Corporate governance is crucial for the smooth
and efficient functioning of a business, and the
driving force behind this governance is the board
of directors (referred to as “the Board”).
However, the Board faces numerous challenges when
making executive decisions, particularly when it
comes to balancing the interests of various stakeholders
in the company.
To address this issue and, amongst other things,
represent the interests of various stakeholders
including the minority shareholders, the Companies
Act, 2013 (“the Act”) introduced the
concept of independent directors and the requirement
that at least one-third of the total directors in
every public listed company are independent directors
and it also laid down requirements for their appointment
and code of conduct to be adhered to by the independent
directors. 1Further, it also mandated
that every unlisted public company crossing certain
thresholds in terms of paid up capital, turnover
or outstanding loan shall appoint at least two independent
directors.2 While unlisted companies
are mandated to comply with the requirements under
section 149 of the Act, listed companies, as well
as those intending to be listed, are obligated to
adhere to the SEBI (Listing Obligations and Disclosure
Requirements) Regulations, 2015 (“LODR Regulations”)
as well.
Why having Independent Directors
on the Board of a company is essential?
The notion of Independent Directors emerged as
a solution to the need for a diverse and unbiased
perspective in the decision-making process of companies.
By having individuals who are independent of the
company’s management and major stakeholders,
the interests of all shareholders, including minority
and small shareholders, can be better protected
and represented. An independent director is a member
of the board of a company, who does not have any
direct or indirect relationship with the company
or its promoters and is not involved in active day
to day management.3
Independent Directors act as a vital link between
the company’s management, board, and other
stakeholders, ensuring a healthy balance of power
and interests. The composition of the Board with
proper proportion of executive and independent non-executive
directors is of great importance for a sound and
smooth governance system in a company. The key role
of independent directors is to bring a fresh perspective,
provide technical business expertise, and offer
unbiased judgment during the Board’s discussions
on a wide range of issues, including strategy, risk
management, and board performance evaluation.
In accordance with the Code of Conduct, Independent
Directors are required to focus specifically on
maintaining the integrity of financial information
and overseeing related party transactions, while
also protecting the interests of minority shareholders.4
To fulfil this responsibility, the Audit Committee
of the board, which is accountable for approving
related party transactions and overseeing the financial
reporting process and accuracy of financial information,
must consist of at least two-thirds of Independent
Directors5.
The major role that independent directors play
in a company broadly includes improving the overall
corporate governance framework and risk management
processes of the company. They serve as trustees
of good corporate governance. However, the true
meaning of Independence can only be practiced as
Independence is a state of mind and depends upon
the individual’s ability to challenge the
powers that be and ask the relevant questions. Thus,
it becomes important to create an environment and
culture where Independent Directors can essentially
practice the independence.
Powers and Duties of Independent
Directors in Corporate Boards:
An independent director is an integral part of
the Board and, like other members, actively contributes
to formulating both long-term and short-term strategies
for the company. The professional qualities possessed
by independent directors play a vital role in guiding
the Board towards making accurate and efficient
decisions to achieve its objectives. Typically,
independent directors are selected from a pool of
highly capable individuals with extensive knowledge
and experience in commerce, industry, and related
domains. The company can leverage their expertise
to enhance its business strategies and overall performance.
An independent director possesses powers both
as a collective member of the Board and in their
capacity as an independent director. The Board of
a company has the right to exercise all such powers
and perform all necessary acts and actions as authorized
by the provisions of the Act, the Memorandum of
Association, the Articles of Association, or any
applicable regulations, as long as they do not contradict
these governing documents. However, certain powers
can only be exercised either under the Act or by
the company in a general meeting, as stated in the
memorandum or articles.
The duties of an independent director as enlisted
in the Act6 encompass a wide range of
responsibilities to uphold the principles of corporate
governance and safeguard the interests of the company
and its stakeholders. They should continuously update
their skills and knowledge, seeking professional
advice when needed. Active participation in board
and committee meetings is essential, and they should
attend general meetings too.
Further as per the Act, Independent directors
must address concerns about the company’s
operations, ensure proper deliberations before approving
related party transactions, and ensure the existence
of a functional vigil mechanism. Reporting unethical
behaviour, fraud, or violations of the company’s
code of conduct is part of their responsibility.
They must act within their authority, protecting
the company’s legitimate interests and not
disclose confidential information without proper
approval or legal requirement. Overall, their role
is to contribute constructively to the company’s
growth while maintaining ethical standards and transparency.7
Strategic Role of Independent
Directors:
The presence of an adequate number of Independent
Directors on the board serves several purposes.
Firstly, their past experiences and distinguished
expertise enable them to contribute valuable wisdom
and professional domain knowledge. Being external
to the company’s payroll, they can adopt an
impartial perspective solely focused on enhancing
stakeholder value, free from any conflicts of interest.
Consequently, they possess the authority to challenge
management decisions that they perceive as detrimental
to the company and/or its stakeholders.
Independent Directors maintain their independence
and are not subordinate to the Chairman, who heads
the board, or to the Managing Director & CEO,
who lead the management. Their role does not involve
any reporting relationship with anyone, allowing
them to freely exercise their influence in board
decisions. They have the option to abstain from
voting on an agenda or express dissent if needed.
Despite the significance of their role, certain
companies have observed a breach in implementing
corporate governance norms, leading to repeated
corporate fiascos as Independent Directors fail
to uphold the integrity of their positions. In the
below paras, we highlight the strategic role expected
from an Independent Directors:
Impartiality and Unbiased
Judgment: Independent directors are entrusted
with providing objective and unbiased insights
into the company’s operations, strategies,
and financial matters. Their impartiality is
crucial in ensuring that decisions are made
in the best interest of all stakeholders.
Corporate Governance:
Independent directors act as custodians of corporate
governance, overseeing that the company adheres
to the highest standards of transparency, accountability,
and compliance with relevant laws and regulations.
Strategic Decision-making:
Drawing on their expertise and experience, independent
directors actively participate in board discussions
and contribute to strategic decision-making.
They offer valuable perspectives on critical
issues faced by the company.
Safeguarding Minority
Shareholders: Independent directors must fulfil
their duties and strive to enhance transparency
in the company’s operations. As shareholders,
particularly minority shareholders, are often
not equipped to scrutinize the company’s
affairs, they rely on independent directors
to offer them the desired transparency and safeguard
their interests by ensuring that their rights
are protected, and they are treated fairly.
Oversight and Risk
Management: They oversee the management’s
performance, ensuring effective risk management
practices and identifying potential risks to
the company’s sustainability.
Nomination and Remuneration
Committees: Independent directors also form
part of the nomination and remuneration committees,
which are responsible for identifying and appointing
suitable candidates for key positions and setting
executive compensation.
Audit Committee: As
majority of the members of the Audit Committee
are independent directors, they play a very
important role in ensuring good corporate governance
in the company. Being independent, they can
expressly review and monitor critical audit
and financial transactions including related
party transactions aspects for the benefits
of the company
Factors Challenging Independence
of Independent Directors:
Independent directors face significant challenges
in terms of governance and maintaining their independence.
To be effective in their role, an independent director
must possess a deep understanding of the specific
industry in which the company operates. Each industry
has its unique features, statutory requirements,
and risk factors that demand specialized knowledge.
Additionally, being aware of the performance parameters
of other market players within the same industry
is crucial.
Furthermore, certain industries are subject to
specific economic statutes, and an independent director
must have a fair understanding of these provisions,
in addition to the fundamental corporate laws. However,
there are concerns that the current framework places
excessive reliance on the executive management for
information, making it difficult for independent
directors to fulfil their responsibilities adequately.
While the Act intended to promote the importance
and contribution of independent directors, we can
argue that it may have overreached itself, creating
complexities that hinder their effective functioning.
Certain provisions of the Act tend to impose rigid
do’s and don’ts, potentially limiting
the decision-making autonomy of independent directors.
There is a need for improvements to raise governance
standards. After several years of the Act’s
implementation, there remains ample scope to understand
and address these challenges. Identifying the obstacles
faced by independent directors and corporates in
complying with the law is essential. Moreover, exploring
the incentives available to independent directors
to ensure adherence to the Act’s intent will
be valuable in enhancing corporate governance to
higher standards.
Ties with Promoters
or Management: Despite the prescribed independence
criteria, some Independent Directors may have
past or even ongoing associations with the company's
promoters or management. While these relationships
may not be classified as “material”
under the legal definition, they could still
impact the director's judgment and decision-making.
Even seemingly innocuous ties can impact an
independent director's decision-making process.
Subconscious biases, loyalties, or undue familiarity
might inadvertently sway judgment, potentially
diluting the rigor and neutrality expected of
their role. The director might find it challenging
to raise tough questions or challenge management
when necessary, fearing strained relationships
or perceived conflicts.
Multiple Directorships:
Independent Directors often serve on the boards
of several companies, which raises concerns
about their ability to devote enough time and
attention to each company. In some cases, this
could even lead to a conflict of interest, particularly
when issues arise involving two or more companies
in which they hold directorships.
Fee Dependency: Independent
Directors are compensated for their services,
and this remuneration could influence their
decisions. The fear of losing lucrative directorship
fees might deter them from taking strong or
inconvenient stands on critical matters that
might displease the management or promoters.
Lack of Expertise:
Appointing Independent Directors who lack domain
expertise or relevant industry experience may
hinder their ability to comprehend complex business
decisions fully. This can limit their effectiveness
in offering valuable insights and contributing
to crucial discussions.
Insider Information:
In some instances, Independent Directors may
inadvertently receive sensitive or confidential
information that could compromise their independence.
The potential for such information leaks raises
questions about how well companies can safeguard
such data.
How can we enhance the strength
of independent directors?
As businesses face mounting challenges and complex
issues, it becomes paramount to explore ways to
bolster the strength and effectiveness of independent
directors. In There are various strategies and initiatives
that can empower independent directors, equipping
them to play a more impactful role in shaping the
trajectory of modern corporations. From refining
selection processes to enhancing training and accountability
measures, we explore the path towards a robust and
resilient system of corporate oversight.
Enhance Independence
and corresponding Authority: Policymakers and
regulators should establish robust criteria
for determining the independence of directors.
Independent Directors bear significant responsibility,
yet the authority bestowed upon them is comparatively
limited. Consequently, there arises a necessity
to augment the authority granted to these Independent
Directors. The same can be achieved by appointing
independent directors with a diverse range of
expertise and professional backgrounds and establishing
a comprehensive board charter that outlines
the roles, responsibilities, and authority of
independent directors. Further, the company
needs to ensure that independent directors have
timely access to accurate and relevant information
about the company's operations, financials,
risks, and performance. Access to information
empowers them to make informed judgments and
actively participate in discussions.
Improvement in selection
process: While there is an online data
bank of the independent directors and the requirement
to clear online proficiency test, most are hand-picked
by promoters. An inference consequently arises
that an independent director cannot be as independent
as they are expected to be.
Regular Assessment:
Regular evaluations of Independent Directors’
performance, both individually and collectively,
can help identify any potential conflicts of
interest or shortcomings in fulfilling their
responsibilities.
Continuous Education:
Companies should invest in continuous training
and development programs for Independent Directors
to keep them updated on industry trends, best
practices, and changing regulatory landscapes.
These programs should cover corporate governance
best practices, legal and regulatory requirements,
risk management, ethics, and sustainability.
Encourage Diversity:
Promoting diversity among Independent Directors,
including gender, age, and professional backgrounds,
can bring a broader range of perspectives to
the boardroom and reduce groupthink.
Empower Whistle-blower
Mechanisms: Establishing robust and confidential
whistle-blower mechanisms can encourage employees
and stakeholders to report concerns about the
company’s practices without fear of retaliation.
Conclusion:
As the business landscape evolves, the role of
Independent Directors will become significantly
more instrumental in shaping the corporate world’s
ethical and responsible future. There is a need
for increased rigor in the screening process to
ensure the suitability of Independent Directors
for board positions. Comprehensive training and
grooming should be provided to them to ensure the
proper implementation of Corporate Governance principles
in both letter and spirit
While the concept of Independent Directors is
a step in the right direction to strengthen corporate
governance, ensuring their true independence remains
a practical challenge. Striking the right balance
between independence and expertise is crucial to
harness their full potential as watchdogs of corporate
integrity. By addressing the factors that challenge
independence and implementing measures to strengthen
their autonomy, companies can uphold the credibility
of Independent Directors, bolster transparency,
and enhance stakeholders’ trust in the corporate
system.
The role of Independent Directors should be redefined
and utilized as an effective mechanism to protect
the long-term sustainability of organizations. By
doing so, the corporate sector can prevent governance
issues that tarnish the image of the entire business
ecosystem and instead ensure a stronger foundation
for a transparent and accountable corporate environment.
The objectives of corporate governance cannot
be effectively met without the inclusion of independent
directors in the larger scheme of things. This becomes
even more convincing in the context of an escalating
Indian economy with unprecedented amounts of funds
flowing into companies from within and outside the
country.
As start-ups aspire to disrupt industries and
redefine norms, the strategic appointment of independent
directors can be the catalyst that propels them
toward sustainable success. While start-ups may
not be bound by regulatory mandates to appoint independent
directors, the voluntary inclusion of such seasoned
professionals can catalyse a transformative journey.
These directors infuse start-ups with expertise,
drive a culture of governance, and send compelling
signals of commitment to stakeholders.
Further, the decision to appoint independent
directors sends powerful signals that reverberate
through the start-up ecosystem. It communicates
a start-up’s maturity and readiness to embrace
external counsel, demonstrating a willingness to
learn, adapt, and thrive. This move resonates with
potential investors, who often seek evidence of
a robust governance structure as a sign of prudent
management. Additionally, the presence of independent
directors can enhance a start-up’s credibility
in negotiations, partnerships, and regulatory interactions,
positioning the company as a reliable and credible
player in the market.
