Academic Literature on Independent Directors in India

Events in Indian corporate governance that occurred starting January 2009 have spurred academic research on the role and effect of independent directors on corporate boards. While some findings indicate an important role for such directors on Indian companies, others are not so optimistic and call for greater reform of that institution. The purpose of this post is to point to some of the available literature.

1. The paper Independent Directors and Firm Value: Evidence from an Emerging Market by Rajesh Chakrabarti, Krishnamurthy V. Subramanian and Frederick Tung represents perhaps the first event study pertaining to independent directors in India. Their study finds a positive impact through the presence of independent directors on corporate boards. Here is the extract:

Do independent directors add value to emerging market firms? Using a natural experiment that provides exogenous changes in independent directors together with unique data on all director resignations, we find that the answer to this question is “Yes!” The natural experiment we exploit is provided by the recent Satyam fiasco in India. Following the disclosure of extensive accounting fraud by the promoter family in Satyam, several independent directors resigned from other Indian firms. Since these resignations were motivated by an unexpected shock external to the firm, they were unaffected by firm- and director-specific factors coinciding with the time of the resignation. Using the extraordinarily large number of such resignations in January 2009, we find the four-day cumulative abnormal return surrounding director resignations to be -1.3%. This effect is robust even after controlling for unobserved firm and director characteristics using fixed-effects and is also reflected in ex-post firm performance as measured by Tobin’s Q. Consistent with the monitoring role of independent directors, we find that the effect is disproportionately greater for those independent directors that sit on the audit committee and possess business expertise; while the effect of being in the audit committee is greater for smaller firms, the effect of business expertise is felt more in large firms. Finally, the departing independent directors are missed less in family owned firms.

This paper appears to follow the trends displayed in two previous studies that report positive results in firm value due to enhanced corporate governance norms. The first study by Black and Khanna reports a positive market response to the introduction of mandatory corporate governance norms, while the second by Dharmapala and Khanna reports positive response to greater enforcement measures.

2. The article The Role of Independent Directors in Controlled Firms in India: Preliminary Interview Evidence by Vikramaditya Khanna and Shaun J. Mathew published in the National Law School of India Review focuses on the precise role that independent directors can discharge on boards of a vast majority of companies in India which have concentrated shareholdings. The abstract of the article is as follows:

The role of independent directors has come under the scanner following the Satyam debacle, and the en masse resignation of independent directors that followed. Professor Khanna and Mr. Mathew argue, on the basis of extensive interview evidence, that there is no clear understanding of the role that an independent director is expected to play in the boardroom. Further, they demonstrate that doubts over the applicability of civil and criminal liability laws to independent directors are often a cause of concern, and argue that these concerns must be addressed in the proposed reform to India’s company legislation.

3. In this paper Evolution and Effectiveness of Independent Directors in Indian Corporate Governance, I attempt to compare and contrast the position of Indian independent directors with their counterparts in the developed markets of the U.S. and the U.K. Here is the abstract:

The goal of this Article is two-fold: (i) to identify the rationale for the emergence of independent directors by tracing their evolution in the U.S. and the U.K. where they originated; and (ii) to examine the transplantation of that concept into India with a view to evaluating the effectiveness of independent directors in that country. This Article finds that there are significant differences in the corporate ownership structures and legal systems between the countries of origin of independent directors on the one hand and India on the other. Due to the diffused shareholding structures in the U.S. and the U.K., the independent directors were ushered into corporate governance norms in those countries in order to operate as a monitoring mechanism over managers in the interest of shareholders. Each stage in the evolution of board independence bears testimony to this fact. However, a transplantation of the concept to a country such as India without placing emphasis on local corporate structures and associated factors is likely to produce unintended results and outcomes that are less than desirable. This Article finds that due to the concentrated ownership structures in Indian companies, it is the minority shareholders who require the protection of corporate governance norms from actions of the controlling shareholders. Board independence, in the form it originated, does not provide a solution to this problem. While this Article is skeptical about the effectiveness of board independence in India, it suggests reforms to embolden independent directors that may empower them to play a more meaningful role in corporate governance.

4. The paper The Naked Truth About Independent Directors by Prithvi Haldea provides several practical and operational insights to the functioning of independent directors in India. Here is an extract:

Corporate governance is not an execution but an oversight mechanism to ensure honesty in a company. (This presumes that dishonesty exists in most companies). So the oversight structure has to be very strong and competent to be able to detect malpractices. If almost the entire foundation of corporate governance rests on the shoulders of the independent directors (IDs), it is now beyond debate that the foundation indeed is extremely fragile.

Surely, the last word is far from being spoken on this issue. It has been reported that the Government is considering the inclusion of specific provisions regarding the roles, responsibilities and liabilities of independent directors in the Companies Bill, 2009. While that will continue to further the academic debate regarding independent directors, it is hoped that some of the lessons from the research listed above will also aid in defining regulatory policy on the topic.