Role of Independent Directors in Maintaining Corporate Governance – Critical Evaluation
This research aims to explore the crucial role of Independent Directors in maintaining the smooth functioning of business corporations by aligning their actions with the firm’s objectives and focuses on the role of Independent Directors in business corporations and how they play an important part in keeping the working of the firm in consonance with its goals. It also puts emphasis on the functions of independent directors. The key area of this paper entails how independent directors keep the board of directors independent from the influence of any other person by keeping close tabs on corporate governance and making sure the firm is compliant with all government regulations.
Key Words: Good Governance, Corporate Governance, Board of Directors, Independence, Independent Director
2. RESEARCH QUESTIONS
1. What are the different functions performed by independent directors, and how do they impact corporate governance?
2. How do independent directors promote the independence of the board by monitoring compliance with regulatory standards and mitigating the influence of external factors on the decision-making process?
3. How does having an effective and diverse independent board enhance firm performance, accountability, and sustainability?
4. What are the key challenges faced by independent directors in fulfilling their responsibilities, and how can these be overcome?
5. How can policymakers, regulators, investors, and practitioners ensure that independent directors play a more active and effective role in promoting transparent and responsible corporate practices?
3. BRIEF INTRODUCTION
The author aims to analyse how independent directors keep close tabs on the decision making, monitoring good governance within the Board of Directors and ensuring that the working of the company doesn’t deviate from its goals. Such Independent Directors have a greater standard of commitment towards the development, growth and success of the corporate organization. Firms with Independent Directors have a greater chance that misappropriations won’t occur, and the power of the CEO’s are curtailed, as all acquisitions shall be heavily analysed, ensuring a quality acquisition.
Corporate governance is a crucial aspect of business corporations, and the role of independent directors is pivotal in ensuring that the firm is governed effectively and ethically. Independent directors are individuals who do not have any direct or indirect business connections with the company or its management, and they are appointed to bring an unbiased perspective to the board of directors. One of the critical functions of independent directors is to monitor the actions of the management and ensure that they align with the objectives of the company. They act as a check and balance system, preventing any decisions or actions that may harm the interests of the company or its stakeholders. They also serve as advisors to the management, providing valuable insights and recommendations that can help the company achieve its goals.
Another key responsibility of independent directors is to ensure that the company complies with all the relevant laws and regulations. They play a vital role in overseeing the company’s internal controls, financial reporting, and risk management processes. They also help in creating a transparent and accountable environment within the company, which promotes trust and confidence among stakeholders. In the context of India, the role of independent directors has gained significant importance in recent years, especially after the introduction of the Companies Act, 2013. The act mandates the appointment of at least one-third of the board of directors as independent directors for listed companies and other specified companies. The act also lays down various provisions related to the eligibility, appointment, and functioning of independent directors.
There have been several instances in India where independent directors have played a crucial role in preventing corporate frauds and malpractices. For instance, in the case of Satyam Computers, the independent directors played a significant role in uncovering the massive financial fraud and ensuring that the company’s interests were protected. Moreover, the role of independent directors in promoting diversity and inclusivity on the board of directors cannot be overstated. They can help in creating a more diverse and inclusive board, which can lead to better decision-making and improved performance.
4. LITERATURE REVIEW
1.Dou, Y., Sahgal, S., & Zhang, E. J. The authors analysed whether Independent Directors should have term limits on the basis that new directors bring in new ideas and are less likely to align with the CEO as time passes. It also provides that directors who have stayed within the organization for long tend to become conservative and refrain from acquisitions, and new ideas which lead to lower revenues.
2. Khanna, V., Mathew S.J. The authors interviewed various Independent Directors at various organizations within India to research on knowing how they add value to the firm, at the same time find other ways wherein Independent Directors can use their roles and liabilities to enhance their own functioning for the greater good of the shareholders and society. Their research was conducted to provide the Indian Government with an equalized approach of reshaping corporate governance practices in India.
3. Malik K., Garg N The paper analyzes the provisions related to independent directors in the Companies Act of 2013, examines the current practices of appointment and functioning of independent directors, and discusses their role in enhancing corporate governance in India. The authors argue that independent directors play a crucial role in monitoring and enhancing the accountability of the board of directors and the management. They also highlight the challenges faced by independent directors in fulfilling their duties, such as lack of access to relevant information and inadequate compensation. It suggests the need for a more robust regulatory framework, improved disclosure and transparency practices, and greater engagement of independent directors in the decision-making process.
5. CRITICAL ANALYSIS
5.1 Independent Directors; Who are these and how are they related to the Board?
Under Section 149, of The Companies Act, 2013, an Independent Director is defined as a director other than the managing director or a whole-time director or a nominee director, who in the board’s opinion, is a person of high integrity and possesses relevant skills and knowledge, is not a promoter, director, partner or employee of the holding, subsidiary, associate company, neither shall their relatives should not have any pecuniary relationship with the promoter or directors of the company, its holding, subsidiary or associate company, during the immediate past two financial years or in the current financial year.
An independent director has the right to demand the Board’s expert judgement or the acquisition of records so that the Board can conduct due diligence. They are entitled to look through the company’s records and any legal compliance reports that have been produced. When there is disagreement, note it in the minutes. An independent director should only be held accountable for any violation of an Act provision that occurred with his knowledge, where they failed to act diligently, or with his consent or connivance. If an independent director is aware of a mistake but does nothing about it, they should be held accountable. The Board’s procedures ought to produce knowledge. Additionally, independent directors should follow up after learning of any wrongdoing by having their actions from the commission of the wrong documented in the board meeting minutes.
5.2 Independent Directors and their Role in Corporate Governance
As per the various academic and legislative sources, we narrow down the functions of Independent Directors with respect of Corporate Governance to two points as follows;
5.2.1 Supervisor on behalf of General Public: One of the main functions of Independent Directors is to oversee the working of the senior management to reduce the chances of misappropriation of funds and assets of the corporation and to exercise strict caution at the behest of the minority shareholders. Although Independent Directors lack voting powers to stop illegal or unethical activities, they have the power to make public any wrongdoings.
5.2.2 Advisors to Board of Directors and Senior Management: Independent Directors are also tasked with the heavy responsibility of advising the senior management and the board of directors to advice on all matters ranging from internal management to shareholder issues.
5.3 Term Limits for Independent Directors
Under Section 149 (10) of The Companies Act, 2013, an independent director shall hold office for a term of five consecutive years at the Board of the Company and shall only be allowed to be reappointed by the passage of a special resolution by the board. But no Independent Director shall hold office for more than two consecutive terms yet can be eligible to be re-appointed after the expiration of three years of becoming an independent director.
Based on the idea that new blood brings in new ideas and new ways for the advancement of the organization, and the fact that new independent directors are less likely to align with the CEO. At the same it, it is in tangent to the fact that experienced independent directors have greater experience in dealing with multiple CEOs.
Although the two functions are well suited for the needs of the organization, yet are ironically set, since being a supervisor demands a continuous oversight by the independent director, on the other hand, being an advisor to the board and senior management is only required when the Board of Directors conduct meetings which happen 4 times a year, with a minimum gap of two months between each meeting.
5.4 Collaborative Governance: Sharing Best Practices for Continuous Improvement
- Enhance independence: Policymakers and regulators should establish robust criteria for determining the independence of directors. This may include setting limits on the number of directorships an individual can hold, assessing potential conflicts of interest, and requiring regular disclosure of relationships with the company or its executives.
- Strengthen board composition: Efforts should be made to diversify the board of directors in terms of skills, experience, and backgrounds. This can be achieved by encouraging gender, racial, and ethnic diversity on boards, as well as ensuring representation from various professional backgrounds. A diverse board is more likely to bring different perspectives and challenge the status quo, leading to better corporate governance.
- Training and education: Providing comprehensive training and education programs for independent directors is crucial. These programs should cover corporate governance best practices, legal and regulatory requirements, risk management, ethics, and sustainability. Investors and practitioners can support such initiatives by funding training programs or partnering with educational institutions and industry associations.
- Clear roles and responsibilities: Policymakers and regulators should define and communicate the roles and responsibilities of independent directors clearly. This includes outlining their fiduciary duties, setting expectations for active engagement, and clarifying their oversight responsibilities. Additionally, regular evaluations of directors’ performance can help ensure accountability.
- Strengthen whistleblower protection: Whistle-blowers play a crucial role in uncovering corporate wrongdoing. Policymakers should enact or strengthen legislation that protects whistle-blowers from retaliation and provides them with mechanisms to report concerns anonymously. This encourages independent directors to be more vigilant and responsive to potential misconduct.
- Shareholder engagement: Investors, including institutional investors and asset managers, should actively engage with companies to promote responsible corporate practices. This can involve proxy voting, engaging in dialogues with boards and management, and supporting resolutions that promote transparency, accountability, and sustainability.
- Encourage long-term focus: Policymakers, regulators, and investors should incentivize long-term thinking and discourage short-termism. This can be achieved by aligning executive compensation with long-term performance, promoting sustainable business practices, and encouraging boards to consider environmental, social, and governance (ESG) factors in their decision-making.
- Robust oversight and enforcement: Regulators should establish effective oversight mechanisms to ensure compliance with corporate governance standards. This may involve conducting regular audits, investigations, and imposing penalties for non-compliance. Effective enforcement sends a strong message that transparent and responsible corporate practices are non-negotiable.
- Reporting and transparency: Companies should be required to disclose relevant information about their governance structures, policies, practices, and performance. This includes transparent financial reporting, disclosure of board composition, executive compensation, and sustainability efforts. Standardized reporting frameworks, such as those developed by organizations like the Global Reporting Initiative (GRI) or Sustainability Accounting Standards Board (SASB), can help in this regard.
- Collaboration and knowledge-sharing: Policymakers, regulators, investors, and practitioners should collaborate and share best practices to improve corporate governance standards. This can be facilitated through industry associations, professional networks, and international forums, allowing for cross-learning and continuous improvement.
1. Encourage companies to appoint independent directors with relevant expertise and experience in areas such as finance, law, and corporate governance. This will help ensure that independent directors have the necessary knowledge and skills to fulfill their responsibilities effectively.
2. Promote diversity on boards by encouraging companies to appoint independent directors from diverse backgrounds, including gender, ethnicity, and nationality. This will help ensure that boards have a range of perspectives and experiences, which can lead to better decision-making.
3. Encourage companies to establish independent audit committees and implement whistleblower policies to promote transparency and accountability. This will help ensure that potential problems are identified and addressed before they become more significant issues.
4. Provide training and support for independent directors to help them fulfill their responsibilities effectively. This could include training on corporate governance best practices, access to legal and financial advice, and opportunities to network with other independent directors.
5. Encourage greater disclosure and transparency around the role and responsibilities of independent directors. This could include requiring companies to provide more information about the qualifications and experience of independent directors, as well as their roles and responsibilities.
6. Promote greater engagement between independent directors and other stakeholders, including shareholders, employees, and customers. This will help ensure that independent directors have a better understanding of the concerns and perspectives of these stakeholders, which can inform their decision-making.
These suggestions are based on research and data indicating the importance of independent directors in promoting transparent and responsible corporate practices. By implementing these suggestions, policymakers, regulators, investors, and practitioners can help ensure that independent directors play a more active and effective role in promoting good corporate governance practices in India.
Through this paper we can infer that the need for independent directors is the need of the hour, by examples from the Satyam Computer Scam and one of India’s biggest investment bankers, Nimesh Kampani. With more regulations and oversight, there are lesser chances of malpractices within the firm taking place on the orders of the Senior Management and the Board of Directors. We have also established the fact that the presence of Independent Directors increases the chances of higher revenue as every financial and managerial decisions are heavily scrutinized by the Independent Directors, who make sure that there are absolutely no loopholes wherein the Senior Management or Board of Directors can illegitimately make profits.
Hence, we can conclude by saying that Independent Directors are a must-have for any publicly listed business organization, since they minimize risks of malpractices, take care for the minority shareholder’s interests, advise the board of directors in its meetings at all levels of discussions and make sure that best corporate governance practices are adopted.
In conclusion, the role of independent directors in ensuring effective corporate governance is critical for the success and sustainability of business corporations. It is essential to understand their functions, responsibilities, and importance in the Indian context, given the regulatory framework and the current business environment. Further research can be conducted on the impact of independent directors on firm performance, the challenges they face in discharging their duties, and the measures that can be taken to enhance their effectiveness.
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- See, Clarke, supra note 4 at 80
- Section 149 (10), The Companies Act, 2013, Government of India
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