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Are they really independent?

The idea of the independent directors is simple. They are expected to be independent from the management and act as the trustees of shareholders. This implies that they are obligated to question the conduct of organisations on relevant issues.

For India 2009 is of great significance with respect to independent directors. More than 600 independent directors resigned that year.  Two events triggered the exodus. One, Nimesh Kampani, the independent director of Nagarjuna Finance, faced the regulators’ wrath for the company’s inability to return money to the depositors. Also that year the Satyam fiasco happened and on its Board that time was, among others, Krishna Palepu and Vinod Dham. The former was a Harvard Professor and the latter was the man who gave Pentium processors to the world. Satyam investors lost more than Rs. 13,000 cr. The investors blamed the independent directors and auditors.    

The ghost of 2009 is back to haunt the independent directors. These directors of Satyam have been fined for not being able to protect the interest of the shareholders in the Satyam fraud. The illustrious professor Krishna Palepu has been fined more than Rs. 2.5 crore for having conflict of interest, as he was also a paid strategic advisor for the company. Further, other independent directors have been fined Rs 20,000 each. This is a landmark judgment, as the role of independent directors would now invite higher degree of supervision. The point of discussion here is: are the independent directors in a position to deliver?

 

The ‘agency’ problem...

Traditional finance states the main objective of an organisation is to maximise the wealth of investors. However, the managers who run the organisation and the people who invest are not always the same. Thus, there is a possibility of conflict of interest between the investors and the managers. Further, the salaries of top executives are often linked to the profits of the company. Thus manager gains by maximising company’s profits in short run rather than maximise wealth.  This is called the agency problem.

The independent directors are appointed to protect the interest of the shareholders and hence their main efforts should be directed to reduce agency problems.  However, independent directors do not seem to be in position to do so. In a seminal paper Understanding Enron: It’s About the Gatekeepers, Stupid” John Coffee Jr has pointed out that the independent directors generally fail to protect the interest of the shareholders. Further, in the book ‘Barbarians at the Gate’ the authors have shown how independent directors are given consultancy projects to get them to ignore excessive perks and salaries of top executives. So why do independent directors fail? Can the directors really do something if they are inclined to protect the interest of the shareholders?


Independent directors’ view …

In 2009, the regulations for independent directors and the power of directors were grey areas. Even though it was mandatory for every company to have an independent director, no one was sure what the role of this director was. Readers would be surprised to know that most of the independent directors who were interviewed by researchers Vikramaditya Khanna and Shaun J Matthew in 2010 for their research paper ‘The Role of independent directors in controlled firms in India: Preliminary Interview Evidencer,’ viewed their role to be that of strategic consultants rather than whistle blowers. The blame cannot be fixed on the independent directors for the same. As discussions held in board meetings were subject to confidentiality clause, one independent board of director could not do much single-handed. He could not effectively act as a whistle blower.

Things have changed from 2009. According to the new Companies Act, the majority of directors in committees such as audit committee and nomination and remuneration committee, should be independent directors.  The regulations have now become tighter. The number of meetings has increased and so has the involvement of the independent director. However, experts still believe it is not possible for independent directors to protect the interest of shareholders.

 

Practical difficulties...

It is common knowledge that the promoter has the final say in the appointment of independent directors. Then how does one expect the independent directors to act without being influenced? The role of independent director in itself is paradoxical, as he independently needs to monitor the activities of individuals who appoint him. With resignation being the only effective tool in the hand of the directors such punitive action as doled by the Hyderabad court would only deter individuals of repute from taking the role of independent directors. Gatekeepers should be gatekeepers and given the weapons needed in the form of regulatory support to protect them.

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