independent directors not truly independent

8/14/2019 Independent Directors Not Truly Independent

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Submitted By:

Akash Gupta

Paper XII

Corporate Law

Are Independent Directors Truly Independent?

The term "Independent Directors" was introduced after the publicationof the Kumar Mangalam Birla committee report which resulted intointroduction of clause 49 in listing agreements. The committeementioned that 'independent directors' are those directors who apartfrom receiving directors remuneration do not have any material

pecuniary relationship or transaction with the company, itsmanagement or its subsidiaries which in the judgment of the Boardmay affect their independence of judgment. Clause 49 also prescribesthat Audit Committee should comprise of majority of independentdirectors.

With the integration of the Indian economy into the world economy,there is consensus among the corporate leaders that the corporategovernance in India should conform to international norms. Barring afew 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 thenon-executive directors has hardly any say in the management of acompany. In most of the companies, hardly any relevant information ispassed on to the directors and the meetings of the Board discuss minorand routine matters. The Board meetings are normally held once inthree months and that too for 2 to 3 hours only. It is obvious thatpromoters would prefer to appoint their cronies and faithful persons ontheir board to have minimum interference of the outside directors.

Who is an Independent Director?

All listed companies in India need to comply with the ListingAgreement which mandates that the number of independent directorsshould be at least one-third of the strength of the Board whereChairman is a non-executive director or one half where Chairman is anexecutive director. The concept of independent directors was first


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brought to India by the 1999 Kumar Mangalam Birla committee oncorporate governance. Three years later the Naresh Chandracommittee gave governance more thought. Finally, in 2004 theNarayanmurthy committee affected changes to clause 49 of the listingagreement. As it stands today, the existing company law has no

mention of independent directors. It's SEBI who defines anindependent director as a person who:

Has no material pecuniary transactions with the company or itsassociates.

Has no relationship with the promoters or senior management.

Has not been an executive with the company in the preceding 3years.

Neither is, nor has been for the past three years, a partner withan audit firm, legal firm or consulting firm to the company.

Is not a material supplier or lessee to company.

Does not own more than 2% of the companys shares.

Is over 21 years of age.

One third of a listed company's directors are required to beindependent. The erstwhile Company's (Amendment) Bill 2003 hadstated that a majority of the minimum seven directors of publiccompanies having share capital in excess of Rs. 5 crore should beindependent. The key difference between a non-executive and non-executive independent director is that the latter is forbidden to haveany pecuniary relationship with the company apart from receiving asitting fee which at the time of writing that clause was Rs. 5000/- andhas since been raised to Rs. 20,000/-.

Why have Independent Directors on the Board?

There are several distinct benefits that an independent board ofdirectors can bring to a company, ranging from long-term survival toimproved internal controls. Independent directors in the board can:

Counterbalance management weaknesses in a company.

Ensure legal and ethical behavior at the company, whilestrengthening accounting controls.

Extend the reach of a company through contacts, expertise, andaccess to debt and equity capital.

Be a source of well-conceived, binding, long-term decisions for acompany.


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authority. If they have a right to regulate, then surely they have aright to even suggest the appointment of certain directors. So, inthe case of listed companies, SEBI must have the right to nominateindependent directors, and if such legislation is brought in, a lot ofpeople good competent independent people will apply to SEBI and

ask for nominations. There are a lot of people who are prepared towork as independent directors and are truly independent becausethen they'll be accountable to SEBI, and not to the promoter.

On the contrary it can be argued that the authority may not begiven to an outside party to place a director on a company. Theremay be some merit in having an approved list which means that theSEBI could perhaps decided that there are certain qualificationswhich directors need. They could screen them for positive negativeattributes and have a panel to say that these are independentdirectors that can be on listed companies and let management

select or the nomination committee select who they want.

Then there's the question of how long an independent director canremain independent. Doesn't familiarity breed dependence? Thereare several instances where independent directors have served forseveral decades. But that's because currently the law doesn't laydown a limit. All directors are appointed for a term of three yearsand when the term expires, they can offer themselves forreappointment. The pending company bill seeks to change that bylimiting independent directors to a maximum of three terms or nineyears, after which they can stay on board but can no longer be

defined independent. Narayana Murthy, when he was on thecommittee of corporate governance, said that independent directorsshould not function on a board for more than nine years.

Hence, it can be said that the notion of independent directors isactually beneficial for a company, but only in concept. The system withwhich independent directors are appointed and regulated is the majorgap that has been put to a harsh test because of the Satyam case. Ifthe system can be improved in its core and its objective can beexpanded, there will be a far lower chance of another embarrassment

like Satyam ever happening again.

independent directors not truly independent

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