Role of Independent Directors
The genesis of the ‘company’ marked as an epoch in the corporate history and has revolutionized the growth of business and trade all around the globe. The company was an extension of partnership with certain modifications, one of them being the limited liability concept. When the directors enter into contracts in the name and on behalf of the company, incase of a default, it is the company which is liable for it and not the directors. The attributes of the company such as separate legal entity, perpetual succession, common seal etc has made it the most preferred mode to carry on giant business ventures. In the present era, there is rarely any business or trade whether on large or small scale that is not being carried on by the corporations. The significance of companies in everyday life has augmented to a great extent and every country has a bundle of legislations specifically regulating them. In India, they are governed by the Companies Act, 1956 (as amended in 2002).
The Directors form a vital organ of the company. Even though the company has its own legal existence, they can act only through the human beings. The role of the director in a company is akin to the role of the brain in the human body, they deal with the operation and management of the company. The Directors act as managers, trustees, agents and in various other capacities for the corporate body. The Directors were recognized as agents as early as 1866 in the landmark case of Ferguson v. Wilson . The basic principles of agency govern the relations of the Directors with the company and of person dealing with company through its Directors. The Directors step into the shoes of the trustees while dealing with the company’s funds and property.
Furthermore, the Directors of a company are classified into two categories:
• Executive Directors: Executive directors are those who look into the day to day transactions of the company. They exercise greater extent of control over the company affairs.
• Non- Executive Directors: They are also in some cases called independent Directors. They are normally appointed primarily for their contribution to the strategic planning and monitor the functioning of the Company. They do not get involved in the day to day activities of the company like the Executive Directors. In addition, the Non Executive Directors may in certain circumstances contribute valuable expertise not otherwise available to the management or act as mentors to the inexperienced executives.
B. INDEPENDENT DIRECTORS: DEFINITION
Independent Directors come under the category of the Non- Executive Directors. The Companies Act however, does not define the term. In clause 49 of the listing agreement, the term Non Executive Director is defined as a person who:
a. apart from receiving Director’s remuneration, does not have any pecuniary relationships or transactions with the company, its promoters, its senior management or its holding company, its subsidiaries and associated Companies;
b. is not related to promoters or management at the Board level or at one level below the Board;
c. has not been an executive of a company in the immediately preceding three financial years;
d. is not a partner or an executive of the statutory audit firm or the internal audit firm that is associated with the company, and has not been a partner or an executive of any such firm for the last three years.
e. is not a supplier, service provider or customer of the company and
f. is not a substantial shareholder of the company, i.e. owning two percent or more of the block of voting shares.
Moreover, an Independent Director has been defined under various committee reports, a few examples being; the Cadbury Committee Report which recommended that majority of the Directors of the Company should be independent and “independent from management and free from any business or other relationship which could materially interfere with the exercise of their independent judgment. Secondly the Kumarmangalam Birla Committee Report states that “Independent Directors are directors who apart from receiving the Director’s remuneration do not have any other material pecuniary relationship or transactions with the company, its promoters, its management or its subsidiaries, which in the judgment of the board may affect their independence of judgment.”
To conclude the above stated definitions of ‘Independent Directors’ means directors who apart from receiving the remuneration, do not have any other material or pecuniary interest in the company.
NEED FOR INDEPENDENT DIRECTORS IN INDIA
An effective Board of Directors is the most essential characteristic of all successful Companies. The Non-Executive Directors play a crucial role in implementing the principles of effective corporate governance. The business activities of the corporations are crossing the national boundaries and involve shareholders and investors from all around the globe. Therefore, there is an urgent need for appointment of independent officers at the top levels of company. The need for of Independent Directors has also arisen due to gradual changes in the mindset of the investors and shareholders. A common feature of such Companies is that they have systems in place, which allow sufficient freedom to the boards and management to take decisions towards the progress of their Companies and innovation, while remaining within a framework of effective accountability. In other words they have a system of good corporate governance. It is important that insiders do not take undue advantage of their position and take unfair advantage. In order to prevent such situation, the demand for Independent Directors has risen during the recent years in India. Independent Directors can counterbalance managerial infirmities in the company. They would ensure legal and ethical behavior of the company. They are the source of well conceived long term decisions for the company. They are deemed to provide the necessary personal and technical expertise in order to abate fraud, misappropriation by the company or its directors.
C. SELECTION OF THE INDEPENDENT DIRECTORS
The process of appointing Independent Directors must be different from those of whole time directors under the Companies Act. The selection and appointment of the Independent Directors must be transparent and value based. The appointment of independent directors should be made by the company from amongst persons, who in the opinion of the company are persons with integrity, possessing relevant expertise and experience. The Companies should have independent nominations committees which would determine the qualifications and other requirements for the independent directors. The candidates should be rigorously scrutinized before making nominations to the board. It would be more appropriate if company itself prescribe the rules and regulations regarding qualifications and appointment of independent directors in their article of associations or code of corporate governance.
In considering the independence, the focus should be on whether he can truly act independently of the management i.e. qualitative independence besides his qualifications and background. They should question intelligently, debate constructively, challenge rigorously and decide dispassionately and they should have the ability to listen sensitively to the views of others, inside and outside the board. They must acquire the relevant expertise and knowledge and must be well-informed about the business.
D. ROLE OF INDEPENDENT DIRECTORS
a. Role in Corporate Governance: A corporation is the congregation of various stakeholders such as customers, employees, investors, shareholders etc. A corporation should be fair and transparent to its stakeholders in all transactions. This has become imperative in today’s globalized business world where corporations need to access global pools of capital, need to attract and retain the best human capital from various parts of the world, need to partner with vendors on mega collaborations and need to live in harmony with the community. Unless a corporation embraces and demonstrates ethical conduct, it will not be able to succeed.
Corporate governance is about the ethical conduct in business. In this regard, the managers make decisions based on a set of principles influenced by the values, context and culture of the organization. In India, the companies fill the Boards with the representatives of the promoters. These Directors may derive personal benefits rather than work for the benefit of the Company. This has posed great difficulties in the functioning of the company and is in contradiction of the principles of corporate governance. Independence of the Board is critical to ensuring that the Board fulfils its oversight role objectively and holds the management accountable to the shareholders. Therefore, ensuring some independent members on the Board can uphold corporate governance principles.
b. Protection of the Minority shareholder: The shareholders, especially the minority shareholders prefer coming to independent directors who provide transparency in respect of the disclosures in the working of the company as well as maintain a balance towards resolving conflict areas. In evaluating the board’s or management decisions in respect of employees, creditors and other suppliers of major service providers, independent directors have a significant role in protecting the stakeholders interests.
c. Risk Management and Review: It means identification, analysis and economic control of all such risks that may threaten assets, resources and earning capacity of the company. The risk may be financial, strategic or any other risks . The role of the Independent Director is to ensure that all the investment, funds, business transaction etc are heading in a right way and critically scrutinize the decision making process. .
d. Role in relation to the board: As members of Board, their role is similar to any other director; Independent Directors primarily provide inputs to all key-decisions, such as strategies, performance evaluation and risk evaluation, affecting the company. Significant contribution is expected when matters relating to the committee on which they are members are being discussed. They should ensure that the Board addresses areas of concern on the running of the company and assist them in resolving the issues harmoniously.
While the legal duties and objectives are the same as Executive Directors, the time devoted by independent Non-Executive Directors to the company’s affairs is significantly less and therefore the degree of care, skill and diligence is lower than that expected from Executive Directors, and this can be seen as a disadvantage by some. However, certain standard of care has to still be ensured. As members of the Board, an Independent Director’s should, not only comply with the code of conduct but also establish, implement, monitor its adherence by other senior management and set an example for others.
e. Improving Internal Control : The consummate internal control is the imperative requirement of the company. It activates the overall management policies and keeps them under the feasible ranges. The process of the internal control commences right from the birth of new policies by the Board of directors and continues to the bottom the organizational structure. It includes development and operation of the management policies, administrative regulations, manuals, directives and decision, internal auditing etc. The responsibility of the independent directors is to act as supervisory body and monitor the internal control system. They must identify the imperfection in the internal control system and present them before the board to find suitable solutions to obviate them.
f. Statutory Compliances: To maintain high standards in the market and excellent reputation in the public or investors, stricter adherence to the statutory laws is a pre-requisite for the company. The postulates of good corporate governance require the Companies to enforce the multiple statutes and rules and regulations given there under. This facilitates the ultimate objective of protection of investors’ interest.
All the directors including the Independent Directors owe liability equally for non compliance of laws. The Independent Directors do not have an excuse in this regard.
In India, the appointment of Independent Directors on the Board is a mandatory requirement for the listed Companies only. The non- listed Companies can still exercise their discretion whether to appoint them or not. However, the role and importance of the Independent Directors has been constantly reminded by the various committee reports on national as well as international scene. For example, in the United States, the Sarbanes Oxley Act was introduced after the stock market crash and scandals in 2002 for better governance of the Companies. It requires 50% of the Board members must be independent which reduces the threat of fraud or misappropriation by the Board members or the Companies to minimal. The sole purpose of appointing the Independent Directors act as watchdog on company’s operations and preserve the ultimate objective of good corporate governance i.e. protection of interest of investors and shareholders.
Therefore, it is recommended that government should make necessary amendments in the Companies Act, 1956 and include provision for appointment of Independent Directors for unlisted Companies as a mandatory requirement.