How independent are the independent directors?

Syed Ashraf Ali The Bangladesh Securities and Exchange Commission (BSEC) issued a notification in 2006 imposing a requirement on the listed companies for appointment of independent directors (IDs). The underlying objective was that the IDs would serve as an eye for the Commission, a trustee for an unwieldy number of faceless shareholders and also to ensure transparency, accountability and good governance in the companies. It did not, however, work the way the regulators had thought. The governance of a majority of the listed companies continues to be bedevilled by lack of transparency and other means that hide their real state of financial health from financing banks, tax authority and regulators. The story of how manipulation of share prices by some companies in the recent past pauperised hundreds of thousands of gullible shareholders is too well-known to need any repetition. The presence of independent directors in their Boards could not prevent them from doing what they did. One reason perhaps is that the business houses did not accept with open mind the idea of appointing independent directors to intrude in their zealously guarded domains. They complied with the letters but missed the spirit of the new regulation by inducting IDs who would be willing to go along with what the controlling groups wanted. That explains why most of the independent directors are not so independent after all. Their usual feeble voices drown out in the chorus routinely heard in the company's Board rooms on issues that are not necessarily related to the company's business. The IDs endure and even join in the chorus to perpetuate the status and other worldly gains that go with the position. The picture is not much different in our neighbouring countries. I am tempted to quote what a Sri Lankan commentator said about IDs: "There are NO independent directors in Sri Lanka. The moment one is invited to be a member of a Board he/she ceases to be independent because the moment he/she becomes 'independent' the controlling director will sack him/her. The so-called independent directors also keep mum because of the perks and status they enjoy." Another reason is the absence of corporate culture. Most of the business houses, including what are described as 'group of companies', are run by first or second generation business people. The key persons who started it all are naturally reluctant to delegate any authority down the stream or share the decision-making process with any one else, least of all with an outsider. With a few notable exceptions, this style of running the business, known in the management parlance as 'pocket management', is quite common in Bangladesh. Pitched in this environment, the interdependent directors find it really hard to make an impact for improving the quality of management or keeping the company in the proper track in terms of sound business practices or compliance with the law of the land. A self-respecting ID has only one option: quit. Contrary to reluctance in our country to bring in outsiders in the Board, the benefits of independent directors have long been recognised in the advanced economies. Many of the business houses in those countries voluntarily induct independent directors even in their family business when their company's operations reach a critical size and complexity. A study conducted in the United States of more than 80 family-owned companies, run by the third or later generation, showed that the existence of an active and outside (non-family-controlled) board was the most critical element in the survival and success of these companies. Among other things, an independent director-- * brings an outside perspective on strategy and control; * adds new skills and knowledge that might not be available within the firm; * brings an independent and objective view from the family; * makes hiring and promotion decisions independent of the family ties; * acts as a balancing element between the different members of the family and, in some cases, serving as objective judges of disagreements among family-member managers; * applies his or her connections and contacts to help the company to grow. Stock exchange regulators in many countries, including the United States, have imposed strict regulations in regard to appointment of independent directors. Both NYSE and Nasdaq, two of the biggest stock exchanges of the world, require that "a majority of the board of directors of a listed company be 'independent'. The NYSE states: "no director qualifies as 'independent' unless the board of directors affirmatively determines that the director has 'no material relationship' with the listed company, either directly or as a partner, shareholder or officer of an organisation that has a relationship with the company." Nasdaq's rules say that an independent director must not be an officer or employee of the company or its subsidiaries or any other individual having a relationship that, in the opinion of the company's board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The listing requirement in India mandates that Independent Directors should constitute 50 per cent of their Boards; otherwise, the defaulting company will face severe penalties. In Pakistan, the central bank, the State Bank of Pakistan, issued a circular in 2007 saying that at least 25 per cent members of the Board of Directors of a bank or development financing institution shall be independent directors. The question of appointment and monitoring of independent directors in Bangladesh is handled by the BSEC under the law governing the capital market. However, a recent amendment has been made in the Bank Companies Act to include a provision regarding appointment of IDs. The idea, initially approved by the cabinet for placing before Parliament, was that each bank would get four independent directors, the BSEC giving consent to two directors and the Bangladesh Bank (BB) the other two. The objective was obviously intended to strengthen the number of IDs and also associate the BB, the regulatory authority of the financial institutions, in the selection process. Somewhere along the way, however, the proposal was watered down for appointment of only two directors in case the total number of directors in the bank is less than 20 which is what most banks now have. They would be appointed only by the BSEC. The bigwigs in the corporate world might have diluted what could have been a sensible decision especially in the backdrop of a series of scams that rocked the banking arena. It is not really important which authority would make the appointments. What is important is to let the regulating agency handle appointment independently, free of dictation from the company or any one else. Those who are currently appointed on the suggestion of the companies owe their loyalty to them and quickly lose their independence in thoughts and actions. To strengthen the independence of the IDs, the regulatory authority should determine the amount of emoluments and pay these directly to them. A small charge may be levied on the listed entities to cover these expenses. A roster may also be prepared, without fear or favour, of truly independent minded persons with competence, knowledge and experience for appointment as IDs. The system and modalities of other countries may be reviewed to gain an insight into the ongoing thoughts on this issue for refinement of our system. The writer is a former central bank official. [email protected]