Corporate governance: are we ready for induction of independent directors?
By M Shaban Uppal
Corporate governance is a generic term, which describes the ways in which rights and responsibilities are shared between the various corporate participants, especially the "management" and "shareholders. Though, there are various definition of "Corporate governance" the most acceptable definition comes from the experts of "OECD" describing it " a system by which business corporations/ companies are directed and controlled. The Corporate governance structure specifies the distribution of rights and responsibilities among different participants in the company/ corporation, such as the Board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, is it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance are determined."

Over the years, many studies have been conducted and the experts have been exerting their efforts aiming to improve the performance of Companies and developing the mechanism and working arrangements between various participants so as to ensure (a) quality management (b) accountability (c) transparency (d) timely disclosure of information (e) competent Board of Directors including the non-executive or independent Directors (f) effective internal/external audit systems/ procedures and the protection of minority shareholders interest.

Good Corporate Governance is not simply about the avoidance of finical shocks, nor should the emphasis be on the negative impact of poor Corporate Governance. Rather, the positive benefit of good governance should be the primary concern of business corollary to this. Good corporate Governance is not simply about fairness in the allocation of limited pie but rather about the enlargement of that pie, the adoption of sound and correct business strategies, and the effectives management of the company.

Companies that adopt a high level of transparency, accountability and fairness, will have strong and sustained impetus to perform and create value for the long term. With greater transparency, there is little room for sweeping problems under the rug, making imperative prompt corrective actions when performance falters. In the fast changing would of business, this can spell the difference between survival and continuing decline.

While there are minimum standards that must be observed by all companies and enshrined in the country's laws or the rules of self regulatory organization, demands of good corporate Governance can vary from industry to industry, firm to firm, and even circumstance to circumstance. Any attempt, however, to codify a very comprehensive code of governance with of sanctions carries with it the risk of stifling the dynamism of private enterprise that lies at the core of a modern economy. A set of unrealistic rules, on the other hand, can make a code paper as a nuisance and detract from the seriousness that this issue deserves. There are distinct roles that different groups should play in putting together a healthy business environment where good practices hold sway. Government practices should be limited to what government prescribes. In the first place, most legitimate businessmen are driven by desire to create real value and to establish lasting enterprises. But there is also a need to reinforce, beyond the coercive power of the state, these positive motivations of businessmen as well as control the foul intentions that admittedly also exist.

In this regard, the capital markets pay a key role in reinforcing good governance practices. Investors vote with their money and capital can easily flee those companies that fail to honor the trust that investors have bestowed on them as it can generously reward those who fully live up to their commitment to act as responsible stewards of investors wealth. Companies that have poor corporate governance run the risk of becoming pariahs in the capital markets with grave implications on their ability to grow and the ability of their controlling shareholders to maximize the value of their investments.

In Asia, as we develop capital markets more fully, there will enter, institutional investors on the lookout for well managed companies. These investors are for the most part, minority investor's of their right and demanding the highest levels of transparency, accountability, and fairness from management. Globalization will be an increasingly powerful force that can accelerate this process of making the capital market an effective catalyst in the promotion of good corporate governance.

While admittedly, there are scores of factors identified by the experts to establish the concept of good corporate governance leading to the achieving of companies objectives based on sound principles of corporate governance represented by effective internal/ external audit system, transparency, management competence and competent Board of Directors representing the stakeholders/ shareholders, there is one element which needs to be taken cognizant of which relates to the induction of non- executive or independent directors so as to ensure that Board's proceedings remain objective and meets the standard of transparency.

The induction of non- executive directors is a latest phenomena attracting attention of the experts and the companies who are indeed concerned about the affairs and management of the company after the debacle of Enorn and World Call in the US and host of other companies around the world. Had there been inter alia the non-executive or the independent directors on their boards, there been enormous possibility to save the skin of minority shareholders who seem to have lost every single penny they had invested. In Asia,th norm of ownership structure are a predominance of family or state controlled business. The challenge is to balance the relationship between majority and minority shareholders.

OECD principles on good governance speak of a board's to exercise objective judgment on corporate affairs independent from that of management. Board independence usually requires that sufficient number of Board members not be employed any the company an dnot be closely related to the company or its management through significant economic, family or other ties. The principles further suggest that "independent board members can contribute significantly to the decision- making of the Board "by bringing an objective view to the evaluation of the decision-making of the board and management.

Research on the subject suggests that " effective board is an independent one". The definition of effectiveness hinges on a Board's ability to take full responsibility for its actions an decisions, and by extension, those of the firm's officers. Unless Board is independent of the influence of management or the controlling of shareholders, it cannot make such a claim and is decisions would be prejudiced. By necessity then, an effective oard will require more than a few independent thinkers within its presence.

Firms in developed countries are moving to place independent directors (also called outside directors) on their Boards, In the United States the percentage of the outside directors on boards has risen to 78% in 2000, up from 66% to a decade earlier. This figure represents an increase by almost a fifth and does not appear to end there . Some of the largest institutional companies even go to the extent of saying that the only company executive on the Board should be the Chief Executive.

Though the depth of independence is more formal than substantial and the percentage of independent thinkers brought on the Board is still a relatively small minority, it is holding ground in Asia. Code of governance in India, Malaysia, and Singapore speaks of directors who have no relationship with the company and are therefore free to exercise independent judgment for the best interests of the company. In many Asian countries, listing rules spell out the requirement of each firm to put on board independent directors (Thailand, Korea) In the Philippines, the requirement is carried in both the Securities Regulation and the General Banking Law.

The required or suggested number of independent directors varies across jurisdictions. In India, the code of governance advocates that 50% of a board must be composed of non executive directors, defined as individuals not involved in the day to day operations of the company nor on its regular payroll as a hired employee. In Malaysia, 1/3 of the board should be independent and non- executive, as is the case with Singapore. Korea listing requirements place the minimum percentage at 1/4 of the board or one director (whichever is higher) though the Korean code of best practice sets higher standard of at least three independent director comprising a least 50% of the board. The Philippines sets the minimum at 1/5 of the board of two directors (whichever is less) Thailand's listing rules sets the minimum at two directors for any board. But the question remains what constitutes TRUE independence?

Outside and non- executive directors have synonymous connotation of not being involved in the day today operations of a company. It is however not a guarantee of true independence. The Asian corporate setting with its reality of predominantly family owned and controlled companies places strong emphasis on relationships- both social and business. Thus, the true test of independence would be found in the degree of removal in the relationship to the controlling shareholder by the so- called independent director. The most obvious test for independence would be to establish the break in family relations with the controlling shareholder or with management. The second test would be to establish the break in social relations, which have tremendous impact in societies where such relations bring with it certain informal obligations based on such notions as loyalty, honour (or shame) face- saving, fraternal kinship, and the like.

In some of he Asian countries,the definition of independence is also linked to the remuneration of directors: independent directors are those who do not derive the majority of their current income from he company and are therefore not beholden to for their own financial well- being. While we might find it difficult to identify truly independent directors, it has to be emphasized that director independence is as much about training them to act independently as it is about setting up boardroom structures and practices. It is a fact, the non- executive director is a key to board independence. But it is also critical that the directors posses the right personalities to act independently. Independence freedom from undue influence by the top management team or the controlling shareholer.

Security and Exchange Commission of Pakistan (SECP) Code of Conduct issued in March. 2002 stipulates various measures strengthening the corporate structure in Pakistan. The code is intended to inculcate a sense of good corporate governance in the corporate setor so as to safeguard the interests of the entire stakeholders including the minority shreholdes in particular. The aspect of inducting the non- executive directors however does not seem to have been given due importance as it was left to be implemented voluntarily. It only suggests that the companies shall encourae effective representation of independent non- executive directors. (clause-I) Further clause -I (b) suggests that the listed company shall include at lest one independent director represtitution, equity interest of banking company, development, financial institution, non-banking financial institution meaning thereby if the company does not have equity of those institutions, it will not be obligatory for the company to have the independent, non- executive director.

What I am going to suggest is the fact that there has been serious deliberations on the subject of inducting non- executive directors to safe the interest of various share holders around he world. Most of the economies in Asia. US and Europe have already adopted the principle of inducting non- executive directors to strengthen the culture of good Corporate Governance. We also need to give due consideration to this aspect and should take tangible steps to regulate the listed companies so as to ensue that the harvest is reaped equally by the stakeholders and the investors stakes are adequately protected. This will certainly strengthen the capital market in the country encouraging the investment by the local as well as the foreign entrepreneurs.

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