Friday, December 19, 2008

The Vexed Issue Of Independent Directors

The recent Corporate Governance fiasco at Satyam raises some interesting issues about the Economics behind the law and policy of corporate governance in India. It shows how these issues from behavoural economics remain unaddressed or imcompletely unaddressed under the compliance driven mandate of clause49.

In this piece I argue that the rule based nature of clause 49 makes the framework underinclusive to address the issues similar to those that arose in Satyam.

An analysis of the underlying theme of clause 49 makes it clear that the term "Independent Director" is defined in the context of her proximity to the promoter/promoter group/BOD. That proximity is seen in two contexts: a) familial association b)Association arising from sustained and repetitive interaction.

This theme is a hedge against moral hazard issues. So far so good. The problem however is that, clause 49 does not address the issue of moral hazard entirely.

It fails to address the issue of moral hazard that arises from being repeat players in the same business segment. Let me try and explain this argument:

If an Independent Director has to be professionally competent (and reason demands that he ought to be competent in the vertical that the firm operates in), then the market for Indepedent Directors includes professionals, and academics well known in that vertical. Now, entrepreneurs, precisely because of their lengthy association with the particular business vertical are more than likely to know these actors. Now the extent of affiliation would differ; in some cases, the affliation will not be more than casual; in others, It could go deeper ( For example, It is likely that the academic was earlier a Ph.D. guide of the entrpreneur or a college senior perhaps). Without going in to the specifics then, it is fairly reasonable to imagine that fact matrices may exist where individuals otherwise qualified within the meaning of clause 49 are "Non Independent" by virtue of moral hazard that arises from being repeat players inthe same business segment and also the sorts that arises from associations that are not familial or professional and yet have decided trappings of affinity.

The other side to this argument is that outside of Directors related to the promoter/promoter group, this is the only set of people that have the skill sets to become directors on the Board of companies operative on that vertical. (Say, for example, Vinod Dham on Satyam).

So, if clause 49 were to include this residuary class as well, acute demand supply mis matches msy arise in the market for independent directors. This again may have its own set of problems; It is reasonable to imagine for example that sitting fees might see an upward revision across the spectrum bringing with it assorted problems of agency costs and issues in Directorial remuneration.

Clearly, the quest to have an optimum SOX in India is far from over!