Do Independent Directors Provide a valuable service to shareholders?

Contributed by: Chetan Shah, CFA

IAIP had the privilege of hosting Kasper Meisner Nielsen, Ph.D, Academic Director and Associate Professor of Finance, The Hong Kong University of Science & Technology, Hong Kong for its speaker events in Mumbai and Bengaluru on September 4^th and 7^th. The topic on whether Independent Directors (ID) provide valuable service to shareholders was well received by the members. Excerpts of the events are reproduced below.

Changing face of Indian Boards
India adopted the best practices for corporate governance and board from the developed economies like the USA following malpractices at companies like WorldCom, Enron etc. Some of these imposed by SEBI for listed companies are:

• 1/3rd directors on the board to be IDs if Chairman is Independent else 50%.
• Term of 5 years for IDs. Maximum of two terms.
• Mandatory Audit Committee with at least 1 financially literate person.
• At least 1 woman on board.

For the later the firms comply with the regulations but majority of woman directors are either wife or siblings or daughter from the family behind the firm. Kasper was of the opinion that shutting down aligning of interests by not allowing stock options to IDs, limiting sitting fees, or replacing fees with commissions are retro steps. According to Nielsen the ideal provision in the Indian law related to independent director should be, “there should be minimum of one man and one woman” in the prescribed norms. Probably, Nielsen did not want the board to be fully dominated by fair sex!

One common question in mind of investors in India is whether in family controlled firms are IDs really independent? Here promoters are majority investors and carry majority risks. So Kasper wonders whether it really matters. However, sensible promoters tend to get independent views.

How to measure value of IDs?

The key tasks of the board is to hire & replace managers, evaluate performance, incentivize managers, ensure accuracy of financial reports, oversee overall strategy, direction & risk management. A dominant view in academic and practitioners circles is that IDs are better at monitoring these tasks. The question is how does one measure value of IDs?

One way is drawing correlation between profits or/and stock price performance and number of IDs on the board of the company. Other method is studying the impact of sudden deaths of ID. Kasper illustrated the study done for this. Of the 772 deceased directors in the US corporations from January 1994 to December 2007, around 272 IDs fall into the definition of sudden death. Sudden deaths include strokes, heart attack, accident etc. and were unexpected.  The sample excludes death on account of cancer, prolong illness or suicides. The study attributes an average impact of -0.85% to sudden deaths of IDs.

Jerry Junkins, CEO and director Texas Instruments, in 1996 was also an independent director on boards of 3M, Caterpillar and Procter & Gamble. Following his unexpected death the stock price of 3M fell by -2.6%, Caterpillar by -1.8%, Procter & Gamble by -1.8% and Texas Instrument by -1.2% as against fall of -0.5% for S&P500 on May 29^th 1996.

When questioned about studies on IDs joining and impact on stock prices, Kasper said the positive impacts are difficult to isolate.

• CGS

PS:

You could find the presentation on India page of CFA Institute…