Leveraging the power of an independent board

This article was first published in the Financial Express on March 14, 2023, Co-authors: Navneet Bhatnagar, Sougata Ray; https://www.financialexpress.com/industry/leveraging-the-power-of-an-independent-board/3008998/

Governance failures often jeopardise businesses, including family-owned firms. Family businesses are often blamed for poor corporate governance and oversight. In India, well known and established family firms have come under the regulatory scanner for opacity in financial dealings, related party transactions, and appropriation of minority shareholders’ wealth.

For corporate governance and monitoring issues, the buck stops at the apex governing body of the company, that is, its board of directors. The board of directors of a company determines its purpose, broad policies, and oversight mechanisms. An effective board ensures that executive decisions are made in the company's best interest. It is critical for the board oversight mechanism to assess the impact of executive decisions on shareholders and other stakeholders.

Aimed at improving corporate governance, the Companies Act 2013 stipulates the appointment of Independent Directors as non-executive members who can objectively scrutinise executive decisions and management performance. While monitoring the firm's reporting mechanism, independent directors are expected to evaluate and check the robustness of financial controls and risk management systems. They must uphold high ethical standards, integrity, and probity. Independent directors are not supposed to receive any monetary benefits except their fees. They are appointed for a five-year term and can not hold more than two consecutive terms.

Corporate governance standards were expected to be elevated through these legal provisions. However, various corporate governance debacles continue to hit the headlines in India. In 2015, Diageo alleged misappropriation of funds at United Spirits, which they had acquired from Vijay Mallya. Malvinder and Shivender Singh's fraudulent loan transactions at Religare and loan fraud at Gitanjali Gems were the other cases that poorly reflected the governance in Indian family businesses. So was the case of the Dhoot family-owned Videocon's loans obtained from ICICI Bank by questionable means and alleged kickbacks. In all these cases, the role that independent directors played as the custodians of stakeholder interest was wanting.

Our research on these cases of corporate governance failures of independent directors reveals some key insights.

Proximity to Promoters: One of the reasons why independent directors fail to discharge their fiduciary duties is their proximity to the promoters. Due to this, they often do not hold management to account and avoid asking tough questions. Independent directors who continue to serve the companies for a long time develop an affinity with key management personnel, making oversight difficult as the emotional costs of a negative exchange escalate. Hence, independent directors impose self-restraint.

Power equation: In several cases, we observed that the aura and assertiveness of the promoter family's leader kept the independent directors constrained to voice concerns. Board selections were made so that the independent directors could not seriously challenge executive decisions.

Incentives: Another reason for this oversight was the lure of the incentives attached to the board position. Independent directors follow what pleases the management or postpone raising their concerns due to the significant monetary/non-monetary incentives they gain from the company.

Overworked: In some other cases, we observed that the independent directors were so occupied with multiple responsibilities across different companies that they failed to devote sufficient time and attention to their oversight responsibilities.

As a result of the above factors, independent directors are rendered “rubber stamps”, corporate governance falters, and the respective businesses suffer a significant loss of monetary and brand value.

The need of our times is to make independent directors “truly independent.” Several measures can be adopted to empower independent directors with the authority to intervene through more effective checks and control mechanisms.

Selection: First and foremost, it is vital to improve the independent directors' selection process. They must be chosen on merit and have an impeccable value system.

Induction: They must be appropriately inducted and familiarized with the business and its key challenges. They must be eager to learn and update their knowledge and skills. They must be able to assess the internal and external environments in which the business operates and be vigilant of the motives that drive executive decisions.

Promoters' Buy-In: The most crucial factor that may make the role of independent directors more effective is the promoters' realization of the genuine need to raise the corporate governance standards of their company. If promoter families embrace good corporate governance in its true spirit, they will see the value in fostering vocal, expert, empowered, and truly independent directors.

Family firms and promoters must realise that when boards fail to exercise effective oversight, deviations from governance norms go unchecked. Ineffective governance eventually results in bigger violations and the destruction of value. Therefore, the boards must be diligent in objectively assessing executive decisions and providing timely advice when remedial measures are required, and they must be 'allowed' to do it.