2. - 1 -
Abbreviations
1. NED Non-Executive Directors
2. SEBI Securities Exchange Board of India
3. MD Managing Director
4. ED Executive Director
5. WTD Whole-Time Director
6. ID Independent Director
7. CII Confederation of Indian Industry
8. AGM Annual General Meeting
9. CEO Chief Executive Officer
10. ASSOCHAM Associated Chambers of Commerce and Industry
of India
11. ASIC Australian Securities & Investment Commission
12. SAIL Steel Authority of India Limited
4. - 3 -
INDEX
S. No. Heading Page No.
1. ‘Non-Executive Director’- Meaning 4
2. Who are the Non-Executive Directors? 7
3. Role of the Non-Executive Directors 8
4. Why are they needed? 11
5. The HIGGS Report: A Base 14
6. The Indian Context 17
7. What provisions do we presently have regarding NEDs? 19
8. Does the Independent Director and the Non-Executive Director
mean the same?
22
9. Can the Independent NEDs really direct the Company? 24
10. Duties and Responsibilities of the Non-Executive Directors 26
11. Can a Non-Executive Independent Director be allowed to
undertake assignments with the company on the basis of
professional capabilities?
30
12. How much do NEDs cost to a company? 32
13. Is the position of a Non-Executive Director all about the ‘Perks’? 34
14. Latest in News 37
15. KUMAR MANGALAM BIRLA 38
16. RATAN NAVAL TATA 39
17. SUNIL BHARTI MITTAL 40
18. K.V. Kamath 41
19. N. R. NARAYANA MURTHY 42
20. The Rt Hon Sir Malcolm Rifkind 42
5. - 4 -
‘Non-Executive Director’- Meaning
A non-executive director (NED) is a member of the board of directors of a company
who does not form part of the executive management team.
That is, to say, NEDs don’t get involved in the day-to-day running of the business.
As such nothing is mentioned in the laws of India governing the Companies i.e. the
Companies Act, or the SEBI regulated laws or any other allied laws defining the
term ‘Non-Executive Directors’, but, the term has been referred by way of the
definition of a ‘Director’ (which is broad and defined under Section 2(13) of the
Companies Act, 1956) and also by way of the term ‘Managing Director’ (which is
the antonym of NED and is defined under Section 2(26) of the Act).
To define the abovementioned terms:
• "Director" includes any person occupying the position of director, by
whatever name called.1
• "Managing Director" means a director who, by virtue of an agreement with
the company or of a resolution passed by the company in general meeting or
by its Board of directors or, by virtue of its memorandum or articles of
association, is entrusted with substantial powers of management which would
not otherwise be exercisable by him, and includes a director occupying the
position of a managing director, by whatever name called.2
1
Section 2(13) of the Companies Act, 1956.
2
Section 2(26) of the Companies Act, 1956 as follows:-
"Managing Director" means a director who, by virtue of an agreement with the company or of a resolution
passed by the company in general meeting or by its Board of directors or, by virtue of its memorandum or
articles of association, is entrusted with [substantial powers of management] which would not otherwise be
exercisable by him, and includes a director occupying the position of a managing director, by whatever
name called:
[Provided that the power to do administrative acts of a routine nature when so authorized by the Board
such as the power to affix the common seal of the company to any document or to draw and endorse any
cheque on account of the company in any bank or to draw and endorse any negotiable instrument or to sign
any certificate of share or to direct registration of transfer of any share, shall not be deemed to be included
within substantial powers of management:
Provided further that a managing director of a company shall exercise his powers subject to the
superintendence, control and direction of its Board of directors;]
6. - 5 -
Thus, a Director can be given any title as regards to the post he holds in the
management of the company. There is no objection to the adoption by companies of
the American nomenclature of President and Vice-President for designating their
managerial personnel.
As regarding the ‘Managing Director’ (MD), the post of ‘Executive Director (ED) is
a common post in many organizations. But, again the Indian Companies Act does
not define the phrase. And, according to the general dictionary meaning as provided
by the www.thefreedictionary.com, he is "a person responsible for the administration of
a business".
Therefore, an ED can be said have to performed the operational and strategic
business functions such as
- managing people
- looking after assets
- hiring and firing
- entering into contracts
EDs are usually employed by the company and paid a salary, so are protected by
employment laws. An Executive Director of a Whole Time Director (WTD) is
virtually an MD, according to a Department clarification. He cannot be an employee
of another company or elsewhere, or be engaged in any other business pursuit,
though he may be an ordinary director of one or more other companies also,
as Ramaiya explains under Section 267.
Now, these having defined we can clearly see that how these EDs, WTDs and MDs
perform and are involved in the day-to-day operations and management.
And, as we have already seen that NEDs are the members of the board of
directors of a company who do not form part of the executive management team.
7. - 6 -
Though, NED not having been defined in any of the Acts, it has also been referred
by another term relating to its ‘independence in the management’, the ‘Independent
Director’. This term has been very clearly defined under the Clause 49 of the Listing
Agreement.
The first line of the definition of ‘Independent Directors’ mentions “the expression
‘independent director’ (ID) shall mean Non-Executive Director of the company
who...”.
Thus, to know the status of an ED it is better to understand it in the way one would
understand the status of an ID.
8. - 7 -
Who are the Non-Executive Directors?
As explained, a Non-Executive Director (NED) is a member of the board of
directors of a company who does not form part of the executive management team.
A non-executive director of a firm is who is not a working or an executive director
and, therefore, does not participate in the day-to-day management of the firm.
A non executive directorship is an appointment to the board of a company on a part
time basis.
The work of a non executive director generally involves attending some board
meetings and company functions, with the aim of providing experienced, intelligent
advice to the company board, the chairman or management.
Non executive directors can offer advice from the perspective of somebody not
absorbed in the day to day details of business - based on the view of an outsider
looking in and on the non executive director's own personal skills, business
experience and industry contacts. He or she is usually involved
in planning and policy making, and is sometimes included to lend prestige to the
firm due to his or her standing in the community.
Non-executive directors are expected to monitor and challenge the performance of
the executive directors and the management, and to take a determined stand in
the interests of the firm and its stakeholders.
In some organizations, their role is to sit on the Audit Committee, Pension Trustee
Body, Directors Remuneration Committee and any other Committees that require
an independent body of thought, separate and not answerable to the Chief Executive,
Managing Director or Chairman.
The details of each position vary, but non executive directorships hold benefits for
both individuals and companies.
9. - 8 -
Role of the Non-Executive Directors
In today's society, people seem to be losing their general faith when it comes to the
activities that are being carried out by many senior business figures and politicians.
Accordingly, the role of the non-executive director is becoming increasingly
important when it comes to modern corporate governance.
The modern 'non-executive' director is a position which is appointment based both
on professional and objective criteria, and this is a position that can easily add real
live value to any organization type.
The importance of such a post was already felt during the time when the
Confederation of Indian Industry (CII) had taken up the initiative on Corporate
Governance. One of the important recommendations by the CII in its Corporate
Governance Code related to the role of the NEDs.
The recommendation IV stated that for Non-Executive Directors to play a material
role in corporate decision making and maximizing long term shareholder value, they
need to
• become active participants in boards, not passive advisors;
• have clearly defined responsibilities within the board such as the Audit
Committee; and
• know how to read a balance sheet, profit and loss account, cash flow
statements and financial ratios and have some knowledge of various company
laws. This, of course, excludes those who are invited to join boards as experts
in other fields such as science and technology.
Besides, according to the Higgs Report, commissioned by the British
Government and published in 2003, Non-executive directors have responsibilities in
the following areas:
• Strategy: Non-executive directors should constructively challenge and
contribute to the development of strategy.
10. - 9 -
• Performance: Non-executive directors should scrutinize the performance
of management in meeting agreed goals and objectives and monitoring,
and where necessary removing, senior management and in succession
planning.
• Risk: Non-executive directors should satisfy themselves that financial
information is accurate and that financial controls and systems of risk
management are robust and defensible.
• People: Non-executive directors are responsible for determining
appropriate levels of remuneration of executive directors and have a prime
role in appointing, and where necessary removing, senior management
and in succession planning.
Having defined the meaning of the term NED, along with who they are, and also by
looking at the extracts of the committee reports formed for the particular purpose,
above it will probably be easier now to know what their roles are.
The role of NEDs should be:
1. To contribute to and constructively challenge the development of the
company strategy.
2. To scrutinize the management performance.
3. To satisfy them that the financial information is accurate and ensure that
robust risk management is in place.
4. To meet at least once a year without the Chairman or the Executive directors
(EDs/MDs/WTDs)- and there should be a statement in the annual report
stating whether such meetings have taken place.
5. To be prepared to attend AGMs and discuss issues relating to their roles
(especially Chairmen of their committees).
6. To have a greater exposure to major shareholders.
11. - 10 -
7. To maintain company resources and completing, monitoring and removal of
tasks relating to those resources.
8. To be responsible for the monitoring and maintaining any or all appointments
relating to the business or the Board of Directors.
9. To be responsible for maintaining a standard of good conduct within the
organization. This involves monitoring management staff and making
necessary changes to promote the highest level of good conduct within the
organization.
12. - 11 -
Why are they needed?
The following passage of Viscount Haldane, Lord Chancellor1
, highlights how the
non-executive directors' contribution can be instrumental in complementing the
executive's competence:
“My Lords, a corporation is an abstraction. It has no mind of its own any
more than it had a body of its own; its active and directing will must
consequently be sought in the person of somebody who for some purposes
may be called an agent, but who is really the directing mind and will of the
corporation, the very ego and centre of the personality of the corporation.
That person may be under the direction of the shareholders in general
meeting; that person may be the board of directors itself, or it may be, and in
some companies it is so, that that person has an authority to co-ordinate with
the board of directors given to him under the articles of association, and is
appointed by the general meeting of the company, and can only be removed
by the general meeting of the company.”
We know that the Board of Directors of a company must have an optimum
combination of executive and non-executive directors with not less than fifty percent
of the board of directors comprising of non-executive directors.2
While at the same
time, the law has not defined precisely who NEDs are.
The law treats them (both kinds) simply as ‘Directors’3
and both carry equal
responsibilities. However, they have different roles to play.
The non-executive independent directors are generally given the chairmanship of
important committees like Audit committee, Nomination committee and
remuneration committee.
1
in Lennard's Carrying Company Ltd v. Asiatic Petroleum Co. Ltd (1915) AC 705)
2
Clause 49 of the Listing Agreement.
3
Section 2(13) of the Companies Act, 1956.
13. - 12 -
They are closer to action. They can question the executives directly. They observe
from a distance how well executives are performing their duties.
Generally speaking, the non-executive director is not going to be involved in the day-
to-day operations of the business. Instead, the non-executive director's duties lay in
monitoring executive activity, and contributing when necessary to strategy
development.
The largest differences in how productive your non-executive director is lies in what
type of business you are running.
For example, in large and formal type organizations that have a much
more strict set of standards when it comes to corporate governance, the
chairman of the board role as well as the CEO or chief executive officer role
are typically separated. The chief executive officer and the executive directors
are in charge of running the day-to-day aspects of a organization, and are also
responsible for putting into action any strategies or policies that are agreed
upon by the board of directors.
At any and all board meetings held by the firm, the executive directors are
responsible for reporting on exactly how well the organization is being run, as
well as recommending any future actions for investment and strategic
direction.
The non-executive directors, then, are responsible for reviewing this
information that has been provided to them, in order to ensure that the entire
organization or business is being run in such a way that all of the shareholders
are being benefited, and that the executive directors running the company are
not doing anything that may be considered to be a breach of the amount of
trust that was placed in them.
On the other hand, in small and medium sized business firms, the chief
executive officer or CEO is typically the owner and the founder of the
14. - 13 -
business or organization, which means that the non-executive director's role
more closely resembles that of an experienced business advisor rather than
that of a mediating party.
Even when it comes to a situation like this, there are still many substantial
legal responsibilities that the non-executive director must deal with, in
addition to liabilities to check facts so that the non-executive director can
determine whether or not all corporate laws are being complied with on the
behalf of the business entity.
In general, a small or medium sized enterprise can probably benefit much greater
from the use of a non-executive director than a larger organization would be able to.
Small organizations and businesses typically cannot afford a large number of
different full time directors who are experienced in all of the tasks and duties that a
normal director would be asked or expected to perform. The owner or the chief
executive officer in charge is usually responsible for making a large number of
decisions, including those that relate to strategy down and individual action plans.
There is only a limited opportunity for delegation, which can oftentimes leave the
CEO in an extremely lonely position as they would be required to make all of the
decisions without ever having anyone there who they can discuss alternative ideas
with.
This is the type of situation where hiring a non-executive director would easily add
unexpected real value to the business model, as this non-executive director could
become a sounding board for many ideas, providing great benefits in the process
through their expertise, their experience and the pool of contacts that they bring to
the table.
15. - 14 -
The HIGGS Report: A Base
The report by Derek Higgs which delved deep into the role and effectiveness of non-
executive directors was published on 20 January 2003.
The report laid stress on the demanding and influential role of non-executive
directors (NEDs). The report is a comprehensive one which can definitely serve as a
guide to the corporate in our country.
Composition of the Board:
The Combined Code of good Governance and code of best practices(The
Code) requires that the board should have a balance of Executive and Non-
Executive Directors (including independent NEDs) - aiming to ensure that no
individual or group can dominate the board's decision making. Taking the
board as a whole, the NEDs (whether independent or otherwise) must
comprise not less than one-third of the board, and a majority of the NEDs
should be 'independent'.
However, the Higgs report requires that at least half of the board, excluding
the Chairman, should be independent (NEDs).
This recommendation will herald a shift in the overall power of the board in
favor of independent NEDs, and away from executive management.
The Chairman:
The Code already recognizes that the roles of chairman and chief executive
involve two distinct tasks - running the board (chairman) and taking executive
responsibility for running the company's business (CEO). The Code currently
accepts that these tasks may be combined in one person, although such a step
does require public justification.
The report also requires that a chief executive should not go on to become
chairman of the same company; and on appointment, the chairman should be
seen to be independent (although it recognizes that, following appointment,
16. - 15 -
the chairman will cease to be independent due to his greater involvement with
the executive team).
The recommendation that a chief executive should not go on to become
chairman of the same company will be unwelcome to many companies, and
has attracted more criticism than other aspects of the Report.
Senior Independent Non-Executive Directors:
The Code recommends that there should be a recognized senior independent
NED (irrespective of whether the roles of chairman and CEO are combined)
who must be identified in the annual report.
The Report envisages an expanded role.
The Code considers the senior independent director as the person, other than
the chairman, 'to whom concerns can be conveyed'.
The Report proposed that the senior independent director should be available
to shareholders if they have concerns that have not been resolved through the
normal channels, or for which contact through the normal channels is
inappropriate.
In addition, the senior independent director should develop a balanced
understanding of the concerns of shareholders by attending sufficient of the
regular meetings between management and the major shareholders.
Tenure and Commitment:
Stricter recommendations were introduced relating to the re-election of
NEDs.
Under the Code, NEDs are required to be appointed for a specific term and
then be subject to re-election thereafter at intervals of no more than three
years. There is currently no maximum term (although various shareholder
bodies already envisage that a NED's 'independence' will be lost after 10
years' service).
17. - 16 -
The Report limits the term that can be served by an NED. It recommends that
an NED should normally be expected to serve two three-year terms unless
exceptional circumstances make a longer term appropriate. Any extension
beyond six years must be justified. Further, any NED serving nine years or
more must be re-elected annually. Once a NED is appointed, the NED must
inform the chairman before any new appointments are accepted; the board
must also be informed.
Remuneration:
The Report endorsed the recommendations of the Code that levels of board
remuneration should be sufficient to attract and retain directors but should
not be more than is necessary.
The Report provides more detailed recommendations in relation to the
remuneration of NEDs by stating that NED fees should be built up from:
- annual fee;
- meeting attendance fees; and
- additional fees for chairmanship of committees; and
NEDs should have the opportunity to take part of their remuneration in
shares but they should not be granted options.
18. - 17 -
The Indian context
On account of the interest generated by the Cadbury Committee Report, the CII, the
ASSOCHAM and the SEBI constituted the Committees to recommend initiative in
Corporate Governance.
CII took a special initiative on Corporate Governance, the first institution initiative
in Indian Industry.
The objective was to develop and promote a code for Corporate Governance to be
adopted and followed by the Indian companies.
Following the CII’s initiative, the SEBI set up a Committee under the Chairmanship
of Kumar Mangalam Birla to promote and raise standards of corporate governance.
This report was the first formal and comprehensive attempt to evolve a Code of
Corporate Governance, in the context of prevailing conditions of governance in
Indian companies.
The recommendations of the Kumar Mangalam Birla Committee led to the inclusion
of Clause 49 in the Listing Agreement.
The recommendations which concerned the NEDs were:
1. The Board should have an optimum combination of Executive and Non-
Executive Directors with not less than 50 percent of the Board consisting
of NEDs.
2. In case of Non-Executive Chairman1
, at least one-third of the Board
should consist of Independent Directors; and in the case of an Executive
Chairman2
, at least half of the Board should consist of Independent
Directors.
3. Non-Executive Chairman should be entitled to maintain Chairman’s
office at the expense of the Company and also allowed reimbursement of
expenses incurred in performance of his duties.
1
i.e. where Chairman is a Non-Executive Director.
2
i.e. where Chairman is an Excutive Director.
19. - 18 -
4. That a qualified and independent Audit Committee should be set up by
the Board of the company which should have minimum three members,
all being the NEDs.
5. Remuneration Committee should comprise of at least three directors, all
of whom should be NEDs.
6. A Board committee should be formed under the chairmanship of an NED
to specifically look into the redressing of shareholder complaints like:
- transfer of shares;
- non-receipt of balance sheet;
- non-receipt of declared dividends; etc.
20. - 19 -
What provisions do we presently have regarding NEDs?
As mentioned above, the Kumar Mangalam Birla Committee Report led to the
inclusion of Clause 49 in the Listing Agreement.
This Clause is applicable to:
a) all entities seeking listing for the first time, at the time of listing.
b) all listed entities having a paid up share capital of Rs 3 crores and above or net
worth of Rs 25 crores or more at any time in the history of the company.
The said Clause is still in force and it is imperative to know what it talks about.
Sub-Clause I talks about the Governance provisions relating to the Board of
Directors.
Sub-Clause I(A) deals with the Composition of the Board of Directors of the
company.
Sub-Clause I(A)(i) reads as:
“The board of directors of the company shall have an optimum combination
of executive and non-executive directors with not less than fifty percent of the
board of directors comprising of non-executive directors.
The number of independent directors would depend on whether the
Chairman is executive or non-executive. In case of a non-executive chairman,
at least one-third of board should comprise of independent directors and in
case of an executive chairman, at least half of board should comprise of
independent directors.”
Sub-Clause I(B) deals with the Non-Executive Directors’ compensation and
disclosures.
21. - 20 -
Sub-Clause I(B) reads as:
(i) All compensation paid to non-executive directors shall be fixed
by the Board of Directors and shall be approved by
shareholders in general meeting. Limits shall be set for the
maximum number of stock options that can be granted to non-
executive directors in any financial year and in aggregate. The
stock options granted to the non-executive directors shall vest
after a period of at least one year from the date such non-
executive directors have retired from the Board of the
Company.
(ii) The considerations as regards compensation paid to an
independent director shall be the same as those applied to a
non-executive director.
(iii) The company shall publish its compensation philosophy and
statement of entitled compensation in respect of non-executive
directors in its annual report. Alternatively, this may be put up
on the company’s website and reference drawn thereto in the
annual report. Company shall disclose on an annual basis,
details of shares held by non-executive directors, including on
an “if-converted” basis.
(iv) Non-executive directors shall be required to disclose their stock
holding (both own or held by / for other persons on a beneficial
basis) in the listed company in which they are proposed to be
appointed as directors, prior to their appointment. These details
should accompany their notice of appointment.
Sub-Clause I(F) deals with the Term of the Office of NEDs.
Sub-Clause I(F)(i) reads as:
“Person shall be eligible for the office of non-executive director so long
as the term of office did not exceed nine years in three terms of three
years each, running continuously.”
22. - 21 -
Sub-Clause II talks about the Governance provisions relating to the Audit
Committee of the Company.
Sub-Clause II(A) deals with the qualifications and composition of the Audit
Committee. Sub-Clause II(A)(i) reads as:
“The audit committee shall have minimum three members. All the members
of audit committee shall be non-executive directors, with the majority of them
being independent.”
Annexure 1C of the Clause 49 deals with the non-mandatory provisions for a
company which includes provisions which are not necessarily to be followed by the
companies on whom the said Clause 49 applies.
Among such provisions, following are our concerns:
1. Chairman of the Board:
A non-executive Chairman should be entitled to maintain a Chairman’s office
at the company’s expense and also allowed reimbursement of expenses
incurred in performance of his duties.
2. Remuneration Committee:
(ii) To avoid conflicts of interest, the remuneration committee, which
would determine the remuneration packages of the executive
directors should comprise of at least three directors, all of whom
should be non-executive directors, the chairman of committee
being an independent director.
7. Mechanism for evaluating Non-Executive Board members:
The performance evaluation of non-executive directors should be done by a
peer group comprising the entire Board of Directors, excluding the director
being evaluated; and Peer Group evaluation should be the mechanism to
determine whether to extend/ continue the terms of appointment of non-
executive directors.
23. - 22 -
Does the Independent Director and the Non-Executive
Director mean the same?
On the very onset of this article, we had understood the term Non-Executive
Directors with the reference to the ‘Independent Directors’ as has been defined under
Clause 49 of the Listing Agreement.
And, quite a few times in this article we have also mixed up these two terms (NED &
ID) while referring to various ‘reports’ and ‘legal provisions’.
Does that mean we can interpret both the terms synonymously?
The Explanation (i) to the Sub-Clause I(A)(i) defines an Independent Director with
the starting words “the expression ‘independent director’ shall mean non-executive
director of the company who…”
This means that an Independent Director has necessarily to be an NED but an NED
may not necessarily be an Independent one. The ‘independence’ depends upon the
qualifications has have been provided in the Explanation.1
1
Explanation (i): For the purpose of this clause, the expression ‘independent director’ shall mean non-
executive director of the company who:
a) apart from receiving director’s remuneration, does not have any material pecuniary
relationships or transactions with the company, its promoters, its senior management or its
holding company, its subsidiaries and associated companies;
b) is not related to promoters or management at the board level or at one level below the board;
c) has not been an executive of the company in the immediately preceding three financial years;
d) is not a partner or an executive of the statutory audit firm or the internal audit firm that is
associated with the company, and has not been a partner or an executive of any such firm for
the last three years. This will also apply to legal firm(s) and consulting firm(s) that have a
material association with the entity.
e) is not a supplier, service provider or customer of the company. This should include lessor-
lessee type relationships also; and
f) is not a substantial shareholder of the company, i.e. owning two percent or more of the block
of voting shares.
24. - 23 -
The meaning of the ‘independence’ can be understood in the following way:-
Independence can be determined when the board determines that the director
is independent in character and judgment and there are no relationships or
circumstances which could affect or appear to affect the director's judgment. An
NED will not be independent in the following cases where he:
• is a former employee of the company or group - the NED will only be treated
as independent five years after the employment has ended;
• has a material business relationship with the company either directly, or as a
partner, shareholder, director or senior employee of a body that has such a
material relationship - the NED will also cease to be independent if he has
had such a relationship within the last three years;
• receives or has received additional remuneration from the company beyond
the director's fee;
• participates in the company's share option scheme or a performance-related
pay scheme;
• is a member of the company's pension scheme;
• has close family ties with any of the company's directors, senior employees or
advisors;
• holds cross-directorships or has significant links with other directors via
involvement in other companies or bodies;
• Has served on the board for more than 10 years; or represents a significant
shareholder.
All these factors have been clearly incorporated in the definition provided for the
‘Independent Director’.
If an NED does not fulfill any of the criteria as given he will not be an ‘Independent
Director’.
25. - 24 -
Can the Independent NEDs really direct the Company?
Barring a few exceptions, in India the appointment of independent or non-executive
directors has become a matter of mere legal compliance. Most of the companies still
function in the same old fashion and the non -executive directors has hardly any say
in the management of a company.
In most of the companies, hardly any relevant information is passed on to the
directors and the meetings of the Board discuss minor and routine matters.
The Board meetings are normally held once in three months and that too for 2 to 3
hours only.
It is obvious that promoters would prefer to appoint their cronies and faithful persons
on their board to have minimum interference of the outside directors.
The independent directors could effectively and substantively contribute if they are
empowered to meet at regularly convened executive sessions without participation of
management or employee directors so that they could openly and freely discuss the
affairs of the company.
The Cadbury Report has observed that 'every public company should be headed by
an effective board which can lead and control the business.'
The following propositions highlight the importance of independent and non-
executive directors on the board of a company:
1. The non -executive directors, when carefully chosen, can complement the
Board's overall strength with their knowledge of best practice outside the
company.
2. Their role should not be to do the job of the executive but to act as candid
counselors to guide the company in benchmarking standards and its level
of ambition.
3. This is a function not of numbers but caliber.
26. - 25 -
4. The non-executive directors must concentrate on a few companies rather
being involved with up to fifteen companies which the Companies1
act
permits.
5. Non-executive directors can bring a broader view to the company. They
bring external and wider perspective and independence to the decision
making.
6. To render effective services the NEDs should be allowed to seek
independent professional advice at the cost of the company.
7. The résumé of the NEDs should be made available to the shareholders
along with the proposal of their appointment or re-appointment.
8. NEDs should be given immunity from the responsibility for compliance
with procedural matters.
9. The remuneration of the NEDs should be commensurate with the time
they devote and experience they possess.
10. Non-Executive Directors who are not qualified professionals (e.g.
Chartered Accountants, Companies Secretaries etc.), should undergo
proper training before they assume directorships.
1
Companies Act, 1956
27. - 26 -
Duties and responsibilities of Non-Executive Directors
A Director should first understand his relationship with the company and the
shareholders as this relationship is what shapes his roll and responsibilities vis-à-vis
the company and the shareholders.
Unfortunately, there is no statutory provision to define this relationship. It is the
judiciary which has over a period of time defined the relationship.
As early as in 1866, the Chancery Division1
held that a company though a legal
entity, cannot act by itself. It can act only through its directors and as such the
relation of a director with the company is that of principal and agent and therefore
general principles of law of agency would govern the relationship between the
company and the directors.
The relationship was further defined by Chancery Division in 18782
that directors,
having been entrusted with the affairs of the company, are trustees of the company
and therefore they are in a fiduciary relationship with the company.
These judicial pronouncements have been universally accepted and applied all over
and now the position of directors' vis-à-vis the company is that they are not only
agents but also trustees.
This relationship would mean that the directors should always act in the interest of
the principal that is the company and in discharge of their fiduciary responsibilities,
they cannot benefit at the cost of the company.
Executive and Non Executive Directors have the same responsibilities in law.
The role of a non executive director has a positive contribution to making and
ensuring that the board fulfils its main objectives. He can exercise an impartial
influence and bring to bear experience gained from other fields; executive directors
would therefore be well advised to consider the appointment of such directors to
serve alongside them.
1
In Ferguson vs Wilson
2
In Forest of Deal Coal Mining Company case
28. - 27 -
As such, NEDs are not required to give continuous attention to company affairs.
However, they should familiarize themselves with the company’s affairs including its
financial position and should attend meetings of the board whenever they are
reasonably able to do so.
Besides, where a director, whether executive or non executive, has a particular skill
for example he is a qualified accountant, he should exhibit the skill or ability
reasonably expected from a person in that profession.
There have been many discussions on Corporate Governance. In some
earlier discussions questions have been raised about the role of Independent NEDs in
maintaining appropriate standards of governance. In this context, a recent Australian
judgment indicates the nature of duties which a non-executive director may be
required to discharge.
The case1
involved a situation where the Australian market regulator, ASIC2
, alleged
certain malpractices in the form of misinformation being given to the market
regulator by the board of the defendant company. ASIC alleged “that a
Draft ASX Announcement was approved at the 15 February 2001 Meeting of the JHIL board
of directors and that it contained a number of statements to the effect that the Foundation
would have sufficient funds to meet all legitimate Asbestos Claims, that it was fully funded and
provided certainty for people with legitimate Asbestos Claims. ASIC alleged that those
statements were false or misleading and that the directors were in breach of (their duties)…”
Among the many issues raised were those concerning the duty of care imposed on
executive and non-executive directors; as well as those pertaining to the extent to
which non-executive directors could rely while exercising their duties on the
information given to them from others.
1
Australian Securities and Investment Commission v. MacDonald
2
Australian Securities and Investment Commission
29. - 28 -
The Court noted at the outset that the position in relation to non-executive directors
was unclear. NEDs were undoubtedly subject to similar fiduciary duties as executive
directors such as the duty to act in good faith and for proper purposes, duties of no
conflict etc. Nonetheless, there was considerable uncertainty in determining how
these duties applied to NEDs.
Quoting from a leading Australian textbook, it was noted:
“For a Non-Executive Director case law has supplied no objective standard of the reasonably
competent company director analogous to the reasonably competent member of a particular
profession or trade, such as architect, solicitor, physician or builder, against whom the conduct
of a director can be measured when determining whether there has been a breach of the duty of
care, diligence and skill. Part of the reason is the absence of any shared body of detailed expert
knowledge of what is involved in the directing of companies. The diversity of companies and
varieties of business endeavour are such as to allow uniformity of standards only on very general
matters.”
The Court however went on to hold that all directors, including non-executive ones,
should have known that there was a possibility that the statements in the
Announcement were false and/or misleading.
Significantly, the Court decided that non-executive directors could not simply rely on
the information provided by the management or by the executive directors. “This was
a key statement in relation to a highly significant restructure of the James Hardie group.
Management having brought the matter to the board, none of them was entitled to abdicate
responsibility by delegating his or her duty to a fellow director.”
Thus, the Court seems to have imposed a duty of care on NEDs which cannot be
satisfied simply by relying on information provided to them by others. What exactly
is the content of this duty is a question not conclusively answered.
30. - 29 -
Nonetheless, the ASIC has described the decision as “a landmark decision in Australian
corporate governance”; and it appears that Non-Executive Directors will not be held to
have satisfied their duties by arguing that they relied in good faith on certain
information provided to them. Particularly when the information concerns an
important management decision, there appears to be a duty on non-executive
directors to confirm the veracity of the information independently.
In even more recent judgment the Inner House of the Court of Session of
Scotland has again commented on the role of non-executive directors.1
Commonwealth Oil’s case can be useful in clarifying the content of the duty – the Court
held that the contents of duty were the same, whether the director was an executive
director or not. Undoubtedly, the executive director may have specific executive
functions in specific areas of business which have been delegated to him to perform.
But this fact does not alter his status: “he is a director of the company as a whole, and his
duties to the company are to manage the general affairs of the company and are not confined to
the responsibilities arising from his executive function. A director's fiduciary duty of loyalty is
owed to the company as a whole; and the duty to avoid a conflict of interest must be related to
the interests of the company as a whole… the fact that he was a Non-Executive Director does
not mean that he did not owe to the company the same fiduciary duties as its executive directors
owed to it.”
1
In Commonwealth Oil and Gas Co. Ltd. v. Baxter and Eurasia
31. - 30 -
Can a Non-Executive Independent Director be allowed to
undertake assignments with the company on the basis of his
professional capabilities?
While in a discussion at an interactive session in the India Economic Summit 2002
organised by the Confederation of Indian Industry (CII) and World Economic
Forum (WEF) the two major issues were posed:
1. Can a non-executive independent director be allowed to undertake
assignments with the company on the basis of his professional capabilities?
2. Does such a practice conform to good corporate governance and behaviour?
The Indian Inc. seemed to be divided on these issues.
It was argued by Mr. Azim H. Premji, Chairman, Wipro Ltd that a company can
certainly use the services of a Non-Executive Director, especially if the person is
competent and perceived to be a "good resource" that an organization should tap.
"We were facing similar issues in our organization as we wanted to use the services
of some of key non-executive directors who knew the company very well. The
competence factor and knowledge of the company tilted our decision in favour of the
non-executive director instead of an outside consultant," Mr. Premji said.
He also pointed out that it was sometimes very difficult to get competent
independent directors.
The Chairman of Bajaj Auto Ltd, Mr. Rahul Bajaj, keeping the competence factor
notwithstanding, disagreed with Mr. Premji on the matter. He argued that using the
services of an independent director for assignments beyond the board would result in
"conflict of interest" situations.
32. - 31 -
"I would not have a business relationship with a non-executive director as it would
lead to a conflict of interest situation. Bajaj Auto has never used the services of a
non-executive director for activities outside the board," Mr. Bajaj said.
The Eicher group Chairman, Mr. S. Sandilya, had told Business Line1
that the
"conflict of interest" factor had discouraged them from having any business
relationship with a Non-Executive Director.
"In fact, we even have a cooling off period of two years before we decide to have
business relationship with employees who have left us. There is no question of using
the services of an independent director outside the board, however competent the
person may be," Mr. Sandilya said.
Mr. Shekhar Bajaj, Chairman and Managing Director, Bajaj Electricals Ltd, said that
"conflict of interest" was the main reason that prevented the company from using the
services of some "competent" non-executive directors.
"If one were to look at the Enron case, Arthur Andersen were the auditors and
consultants. Their independence as an auditor was compromised because of
consulting assignments. The same argument can apply to directors also," Mr.
Shekhar Bajaj told Business Line.
1
Business Line or The Hindu Business Line is an Indian business newspaper published by Kasturi & Sons,
the publishers of the newspaper ‘The Hindu’.
33. - 32 -
How much do NEDs cost to a Company?
Now, we all know that Non-Executive Directors bring knowledge, expertise,
understanding, experience and new contacts and resources to the table when they are
recruited to work for your firm. None of these things could ever even begin to be
viewed as a flaw or a failure, as they are characteristics that will continue to be
valuable to companies throughout the years.
And, since there is such a vast difference in the usefulness and duties for a non-
executive director in a large corporation setting, and hiring one for a small or start up
business, it is important to determine exactly what recruiting a non-executive director
will actually mean for your company. Will your NED be your advisor, or would you
prefer that they do most of the work on their own? Will you work closely with them,
or is the NED a position that you cannot see yourself working with? Once you have
determined what kind of relationship you want to have with a Non-Executive
Director, you can hire one who will blow you away, and your business will see a
great increase not only in organization, but also in communication and possibly even
strategy for profit.
There are many legal responsibilities and legal liabilities that absolutely must be
taken into consideration, and it is because of these that an NED will typically expect
a reasonable fee in return for their services.
The cost is still typically much lower than what you would experience by hiring a
normal consultant or even an interim director. NEDs are also much more cost
effective because these directors tend to attempt forming long-term relationships with
the owners of the company and the organization itself, which means that once you
have found a NED that works well with the needs of your company, they may stick
around for a good long time, continuing to be useful, helpful and extremely
necessary over time.
34. - 33 -
To talk about the actual remuneration, this is negotiable and there are quite a few
permutations available. Some are paid by the day, some may have bought or been
given shares in the business that attract dividends and some may have an annual
retainer. The amount will vary depending on whether you are a large public limited
company or a start-up.
Legally, the remuneration payable to non-executive directors is governed by sub-
section 4 of Section 3091
, which permits different modes of payment to such
categories of directors. Briefly, remuneration to such director other than managerial
personnel is limited to 1 per cent of net profit of the company where there is a
manager or a whole-time director or 3 per cent of net profit of the company where
there is no such managerial personnel.
For many NEDs it isn't just about earning money, however, these are people who
have made their mark already and may be looking to encourage and help aspiring
young businesses to achieve. They may be happy with just a small monthly retainer,
or welcome the ability to purchase or earn shares in an exciting opportunity.
1
309. Remuneration of directors.
(4) A director who is neither in the whole- time employment of the company nor a managing director may
be paid remuneration either:
(a) by way of a monthly, quarterly or annual payment with the approval of the Central
Government; or
(b) by way of commission if the company by special resolution authorizes such payment:
Provided that the remuneration paid to such director, or where there is more than one such director, to
all of them together, shall not exceed
(i) one per cent. of the net profits of the company, if the company has a managing or whole- time
director, a managing agent or secretaries and treasurers or a manager;
(ii) three per cent. of the net profits of the company, in any other case:
Provided, further, that the company in general meeting may, with the approval of the Central
Government, authorize the payment of such remuneration at a rate exceeding one per cent or, as the
case may be, three per cent of its net profits.
35. - 34 -
Is the position of a Non-Executive Director all about the
‘Perks’?
KESHUB MAHINDRA.
This one name we all should and need to remember. For over five decades, Keshub
Mahindra has enabled Mahindra (the Mahindra Group) and its people to rise. He
joined Mahindra & Mahindra in 1947 and became Chairman in 1963. He continues
to be involved with the day-to-day activities of the company today and has literally
been the backbone of the company.
Mr. Keshub is a philanthropist who redefined corporate governance by effectively
channeling funds into the social sector. From building ethical corporate
organizations in India to serving on prestigious boards and committees, Keshub’s
immense contribution to Indian business has established him as an inspirational
business leader and an iconic corporate citizen.
At a dinner in one of South Mumbai's luxury hotels, some time back, everyone
around the table was full of sympathy for Keshub Mahindra.
Those present, well-known figures from the corporate, financial and legal worlds
trotted out a series of arguments: He is in his 80s, and has been such a fine business
figure. He has stood for principle all his life, and turned down a Padma Bhushan
because Bhopal hung over his head.
He was only the Non-Executive Chairman of Union Carbide India; all he got was Rs
250/- as sitting fees; how did he know all the technical stuff about risks and safety
issues? You know what it was like in those days, an international company wanted a
respected local figure to be chairman, and Mr Mahindra was just obliging Carbide... .
There is a counter-view, of course. What was he doing as chairman of the board, if
he didn't know what was going on in the company? Surely, safety is a vital issue in a
chemical plant, and the safety warnings about the Bhopal plant must have reached
36. - 35 -
the board; if not, the board was clearly negligent about its responsibility to
shareholders as well as to staff and the general public.
And if the warnings had reached the board, which then did nothing, surely that was
something worse than negligence.
To be sure, an NED does not have the direct responsibility that an executive director
has (a distinction that exists when it comes to bounced cheques), but does he have no
responsibility at all?
Mr. Deepak Parekh1
, stated that no one will want to be a Non-Executive Director if
he is going to be held responsible for design flaws in a plant, and that he himself was
under pressure from his family to get off various boards, if the price could be going to
jail.
It is also obvious that Mr. Mahindra's real mistake was to accompany Warren
Anderson to Bhopal, where both were arrested. No other Non-Executive Director of
the Indian company has been touched, and Mr. Mahindra too would have been
untouched if he had not decided to visit the site of the disaster.
These arguments have merits and, of course, the Indian corporate world needs more
people like Mr. Mahindra, not less.
It is also true that NEDs are mandatory in listed companies and that it is actually
quite hard to find suitable candidates for board seats -- state-owned companies like
the SAIL2
are unable to do a public issue because they don't have the required
number of NEDs!
Still, the position of director is more than the sinecure3
that all too many retired
executives seek out because of the sitting fees and profit share, sumptuous lunch and
1
Deepak Parekh is the Chairman of Housing Development Finance Corporation, India's leading
housing finance company.
2
Steel Authority of India Limited
3
A sinecure means an office that requires or involves little or no responsibility, labour, or active service.
37. - 36 -
car and luxury hotel room, not to mention the opportunity to feel important and rub
shoulders with decision-makers.
The position comes with responsibility, especially in matters of safety. But that is the
formal position; the reality, as in the Satyam case, is that most non-executive
directors (including illustrious names) are rubber-stamps.
The irony is that committee after committee charged with recommending corporate
governance norms has placed its faith in the appointment of non-executive directors.
Look around at the corporate sector and this becomes obvious. Non-executive
directors have little to do with it, because all that your garden variety non-executive
directors want to do is have their lunch and eat it too.
38. - 37 -
Latest in News
Dr. JAMSHED J. IRANI.
This is another name to remember in our profession.
Dr. Jamshed J Irani is a renowned personality in the Iron and Steel Industry. He is a
Director on the Board of Tata Steel. Dr. Irani was the National President of the
Confederation of Indian Industry (CII) for 1992-93. Dr. Irani is a member of the
Scientific Advisory Committee to the Cabinet (SAC-C) Government of India. He
was Chairman of the Expert Committee set up by the Government to draft the new
Companies Act.
Besides, he was a Non-Executive Chairman of Everonn Education Limited from
which post he recently resigned.
Everonn has been a leading presence in the Indian education industry for over two
decades and is listed on both the BSE and NSE.
Dr Jamshed J. Irani has resigned as the Non-Executive Chairman of Everonn
Education Ltd. following the arrest of the company's CEO, Mr P. Kishore, on
Tuesday by the Central Bureau of Investigation for allegedly bribing an Income-Tax
officer.
Dr Irani, former Managing Director of Tata Steel Ltd, was appointed additional
director and non-executive Chairman of Everonn on December 9, 2010.
39. - 38 -
KUMAR MANGALAM BIRLA
Kumar Mangalam Birla is the person behind the framing of the Clause 49 of the
Listing Agreement as it exists today. It was in his Chairmanship that the SEBI had
constituted a Committee to promote and raise the standards of Corporate
Governance. The report of this Committee was the first formal and comprehensive
attempt to evolve a Code of Corporate Governance.
Mr. Kumar Mangalam Birla is the Chairman of the US$ 35 billion Aditya Birla
Group, a global conglomerate with operations spanning 33 countries. An iconic
figure, Mr. Birla holds several key positions on various regulatory and professional
boards. He is a Director of the Central Board of Directors of the Reserve Bank of
India and Chairman of the Staff Sub-Committee of the Central Board of the Reserve
Bank of India. He serves on the Prime Minister of India's Advisory Council on Trade
and Industry.
He was the Chairman of the Board of Trade constituted by the Ministry of
Commerce & Industry, and also Chairman of the Ministry of Company Affairs'
Advisory Committee.
He served as the Chairman of Securities and Exchange Board of India's (SEBI)
Committee on Corporate Governance, and as Chairman of SEBI's Committee on
Insider Trading. He has authored the nation's First Report on Corporate
Governance.
Mr. Birla is on the National Council of the Confederation of Indian Industry (CII),
the Apex Advisory Council of the Associated Chambers of Commerce and Industry
of India, New Delhi, and the Advisory Council for the Centre for Corporate
Governance.
40. - 39 -
RATAN NAVAL TATA
We have so far seen two great names as Non-Executive Directors-
- Keshub Mahindra
- Jamshed J. Irani
The third name we can observe is that of another Steel giant, the Chairman of the
major companies of the Tata Group.
He holds the Chairmanship as a Non-Executive Director (though, not Independent)
in Tata Steel and Tata Motors.
Mr. Ratan N. Tata is presently the Chairman of Tata Sons, the holding company of
the Tata Group and also Chairman of the major Tata companies including Tata
Steel. It is under his leadership that the Company has scaled new heights and
established a presence as one of the leading steel conglomerates in the world.
Mr. Tata was appointed as the Chairman of the Board of Directors of the Company
in April 1993. Mr. Tata was named Chairman of Tata Industries Limited in 1981. In
1991, Mr. Tata was appointed Chairman of Tata Sons, the principal shareholder of
the Company in 1991. He is also currently the Chairman of several other Tata Group
companies, including Tata Motors, Tata Power, Tata Tea, Tata Chemicals and
Indian Hotels.
Mr. Tata is associated with various organizations in India and abroad. The
Government of India honoured Mr. Tata with its second highest civilian award, the
Padma Vibhushan, in 2008. Earlier, in 2000, he had been awarded the Padma
Bhushan.
Mr. Ratan Tata is on the Board of a number of prestigious companies and
Government bodies and holds many other esteemed positions as well.
41. - 40 -
SUNIL BHARTI MITTAL
Sunil Bharti Mittal is an Indian telecom mogul, philanthropist and the
founder, chairman and Group CEO of Bharti Enterprises.
The US$8.3 billion turnover company runs India's largest GSM-based mobile
phone service and world's fifth largest wireless company with over 190 million
customers across 19 countries in Asia and Africa. He also serves as a Non-Executive
Director on the board of the Unilever Limited
In 2007, he was awarded the Padma Bhushan, India's third highest civilian honor.
He started his first business at the age of 18, working in several industries before
gaining experience in the telecoms sector. He was therefore well positioned to take a
pioneering role when the mobile phone industry reached India and the first network
licenses were auctioned.
Today Bharti Enterprises – which he founded and where he serves as chairman and
Group CEO – is one of India’s leading business groups, with interests not only in
telecoms but also in retail, financial services, real estate and agri-products. Bharti has
joint ventures with several global leaders: Singtel, Wal-Mart and Del Monte.
He is a member of the Prime Minister’s Council on Trade & Industry and serves on
its sub-committee on promoting financial inclusion. In 2007–08, he served as
president of the Confederation of Indian Industry.
A number of his public appointments are in the telecoms industry. He is on the
Telecom Board of the International Telecommunication Union (the UN agency for
ICT), where he is also a commissioner of the Broadband Commission.
Sunil has a strong sense of corporate responsibility and, in 2000, set up the Bharti
Foundation, which provides education to over 30,000 under-privileged children in
rural India through a far-reaching schools programme.
42. - 41 -
K.V. Kamath
Kundapur Vaman Kamath is the Non-Executive Chairman of the Board of Directors
of Infosys Limited and ICICI Bank.
He has a degree in mechanical engineering and did his management studies at the
Indian Institute of Management, Ahmedabad.
Kamath started his career in 1971 at ICICI, an Indian financial institution that
founded ICICI Bank and merged with it in 2002. In 1988, he moved to the Asian
Development Bank and spent several years in South-East Asia before returning to
ICICI as its Managing Director and CEO in 1996. Under his leadership, the ICICI
Group transformed itself into a diversified, technology-driven financial services
group that has leadership positions across banking, insurance and asset management
in India, and an international presence. He retired as the Managing Director and
CEO in April 2009, and took up his present position as the Non-Executive
Chairman.
Kamath joined the Board of Infosys in May 2009 and took over as Chairman of the
Board in August 2011.
Kamath was conferred with the Padma Bhushan, one of India’s highest civilian
honors, in 2008. He has received widespread recognition internationally and in
India, including being named “Businessman of the Year” by Forbes Asia and
“Business Leader of the Year” by The Economic Times, India in 2007 and CNBC’s
“Asian Business Leader of the Year” in 2001.
Kamath was the President of the Confederation of Indian Industry from 2008 to
2009. He is also an Independent Director on the Board of Directors of Schlumberger
Limited. He has been a co-chair of the World Economic Forum's Annual Meeting in
Davos and is a member of the Board of the Institute of International Finance.
