THE ROLE OF INDEPENDENT DIRECTORS

By Mahwesh Bilal Khan, IFC

Independence means that a directors decision is based on the
corporate merits of the subject before the board rather than
extraneous considerations or infuences
Delaware court ruling: Martha Stewart Living Omnimedia, Inc v Stewart
The recent spate of highly publicized corporate governance scandalsstarting from
Enron and including the Walt Disney Company, Hollinger International and irbus
Industries, to name a fe!has resulted in putting corporate governance in a very
strong spotlight" These corporate governance failures indicated that the internal
chec#s and balances being used by these companies at the time !ere not sufficient"
The enhanced interest in ho! companies are run and controlled has caused
shareholders and investors to demand better and tighter corporate governance
structures" These changes have translated in a stricter scrutiny of the composition
and structure of the board, particularly of listed companies and large public$ family%
o!ned companies"
It is in this conte&t, that the role of independent directors on boards of companies
has seen an enhanced value and demand across the globe" recent Standford Law
Review paper suggests that bet!een '()* and +**), the composition of large public
company boards in the ,nited -tates has dramatically shifted to!ards independent
directors, from appro&imately +*. independents to /). independents
'
" The move
to independent directors, !hich began as a 0good governance1 catch phrase, has in
many 2urisdictions become a mandatory element of corporate governance la!"
The 3a#istan Code of Corporate 4overnance, +**+ requires the 5oard of Directors of
each listed company to include at least one independent director representing
institutional e6uity interest of a ban#ing company, development financial institution
7D8I9, :on%ban#ing financial institution 7:58I9, mutual fund or insurance company
+
"
Ho!ever, for the representation of minority shareholders the Code provides a blan#et
recommendation for companies to ;encourage effective representation of
independent non-executive directors, including those of minority interests, on their
oards of !irectors<=
>
, and does not ma#e mandatory a specific number of
independent directors on the boards"
-o the 6uestion that comes to mind is? !hat is it that independent directors bring to
5oard that the e&ecutive and$or non%independent directors do not@ The ans!er is
6uite intuitive albeit not very straightfor!ard"
1. Avoidance of potential conflicts of interest
Aanagerial oversight is an important function of a board of directors" longside the
appointment of e&ecutive members 7those employed by and involved in running day%
1
Gordon, The Rise of Independent Directors in the United tates, 1!"#$%##"& 'f hareholder (al)e and
toc* Mar*et +rices, -%##./, Col)01ia 2aw and 3cono0ics 4+ 5o6 7%7
%
Cla)se i -1/ of the Code of Corporate Go8ernance, %##%
7
Cla)se i , of the Code of Corporate Go8ernance, %##%
to%day affairs of a company9, boards have to ensure that there is still an effective
representation of independent members to ob2ectively oversee the management"
Independence is particularly crucial in those areas !hich involve a potential conflict
of interest bet!een managers and shareholders? nomination of the management,
managerBs pay and audit of the companyBs performance C itself an indicator of the
performance of the manager" ,sually, presence of independent non e&ecutive
directors ensures that any material conflict of interest involving directors are properly
dealt !ith"
2. Protection of Minority Shareholders Rights
Independent directors have an important role to play in companies !here a
controlling shareholder 7e"g", a family holding more than D*. shares of a company9
has strong control over the management? a typical scenario for the emerging
mar#ets" In such cases, conflicts of interest may arise bet!een the ma2ority and
minority shareholders" The presence of a good ratio of independents on the board
can help ensure that there is enough representative voice of the minority
shareholders on the board for their rights to be !ell protected"
3. Exercising Independent !dg"ent
:o matter ho! !ell meaning the e&ecutive directors may be, more often than not,
being involved in the day%to%day affairs of the companies that they !or# for, these
directors tend to get myopic" The independent non%e&ecutive directors on a board
provide the much needed ;outside vie!= of things, and e&ercise an independent
2udgment !hen it comes to ma#ing a long term strategy !or#"
Independent directors are generally sub2ect$ field e&perts" Ether than mere
pecuniary considerations, independent directors are li#ely to be motivated by the
contribution they can ma#e to a company through bringing in their o!n
achievements, s#ill%sets and e&periences" company can dra! many important
lessons from the e&perience and e&pertise of such independents"

5. Investor #onfidence
s public information has become more transparent and reliable, investors
especially institutional investors no! clearly prefer companies !ith better governance
standards, over those !hose corporate governance practices may still be dubious"
Having independent directors on boards sends a very strong signal to investors that
the company is !ell run and governed, and its board is sound enough to ensure that
nothing less than the very best international corporate governance practices are
adhered to"
$. Independent %irectors as co!nter &alance
Effective representation of independent directors on a board tends to balance the
board=s s#ill mi&" Whilst e&ecutive directors bring !ith them the organizational
insight, independent members of the board are generally regarded for their e&pert
#no!ledge and ob2ective mindedness" Together, a balanced board can steer the
company to success" Ene caveat though is that the independence is a state of mind
and depends upon the personal characteristics of each individual" nd !hile, there
can be !ays of defining ;independence=, at the end of the day a very independent
director may not be able to e&ercise independent 2udgment" En the other hand, an
e&ecutive director may be totally unaffected by his position in the company, and ta#e
totally unbiased decisions in his role as a board member"