Board Independence & Corporate Governance in India: Recent Trends & Challenges Ahead

Abstract

Introduction The increasing attempts at reforming extant governance systems in both developed and developing countries have come in the wake of major corporate scandals in internationally renowned companies like Enron, Tyco and Worldcom as well as the East Asian crisis of the early nineties. One of the factors that has been identified to be common across all these major corporate failures around the world has been the failure of the board of directors of a corporation to detect internal crisis early on and act in a timely manner to put the organization back on track before difficulties become irreversible (Jensen 1993). In India, the renewed focus on the functioning of corporate boards along with a debate on the rights and responsibilities of board members followed the disclosure failures at Satyam Computer Services reportedly to the tune of Rs. 7000 crore which, by the company's founder-chairman's own admission, had continued for seven long years. It is thus not surprising that with every major corporate scandal and the subsequent crisis that it unleashed, renewed attempts have been made to reform corporate boards of publicly held corporations to make these structurally and operationally more effective in ameliorating problems between shareholders and owners/managers. This has included a whole gamut of reforms evolving over time to deal with the constitution and functioning of corporate boards, the most important of which are regulations aimed at ensuring board independence from internal management and improving the quality of board governance. The objective of this article is to examine some important policy issues related to board independence based on lessons of experience gained from implementing board reforms across the countries, including India. In doing so, the article seeks to put in perspective the progress made in India regarding the adoption of international best practices for the constitution and functioning of independent boards as well as discuss their implications on the quality of board governance. Foremost among these are the determination of the optimal proportion of independent directors, the sufficiency of the set of criteria for defining director independence, the quality of independent directors, and the larger question of whether board independence actually matters in corporate performance. Board Independence & Corporate Governance The origin of the corporate governance problem lies in the separation of ownership and control in widely held corporations owned by a large number of small and dispersed shareholders who need to delegate the responsibility of running the day-to-day operations of the corporation to professional managers. Since these shareholders find it costly and lack the incentive to monitor management, managers may behave opportunistically to run the company in their interests rather than that of the shareholders. Managerial opportunism imposes agency costs, manifested in unobservable and often unverifiable actions taken by them such as expanding firm size beyond optimal level, consuming perquisites, or satisfying managerial hubris, all of which increase their private benefits but which reduce the value of the firm and hence the benefits to the shareholders. The board of directors acts as one of the most important governance mechanisms in aligning the interests of managers and shareholders. The important functions of the board, as laid down in the Report on the Financial Aspects of Corporate Governance issued in 1992 by the Cadbury Committee that brought into forefront the role that corporate boards can play in governance, are to define a company's purpose, to strategize and draw up plans to achieve that purpose, to appoint the chief executive, to monitor and assess the performance of the executive team and last but not the least, to assess their own performance. In executing these functions, the universally accepted principle is that the board of directors acts as fiduciaries of shareholders' and other stakeholders' interest. …

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