Capital Markets: Challenges and Developments

SEBI needs to adopt dual approval system for independent directors

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Independent director

Mains level : Paper 3- Dual approval system for independent directors

Context

While the regulators have taken giant strides to enhance board independence in India, one significant conundrum persists about appoint and removal process of the independent directors.

How appointment and removal process affects the independence of independent directors?

  • Independent directors are appointed just like other directors through shareholder voting by a simple majority.
  • This confers a significant power in the hands of significant shareholders to handpick the independents.
  • In case of family-owned companies, it is not uncommon to appoint “friendly” independent directors.
  • As for public sector undertakings, there is a demonstrable affiliation between independent directors and the ruling political parties.

Dual Approval System: Way forward

  • The above trends suggest that unless independent directors owe their allegiance to the shareholder body as a whole, independence is likely to remain largely in form and not function.
  • In its consultation paper, SEBI proposed a “dual approval” system.
  • Under this system, the appointment of an independent director required the satisfaction of two conditions:
  • First, the approval by a majority of all shareholders.
  • Second, the approval of a “majority of the minority”, namely the approval of shareholders other than the promoters.
  • SEBI recommended the same “dual approval” system for the removal of independent directors as well.
  • SEBI drew inspiration from Israel and the premium-listed segment of the United Kingdom, which confers greater power to minority shareholders in installing or dethroning independent directors.
  • SEBI has not yet made any mention of implementing the dual approval system.

Issues with Dual Approval System

  • The first issue is that it militates against the majority rule principle that is intrinsic in a corporate democracy.
  • While understandable, that is hardly an immutable rule as corporate law does make exceptions in cases involving oppression of minority shareholders.
  • The second concern is that placing too much power in the hands of minority shareholders would be counterproductive, as it could result in a tyranny of the minority.
  • However, the dual approval system instead represents the best of both worlds. It does not negate the promoter’s involvement in the process of appointing or removing independent directors.
  •  Only consensus candidates would end up becoming independent directors.
  • The third issue is one of shareholder apathy: Will minority shareholders be motivated to exercise an informed and meaningful choice?
  • Minority shareholders tend to be passive when they are unable to influence the outcome of shareholding voting.
  • However, where they do have a significant say, like in the “majority of the minority” process, they are likely to be more active in exercising their franchise.

Consider the question “How far has the provision of appointing independent directors to safeguard the interest of minority shareholders succeeded in its objectives? Suggest the changes to improve the challenges faced by the independent directors.”

Conclusion

In all, the appointment and removal system continues to undermine the independence and efficacy of corporate boards. The SEBI needs to implement the dual approval system at the earliest.

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