Opinion | Independent directors are an endangered species in India

When I saw the story in BusinessLine (12 June), Independent Directors Will Soon Have To Take Exams Before Appointment, I thought to myself that this was yet another classic instance of public policy preparing the ground for the law of unintended consequences to take effect. At this rate, many people would not wish to be appointed as independent directors. In the interests of full disclosure, I am a non-executive independent director at a few companies in India, only one of which is a listed entity.

The strengthening of the role of independent directors in the Companies Act, 2013, is actually an example of true legislative consensus reached after three years of detailed deliberation by a parliamentary standing committee. In terms of the process involved, it was a model law having had the maximum amount of scrutiny, discussion and legislative debate. The final product is proof that parliamentary debate and committee scrutiny—a favourite of many intellectuals—does not guarantee a good product and may, in fact, produce an unrealistic outcome.

It is not the exam per sethat is problematic. That may even be welcome, for independent directors would know, at least once, what is expected of them. However, the philosophy behind the exam (one has to read the full news story mentioned above) is problematic.

Management abuse of shareholders is an age-old issue of the principal-agent relationship. Directors are now seen as agents of shareholders and the public interest to oversee managers, another set of agents. Agents can and do collude and, hence, the law now wants to punish both sets of agents. However, directors are outside the company and usually interact with the management on a quarterly basis. Unless someone is there in the office on a daily basis, participates in meetings where controversial and unethical decisions are discussed and/or is privy to internal documents and emails, it is impossible for independent directors to blow the whistle. Therefore, the responsibility on both sets of agents cannot be the same, nor can the consequences of failure to act.

Independent directors have no independent sources of information. They rely on the information provided by the company and by statutory and internal auditors who are appointed by the board of directors but are paid for by the company. However, there is a big gap between what auditors sign off on and what independent directors are expected to do. Therefore, what India’s Companies Act, 2013, enjoins upon independent directors is fundamentally flawed. Independent directors have increasingly onerous fiduciary responsibilities, but no resources or tools to discharge them.

A friend who has been an independent director at several companies argued that this was needed because many independent directors were not even aware of the tasks involved in directorship. He advocated a dashboard for directors that, in turn, would help them seek the right information from the management. In his view, without even bothering to know what questions to ask, it is not correct to argue that there is an inherent problem with sourcing information from the very management that is under scrutiny. Fair enough, but only up to a point.

Independent directors are expected to be experienced investors/professionals who possess the expertise and experience to guide managements to act in the interest of shareholders and other stakeholders. Besides possessing such expertise, they also ought to have the inclination and commitment to perform such a role. When the stakes are very high and the management incentives are in conflict with these responsibilities of independent directors, the commitment can start to fray. Regulations can scrutinize them for expertise. However, it can do little on the latter.

As always, the government appears to be overreacting to high-profile frauds. Its standard presumption under such provocation is that everyone is guilty until proven innocent. It is going to make life difficult for good companies and going to turn away genuinely independent and conscientious people from volunteering to become independent directors. Then, companies will have directors who are only nominally independent. There will be more frauds. They will be met with even more draconian regulations. It is a downhill ride for public policy.

Surely, social and economic interactions are built on the foundation of norms, conventions, shared values and ethics, and involve moral principles. Trust and reputational premiums, too, are critical preconditions, and both are scarce in the Indian context. But presumption of guilt by default under the law is not going to build that foundation. It is impossible to legislate morality or infuse it through regulation, even though it is a crucial precondition for a functional capitalist system.

In sum, it is right to expect independent directors to be diligent. However, to expect them to be vigilant is counterproductive because they do not have the tools to play that role. They will become sacrificial lambs and governance will suffer even more as a result. That is why the road to hell is often paved with good intentions.

V. Anantha Nageswaran is dean of IFMR Graduate School of Business (KREA University).

These are the author’s personal views