Sucheta Dalal :Watching Over The Watchdogs (6 January 2003)
Sucheta Dalal

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Watching Over The Watchdogs (6 January 2003)  

Several years ago, at another of those endless seminars on corporate governance, an academic quoted an unnamed Tata director saying something to the effect that: It is absurd to think that a bunch of old men meeting a few times every year over cups of tea and loads of bonhomie, can be held accountable for the performance and ethics of a company, in a business environment that requires instant decisions involving large sums of money.

Although this statement is perfectly true, it flies in the face of modern wisdom that independent directors will keep management in check and act as the guardian angels of minority shareholders. Corporate scandals among giant US companies have only led to an increased focus on independent directors under legislations such as the Sarbanes-Oxley Act.

In the circumstance, the selection of independent directors becomes crucial, since they are expected to play the role of watchdogs, made accountable for the financial results of a company, and the salaries that management pays itself. They also have to be paid well for their time and the responsibilities they have taken on; this has taken the form of fat sitting fees, stock options, loans and other benefits. That is not all. There is also a demand that independent directors be allowed to seek outside ‘expertise’ for a fee in matters relating to law, finance and business. And finally, with companies continuing to insist on appointing film stars and beauty queens as directors, there is pressure to ‘train’ independent directors to understand their role on the board.

Isn’t this absurd? If companies are paying as much as Rs 12 to 24 lakh as sitting fees plus perquisites and stock options, they are at least expected to pick the right people as directors. High fees and fat perks are also creating a chicken-and-egg situation. If independent directors are to do their job diligently, they must be paid well, but if they were paid too well, that itself would kill their independence. A maximum term of five years, with no scope for re-appointment, would help preserve their independence; it will also force companies to find new persons on their boards and release experienced directors to other companies.

Typically, even the best companies refuse to look beyond a charmed circle of 100 to 200 persons who recommend each other to various boards and are considered fit to be independent directors. This group includes retired bureaucrats and bankers who have obliged them by turning a blind eye to their shenanigans when in service. Otherwise, the ‘most eligible’ directors are heads of companies and are on the boards of 14 others. This again reduces the concept of independence of directors to an absurdity.

Here is why. All independent directors are expected to attend at least four board meetings every year and one Annual General Meeting. They are usually on at least three committees such as the audit committee, remuneration committee, and human resources committee etc that meet another four to six times a year. Even if some of these meetings are combined or held in sequence, it still requires at least a dozen intense meetings per company. Multiply these by even ten such directorships, and you have 120 meetings per year by independent directors, over and above their full time assignments as CEOs, lawyers, chartered accountants or teachers. This means that the most eligible directors are least likely to perform their watchdog role efficiently. Hence, they are now demanding access to outside expertise for a fee and exemption from criminal and civil liabilities under certain circumstances.

This leads us to more ludicrousness. Are we then expecting ‘independent directors’ to run little secretariats at shareholders’ expense so that they are able to discharge their duties? Weren’t they appointed as independent directors precisely because the company felt that they would bring in their own, rather than hired, expertise to the board? And won’t such hired help potentially lead to leakage of inside information?

The enhanced role, responsibility and remuneration of independent directors has also led to increased jockeying for a position on corporate boards. Minority shareholders, for instance, are pressing for strict implementation of Section 265 of the Companies Act, which provides for proportional representation on the Board of Directors. Some consumers’ and shareholders’ associations believe that the provision will get them board directorships; but in all likelihood, proportional representation based on an election by minority investors may only lead to a cabal of speculators with large investment holdings finding their way to the boards of top companies.

Another suggestion from influential quarters is that the regulator, in consultation with stock exchanges, should create a list of eligible independent persons. Companies should then be asked to pick their representatives from this pool. Were this to happen, one can only imagine the lobbying and pressure from politicians and bureaucrats to get their people into the regulator’s golden list. It will kill forever the hope of minority shareholders’ interests being adequately represented on the boards of companies.

Another category of directors that needs more attention is ‘nominee’ directors from development financial institutions (DFIs) and hybrid mutual funds such as Unit Trust of India (UTI). There are several reasons why we need to get rid of nominee directors. First, the DFIs themselves are dying out and their directorships have to end. UTI, for instance, is now on par with other mutual funds and cannot have access to privileged board information. Second, these directors, on the rare occasions that they remember their fiduciary responsibility, only protect lenders’ interests. This is often in conflict with the interest of minority shareholders and debenture holders. That is why none of the institutional directors felt obliged to remember their fiduciary duty towards debenture holders (where the institution they represented was also a debenture trustee) when companies defaulted on debenture interest and redemption.

Obviously, we need some rethinking on who should be independent directors and what we expect from them. Firstly, let us recognise that independent directors can only play a limited role as watchdogs and they certainly cannot take over the fiduciary responsibilities of full-time management.

Having recognised that, let us not waste time worrying about outside expertise for independent directors at shareholders’ expense and let us not allow them to grow roots within the company. That is bound to compromise their independence. To my mind, nobody should be an independent director of more than five companies or for more than five years

-- Sucheta Dalal