Professional Documents
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insight
revathy@crisil.com
August 2005
companies. This article explores the issue of a Boards independence.
It attempts to answer questions on how much independence a Board
should have, how the role of independent directors is evolving, and
how a company can benefit from independent directors.
A Boards independence implies the degree to which its members are
non-biased and free from control by the management or other
influential groups. A Boards independence is vital for effective
functioning of a company, since it leads to unbiased decision making,
which benefits the shareholders. One way to achieve this independence
is to induct independent directors on the Board. Independent directors
bring with them specialised knowledge, skills, experience, and an
unbiased perspective of the companys business. The quality and
effectiveness of the Board depend greatly on the value that independent
directors bring with them. This value could be in terms of objectivity to
the Boards functioning, questioning of the managements intent and
promotion of healthy and meaningful discussions during Board
meetings.
Though it is extremely important to have independent directors on the
Board, it is also essential to realise that they are not solely responsible
for the effective and unbiased functioning of the Board. It is the
responsibility of the entire Board to make sure that the company is
being run in keeping with the best corporate governance practices. The
members, whether independent or executive, need to bring to the Board
their professional expertise and work with the goal of improving
shareholder wealth over the long term.
How much independence leads to good governance?
A Board needs to have the right mix of directors who, as a collective
body, are able to govern the company effectively. The shareholders
and a companys Board are most equipped to decide the right mix of
directors. No single code, guideline, or regulation can accurately
determine the right mix for all companies. This is because every
company is unique in size, operations, growth objectives, and
ownership pattern. This, however, does not mean total flexibility and
freedom without responsibility and accountability. Regulation has to
ensure that a certain framework is in place, so that companies can
operate within that framework while having flexibility in deciding the
Boards structure and composition.
Undoubtedly, listed companies should have independent Board
members, since this leads to better Board functioning, imparting
independence. The moot point is how many independent directors a
company should have. Should the shareholding pattern, ownership of
August 2005
Spirit of independence Enforcement is a challenge
The Irani Committee has rightly defined the qualities and the attributes
of independent directors in detail. The definition of an independent
director, though more than illustrative, is not exhaustive. In reality,
there could be instances of a director complying with all the
requirements of this definition, but still not functioning as an
independent director. For example, an ex-employee who has retired
from a company a year back may still have preferences and linkages
with the management. Again, in the case of a joint venture company,
an ex-CEO of a joint venture partner who is appointed as an
independent director after a year may still act in concert with the other
directors representing the joint venture partner on the Board. Three
themes arise from this discussion:
While many will agree on most of the points above, the most likely
disagreement will be on the point of remuneration. The common belief
is that the lower the remuneration from a company, the higher the
level of independence of a director. On the other hand, it may be
argued that unless a reasonable monetary benefit is promised to
independent directors, a company may not be able to attract the best
talents, despite the popularity and performance of the company.
Remuneration becomes a significant factor, especially since the
company stands to benefit from the valuable executive time of the
respective director. As long as the compensation from a company
does not infringe on the concept and practice of independence, there
should be no ceiling on issues like sitting fees. However, there could
be an overall ceiling on the compensation (including stock options,
August 2005
performance linked benefits, shareholding, etc.) to independent
directors, which can be decided by the company itself and stated
upfront in the public domain. A company and its shareholders are
best suited to decide this ceiling, which should be disclosed adequately
in the public domain.
Another significant tool to motivate and get the best out of independent
directors is to assess the role and contribution of the directors towards
the Board and the company they serve. The nature of self-assessment
or peer group assessment could be designed to ensure the attainment
of the objective, without causing embarrassment to the directors. When
an independent director has to actually record his contribution and
effective participation at Board meetings, he or she will most certainly
be motivated to do more and will emerge as a better director.
The changing role of independent directors
The nature and extent of association of independent directors with the
company makes their role very different from that of executive directors.
This brings about a distinction in the rights, duties, and liabilities of
an independent director. Having said that, it is appropriate to look at
the way the role of independent directors has been changing in the
recent past ever since corporate scandals broke out in U.S.A., Europe,
and other parts of the world. Greater responsibility is being vested in
them from the corporate governance angle. The responsibilities include: