Saturday, January 10, 2009

The Vexed Issue Of Independent Directors-II- The Solutions

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I think one of the policy alternatives that the State ought to consider is by way of tightening the ex post law activation and enforcement.

Say have a law to provide Class action litigations.

Once the Directors know that there are expedited judicial processes to aid the share holders which disperse litigation costs and risks, ex ante, there will be considerable incentives to act in a manner befitting their fiduciary status. The Independent Directors also will be more agile in monitoring the executive component of the Board.

The problem with placing too much reliance on Institutional Share holders to do the monitoring and to let retail share holders to piggy back is that with portfolio holdings, Institutional share holders hardly have any inclination to monitor their agents. (Although there are instances recently where activist hedge funds did a very good job of monitoring. (Sterlite's failed restructuring).

But its not going to be easy to bring a Class action law on the statute books. For one, its going to add to the cost for Corporates. I see an immediate uopward revision in the D& O liability Insurance premium for example. Also, the possibilty of being found party to a law suit at a later date will act as an ex ante disincentive for the Independent Director to accept the post. ( we have a very recent example of Nimesh Kampani in Nagarjuna Finance)

Also, easier access to remedy ex post might lead to ex ante laxity in monitoring the Boards among the share holders. Clearly, the field is ripe for research!

Should the SRO have a say in appointment of Independent Directors, that might be quasi nationalisation ; management rights to an enterprise are after all a form of property.

May be a peer review mechanism that uses reputation costs as a tool for deterrence can be used in appointment of Independent Directors. That will augment the formal deterrence mechanisms that the legal system provides. This is especially because, Satyam showed that investors factor in corporate governanxce standards in the secondary market. We saw the sensex reacting negatively and FIIs pulled ouit their money. The peer review mechanism will act as an ex ante hedge against the Company appointing Independent Directors with suspect affliation.

2 comments:

Jeet said...

I cannot claim to have much knowledge on this topic. My opinions are guided by hearsay and by the daily newspaper. I agree when you say that an independent director has greater disincentives than incentives to take up the job, particularly after Satyam. I think the best system therefore is to cast them in the role of whistle-blowers. An independent director can be exempt from liability so long as he responsibly reports any aberration in the working of a Company. If not, the Courts would do well to inquire into whether there existed mens rea or complicity in the fraud. In the absence of complicity, they shouldnt be liable for anything more than negligence.
Again, Im not sure how nuanced a view this is.

ilexpert said...
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