An Independent Director is a member of the Board of directors who does not have a material or pecuniary relationship with company or related persons. It is widely accepted that the presence of Independent Directors in the board room improves the quality of corporate governance. Accordingly, corporate governance mechanism in India, focuses on Independent Directors. The Independent Directors are expected to protect the interests of minority shareholders.

I. Definition under Companies Act:

Section 149 (6) of the Companies Act, 2013 defines an Independent director as a director other than a managing director or a whole-time director or a nominee director:

a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience

b) who is or was not a promoter of the company or its holding, subsidiary or associate company

c) who is not related to promoters or directors in the company, its holding, subsidiary or associate company

d) who has or had no pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year

e) none of whose relatives has or had pecuniary relationship or transaction with the company, its holding, subsidiary or associate company, or their promoters, or directors, amounting to two per cent. or more of its gross turnover or total income or fifty lakh rupees or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year

f) who, neither himself nor any of his relatives

• hold holds or has held the position of a key managerial personnel or is or has been employee of the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed

• is is or has been an employee or proprietor or a partner, in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed, of a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to ten per cent. or more of the gross turnover of such firm or holds together with his relatives two per cent. or more of the total voting power of the company

• is a Chief Executive or director, by whatever name called, of any nonprofit organisation that receives twenty-five per cent. or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds two per cent. or more of the total voting power of the company

• who possesses such other qualifications as may be prescribed

The definition of Independent Director as per the Companies Act, 2013 provides quantitative threshold for evaluation of significance of the relationship and considers all pecuniary relationship (both material and immaterial).

 II. Though the definition establishes independence, Can Independent Directors be really INDEPENDENT?

One can either be a director or independent, but not both, say some critics of corporate governance. The role of independent director, in part, is to act as a watchdog on the promoters and the management of the company and protect minority shareholders' interests.

Usually, one has to be well known and trusted by the promoters/directors to be invited to join the board as an independent director. In public sector companies, where government is the promoter, a lot of influence is required to become an independent director. How can these people be expected to be really independent? It is like getting invited to an event, and then being critical of the arrangements. This is very difficult, not impossible though.

The process of identification and appointment of an Independent Director itself provide hints about the likelihood of the person acting independently. A good way to identify and appoint an Independent Director is to involve the nomination committee of the board, or involve the entire board. This will ensure that prejudice and proximity to management, or a majority shareholder do not influence the selection of Independent Directors. Because the concept is still evolving, we can possibly expect a few changes in the process of identification and appointment of Independent Directors in future.

III. Challenges faced by Independent Directors

Major challenge for independent directors is the asymmetry of information. Promoters and managements have far more information and knowledge regarding the affairs of a company and more resources at their disposal compared to independent directors. The promoters and managements also have more financial stake in decisions and, therefore, protect their interests vigorously. We have to accept the reality that Independent Directors cannot monitor the executive management. At best they provide checks and balances and enrich boardroom deliberations. This makes the job of an independent director very difficult.

Every Independent Director should understand the business well and should have adequate knowledge to appreciate management issues. They have to apply sound due diligence in carrying out their responsibilities. There is a gap between what is expected from Independent Directors and what they can do in practice.

However, Independent Directors in enlightened companies, improve enterprise performance by providing innovative solutions to issues that pull down performance of company. They, through the audit committee, strengthen audit functions and risk management systems. They usually stop decisions that directly hurt the interest of non-controlling shareholders. Perhaps, that is what shareholders i.e. minority shareholders expect from Independent Directors but of course what do promoters expect is debatable.

IV. Voice in a concern

Before joining a board, an Independent Director has to do diligence and make a judgment on the character of the management. He/She has to be sure that the corporate culture of the organisation encourages compliance with regulations and ethical behavior. They must know that other independent directors are like-minded and strong. They must be sure that the promoters indeed believe in proper corporate governance.

For Independent Directors, their voice and their willingness to resign, in case of any wrongdoing are the most effective weapons. Even in the public sector, independent directors in Coal India and Air India stood up to the government on very important issues of conflicts of interest.

So, being an Independent Director is just a difficult service to shareholders that is still evolving.

V. Raising red flags, is it too difficult?

Recent years have witnessed some instances of corporate mismanagement and lack of corporate governance in a few companies that boasted of having high standards of compliance and governance.

There have been instances where independent directors have resigned when the company started facing some issues. After problems surfaced in Jet Airways, several of its independent directors resigned from the Board of the company. In fact, although some directors cited “time constraints” as a reason for the resignation, they continue to hold this position in various other companies.

Also, in IL&FS where several independent directors stepped down when the company defaulted on its payment obligations. None of these directors have provided any adequate reasons for their immediate resignation in times of trouble. why did they not raise red flags when they should have sensed trouble. Reports reveal that the Risk Management Committee of IL&FS, which includes independent directors as well, had not conducted atleast one meeting in four years. Although one of the independent directors took a defence of lack of knowledge, most people are not accepting this contention as they believe that even outsiders were aware of the internal concerns and thus, it was the duty of independent directors to raise questions. Same is the case with Yes Bank though the reason was resignation was clearly stated as lack of governance standards.

This raises serious questions regarding the role of independent directors in corporate governance. Instead of performing their duty of protecting the interests of the minority and reporting fraudulent conduct. they are often cited running away when things go wrong. This makes us believe that Independent Directors find it extremely difficult to raise red flags.

However, there have been occasions where independent directors have raised their voice against alleged corporate governance failures in their company and the results have been disastrous. One such example is the role played by Nusli Wadia.

VI. Conclusion

It is to note that not all independent directors perform their functions perfectly but then there are some who are determined to work effectively and in compliance with their duties and expectations. Independent directors with good business sense, strength of character, dedication and positive attitude are playing a major role in improving corporate governance. Fortunately, investors are recognising the importance of such independent directors and superior corporate governance in companies and are rewarding such companies with a governance premium. Having strong independent directors is good for all shareholders, including promoters.

The effective role of Independent Directors is significant to achieving high governance standards as independent directors are the catalysts in corporate governance. However, good corporate governance is not just the outcome of appropriate selection and effective functioning of Independent Directors. It’s the collective effort of the Board.