Role of Independent Directors in Corporate Governance

Role of Independent Directors in Corporate Governance

Setting the scene

When it comes to maintaining fairness, transparency, and accountability in corporate governance, independent directors play a significant role. Appointment of independent directors is not just a regulatory requirement! A company which consists of a higher number of independent directors is more inclined to perform better,  along with having a higher efficiency in management, as per a study conducted by the China School of Economics. As per the regulations in India, independent directors play a crucial role in balancing the interests of the company along with strengthening the governance in companies. 

Independent Directors in Corporate Governance

An independent director is also commonly referred to as an outside director. An independent director does not have stock ownership or represent the company. The outside director helps the board in improving governance in the company along with strategy. An independent director also helps in leadership. The independent directors do not take part in the day-to-day activities of the company. 

A company consists of various different parties such as stakeholders, employees, customers, shareholders and investors. It is very important to have good corporate governance to attract more investors and investments. Corporate governance is very vital for the growth of any business. The main driving force which ensures corporate governance is an independent director. 

Legal Framework and Regulatory Mandate for Independent Directors

Section 2(47) of the Companies Act, 2013

As per Section 2(47) of Companies Act, 2013, independent directors are non-executive directors who help in improving corporate governance. They are like the neutral party which observes the board of directors. 

Section 149 of the Companies Act, 2013

This Section talks about the mandatory appointment of an independent director in a company in India. All the publicly listed companies are required to have 1/3rd of their directors as independent directors. Whereas, for the non-listed companies, Rule 4 in The Companies (Appointment and Qualification of Directors) Rules, 2014 states that there must be at least 2 independent directors in: 

  1. Public companies which have paid-up capital of Rs. 10 crore or more. 
  2. Public companies who have aggregate outstanding loans, deposits and debentures worth Rs. 50 crore.
  3. Public companies whose turnover is Rs. 100 crore or more than it. 

Eligibility criteria of Independent Directors

In order to become an independent director, you must:

  • Have the required expertise and integrity.
  • The person should not be a promoter of the company.
  • The person should not have any kind of close relations with any other directors or promoters of the company.
  • The person or his family should not have any managerial ties with the company.
  • The individual or his family must not have been previously employed with the company.
  • No relative of the person must hold any significant financial interest in the company. 
  • No relative of the person should be indebted or have provided securities or guarantees for third party debts to the company. 
  • The person himself should not have any pecuniary interest in the company. 

Why have Independent Directors in a company

  • Independent directors ensure that there is unbiased decision-making in the company. They have an objective viewpoint, which is not influenced by anything or anybody. 
  • Independent directors also protect the minority shareholders and make sure that they have fair representation in the company.
  • These directors also help in maintaining long-term growth and sustainability in the company. 
  • The independent stance of the independent directors build credibility amongst the investors, public and the regulators. 
  • Independent directors promote transparency and accountability which enhance corporate governance. 
  • As independent directors have expertise and knowledge in different fields, they offer specialised insights and expertise in fields like finance, law, etc. 
  • Independent directors uphold integrity, responsible business practices and accountability. 

Roles and Responsibilities of Independent Directors in Corporate Governance

As we have already established that independent directors are a key player when it comes to enhancing corporate governance. Following are the roles and responsibilities of independent directors in corporate governance:

Mentors at the helm

The main, foremost role and responsibility of an independent director in corporate governance is to guide the leadership of the company. An independent director uses their strategic expertise and vast experience to guide the leaders of the company. 

Champions of governance

The next vital responsibility and role of an independent director is to promote accountability, ethical conduct and transparency in the company. 

Gatekeepers of ethics

An independent director ensures that the company is working as per the corporate ethics and is in legal compliance. They also help the company manage their reputational and operational risk. 

Main players in committees

Independent directors are key players in the committees. They have an active role in nominations, audits and other important governance-related committees and decisions. 

Voice for shareholders

One of the main roles of an independent director is to protect shareholders rights, especially minority shareholders. 

Neutral party

These types of directors play a neutral role in the company and help in mediation. They mediate between the shareholders and management when a dispute arises. 

Protectors of financial integrity

They ensure that reliable and accurate financial reporting is done and internal control systems are working ethically. 

Performance monitors

An independent director evaluates the performance of the board and its effectiveness in order to make sure that the goals are aligned. 

Challenges faced by Independent Directors in Corporate Governance

There are various challenges which are faced by the independent directors when they are practising corporate governance. Independent directors often serve more than one company. This raises concerns related to their time management and ability to give enough attention to all companies where they serve. 

Independent directors and their ties with the management or promoters in the past or present also lead to many challenges. Having no interest or relationship with anyone associated with the company is one of the key requirements for independent directors. Despite having ties which are not legally material, it can also lead to subconscious bias from the side of the independent director. 

An independent director is remunerated by the company where he serves. The financial dependency on the company may also hinder his stance. If the directors are appointed who lack the specific skill required in the industry, then they may struggle in contributing to complex decision-making processes. There is also a high chance that an independent director’s exposure to confidential data can cause high risk and may also compromise the independence of taking decisions. 

Skills required in independent directors

The corporate landscape is very complex in nature. There are some traits and skills which all the independent directors must have to enhance the corporate governance in the companies:

  1. Emotional intelligence
  2. Objectivity
  3. Diligence
  4. Ethical leadership
  5. Strategic vision 
  6. Industry expertise

Practices for effective Corporate Governance

One of the best practices for effective corporate governance is to enhance board independence. The company can conduct regular training programs on corporate governance. This will help the independent directors stay updated with the new norms. Another equally important practice is to maintain objectivity. There should be a clear boundary between the practices of the independent directors and management. 

There should be transparent communication between independent directors and companies. This will help in fostering collaborations and insights in the corporate environment. Independent directors must advocate honest and clear reposting and support accountability. 

Difference in role of Independent Directors and Non-Executive Directors

Basis Independent directors  Non-executive directors
Role Gives objective viewpoint in policies, risk management, decisions made by board, and strategies of the company.  These directors do not perform any day to day tasks.
Relationship  Independent directors are not related to the company in any way. They have no interest in the company.  Non-executive directors may have existing or prior relations with the company.
Responsibilities The main responsibility of an independent director is to give independent judgement. This should be given along with protecting the interests of the shareholders.  The non-executive directors have the responsibility of attending the board meetings and proving specific expertise and skills whenever required. 
Decision making power They make decisions which are independent in nature from the existing board members.  They do not make any decisions. 
Appointment  The independent directors are appointed as per the mandatory requirements and needs of the company.  Non-executive directors are appointed on the basis of expertise and skill which is needed in the company. 

Conclusion

We can conclude that independent directors are the guardian of good governance in the company. It is very vital to strike the right balance between collaboration and oversight. Independent directors help in bringing the objective in the board meetings. They ensure that risks are managed, compliance is there and strategic decisions are made. With the evolving corporate landscape, independent directors must evolve too. Independent directors must stay informed, proactive, and flexible to changes. This will ensure that governance standards are elevated and long term success is the main focus. 

Frequently Asked Questions (FAQs)

How many years does the independent director serve?

An independent director can service up to five consecutive years.

What are the duties of independent directors?

Some of the key duties of independent directors are making informed decisions, active participation in board and general meetings, reporting of the ethical conduct, protecting the legitimate interests of the company, maintaining confidentiality etc. 

References

 

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