Is Independent Director\'s service a charity?

| Updated: October 20, 2017 23:24:56

Is Independent Director\'s service a charity?

As part of its initiative to enforce better governance, the Bangladesh Securities and Exchange Commission (BSEC) has introduced the Code of Corporate Governance for companies listed with local bourses. When the Code was first introduced in 2006 after the debacle of 1996 stock market, it was applied on 'comply or explain basis'. The 'Comply or Explain' principle left the compliance issue to discretion of the companies. The companies that do not comply with the Code were required to explain in their annual public reports the reason for non-compliance if any. By doing so, the matter was left to the investors to make their decisions based on the level compliance to the Code by the concerned companies. This flexibility was similar to the provision of the UK Combined Code of Corporate Governance introduced as long back in 1992. However, in 2012, the BSEC through a notification made compliance to the corporate governance code mandatory for the listed companies excepting banks, insurance and non-banking financial institutions (NBFIs).  
It is the BSEC Code that for the first time gave statutory footing to the concept of Independent Director (ID) in the corporate board rooms of Bangladesh. The code requires that all companies shall encourage effective representation of the IDs on the board and at least one fifth of the board members shall be Independent Directors.
In a sponsor-controlled and family-dominated corporate environment, induction of Independent Director is aimed at protecting the interest of the vast majority of general shareholders. The Independent Director is expected to play an unbiased role in running the affairs of the company. As a Non-Executive Director (NED) with no individual interest, he is supposed to act for the interest of the company particularly in cases where the shareholders or the executive directors have got conflicting interest. He, being not involved in the day-to-day operating activities, will be able to look into every important business decision from an impartial point of view and will help take decision that best serves the interests of the entity. The model of corporate governance, therefore, gives additional responsibilities to the Independent Directors.
Besides his role as a member of the board, the ID has additional responsibility as a member of the Audit Committee. According to the CG guideline, the chairman of the Audit Committee must be an Independent Director (ID). The Audit committee is one of the very important and powerful committees under the current CG practice. The code provides a detailed list of functions of the Audit Committee. One of the important responsibilities of the Audit Committee is to confirm that the company has appropriate internal control system in place to prevent any fraudulent activity or misappropriation. The Audit Committee is also required to see the accounting and reporting process of the company: reviewing the financial statements being issued for public, ensuring that related party transactions, a tool commonly used in financial manipulation, are being carried out on arm's length basis, overseeing the hiring of external auditors and evaluating their work and ensuring that external audit activities are carried out in an independent manner.
The Audit Committee must report to the board any fraudulent or illegal activity or any infringement of legal or regulatory provision or any other matter that has material impact on the financial condition or operation of the business.  If corrective actions are not taken on any matter raised by the Audit Committee, it is to be reported to the Commission. The Committee is also required to submit a report to the shareholders on an annual basis on the activities it has carried out and the reports, if any, are submitted to the board of directors. This means besides bringing in diversity of knowledge and skills in the corporate board, the induction of Independent Director has a great role in ensuring financial transparency which is a key element of good governance of the corporate entities.
QUALIFICATION AND DISQUALIFICATION OF  ID: The BSEC Code also contains a long list of qualification and disqualification of Independent Director. According to the regulation, an ID should be a 'knowledgeable' person, an individual with 'integrity', should have ability to 'ensure compliance with financial, legal and corporate laws' and should be able to make meaningful contribution to business and above all he should be 'financially literate'. Additionally, he should be a 'business leader/corporate leader /bureaucrat /university teacher with economics or business studies or law background/ professionals like Chartered Accountants, Cost and Management Accountants, and Chartered Secretaries.
Any involvement with the company by way of family relationship with the sponsors or directors; any business interest with the company or its associated company; holding of more than 1.0 per cent shares in the company, any association with the company as auditor, employee or similar other manner and default in repayment of loan of any bank or financial institution are considered, among others, as disqualifications to be an Independent Director. It is apparent that in enforcement of good CG practice and in protection and promotion of the general shareholders' interest, the ID has a vital role to play.
Now, the question is what is the legal consequence if the ID does not perform or fails to perform his statutory responsibilities? The Companies Act 1994 contains provisions as regards the liability of the directors and the consequence of any non-compliance. The definition of directors in the Act does not contain any definition of ID. As far as the liabilities of the directors are concerned, no distinction is made between executive, non-executive or Independent Directors. The BSEC regulation also does not contain anything about the legal liability of the IDs. There is no special immunity given to the Independent Directors for any civil or criminal offences done in the company.  This means that an Independent Director has the same degree of liability as other directors for wrong-doings or mismanagement or non-compliance of any provision of the law. While there are complex legal disputes as when and to what extent an ID may be held responsible for any misdoing by the company, there is no disagreement on liability for his individual failure to perform his statutory responsibilities. Besides legal liability, he is putting his social reputation at stake for any failure of the company or for any failure on his part to perform as per the required standard.
The discussion above is relevant for understanding the risk that an ID is takes by accepting directorship in the company in which he has no financial benefit or interest. Now, our other question is: what is his reward for taking up the risks and responsibilities as a director of the company as the ID is a non-executive and non-shareholding director. Why should an ID be interested to attach himself with a company?
The BSEC regulation does not contain any provision as to the remuneration to be paid to the Independent Directors. It only says that remuneration paid to the directors, including the Independent Director, is to be disclosed in the annual report. This implies that the BSEC has left the matter to the discretion of the companies. In this context, it would be appropriate to see how are the companies actually rewarding their IDs?
There is no survey report available on the remuneration paid to the IDs by our listed companies. However, the people associated with the companies reveal that almost in all cases, IDs are paid nothing more than their paltry meeting attendance fees. A short survey by this scribe on the annual reports of the listed companies also endorses the fact. Subject to exception, the amount of meeting fee is also a very meagre and in most cases, ranges between Tk. 5,000 to Taka 10,000. As such, the annual earnings of an Independent Director from the company can hardly reach Taka 100,000.
GLOBAL PRACTICE: Against this backdrop, globally IDs are recognised for their important role in the modern corporate governance structure and their services are very well compensated. Take for example, the case of our neighbouring India. According to a 2015 survey report, average annual remuneration received by the IDs in Indian companies in 2014 was INR 8,00,001  with highest being INR 9.3 million. Even earnings of the IDs from the public sector companies which are least payers among the companies surveyed averages INR 3,20,000. It may be mentioned here that the Indian Companies Act 2013 disallows remuneration to IDs other than sitting fees and reimbursement of travelling expenses for attending board and other committee meetings. However, profit-related commission may be paid to them subject to approval of the same by the shareholders. It can, therefore, be reasonably assumed that the compensation paid is mostly in the form of fees. Similarly, a 2013 study by KPMG reveals that the weighted average earnings per NED including the Independent Directors in top 30 Malaysian companies is RM 357,000 per year (equivalent approximate Bangladeshi Taka 7.10 million). Seventy per cent of the compensation is the director's fee while the rest are other benefits. Subject to a few exceptions, in Singapore, companies predominantly pay directors' fees and no other benefits in kind as compensation to their non-executive directors which include IDs. According to global management consultancy Hay Group report, NEDs in the listed companies of Singapore received S$ 56,000 in financial year 2012/13 which is almost 10 per cent more than the average pay in the previous year.
These few examples are enough for our readers to understand the trend of compensation given to the Independent Directors for their advisory and oversight roles in the companies.
The qualification and experience profile demanded from an ID is of high standard. The advisory and oversight functions they are assigned to perform would definitely require considerable amount of their professional time and given their profile such services must be highly expensive. Moreover, being a member of the board and other important committees including the Audit Committee responsible to oversee the financial affairs of the companies, the IDs are taking consequential legal risk of any mismanagement or fraudulent activities done by the company.  They are also responsible for their own failure to perform their legally stipulated functions.
SOME ASSUMPTIONS: It will be an interesting study for any inquisitive researcher to know why our high-profile IDs are taking directorship role in the companies which are not at all rewarding for them. In the absence of any such study, we can proceed with some hostile assumptions.
Our first hypothesis could be that Independent Directors are compensated in other than non-financial terms which are not reflected in the financial statements and as such they are happy with what they are receiving for their contribution.
The second hypothesis is that companies want the IDs just to give some extra flair to their corporate profile. They are virtually an 'ornament' to the company without actually doing any oversight functions other than just attending the board or committee meetings just as an endorser of what the company management is placing before them.  This virtually requires no significant time and efforts for them.
Our third assumption is that most of our IDs are not well aware of their statutory responsibilities and legal liabilities and as such are not conscious about the value of their services and the corresponding risks they are exposed to. They are taking it as voluntary service as if having no corresponding obligation.
Our final hypothesis is that they are taking it as a matter of social pride and status to sit in the boards of reputed companies and unaware of the risk of reputational loss associated with any failure of the company as well as the legal liability for their failure to perform the oversight functions
If any of our hostile assumptions is true, then the very essence of inducting IDs in the corporate boards becomes a futile exercise.
It will be really interesting to know how our companies are negotiating the trade-off with the IDs for such high-profile functions with such a paltry reward structure. This is, after all, not a voluntary service without accountability.

The writer is Vice President, ICMAB

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