Independent DirectorsLecture 11

By : Kanchan Damithendra

Concept of Independent Director

Independent director means a director who is notconnected or associated with the company in anymanner and works only to safeguard the interest ofmembers who individually cannot look after theirinterest.

Who is

Independent Director???

Independent Director

Absence of Pecuniary

Relationship

Absence of Material Relationship

One who has Independency of Judgment

Independent Director

Interdependent DirectorVs.

Code of Best practice on Corporate Governance• Issued jointly by The Securities and Exchange Commission of Sri Lanka

& The Institute of Chartered Accountants of Sri Lanka

(Year 2008 )

It is preferable for the Board to have a balance of Executive and Non-Executive

Directors such that no individual or small group of individuals can dominate the

Board’s decision-taking.

A.5.1

The Board should include Non-Executive Directors of sufficient calibre and

number for their views to carry significant weight in the Board’s decisions. The

Board should include at least two Non-Executive Directors or such number of Non-

Executive Directors equivalent to one third of total number of directors, which ever

is higher. In the event the Chairman and CEO is the same person, Non-Executive

Directors should comprise a majority of the Board

A.5.3

For a Director to be deemed ‘independent’ such Director should be independent of

management and free of any business or other relationship that could materially

interfere with or could reasonably be perceived to materially interfere with the

exercise of their unfettered and independent judgment

BOARD BALANCEPrinciple A.5

Conditions

A Director would not be independent if he/she:

• has been employed by the Company during the period of two years immediately preceding appointment

as

director;

•currently has/had during the period of two years immediately preceding appointment as director, a

Material Business Relationship with the Company, whether directly or indirectly has a close family

member who is a director, chief executive officer (and/or an equivalent position) in the Company;

• has a Significant Shareholding in the Company;

•has served on the Board of the Company continuously for a period exceeding nine years from the date of

the first appointment;…………………

DEFINITIONS RELATING TO INDEPENDENCE CRITERIA

Close Family Member

- shall mean and include the director’s spouse, parents, grandparents, children, brothers, sisters, grandchildren

and any person who is financially dependent on such director.

Financially Dependent Individuals

- include any person who received more than half of their support for the most recent fiscal year from a

director and/or his or her spouse.

Material Business Relationship

- includes any relationship that results in income/non-cash benefits equivalent to 10% of the director’s annual

income.

Business Connection

- shall mean a relationship resulting in transaction value equivalent to 10% of the turnover of that company or

business.

Significant Shareholdings

- can be defined as a shareholding carrying not less than 10% of the voting rights of a company.

Position of Independent Director

Executive Director

Owner DirectorIndependent

Director

Board of Directors

Interest of Company

Interest of Shareholder

Interest of Stakeholders

Balancing of Interests

Primary Duty

Enhanced Responsibility

Independency of Director

Concept & Reality

Concept

• Legal• Disinterested director• Unbiased decisions• Balancing of conflicting interests• Protection of shareholders’ interests• Protection of stakeholders’ interests • Protection of whistleblower’s interests

• Managerial • Bring expertise in the Board composition• Infusion of new ideas• Develop a system in the Board Culture

Reality – Appointment of Independent Director

Compliance in Spirit Compliance in Letter

Knowledge about the Company’s business

Precedence to knowledge over names

Capability to dissent

Not concerned with the Company’s business

Precedence to name over knowledge

Yes- Man

Reality – Working of Independent Director

Compliance in Spirit Compliance in Letter

Provides independent assessment of business decisions.

Provides expert comments on the subject

Acts as per the whims of management.

Silent observer at the Board meetings.

Compliance in Spirit Compliance in Letter

Informed decisions

Ensures unbiased decisions

Decision on selective information.

Independent status takes a backseat.

Reality – Working of Independent Director

Independent Director

Critical Issues

Insufficient knowledge regarding the business

Reliance on Executive Director/CEO for information

Selective information sharing

Lack of understanding

Informed Decisions – Not possible

No legal requirement for qualification of Independent

Director except for the member of Audit Committee

who shall be financial expert.

Quality & ingredients are subjective phenomenon.

No independent appointment.

Capability & Capacity

Major Shareholders

Executive Directors

Independent Director

In 60% companies, Board consists of shareholders holding more than 50% stake.

Unbalanced Risk & Reward Equation

≠

Compensation

Too less will deter experts from undertaking responsibility

Too high will loose independence .

Independent Director

Rights & Duties

Rights & Authorities

• Right to attend and vote in every Board Meeting.

• Right to be appointed on various committees.

• Right to demand information on every business

matter.

• Right to seek clarifications/justifications

• Right to dissent.

Duties & Responsibilities

Primary Duties Enhanced Responsibilities• Act in the best interests of the company

• Safeguard the interests of the stakeholders

• Attend Board Meetings and participate in

decisions

• Avoid conflict situations

• Not seek personal gains

• Maintain confidentiality

• Fiduciary duty

• Discharge duties required in specific

committees of the Board

● To compel directors to act in

accordance with the strict terms of

their mandate

● To compel them to exercise care and

skill in carrying out their various

functions

● To compel them to use their wide

discretionary powers in good faith and

proper purpose, &

● Finally, to compel them to act loyally

in advancing the interest of their

company.

Independent Director

Corporate Issues & Regulator perspective

Corporate Issues

• Preference of Stakeholders’ interest above the interest of Company.

• Forces disclosure of confidential information.

• Interferes in Management Decisions.

• Acts as Bloodhound dog

Regulator Perspective

• Independence director has primary duty towards the Company and

enhanced responsibility towards stakeholders.

• Reduce conflict of interests of management.

• Ensures protection of wider interest of Company and stakeholders.

• Ensures transparency of information.

• Provides independent Assessment while evaluating business decisions

as an independent Business Advisor.

• Acts as a watchdog.

THANK YOU!