People and Organisations: The importance of independent directors

Success or failure of a business gets directly linked to its independent directors, reckons Tarun Bhatia, managing director at Kroll

Companies and CEOs who have utilised their board effectively have a greater likelihood of outperforming and creating value. Increasingly, independent directors are becoming more involved with their companies, going beyond the traditional quarterly meetings. Since the pandemic, executives are seen to be relying more on independent directors to manage their business and risks.

It has been both fascinating and enriching to observe how companies and leadership by their executives and the board have navigated the unknown from past two years.

There have been a few critical takeaways, as listed below:

• The growing interlinkage between businesses and society — COVID-19 has reinforced this view.

• The global business environment is likely to remain volatile for an elongated period due to the changing political, economic and social dynamics.

• Boards are now focusing beyond return to shareholders and thinking about other stakeholders.

• There has been greater accountability on independent directors and higher scrutiny on their contributions.

Despite all of this, organisations continue to adhere strongly to the concept of value creation. Senior executives in organisations have set KRAs (key result areas) and their compensation linked to the company’s performance. They are also involved in operations on a day-to-day basis Thus, the success or failure of the business gets directly linked to them.

A McKinsey quarterly survey indicated that 70% of privately held company boards are involved in core performance and value-creating activities (up from 59% about a decade ago). However, only 43% of respondents said their boards and members are effective in “REALLY” affecting the increase in enterprise value. This reflects the fact that organisations seek a lot from their independent directors.

On the other hand, independent directors have been under greater market and regulatory scrutiny given the failures of large listed companies in the recent past. Investigations reveal that many of these companies had serious corporate governance failures and that adverse management actions had gone unnoticed. The overall impact of such failures on the system is massive, and the debate over who is ultimately responsible for such failures is still ongoing.

However, are independent directors adequately equipped to help the company and stakeholders?

Kroll has been in India for over 25 years and has looked closely at many listed and private companies, and also investigated company failures. Over these years, the following five questions seem to be the most critical when looking at independent directors:

1. Why do you add an independent director to your board? Do they know their function?

While the regulators have introduced a series of guidelines around the tenure, remuneration, diversity, etc. of the directors, the question of fitment is most important one. Historically, the construction of boards in India wasn’t so transparent and was more about being in compliance with regulations. We have come a long way over the last 10 years with greater influx of private and global capital. However, many companies still do not have a structured and independent process of board hiring. Adding an independent director should go through the same level of rigour and diligence as hiring a CXO.

Similarly, beyond the broader expectations of an independent director, having clearly defined expectations goes a long way. Effective boards exponentially increase the probability of success when the roles and agendas of the directors are rightly structured. Similarly, the appointment of a chairman should not be based on years of experience or market stature alone; they may not be as relevant to what a company needs at present. The chairman generally sets the tone. Hence, thinking seriously about the role is a must.

2. What specific values do independent directors bring?

We are increasingly talking about the convergence of corporates and society and also the need to look after all stakeholders’ independent directors, who are generally successful professionals, entrepreneurs, academicians, or bureaucrats. However, what made them successful in an executive role is different from adding value in a non-executive role. Thus, it becomes important that the company knows what they are seeking from each of their directors.

Given that the agendas of board meetings are long, you may get limited time or questions per director. Knowing what you seek from whom is a great asset which ensures your board meetings are effective.

A recent Harvard Business Review article classified independent directors in four categories: police, data junkies, architects and pilots. You need to know who is playing what role on your board.

3. How informed is the independent director about the business and the market?

Independent directors need to upskill themselves. You can’t rely only on your past experiences to help the company. Globalisation and technology are changing the way we operate. During COVID-19, the business models changed overnight. Diversified boards were able to adapt much faster. This would also mean that companies need to be more disciplined about updating their boards  on business and strategy, sharing their agendas much in advance and having adequate time for discussions.

Many companies believe that a quarterly or annual presentation to the board about business and future plans is adequate — you could not be far from the truth; a focused five-slide deck with relevant insights on business, market, competition, people and risks is what the board seeks. They trust the management with the background work. Yet many companies make the mistake of throwing too much information at the board.

4. Does the independent director have access to people besides the executive directors?

From our experience investigating large-scale frauds, not having access to people other than executive directors has been a major deficiency. Independent directors predominantly rely on the CEOs for information. There are extremely few companies that provide directors’ access to senior or midlevel management. However, it is important for an independent director to get a 360-degree view.

The majority of companies that have failed are because the board relied on one person for all the information. In one recent example, we saw a board actively reviewing the nature of whistleblowing allegations—from a simple complaint about food in the pantry to CEO using company resources for personal use. This seemed like a waste of time, but constantly reviewing the nature of allegations has helped the company develop a culture of listening, in addition to accountability.

5. Are independent directors allowed to show dissent?

Board room discussions that are open and where independent directors are allowed to speak up tend to get the best value from their board. This does not happen often due to the perceived conflict of interest. However, constructive criticism and open debates on board agendas create a high degree of trust among the stakeholders.

The ability of the board is a reflection of how responsible it is and of its power to question the management.

Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect the views of the Economic Times – ET Edge Insights, its management, or its members

Scroll to Top