Independent directors of company boards have significant responsibilities under the Companies Act and are part of various committees, including those related to remuneration. (Photographer: Giulia Marchi/Bloomberg)

Board Failures: What Makes Boards Effective - An Independent Director’s Views

BloombergQuintOpinion

Whilst a great deal of effort has been devoted to making boards of directors more effective, the continuing cases of board failure put their efficacy in doubt. That is because all the reforms are aimed at ritualising governance and not at addressing the core issue – board behaviour. There are several factors that powerfully affect behaviour, some of which are unique to hoary societies such as India’s.

Capitalism

This influence is powerful throughout the world. It makes the provider of equity pre-eminent amongst all stakeholders and, in a democratic system of governance, this results in the controlling shareholder being lord and master of his company. This pre-eminence was snatched 400 years ago because it was the only factor of production in the old industrial economy that was scarce. The pre-eminence of the controlling shareholder means that every decision must sub-serve his interest, often to the disadvantage of the other participants in wealth creation. As long as the controlling shareholder rules the roost, the hens in that nest will do his bidding, regardless of the rituals that regulators prescribe for the flock.

A basic failing of capitalism is to measure success by growth rather than by survival. The eight-ton Tyrannosaurus Rex is history. The unicellular Cyano-bacteria is still around after nearly three billion years.
A Tyrannosaurus Rex fossil in California. (Photographer: Michael Short/Bloomberg)
A Tyrannosaurus Rex fossil in California. (Photographer: Michael Short/Bloomberg)

Also read: Board Failures: A Series Of Columns On Corporate Governance Crises

Groupthink

This is a common behavioural problem and the regulators have attempted to get around it by increasing diversity on boards. Whilst individuals can be classified into genders, castes, religions practiced or colour, what is needed is diversity in thought. As boards generally select directors who have a corporate background, that diversity of thought is absent. The corporate system ensures that a business manager reaches seniority only after he thinks like his peers, regardless of gender.

Managers are trained to be optimists and carry this ingrained trait into the boardroom; even after they become non-executive directors; they cheer-lead rather than critically evaluate. More companies have come to grief because boards did not challenge the hubris of their chief executive officers and controlling shareholders than because of abuse of minority shareholders; the current pile of cases going through the Insolvency and Bankruptcy Code is testimony to that.

The fundamental difference between managements and boards is that the former should bring optimism to their recommendations which must be balanced by the constructive pessimism of the board.

That is the yin and yang of company survival.

Disagreement

All old cultures shy away from open disagreement and they tend to put age on a pedestal. That is how those cultures are perpetuated. The New World has no old culture to preserve and it accepts disagreement far more easily. Indian directors are loath to openly disagree, instead use hints or outside-the-boardroom discussions to express their differences. Because such conduct results in a one-on-one conversation, many critical weaknesses of an idea are not disseminated to the rest of the board and are snuffed out by an opinionated CEO or controlling shareholder. The situation is worse when the CEO or chairman is a legendary, old man; disagreeing with him is unthinkable.

Further, the attitude of many non-executive directors is that ultimately it is the controlling shareholder’s money at stake and if he is keen on doing something, why stand in his way? Even where directors believe that a plan could seriously harm the company, having raised their objections, they will then be content if the CEO glibly assures them that he will take the concerns into account in the plan’s execution. Few will record dissent even if a plan could hurt a company badly because that error will only surface in the future.

Wisdom

If one plots the old hierarchy of data-information-knowledge-wisdom, against a corporate organogram, the corresponding levels are junior employees-junior managers-senior managers-the board. Why? Because the board’s principal function is to appraise strategy that management has proposed. Management develops strategy by extrapolating their business knowledge into the future. It is for the board to bring its experience and breadth of knowledge-beyond-the-business to appraise the proposed strategy. That is wisdom. Wisdom is the ability to peer into the gloom of the future to decipher the vague shapes one sees to compare with the perfect solids that management predicts.

Management is medium-term tactical, the board long-term strategic.
A crew member uses binoculars on the bridge of an  oil tanker. (Photographer: Ali Mohammadi/Bloomberg)
A crew member uses binoculars on the bridge of an oil tanker. (Photographer: Ali Mohammadi/Bloomberg)

If boards are to function effectively, there are only two purposes that the non-executive directors need to serve:

1. Be the voice of those not in the boardroom.
The equity shareholder is adequately represented in the room through the controlling shareholder and management generally speaks for the employees. Customers are usually respected, though their exploitation is not uncommon.

But when have boards discussed the fair treatment of vendors or the effect of the company’s business on society, the community or future generations?

Being their champion is now the principal role of a non-executive director; the protection of minority rights is relevant only if the controlling shareholder is oppressing them.

2. Challenge management and the controlling shareholder.
Cultural conditioning means that lions outside the boardroom morph into sheep once they sit at the board table. Persons who come from the professions are generally better at constructive criticism in a group setting than are those who have been indoctrinated to applaud the boss.

In order to do this successfully, directors must possess three attributes:

  • They must have wisdom. To paraphrase Churchill’s words, to look back far into the past to be able to look far into the future.
  • They should possess integrity. To say what they think and to do what they say. CEOs and controlling shareholders can exploit a hypocrite.
  • They should have courage. Courage to speak up, to challenge the controlling shareholder. If necessary, to make public a serious wrong. They must be ready to face a very cold and uncomfortable situation without fear.
Some believe in expressing extreme dissent by quietly resigning. On boards, silent resignation is the coward’s way out.

For those directors who are classified as independent, the key is independence from emotional dependence on a directorship. If a directorship brings prestige to a director and he is afraid of losing that status, he will not be independent. This cannot be legislated but it is the biggest shackle to very competent independent directors continuing to sit when they must stand-up.

Good boards foster a culture that enables good behaviour from their members. As much depends on the individual directors as on the chairman or controlling shareholder to bring about such an atmosphere. A single courageous and wise director can bring change in a boardroom. The key is to foster such individuals and get them into a board.

Nawshir Mirza is a professional independent director, and serves on the boards of a number of large Indian companies.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.