03 Jul Corporate Governance-How lack of independence can influence Board?
Background for Independent Directors on the Board
The corporate governance culture of an organization is guided and percolated by the leadership of its Board of Directors and Key Management Personnel. In this piece of writing, we want to highlight how the effective functioning of the board is influenced by the independent directors or lack of their independence.
The Companies Act, 2013 and the Listing Regulations define an ‘independent director’ as a person who is not a promoter or employee or one of the key managerial personnel of the company or its subsidiaries. Further, the person should not have a material pecuniary relationship or transactions with the company or its subsidiaries, during the two immediate preceding financial years or during the current financial year, apart from receiving remuneration as an independent director.
Reasons for lack of Independence of Independent Directors
However, they are not truly independent because they are hired by the directors of the Nomination and Remuneration committee who are themselves influenced by the Promoter Chairman of the board who could influence selection of certain directors of their choice.
Thus the Independent directors could prefer not to upset the Board or the Chairman to ensure that their tenure on the Board remains intact. They would prefer continuation of their remuneration in the form of sitting fees and related perks. In certain cases, the independent directors along with other directors can collectively earn remuneration of upto 1% of the Net Profit as per approval from the Shareholders. So which Independent Director would like his/her tenure to be discontinued abruptly?
Even if the independent directors are removed, they are asked to tender resignations. In their resignations they are supposed to provide details of their resignation or exit, however many prefer to give personal commitments or such immaterial reasons for their resignation. This will also ensure that they don’t come across as difficult person to deal with in subsequent hiring as independent directors in any other company.
The mandatory separation of the role of Chairman and Managing Director/CEO (executive director) has been deferred for another 2 years as announced in January, 2020. As shared on CNBC TV18 by Mr. Prithvi Haldea and Mr.S. Damodaran, both former Chairman of SEBI, it is necessary that the Chairman & MD/CEO roles should not be held by the same person or related to improve corporate governance.
Deferment of the separation of roles is completely inconsistent with any corporate governance model. So if the Chairman of the board continues to be involved in the operations of the business as a Managing Director, the person will continue to wield his/her influence on the Board and on the selection of independent directors.
The independent directors should insist for documenting their voting on serious issues and matters in the minutes of the respective committee meetings and quarterly board meetings.
This will help both the statutory auditor as well as representative from the Ministry of Corporate Affairs to know the real facts on which independent director had given what opinion on strategic and legal issues. This will also protect the independent directors from legal proceedings against them.
Solutions to enforce independence by Independent Directors:
- Independent directors could provide greater details in their resignation letter in case of forced resignation so that it puts pressure on the board to amend their ways.
- Independent directors could be more courageous and vocal and insist on getting their documents and voting properly documented instead of letting the secretary to summarize it as the committee or board decision.
- In case of Serious Frauds, they should have a Hotline to report directly to SEBI, Registrar of Companies or Ministry of Corporate Affairs.
What other good corporate governance solutions would you suggest to bring more independence in the board?
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