Author(s) :

Amrita Singh.

Volume/Issue :

Abstract :

In the wake of the corporate governance scandals, concept of Independent directors has grappled academicians and policy makers worldwide as to whether these independent directors are working effectively or not. The main objective of the paper is to enunciate the factors influencing the effectiveness of independent directors in listed Indian companies. The study uses Principal Component factor analysis to identify the factors that impact the effectiveness of independent directors. Research findings: The results of the analysis suggest that presence of independent directors has an impact on the accounting returns of the company as well as market returns by increasing investor confidence. Further it is observed that most of the Independent Directors are selected through personal channels and thus lack the ability to take proper decisions due to biasness towards those who have appointed them. Proper system of appointment and selection of Independent Directors is required for making them more effective. Implications: Independent directors are required for not only running the organisation in an efficient manner but also for improving its performance and enhancing investor confidence. In fact it is an interrelated concept. If the independent directors efficiently discharge their duties it will lead to improved financial results in the long run which in turn will boost investor confidence thereby leading to increased market value of the firm. Policy makers need to formalise the institution of independent directors and regulate their appointment and selection. Further it is suggested that efforts need to be made to increase the autonomy of independent directors so that they can more actively participate in the corporate system

No. of Downloads :

26

KEYWORDS:

Independent Directors, Corporate Governance, Firm Performance, Factor Analysis

INTRODUCTION & OBJECTIVES:

Corporate governance scandals worldwide have caused a crisis of confidence in the corporate sector. Loopholes in corporate governance system has endangered the global financial stability and shifted the focus of the regulators on the boards of the company. Board of directors in a company play the crucial role of not only protecting the interests of the shareholders but also ensuring that the decisions taken by the board leads to maximisation of shareholders wealth. The composition of the board of directors is crucial to the independent functioning of the board. There are primarily three types of directors in the company-executive directors, non-executive directors, and independent directors. There is a significant body of literature on corporate governance, which has guided the composition, structure and responsibilities of the board and studied their impact on the performance of the company. Jensen and Meckling (1976) argue that a bigger board size improves the effectiveness of the board and helps in bringing down the agency cost thereby leading to better financial results.Adam and Mehran (2005), Dalton (2005) and Kiel and Nicholson (2006) also argued that larger board increased the diversity in terms of skills, experience, gender, knowledge and nationality. Fama and Jensen (1983) and Raheja (2005) suggest that although inside directors have an informational advantage, but outside directors bring in neutrality and help solve the principal-agency problem. On the other end, Hermalin and Weisbach (1991) and Lipton and Lorsch (1992) argued that firm performance is insignificantly related to higher proportion of outsiders on the board. Bhagat and Black (1998) also found no consistent evidence that the proportion of independent directors affected future firm performance. They found that high proportion of independent directors rather correlated with slower growth. Thus it is observed that the though companies are realising the importance of having an independent board still its impact on returns is debatable The concept of Independent directors (ID) is new to India. The concept originally was introduced in U.S. during 1950’s and later moved to U.K. in 1990’s. In India, the concept of Independent directors gained momentum with the introduction of corporate governance in late 90’s. The Companies Act, 1956 did not directly mention about Independent Director's and no provision existed regarding the compulsory appointment of Independent Director's on the board. However, Clause 49 of the listing agreement which is applicable to all listed companies mandated the appointment of Independent Directors on the board. In spite of the fact that most of the companies were adhering to the provisions of the Clause 49, scams and frauds were on a rise. With the growing corporate scams and the alleged involvement of Independent Directors in them, a need was felt to update the Act and make it globally compliant. The Companies Act 2013 that replaces the old Companies Act 1956 is regarded as a landmark change in the corporate world after almost six decades. The new act contains comprehensive provisions related to corporate governance and independent directors. The Companies Act 2013 was passed by the parliament on 29th August, 2013 and was made partially effective by implementing 98 Sections w.e.f. 12thSeptember 2013. The Ministry of Corporate Affairs, on 26th March 2014 notified a majority of the remaining sections of the Companies Act, 2013, including sections 139 to 148, relating to audits and auditors. The Act was stated to be effective from 1st April, 2014. As per sec 149(6) of Companies Act 2013, an Independent director in relation to a company, means a director other than a Managing director or a whole-time director or a nominee director,— (a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience; (b) a person (i) who is or was not a promoter of the company or its holding, subsidiary or holding company (ii) who is not related to promoters or directors in the company, its holding, subsidiary or associate company; (c) who has or had no pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the twoimmediately preceding financial years or during the current financial year; (d) none of whose relatives has or had pecuniary relationship or transactionwith the company, its holding, subsidiary or associate company, or their promoters or directors, amounting to two per cent. or more of its gross turnover or total income orfifty lakh rupees or such higher amount as maybe prescribed, whichever is lower, during the two immediately preceding financial years or during the current financialyear; (e) who, neither himself nor any of his relatives— (i) holds or has held the position of a key managerial personnel or is orhas been employee of the company or its holding, subsidiary or associatecompany in any of the three financial years immediately preceding the financialyear in which he is proposed to be appointed; (ii) is or has been an employee or proprietor or a partner, in any of thethree financial years immediately preceding the financial year in which he isproposed to be appointed, of— (A) a firm of auditors or company secretaries in practice or cost auditorsof the company or its holding, subsidiary or associate company; or (B) any legal or a consulting firm that has or had any transactionwith the company, its holding, subsidiary or associate company amountingto ten per cent or more of the gross turnover of such firm; (iii) holds together with his relatives two per cent. or more of the totalvoting power of the company; or (iv) is a Chief Executive or director, by whatever name called, of any non profit organisation that receives twenty-five per cent. or more of its receipts fromthe company, any of its promoters, directors or its holding, subsidiary or associate company or that holds two per cent. or more of the total voting power of the company; or (f) who possesses such other qualifications as may be prescribed Every listed public company was required to have at least one-third of the total number of directors as independent directors. However, the Central Government could prescribe the minimum number of independent directors in case of any class or classes of public companies. Given the recent trend of globalization, the importance of board of directors who are viewed as vehicles of growth of a company has sharply increased. The present paper focuses on independent directors and their role in enhancing corporate performance. The paper is divided into six parts. The first part studies the concept of independent directors. The second part talks about the literature review. Third and fourth part lay down the objectives and research methodology of the paper. Fifth part of the chapter analyses the information collected with the help of a structured questionnaire using factor analysis to find out factors that lead to effectiveness of independent directors. Last part of the paper lays down the conclusion and limitations of the study. Objectives of the study - Various studies have proposed that the board composition influences organization in either positive or negative manner. Although the issue is debatable, various conceptual analyses have suggested that a firm’s board of directors contribute to the process of corporate governance by selecting and evaluating the firm’s chief executive officer (CEO) and other top managers, shaping the firm’s strategic direction, setting corporate productivity objectives, and assessing business success. As discussed earlier, a number of studies have been conducted worldwide to examine the relationship between the composition and effectiveness of boards of directors of the firms. In view of the major research findings and the plight of independence directors in India with respect to their fiduciary duties and powers along with the increasing rate of high profile scams and scandals, the present paper proposes the following objectives: 1. To enunciate the factors influencing the effectiveness of independent directors in India. 2. To evaluate how independent actually are independent directors in Indian firms.

DOI:

https://doi.org/10.58426/cgi.v1.i1.2019.1-26