By Mandar Kagade, Analyst, Bharti Institute of Public Policy

Principle 1 of the National Voluntary Guidelines states that businesses ought to conduct and govern themselves with Ethics, Transparency and Accountability.  One of the ways in which the law monitors that businesses actually conduct and govern themselves likewise, is through the institution of independent directors. Before the enactment of the new Companies Act in 2013, clause 49 of the listing agreement was the only law applicable to independent directors. The new Companies Act for the first time, imparts statutory recognition to the idea of independent directors and prescribes obligations for them. Notably, it significantly enlarges the scope of their obligations to include acting in good faith and for the benefit of members (shareholders) and employees of companies, the community and protection of the environment.[1] Moreover, contravention of the provisions of this section is punishable with fine that may extend up to INR 0.5 million.[2]

The obligation on directors to act in good faith and for the benefit of stakeholders other than shareholders in a sense embraces the spirit that defines Principle 1 discussed above. Directors are after all the alter ego of businesses, and imposing obligations to act in good faith and for the benefit of specified stakeholders makes them accountable to those groups. However, while well-intentioned, this approach of making businesses responsible can have undesirable and unintended consequences; for example, making independent directors personally liable by way of a monetary penalty can further deplete an already scarce talent pool of independent directors because of the financial and reputational risks involved. Moreover, as the interests of various stakeholders are divergent, satisfaction of one constituency’s interests may expose the directors to claims from other constituencies.  How is the Director to decide in good faith, in the face of these realities? Acquisition of a competitor may confer pricing power on the acquirer. While this move will benefit the shareholders, it may not necessarily benefit the community; navigation of such “zero-sum-game” issues could well nigh be impossible in face of a mandate to look after the interests of all stakeholders.

At present, India’s corporate law ethos is rooted in the Anglo-saxon model where shareholder as the last bearer of risk, ought to be protected through voting rights and legal rules. Directors, including independent directors, are elected by shareholders and may be removed by them too. Moreover, Independent directors are outside directors and as such their ability to account for the interests of various stakeholders is severely restricted owing to information asymmetry they suffer from as also the limited time they have at their disposal.  Given these practical realities, enforcing a stakeholder approach in corporate law piece meal, to forcibly make them behave responsibly is a myopic regulation that will more likely harm than do good in the long run.

However, all is not lost for stakeholder approach to corporate regulation. Businesses could still behave responsibly if the structure of corporate law is made suitable for stakeholder approach. One prominent example that appears more suited to this approach is the German model of having dual boards instead of unitary boards prevalent in Anglo-saxon model of governance. The new Companies Act may provide for companies of a pre-defined size to have a dual board mechanism to account for the interests of other stakeholders like employees and the environment while retaining a board that will be an exclusive fiduciary to the shareholders. Companies may have the liberty to “opt-out” of this regime under a “comply-or-explain” model.

[1] Section 166 (2).

[2] Section 166 (7).

The article was first published in Responsible Business India on July 25, 2013