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Role of Independent Director in Corporate Governance

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    Role of independent director in corporate governance

    Contents

    INTRODUCTION

    “Corporate Governance is the system by which companies are directed and controlled.”1

    Corporate governance is integral to the existence of a company. It inspires and strengthens investor confidence by ensuring company’s commitment to higher growth and profits. The overall objectives of governance should be to maximize long term value and shareholders’ wealth.

    Corporate governance is possible only by refurbishing the governing organ i.e. is board. The Board of Directors are crucial part of corporate structure. They are the guardians of their respective enterprise as also the protectors of the shareholders’ interest. They are the link between suppliers of capital (shareholders) as well as those who manage capital (management) to create value. In law, the board owes a strict fiduciary duty to ensure that the company is run in the long term interest of owners.

    Management consultant McKinsey published in 2002 their annual Global Investor Opinion Survey2 suggesting that the companies with high corporate governance standards were worth significantly more to investors than those with loose governance standard- even if the comparison was between companies with identical business and financial profiles. For the purpose of the survey, well- governed companies were defined as those having: a. A significant amount of “independent director” including financial specialist on the board, b. A culture of broad disclosure.

    c. Strong right and equal treatment for shareholder.
    Thus, to perform effectively, it is important for the board to have a substantial degree of independence from management. Predominantly, independence of board lies at the core of corporate governance.

    When the goal of management come in conflict with the interest of the shareholders, the independent segment in the Board of Director must be able to stand up and discharge its fiduciary oversight functions. The inclusion of independence directors enhance objectivity and accountability. It is highly believed that a board comprising of majority of independent director can bring about progress.

    The NACD Blue Ribbon Commission on Director Professionalism3 has suggested as follows: a. That the board should define and disclose to shareholders a definition of ‘independent director’ and b. That the board should require the candidates to disclose all existing business relationships between them or their employer and the board’s company.

    INDEPENDENT DIRECTOR

    The role of independent director is drawing attention especially in the context of public companies. This class of DIRECTOR ARE NOT EXECUTIVE DIRECTOR, and who don’t participate in the day to day activity of the company.

    Independent director is defined as an entity who don’t have a material pecuniary relationship or transaction with the company, its promoters, its management and its subsidiaries, which in attention of the board may affect the independence of judgment.4

    The term ‘independent’ mean one who is not subject to control or influence of another, not dependent or contingent on something else.5

    As per Clause 49 of the Listing Agreement has defined ‘independent directors’ to mean directors who apart from receiving director’s remuneration do not have any material pecuniary relationship or transactions with the company, its promoters, its management or its subsidiaries which in judgment of the board affect independence of judgment of the director.

    COMPOSITION OF BOARD

    As per clause 49-1(A) of Listing Agreement there shall not be less than 50% Independent directors the board.

    Where the chairman of the board is a non-executive director, at least one third of the board should comprise of independent director and incase he is an executive director, at least half of the board should comprise of independent director.

    ATTRIBUTES OF INDEPENDENT DIRECTORS

    The different attribute of the independent directors are as follows: a. Has not been employed by the company in executive capacity with the past five6 years. b. Is not related to promoters or the persons occupying management position at the board level or at one level below the board. c. Is not an executive or was not partner or an executive during the preceding three, or the following:

    i. The statutory audit firm or the internal firm that is associated with the company, ii. The legal firms and consulting firm that have a material association with the company.

    d. Is not a material supplier, service provider or customer or s lessor or lessee of the company, which any affect independence of the director. e. And should not be substantial shareholder of the company, i.e., owing two per cent or more of the block of voting shares. f. Is not affiliated with significant customer, vendor or supplier of the company. g. Should not be a nominee director.

    h. Has not been any type of director in any company for more than nine years. i. Should not be less than 21 years.7

    According to Naresh Chandra Committee an employee, executive director or nominee of any bank, financial institution, corporation, or trustee of debenture or bond holder who is normally called a nominee director will be excluded from the pool of directors in the determination of independent directors.

    This requirement are applicable to all public companies that have capital and free reserve of Rs. 100 million or turnover of Rs. 500 million. However it is not applicable to unlisted companies, which do not have more than 50 shareholder and are without any debt from public, bank and financial institution. According to current norms, institutional directors on the board of companies should be considered as independent directors whether the institution is an investing institution or a lending institution.8 They shall have the same right, duties and responsibilities as other member of the board and as prescribed by the Companies Act and Listing norms.

    LIABILITY

    If a company fails to comply with the provision of Clause 49, the company can be delisted from the Stock Exchange Listing Agreement. It can also attract financial penalties by government.9

    Other than this there are many other provisions that imposes liability on the directors if they fails to comply with the duties imposed upon them. Like for example- The SEBI Regulations, 2003 u/s 4 and u/s 3 various prohibitions is in imposed for fraudulent and unfair trade practices and prohibition of dealing with the securities in a fraudulent manner respectively.

    The provisions of IPC are applicable when director causes breach of trust10 and has been held liable for cheating11. Under companies Act, 1956 independent director is consider at par with the other type of director. The independent director is bestow with certain duties, responsibilities and liabilities as he being on the Boards. They undergo the same liability as the executive directors.

    The law doesn’t make any distinction of the directors who run the day to day management of the company and the non-executive directors who attend the meeting once in a while A director may however be held liable for criminal violation and a person can be arrested for the same and can be convicted. It is after the Satyam incident, that the liability of the directors have increased.12

    ROLE AND IMPORTANCE OF INDEPENDENT DIRECTOR

    Governance is like ‘steering’ a company in the right directions. The former SEBI Chairman, Mr. Damodaran13, described corporate governance as a continuing process beyond the scope of mere legislation. From this he wanted to convey is that legislative requirement should be considered as the starting point. Companies must follow these regulation not because of the fear of section, but because the absence of such governance will led into failure and true accountability cannot be achieved. In his address, the former Chairman defined independent director as functionaries who contribute to the board with their divergent views.

    Independent director are known to bring an objective view to the board’s deliberations. They ensure that the decisions taken will not be the interest of one individual or in special interest of a particular group. They act as the guardian of the shareholders and stakeholders. They contribute significantly to the decision making process of the board.

    They play an important role in the area where the interest of management, the company and the shareholders diverge or are in conflict. They play a big role in the progress of the company. Independent directors are considered as both a safeguard and a significant source of competitive advantage. The inclusion of independent director adds a more knowledgeable and professional. The capabilities required in an independent director include financial and marketing literacy, mentoring capabilities independent of mind, etc.

    Primarily independent directors are required to perform the following important role- i. Balancing the conflicting interest of the stakeholders.
    ii. Fulfill a useful role I succession planning.
    iii. Provide independent judgment and wider perspective.

    Independent Director is appointed by the board primarily for their contribution to the development of the company’s strategy. The Cadbury Committee Report, 1992 stated that non – executive director should bring independent judgment to bear on issues of strategy, performance, resources including key appointment and standards of conduct.14 Hampel Committee Report pointed out that most of the non-executive directors are the executives or former executives of the other companies. This experience is helpful for them in constructive policy making and also in monitoring role. Independent directors are appointed for their technical knowledge, their knowledge relating to overseas market and their political contracts.

    The Derek Higgs Committee Report, 200215 pointed out that effective and robust board are essential features of successful company. It’s also stated that, non-executive directors have a crucial part to play within the unitary boards. The key to non- executive director effectiveness lies much in his behavior and relationships as structures and processes. Blue Ribbon Committees has also laid considerable stress on the role of independent directors in bringing an independent judgment. Independent directors play an important role in corporate governance and the roles are as follows:-

    i. Independent directors contribute to the development of company strategy. ii. They should scrutinize management performance.
    iii. Independent directors should be stratified that financial information is accurate and ensure that robust risk management is in place. iv. They should meet at least one year without the Chairman and executive directors. v. Independent directors must have a greater exposure to the shareholders. vi. Balancing of contracting interest of stakeholders.

    RESPONSIBILITY OF INDEPENDENT DIRECTOR

    1. Independent Director must periodically review legal compliance report by the company. In the event of any proceeding against an independent director in relation with the affairs of the company, no defense shall be allowed on the ground that the independent director was unaware of his responsibility 2. To function properly as a board member and also as member of various committees like, the Audit Committee, the Shareholder Grievance Committee and the Remuneration Committee of the Company. To build up the spirit of good corporate governance. 3. A director shall be a member of more than ten committees or act as a Chairman of more than five committees in a company. 4. There should be mandatory annual requirement for every director to inform the company about the committees positions which he occupies in the other companies and shall notify, the changes as and when they take place. 5. At least one independent director of a holding company must be a director on the Board of Directors of a subsidiary company.

    Independent director add up to the true spirit of corporate governance. It is not through legislation alone that an effective frame work and independence of the board can be ensured. The board of director should make some efforts to promote transparent, objective and independent discussion and decision, and then only the true objective of the independent director can be achieved. Independent director contribute to the board by challenging the policy decisions and by guiding them to take proper decisions and in implementing them. Sarbanes Oxley Act, 200216 indicates that the regulations have improved corporate governance standard. Recent research also show that companies do benefit with higher accountability and it automatically increases investor’s confidence. STRENGTHING THE SITUATION OF INDEPENDENT DIRTECTOR

    The law can only prescribe the criteria for determining the independence of a particular director. The independent director should not be chosen, merely to comply with the statutory requirement.

    STRATEGIC MANAGEMENT

    With the increase in the intensity of global competition, there must be some independent director capable of commenting on the company’s business strategies and particularly the strengths, the weakness, opportunities and threats. Despite major strides in corporate governance and disclosure in the last few years, most companies including those listed in the Groups A and B-1, still do not have enough independent directors capable of contributing in this field. 17

    FINANCIAL EXPERTISE

    One to three of the independent directors ought to possess financial expertise in the sense of the capability to carefully possess financial statement, notes on accounts, significant Accounting policies,
    qualifications besides the capacity to question audit finding. They should be comfortable in attending Audit Committee meeting and marking value addition.

    MAJOR SCANDAL IN CORPORATE INDIA

    SATYAM SCAM

    Satyam scam is one of the most shocking scams that India has witnessed. Satyam mean truth in Sanskrit. B. Ramalinga Raju, the founder of and the chairman of the Satyam Computer Services, confessed accounting fraud in the books of account which estimated around Rs. 14,000 crore.18 Raju accepted the fabrication of around US$1 billion amount in the Balance Sheet of the Company. I this scam, the managing director of Satyam, Raju, and two auditor of the PWC and the chief officer of Satyam were arrested and charged with the offence of Criminal breach of trust, cheating, criminal conspiracy falsification of records and forgery under IPC.19 Investigation was launched by various authorities like the SEBI, MCA, The Government of India and Serious Fraud Investigation Office.20

    Going to details as to the governance of the company, the board consisted on 6 out of 9 independent director on the board. Few to be counted, included jury of eminent members like accounting professor from the Prof. Krishna Palepu Harvard Business Schools, Prof. M. Rammohan Rao the dean of Indian School of Business and the former Indian Cabinet Secretary, Mr T.R. Prasad, and the father of Pentium chip, Mr Vinod Dham and others. These directors had notably escaped the conviction in the Satyam Scandal. These director should have been held accountable for the failure to perform their duty and detect such a large fraud and for the undisputed approval for acquiring the two firms that were controlled by Satyam’s Promoters.21

    The companies audit were managed by one the big four accounting company. Ironically the company had also been awarded the title for “Best Corporate Governance Practices.”22

    POST SATYAM SCAM

    The revelation of corporate governance irregularities which came to light with the investigations into the Satyam scam have given an impetus to contemporary debate on independent directors and the need to improve corporate governance structures in India. The role of the independent directors of Satyam came into question when the investors and regulators questioned a bid by the Satyam founder B. Ramalinga Raju to acquire a firm promoted by his kin. In the immediate aftermath of the Satyam fiasco, nearly 350 independent directors resigned from their positions across India. The resignation of the independent directors signals to the investors that all is not well within the board. This is perhaps attributed to the fact that a considerable proportion of independent directors do not feel confident of facing the consequences of the conduct of their companies.

    This may be because they either have knowledge of illegal conduct and have failed to influence the board to counter-act effectively or because they are not in control of the happenings of the company – neither of the two reflect positively for the present state of corporate affairs in India. It also brings to the fore another paradox – can independent directors be said to be independent if their jobs are in the hands of the promoters? If anything, this would make a case for a stronger voice (through numbers) for independent directors on the boards.

    With the Satyam debacle behind us, there is optimism that corporate India shall heed to the reality that independent directors are so placed as guardians of the shareholders and that their accountability is of paramount concern to the investors and the company management alike.It was after the Satyam Scam that the independent directors under the fear of being arrested and put behind bar started resigning from their post of independent director. Around 935 of Indian’s independent directors left the board of directors of Indian Companies.23

    PROVISION UNDER THE NEW COMPANIES ACT, 2013

    DEFINATION AND QUALIFICATION

    Independent director is defined under clause (6) of sec 149 as, “An
    independent director in relation to a company, means a director other than a managing director or a whole-time director or a nominee director,— (a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience; (b) (i) who is or was not a promoter of the company or its holding, subsidiary or associate company;

    (ii) who is not related to promoters or directors in the company, its holding, subsidiary or associate company;

    (c) who has or had no pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year;

    (d) none of whose relatives has or had pecuniary relationship or transaction with the company, its holding, subsidiary or associate company, or their promoters, or directors, amounting to two per cent. or more of its gross turnover or total income or fifty lakh rupees or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year;

    (e) who, neither himself nor any of his relatives—

    (i) holds or has held the position of a key managerial personnel or is or has been employee of the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed; (ii) is or has been an employee or proprietor or a partner, in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed, of— (A) a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or (B) any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to ten per cent. or more of the gross turnover of such firm; (iii) holds together with his relatives two per cent. or more of the total voting power of the company; or (iv) is a Chief Executive or director, by whatever name called, of any nonprofit organisation that receives twenty-five per cent or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate Company or that holds two per cent. or more of the total voting power of the company; or (f) who possesses such other qualifications as may be prescribed.”

    An alternative director as in place for independent director can’t be appointed unless he is qualified under the provision of the Act as an Independent Director.24 An Independent Director can be reappointed on the basis of the performance evaluation report.

    COMPOSITION

    Under sec 149 (4), say that least one third of the total number of the director shall be independent director in a public limited company. The Central Government has reserved the right to prescribe the number of independent director on the board for different types or class of companies.

    TERM OF OFFICE

    An in Independent Director shall holds the office for a term up to five years on the Board of Director and shall be reappointed by passing a special resolution in the company’s board meeting and by disclosure of the same in the board report.25

    LIABILITY

    An Independent Director shall be held liable for the act of omission and commission within his knowledge and with his consent or connivance or where he has not acted diligently.26

    MEETING

    MEETING OF THE INDEPENDENT DIRECTOR

    An Independent Director shall hold least one meeting in a year without the presence of the other management member. All the Independent Director shall be present at the meeting. The agenda of the meeting shall include the review of the performance of the non- Independent Director. Review the performance of the Chairman of the company talking into consideration the
    thoughts of the executive director and non-executive directors.

    ROLE OF THE INDEPENDENT DIRECTOR

    The independent directors shall:
    1. help in bringing an independent judgment to bear on the Board’s deliberations especially on issues of strategy, performance, risk management, resources, key appointments and standards of conduct; 2. bring an objective view in the evaluation of the performance of board and management; 3. scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance; 4. satisfy themselves on the integrity of financial information and that financial controls and the systems of risk management are robust and defensible; 5. safeguard the interests of all stakeholders, particularly the minority shareholders; 6. balance the conflicting interest of the stakeholders;

    7. determine appropriate levels of remuneration of executive directors, key managerial personnel and senior management and have a prime role in appointing and where necessary recommend removal of executive directors, key managerial personnel and senior management; 8. moderate and arbitrate in the interest of the company as a whole, in situations of conflict between management and shareholder’s interest.

    DUTIES OF INDEPENDENT DIRECTOR

    The independent directors shall—
    1. undertake appropriate induction and regularly update and refresh their skills, knowledge and familiarity with the company; 2. seek appropriate clarification or amplification of information and, where necessary, take and follow appropriate professional advice and opinion of outside experts at the expense of the company; 3. strive to attend all meetings of the Board of Directors and of the Board committees of which he is a member; 4. participate constructively and actively in the committees of the Board in which they are chairpersons or members; 5. strive to attend the general meetings of the company;

    6. where they have concerns about the running of the company or a proposed action, ensure that these are addressed by the Board and, to the extent that they are not resolved, insist that their concerns are recorded in the minutes of the Board meeting;

    7. keep themselves well informed about the company and the external environment in which it operates;

    8. not to unfairly obstruct the functioning of an otherwise proper Board or committee of the Board;

    9. pay sufficient attention and ensure that adequate deliberations are held before approving related party transactions and assure themselves that the same are in the interest of the company; 10. ascertain and ensure that the company has an adequate and functional vigil mechanism and to ensure that the interests of a person who uses such mechanism are not prejudicially affected on account of such use;

    11. report concerns about unethical behaviour, actual or suspected fraud or violation of the company’s code of conduct or ethics policy;

    12. acting within his authority, assist in protecting the legitimate interests of the company, shareholders and its employees;

    13. not disclose confidential information, including commercial secrets, technologies, advertising and sales promotion plans, unpublished price sensitive information, unless such disclosure is expressly approved by the Board or required by law. CONCLUSION

    It seems that good governance now does matter, partly because capital raising is cheaper and easier, and partly because investors generally believe it matters and are apparently prepared to pay a premium for it, or at least to support management through bad or hostile times.

    The trend of appointing of independent director in public companies (more particularly in listed companies) is growing now. Transparency, better corporate governance and technological improvement and competitiveness have been the buzzword to be transformed into realistic working of such public companies having larger public interest.

    These developments taking place in the management of Indian corporate sector as a whole, would pave the way for sound footing not only for their continued existence but also for their steady growth and overall improvement in their functioning. However, the results achieved would depend on the truer acceptance and faithful implementation of the system by the promoter and bodies corporate, as also the effective occupies and the function and duties which h discharges that determine whether in fact he is a director or not. “Functioning is everything, name matters nothing.”27

    In practical realm, there is no denying the fact that concept of independent director is entirely bunkum as none of the independent directors can be unknown to the promoters group who select them for appointment. The so called independent director under various situation might fell inconvenient to oppose the proposal or decision even if it may not be in overall interest of the company. Notwithstanding, the above position, enforcement of corporate governance through induction of independent director in listed companies having substantial public interest would bring some discipline in corporate world as without regulation there is great chance of manipulation.

    The selection and appointment of independent director have become more difficult due to revised clause 49 notified by SEBI (made effective after 31-12-2005). One may appoint independent director within the framework of law but it is to be seen the director appointed so really functions as “independent”.

    The independent can be rightly conceived as described in a proverb: “The strongest man in the world is he who stands most alone.”

    ***

    BIBLIOGRAPHY

    BOOK REFFERENCE

    Dr. C.L. Bansal, Corporate Governance, Law Practice & Procedures with Case Studies. Avtar Singh, Company Law
    A.K. Majumdar and Dr. G.K. Kapoor, Company Law and Practices, 17th Edition. Towards Better Corporate Governance– Independent Directors In The Boardroom, 1st Edition

    WEBLIOGRAPHY

    http://www.mca.gov.in/Ministry/reportonexpertcommitte/chapter4.html http://www.ecgi.org/codes/documents/hampel.pdf
    http://aci.kpmg.com.hk/docs/CG%20in%20UK/Higgs%20summary.pdf http://www.bis.gov.uk/files/file23012.pdf
    http://www.ecgi.org/codes/documents/cadbury.pdf
    http://www.ey.com/IN/en/Services/Assurance/Fraud-Investigation—Dispute-Services/Corporate-governance–role-of-independent-directors http://tejas.iimb.ac.in/articles/104.php
    http://www.manupatra.co.in/newsline/articles/Upload/8BC687F7-9B76-4342-A173-28F598A94BE9.pdf

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