Independent Directors: Steering the Governance Wheel

Corporate governance plays a pivotal role in ensuring the effective and smooth functioning of a business. At the heart of corporate governance is the board of directors, responsible for making crucial executive decisions. However, the board faces significant challenges, especially in balancing the interests of various stakeholders within the company.

To address this challenge and enhance corporate governance, the Companies Act of 2013 in India introduced the concept of independent directors. The Act mandates that at least one-third of the total directors in every publicly listed company must be independent directors. Moreover, the Act specifies requirements for their appointment and outlines a code of conduct that independent directors must adhere to.

For unlisted public companies crossing specific thresholds in paid-up capital, turnover, or outstanding loans, the Act requires the appointment of at least two independent directors. This underscores the importance of independent directors in upholding corporate governance standards across different types of companies.

While unlisted companies must comply with the provisions outlined in section 149 of the Companies Act, listed companies, and those aspiring to be listed must also adhere to the SEBI (Listing Obligations and Disclosure Requirements) Regulations of 2015 (LODR Regulations). These regulations further strengthen the governance framework by imposing additional obligations and disclosure requirements on listed entities.

The role of independent directors is crucial in representing the interests of various stakeholders, particularly minority shareholders. Their independence is designed to ensure unbiased decision-making and effective oversight of management actions. By implementing these regulatory provisions, companies can foster a culture of transparency, accountability, and fairness, ultimately contributing to the long-term sustainability and success of the business.

WHY HAVING INDEPENDENT DIRECTORS ON THE BOARD OF A COMPANY IS ESSENTIAL? 

The concept of Independent Directors has evolved as a remedy to address the necessity for diverse and impartial perspectives in a company's decision-making processes. These individuals, devoid of direct or indirect connections with the company or its promoters and not engaged in day-to-day management, play a pivotal role in safeguarding and representing the interests of all shareholders, particularly minority and small shareholders.

Independent Directors serve as a crucial bridge between a company's management, board, and various stakeholders, ensuring a well-balanced distribution of power and interests. The composition of the board, with an appropriate mix of executive and independent non-executive directors, is vital for establishing a robust and seamless governance system within a company. The primary function of independent directors lies in offering a fresh outlook, providing specialized business knowledge, and delivering unbiased judgment during board discussions encompassing strategic decisions, risk management, and board performance evaluation.

In alignment with the prescribed Code of Conduct, Independent Directors bear a specific responsibility for upholding the integrity of financial information and overseeing related party transactions. Simultaneously, they are tasked with protecting the interests of minority shareholders. To fulfil these obligations, the Audit Committee, responsible for approving related party transactions and overseeing the financial reporting process, must consist of at least two-thirds Independent Directors.

The substantial role played by independent directors within a company extends to enhancing the overall corporate governance framework and fortifying risk management processes. Essentially acting as custodians of good corporate governance, they contribute to the establishment of practices that uphold ethical standards and promote transparency. However, the essence of independence extends beyond compliance; it is a state of mind that relies on an individual's capacity to question authority and pose pertinent queries. Hence, it is imperative to cultivate an environment and culture that empowers Independent Directors to genuinely exercise their independence.

In essence, independent directors emerge as a critical component in fostering an environment where decisions are made with a holistic view, considering the interests of all stakeholders. Their role extends beyond a mere regulatory requirement, becoming integral to the very fabric of a company's governance structure and contributing significantly to its long-term success and sustainability.

POWERS AND DUTIES OF INDEPENDENT DIRECTORS IN CORPORATE BOARDS: 

An independent director's function on the board is essential, and they actively participate in the development of the company's short- and long-term strategies.  Their professional qualities are crucial in guiding the Board toward accurate and efficient decision-making to achieve organizational objectives. Typically, independent directors are selected from a pool of highly capable individuals with extensive knowledge and experience in commerce, industry, and related domains, allowing the company to leverage their expertise to enhance business strategies and overall performance.

The powers vested in an independent director are twofold, both as a collective member of the Board and in their specific capacity as an independent director. The Board possesses the right to exercise powers and perform necessary acts as authorized by the company's governing documents, including the Act, Memorandum of Association, Articles of Association, or any applicable regulations, provided they align with these foundational documents. However, certain powers can only be exercised either under the Act or by the company in a general meeting, as stipulated in the memorandum or articles.

The duties of an independent director, as outlined in the Act, encompass a broad spectrum of responsibilities aimed at upholding the principles of corporate governance and safeguarding the interests of the company and its stakeholders. Continuous skill and knowledge updates are emphasized, and seeking professional advice when necessary is encouraged. Active participation in board and committee meetings, along with attendance at general meetings, is deemed essential.

According to the Act, independent directors are mandated to address concerns about the company’s operations, ensure thorough deliberations before approving related party transactions, and establish a functional vigil mechanism. Reporting unethical behaviour, fraud, or violations of the company’s code of conduct falls within their purview of responsibility. Acting within their authority, they are tasked with safeguarding the company’s legitimate interests and refraining from disclosing confidential information without proper approval or legal requirements. In essence, their overarching role is to contribute constructively to the company’s growth while upholding ethical standards and ensuring transparency.

In summary, independent directors play a pivotal role in shaping the company's strategic direction and decision-making processes. Their professional acumen and commitment to corporate governance principles make them essential contributors to a company's success, fostering growth while maintaining ethical integrity and transparency.

STRATEGIC ROLE OF INDEPENDENT DIRECTORS: 

The inclusion of an adequate number of Independent Directors on a company's board serves multifaceted purposes, contributing to the overall governance and strategic direction of the organization. Their past experiences and distinguished expertise bring valuable wisdom and professional domain knowledge to the table. Importantly, being external to the company's payroll, they can adopt an impartial perspective focused solely on enhancing stakeholder value, free from any conflicts of interest that may arise from internal roles.

One of the critical contributions of Independent Directors lies in their authority to challenge management decisions that they perceive as detrimental to the company and its stakeholders. Maintaining independence is a cornerstone of their role, and they are not subordinate to the Chairman, who heads the board, or the Managing Director & CEO, who leads the management. This lack of reporting relationships grants them the freedom to exercise their influence in board decisions autonomously, providing a valuable check and balance mechanism. They can abstain from voting on an agenda or express dissent when deemed necessary, ensuring a diversity of opinions within the boardroom.

Despite the paramount importance of their role, instances of companies falling short in implementing corporate governance norms have been observed, leading to corporate fiascos. In the subsequent paragraphs, we delve into the strategic role expected from Independent Directors, outlining the key responsibilities and functions they undertake:

1. Impartiality and Unbiased Judgment: 

Independent Directors are entrusted with providing objective and unbiased insights into various facets of the company's operations, strategies, and financial matters. Their impartiality is crucial in ensuring that decisions are made in the best interest of all stakeholders.

2. Corporate Governance: 

Acting as custodians of corporate governance, Independent Directors oversee that the company adheres to the highest standards of transparency, accountability, and compliance with relevant laws and regulations. They play a pivotal role in creating a governance framework that fosters ethical practices and ensures the company's long-term sustainability.

3. Strategic Decision-making: 

Leveraging their expertise and experience, Independent Directors actively participate in board discussions and contribute to strategic decision-making. They offer valuable perspectives on critical issues faced by the company, bringing an external viewpoint that complements the insights of executive directors.

4. Safeguarding Minority 

Shareholders: Independent Directors must fulfil their duties to enhance transparency in the company’s operations. Given that shareholders, especially minority shareholders, may not possess the resources to scrutinize the company’s affairs thoroughly, they rely on Independent Directors to provide transparency and safeguard their interests by ensuring that their rights are protected and they are treated fairly.

5. Oversight and Risk Management: 

Independent Directors play a crucial role in overseeing the management’s performance, ensuring effective risk management practices, and identifying potential risks to the company’s sustainability. Their objective viewpoint contributes to a comprehensive evaluation of the company's risk landscape.

6. Nomination and Remuneration Committees: 

Independent Directors form an integral part of the nomination and remuneration committees, responsible for identifying and appointing suitable candidates for key positions and setting executive compensation. Their involvement ensures a fair and objective evaluation of leadership and compensation structures.

7. Audit Committee: 

Given that the majority of the members of the Audit Committee are independent directors, they play a pivotal role in ensuring good corporate governance. Their independence allows them to expressly review and monitor critical audit and financial transactions, including related party transactions, for the benefit of the company.

In essence, Independent Directors play a central role in shaping the governance and strategic trajectory of a company. Their contributions go beyond mere compliance, serving as a cornerstone for ethical decision-making, transparency, and the overall success of the organization. The diverse and unbiased perspectives they bring to the boardroom contribute significantly to a robust and sustainable corporate governance framework.

FACTORS CHALLENGING INDEPENDENCE OF INDEPENDENT DIRECTORS: 

Independent directors encounter substantial challenges in fulfilling their governance role and maintaining true independence. Effectiveness in this capacity requires a profound understanding of the specific industry in which the company operates, considering the industry's unique features, statutory requirements, and risk factors. Additionally, awareness of the performance parameters of other market players within the same industry is crucial for informed decision-making.

Despite the intention of the Act to underscore the significance of independent directors, it is arguable that it may have introduced complexities that hinder their effective functioning. The Act, in certain provisions, appears to impose rigid guidelines that may limit the decision-making autonomy of independent directors. These constraints necessitate a closer examination to identify obstacles faced by both independent directors and corporates in complying with the law, emphasizing the need for continuous improvements to elevate governance standards.

Addressing these challenges requires a comprehensive understanding of the nuanced issues involved. Relationships with promoters or management, often overlooked despite prescribed independence criteria, can potentially influence an independent director's judgment. Multiple directorships may raise concerns about their ability to dedicate sufficient time to each company, potentially leading to conflicts of interest. Fee dependency introduces the risk of decision-making influenced by compensation concerns. Lack of expertise in the specific industry may limit the effectiveness of independent directors, while inadvertent exposure to insider information poses a threat to their independence.

To enhance the strength of independent directors and fortify corporate oversight, various strategies and initiatives can be explored:

1. Enhancing Independence and Authority: 

Policymakers and regulators should establish robust criteria for determining independence and consider broadening the authority granted to independent directors. Appointing directors with diverse expertise and establishing comprehensive board charters can clarify roles, responsibilities, and authority. Ensuring timely access to relevant information empowers independent directors to make informed judgments.

2. Improving Selection Processes: 

There is a need for transparency and objectivity in the selection of independent directors. While there are online proficiency tests, the current practice of hand-picking by promoters raises concerns about true independence. An improved selection process could involve a more rigorous and transparent approach to ensure genuine independence.

3. Regular Assessment: 

Regular evaluations of independent directors' performance can help identify conflicts of interest or shortcomings in fulfilling their responsibilities. This assessment, both individually and collectively, ensures continuous improvement and accountability.

4. Continuous Education: 

Investing in continuous training and development programs for independent directors is essential to keep them abreast of industry trends, best practices, and changing regulatory landscapes. These programs should cover corporate governance, legal and regulatory requirements, risk management, ethics, and sustainability.

5. Encouraging Diversity: 

Promoting diversity among independent directors, including gender, age, and professional backgrounds, fosters a broader range of perspectives in the boardroom and reduces the risk of groupthink.

6. Empowering 

Whistle-blower Mechanisms: Establishing robust and confidential whistle-blower mechanisms can encourage employees and stakeholders to report concerns about the company’s practices without fear of retaliation, reinforcing a culture of transparency and accountability.

CONCLUSION

In conclusion, the evolving business landscape underscores the increasingly pivotal role of Independent Directors in shaping a corporate future characterized by ethics and responsibility. A more rigorous screening process is imperative to ensure the suitability of Independent Directors for board positions, complemented by comprehensive training to ensure the effective implementation of Corporate Governance principles in both theory and practice.

While the concept of Independent Directors represents a positive step toward strengthening corporate governance, preserving their true independence remains a practical challenge. Striking a delicate balance between independence and expertise is paramount to unlocking their full potential as guardians of corporate integrity. By addressing challenges to independence and implementing measures to fortify their autonomy, companies can enhance the credibility of Independent Directors, fortify transparency, and foster increased trust among stakeholders in the corporate system.

The redefinition and optimal utilization of the role of Independent Directors can be a potent mechanism to safeguard the long-term sustainability of organizations. This proactive approach helps prevent governance issues that could otherwise tarnish the image of the entire business ecosystem, fostering a more robust foundation for a transparent and accountable corporate environment.

In the context of a burgeoning Indian economy attracting substantial funds, the inclusion of independent directors becomes indispensable for meeting the objectives of corporate governance. As start-ups strive to disrupt industries and set new norms, strategically appointing independent directors can act as a catalyst for sustainable success. Although not bound by regulatory mandates, the voluntary inclusion of seasoned professionals enhances a start-up's governance culture and signals commitment to stakeholders.

Moreover, the decision to appoint independent directors sends powerful signals within the start-up ecosystem. It signifies maturity, a readiness to embrace external counsel, and a commitment to continuous learning and adaptation. This strategic move resonates with potential investors, who view a robust governance structure as evidence of prudent management. The presence of independent directors further elevates a start-up's credibility in negotiations, partnerships, and regulatory interactions, positioning the company as a reliable and credible player in the market.

Our Directors’ Institute- World Council of Directors can help you accelerate your board journey by training you on your roles and responsibilities to be carried out efficiently, helping you make a significant contribution to the board and raise corporate governance standards within the organization.