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Saturday, August 28, 2010

Company Law - Need to define the Role of Independent Directors in Effective Corporate Governance: Quality v. Quantity Debate


The composition of Board is critical to the independent functioning of the board. It determines the ability of the board to collectively provide the leadership and ensures that no one individual or group is able to dominate the board. It should be an ideal combination of executive, non executive and independent directors.

Composition of the board has been the area of concern for all the times. Beginning from the CII Code of Corporate Governance, 1998;Birla Committee, 2000;Naresh Chandra Committee, 2002; Narayanmurthy Committee, 2004; and recent Irani Committee, 2005; all have elaborately talked and deliberated upon the structure of board and one thing commonly suggested by all of them was that all recommended presence of independent directors in board to ensure independence in working of the board and to keep an eye that board functions in the interests of the company as a whole and not for a dominating group of people.

While directors representing specific interests would be confined to the perspective dictated by such interests, independent directors would be able to bring an element of objectivity to Board process in the general interests of the company and thereby to the benefit of minority interests and smaller shareholders.[5]

Mere presence of directors who are independent in terms of the provisions of law does not mean that there would be checks and balance. What is to be ensured is that these directors think and act independently. Even though in law, the directors are to be elected by the shareholders, yet, in practice, the directors proposed for election are normally the nominees of the promoters.

Here it is submitted that till corporate by themselves voluntarily and intentionally do not want to follow corporate governance as part and parcel of their policy and keep on taking it as a regulation which shall have to be complied with in letter but not in spirit, the mechanisms like IDs or any other good Corporate governance practice is not going to be quality oriented and would not yield expected results. So it will remain again game of compliance with the quantity i.e. the prescribed number and no assurance of quality.[6]

It is to be noted that the debate in India focuses on the numbers and not takes into account the totality of perspectives on corporate governance. The central questions are:[7]
• What is independence? How is to be identified and developed?
• How is the overall board independence to be perceived, nurtured, defined, articulated and institutionalized?
• What contributions would regulators and stock exchanges make to the public policy on corporate governance?
• Do the promoters - government or private - really appreciate, understand and want better corporate governance?
• Does the top management of the corporate world and PSUs have any idea of the existing numbers and potential sources of independent directors?
• Is there any agreement on the training needs of independent and other directors/ Have we developed an agency to train them?
• As a community of trade and commerce, are we preparing ourselves for improved corporate governance?
The numbers are to be prescribed but are unimportant in themselves; because it is the qualities, experience and expertise and above all the courage of conviction of independent directors that will eventually contribute to an effective board governance process. The relative ability and willingness of the independent directors to exercise their freedom of expression is very crucial to their expected role and contribution.
Even when various Committees suggest the number of independent directors, the debate continues to be inconclusive. We are referring to at least an existing population of 30,000 independent directors, assuming a board size of a minimum 10 directors for nearly 10,000 listed companies. (In India more than 6, 00,000 companies are registered). This number will become even more staggering as more companies are listed on the stock exchanges in India. We have no mechanism of talking about corporate governance in process and content of the unlisted companies. So the numbers are suggestive of a complex range of issues in corporate governance.
For the sake of mere compliance a company may appoint independent directors but whether they are really independent in their thinking, approach and actions is a moot issue. The limitations of influence of independent directors arise because of internal sources such as the personality of an individual director or external sources such as ownership of a firm, board composition and structure, board process and strategies. The value that independent directors add to the board process only will ensure effective corporate governance.
We also need to note that leadership is not synonymous with designations and age; for leaders need to be developed at a fairly early stage of managerial career life cycle. There is therefore, scope for introducing leadership courses and a generic curriculum at the higher secondary levels of education so that in the more specialized modules of management education can be inculcated in the mindset of the potential managers.
The regulatory and legislative framework can only streamline the existing practices of corporate governance but too much focus on compliance orientation so far has not resulted into awareness for self-regulation and accepting best practices of corporate governance as a way of life for the corporations. A conscious effort by the top leadership in companies is required, regardless of ownership, to inculcate a culture of transparency and accountability and propagate a well articulated message that in the long run ethical behaviour and corporate social actions are not incompatible with good corporate governance and sustainable profitability of the companies.
Independent directors are a general tonic and not specific therapy

Do Outside Directors Destroy the value of the firm? There has been some puzzling evidence from US academic circles that there is a negative correlation between their numbers and firm value. There is also a conclusion that corporate performances do not improve for boards with more representation by independent directors and that outside directors could be pursuing a political agenda. If such conclusions are true for other countries as well, the proportion of outside directors may merit a closer examination.

There is no unanimity on the ideal numbers of outside and independent directors, either among nations or researchers. The prescription of independent directors is like health tonic that will do general good in moderate measure. They are required at least to bring in the climate and aspiration of independence. However, too many independent directors may bring little additional benefit to companies which are actively monitored, transparent and accountable. They may even crowd out active governance by those who may have more at stake.

Overall, the contrarian preference of India Inc., for a smaller number of independent directors than what SEBI wants, is not without merit. In the absence of the widely held corporation and the continued control of management by the dominant shareholders, too many independent directors may only increase the transaction cost. At worst they may even mask the illegitimate activities of the dominant shareholders with their reputation and contribute to the decline of the firm. Sometimes the general tonic can be intoxicating if taken in large measures.
As large doses of independent directors is no cure at all, Shareholders, particularly the active institutional investors, may be best positioned to recognize the specific needs of the company and use independent directors as therapeutic interventions.[8]


Updating the knowledge of captains of corporate is a prime concern. Realizing the desirability of training of IDs, the Naresh Chandra Committee recommended that the DCA should encourage institutions of prominence including their proposed centre for corporate excellence to have regular training programmes for IDs. In framing the programmes, and for other preparatory work, funding could possibly come from the Investor Education and Protection Fund.[9]
All IDs should be required to attend at least one such training course before assuming responsibilities as an ID, or, considering that enough programmes might not be available in the initial years, within one year of becoming an ID. An untrained ID should be disqualified under s. 274 (1) (g) of the Companies Act, 1956 after being given reasonable notice.
Considering that enough training institutions and programmes might not be available in the initial years, this requirement may be introduced in a phased manner, so that the larger listed companies are covered first.
The executing bodies must clearly state their plan for the year and their funding should be directly proportionate to the extent to which they execute such plans.
There should be a trainee appraisal system to judge the quality of the programmes and to help decide, in the second round which agencies should be given a greater role and which should be dropped.
The Combined Code on corporate Governance in UK in paragraph A.1.6 states, “an individual should receive proper training on the first occasion that he is appointed to the board of a listed company and subsequently as and when necessary.” the Non-executive Director’s Forum in UK has identified two sets of programmes; one geared to non-executive directors on the boards of listed plcs and the other geared to NEDs on boards of private limited companies.
The description of the structure of the plc programme will illustrate the approach which has proved to be effective so that this model can be adopted in India also with necessary modifications. The key elements of the programme are:
  • Case studies: these are current and ongoing situations, and are conducted to draw out observations and lessons for professional development as an ID. They also include role playing, whereby participants are asked to respond to particular circumstances how will they act as IDs.
  • A session on corporate governance which includes a look at corporate governance codes and institutional shareholder activism.
  • An institutional shareholder’s perspective with sufficient time to discuss and debate institutional shareholder attitudes and present the views of company directors.
  • The contribution from experienced non-executive directors: this takes tow forms; firstly their own experience and secondly, as members of a panel, comments on presentations, stimulating discussions and debate and their answers to questions.
  • A close interaction amongst participants by limiting the numbers on any one programme to not more than 15.
  • The opportunity for one-to-one contact and discussion by participants with experienced businessmen.
Finally, programmes are but the beginning of the necessary and continuous professional development which is facilitated by membership of an active alumuni to share experience and knowledge through publications, meetings and refresher programmes.
In India Bombay Chartered Accountants’ Society has launched its second course on independent director studies in association with SP Jain Institute of Management studies, commencing August 27, 2005. The six weekend sessions are designed for individual currently sitting or aspiring to be on the board of the company, considering the need of contemporary corporate governance and the responsibilities of IDs.

Involving around 72 hours of study, the course offers an in-depth guideline on what to do in order to become an independent director. The course also trains on conducting due-diligence on a company before accepting its directorship.
The course aims at creating a bank of such trained professionals who are better equipped to take up the responsibility. The course briefs the candidates on corporate laws, rules, guidelines, ethics and study of balance sheets, while it also trains them on what kind of questions to ask at board meetings. During the study sessions, real-life case studies are presented to the candidates who are then encouraged to react to it and make their recommendations.[10]
SCOPE in association with the Ministry of heavy Industries and the Academy of Corporate Governance (an association of the Commonwealth), has designed a programme to train former executives on company law, corporate governance, on their expected role in audit, risk management, remuneration and project evaluation.[11]


Role of independent director

The amendment proposed to be made in the code of corporate governance requires independent director to periodically review legal compliance reports prepared by the co. as well as steps taken by the co. to cure any taint. To ensure compliance with this requirement, the code further provides that in the event of proceedings against the ID in connection with the affairs of the company, defense shall not be permitted on the ground that he was not aware of his responsibility.[12]
They also have to see that the reporting enterprise reports everything on “as is where is” basis and there is no window dressing of facts. They have to ensure that the reporting enterprise does not mince words while reporting averse matters specially when it relates to matters having special financial implications.
They should ensure that the control system is effective enough so that frauds get detected as a matter of routine and the systems in place are capable of deleting the loopholes as soon as possible.
They should work in close coordination with internal and external auditors and provide an atmosphere wherein they can report significantly on important matters openly. They should particularly contribute ion those matters where the regular directors have conflict of interest.

Audit Committee
Every listed company should establish an audit committee of directors. It shall have at least 3 directors, all being non-executive ones. Majority of the members should elect its chairman (s. 292A of Companies Act, 1956). The chairman shall be an independent director and he should be present at the company’s Annual General Meeting to answer shareholders’ queries. In the quorum minimum two IDs are required to be present. This committee recommends appointment of auditors and fixes their remuneration.
Remuneration committee
Clause 49 of the listing agreement recommends the setting up of a remuneration committee of directors with at least 3 members. However, sch. XIII of the Act requires all the public companies to establish a remuneration committee for sanctioning remuneration to executive directors comprising at least three independent directors. The quorum for the meeting is all the members. The chairman of the committee who is an ID should attend the AGM of the co. to answer shareholder’s queries.

Advisory group’s recommendation
It has recommended that in view of the complexity of the tasks of governance, the boards of companies should appoint at least four committees of IDs for monitoring and direction of affairs of the company, viz. audit committee, remuneration committee, appointment committee and investment committee.

Qualification of independent director
The Advisory Group on Corporate Governance set up by the RBI suggests that independent directors should be professionals with experience in the area of activity of the company. This would enable them to effectively discharge their fiduciary duties. According to the CII Code, an independent director should know how to read a balance sheet, profit and loss account, cash flow statement and financial ratios and have some knowledge of company law.[13]
Apart from the laws, the general characteristics required for a quality ID are[14]:
  1. high integrity;
  2. analytical mind with an ability to convince the management to reject proposals with a potential threat in the interest of the co. as a whole;
  3. ready to relinquish his office rather than succumbing to pressure;
  4. Straightforward approach.

ID-myth or reality
Since the board appoints him, will he be truly independent vis a vis the incumbent board? Would the promoter directors of the co. or any board generally invite persons with whom they are not familiar, to become a director of the co? The answer in all probability would be unlikely. If that be so, will the ID be really independent? Most likely he will be independent only in letter of law and not in the spirit of law. In other words the IDs will hold the office at the discretion of the promoter directors.
Secondly, cos. Pay hefty amounts as sitting fees to IDs besides remuneration by way of commissions.[15] Will IDs of such companies deem it worthwhile to express dissent with the majority decision with the risk being neutralized and be ultimately a loser? However, it is a probability and not a general rule.
The World Bank report on compliance with the OECD principles has recommended that on a priority basis, the directors should upgrade their knowledge and skill. If boards are not expected to simply “rubber stamping” the decisions of management or promoters, they must have a clear understanding of what is expected from them. They should know their duties of care and loyalty to the company and all shareholders. They should know their changing responsibilities and should be familiar with the changes in this regard arising from changes in laws and regulations.[16] A key missing ingredient is a strong focus on professionalism of directors. Director training institutes can play a key capacity building role and expand the pool of competent candidates.
1.      Majority of the directors are unaware that they are agents of shareholders and that they hold a position of trust and faith.
2.      Participation of a non executive director in meetings whether of the board or its committees is inversely proportional to the health of bottom line lesser the participation.
3.      Most directors of companies do not consider it necessary to update themselves on changes in laws and regulations or the business model of the company of which they are directors and which affect their duties and responsibilities as directors.
4.      So long as the performance of the company is satisfactory, which is judged by the health of bottom line; refusal to approve or object to any proposal of management is considered bad manners.
5.      Non executive directors do not consider themselves as watch dogs of shareholders.
6.      Board rooms are invariably filled up with “yes men” who do not raise relevant questions and assent to all proposals put up by the management.
7.      A person is invited to become non executive director only if he enjoys the patronage of the chairman/CEO through old school connection or social circuit or golf club.
8.      Is it right that non executive directorships are considered more as a symbol of social status and connections than as a position of responsibility?
However there are exceptions also. There are many directors who come to the meetings of the board or committees fully prepared and will never be afraid to raise questions howsoever uncomfortable they might be to the management. But perhaps their number is low and a vast majority still believes in supporting every proposal of management without critically examining it.
IDs ought to be a guarantee against mismanagement
Where the affairs of a company having independent directors are mismanaged and there are sufficient evidences to show that the affairs of the co. have been conducted in a manner prejudicial to the interest of the co. and also to public interest, it indirectly shows that the presence of IDs has not been fruitful or has not been objectively succeeded in eradicating malpractices in managing its affairs.
As stated by Mr. Madhav Mehra, President, World council for Corporate Governance, recent scandals have shown that even IDs develop a cozy relationship with the management because their cheques come from the same management. Corporate scandals of Enron and have revealed how this independence has been compromised by a cozy relationship between the CEO even with the so called IDs.
IDs: Hidden nominees of promoters
Directors including IDs elected by shareholders are hidden nominees of promoters. The persons elected on the board develop in a course of time a cozy relationship with the promoters or the management. Thus, there s lack of credibility and trust and above all lack of accountability. As per the practice prevailing IDs are invitees of the controlling interest and their independence is bound to be compromised with the fee, commission, power and status they receive from the management. The person appointed as ID should be really an ID in thought and action. In fact, independence is a state of mind and should enable one to weigh the prose and cons while considering a proposal in the board in the interest of the company alone.[17]

Making ID accountable
Such ID if the need arises should be accountable to the government and the society and prove their accountability by explaining that their role had been quite independent and they did not side or develop any such cozy relationships with the management. Subsequently, if the affairs of the company are found to be conducted prejudicial to the interest of the co. and to public interest and such ID can establish that he had taken sufficient steps to avoid such a situation by way of note of dissent or disagreement with the decision made having been recorded in the minutes or by an intimation to the government or the organization appointing him or the government, then his presence on the board will serve real purpose. Such system would also forewarn the management and other directors on the board to work with greater vigilance and this in turn would ensure a greater transparency to the investors in general. Further there should be separate code of conduct for IDs.
There exists a controversy as to the exact demarcation of responsibilities of IDs. One view is that since they are not able to gain an insight into the day-to-day affairs of the co., they should not be held liable for defaults. Another view is that the fact of a person being an ID should not be held as an excuse in making him liable for acts of misfeasance within his knowledge.[18]
Birla committee recommended that an adequate compensation package be given to non-executive IDs so that their position becomes sufficiently financially attractive.
Naresh Chandra committee recommended that the statutory limit on sitting fees should be reviewed, although ideally it should be a matter to be resolved between the management and the shareholders. In addition, the loss making companies should be allowed by the DCA to pay special fees to any ID subject to reasonable caps in order to attract the best restructuring and strategic talents on the board. It further recommended that the time has come to insert provisions in the definitions chapter of certain Acts so as to specifically exempt no-executive and IDs from civil and criminal liabilities. They should also be indemnified for the costs of the litigation.
However, Joshi committee suggested that the definition of “officer in default” in s. 5 of the Companies Act, 1956 should be widened to include IDs. The words suggested to be inserted were, “any other director including a part time, nominee or non-executive director in respect of contravention of any of the provisions of the Act which had taken place with his consent or connivance or is attributable to any neglect on his part.”
Narayanmurthy committee recommended that legal provisions must specifically exempt non-executive and IDs from criminal and civil liabilities under certain circumstances. SEBI should recommend that such exemptions need to be specifically spelt out for the relevant laws by the relevant departments of the government and independent regulators as the case may be.

SEBI Guidelines
The new clause 49 of the listing agreement requires all members of the audit committee to be financially literate and precisely defines the term financially literate in the line with CII Code on Corporate Governance. Furthermore, the peer review of director’s performance, special training to directors in the business model and risk profile of the company and whistle blower mechanism are some of the mandatory requirements inserted with a view to increase the competency of the directors, especially the independent ones so that they can become actively associated in strategy formulation and functioning of the company and not merely serve as passive advisors. Clause 49 does not postulate anything as regards criminal liabilities to be imposed on the IDs in relation to the defaults under various statutes as was recommended by Joshi n Narayanmurthy committee.

Cases on IDs’liability
In Beejay Engineering (P.) Ltd, In re[19] it was held that no distinction could be drawn amongst the directors for fastening the liability or granting of relief from the liability on the consideration that a person is on the board purely by virtue of his technical skill or because he represents certain social interests and there are other directors who are in effective management and control of the company.
In Supreme Bank Ltd. v. P.A. Tendolkar[20] it was held:
A director cannot shut his eyes to what must be obvious to everyone who examines the affairs of the company even superficially. If he does so, he could be held liable for dereliction of duties undertaken by him, and be compelled to make good the losses incurred by the company due to his neglect even if he is not shown to be guilty of participation in the commission of fraud. It is enough if his negligence is of such a character so as to enable the fraud to be committed resulting in the company incurring losses.
Thus the settled position of law emerging from the above cases is that there is no difference between being guilty and in neglect as regards a prosecution in respect of defaults under various statutes. An ID cannot take defense of the fact that he was retained purely by virtue of his technical skill and was not involved in the day to day affairs of the company in case the default was attributable to neglect on his part in performing his duties properly.
The time has come for the IDs to be active members in the board asking tough questions on important matters and reviewing the compliance of various rules and regulations applicable to the company. It is for him to see that the board is exercising its powers in the interest of the company. He has to also ensure that all the matters of statutory nature warranting liability on the co. and its directors are promptly brought to the notice of the board to enable an immediate remedial action. A sheer neglect in performing these duties should not enable an ID to go scot-free without incurring the liability prescribed for directors under the governing statute for such defaults.
Independent directors are not powerless
The role of independent director has been more important although it depends on the individual concerned how much he chooses to exercise himself. He can appoint an auditor as distinct from the statutory one whose expenses would be borne by the company to look into any matter which he field is not right. IDs can no longer say that they are powerless. Even if one director stands for his duties it will make all the difference.
How do you think that India Inc. can address the challenges of finding IDs once the demand increases? Industries and associations will have to take steps to ultimate people who could be invited as independent directors. Well, you can not call these people for training but they must acquire some knowledge. I believe, if the people who have the potential were to join some kind of mentoring program, they will certainly benefit. In western countries, management training is advanced and that takes care o the demand for IDs. Things are good in India but the danger is, self-appointee firms can crop up and claiming to make such IDs available for companies but the industry should wisen up to that. To make the appointment transparent the Irani committee has recommended that IDs should be invited by the chairman of a committee comprising majority of IDs.[21]
Rights of Independent/Non-Executive Directors
As per Irani committee Independent / Non-Executive directors should be able to:-
  • Call upon the Board for due diligence or obtaining of record for seeking professional opinion by the Board;
  • Have the right to inspect records of the company;
  • Review legal compliance reports prepared by the company; and
  • In cases of disagreement, record their dissent in the minutes.

It is submitted that the real issue is not the quantity but the quality (i.e. effectiveness) of independent directors. The appointment of prescribed percentage of independent directors is no guarantee of corporate governance. A look at the active independent directors, as they are now in some companies will reveal that several lack adequate knowledge of the company, its business model and risk profile, and many do not even attend the meetings regularly. The truly independent directors must be competent, committed and have an independent “state of mind” to challenge and ask the right questions and be able to provide insight for the growth of the company. How many of such persons would we have? Would we be able to have around three thousand such persons for meeting the envisaged requirements? In today’s global business environment, corporates are conscious that to survive they must have good corporate governance. Across the world, companies are increasingly choosing to move beyond seeing it in compliance terms to looking at it as a strategic investment. The changes in the operating environment have raised the stakes on managing business risks. Strong and effective Corporate Governance is no longer a “nice to have” but a “must have”. Why should then there be a minimum percentage limit for the appointment of independent directors? Let the shareholders and the Board decide as to how many of them would be adequate to have effective governance for their company.[22]
In the case of independent directors is it the question of numbers? For me it is a question of effectiveness. You can always find independent directors but they may not be competent, they may not know the business, they may not know the sectors, they may have no skills in financial matters and so on. The more a company has an open shareholding i.e. there is no one person controlling the company, the more directors would anyway be like independent directors. Also in this case, it depends on a number of factors. In such a company a person with 4% shareholding may be chairman and may become director, now will he be independent or not?[23]
One may argue that to be independent, directors should have no shareholding. But one can also say that you are independent and you have no shareholding so you have no interest in the performance of the company.
What about responsibility of independent directors for their actions? I think it is exactly the same question as responsibility of auditors. I do not think that in the context of corporate governance, the regulator or the law makers are taking care of this issue. And not taking care of this issue right now may prevent some good people from becoming good independent directors. They are not clear if there will be unlimited liability or if they will be prosecuted for criminal act, as they have to confirm some numbers provided to them by the management.
I am now seeing two patterns—difficulty in getting good directors because they are afraid of that and secondly, there are some who are not afraid of the risk but are asking for a lot of money to be director. In many countries people are trying to find answers to the question of what should be the due diligence of an independent director and in what cases the work of independent director should be questioned. Answers may emerge form the court cases in future.
In order to meet the SEBI deadline of 31st Dec. 2005 to have 50% board as independent directors, the Standing Conference on Public Enterprises (SCOPE) is assisting PSUs by preparing a data bank of people competent to act as independent directors. The C & AG and the Central Vigilance Commissioner have also supported the idea of appointing former CEOs of PSUs as independent director.[24]
In this state of flux, there is always a temptation to claim that entrepreneurs know best what is good for their companies and that IDs have neither the time nor the inclination to appreciate the nuts and bolts of business to provide effective stewardship for corporate businesses. It is contended that IDs are boardroom intruders to be tolerated for the sake of compliance with the corporate governance regulation.
The regulator is justified in framing strict corporate governance regulations with the emphasis on the mechanism of IDs. At the same time the present corporate leadership is also justified in not seeing any tangible business benefits in complying with corporate governance regulations in letter and spirit. Then what is the real problem? The real problems seems to be the apathy of major institutional inventors in this country to the view that good corporate governance practices can help long term wealth creation. The institutions do not seem to exhibit the kind of sensitivity expected of them as investors of public funds by demanding corporate transparency and accountability; they are also to a large extent driven by a speculative mindset to maximize profits on the stock markets. Unless this attitude changes, IDs will not be taken seriously for what they are really worth and will continue to be what they are today—independent in definition but not in practice.
Harbingers of soft power
This can change only if major institutions as investors of public funds enthrone the highest principles of public accountability and transparency. The regulators should step in and do credible realities check on such investors. Once the major institutional investors are reined in, corporate India will automatically be questioned by them on the standard of corporate governance practiced by companies. This in turn will have a multiplier effect on the market capitalization of companies. Once this happens the corporate leadership will sit up and take notice. Corporate governance and IDs will no longer be seen as board room intrusions but as harbingers f soft power and corporate wealth.
Corporate India is at strategic inflexion point in this regard. Future competition is going to be based not only on hard factors of business but mainly on soft factors like corporate credibility and governance standards. That is where the IDs come in. Corporate India would do well to adopt a stiffer prescription on IDs as a wise preparation for a challenging but a rewarding future.

Bulwarks against frauds
Corporate India should have a vested interest in preventing and minimizing corporate frauds and scams. One effective tool in this regard is to reinforce the institution of audit.
A sure way of reinforcing the institution of audit is effective oversight provide by the audit committees. IDs on audit committees provide one of the best ways of reinforcing both internal and annual statutory audit. However it should be kept in mind that independence alone without competence can hardly make for a good ID.
If corporate India is serious about raising the bar on governance standard, it should appoint highly competent IDs after a thorough and even global search.
This brings us to the next question of appropriate remuneration for competent IDs. The popular saying goes, “when you offer peanuts you get only monkeys”. This is also true when it comes to IDs. Without attractive remuneration, the best persons will not offer themselves as IDs. It is erroneous to say that attractive remuneration will erode their independence.
This may happen in the short term. But if large corporations start offering attractive remuneration as a norm, competent IDs who are not many, will have choice and will not compromise their independence.
When India is slowly but surely integrating with the global economy, the need for a global reach and size cannot be ignored by the top Indian companies. And for this they need to raise huge capita from domestic as well as international market. This can be done well only if their governance standards are quite high. And one of the essential component of these high standards of governance is significant presence of IDs in the Board.[25]

Change in Independent status-Duty to inform the company
It is quite possible for a director to lose his independent status during the tenure of his office as an ID with the company. The terms of ID’s association with the company should include a provision that if at any time, during his tenure any change occurs in his independent status, it shall be communicated to the company forthwith. The company should make adequate disclosures to the shareholders of the manner in which the independent status of the director has changed. The board must also ensure that the present proportion of IDs in the composition of board as well as the board committees is maintained.
To ensure that the independent status of ID is not compromised, the board must take adequate preventive measures. In case a non-executive director enters into any contract or arrangement with the company, he must be treated as non independent director and accordingly he will cease to remain a member of those committees which are required to have certain number of IDs.

Can substantial shareholding compromise independence of an ID
There is no clear cut answer to this in the listing agreement. Before the recent 2005 amendment, the Explanation to clause 49-I (A) provided that institutional directors on the boards of the companies should be considered as independent whether the institution is an investing institution or a lending institution. Shareholding will not jeopardize the independent status of a director. The US and UK views also seem to suggest that the interest of investors and directors will be more closely aligned if the board members are also shareholders. What needs to be guarded against is the likelihood of directors holding significant number of shares from using their position to promote their own interests rather than that of the company. For this reason, the Australian code has provided that independence is more likely to be assured when the director is not a substantial shareholder of the company.
Institutional shareholders: What do they want?
More and more institutional shareholders are examining both the qualifications and independence of non-executive directors in relation to the boards of companies in which they invest.
In the statement of corporate governance issued by the well known fund management group of UK, Herms in July 1998, it was stated that the key role of IDs is to ensure that the chief executive and the board as a whole concentrates on maximizing long term shareholder value. There are three aspects to this for which they should expect to be held accountable:
  1. Strategic functions: bringing their independence of judgment in strategic decisions.
  2. Expertise: providing skill and experience that may not otherwise be readily available to the company. This applies particularly to small and medium sized companies.
  3. Governance Function: ensuring compliance with best practice, participating in appointment of new directors and monitoring the performance of executive directors.
Herm’s March 1997 Statement stated following characteristics as essential for an ID:
(i)                 Commitment;
(ii)               Know the business;
(iii)             Probe/anticipate;
(iv)             Apply specialist knowledge/expertise;
(v)               Know the organization’s strengths and weaknesses;
(vi)             Know/support/coach/evaluate executive directors;
(vii)           Be an effective member of a team;
(viii)         Establish a professional relationship with the Chairman;
(ix)             Appointment of directors is a key responsibility;
(x)               Contribute to improve board performance.
In September 1995, the City Group for smaller companies (CISCO), which broadly represents smaller listed companies in UK carried out a survey of 200 smaller PLCs on a number of aspects of governance policies, interviewing companies, executive directors, non-executive directors and institutions.
The survey disclosed a mismatch between the perception of companies in relation to non-executive directors, institutional shareholders and non-executive directors themselves. For example, the survey found from the companies’ point of view, non-executive directors advised the board on the following subjects:
  • Remuneration = 25%
  • Strategy = 24%
  • Audit = 23%
  • City Relations = 16%
  • Personal Networking = 7%
  • Marketing = 5%
However, the skills and experience that non-executive directors themselves considered that they possessed and were relevant to their company were as follows:
  • Strategic advice = 38%
  • Personal Network = 20%
  • Specific industry knowledge = 18%
  • Marketing = 4%
  • Others = 20%
Moreover, 43% institutional shareholders considered NEDs should adopt the role of “policemen” on behalf of the shareholders, whereas 12% of the companies view their independent directors as policemen and 45% viewed them as “supporters”.
A potential ID should ask himself or herself, before taking the post:
  • Whether he has the necessary time?
  • If the appointment give rise to conflict of interests;
  • If to resign from the post would materially impair his standard of living and therefore compromise independence;
  • Whether his relationship with the CEO is sufficiently detached to enable a true and honest objective role to be played.
In addition IDs should be encouraged to talk to auditors and the company secretary, fellow directors and senior management in an informal atmosphere. In an ideal world, they should also be encouraged to talk to significant shareholders, but in practice it is often not possible.

Independence of IDs
This issue was raised in the CISCO survey in UK. The institutional shareholders considered independence of IDs as follows:
  • Marginally independent = 30%
  • Very independent = 0%
  • Not independent at all = 0%
The advisors to the company considered the independence of IDs as follows:
  • Marginally independent = 54%
  • Very independent = 23%
  • Not very independent = 23%
  • Not independent at all = 0%
When it came to the independent directors themselves, they considered their independence as follows:
  • Very independent = 91%
  • Marginally independent = 6%
  • Not very independent = 3%
  • Not independent at all = 0%
The companies themselves considered independence of their IDs as follows:
  • Very independent = 67%
  • Marginally independent = 23%
  • Not very independent = 8%
  • Not independent at all = 2%
When it came to the question as whether the independence of the IDs was judged by their ability to influence decisions of the board, 48% of the IDs, 44% of the companies and 37% of the institutional shareholders judged their independence in that manner-in each case this was the single most important factor.

Independent Non-Executive Directors as the Directing Mind and Will of the Corporation
The selection and appointment of independent directors should be transparent and on certain valued basis. Therefore, the companies should have an entirely independent nomination committee which should determine the qualifications for Board membership and should identify and evaluate candidates for nomination to the Board. It would be more appropriate that the code of Corporate Governance of a company should specifically include the qualifications and attributes that the company seeks of an independent director. A critical element of a director being independent is his independence to the management both in fact and perception by the public. In considering the independence, it is necessary to focus not only on whether a director's background and current activities qualify him as independent but also whether he can act independently of the management. In other words, the independent directors must not only be independent according to the legislative and stock exchange listing standards but also independent in thought and action i.e. qualitatively independent. Such qualitative independence will ensure that directors think and act independently without regard to management's influence.
Qualitative directors' independence should include the will and ability in terms of knowledge and experience to ask the hard questions required to provide effective oversight and character and integrity in general and especially in dealing with potential conflict of interest situations. The Board to be successful should have mix of skills and should be tailored to meet the needs of the company. Even though, there could be no precise mix of qualifications and experience, which will depend on various factors, yet, specialists in the areas of accounting and finance, technology relevant to the company, corporate management, marketing and industry knowledge etc could be considered for independent directors. Although, the level of knowledge, integrity and independence necessary to carry out the functions of a director are difficult to summarize, the behavior characteristics of a good director should include the attributes of asking the hard questions, working well with others, having industry awareness, providing valuable inputs, availability when needed, be alert and inquisitive, making long range planning contribution etc.
The independent directors could effectively and substantively contribute if they are empowered to meet at regularly convened executive sessions without participation of management or employee directors so that they could openly and freely discuss the affairs of the company. Accountability is an important element of Board effectiveness. There should be some mechanism for evaluating the performance of the directors. Perhaps, a system of 3 tier director evaluation mechanisms could be evolved by which the performance of the Board as a whole, the performance of each committee and performance of each individual director is assessed. Since the shareholders who elect the directors lack the knowledge of the inner working of the Board, the Board could disclose their mechanism and process of the 3 tier evaluation to the shareholders. How and in what manner the evaluation is to be carried out has to be specifically spelled out by the Board.
Now comes the liability of the directors. There are two types of director’s liability. One relating to statutory compliance and the other is in relation to their fiduciary obligations. The Companies Act and other Acts lay down various requirements on the part of the company and most these provisions provide for penal action against the directors. As I have said earlier, the extent of liability of a director would depend on the nature of his directorship. No doubt, full time directors being offices in default have to be fully liable while part time directors may not be so liable. But as far as fiduciary duties/obligations are concerned, any breach by any director would visit them with liability.
The Indian Scenario
The term "independent Directors" became a part of the Indian corporate lexicon after the publication of the Kumar Mangalam Birla committee report which resulted into introduction of clause 49 in listing agreements.
With the integration of the Indian economy into the world economy, there is consensus among the corporate leaders that the corporate governance in India should conform to international norms.
Barring a few exceptions, in India the appointment of independent or non-executive directors has become a matter of mere legal compliance. Most of the companies still function in the same old fashion and the non -executive directors has hardly any say in the management of a company. In most of the companies, hardly any relevant information is passed on to the directors and the meetings of the Board discuss minor and routine matters. The Board meetings are normally held once in three months and that too for 2 to 3 hours only. It is obvious that promoters would prefer to appoint their cronies and faithful persons on their board to have minimum interference of the outside directors.
But a million dollar question begging an answer is that when the Indian businessman will come out of the pond and start swimming in the main stream of global village How will they satisfy the foreign institutional investors who are demanding greater professionalism in the management of Indian corporate? Even the lending institutions are now giving much more emphasis to good and efficient corporate governance.
It is true that the law alone cannot bring changes and transformation. A judicious mix of regulations and voluntary compliance will play an important role in developing a system of good corporate governance.
Can the Independent Directors really direct the Company?
The following propositions will highlight the importance of independent and non-executive directors on the board of a company:[26]
1. The non -executive directors, when carefully chosen, can complement the Board's overall strength with their knowledge of best practice outside the company.
2. Their role should not be to do the job of the executive but to act as candid counselors to the guide the company in benchmarking standards and its level of ambition.
3. This is a function not of numbers but caliber.
4. The non-executive directors must concentrate on a few companies rather being involved with up to fifteen companies which the companies act permits.
5. Non-executive directors can bring a broader view to the company. They bring external and wider perspective and independence to the decision making.
6. To render effective services the NEDs should be allowed to seek independent professional advice at the cost of the company.
7. The resume of the NEDs should be made available to the shareholders along with the proposal of their appointment or re-appointment.
8. Non-executive directors should be given immunity from the responsibility for compliance with procedural matters.
9. The remuneration of the non-executive directors should be commensurate with the time they devote and experience they possess.
10. Non-executive directors who are not qualified professionals (e.g. Chartered Accountants, Companies Secretaries etc.), should undergo proper training before they assume directorships.


It is submitted that we need to stress upon the quality over the quantity of independent directors. Not having a material relationship with the company doesn’t ensure that that person has independence of judgment. Directors need to understand their roles and be able to ask the “tough questions” of management, and must be of the proper caliber and have enough information at their disposal to be able to do this. Without this, the concept of an independent element on the board is reduced to a simple corporate governance “box ticking” exercise.
It is submitted with regret that so far no attempt has been made in India to provide any guidance to these independent directors about the practice that they should follow at meetings. The author submits the following for consideration:
(i)                 He should familiarize himself fully about the duties and responsibilities of a director.
(ii)               He should continuously upgrade his skills and knowledge so as not to become obsolete.
(iii)             He should familiarize himself with the business model of the company and should generally be aware about the changes in laws and regulations affecting the industry in which the company operates.
(iv)             He should carefully study the agenda papers and background notes before coming to attend the meetings.
(v)               He should participate in deliberations at the meeting, listen to the views of other directors and raise constructive questions without ever sounding like a stumbling block.
(vi)             He should support the management in the running of company’s business and at the same time monitor their conduct.
(vii)           He should always support decisions which are aimed at benefiting majority of the shareholders rather than the promoters only.
(viii)         He should uphold highest standards of integrity.
(ix)             He should satisfy himself about the integrity of financial statements and about the effectiveness of the internal control system and the risk management system of the company.
(x)               In Singapore, whenever a person is appointed as a director of the company, the registrar of companies sends a letter to him outlining the duties and responsibilities of a director under the law of that country. Perhaps in India also similar system might help.[27]
(xi)             The central government could set up a panel and identify persons who shall be considered to be IDs, provided that they are not otherwise related to the companies in which they are so appointed
(xii)           Presence of IDs in board meetings is not mandatory (however the concept paper on Companies Act necessitates presence of Ids in emergency meetings). Since the quorum for board meeting is only one third of the directors, issue could be decided without taking ids consent. Therefore it is suggested that presence of at least one ID in board meeting be made mandatory to form a quorum and decisions be taken by the board only if it has his consent. Of course if he dissents he has to give his logical reasons for that which should be recorded in the minutes. In case a decision falls due to his dissent but the board still feels that the issue should be pursued, the same could be put up to shareholders in G.M. where in the explanatory statement to the notice, dissent of Ids and reasons together with board’s reason for taking up the issue should be mentioned. Of course majority of Ids agree with the decision, dissent of one ID will not have significance.
(xiii)         Special higher remuneration package should be provided to IDs.
(xiv)         Stringent penal provisions for the IDs in the event of default.
(xv)           Protection from ouster from companies e.g. to make central government’s prior approval necessary in such a case.
(xvi)         A certificate in the annual repot signed by IDs to the effect that the consent given by them to the decisions taken shall be in the interest of the company and that they applied their conscience and mind and used their independent judgment.
(xvii)       Hence ID’s contribution in success of CG would depend on the conscience, integrity and high sense of dedication towards the code by him and the co. concerned.[28]
(xviii)     Any definition provided for ID would perhaps not solve the real problem for achieving transparency and better corporate governance. The appointment of ID pursuant to any law would not provide independence to him unless the appointee is of sound character and determines to follow certain norms or principles while discharging his functions as ID. His appointment, removal and payment of fees and other reimbursement should not depend upon the mercy of the management.[29]
(xix)         What we need is an independent organization or institute maintaining a panel of IDs after appropriate screening and training where required, so that appointment of IDs is made by such organization alone on board of companies requiring IDs. The fees and other expenses are directly paid by the organization to the IDs for attending meetings of board and committees. The companies availing services of IDs can pay for such reimbursements in the form of a levy or fee to such organization. Such organization can be part of either SEBI or MCA. The procedure of appointment f IDs can be dovetailed on the lines of appointment of auditors for government companies who are appointed by the CAG.

The ID would justify his position as such only if he can add something new and positive to the co. corpus or goodwill or efficiency.
While selecting a person as an ID, the co. should see to it that he is capable of handling his coveted position. The position should not be misused by absorbing big names retiring from the influential government posts. The actual capacity and efficiency of the proposed person is rather more important.



  1. Abhinav Gulecha, Independent Directors-Roles & Responsibilities, (2005) 52 (1) CC (Comp. Sec.) 6.
  2. C.M. Bindal, Independent director vis-à-vis government directors, [2005] 66 CLA (Mag.) 64.
  3. Davendra Soni, Tips for efficient working by Independent Director, (2005) 50 (1) CC (Comp. Sec.) 284.
  4. Dilip Kumar Sen, Governance, Directors and Accounts, SEBI& Corporate Laws-Magazine, vol. 60, 2005, p. 183.
  5. K. Balasubramanium, Independent director-reality or myth, SEBI& Corporate Laws-Magazine, vol. 60, 2005, p. 29.
  6. LVV Iyer, Key Role of Independent Directors, The Hindu, 22nd August, 2005, p. 16.
  7. Pawan Agarwalla, Can Independent Non-Executive Directors Become the Directing Mind And Will Of The Corporation? <www.>
  8. Prof CV Baxi, Grooming independent directors to be change agents, Financial Express, June 25, 2005.
  9. S. Venugopalan, Role of Independent Directors in Listed Companies, (2002) 2 Comp LJ 97.
  10. YRK Reddy, Do Outside Directors Destroy Value?, The Financial Express, 23rd July, 2005, p. 6

Books referred:
Corporate Governance Reporting (Model Formats), The Institute of Company Secretaries of India, (Taxman Publications Pvt. Ltd., New Delhi, 2003).

1.      Beejay Engineering (P.) Ltd, In re, (1983) 53 Comp Cas 918.
2.      Supreme Bank Ltd. v. P.A. Tendolkar, (1973) 43 Comp Cas 382.

  1. Course on Independent Directors, The Financial Express, 11th August2005, p. 13.
  2. Cash Rich PSUs set to miss deadline, The Economic Times, 1st august, 2005, p. 13.
  3. Directors’ Spl: Cos rush to vote for independents, The Economic Times, 29th July, 2005, p. 26
  4. Governance is now Law Driven, The Economic Times, 4th August, 2005, p. 14.
5.      Irani Committee Report on Company Law, 2005.
6.      SEBI Circular No. SEBI/CFD/DIL/CG/1/2004/12/10.
7.      SEBI Circular No. SEBI/CFD/DIL/CG/1/2005/29/3 of 29th March 2005.
8.      The Economic Times, 9th August, 2005, p. 7.

[1] Circular No. SEBI/CFD/DIL/CG/1/2004/12/10.
[2] Circular No. SEBI/CFD/DIL/CG/1/2005/29/3 of 29th March 2005.
[3] Irani Committee Report on Company Law, 2005, para 8.2.
[4] Cash Rich PSUs set to miss deadline, The Economic Times, 1st August, 2005, p. 13.
[5] Irani Committee Report on Company Law, 2005, para 8.1.
[6] LVV Iyer, Key Role of Independent Directors, The Hindu, 22nd August, 2005, p. 16.
[7] Prof CV Baxi, Grooming independent directors to be change agents, Financial Express, June 25, 2005.
[8] YRK Reddy, Do Outside Directors Destroy Value?, The Financial Express, 23rd July, 2005, p. 6
[9] Corporate Governance Reporting (Model Formats), The Institute of Company Secretaries of India, (Taxman Publications Pvt. Ltd., New Delhi, 2003), p. 127.
[10] Course on Independent Directors, The Financial Express, 11th August2005, p. 13.
[11] Cash Rich PSUs set to miss deadline, The Economic Times, 1st august, 2005, p. 13.
[12] K. Balasubramanium, Independent director-reality or myth, SEBI & Corporate Laws-Magazine, vol. 60, 2005, p. 29.
[13] S. Venugopalan, Role of Independent Directors in Listed Companies, (2002) 2 Comp LJ 97.
[14] Davendra Soni, Tips for efficient working by Independent Director, (2005) 50 (1) CC (Comp. Sec.) 284.
[15] See Directors’ Spl: Cos rush to vote for independents, The Economic Times, 29th July, 2005, p. 26.
Infosys, the benchmark in Corporate Governance, paid its eight independent directors Rs. 1.29 crore last year. “Companies have to compensate well if they want these bright independent members to add value to the company boards. Many of them carry terrific brand equity”, says Preeti Malhotra, Council Member, Institute of Company Secretary of India and member of JJ Irani Committee.

[16] Dilip Kumar Sen, Governance, Directors and Accounts, SEBI & Corporate Laws-Magazine, vol. 60, 2005,  p. 183.
[17] C.M. Bindal, Independent director vis-à-vis government directors, [2005] 66 CLA (Mag.) 64.
[18] Abhinav Gulecha, Independent Directors-Roles & Responsibilities, (2005) 52 (1) CC (Comp. Sec.) 6.
[19] (1983) 53 Comp Cas 918.
[20] (1973) 43 Comp Cas 382.
[21] The Economic Times, 9th August, 2005, p. 7.
[22] FICCI’s Suggestions on J.J.Irani Committee Report
[23] Views of Christian Moullion, Global Vice President (Assurance & Advisory), Earnst & Young Global, Governance is now Law Driven, The Economic Times, 4th August, 2005, p. 14.
[24] Cash Rich PSUs set to miss deadline, The Economic Times, 1st august, 2005, p. 13.
[25] LVV Iyer, Key Role of Independent Directors, The Hindu, 22nd August, 2005, p. 16.
[26] Pawan Agarwalla, Can Independent Non-Executive Directors Become the Directing Mind and Will of the Corporation? <www.>
[27] Dilip Kumar Sen, Governance, Directors and Accounts, SEBI & Corporate Laws-Magazine, vol. 60, 2005,  p. 183.
[28] K. Balasubramanium, Independent director-reality or myth, SEBI & Corporate Laws-Magazine, vol. 60, 2005, p. 29.
[29] C.M. Bindal, Independent director vis-à-vis government directors, [2005] 66 CLA (Mag.) 64.

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