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Critiquing SEBI’s 2021 Consultation Paper on Independent Directors

The author is Isha Khurana, a fourth-year student at Jindal Global Law School, Sonipat.



To better understand the standing of corporate governance in India today, especially in terms of the conduct that is required or expected of directors, it becomes important to study recent developments regarding directors’ duties and compensation. In this article, it will be argued that the approach adopted by Securities and Exchange Board of India (“SEBI”) through its 2021 Consultation Paper on Review of Regulatory Provisions Related to Independent Directors (“Consultation Paper”), goes against the fundamentals of “independent judgement” that director duties and corporate governance is based on. Thus, the Consultation Paper is critiqued, and it is put forth that SEBI’s approach towards independent directors portrays how the regulatory body is moving against the fundamental principles of corporate governance.


A Critical Analysis of the 2021 Consultation Paper


Corporate governance may be understood as the method by which a corporation is governed, and primarily aims to resolve any conflicts that may arise between different stakeholders and more specifically, is meant to protect minority shareholder rights. An apt example of this, in the Indian context, would be the resolution of agency conflicts that may arise between minority and majority shareholders, or general conflicts between shareholders and the management.


In 2021, SEBI released its Consultation Paper that reviews the regulatory provisions regarding an independent director of a company. Amidst this paper was a recommendation (in paragraph 4.8, point 4) that equity share options (“ESOPs”) be given to independent directors, to provide them with more ‘skin in the game’. ESOPs, under Section 2 (37) of the Companies Act, 2013, represent the right of a director (amongst other parties) to purchase the shares of a company, at a later date but at a pre-determined price. ESOPs in general may be awarded to directors, but such an issuance becomes contentious when they are granted to independent directors as it results in their financial involvement in the company. The Consultation Paper acknowledges that long-term compensations may compromise the independence that is required from an independent director in the first place, and that insufficient compensation or limited focus on short-term benefits would not attract skilled directors of a high caliber. The paper thus thought it fit to award ESOPs to independent directors as it would result in alignment of the director’s interests with those of the company. The consultation paper, while seemingly acknowledging the risks with providing independent directors with any remuneration or commission that is linked to profits or performance of the company, continues to suggest ESOPs as a way to balance these concerns. This article argues against this approach, keeping in mind the pecuniary nature of ESOPs.


One of the preferred approaches to upholding corporate governance practices is to ensure that the independence of directors is kept intact. For this, corporations must guarantee that the directors who are appointed under the category of ‘independent directors’ are kept away from any pecuniary or financial interests involving the company. It is also a well-accepted principle that while it is not impossible or looked down upon per se for independent directors to have shareholding in a company, it is preferable that independent directors do not engage in share options. The same is also concretized in the Cadbury Committee Report on the Financial Aspects of Corporate Governance, wherein it was observed that non-executive directors must bring an independent sense of judgement. Further, the report noted how it is considered good practice when such directors do not participate in share option schemes such as ESOP’s and their service is not subject to pension by the company. Rather, independent directors of a ‘high caliber’ (as required by most corporations) may be incentivised through industrial recognition and their association with efficient companies, which prioritise corporate governance principles.


Although it may be argued that ESOP’s provide independent directors with more ‘skin in the game’ and provide them with greater incentive, it is necessary to differentiate between the type of conduct that is expected from an executive manager and that which is expected from an independent director. Independent directors, by their very nature, are appointed for their skill and expertise in the company’s practice area. Thus, it is unreasonable to expect them to have an interest in the company or to pin any liability on them for the manner in which the company is working. Furthermore, since they are employed for their niche skill and expertise, it is not their mandate to look after the executive matters or day-to-day functioning of the company and thus, any argument of financial involvement as an incentive falls short. This further negates the argument that financial incentives are the primary method through which directors of a high caliber are attracted to companies, since their mandate focuses on growing their expertise, while simultaneously working on the company’s practice area. 


The actual mandate for an independent or non-executive director has been discussed by the Cadbury Committee Report mentioned above. While dealing with matters of corporate governance, it must be recognized that interests of the executive management and the companies may not align, causing trouble in decision-making, especially in matters concerning takeovers, directors’ pay, employment of directors, and so on (note that these are matters which most often require an application of independent judgement, since directors may have a self-dealing interest in these transactions). It is during circumstances such as these that independent directors are required to step in, since they are not anticipated to have any self-interest motives and are expected to resolve such situations. Thus, if the independent directors are given more ‘skin in the game’ and pecuniary incentives as recommended by SEBI’s paper, it would work against the corporate governance principles and structure that India and most other jurisdictions have instilled. Thus, SEBI seems to be doing very little for ensuring that there is progress in the corporate governance regime.


A Missed Opportunity to Protect Minority Rights


Due to the unique nature of India’s business environment, which is dominated by family-business enterprises, the largest agency conflict arises from majority-minority shareholder disputes. Since independent directors are also appointed by these majority shareholders, it is often observed that those directors who display a certain ‘friendly nature to the majority shareholders find themselves with seats on the board. This defeats the entire purpose of having independent directors in the company’s board.


Perhaps having noted this conundrum, SEBI proposed a dual approval system, wherein the appointment of an independent director would first be approved by the majority shareholders and thereafter, by a majority of the minority. If the same were to be implemented, then India would have followed other jurisdictions such as the United Kingdom in becoming a more minority shareholder-friendly corporate regime. This approach would have been an extremely welcome change as minority shareholders in India often find themselves receiving the short end of the stick. This is even more so, given the fact that majority shareholders are often on the board of directors or control the decisions made by the board (due to India’s peculiar issue that there is no separation of ownership and management).


Unfortunately, this also led to another disappointment for minority shareholders. SEBI, in its follow up press release to this set of guidelines, made no particular mention of the dual approval system and stated that the appointment or removal of independent directors would be by way of a special resolution. The same is arguably a step back in the vision of incorporating a successful corporate governance mechanism that caters to the issue of majority-minority disputes in India.


Concluding Remarks


In conclusion, there seems to be a trend that Indian corporate governance standards are moving against well-established principles of company law and regulatory bodies like the SEBI are doing little to prevent this. The same was illustrated by the initiative by SEBI itself by firstly, encouraging financial involvement of independent directors in a company, and secondly, by first suggesting a voting mechanism that accounts for minority shareholders and then rejecting the same without any rationale or grounds. The SEBI must thus take note of these fallacies and work to rebuild harmony in corporate governance mechanisms. Given that the independence of independent directors and protection of minority shareholders form an integral facet of the corporate governance machinery, it is suggested that the dual approval system be revisited in order to grant some relief to minority shareholders, and the financial involvement of independent directors in a company via ESOPs be rejected, so as to secure the independence of this category of directors.

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Nankee Arora
Nankee Arora
22 трав.

Insightful analysis.

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