How effective are ‘Independent Directors’ in Sri Lanka?
There are a couple of interesting issues which follow the two matters raised by Charitha P.de Silva in his article on ‘Some aspects of Corporate Governance’ published in the Business Times last week. My thoughts on this subject are as follows:
In Sri Lanka, according to research, most public listed companies are controlled by major shareholders. By virtue of the voting power which such major shareholders possess they will always be represented on the board. The problem is that there may be situations where the interests of the major shareholders take precedence over the best interests of the company. This is not in the interests of the company and the minority shareholders. This is where Independent Directors have an important role to play. For this reason, if the Independent Directors are chosen from among the major shareholders it would serve no useful purpose … thus the reason to exclude major shareholders from serving as Independent Directors. As regards this aspect the provisions of the Code are correct and I have no qualms about it. In any case, the contents of section A.5.5 of the Corporate Governance Code should as stated therein only be treated as a guide to be followed in the appointment ofIndependent Directors. It is not exhaustive. There are however issues with the Code and a few of these are dealt with in the rest of this article.
The criteria for independence stated in the Code deals with who should not be an Independent Director. The positive factors which deal with who should be an Independent Director are not stated in the Code. For example it does not state the skills, experience and qualifications which Independent Directors should possess. It does not even state the duties of Independent Directors. The characteristics which are more important than independency are perhaps impartiality and an ability to make a contribution towards strategy and compliance. What is necessary for Independent Directors to function effectively should not be limited to independence. It must include motivation to work in the best interests of the company. Absolute trustworthiness is another important characteristic. To this end, Independent Directors must be required to conform to a stringent ‘fit and proper’ criterion. Mere compliance with the Code must not be seen as an end but a means to end to improve corporate performance and enhance shareholder value. I hope that these matters would be taken note of in the next revision to the Code.
Independent Directors must be able to voice their opinions without fear or favour in the best interests of the company. However to do so and not toe the line with the major shareholders would mean that such Independent Directors run the risk of earning the wrath of the major shareholders. This would result in them not being re-appointed following the expiry of their tenure. For this reason, Independent Directors tend to pledge allegiance to the major shareholders who appointed them. This brings into question the effectiveness of Independent Directors. If Independent Directors are to be effective then the appointment and removal of such directors must not lie with the major shareholders.
In India the Companies Act makes provision for the minority shareholders to elect one director to represent them on the board. It is the same in Italy. There are other mechanisms such as vote capping of major shareholders which may also be used in voting for appointments of Independent Directors. There are many other ways of limiting the majority and empowering the minority which are followed in other jurisdictions. These practices however run counter to the company law principle that that all shareholders of the same class must be treated alike and that majority will should prevail. However as shareholder preferences are not always the same and major shareholders have legitimate power to shape corporate policy by virtue of their voting power some level of unequal treatment among shareholders seems necessary.
It is time that a study is conducted to consider ways of improving the effectiveness of Independent Directors in public listed companies in Sri Lanka. Such a study would provide insights to reform company law and the corporate governance regulatory framework in Sri Lanka. The need to provide Independent Directors statutory power is also worthy of consideration. Academic research has shown that better shareholder protection is empirically associated with enhanced corporate valuations. At present it is doubtful if Independent Directors are effective in the functions that they perform. It seems that Independent Directors are a mere public relations exercise to show outsiders that the company is being well managed and monitored by Independent Directors.
(The writer is an International Capital Market Development Expert and can be reached at rohanfdo@sltnet.lk