in India, the paper of January, 2001 by Jairus Banaji and Gautam Mody highlighted in detail this unique circumstance of India and how the otherwise revered Cadbury Report may be fatally irrelevant to India.

For example, they observed, "Cadbury (Report) is not tailor-made to a context where dominant shareholders, for instance, promoters, control management and where the corporate governance problem is chiefly one of the protection of minority shareholder rights".

They observed at another place, "The assumption of dispersed ownership is seen to be limited in at least two ways once we extend this largely American model to the contemporary world and to corporate and to corporate regimes outside the US and the UK...the dispersion of shareholding cannot be, and was never, a valid description of those situations, such as in Europe, India, and east Asia, where corporate ownership patterns have traditionally been highly concentrated...."

There are other assumptions in such western models that are inconsistent with Indian realities. For instance, it is accepted, and rightly so, that promoters and managers in the West have a tendency to enrich themselves at the cost of the company through huge remuneration, bonuses, stock options and perquisites.

They would get these amounts often irrespective of their performance. Hence, there is a need for a remuneration committee consisting mainly of independent directors.

In India, it is the exception rather than the rule that the management gives itself substantial remuneration. Again, the obvious question is why should they remunerate themselves hugely when they own a majority or much more of the company? Thus, the remuneration committee is another example pitiful attempt to ape the West

This is not to say that the concept of independent directors is irrelevant to India. Even with such high holding, there is a need to have some checks and the benefit of expert advice of independent directors would be useful.

But it would be almost expropriation of the promoters if one were to ask that at least half of the board should be of people other than promoters.

It is also not argued that there are no corporate ills in India or that corporate governance per se is irrelevant to India. But the disease is different and the cure, therefore, has to be different.

If this reality is taken into account and an appropriate lower number is suggested to just keep a check extreme tendencies or temptations, it would have a greater chance of positive and substantive acceptance rather than being resisted and thereafter followed only in the letter.

It would incidentally also solve the problem of the need of a large number of independent directors by the deadline.

It is not surprising, therefore, that the J J Irani Committee has recommended recently that only one-third of the directors need be independent directors.

Further, it has also rightly deemed to be irrelevant for this purpose whether the chairman is executive or not. This is a marked change from western models which are suitable there but not here.

Note, further, the Irani Committee suggested that even this one-third requirement should be only for "companies having significant public interest".

To conclude, one will recollect that Clause 49 for corporate governance has had to be repeatedly be suspended and revised, and it is only now being slowly realised that an important reason for resistance is some of the unsuitable aspects of the model to India.

(The author is a chartered accountant)