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The following passage of Viscount
Haldane, Lord Chancellor, in Lennard's Carrying Company Ltd v. Asiatic
Petroleum Co.Ltd (1915) AC 705) highlights how the non-executive
directors' contribution can be instrumental in complementing the
executive's competence :
"My Lords, a corporation is an
abstraction. It has no mind of its own any more than it had a body of
its own; its active and directing will must consequently be sought in
the person of somebody who for some purposes may be called an agent, but
who is really the directing mind and will of the
corporation, the very ego and centre of the personality of the
corporation. That person may be under the direction of the shareholders
in general meeting; that person may be the board of directors itself, or
it may be, and in some companies it is so, that that person has an
authority to co-ordinate with the board of directors given to him under
the articles of association, and is appointed by the general meeting of
the company, and can only be removed by the general meeting of the
company."
The board of a company comprises of
executive and non-executive directors. Though the law treats them simply
as directors and both carry equal responsibility, they have different
roles to play. The non-executive independent directors are generally
given the chairmanship of important committees like Audit committee,
Nomination committee and remuneration committee. They are closer to
action. They can question the executives directly. They observe from a
distance how well executives are performing their duties. An attempt has
been made in this article to critically analyze the role and
effectiveness of independent non-executive directors especially in the
light of Higgs Committee Report in U.K.
Duties And
Responsibilities Of Directors
A director should first understand his relationship with the company and
the shareholders as this relationship is what shapes his roll and
responsibilities vis a vis the company and the shareholders.
Unfortunately, there is no statutory provision to define this
relationship. It is the judiciary which has over a period of time
defined the relationship. As early as in 1866, that is about a century
and half back, in Ferguson Vs. Wilson, the Chancery Division held that a
company though a legal entity, cannot act by itself. It can act only
through its directors and as such the relation of a director with the
company is that of principal and agent and therefore general principles
of law of agency would govern the relationship between the company and
the directors. The relationship was further defined in Forest of Dean
Coal Mining company case by Chancery Division in 1878 that directors,
having been entrusted with the affairs of the company, are trustees of
the company and therefore they are in a fiduciary relationship with the
company. These judicial pronouncements have been universally accepted
and applied all over and now the position of directors' vis-à-vis the
company is that they are not only agents but also trustees. This
relationship would mean that the directors should always act in the
interest of the principal that is the company and in discharge of their
fiduciary responsibilities, they cannot benefit at the cost of the
company.
As far as the relationship with the
shareholders is concerned, the legal position which has evolved over a
period of time, is that the directors are neither agents nor trustees of
the shareholders but special circumstances depending on facts of a
particular circumstance may give rise to that relationship.
In Principles of Modern Company Law,
6th Edition, 1997, Gower has summarized the legal position as (quote)
"In applying the general equitable principles to company directors, four
separate rules have emerged. They are (1) that directors must act in
good faith in what they believe to be the in the best interest of the
company (2) they must not exercise powers conferred upon them for
purposes different from those for which they are conferred. (3) that
they must not fetter their discretion as to how they shall act and
finally that without the informed consent of the company, they must not
place themselves in a position in which their personal interests or duty
to other persons are liable to conflict with the duties to the company".
Thus over a period of time the view
that a director's duties to a company is that of a man of ordinary
prudence has changed and now it is more than that of a man of ordinary
prudence.
The role and responsibility of an
individual director, of course, would depend upon the nature of his
directorship. Broadly, there are three types of directors. Full time,
executive director who is normally a paid employee of a company having
some functional responsibility, non executive but non independent
director who is normally a promoter of the company or having high stakes
in the company and finally independent directors who are not full time
directors. There is another class of directors known as nominee
directors representing some interests like lending institutions etc. An
executive director, by very nature has much more responsibilities than
non executive directors. In law it is their responsibility to ensure
compliance with provisions of law failing with they could be held liable
as officers in default. As far as independent directors are concerned,
the position of law is nebulous.
Of late thee has been great emphasis
in appointing independent directors on the Boards of companies. On the
basis of Naresh Chandra Committee Report, in the new Companies Bill
introduced in the Parliament, certain provisions have been made in
relation to independent directors. These provisions do not define an
independent director but only specify grounds which would disqualify a
person from being considered as an independent director. The rationale
of having independent directors on the Board of a company is with an
idea to keep a special eye on the finances of a company particularly
through the audit committee. It is a known fact that most of the
companies which went into difficulties in USA did have independent
directors. Mere presence of directors who are independent in terms of
the provisions of law does not mean that there would be checks and
balance. What is to be ensured is that these directors think and act
independently. Even though in law, the directors are to be elected by
the shareholders, yet, in practice, the directors proposed for election
are normally the nominees of the promoters.
The selection and appointment of
independent directors should be transparent and on certain valued basis.
Therefore, the companies should have an entirely independent nomination
committee which should determine the qualifications for Board membership
and should identify and evaluate candidates for nomination to the Board.
It would be more appropriate that the code of Corporate Governance of a
company should specifically include the qualifications and attributes
that the company seeks of an independent director. A critical element of
a director being independent is his independence to the management both
in fact and perception by the public. In considering the independence,
it is necessary to focus not only on whether a director's background and
current activities qualify him as independent but also whether he can
act independently of the management. In other words, the independent
directors must not only be independent according to the legislative and
stock exchange listing standards but also independent in thought and
action i.e. qualitatively independent. Such qualitative independence
will ensure that directors think and act independently without regard to
management's influence.
Qualitative directors' independence
should include the will and ability in terms of knowledge and experience
to ask the hard questions required to provide effective oversight and
character and integrity in general and especially in dealing with
potential conflict of interest situations. The Board to be successful
should have mix of skills and should be tailored to meet the needs of
the company. Even though, there could be no precise mix of
qualifications and experience, which will depend on various factors,
yet, specialists in the areas of accounting and finance, technology
relevant to the company, corporate management, marketing and industry
knowledge etc could be considered for independent directors. Perhaps, a
skill matrix which lists desirable competency versus those presently
present on the Board is useful in determining where the holes exist on
the Board, which skills compliment each other etc. Board dynamics are
difficult to prescribe as groups of people gather together to make
informed decisions about the direction of the company. Although, the
level of knowledge, integrity and independence necessary to carry out
the functions of a director are difficult to summarize, the behavior
characteristics of a good director should include the attributes of
asking the hard questions, working well with others, having industry
awareness, providing valuable inputs, availability when needed, be alert
and inquisitive, making long range planning contribution etc.
The independent directors could
effectively and substantively contribute if they are empowered to meet
at regularly convened executive sessions without participation of
management or employee directors so that they could openly and freely
discuss the affairs of the company. There has always been a conflict of
opinion as to whether the combination of the position of Chairman and
CEO is preferable or two different persons should hold these positions
independent of each other. Each has its own merits and demerits and it
is for the Board to decide the best alternative that is suited to the
company.
Accountability is an important element of Board effectiveness. There
should be some mechanism for evaluating the performance of the
directors. Perhaps, a system of 3 tier director evaluation mechanism
could be evolved by which the performance of the Board as a whole, the
performance of each committee and performance of each individual
director is assessed. Since the shareholders who elect the directors
lack the knowledge of the inner working of the Board, the Board could
disclose their mechanism and process of the 3 tier evaluation to the
shareholders. How and in what manner the evaluation is to be carried out
has to be specifically spelled out by the Board.
Now comes the liability of the
directors. There are two types of directors liability. One relating to
statutoty compliance and the other is in relation to their fiduciary
obligations. The Companies Act and other Acts lay down various
requirements on the part of the company and most these provisions
provide for penal action against the directors. As I have said earlier,
the extent of liability of a director would depend on the nature of his
directorship. No doubt, full time directors being offices in default
have to be fully liable while part time directors may not be so liable.
But as far as fiduciary duties/obligations are concerned, any breach by
any director would visit them with liability. Our Supreme Court has
considered this issue of fiduciary liability. It has observed in
Official Liquidator Vs. PA Tandulkar (AIR 1973 SC 1104)[As mentioned by
shri S.Balasubramanian in one of his speeches.]
The Higgs
Report
The report by Derek Higgs into the role and effectiveness of
non-executive directors was published on 20 January 2003. The report
lays considerable stress on more demanding and influential role of
non-executive directors (NEDs). The report is so comprehensive that it
can definitely serve as guide to the corporate in our country.
Composition
Of Board
currently, the Combined Code of good Governance and code of best
practices(in short, The Code) requires that the board should include a
balance of executive and non-executive directors (including independent
NEDs) - aiming to ensure that no individual or group can dominate the
board's decision making. Taking the board as a whole, the NEDs (whether
independent or otherwise) must comprise not less than one-third of the
board, and a majority of the NEDs should be 'independent' However, the
Higgs report requires that at least half of the board, excluding the
Chairman, should be independent (NEDs).This recommendation will herald a
shift in the overall power of the board in favor of independent NEDs,
and away from executive management.
The
chairman
The Code already recognizes that the roles of chairman and chief
executive involve two distinct tasks - running the board (chairman) and
taking executive responsibility for running the company's business
(CEO). The Code currently accepts that these tasks may be combined in
one person, although such a step does require public justification. The
report also requires that a chief executive should not go on to become
chairman of the same company; and on appointment, the chairman should be
seen to be independent (although it recognizes that, following
appointment, the chairman will cease to be independent due to his
greater involvement with the executive team). The recommendation that a
chief executive should not go on to become chairman of the same company
will be unwelcome to many companies, and has attracted more criticism
than other aspects of the Report.
Role Of
Non-Executive Directors
The non-executive directors should:
1. contribute to and constructively challenge development of company
strategy.
2. Scrutinize management performance.
3. Satisfy them that financial information is accurate and ensure that
robust risk management is in place.
4. Meet at least once a year without the chairman or executive directors
- and there should be a statement in the annual report saying whether
such meetings have taken place.
5. Be prepared to attend AGMs and discuss issues relating to their roles
(especially chairmen of committees).
6. Have a greater exposure to major shareholders (particularly the
senior independent director).
Senior
independent non-executive director
currently, the Code recommends that there should be a recognized senior
independent NED (irrespective of whether the roles of chairman and CEO
are combined) who must be identified in the annual report.
The Report envisages an expanded role. Currently the Code tasks the
senior independent director as the person, other than the chairman, 'to
whom concerns can be conveyed'. The Report proposes that the senior
independent director should be available to shareholders if they have
concerns that have not been resolved through the normal channels, or for
which contact through the normal channels is inappropriate. In addition,
the senior independent director should develop a balanced understanding
of the concerns of shareholders by attending sufficient of the regular
meetings between management and the major shareholders.
The Report contains guidance on the
recruitment and appointment of NEDs, and envisages a more developed role
for nomination committees (which should consist of a majority of
independent NEDs and be chaired by an independent NED
The meaning
of independence
when the board determines that the director is independent in character
and judgment and there are no relationships or circumstances which could
affect or appear to affect the director's judgment'. Such relationships
or circumstances would include cases where the NED:
* is a former employee of the company or group - the NED will
only be treated as independent five years after the employment has
ended;
* has a material business relationship with the company either
directly, or as a partner, shareholder, director or senior employee of a
body that has such a material relationship - the NED will also cease to
be independent if he has had such a relationship within the last three
years;
* receives or has received additional remuneration from the
company beyond the director's fee;
* participates in the company's share option scheme or a
performance-related pay scheme;
* is a member of the company's pension scheme;
* has close family ties with any of the company's directors,
senior employees or advisors;
* holds cross-directorships or has significant links with other
directors via involvement in other companies or bodies;
* has served on the board for more than 10 years; or* represents
a significant shareholder.
Tenure and
commitment
stricter recommendations are introduced relating to the re-election of
NEDs. Under the Code as it currently stands, NEDs are required to be
appointed for a specific term and then be subject to re-election
thereafter at intervals of no more than three years. There is currently
no maximum term (although various shareholder bodies already envisage
that a NED's 'independence' will be lost after 10 years' service).
The Report limits the term that can
be served by a NED. It recommends that a NED should normally be expected
to serve two three-year terms unless exceptional circumstances make a
longer term appropriate. Any extension beyond six years must be
justified. Further, any NED serving nine years or more must be
re-elected annually. Once a NED is appointed, the NED must inform the
chairman before any new appointments are accepted; the board must also
be informed.
Remuneration
The Report endorses the current recommendations of the Code that levels
of board remuneration should be sufficient to attract and retain
directors but should not be more than is necessary. The Report provides
more detailed recommendations in relation to the remuneration of NEDs by
stating that NED fees should be built up from an annual fee, meeting
attendance fees and additional fees for chairmanship of committees and
NEDs should have the opportunity to take part of their remuneration in
shares but they should not be granted options.
The Indian
Scenario
The term "independent Directors" became a part of the Indian corporate
lexicon after the publication of the Kumar Mangalam Birla committee
report which resulted into introduction of clause 49 in listing
agreements. The committee mentioned that 'independent directors' are
those directors who apart from receiving directors remuneration do not
have any material pecuniary relationship or transaction with the
company, its management or its its subsidiaries which in the judgment of
the Board may affect their independence of judgment. Clause 49 also
prescribes that Audit Committee should comprise of majority of
independent directors.
With the integration of the Indian
economy into the world economy, -there is consensus among the corporate
leaders that the corporate governance in India should conform to
international norms. Once Mr. Rosie Catherwood , director of Dewe
Rogerson had said that " while Indian companies were rated high on
ability, they continued to suffer from low credibility amongst
shareholders. He further mentioned that only multinational and public
sector units operating in India have been rated highly on management
credibility. While MNCs score for the quality of management that they
offer, PSUs are rated highly for the transparency of management."
Barring a few exceptions, in India
the appointment of independent or non-executive directors has become a
matter of mere legal compliance. Most of the companies still function in
the same old fashion and the non -executive directors has hardly any say
in the management of a company. In most of the companies, hardly any
relevant information is passed on to the directors and the meetings of
the Board discuss minor and routine matters. The Board meetings are
normally held once in three months and that too for 2 to 3 hours only.
It is obvious that promoters would prefer to appoint their cronies and
faithful persons on their board to have minimum interference of the
outside directors.
But a million dollar question
begging an answer is that when the Indian businessman will come out of
the pond and start swimming in the main stream of global village. How
will they satisfy the foreign institutional investors who are demanding
greater professionalism in the management of Indian corporate. Even the
lending institutions are now giving much more emphasis to good and
efficient corporate governance.
It is true that the law alone cannot
bring changes and transformation. A judicious mix of regulations and
voluntary compliance will play an important role in developing a system
of good corporate governance.
Can the
Independent Directors really Direct the Company?
The Cadbury
Report has observed that 'every public company should be headed by an
effective board which can lead and control the business.' The following
propositions will highlight the importance of independent and
non-executive directors on the board of a company:
1. The non -executive directors, when carefully chosen, can complement
the Board's overall strength with their knowledge of best practice
outside the company.
2. Their role should not be to do the job of the executive but to act as
candid counselors to the guide the company in benchmarking standards and
its level of ambition.
3. This is a function not of numbers but caliber.
4. The non-executive directors must concentrate on a few companies
rather being involved with up to fifteen companies which the companies
act permits.
5. Non-executive directors can bring a broader view to the company. They
bring external and wider perspective and independence to the decision
making.
6. To render effective services the NEDs should be allowed to seek
independent professional advise at the cost of the company.
7. The resume of the NEDs should be made available to the shareholders
along with the proposal of their appointment or re-appointment.
8. Non-executive director5s should be given immunity from the
responsibility for compliance with procedural matters.
9. The remuneration of the non-executive directors should be
commensurate with the time they devote and experience they possess.
10. Non-executive directors who are not qualified professionals (e.g.
Chartered Accountants, Companies Secretaries etc.), should undergo
proper training before they assume directorships.
Qualities
of a director
It is not uncommon that on the Board of directors of a commercial
enterprise a retired bureaucrat , a celebrity like a film artist, a
retired major general from the army, a retired judge from the High Court
or the Supreme Court etc are nominated. There is nothing wrong in this
approach per se but one must remember that more often than not these
directors prove a decoration on the Christmas tree. In his though
provoking book "The Brave New Manager" the author on page 142 has given
an interesting example; When one such
Major-general, CEO of public sector company, enquired from the other
Majors-turned-managers, as to how they found the assignment of building
the dam for a hydroelectric project, the answer came- "Those who had
spent their entire military career in demolishing dams are now being
asked to build one. We were taught to demolish and not to build."
Business has become complex, competitive, risky and challenging.
Globalization has made the outcome of a commercial activity
unpredictable and uncertain. Today it is not Ford competing with Toyota,
its Ford competing with Ford of Europe as has been observed by Tom
Peters. At a conference held in Cochin, Abid Hussein, while talking
about globalization, said:
"There was a
time when the Americans used to say, what is good for the General Motors
is good for America and what is good for America is good for general
Motors. No longer so. During the Bush period, the Americans gave the
slogan, "Be American, Buy American." I have seen those posters. I have
seen those handbills. The movement did not last more than 10 days. Men
and women came out of their houses and tore those posters and handbills
into bits and pieces. The point was that, if the American companies are
not able to give me what I want, you can't stop me from buying the goods
produced by other countries."
The cardinal sin of management is
wrong selection, or a chain or wrong selections. I call it 'cardinal'
because it is the most horrendous 'sin' of management. No sin equals it.
Factors like caste, creed, color, province, language and
blood-relationships are the major factors responsible for the commission
of this cardinal blunder. One may imagine that family-controlled
(Pedi-type) companies alone suffer from that malady. This is totally
incorrect to imaging so. We know, abundantly, about politically-defeated
MLA's and MPs being rehabilitated as Chairmen of state and central
government undertakings. We all know the results of such appointments:
persistent losses, extremely low morale, and flight of high caliber /
honest men and women.
Corporate structures fail because
they have given the least importance to their man-power, or they have
prospered because they have given a paramount consideration to their
man-power, somewhat like this: "Raze down my factories, take away my
plant and machinery, but give me back my men, and I will build a new." (B.T.
Dastur, in his article. 'Why Corporate Fail?')
The composition of the Board should be such as to provide vast array of
expertise and business knowledge and correct direction to the company. A
non-executive director should be able to devote enough time in the
affairs of the company. The importance of non-executive director has
been underscored by SEC Chairman Arthur Leavitt, in warning against
multiple directorships: "I don't care how
talented you are, you can't be a good watchdog if you're only on patrol
three times a year."
Epilogue
The appointment of independent non-executive directors of the Board of a
Corporation is not a panacea for all the evils. Nor is the system of
corporate governance an innovation like 'Eureka'. However, as Mr. Amit
K. Vyas says in one of his article," it would definitely act as a
spirited move towards achievement of excellence by the corporate not
only in the terms of increased profits and revenue but also in terms of
respectability for the laws of the land, protection of interest of
shareholders, creditors and employees of the company." Let us not forget
that these directors are a part and parcel of our society. We cannot
have a better Board of directors than the society itself. A company
alone cannot fight the fierce battle of corruption and other social
abuses. But collectively, any problem can be tackled and a solution
found. The need of the hour is to combat these evils privately as well
as publicly. Nothing happens in this world, unless we intend it to
happen. Let the stories of good corporate governance be given wide
publicity. WE need more and more Azim Premji and Narayana Murthy. The
writing on the wall is very clear. Unless ethics are as important to us
as economics, fair play as crucial as financial success, morals as vital
as market share, we run the risk of being blotted out of our stake
holder's landscape
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