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Myth of Independent Directorship: Promoters Appoint Well Wishers; Never Accepts Outsiders on Board

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By  Prithvi Haldea, Chairman & MD, Prime Database

To ascertain the relevance of independent directors (IDs), let’s first examine their fundamental role.

I would address this issue mainly from the Indian perspective, where most companies are family-owned and family-managed. Now, look at this typical scenario. Over years, a person grows a company to a reasonable size.

In order to grow further, his company raises some funds from the public…in many cases only 10 to 15% of the capital. Investors put in money because they like the way the company has been built, and have faith in the promoter’s competence.

Then, at the time of the IPO, the regulator requires the company to have half of its board comprise of IDs. Is it because the regulator believes that the promoter will not be able to run the company as well, just because he now has some public money?

Surely not, as the regulator’s job is not to ensure better management of companies, because then the regulator should have, at the least, prescribed some qualifications and experience for a person to become an ID.

In reality, the regulator believes, based upon worldwide experience, that because the company now has public shareholders – the voiceless, disintegrated small shareholders – the promoter may shortchange them to unduly enrich himself or misuse the listing status to derive personal gains, and hence the regulator wants the IDs to ensure that the promoter does not do this.

So clearly, the only role of IDs is to protect the interests of the minority shareholders and ensure better corporate governance.

If that be so, nothing much has been achieved on that front. The very word independent is fully compromised…as ironically, these ‘insider’ IDs are appointed by the very person whose misdeeds the IDs are supposed to prevent! And many of these IDs are promoter’s relatives, friends, classmates, ex-colleagues or neighbours.

They do not even recognise their primary role. Similar is the case of PSUs where the main promoter- the government- itself appoints the IDs. Worse, while the regulator insists on numerical compliance at the time of an IPO, subsequent non-compliance is totally overlooked…as if IDs are only essential for an IPO!

Surely, besides such ‘insiders’, there are several IDs who are experts – though, again, personally known to the promoters- and they definitely help the companies in several ways. But they rarely play the guardian’s role, as was well evidenced in the Satyam case, which is a typical and not a one-off case.

Independence is also compromised as these experts are paid extremely well, more so in the case of retired people, who occupy nearly half of all ID positions. These experts should rather join companies as advisors.

Most companies are actually run like proprietary firms. On a regular basis, we see so much that is being done by companies to the detriment of the minority shareholders. For example, in preferential issues, mergers, demergers, acquisitions, unfair related party transactions and siphoning of funds through over-invoicing or through subsidiaries.

Has anyone ever heard an ID bring any of the above to public notice? Since Satyam, over 3,000 IDs have resigned, mainly out of fear (bred by ignorance or reality) of ruining their life’s reputation. However, the reason cited is always ‘resigned’, no one ever cites the real reason.

How do investors then derive any confidence from the very institution of IDs, which truly is a myth? IDs were a regulatory response to the crash in investor’s confidence. However, this institution has been designed and implemented in a manner that is only giving a false sense of security. There is no demonstrable evidence in six years of their usefulness.

Finally, ethics cannot be an afterthought. Nor can they be mandated. The truth is that if the DNA of the promoter is right, IDs are not required. Conversely, IDs can be of no help. For good corporate governance, it is only simple laws, and the fear of these laws that is required. IDs are not the solution.

Independence is and will remain a myth. Promoters will never accept outsiders on their boards, and quality people will never join unfamiliar firms. We need to abolish the very institution of IDs.

(Economic Times, 30 July 2012)

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Posted by on Jul 30 2012. Filed under Corporate Governance. You can follow any responses to this entry through the RSS 2.0. Both comments and pings are currently closed.

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