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Role of Independent Directors in Corporate Governance
The present paper deals with the Role of Independent Directors in Corporate Governance. Independent directors play a key role in the corporate governance system that has been developed in Europe, following the Sarbanes-Oxley Act in the United States. The basic idea is that corporate governance should ensure that boards exercise appropriate scrutiny over management and shareholders (in their capacity as owners of the company). Boards are thought less likely to exercise efficient monitoring if they are composed of individuals who either maintain close ties to the management or lack the appropriate expertise. Independence is particularly crucial in those areas which involve a potential conflict of interests between managers and shareholders: for example, appointment of the management, manager’s pay, and auditing of the company’s performance.
The independent director system originated from countries with a law system of US and UK in which the Common Law is the primary law. These countries usually adopt the Board of Directors system structure of “single system” in the shareholding organization of corporate governance and there isn’t any independent Board of Supervisors in corporate organizational structuring. Therefore, the companies strengthen independence of the Board of Directors, introduce the independent director system, try to reform the supervision mechanism within the existing “single system” framework, and to enable the Board of Directors to exercise the supervision responsibility on the managerial authorities, so as to regress controlling power of the shareholders and to balance the insider control. The so-called independent director refers to a director who doesn’t hold a managerial position in the company in which he holds the position of director, and who doesn’t have a close relation with top management in terms of economics or relative interests. Independence director is particularly crucial in those areas which involve a potential conflict of interests between managers and shareholders: for example, appointment of the management, manager’s pay, and auditing of the company’s performance. America is the country that established the independent director system earliest and perfect .
Role of Independent Directors
The board is an indispensable part of the corporate governance and the independent directors system is designed to improve the corporate governance. In this sense, the independent directors system is applicable to all companies. Listed companies are public companies and their governance structure concerns the interests of many investors. Investors have the right to put their demand and the state securities regulatory organizations and stock exchanges also have the right to put their demand on the governance structure of listed companies. So, the internal and external needs have become more and more pressing to set up the independent directors system. The shareholders have the capacity and energy to manage the companies or entrust the management to manage companies. It is, therefore, not so pressing, both internally and externally, to set up such a system. The discussion of the independent directors system is confined to the scope of listed companies in that different types of companies and their shareholders are different in their obligations and rights. Correspondingly, different types of companies also vary in their governance structures and in the functions of the board, composition, rights and obligations of directors. In fact, there have already appeared different concepts about independent directors .
Rules and norms of corporate governance are important components of the framework for successful market economies. Although corporate governance can be defined in a variety of ways, generally it involves the mechanisms by which a business enterprise, organized in a limited liability corporate form, is directed and controlled. Corporate governance is not an execution but an oversight mechanism to ensure honesty in a company. (This presumes that dishonesty exists in most companies). So the oversight structure has to be very strong and competent to be able to detect malpractices. If almost the entire foundation of corporate governance rests on the shoulders of the independent directors, it is now beyond debate that the foundation indeed is extremely fragile. Corporate governance is not an execution but an oversight mechanism to ensure honesty in a company. (This presumes that dishonesty exists in most companies). So the oversight structure has to be very strong and competent to be able to detect malpractices. If almost the entire foundation of corporate governance rests on the shoulders of the independent directors, it is now beyond debate that the foundation indeed is extremely fragile. 
The Securities and Exchange Board of India (‘SEBI’) has issued similar guidelines for the appointment of independent directors. These, however, are less stringent than those recommended by the IFC. As per SEBI, the expression ‘independent director’ refers to a non-executive director of a company who does not have any material pecuniary relationships or transaction with the company or its promoters or directors or senior management or holding company or subsidiaries and associates, apart from receiving the director’s remuneration, which may affect independence of the direction. Independent directors must not be related to the promoters or persons occupying management positions at the board level or one level below the board or have been an executive of the company in the preceding three financial years. They must not have been a partner or an executive or involved with the statutory audit firm associated with the company or a legal or consulting firm with material association with the company at any time in the preceding three years. They must not be a material supplier or service provider or customer or a lessor or lessee or a substantial shareholder of the company.
The Board of Directors is the focal point of voluntary efforts by firms to improve corporate governance, given the Board's key role in ensuring that an effective team of managers is in place and efficiently and competitively uses corporation's assets. One of the principle characteristics of efficient corporate governance is the ability of directors to independently approving the corporation's strategy and major decisions, independently hiring managers and monitoring their performance.
Independent directors are therefore also seen as a check on the management of companies, as an oversight mechanism, apart from the value addition that they bring to board deliberations. This is to ensure that action for wrongdoing by the majority stake holders who control the management by holding a majority of their own shares, is not hampered.
A director's fulfilment of fiduciary responsibilities requires more than the mere absence of bad faith or fraud. Representation of the financial interests of others imposes on a director an affirmative responsibility to protect those interests and to oversee with a critical eye.
The definition of independent directors varies between that laid down under section 292A of the Companies Act 1956 and as per clause 49 of the 'listing agreement' issued by SEBI.
Independent directors according to Companies Act are defined as persons who:
Are not relatives of the chairman, managing director, whole time director, or the company secretary
# Should not have been auditors, internal auditors, legal advisors or consultants to the company during any of the preceding three financial years
# Should not have been suppliers, vendors or customers of the company
# Should not hold below two per cent of the shares of the company, presently or in past
# Should not have held any position in the company
# Should not have been a director for a continuous period of nine years
# Nominee directors of banks or FIs cannot be considered independent directors
Independent directors according to SEBI's clause 49 of the listing agreement:
# Should not be related to promoters or the management at the board level or at one level below the board
# Should not have been a partner or an executive of the statutory audit firm or an internal audit firm or legal and consultancy firm, during the last three years
# Should not have been suppliers, service providers or customers of the company
# Should hold below two per cent of the shares of the company
# Should not have been an executive of the company in the immediately preceeding three financial years
# Appointment of non executive director a beyond continuous period of nine years not permissible
# Nominee directors of banks will be considered as independent directors
# To ensure that corporates are able to find qualified independent directors, the Bombay Chartered Accountants Society has undertaken to train professionally eligible individuals as independent directors through study courses covering the changing business environment, corporate governance, the legal framework, risk management, auditing, etc.7
Independent Independent directors can revolutionise the functioning of corporates and ensure that they become good corporate citizens contributing to the growth of nation. The evolution of the institution of independent directors has somewhere some link or something to do with the concept of corporate social responsibility. An independent director can counter-balance management weaknesses in a company, and ensure legal and ethical behaviour at and by the company. India is on the threshold of adopting a new Companies Act which has shareholder rights and democracy as its cornerstones. The Companies Bill envisages a much bigger role for independent directors as they are seen as a crucial link between promoters / management on one hand and minority shareholders / stakeholders on the other.
Independent directors are the trustees of good corporate governance. An active and involved board consisting of professional and truly independent directors plays an important role in creating trust between a company and its investors, and is the best guarantor of good corporate governance. Increasingly, institutional investors, both in India and internationally, are closely scrutinizing the corporate governance practices and the quality of boards before taking investment decisions. As Indian companies look towards accessing funds from foreign institutional investors and tapping global financial markets, the credentials of their independent directors will become important. Competent and qualified independent directors play an important role in the stewardship and strategy formulation of companies. Indian corporates that have appointed such directors to their Board have benefited immensely from their guidance and inputs.
6. “The Associated Chamber of Commerce and Industry of India”, Report on “Strengthen role of independent director for corporate governance: experts”, Friday, February 11, 2011.
# Corporate Governance the Securities and Exchange Board of India (SEBI)”, “Independent Directors” 25 August 2005. http://www.domainb.com/management/general/20050825_independent_directors.html
# Assistant Professor in Law, N.N.P.G. college Nawabganj, Gonda firstname.lastname@example.org, Mob. 9415718416
# See Cl. 49 A(iii) of the Listing Agreement.