The Role Of Independent Directors In Corporate Governance

Who Is An Independent Director?

Section 149(6) of Companies Act 2013 provides, that an independent director would mean a director other than a managing director, a whole-time director or a nominee director which is to say that the independent director would be a part of non-executive director in relation to a company[1].

Independent director is a director who does not work within the company but is able to make independent judgments about the company's affairs and is independent of the company's shareholders, and has no significant business or professional ties to the company or its management.

Section 149(4) of the Companies Act, 2013 provides that at least one-third out of the total number of directors to be independent directors for every listed public company[2].
Rule 4, the Companies (Appointment and Qualification of Directors) Rules, 2014.

Even unlisted public companies are required to appoint at least two independent directors if: the public company's paid-up share capital is Rupees 10 crore or more; turnover of Rupees 100 crore or more; and public company with total unpaid loans, debentures and deposits comprising of more than Rupees 50 crore[3].

The Act defines an independent director as a person of integrity and possessing relevant expertise and experience, someone with no material or pecuniary relationship with the company or its management, who is not a promoter of the company or its holding, subsidiary or associate company, and who is not related to promoters or directors in the company, its holding, subsidiary or associate company.

According to The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, an independent director must have sufficient knowledge and experience in the relevant field, no conflict of interest with the firm, and enough time to devote to company affairs. In addition, the SEBI requires that independent directors establish a separate committee to oversee the company's performance and provide suggestions to the board[4].

Schedule IV of the Companies Act, 2013 provides Code for Independent Directors. The code is a guide to professional conduct for independent directors and lays down the guidelines relating to their role and functions, duties, manner of appointment, re-appointment, resignation or removal, separate meetings, and evaluation mechanism. The code aims to promote confidence of the investment community, particularly minority shareholders, regulators and companies in the institution of independent directors.

Role of independent directors

Oversight of board decisions and management actions: They act as a check and balance mechanism, ensuring that the decisions made by the board are in the best interest of the company and its stakeholders. They play a crucial role in ensuring that the board operates effectively and in compliance with legal and regulatory requirements.

They review board agendas, assess the quality of information provided to the board, and actively participate in board discussions and deliberations. By actively engaging in board meetings, independent directors contribute to the overall effectiveness and efficiency of the decision-making process[5].
Safeguarding the interests of shareholders and stakeholders: Independent directors have a fiduciary duty to safeguard the interests of shareholders and stakeholders. They act as representatives of minority shareholders, ensuring that their rights are protected and their voices are heard in the boardroom. Independent directors provide a counterbalance to executive directors and major shareholders, promoting fairness, transparency, and accountability.

In fulfilling their responsibility to shareholders, independent directors monitor the performance of the company, including financial performance, risk management, and compliance with regulatory requirements. They review financial statements, audit reports, and internal control systems to ensure accuracy, transparency, and reliability of financial reporting. By actively engaging with auditors and internal control mechanisms, independent directors contribute to building investor confidence in the company[6].
Monitoring executive management and mitigating conflicts of interest: Independent directors play a crucial role in monitoring the performance and conduct of executive management. They evaluate the effectiveness of the management team, assess executive compensation, and monitor the implementation of strategic plans. Independent directors act as a bridge between the board and management, facilitating effective communication and ensuring that management actions align with the strategic direction set by the board. Moreover, independent directors help mitigate conflicts of interest that may arise between different stakeholders. They identify and address potential conflicts of interest involving executives, board members, and related parties. By exercising independent judgment and providing unbiased guidance, independent directors ensure that conflicts are managed effectively and in accordance with the best interests of the company[7].
Contribution to strategic decision-making and risk management: Independent directors bring diverse skills, expertise, and industry knowledge to the boardroom. They actively participate in strategic decision-making processes, providing valuable insights and perspectives. By leveraging their experience and independent judgment, independent directors contribute to the formulation and evaluation of strategic plans, capital allocation decisions, and long-term value creation. Furthermore, independent directors play a vital role in risk management. They assess and monitor risks faced by the company, including financial, operational, reputational, and compliance risks. Independent directors work closely with management to develop robust risk management frameworks, establish internal controls, and ensure that risk mitigation strategies are in place. Their involvement in risk oversight strengthens the overall governance structure and contributes to the sustainability and resilience of the company[8].
Provide objective viewpoint and independent judgement: Independent directors are not part of the company's management; as a result, they can provide an objective perspective to board meetings. They help bring independent judgment to bear on the board's deliberations, especially on issues of strategy, performance, risk management, resources, key appointments, and standards of conduct[9].
Ensure transparency and accountability: Independent directors must guarantee that the company maintains openness in its activities and is accountable to all its stakeholders, including shareholders, employees, and customers. They moderate and arbitrate in the interest of the company as a whole in situations of conflict between management and shareholders' interests[10].
Determine remuneration: They determine appropriate levels of remuneration for executive directors, key managerial personnel, and senior management, and play a prime role in appointing and, where necessary, recommending the removal of executive directors, key managerial personnel, and senior management[11].
Contribution of Independent Directors to Board Committees: Independent directors make significant contributions to the functioning of various board committees, offering their expertise and unbiased insights. They actively participate in committees dedicated to critical functions like financial oversight, board nominations, executive compensation, and corporate social responsibility. Their active engagement ensures thorough discussions and effective decision-making, leading to improved governance outcomes[12].

Independence Of Independent Directors

Because independent directors are not involved in the day-to-day operations of the company, they are able to provide an objective and impartial perspective on the company's affairs. However, most independent directors are elected through the executive directors and may have had previous business dealings with the company.

Some independent directors are executive directors of other companies or have previous management experience. As such, they share similar backgrounds and interests with the executive directors of the company. They also rely on the executive directors to provide them with the information they need to carry out their duties. They therefore need to maintain a good relationship with the executive directors to perform their functions better. As a result, their "independence" is questionable.

The focus on ensuring the independence of independent directors is to establish a mechanism that protects their independence in the discharge of their duties. Having appointed independent directors, they need some power to protect themselves from being able to express their views freely and without fear of being expelled from the company. They must not be afraid to use their powers in the discharge of their duties.

What Is True Independence:

When a non-executive director is identified, there are two broad parameters applied – relationships with the promoters and their skills and the ability to add value. Regardless of the underlying parameter, it is up to the individual concerned to determine how independent he or she would like to be.

For instance, personal friendships outside the board room does not necessarily lead to independence being compromised within the confines of the board room if the individual is prepared to challenge and ask the right questions. Independence therefore is a state of the mind and depends upon the individual's ability to challenge and ask the important questions. Independence stems from professionalism both at a corporate level in terms of how the company approaches the subject of board composition and processes at an individual level in terms of how an independent director gears himself or herself for effective board service[13].

According to Schedule IV of the Companies Act, 2013, every listed public company shall hold at least one meeting in a year, without the attendance of non-independent directors and members of management. The purpose of this meeting is to review the performance of non-independent directors and the board, review the performance of the chairperson, and assess the quality and timeliness of information flow between management and board. The meeting shall also be attended by all independent directors who are present at such meeting.
Correlation between Independent Director and Corporate Governance

What Is Corporate Governance?

Corporate Governance is a term with a very wide connotation, but in its most general sense, it means the system of rules, practices, and processes by which a company is directed and controlled. It essentially involves working in the best interests of the company while balancing the interests of the many stakeholders in a company.

Since corporate governance also provides the framework for attaining a company's objectives, it encompasses practically every sphere of management, from action plans and internal controls to performance measurement and corporate disclosure. Effective corporate governance ensures transparency, accountability, and fairness in decision-making, which is crucial for the sustainable growth and success of businesses.

Although Corporate governance is not defined under Companies Act but following are famous definition of the same –
Cadbury Committee characterised "corporate governance" in its report (Financial Aspects of Corporate Governance, distributed in 1992) as "the framework by which organisations are coordinated and controlled.

The fundamental code for corporate administration was proposed by the Chamber of Indian Industries (CII) in 1998. The definition proposed by CII was—corporate governance manages laws, methods, practices and understood principles that decide an organisation's capacity to take administrative choices—specifically its investors, banks, clients, the State and the representatives.

According to the Institute of Company Secretaries of India (ICSI), corporate governance is "the application of best management practices, compliance of law in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stakeholders."

Influence Of Independent Directors On Corporate Governance:

Enhancement of board independence and diversity: Independent directors play a significant role in enhancing board independence and diversity. They bring fresh perspectives, diverse experiences, and expertise from various fields, which contribute to well-rounded board discussions and decision-making processes. By ensuring a balanced representation of independent directors on the board, companies can reduce the influence of dominant shareholders or executives and promote independent thinking. Independent directors are crucial in preventing conflicts of interest and ensuring that the board acts in the best interest of the company and its stakeholders.

They provide an independent check on the actions of executive directors and management, promoting transparency and fairness. With their unbiased judgment, independent directors can safeguard against undue influence, nepotism, and self-serving practices, thereby strengthening the overall independence and integrity of the board[14].
Strengthening of board committees and governance structures: Independent directors play an instrumental role in strengthening board committees and governance structures. They are often appointed as members or chairs of key board committees such as audit, remuneration, and nomination committees. Their participation ensures the effectiveness and independence of these committees, which are responsible for critical aspects of corporate governance. In the audit committee, independent directors oversee financial reporting processes, internal controls, and risk management systems.

Their presence enhances the credibility of financial statements and reinforces the integrity of the company's financial reporting practices. In the remuneration committee, independent directors contribute to the fair and transparent determination of executive compensation, aligning it with company performance and shareholder interests. Independent directors also play a crucial role in the nomination committee, ensuring a rigorous and objective selection process for board members.

By actively engaging in these committees, independent directors bring expertise, oversight, and independent judgment to the governance structures of the company. They promote accountability, transparency, and ethical conduct, further enhancing the overall corporate governance framework[15].
Improving board effectiveness and decision-making processes: Independent directors contribute to improving the effectiveness of the board and its decision-making processes. Their diverse backgrounds and experiences bring a broader range of perspectives to board discussions, leading to more informed and robust decision-making. Independent directors challenge management assumptions, ask critical questions, and provide independent assessments of proposals, ensuring thorough deliberation and consideration of alternatives.

Moreover, independent directors facilitate effective communication and collaboration between the board and management. They bridge the gap between executives and non-executive directors, facilitating the flow of information and ensuring that the board has access to all necessary information to make informed decisions. Independent directors act as a voice of reason and advocate for the interests of shareholders and stakeholders, promoting a culture of accountability and transparency[16].
Fostering a culture of accountability and ethical conduct: Independent directors play a pivotal role in fostering a culture of accountability and ethical conduct within the company. They set the tone at the top by exemplifying high standards of integrity and ethical behavior. Independent directors are responsible for overseeing the company's compliance with legal and regulatory requirements, including codes of conduct and corporate governance norms.

By actively engaging in discussions on ethics, integrity, and compliance, independent directors contribute to the development and implementation of robust ethical frameworks. They ensure that appropriate policies and procedures are in place to prevent and detect unethical practices, conflicts of interest, and corruption. Independent directors also encourage transparency in reporting and disclosure, promoting the disclosure of relevant information to shareholders and stakeholders.

Furthermore, independent directors play a key role in establishing and monitoring effective whistleblower mechanisms and whistleblower protection policies. They create an environment where employees feel comfortable reporting any wrongdoing, ensuring that concerns are appropriately addressed and resolved[17].

Conclusion & Suggestion
Independent directors play major role in good corporate governance. One of the main roles of independent directors in corporate governance is to act as a watchdog for the company and its management. The establishment of independent directors can oversee the prevention of insider control and safeguard the legitimate interests of shareholders, thereby reducing the overlap between the decision-making and operating powers of the company and enhancing the supervisory function of the board of directors. They check the dominance of management and improve the level of decision-making by the board of directors.

Their duty is not to make specific business judgments, but to monitor the work of insiders, especially to review decisions made by insiders. As they come from outside, they are not employed by the company and have no hierarchical relationship with the inside directors, so they are less subject to the constraints of the inside directors, and they are not involved in the management, so they can make an objective evaluation and supervision of the management decision.

Unlike executive directors who are involved in day-to-day management, independent directors are expected to provide unbiased oversight, protect the interests of minority shareholders, and ensure ethical conduct within the organization.

Their helps in reducing conflicts of interest and mitigating the risk of management misconduct. They act as guardians of corporate integrity, ensuring that the company adheres to legal and regulatory requirements. Independent directors bring diverse skills, expertise, and industry knowledge, which are invaluable in strategic decision-making and risk management.

Moreover, their independence from management and substantial shareholders strengthens the overall governance structure.
Independent directors broadly fit into the overall structure of corporate governance. Their appointment ensures an effective and balanced composition of the boards. It is widely recognized that the board of directors is the most significant instrument of compliance with corporate governance. The independent directors contribute to the board by constructively challenging the development of policy decisions and company strategies.

They also scrutinize the performance of the management and hold them accountable for their actions. Their independence, on account of lack of affiliation which is likely to prejudice their decisions, allows them to fulfil these tasks more efficiently. While they are answerable for the company's actions, they are less likely to be affected by self-interest in these actions. They are considered as the supervisors of the company. The ensure that every action begets value appreciation to various stakeholders of the company, and to also protect the interest of the minority shareholders.

End Notes:

Section 149(6) of Companies Act 2013
Section 149(4) of the Companies Act, 2013
Rule 4, the Companies (Appointment and Qualification of Directors) Rules, 2014
The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015
Indian Institute of Corporate Affairs (IICA). (2019). Guidance Manual on Independent Directors
Kapoor, A., & Gupta, N. (2018). The Role of Independent Directors in Corporate Governance: A Comprehensive Literature Review. Journal of Corporate Governance, 5(1), 57-78
Mahadevan, J., & Balasubramanian, K. (2015). Independent Directors and Corporate Governance: A Review of Literature. International Journal of Commerce, Business and Management, 4(3), 115-121
Narayanan, R., & Ranganathan, K. (2018). The Role of Independent Directors in Corporate Governance: Evidence from India. Journal of Applied Finance and Banking, 8(1), 57-70
Tyagi, A., & Arora, S. (2019). Role of Independent Directors in Corporate Governance: A Case Study of India. International Journal of Economics, Commerce and Management, 7(2), 6-17
Indian Institute of Corporate Affairs (IICA). (2019). Guidance Manual on Independent Directors
Kapoor, A., & Gupta, N. (2018). The Role of Independent Directors in Corporate Governance: A Comprehensive Literature Review. Journal of Corporate Governance, 5(1), 57-78
Mahadevan, J., & Balasubramanian, K. (2015). Independent Directors and Corporate Governance: A Review of Literature. International Journal of Commerce, Business and Management, 4(3), 115-121
Bhagat, S., & Black, B. (2002). The Non-Correlation between Board Independence and Long-Term Firm Performance. Journal of Corporation Law, 27(2), 231-274
Tyagi, A., & Arora, S. (2019). Role of Independent Directors in Corporate Governance
Narayanan, R., & Ranganathan, K. (2018). The Role of Independent Directors in Corporate Governance: Evidence from India. Journal of Applied Finance and Banking, 8(1), 57-70
Kapoor, A., & Gupta, N. (2018). The Role of Independent Directors in Corporate Governance: A Comprehensive Literature Review. Journal of Corporate Governance, 5(1), 57-78
Mahadevan, J., & Balasubramanian, K. (2015). Independent Directors and Corporate Governance: A Review of Literature. International Journal of Commerce, Business and Management, 4(3), 115-121