Is the Institution of Independent Directors Irrelevant?: A Critical Inquiry into Why the Institution Has Failed to Lead to Better Corporate Governance

Abstract

Post-Enron in 2000, the pressure on corporates to improve the corporate governance increased dramatically. Indian law makers and regulators also took measured steps to improve the governance of Indian corporates. Securities Exchange Board Of India (SEBI), the capital market regulator has been very proactive in moving ahead with a number of regulatory measures which they incorporated into the listing agreement of the companies with the respective stock exchanges where the company’s shares get listed in the form of Clause 49 of the listing agreement. The Clause 49 was implemented in phases starting 2002 (having insisted on compliance by bigger companies mandated by certain parameters relating to size) and SEBI made it mandatory for all listed companies to meet the requirements latest by December 31,2005. EBI made it mandatory even for the public sector undertakings (PSUs) which were listed on stock exchanges. Clause 49 also insists lot of changes in board and governance structure. One of the strong pillars of the modern corporate governance laws and regulations anywhere in the world is the institution called the Independent Directors (IDs). Majority of the board-structure related reforms in corporate governance revolve around this very institution. Having been in legitimate existence for more than a decade at least in developed nations like the US and UK, and almost seven years in India, a number of studies have already been conducted to ascertain the contribution and relevance of independent directors in corporate performance and governance practices. A number of corporate governance experts and watchers have written on the subjects and some of them provide evidences for the lack of any improvement in corporate performance and also in the governance practices and processes. This paper, from a conceptual framework, tries to look into the arguments and/or reasons as to why the independent directors, supposed to be the backbone of the new age governance practices and processes, have failed to make any impact leading to a general feeling that they are irrelevant and hence the laws or regulations making them mandatory on boards may be abolished and what needs to be done to resurrect the respectability that was expected from this institution. While examples from across the globe might be referred to in the process, the study basically concerns with examples and practices followed in the Indian context. This paper tries to assert that: - The concept of Independent Directors is inherently & fundamentally strong. - To advocate that it’s irrelevant will be like throwing the baby with the bathwater. The paper tries to establish that the concept failed to show impact mainly due to: - The flawed assumption about why Corporate Governance is required. - IDs not exercising their power on the board. - The Company Performance & It’s Relationship to Presence of IDs. - IDs & Commitment of Time. - IDs and Conflicts of Interests. - Real Independence & Stock ownership. - CEOs/WTDs not restrained by their boards on outside membership. - Short period used to make assessment. Based on the analysis of the reasons, it is felt that in order to strengthen the institution of Independent Directors: - IDs must exercise their power to see that the interests of the company as a separate entity are protected. - IDs shall be really independent; they should resist the temptation to compromise and must even go beyond regulations. - IDs must restrict their directorships to a very limited few.