How to gauge board's independence?

Tue, 30 Oct Pre-Open

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An independent opinion in the board room is critical for an unbiased view on important subject matters. And that comes from having independent directors on board who are not related to the company. Because they are not related to the company they can freely express their opinions without any biases. This is in the long term interests of the shareholders. Also, greater the composition of independent directors better the corporate governance standards.

But more often than not we focus too much on independence of the board in gauging corporate governance. The role of the chairman of the board is ignored. His role is particularly important given the powers that are vested with him. Generally, it is believed that it is the managing director (MD) or the chief executive officer (CEO) who runs the company and chairman runs the board. However, whenever it comes to actual roles that are played by them, there is a wide divergence.

More often than not the chairman of the board is also the MD or the CEO of the company. Sometimes the role of chairman is played by some executive or family person of the promoter group. Very few companies have non-executive independent chairman. As the chairman can overturn/oppose any board decision there should be an independent person at the helm. But this is rarely the case. Both the roles of chairman and CEO are played by a single person in most cases.

Just imagine, if that is the case, then, while the MD reports to the board he is also the boss of the board! Thus, he can influence the board decision at his will.

In a nutshell, chairman and CEO cannot be one unit. There has to be some level of independence which generally lacks. And this poses governance risk. Further, if the chairman is a significant shareholder, the risk increases even more. That's because he will be more inclined and emotionally attached to the company. This can impact his rationality in decision making at the cost of long term returns to the other shareholders. We are not saying that having a non-independent chairman as a CEO is a recipe for disaster. The point we want to highlight is that when both these roles are played by a single individual his actions are more often than not governed by emotions rather than prudence. While some can overpower the emotional factor and act with prudence, some cannot.