Tata-Mistry fallout: Independence of independent directors

Continued relevance of independent directors would depend on how independent they can be in a challenging environment

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Manoj Kumar | November 3, 2016 | New Delhi


#companies act   #independent director   #Tata chairman   #Tata Sons   #Cyrus Mistry   #Ratan Tata  
Rata Tata and Cyrus Mistry fallout

The Tata-Mistry melee prompts a reassessment of the institution of independent directors and the role they play in ensuring effective corporate governance in India. Though independent directors are often expected to protect the interests of minority shareholders, their foremost duty is to act for the benefit of the company as a whole. 

 
The independent director holds a special place in terms of the governance of a company, its board and its management. He is required to exercise judgment on corporate affairs objectively. This role is especially critical when there is a divergence of opinion between shareholders, the company and its management. The 2013 Companies Act sought to bring about better corporate governance through provisions that facilitated increased transparency, accountability and an independent board of directors.  
 
Section 149 (6) of the Companies Act, 2013 provides for the election of an independent director to the board of directors of a company. It provides that an independent director must be a person of integrity and possess relevant expertise and experience. He/she must not be related or affiliated with the company or any of its affiliates in any way. Rule 5 of the Companies (Appointment and Qualification of Directors) Rules, 2014 further supplements this provision by prescribing a number of general qualifications requisite of an independent director. 
 
The JJ Irani Committee, an expert committee constituted by the ministry of corporate affairs to advise the government on company law reform, was of the opinion that since the board of a company was required to balance a number of interests, the presence of a neutral entity on the board would facilitate better corporate governance. An independent director lends a note of objectivity to the board, bringing an unbiased and fresh perspective on corporate affairs. This impartiality goes a long way in protecting the company’s general interests as well as the interests of minority and small shareholders. 
 
Schedule IV of the 2013 Act contains a code for independent directors. The code comprises of eight clauses, which set out guidelines for professional conduct, duties and functions, and a mechanism for evaluation for independent directors. 
 
A number of studies have shown a correlation between the presence of independent directors and positive fiscal outcomes. Rosenstein and Wyatt found that shareholders react favourably to the appointment of outside directors. Another study has found that independent directors improve firm performance when the cost of acquiring information about the firm is low. 
 
However, an opinion which is ubiquitous amongst all studies on the subject is that independent directors must in fact be ‘independent’ in order to be effective. This is the core issue with independent directors in India. Most large companies or business groups in India are run by tight-knit families that do not want to relinquish control of their commercial concerns. This often leads to the downfall of business empires in India. The Tata Group is a prime example of this. 
 
Many would argue that the appointment of TVS Motor chairman Venu Srinivasan and Piramal group chief Ajay Piramal as independent directors to the Tata Sons board was in direct contravention to the tenets underpinning the independent director institution. Reports have stated that they were essentially appointed by Tata Trusts, the majority shareholder in Tata Sons without consulting Cyrus Mistry, Tata Sons’ recently ousted chairman. It was alleged that their appointment was to consolidate the Trusts’ hold on the inner workings of the Tata Sons board. 
 
According to the Tata Sons Articles of Association, the Trusts were already responsible for nominating 40 percent of the members on the board of directors. The presence, direct or indirect, of controlling shareholders on a board weighs heavily on how directors interact with one another and make decisions. The controlling shareholder’s opinion tends to prevail over all others. 
 
A division is often created between insiders and outsiders regarding influence and perception of what constitutes the best interests of the company and shareholders. Opinions and decisions during board meetings reflect convocations held outside the boardroom, as they very often did in the case of Tata Sons. Objectivity is frequently skewed by majority shareholder priorities, disputes, interpersonal relationships, and shared understandings. Further, it is not easy to renounce power, especially if you have been the recipient of a fair amount of exaltation, as Ratan Tata had been. 
 
In Indian society, respect for elders is paramount; it is customary to demonstrate deference to their views. This cultural trait often influences the selection of directors and boardroom dynamics. Business leaders and politicians also tend to retire late in India. For example, the chairman of family-owned conglomerate Mahindra & Mahindra is 86 years old and has been at the helm since 1963. If the selection of directors is made by proxy, families will invariably determine the choice, because their votes likely constitute the majority.
 
Incidentally, the succession of the Tata chairmanship was a closely watched case, primarily because long-time patriarch Ratan Tata stepped down in 2012 when he turned 75 and handed over the reins of the company to Cyrus Mistry, an outsider. The outcome was to set a precedent for other family-owned businesses however it was a failed experiment as Ratan Tata, too, was unable to defect from the status quo. 
 
The notion of independent directors in India, thus, still seems to be a theoretical construct. A recent survey found that 25 percent of Indian companies have independent directors who are relatives of the owners. It further states that around 92 percent of the companies in India have yet to nominate an independent director. 
 
Ultimately, the efficacy of any norm comes down to its enforcement. Unless regulators ensure strict compliance with the extant rules and regulations, companies will continue to flout them and maintain the status quo. 
 
One can only hope that the new generation of family heirs and global competition will catalyse a change in the current state of corporate affairs. One can only hope that India will find its own way to adhere to best practices in corporate governance with the support of the expertise of those countries well on their way to successfully transitioning their economies. 
 
Back home, the role of independent directors on the boards of all the large-cap Tata Group companies over the next few quarters could well-define what lies ahead for the Tata Group as well as its shareholders. 
 

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