Summary: Every time a serious governance failure is discovered, the subject of corporate governance and the role of independent directors take centre stage and become the subject matter of intense media debate. The reality is that independent directors are non-executive directors and have a limited role to play in the day-to-day management of the company. This blog examines the need for regulators to strike a healthy balance between authority and responsibility. The author appeals to the regulators to re-examine the roles and responsibilities of independent directors and set realistic expectations.
Context
If there is one sector that has been in the proverbial and literal eye of the storm, it is the Indian aviation sector. There is not a single carrier, save perhaps the newest kid on the block, that has not faced at least one major crisis. The latest one has once again brought to the fore the subject of corporate governance and the role of independent directors. This issue gets debated every time a serious governance failure is discovered, and independent directors become the focus of attention of all regulators and stakeholders, including the media and the public. From having little to no understanding of the expression ‘corporate governance’ 30 years ago, to today, when everyone is an expert and has an opinion, we have come a long way.
Reality
The fundamental issue with independent directors that is often ignored is that they are ultimately non-executive directors, whose involvement and knowledge about the company is restricted to: (i) four to five board meetings per year, and (ii) the quantity and quality of information provided to them through board processes. Independent directors are entirely dependent on the management team for information necessary to make vital decisions. However, managements often withhold comprehensive information such as regulatory lapses and serious negative developments that have occurred since the last board meeting. Often, independent directors learn about such negative developments from newspaper reports.
Seventy-five percent of listed companies in India are promoter driven, and many of them view independent directors as a legal imposition rather than a valuable governance mechanism. It is also true that independent directors are imperfect individuals working with incomplete information and, being non-executive, their knowledge about the company’s business and complex operations is strictly limited. The Companies Act, 2013, has prescribed an elaborate code of conduct for independent directors, with an extensive list of duties and responsibilities that are practically impossible to fulfill. The problem is compounded by India’s uniform financial year system, which results in quarterly board meetings being held within the same one or two weeks, creating a deluge of agenda papers from various companies simultaneously. Most managements invoke unpublished price-sensitive information as grounds for withholding advance information, and quarterly financial results are provided to the directors at the eleventh hour. Independent directors are not magicians who can digest voluminous information instantaneously, yet they are expected to approve quarterly results expeditiously alongside numerous other agenda items.
Another major challenge is that most company managements do not provide structured and comprehensive orientation about their companies, businesses, and global operations to new board members. New directors must understand major policy decisions taken previously, but they lack access to board deliberations and meeting notes prior to their appointment, significantly diminishing their ability to contribute effectively to board deliberations.
Independent directors’ involvement in major M&A transactions is often superficial, even though these deals can have lasting impacts on business operations, future profitability, and company viability. In practice, independent directors are asked to approve such transactions based solely on PowerPoint presentations by investment bankers shortly before the deal closure. The author’s experience indicates that managements and investment bankers often present only the positive aspects of transactions without adequately addressing the risk factors. Empirical evidence suggests that many large M&A transactions have caused significant financial distress to companies, for which the independent directors get blamed for approving such transactions without adequate scrutiny. Independent directors often attract disproportionate media attention compared to CEOs and management teams, even though their role in such decisions is limited. Their position is especially challenging in cross-border transactions, where knowledge of foreign laws and regulations is required.
Way forward and concluding thoughts
Discharge of board duties requires sound experience, judgement, and deep intuition. Having served on several leading boards over the last three decades, the author is of the view that a director with deep intuition is among the earliest to pick up early signals of misgovernance, though he may not have proof. Due to the absence of lead independent directors in India, most directors are unable to share their discomfort about misgovernance until it is too late. There have been several academic debates about whether India should adopt the German model of two-tier boards, namely the executive board and supervisory board. However, it remains unclear whether this will solve the governance challenges, and no better system than the board of directors has been devised so far, even though regulators have been constantly debating about ways to solve governance issues plaguing India Inc.
Independent directors are retired professionals by and large, who have now realised that board directorship is no safe haven and can cause severe reputational damage if major governance lapses surface under their watch. Regulators must now seriously review the roles and responsibilities of independent directors and have realistic expectations, keeping in mind that they are only non-executive directors with limited involvement in the company. Recent SEBI and higher court rulings have held independent directors liable for governance failures and regulatory infractions of the companies, which is unfair. They need to be cognizant of the material distinction between the roles of executive and non-executive directors in the day-to-day affairs of the company. The tendency to treat them at par with executive directors has discouraged several experienced professionals from joining corporate boards as they are petrified of getting unnecessarily dragged in civil or criminal litigation and suffering reputational damage over decisions beyond their control. The Government and SEBI must undertake a thorough review of the roles and responsibilities assigned to independent directors, and establish realistic expectations regarding their contribution to corporate governance within India Inc. The current situation is a classic case of onerous responsibility without corresponding authority.
