“(Coote) got me in as a director of something or other. Very good business for me – nothing to do except go down to the City once or twice a year to one of those hotel places – Cannon Street of Liverpool Street – and sit around a table where they have some very nice new blotting paper. Then Coote or some clever Johnny makes a speech simply bristling with figures, but fortunately you needn’t listen to it – and I can tell you, you often get a jolly good lunch out of it!”

Agatha Christie in The Seven Dials Mystery (1929), Collins; pp.83-84

“One [ceremonial aspect] is a board of directors selected by management, fully subordinate to management but heard as the voice of the shareholders. It includes men …. who need only a passing knowledge of the enterprise; with rare exceptions, they are reliably acquiescent. Given a fee and some food, the directors are routinely informed by management on what has been decided or is already known. Approval is assumed … “

John Kenneth Galbraith in The Economics of Innocent
Fraud (2004),Houghton Mifflin; p.27

Being on the board of a company used to be fun. A very satisfying and often extremely remunerative digression from the managerial routine. For the full time executive, it was a mark of recognition and reward for the good work done or for what the person is perceived to be potentially capable of delivering. For the non-executive, “Independent” director, again a signal of having “arrived”, a welcome transition to asking questions rather than having to answer them. The more such directorships, the merrier and more money in the bank, very valuable especially in the “retired” phase of one’s professional life!

Regrettably, those good old days seem to be behind us. One knew there were responsibilities to the shareholders and to the company and so on, but they were all in theory. In case of any untoward problems, outside directors were always treated with sympathetic understanding:they were not in day-to-day management, they attended meetings maybe five or six times a year and mostly depended upon management to tell them what was happening in the company, and so on. But not anymore. While their non-executive status is appreciated, they are now being questioned not only on what they knew (limited as it may be) but also on what they ought to have known (by asking questions and probing answers with their experience and expertise). The legal liabilities have always been there though they may not have been spelt out in as much detail and rigour as they arenow, or as much punishment for non-compliance as they are now increasingly being prescribed. And yes, there is also the new breed of aggressive and self-righteous media asking those uncomfortable questions you were never used to in the good old decorous days!

The Institution of Independent Directors

It is probably necessary to get back to the fundamentals leading to the concept of Independent Directors on company boards. From an organisational structure perspective, in a listed company there are three actors: the shareholders, the executive management, and in between them the board of directors who are the shareholders’ representatives to protect their and other prescribed stakeholders’ interests. The board has three roles to play: first, the Contributing role where with their domain expertise, the challenge and guide management in the formulation and implementation of approved strategies and policies; the second is the Counselling role where with their wisdom directors mentor and counsel management where required or necessary to further the interests of the company and its constituencies; and the third is the Controlling role where the board monitors management performance in creating wealth according to approved plans and values, coping with risks involved, and transmitting the created wealth to, (or holding for) the rightful claimants, namely the shareholders, with minimum leakage in the process.

While all directors can and do play these roles to the best of their ability, the third role of Controlling in particular calls for objectivity and exercise of sound judgement to ensure that the actions and decisions are in the best interest of the company, its shareholders, and other applicable stakeholders. Human nature being what it is, one cannot rule out attempts by the executive management to put their personal interests ahead of the interests of the company and its shareholders. This is an area where independent directors primarily required to pay attention to; in legal parlance, they owe a fiduciary obligation to the shareholders who elected them to the board in the first place.

The Controlled Companies Challenge

While this governance platform is the common template for board governance, the situation gets muddied when some of the shareholders also operate as the executive, as happens in the case of Controlled Companies defined as those entities which are managed by controlling shareholders, whether they have a majority or even a substantial voting equity or not. It becomes imperative in such cases that the board and especially its independent directors play their surveillance role effectively to prevent any extortion of created wealth by the managing shareholders. In effect, the non-controlling shareholders (who I prefer to label as absentee shareholders since they are absent in the management of the company’s affairs, instead of the usual title of minority shareholders though in several companies they may actually be majority shareholders!) need protection not only from greedy or unscrupulous managers (as in the case of dispersed ownership geographies like the US and the UK) but also from the potential misdemeanours of the controlling shareholders (in case of concentrated ownership geographies like India). This is easier said than done for the obvious reason that the controlling shareholders play such an important role in appointing independent directors on their boards; independent directors (with rare and courageous exceptions) in their personal interest may not wish to antagonise their benefactors (following the dictum of not biting the hand that feeds!).

This is the bullet independent directors have to bite in the war (in their own minds) between the right and the wrong. Not many independent directors have been able to stick to the courage of their convictions and do their duty (both legal and moral) by the people who had trusted for doing precisely that. The consequences of failing to discharge their fiduciary obligations are there all over the world including in India for everyone to see. No wonder then, this great innovative institution of independent directors is universally accused of being ineffective in the performance of its stated role of safeguarding the interests of the company, its shareholders, and other stakeholders. Consider just a few illustrative high-profile cases reported since the turn of this century:

• Enron in the US –large scale manipulations of the financials, moving major liabilities of the balance sheet through special purpose vehicles, huge conflicts of interest involving top executives, and so on. A five-star board of directors with impeccable expertise and invaluable experience, all to no avail.
• Lehman Bros in the US – constantly exceeding risk levels laid down by the board, underwriting toxic mortgages and selling them bundled to further players in the business chain, window-dressing of financials to understate over-stretched financial leverage levels, not heeding whistle blower alarms, and so on. Once again, an excellent board of independent directors, to no avail.
• Satyam Computers, closer home in India- systematic manipulations of financials over several years, fictitious bank balances and head counts, de-risking attempt by merging with (controller-owned) entities with similar or higher risk profiles)!), and so on. Outstanding board of directors of internationally acclaimed academics and technology innovators, to what purpose?
• Public and Private sector banks in India – dubious lending practices, ever-greening of suspect loans, non-heeding of Reserve Bank’s oversight counsel, non-provisioning of bad loans, and so on – non-performing boards?
• Infrastructure Leasing and Financial Services – currently unfolding story of irresponsible and self-dealing loans and transactions.

These are some instances that have been exposed, one may never know how many more such cases are under the surface, like the invisible mass of floating icebergs. And yet, as Mark Antony would say of Julius Caesar’s killers, they are all “honourable men!”

Looking Ahead

All however, is not lost. As explained in a recent Quarterly Briefing of NSE’s Centre for Excellence in Corporate Governance (April 2019), although Hairpin Bends are ahead for Independent Directors to navigate with caution, conscientious individuals can still survive and contribute their companies’ board governance. Following are some of the steps that may be helpful:

To be actioned by the Regulators

1. Independent directors should be elected by a majority of voting shareholders and a majority of total non-controlling shareholders. To illustrate: In addition to getting a majority of votes of all shareholders participating in person or proxy or by electronic voting, the winning director should also get a majority of all the non-controlling votes; for example, if non-controlling votes constitute 60% of the total (the other 40% being controlling shareholders’), then at least one half of the non-controlling shareholders should approve the appointment. This would hopefully minimise the chances of controllers getting their supporters and sympathisers as directors on the board, and make the selection more broad-based.
2. Getting independent directors on the board is only one part of the equation; the other part is to ensure that their voice is heard and heeded on all key matters. This can likely be achieved by modifying quorum requirement to ensure at least one half of all the independent directors are present at the meetings; prescribing support of at least one half of independent directors for certain key resolutions; and so on.

 

To be actioned by Independent Directors

3. Due diligence before accepting any offer of ID position. Who conveys the invitation is an important signal of the value and respect the company attaches to the position. Generally, it should be the Chairman, or the Managing Director, or other Seniopr Director on the board.
4. Consider if the remuneration proposed is reasonable for the size and type of the company. Excessive remuneration outside industry range may not always be free from expectations of unequivocal support to the management or controllers.
5. Review the offered remuneration as a proportion of your total income from all sources. If it is too large a proportion, the chances are behaviourally it might impair your independence of judgement.
6. Theoretically all directors are equal but because of experience or other factors, some may feel more important than others. Do not let this bog you down if your views on any matter happen to differ from such dominant colleagues. Being polite and yet firm that is a trait that especially younger and newer directors ought to develop consciously.
7. Negotiating skills are important in a body like board of directors. It is useful to realise winning wars is more important than winning battles. Tactical retreat on immaterial items may well be a good strategy if it helps in winning on larger issues.
8. Never ask for or accept perquisites or facilities from the company which are not part of the members’ approved package. Avoid even unwittingly getting obligated to the management or controllers: there are no free lunches in the material world, there will be times when reciprocal support may be expected even if your conscience militates against it.
9. Devote adequate time and effort to the job as an ID. Not only in reviewing all papers provided but also from other sources about the industry, technology, competition, market performance, and so on. Exclusive dependence on the executive for bringing you up to speed is not a good strategy for success as an ID.