An independent director, usually from outside, is a member of a company's board of directors (BoD) that the company brought in from outside (as opposed to an inside director chosen from within the organization).
Because independent outside or external directors haven't worked with the company for a considerable period (typically for at least the previous year), they aren't existing officials or professionals and do not have ties to the company's current way of doing business. It is desired that independent outside directors can bring new insights and balance to a team; however, some downsides may also exist.
The consensus among stockholders is that independent directors improve the performance of a company through their objective or professional view of the company's health and operations. At times, independent external directors can also bring specific expertise from their sector and/or personal experience. For example, a company specializing in health technologies might bring in an outside director with a prestigious medical background and degree to provide additional insight into the science behind their product(s).
An additional advantage of an independent outside director is that they do not have to worry about retaining their job within the company and can make their voices heard in a more objective manner. Stockholders and politicians pushed for more independent outside directors for large corporations in the wake of the Enron collapse in the early part of the 2000s. The consensus was that the lack of outside perspective and accountability masked many of the deep issues and false claims that were occurring, and allowed them to repeat within the company.
A company should always have a balance of both outside and inside directors, though in developing markets, independent directors are often outnumbered by owner directors. While outside directors can provide valuable and distinct perspectives, inside directors have the advantage of knowing the company’s inner workings, culture, history, and issues that need solving in real-time. Inside directors can be current employees, officers, or direct stakeholders in the company.
More specifically, they typically include a company's top executives, such as the chief executive officer (CEO), the chief financial officer (CFO), and the chief operating officer (COO), and representatives of major shareholders and lenders, such as large institutional investors. In this case, the majority shareholder will often insist on appointing one or more representatives to the company's board of directors.
As with outside directors, inside directors still have a fiduciary duty to the company and are expected to always act in the company’s best interests.
External directors have an important responsibility to uphold their positions with integrity, and protect and help grow shareholder wealth. In the case of Enron, many accused the company’s outside directors of being negligent in their oversight of Enron.
In 2003, plaintiffs and Congress accused Enron's outside directors of allowing the company’s former CEO Andrew S Fastow to enter into deals that created a significant conflict of interest with shareholders as he concocted a plan to make the company appear to be on solid financial footing, despite the fact that many of its subsidiaries were losing money.
As the Enron example showed, it’s important to set and support clear corporate governance policies to mitigate the risk of such fraud. Corporate governance is a comprehensive system of rules that control and direct a company. This protocol balances the interests of a company's many stakeholders, including shareholders, management, customers, suppliers, financiers, government, and the community. They also help a company attain its objectives, offering action plans and internal controls for performance measurement and corporate disclosure.
In Bangladesh, most of the businesses are being family owned. Hence other than complying with the regulatory compulsion, institutions don’t tend to be welcoming to have independent directors. We mostly get to see banks and financial institutions and the listed companies do have the provision for inducting independent directors from outside.
As per rule, for every three owner directors, there should be one independent director in the board of the company. On the other hand, local family-owned companies would have been immensely benefitted with the induction of independent directors from the available pool of senior professionals, as they can’t attract reputed professionals in management positions, competing with global companies.
However, if one would ask -- how independent are the independent directors, I am sure most of the people will be uncanny with the answer. The very way independent directors are being chosen, how they get inducted into the board, and what role do they play in ensuring corporate governance within the company, will give us a fair picture of why the system is not working.
It is mostly the people known to the influential board members or board chairmen, their school mates or former colleagues joining the organization’s board as independent directors. A friend the other day was making a joke out of this -- “rehabilitation of the old friends and colleagues.”
Jokes apart, why can’t the independent directors play their desired role? They are not allowed to or expected to or even empowered to. Many of the senior government servants become independent directors as ex-officio. Once they get transferred to another job, they are no longer the directors.
Hence most of them want to derive the best out of this role -- an additional car, jobs for their relatives, foreign trips, or similar other benefits. Same is the case with some senior citizens or retired professionals. They simply take it as a retirement posting or vacation, with not much to do.
At times though, some of them come up with some ‘knowledge donation” but they never want to take a position against the actual directors or owner directors. Most of them don’t find any role for the organization other than the two-three hours board meeting time.
Apart from the above, independent directors in Bangladesh are paid no money for being a board member or paid very low for attending board meetings. In Singapore, if an illustrious professional wants to take an independent director role, apart from being very prestigious, it also brings a good amount of money. Even in India, I have seen many companies also keeping a portion (though small) of their net earnings for distribution among independent directors. They take regulatory approval for this.
Owner directors in Bangladesh enjoy various benefits apart from dividend earnings from the company, whereas the independent directors, though deemed to be contributing because of their long-standing professional background, are paid a miniscule amount as per regulatory guidelines, apart from a “good lunch” on the board meeting day.
In order to get the best out of the independent board members or external directors, the regulatory agencies should review the existing norms or guidelines, re-look at the process they are being inducted in, and make sure the independent directors are empowered well and compensated well as per the ultimate performance of the company.
In the developed world, most of the successful companies are being run by independent directors and more importantly, the professional management. Owners or shareholders mostly remain happy with their return on investment or return on equity or return per share. That means the ultimate satisfaction for them, not the day-to-day interference.
Mamun Rashid is an economic analyst.
