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In India, the role or failure of independent directors in preventing corporate scandals became one of the central themes in corporate governance. Leading companies in the country expressed substantial concern when SEBI issued a Consultation paper proposing a dual approval process for appointing independent directors. The SEBI board has ultimately resolved to abandon the proposal for dual approval and instead pursue approval by a special majority following discussions. Several commentators, including Mr. Umakanth Varottil, have expressed dissatisfaction with SEBI's decision to forgo dual approval. Consequently, there is a heated debate regarding appointing independent directors.
In an increasingly interconnected global economy, the role of independent directors has become a cornerstone of corporate governance. These pivotal figures ensure that boards act in the best interests of shareholders and stakeholders, untainted by conflicts of interest. Yet, independent directorship varies significantly across regions and cultures, reflecting a mosaic of legal frameworks, business practices, and societal values.
From the rigorous regulatory environments of the United States and the European Union to the evolving governance landscapes of emerging markets like India and China, the expectations and challenges faced by independent directors are as diverse as the regions they represent. In the US, the Sarbanes-Oxley Act and the Dodd-Frank Act impose stringent standards, while in Europe, the Corporate Governance Codes provide a flexible, principles-based approach. Meanwhile, in countries like Japan and South Korea, traditional corporate cultures and recent reforms are shaping the evolving role of independent directors in unique and complex ways.
This global patchwork of practices and challenges invites a fascinating exploration into how independent directors navigate their roles in varying cultural and regulatory contexts. How do they balance the interests of diverse stakeholders in different economic climates? What challenges do they face in regions with evolving legal standards and varying levels of transparency? And how are these practices not just shaping but also influencing corporate governance on a global scale?
By comparing the approaches and obstacles encountered by independent directors across different regions, we can gain invaluable insights into the universal and culturally specific aspects of governance. This comparative analysis highlights the innovative practices emerging from different parts of the world. It underscores the common challenges that independent directors face in their quest to uphold integrity and accountability in today’s complex corporate landscape.
The Development of Independent Directors in India
The concept, or rather the necessity, of having Independent Directors on the boards of companies, particularly those that involve public interest, was recognised in India before the early 2000s. In late 2013, the legislature eventually recognised the concept, as the Companies Act, 2013, was formulated and characterised.
The Western world was significantly ahead of India in this regard. The concept of Independent Directors was first introduced in the 1950s when there were concerns about the representation of minor shareholders in the corporate world. Nevertheless, similar to India, the concept was not incorporated into the regulatory framework in Europe and North America for a considerable period. The Sarbanes-Oxley Act of 2002 in the United States granted regulatory recognition to the concept of an independent director. Subsequently, the regulations implemented by numerous stock exchanges assumed precedence.
Who is an independent director? - The Indian Perspective
The term "independent director" was the subject of much discussion after the recent controversy. Although the terminology generally indicated the answer, which was "an individual who is capable of expressing an independent perspective on the company's operations," it was imperative to provide a definition.
The definition of an independent director is derived from Section 149 of the Companies Act, 2013 (‘Act’) and Regulation 16 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘LODR’). Although unlisted companies must comply with the requirements outlined in section 149 of the Act, listed companies or those that aspire to be listed must adhere to LODR.
In the same vein, as previously mentioned, LODR defines an independent director as an individual who is not affiliated with the company, either as a promoter or director of the company or its group companies and who does not have a material pecuniary relationship with the company or its group. Additionally, an independent director must not have been associated with the company in any capacity in the past, such that they could influence the company's decisions or business.
The Online Proficiency Test and the Database of Independent Directors
In India, one of the requirements for becoming an Independent Director is to include their name in the Databank of Independent Directors ('Databank') and pass an Online Proficiency Test ('Test') within two years of the date of inclusion in the databank, as outlined in Section 150 of the Act and Rule 6 of the Companies (Appointment and Qualification of Directors) Rules, 2014. Nevertheless, certain categories of individuals who possess the necessary experience and expertise as specified have been exempted from the requirement to pass the Test.
However, the question is whether the arduous and tedious criteria required for appointment ensure board independence and sound governance practices. It is widely recognised that the principle behind these measures was quality control, guaranteeing that only individuals with specific expertise and experience were appointed as Independent Directors.
Additionally, the role of IDs is to ensure sound governance practices and uphold the interests of all stakeholders, including minority stakeholders. Therefore, some previous instances of celebrity directorships were to be discouraged. Consequently, it should not be employed solely as a publicity instrument.
Nevertheless, the requirement to pass the test is rather peculiar. It introduces anomalies in the regulatory regime of IDs in India compared to the rest of the world, given the seniority of the position of directors in companies and the lack of precedent.
Global Perspectives on Independent Directorship: A Comparative Analysis
In the globalized business environment of today, independent directors play a crucial role in ensuring transparency, accountability, and balanced decision-making within boards of directors. Their function—providing unbiased oversight and governance—is pivotal across different corporate landscapes. However, the role and effectiveness of independent directors can vary significantly depending on regional practices, regulatory frameworks, and cultural contexts. This blog delves into how independent directorship is practised around the world, highlighting the challenges and unique approaches that define this role across different regions and cultures.
North America: Rigorous Standards and High Accountability
In North America, particularly in the United States, the role of independent directors is governed by a rigorous set of regulations and best practices. The Sarbanes-Oxley Act (2002) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) have set high standards for corporate governance, emphasizing the need for independent oversight.
Key Practices:
Regulatory Framework: The Securities and Exchange Commission (SEC) mandates independence standards for board members, with detailed rules regarding their financial expertise and conflict of interest.
Board Composition: Independent directors must make up a majority of the board, and audit, compensation, and nominating committees are typically required to be composed entirely of independent members.
Regular Assessments: Boards undergo regular evaluations of their performance, including the effectiveness of independent directors.
Challenges:
Complexity of Compliance: Navigating myriad regulations can be complex, and non-compliance can lead to severe penalties.
Perception of Independence: The effectiveness of independent directors can be questioned if they are seen as having conflicts of interest, especially in cases where large shareholders nominate them or have longstanding relationships with the company.
Europe: Principles-Based Approach with Variations
In Europe, corporate governance practices vary significantly from country to country, though many are guided by the principles outlined in the European Union’s Corporate Governance Codes. The focus tends to be on principles rather than prescriptive rules, allowing for flexibility in interpretation.
Key Practices:
Corporate Governance Codes: These codes, such as the UK’s Corporate Governance Code and Germany’s Corporate Governance Code, provide guidelines on the role of independent directors, emphasizing the need for a balance of power and the protection of minority shareholders.
Diverse Structures: The UK and the Netherlands, for example, require a majority of independent directors on boards, while in Germany, the dual-board system separates management and supervisory roles, with the latter including independent members.
Challenges:
Diverse Regulations: The lack of a unified regulatory approach means that practices can differ widely across countries, complicating cross-border governance and compliance.
Cultural Differences: In some European countries, traditional business practices and networks may influence the degree of true independence among directors.
Asia: Evolving Practices and Cultural Influences
In Asia, the role of independent directors is shaped by a mix of traditional business practices and evolving regulatory standards. Countries like Japan, China, and India are at different stages of integrating independent directorship into their corporate governance frameworks.
Key Practices:
Japan:
The traditional keiretsu system, where companies are interconnected through cross-shareholdings, has historically influenced the role of independent directors. However, recent reforms have introduced stricter independence requirements, such as those under the Corporate Governance Code which encourages the inclusion of independent directors.
China:
The regulatory framework for independent directors is relatively new, with recent regulations aimed at enhancing transparency and accountability. The China Securities Regulatory Commission (CSRC) has set guidelines for independent directors in listed companies, focusing on their role in auditing and financial reporting.
India:
India has implemented robust guidelines through the Companies Act of 2013, which mandates a minimum number of independent directors on boards and outlines their roles in protecting minority shareholders and enhancing corporate governance.
Challenges:
Cultural and Institutional Barriers: In many Asian countries, entrenched business practices and familial ownership structures can hinder the effectiveness of independent directors.
Regulatory Evolution: Rapidly changing regulations and enforcement practices can create uncertainties for independent directors, especially in emerging markets.
Latin America: Emerging Standards and Regional Variations
In Latin America, corporate governance practices are still developing, with significant variations between countries. Some nations are making strides towards strengthening the role of independent directors, while others are grappling with foundational governance issues.
Key Practices:
Brazil: Brazil has implemented several reforms to improve corporate governance, including requirements for independent directors in publicly traded companies. The Brazilian Corporate Governance Code encourages the appointment of independent directors and the formation of independent committees.
Mexico: Recent reforms under the General Law of Commercial Companies emphasize the role of independent directors in enhancing transparency and accountability.
Challenges:
Enforcement and Compliance: The enforcement of corporate governance standards can be inconsistent, and the effectiveness of independent directors can vary based on local governance structures and practices.
Market Maturity: In emerging markets, the role of independent directors is still evolving, with varying levels of market maturity and regulatory development
Organised Body for the Selection of Candidates for the Position of IDs
The NRC recommends that individuals be appointed as IDs on the company's board according to the current laws in India. This committee is responsible for formulating and recommending the remuneration of senior management and directors. It has been determined at the SEBI Board Meeting that the process by which NRC will select candidates for appointment as IDs will be more detailed and transparent. This will include improved disclosures regarding the skills necessary for appointment as an ID and how the proposed candidate fits into that skill set.
Companies in the United States are required to establish a Compensation Committee by the NASDAQ Stock Market LLC Rules [5605. Board of Directors and Committees], similar to the NRC in India. "Each company must establish and maintain a compensation committee consisting of at least two members." Each committee member must be an Independent Director, as Rule 5605(a) (2) defines.
By the NASDAQ Rules, director nominees must be either selected or recommended for the Board's selection by:
A majority of the Board's Independent Directors are Independent Directors in a vote in which only Independent Directors participate, or b—a nominations committee solely composed of Independent Directors.
The nominating/corporate governance committee is the sole entity with the authority to retain and/or terminate any search firm used to identify director candidates, as well as the sole authority to approve the search firm's fees and other retention terms, as outlined in the New York Stock Exchange Listed Company Manual ('NYSE Manual').
The UK Corporate Governance Code, 2018, mandates the board establish a remuneration committee of independent non-executive directors. The committee must have a minimum of three members or two in the case of smaller companies. Furthermore, the head of the board is only eligible to serve as a member if appointed independently and is not permitted to chair the committee. The individual appointed as the chief of the remuneration committee must have served on a remuneration committee for a minimum of 12 months before that appointment.
IDs' tenure and reappointment
IDs are appointed for a maximum of five years and may be renewed for an additional term in India. A special resolution must be passed to effectuate such a re-appointment. Furthermore, the NRC is required to evaluate the performance of Independent Directors annually, and based on this evaluation, it will determine whether the director should be reappointed. Nevertheless, the issue of such a recommendation is only raised when the director's tenure is nearing its conclusion.
The UK Corporate Governance Code also mandates that all directors be eligible for annual re-election. The code also regards the presence of an ID on a company's Board for a period exceeding nine years as a threat to his independence.
In Singapore, all directors are required to submit themselves for re-nomination and re-election at least once every three years, as stipulated in Rule 720(5) of the SGX Listing Rules (Mainboard) / Rule 720(4) of the SGX Listing Rules (Catalyst).
The rule mandates that all company directors be renominated and reelected at least once every three years. This ensures that members assess independence every three years.
Cooling-off Period for appointment/reappointment of IDs
In India, a cooling-off period of 2 years is required in case of any material pecuniary transactions between a person or his/her relative and the listed entity or its holding, subsidiary or associate company. The LODR has prescribed a cooling off period of three years for Key Managerial Personnel (and their relatives) or employees of the promoter group companies, for appointment as an ID in the listed entity. However, relatives of company employees, their holdings, subsidiaries, or associate companies have been permitted to become IDs, without the requirement of a cooling-off period, in line with the Companies Act, 2013.
The NASDAQ Stock Market LLC Rules (‘NASDAQ Rules’) have prescribed a cooling-off period of 3 years for the appointment of an independent director where such person has a relationship with the company as prescribed under the rule.
The UK Corporate Governance Code, 2018 (‘UK Code’) provides that a person who has, or has had within the last three years, a material business relationship with the company, either directly or as a partner, shareholder, director or senior employee of a body that has such a relationship with the company, shall not be appointed as an Independent Director.
The Singapore Code of Corporate Governance, 2018 prescribes a cooling-off period of 3 years for the appointment of an independent director who has a relationship with the company.
Remuneration of Independent Directors
In India, offering stock options to Independent Directors is prohibited. On the contrary, as per the New York Stock Exchange Listed Company Manual (‘NYSE Manual’), Independent directors must not accept any consulting, advisory, or other compensatory fee from the Company other than for board service.
Further, the UK Corporate Governance Code 2018 provides that remuneration for all non-executive directors should not include share options or other performance-related elements. Independent directors shall not be a member of the company’s pension scheme.
In the Singapore Code of Corporate Governance 2018, the Remuneration Committee should also consider implementing schemes to encourage non-executive directors (NEDs) to hold shares in the company to better align the interests of such NEDs with the interests of shareholders. However, NEDs should not be over-compensated to the extent that their independence may be compromised.
India's Corporate Governance's Historical Evolution
India's experience with corporate governance has been distinct due to the country's socioeconomic environment. The historical predominance of family-owned companies in India influenced governance patterns. An important turning point was the 1990s economic liberalisation of India, which brought in more shareholder-centric and market-driven processes.
Disparities in the Practices of Corporate Governance
Indian corporate governance practices are very different from global standards, especially those of Western nations. For example, unlike Western organisations, which have a more distributed ownership structure, Indian companies have generally used promoter-driven structures, where controlling families play a key role.
1. Models Driven by Promoters:
A large portion of businesses in India, particularly those in the private sector, are owned by family members or promoters. As of 2020, promoters held more than 50% of around 43% of the NIFTY 500 companies, according to a KPMG analysis. In comparison, ownership is typically more distributed among different institutional and retail investors in the US or Europe.
2. Makeup of the Board:
Inside directors, which includes promoters and their families, are more common on Indian boards. According to data from the Indian Institute of Corporate Affairs (IICA), promoter representatives made up over 35% of directors on the boards of prominent Indian companies in 2021. This is a much larger percentage than is typical in Western standards, where independent directors often hold the majority of board positions.
3. Responsibility for Corporate Social Concerns (CSR):
India's CSR environment is distinct because of the Companies Act of 2013's necessity for required spending. According to this law, businesses must invest at least 2% of their average net profit over the previous three years in corporate social responsibility (CSR) initiatives if they have a net worth of ₹500 crores or more, an annual turnover of ₹1000 crores or more, or a net profit of ₹5 crores or more during the previous fiscal year.
4. The Impact of Families on Business Decisions:
In India, families continue to have a big say in business decisions. According to a survey conducted by the Indian School of Business's Thomas Schmidheiny Centre for Family Enterprise, family businesses in India account for almost 60% of all company market capitalisation. This has an impact on succession planning and long-term strategic decisions in addition to board dynamics.
Factors Pushing Corporate Governance to Converge
Due to factors like foreign investments and the international listing of Indian companies, corporate governance in India is becoming more and more in line with international standards. Global governance principles are being pushed towards Indian enterprises via partnerships and the influence of foreign institutional investors.
1. Cross-border listings and foreign investments:
Foreign direct investment (FDI) has increased significantly in India. The Department for Promotion of Industry and Internal Trade (DPIIT) reports that FDI equity inflows to India were USD 46.03 billion, with $70.97 billion of those inflows coming from outside the country. To preserve investor confidence, this inflow of foreign cash requires adherence to global governance standards.
2. International Institutional Investors' Influence
International institutional investors now play a far larger role in Indian companies. These investors frequently support strict governance guidelines that align with international best practices. Their involvement pushes Indian businesses towards more accountable and transparent governance frameworks, which over time builds trust and sustainability.
3. Strengthened Requirements for Disclosure:
SEBI mandates enhanced disclosure requirements for listed firms. These consist of risk management procedures, related party transaction disclosure, and comprehensive quarterly financial statements. Thanks to the introduction of the Business Responsibility and Sustainability Report (BRSR) in 2021, India is now even more in line with international sustainability reporting standards.
Rules and Regulations of Corporate Governance: Mandatory Board Composition: In India, corporate boards must meet a certain composition requirement. These consist: of requiring the inclusion of women directors, guaranteeing diversity, and having a minimum number of independent directors. By ensuring different points of view, this rule lowers governance risks.
SEBI, India's securities regulator, enforces the listing obligations and Disclosure Requirements (LODR) of listed businesses. This requires thorough financial disclosures, minutes from board meetings, and shareholder data, guaranteeing transparency in keeping with international corporate governance norms.
Audit Committee Regulations: Organisations must establish an audit committee, mostly composed of independent directors. This committee is in charge of risk management, audits, and financial reporting to maintain transparency and responsibility in financial disclosures.
Issues with International Corporate Governance
Managing Family-Centric Models and Professional Management: Many Indian businesses continue to run on family-centric models, in which family relationships can impact decision-making. Creating a board with actual independence is challenging, particularly in businesses where founding families or promoters have much power.
Managing Minority Shareholder Interests:
It can be difficult to safeguard minority shareholders' rights and interests in businesses where large stakeholders or families wield disproportionate power.
Application of Legal and Regulatory Reforms:
Although India has made great progress in modernising its legal and regulatory systems to conform to international norms, applying these changes at the corporate level is frequently uneven and difficult.
Overcoming Cultural and Behavioural Barriers:
It can be challenging to fully embrace and absorb these international techniques since India's traditional business methods and cultural norms can clash with contemporary governance concepts.
Oversight and Implementation by Regulating Authorities:
Maintaining uniform compliance in a wide-ranging and diverse corporate landscape presents its own set of issues, notwithstanding the importance of ongoing monitoring and enforcement by organisations such as SEBI.
Prospects for Corporate Governance in the Future
AI and other emerging technologies have the potential to completely transform corporate governance in India by placing a greater focus on transparency and data-driven decision-making. Accelerated digital transformation and a stronger emphasis on sustainability and stakeholder welfare in corporate governance frameworks are expected in the post-pandemic age.
AI and Decisions Based on Data:
AI is becoming more and more integrated into governance procedures at IT businesses like Infosys and TCS. For instance, Infosys improves efficiency and transparency by utilising AI for risk assessment and compliance management.
Digital Revolution Following the Pandemic:
The COVID-19 epidemic hastened the introduction of digital technology in Indian enterprises. In 2020, Reliance Industries initiated the first-ever virtual Annual General Meeting (AGM), thereby establishing a precedent for digital governance methodologies.
The potential of blockchain technology to improve security and transparency in governance procedures is also being investigated.
Dictator Holdings, a Polish corporation, has recruited Mika, the first AI CEO. In terms of corporate governance, it represents a new frontier.
Pay attention to stakeholder welfare and sustainability:
An increasing number of Indian businesses are implementing ESG (Environmental, Social, and Governance) standards. The Tata Group is one company that has led the way in incorporating sustainability into its corporate governance structure.
Using Advanced Analytics in Governance Integration:
Companies committed to using cutting-edge technology to improve governance procedures include Reliance Industries, which incorporates sophisticated analytics into its governance frameworks to improve decision-making and predictive insights.
Conclusion
The role of independent directors is a linchpin of effective corporate governance, ensuring transparency, accountability, and balanced decision-making across diverse global contexts. While the core principles of independence and oversight remain consistent, the implementation and challenges associated with this role vary widely across regions.
In North America, stringent regulations and detailed frameworks set high standards for independence and board effectiveness. Europe’s principles-based approach offers flexibility but also introduces variations in practices. Meanwhile, Asia’s evolving landscape reflects a blend of traditional practices and modern regulatory reforms, each country navigating its unique challenges. With its emerging standards, Latin America illustrates the ongoing journey toward strengthened governance amid varying levels of regulatory maturity.
India’s corporate governance journey highlights progress and ongoing debates, reflecting a transition from family-centric models to more structured and transparent practices. The recent discussions around the dual approval process for independent directors underscore the dynamic nature of governance reforms in response to evolving needs and challenges.
Understanding these global perspectives not only illuminates the diverse approaches to independent directorship but also underscores the universal quest for improved governance. As businesses continue operating in an interconnected world, the experiences and practices from different regions offer valuable insights into enhancing board effectiveness and global corporate integrity. By learning from these varied approaches, companies can better navigate the complexities of governance and drive forward more robust, transparent, and accountable corporate practices.
Our Directors’ Institute- World Council of Directors can help you accelerate your board journey by training you on your roles and responsibilities to be carried out efficiently, helping you make a significant contribution to the board and raise corporate governance standards within the organization.
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