Miles To Go... For Director Independence
“In India, there are broadly two styles of running a company - the “Raja” (Monarch) model and the “Custodian” (Trusteeship) model. In the “Raja” model, promoter interest i.e. self-interest precedes interests of “Praja” i.e. other stakeholders.”
These are the exact words of the chairman of the SEBI Committee on Corporate Governance in his preface to its recently published report, released for public comment by the capital market regulator. A more honest admission of the true state of play in large sections of corporate in India is hard to come by, and Chairman Uday Kotak deserves to be complimented in the highest possible terms for so courageously calling a spade a spade.
That said, the next question is – how do we even begin to correct the situation and restore if possible a semblance of equity in dealing with the interests of absentee shareholders? The key weapon to contain executive (and promoter) exuberance in expropriating created wealth and corporate opportunities that ought to be shared equitably among all shareholders is the institution of independent directors – a set of objective, free-thinking and trustworthy people who would attempt to minimise (since they cannot possibly wholly eliminate) the impact of such inequitable actions and attempts to steal (that is what it is) what is rightly due to others.
Has this weapon – that has been around for several decades now – achieved its objective or even succeeded as a deterrent to such unethical and unlawful practices in the corporate world? Unfortunately, experience around the world (and India is no exception) has by and large been less than satisfactory. If proof is required, one has only to look at the spate of often reactive legislative and regulatory interventions and listing requirements across countries: Sarbanes-Oxley and Dodd-Frank in the United States, Walker Review in the United Kingdom, Naresh Chandra Review, Companies Act revision and the present Kotak Committee recommendations in India, just to mention a few.
While, undoubtedly, there do exist truly independent directors and enlightened executives and shareholders in control of companies all over the world, it is a sad reality that their number is limited and they do not represent the corporate population at large.
And it is not anyone’s case either that independent directors on boards as a group are intent on not discharging their responsibilities conscientiously; it is just that there are inherent inhibitors in the system that militate against all but a few of such directors functioning as they ought to, objectively, fairly, and independently.
All directors on the board have the three dimensions of their responsibility (contributing, counselling, and controlling) well established but the independent directors, in particular, have a much sharper delineation of their controlling role and are expected to protect the interests of the company and the non-controlling shareholders (and even of the other designated stakeholders). This can likely position them often in a situation opposite the controlling shareholders (and the executive) if some of the actions or inactions are perceived as being not in the interests of those they are expected to protect.
This is a responsibility independent directors likely find difficult to discharge if they feel obligated to the controlling shareholders, or the executive, for having got them on their board.
This feeling is inescapable when the controlling shareholders, or the executive, are seen as virtually wholly responsible by first identifying the individuals, navigating their induction through the board nomination processes, and finally voting for them in substantive numbers (and otherwise facilitating their election) at shareholders’ general meetings. And also not to forget their role in fixing their remuneration and other on-or-off the record perquisites, hospitality, and so on.
One solution that has been talked about is to take away the controlling shareholders’ voting power when it comes to electing independent directors at shareholders’ meetings. They can still participate in and influence board nomination processes as they undoubtedly do presently but only will not be able to vote for the actual election of the candidates at members’ meetings. After all, their inputs would be as valuable as others’ in finding the right candidates to join and enrich their boards. A majority of the remaining non-controlling shareholders will be given the opportunity to approve the nominations or reject them. To make sure that the choice reflects a true majority of all non-controlling shareholders – and not just those present at the members’ meeting – the required majority could be one half or more of all the non-controlling votes in the company. This will also impose a moral obligation on institutional shareholders – clearly a large proportion of the non-controlling shareholders block in any company – to exercise their vote in their own interest of having an effective board of their choice.
Is there a danger of abuse of this new-found authority among non-controlling shareholders leading to confrontational boards (surely, not desirable) or instability of current management (unlikely if it is seen as reasonable and investor-friendly)? Rationally, why would an investor group gang up together and reject nominations of the board in the normal course unless the nominated candidate’s independence, reputation and track record warrant such an action?
Maybe there will be stray instances of potential abuse but should the majority be denied the opportunity for fear of an abuse by a small proportion of company shareholders?
Even that can be addressed by suitable appellate procedures if necessary. Well managed companies should have nothing to worry by such reform. Others may have cause for concern, and probably deservedly so.
Since, as a nation, we always look for precedents, let it also be said that such a provision has been adopted in some other countries, prominent among them the UK where such is a contracted requirement for Premium Listed companies. Maybe, we should try this out initially for the largest hundred companies and extend to others based on gained experience. That the Kotak report has not addressed this core issue is a matter of some disappointment. Maybe, the regulator would step in.
N Balasubramanian is Founding and Former Chairman of the Indian Institute of Management Bangalore Centre for Corporate Governance and Citizenship. He was an adjunct/visiting professor at IIM Ahmedabad and Bangalore.
The views expressed here are those of the author’s and do not necessarily represent the views of Bloomberg Quint or its editorial team.