The country’s biggest-ever corporate accounting fraud, namely the Satyam scam, put the role of independent directors in the spotlight. However, Satyam is not an exception. Earlier in Enron, WorldCom and Lehman Brothers, these directors failed miserably.

Recently ILFS, Dewan Housing Finance Ltd, Kingfisher, Jet Airways, Amrapali Builders, PMC Bank, Lakshmi Vilas Bank, CG Power and Yes Bank joined the list. So much so that in the case of ILFS, the company’s Risk Management Committee is alleged not to have met for three years.

The present corporate governance structure hinges on the independent directors who are supposed to bring objectivity to the board’s oversight function and improve its effectiveness. Stakeholders place a high expectation on them. But is the expectation misplaced?

Perhaps, yes. An individual independent director cannot play an influential role in isolation. Even if he is highly committed, he can only ‘watch’ wrongdoing and, at best, initiate a discussion. He alone cannot stop a decision, and neither can he turn whistleblower because board proceedings are considered confidential.

It may not be out of place to mention that in certain companies, banks and public sector undertakings the nominee directors from Government, financial institutions and the regulators have been found to be wanting in their role to protect the interests of various stakeholders. The only way independent directors can stop wrong choices is by collaborating.

Even then, they can seldom be expected to prevent ‘management fraud’ since turning independent directors into policemen in the board room will have detrimental effects on the managers’ freedom of enterprise. In discharging its responsibility of ensuring adequate and effective internal control, the board must depend on other corporate governance institutions such as internal audit, external audit, and legal counsel.

Therefore, the effectiveness of independent directors depends significantly on the independence and effectiveness of those institutions. While they cannot magically prohibit the scams from happening in a company, they must put checks and balances on each company’s activity.

Surprisingly in recent times without even having examined the full facts establishing the guilt of independent directors, in certain cases bank accounts of such directors were frozen and notices were issued to all independent directors. In the IFLS case, no such action was taken against certain directors including the nominee directors.

Can it be presumed that a nominee director’s liability is lesser than that of an independent director? In our opinion it should be the other way round as nominee directors are privy to certain information which independent directors may not be to. It can be safely estimated that the need for the introduction of the Independent Directors Rules results from various corporate governance lapses and fiascos.

This is likely to weed out the practice of appointing (distant) relatives and (at times) friends and domestic help as independent directors. This is expected to infuse some sanity in the entire process, and they will uphold the very objective of having independent directors in the first place.

The independent director, unless exempted, is now required to take an online proficiency self-assessment test, and only those passing that can act as independent directors. According to the law, independent directors can be paid up to Rs 1 lakh as sitting fees per board meeting.

Companies have the flexibility to pay more as a commission on profits in accordance with the provisions of the Companies Act 2013. The total commission paid to all nonexecutive directors including independent directors in a company can be as much as one per cent of its profit.

The number of independent directors taking home over Rs 1 crore annually is on the rise. The government looks to cap the remuneration of independent directors to ensure their impartiality. It is widely perceived that higher compensation tends to dilute the effectiveness of independent directors.

Simultaneously, without an adequate compensation mechanism, it is impossible to find top-notch talent particularly in case of companies requiring a turnaround, thereby creating a paradoxical situation in the real sense. It is also observed that certain bureaucrats, bankers and other officials having handled the companies’ files in their official capacity have been undertaking board positions, post retirement, in the same companies.

It may be fine legally but is it ethically justified? And, will this not be a fit case of quid pro quo? We leave it for the readers, regulators and government to decide. Significantly the 2013 Act confers  powers on the Independent Director for the fair and smooth functioning of the Board of Directors and the company, which are being widely believed as a change in the way principles of corporate governance are upheld through the renewed role of Independent Directors.

Whether in reality this is practiced or not, “majority rule-minority protection” is the central canon for effective functioning of a sensible and responsible corporate. To make them more potent in counterbalancing managerial infirmities, ensuring maintenance of legally, morally and ethically approved corporate behavior and above all holding the corporate reputation high, there is need for constant reform of the factors which have potential to impair independence.

These factors include selection criteria, remuneration mechanism, defining accountabilities and protection or immunity available in eventualities etc. In the end, the litmus test for an effective Independent Director in the context of ideal corporate governance lies in the independence of judgment and absence of a material pecuniary relationship.

(Concluded)

(The writers are chartered accountants)