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Certified independent directors play a critical role in shaping the future of Indian business, a fact that becomes evident through firsthand observations. Their involvement is crucial in enhancing the governance structure of corporations and ensuring operations are conducted efficiently, ethically, and transparently. These directors bring unbiased oversight and strategic guidance to the table, leveraging their independence from company management to provide an objective viewpoint in board deliberations.
Companies Act of 2013 required companies to have independent directors on their boards to provide fair and unbiased opinions and look out for everyone's best interests. However, the impending mandatory retirement of over 800 independent directors in March 2024 has created a massive demand for new talent to fill the void.
The demand for independent directors has shifted in recent years, with companies looking for individuals with diverse skill sets to meet future business demands. Environmental, social, and governance (ESG) skills, digital transformation expertise, and a thorough understanding of regulations are among the key skills sought after by businesses. Indian boardrooms are adopting a more strategic and forward-thinking approach to board composition to create a balanced board that can meet future business needs.
Independent directors bring a unique perspective, experience, and expertise to drive growth and innovation. They serve as an advisory body for management, providing strategic direction and aiding in the resolution of intricate business obstacles. The presence of independent directors is of the utmost importance in safeguarding companies' transparency, accountability, and good corporate governance.
However, the importance of independent directors extends beyond simply meeting legislative requirements. Independent directors must be active participants in the board's decision-making process, ensuring that the firm complies with applicable rules and regulations, and act as a defender of the company's long-term interests.
Independent directors play an important role in balancing corporate interests and improving company governance. According to the Companies Act of 2013, they provide knowledge without involvement in day-to-day operations. Their responsibilities include guidance, risk management, stakeholder protection, and ethical oversight. Qualifications are strict, assuring independence. There are restrictions on directorships, and appointments require board approval. If they fail to fulfil their fiduciary duties, they become liable.
In the Indian business landscape, the function of independent directors is critical in improving corporate reputation and governance standards. Independent directors play an important role in balancing the interests of a company's management and shareholders. They help to achieve not just maximum profits but also the well-being of stockholders.
According to Section 2(47) of the Companies Act 2013, independent directors are non-executive directors who work to improve corporate governance. They are not directly or indirectly involved with the company's day-to-day activities.
Simply put, an independent director serves as a neutral observer on a company's board of directors. They are not involved in day-to-day operations or part of the company's executive team. Instead, they provide an outsider's perspective on decision-making.
Mandatory appointment of Independent directors in India
In India, Section 149 of the Companies Act 2013 and accompanying Rules and Regulations govern the appointment of independent directors. Companies that are required to appoint independent directors or have the authority to do so are as follows:
Public listed companies (mandatory)
Requirement: Every publicly listed company must have at least one-third of the total number of directors as independent directors.
Explanation: This is a mandatory requirement to ensure that publicly listed companies have a large number of independent directors to improve corporate governance.
Other classes of public companies (prescribed by the federal government)
Requirement: The Union government has the authority to prescribe the minimum number of independent directors for other classes or classes of public companies.
Explanation: The government can extend the requirement of appointing independent directors to specific categories of public companies beyond the mandatory provision for listed companies.
Public companies with certain criteria (mandatory)
Criteria: Public companies meeting the following criteria must have at least two independent directors:
Paid-up share capital of INR 100 million or more
Turnover of INR 1 billion or more
Aggregate outstanding loans, debentures, borrowings, and deposits exceeding INR 500 million.
Exceptions: However, there are exceptions to these criteria, including:
Joint ventures
Wholly-owned subsidiaries
Dormant companies, as defined under the Act
Role and duties of an independent director in corporate governance
Independent directors play a pivotal role in enhancing corporate governance and ensuring ethical practices within a company. Their responsibilities extend to various aspects of guiding and monitoring the company’s operations.
Role of an Independent Director:
By imparting their knowledge and understanding to direct the organisation in the right direction, independent directors function as mentors, coaches, and guides for the company.
They help to boost corporate credibility and governance standards by promoting transparency, accountability, and ethical behaviour.
They actively participate in various committees established by the company, such as the audit, nomination, and remuneration committees, which contribute to improved governance practices.
Independent directors protect the interests of all stakeholders, particularly minority shareholders, by balancing competing interests and advocating for ethical behaviour.
Independent directors serve as watchdogs, ensuring that the company operates within legal and ethical boundaries while also assisting with effective risk management.
They offer an independent viewpoint on critical issues such as strategy, performance, risk management, resource allocation, and key appointments.
They oversee the accuracy of financial information and ensure that effective financial controls and risk management systems are in place.
Independent directors assess the performance of the board and management, ensuring that goals and objectives established at board meetings are met and reported on.
When management and shareholder interests clash, independent directors work to find solutions that benefit the company as a whole.
They determine appropriate remuneration for executive directors, key managerial personnel, and senior management.
FACTORS CHALLENGING INDEPENDENCE OF INDEPENDENT DIRECTORS:
Independent directors face significant governance challenges while maintaining their independence. An independent director must have a thorough understanding of the industry in which the company operates to carry out their duties effectively. Each industry has distinct features, legal requirements, and risk factors that necessitate specialised knowledge. Additionally, understanding the performance parameters of other market players in the same industry is critical.
Furthermore, specific economic statutes apply to certain industries, and an independent director must understand these provisions in addition to the fundamental corporate laws. However, there are concerns that the current framework relies too heavily on executive management for information, making it difficult for independent directors to carry out their duties adequately.
While the Act intended to promote the importance and contribution of independent directors, some argue that it went too far, creating complexities that impede their effective functioning. Certain provisions of the Act impose strict dos and don'ts, potentially limiting independent directors' decision-making autonomy.
There is a need to improve governance standards. After several years of Act implementation, there is still plenty of time to understand and address these challenges. It is critical to identify the obstacles that independent directors and corporations face when complying with the law. Furthermore, investigating the incentives available to independent directors to ensure compliance with the Act's intent will help to raise corporate governance standards.
Ties with Promoters or Management: Despite the company's independence criteria, some Independent directors may have had or continue to have relationships with its promoters or management. While these relationships may not be considered "material" by legal definition, they may still have an impact on the director's judgement and decision-making. Even seemingly insignificant connections can influence an independent director's decision-making. Subconscious biases, loyalties, or undue familiarity may inadvertently influence judgement, potentially diluting the rigour and neutrality required of their role. The director may find it difficult to ask tough questions or challenge management when necessary, fearing strained relationships or perceived conflicts.
Multiple Directorships: Independent Directors frequently serve on the boards of numerous companies, raising questions about their capacity to spend adequate time and attention to each one. In some situations, this may result in a conflict of interest, especially if concerns emerge involving two or more companies in which they hold directorships.
Fee Dependency: Independent Directors receive compensation for their services, which may influence their decisions. The prospect of losing lucrative directorship fees may dissuade them from taking strong or unpopular positions on vital issues that may offend management or promoters.
Lack of Expertise: Appointing Independent Directors who lack domain expertise or appropriate industry experience may limit their capacity to understand complicated business choices fully. This can impede their ability to provide key insights and contribute to important discussions.
Insider Information: Independent Directors may mistakenly get sensitive or confidential information, which could jeopardise their independence. The possibility of such information leaks raises concerns about how well organisations can protect such data.
HOW CAN WE ENHANCE THE STRENGTH OF INDEPENDENT DIRECTORS?
As organisations face increasing problems and complicated issues, it is critical to investigate strategies to strengthen and improve the effectiveness of independent directors. There are numerous tactics and efforts that can empower independent directors, allowing them to play a more influential role in setting the course of modern organisations. From improving selection processes to improving training and accountability measures, we look at how to build a strong and resilient corporate oversight system.
Improve Independence and Authority: Policymakers and regulators should develop strong standards for assessing director independence. Independent Directors have major responsibilities, but their authority is comparably limited. As a result, there is a need to expand the authority assigned to these independent directors. The same can be accomplished by hiring independent directors with broad experience and professional backgrounds, as well as creating a complete board charter outlining independent directors' roles, responsibilities, and authority. Furthermore, the corporation must ensure that independent directors have timely access to accurate and relevant information regarding the company's operations, finances, risks, and performance. Access to information enables students to form educated opinions and actively participate in conversations.
Improvements in the selection process: While there is an online database of independent directors and a necessity to pass an online competence exam, the majority are handpicked by promoters. As a result, one can conclude that an independent director cannot be as independent as they are expected to be.
Regular Evaluations: Assessment of Independent Directors' performance, both individually and collectively, can assist in detecting potential conflicts of interest or deficiencies in carrying out their tasks.
Continuous Education: Companies should invest in ongoing training and development programmes for independent directors to keep them up to date on industry trends, best practices, and changing regulatory landscapes. These programmes should address corporate governance best practices, legal and regulatory requirements, risk management, ethics, and sustainability.
Encourage Diversity: Promoting diversity among Independent Directors, including gender, age, and professional backgrounds, helps broaden the boardroom's ideas and decrease groupthink.
Empower Whistleblower Mechanisms: Establishing strong and confidential whistle-blower protection processes can encourage employees and stakeholders to disclose concerns about the company's activities without fear of punishment.
THE FUTURE OF INDEPENDENT DIRECTORSHIP AND TRENDS:
As the business world changes, the role of Independent Directors will become increasingly important in creating the corporate world's ethical and responsible future. The screening procedure must be more rigorous to guarantee that Independent is qualified for board posts. They should receive comprehensive training and grooming to ensure proper execution of Corporate Governance principles in both letter and spirit.
While the concept of Independent directors is a positive step towards improving corporate governance, establishing their genuine independence remains a practical difficulty. To fully realise their potential as corporate integrity watchdogs, they must strike the correct balance between independence and expertise. Companies can maintain the credibility of Independent directors, improve transparency, and increase stakeholder trust in the corporate system by addressing the reasons that challenge independence and implementing actions to support their autonomy.
The function of Independent Directors should be reinterpreted and used as an effective method to ensure an organization's long-term sustainability. By doing so, the corporate sector can avoid governance difficulties that harm the reputation of the entire business ecosystem and instead provide the groundwork for a more open and accountable corporate environment.
Corporate governance objectives cannot be properly achieved unless independent directors are included in the bigger picture. This is even more convincing in the context of an expanding Indian economy, with unprecedented amounts of capital streaming into enterprises from both within and outside the country.
Start-ups seek to disrupt sectors and reinvent standards, and the judicious nomination of independent directors can serve as a catalyst for long-term success. While start-ups are not legally compelled to select independent directors, the voluntary inclusion of such experienced persons might pave the road for a revolution paving the road for transformation. These directors bring knowledge to start-ups, foster a governance culture, and send strong signals of commitment to stakeholders.
Furthermore, the move to nominate independent directors sends strong signals across the start-up sector. It indicates a start-up's maturity, preparedness to seek external advice, and willingness to learn, adapt, and thrive. This action appeals to potential investors, who frequently seek evidence of a strong governance framework as an indication of cautious management. Furthermore, the inclusion of independent directors can boost a start-up's credibility in negotiations, alliances, and regulatory interactions, establishing the company as a trustworthy and reputable market player.
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 in an efficient manner helping you to make a significant contribution to the board and raise corporate governance standards within the organization.
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