Not a solution

A test will not ensure accountability of independent directors

Corporate governance has rarely been India’s strong point, and the recent past has reminded investors of this weakness with startling frequency. Especially noticeable is the failure of the checks and balances vested in the institution of the independent director. From Satyam, Kingfisher Airlines, ICICI Bank, Jet Airways, and IL&FS, independent directors have shown themselves to be ineffectual or somnolent witnesses to gross irregularities by promoters and managements. The government’s proposal to tackle this widespread failure of due diligence and ethics is unlikely to change things significantly. From December, it has decreed, the Indian Institute of Corporate Affairs will administer an online qualifying exam — with a 60 per cent pass mark — for independent directors who sign on with listed and unlisted companies with paidup capital of more than ~10 crore (the rule excludes those who have served as director for 10 years). It has also mandated that annual reports must include the test scores and the board’s comments on the integrity, expertise, and experience of its independent directors. These proposals are problematic from both the practical and ethical standpoints. For one, what level of “proficiency” will this exam be testing? The basics? Or an advanced understanding of corporate law and balance sheets? Second, how can a board opinion of some of its own members be relied on as credible proof of proficiency? Third, qualifications are the least of the problem.

A proficiency exam may address the problem of promoters or smaller companies stocking boards with friends and personal employees (appointing drivers or household staff is not unknown) who can be relied on to turn a blind eye to their shenanigans. But most medium and large companies do actually hire proficient individuals with specific skills in, say, HR or audit or marketing to head various board subcommittees. It is worth noting, too, that smaller companies are not the only ones to have displayed a spectacular failure on the part of independent directors to exercise their fiduciary duties. In many large companies, for example, the directors concerned were stalwarts of the corporate and banking communities, some of international stature, or former senior civil servants. It is not obvious that a proficiency test will ensure accountability — the principal objective for the rule that independent directors must comprise a third of corporate boards — when these directors are appointed by the same promoters they are supposed to monitor. If this conflict of interest is unavoidable — the alternative, of government or external agency appointees, is undesirable — tightening the ambit of accountability and penalties could well concentrate the minds of independent directors on their responsibilities by demanding better disclosures from managements. The law stipulates that they are liable for “acts of commission and omission” that occurred with their knowledge and attributable to board processes. Since establishing such knowledge is tough, most independent directors get off lightly. For instance, those on IL&FS only lost their sinecures when the entire board was replaced. Unlike several of IL&FS’ executive directors, no non-executive director has been fined or even investigated for the implosion that has brought India’s financial sector to a standstill. In fact, moves such as the Supreme Court’s order to arrest three group directors of Amrapali, the real estate firm, are a rarity. Aligning duties and penalties would be a far more effective way of improving the quality of governance than an exam.