“The need for independent directors”;
In today’s dynamic and competitive environment firms require good management as well as good corporate governance. Corporate Governance is very much different from corporate management as there lays a difference in their functioning. Corporate Governance is basically related to safeguard the business in changing corporate environment, while management is more related to developing expanding and leading the business in the right direction. “Governance alludes to the policies and procedures set up to guarantee that the business works inside of the law and for the ideal advantage of all stakeholders. Administration is concerned about the techniques the executives use to operate and flourish the company.”[Sam Ashe-Edmunds, Demand Media]
The report currently focuses on the importance of Independent directors; their respective roles and responsibilities in an organization, and how they are important for maintaining good governance within an organization. But who are independent directors? “An independent director is said to be a Non-executive director of an organization who helps in improving corporate credibility and governance standards.”[ET Bureau, 2/1/2013]
Every independent director is a non-executive director but not every non-executive director is an independent director. A non-executive director has no financial stake in the company and thus has no shares in the company too. He cannot enforce people to buy his independent decisions. Such type of directors does not have any “Vested-Interest” in an organization i.e. the performance o the organization does not affect them. Every independent director gets remunerated for the number of hours he works for an organization.
As per clause 49 of the listing agreement, “An independent director is a non-executive director who does not have any pecuniary relationship with the company, its promoters, senior management or affiliate companies and also has not been an executive with the company in three preceding financial years. It also says that an independent director should not have been a partner or executive director of the auditors/lawyers/consultants of the company in the preceding three years or should not hold 2% or more of shares of the company. Further, he should not be a supplier, service provider or customer off the company. The Listing Agreement mandates that the board of a listed company will have an optimum combination of executive and non-executive directors with not less than 50% of the board comprising of non-executive directors. Where the chairman of the board is a non-executive director, at least one-third of the board should be independent directors. Where the Chairman is an executive director, at least half of the board must be independent directors.”[ET Bureau, 2/1/2013]
“Non-executive directors act as an instructor for an organization whose role is to enhance the corporate credibility and governance standards functioning within the corporation. The independent director is a part of several committees operating within an organization to ensure good governance as he is the one who plays a significant role in risk management.” ET Bureau, 2/1/2013]
A non-executive director analyzes the workings of management and puts forward the objective view in the assessment of the performance of the board and management. It’s his duty to safeguard the interests of the stakeholders of the organization especially the ones who have minor share holders. He is the one who brings balance between the management and the shareholders. Independent directors are the key managerial personnel, part of senior management. Also they are ones who play a prime role in appointing the executive directors and in determining their remuneration too.
Absence of independent director deprives the company of making independent decisions and thus hampers decision making capability within an organization. And thus play an important role in an organisation.
Several scams on the past serve as proof of how important it is to have effective independent directors in order to have good corporate governance. The scam that will be discussed in the report is that of WorldCom which shows how an absence of good corporate governance and ineffective independent directors can deteriorate a company. The following report focuses on what went wrong with the organization which was quite successful at one period of time.
WorldCom Scandal
WorldCom was a provider of long distance phone services to businesses and residents. It had started as a small company known as Long Distance Discount Services and gradually grew and became the third largest telecommunications company in the United States of America due to the effective management of Chief Executive Officer Bernie Ebbers who was initially recruited in the company as an investor and later became the CEO. He was the one who helped the company to grow from a small investment to a $30 billion revenue producing company. But it wasn’t exactly the way it looked. IT was way more complex. In 2002, the company revealed that it had been involved in a fraudulent reporting which stated that the company was in a profit of $3Billion dollars but had actually suffered a loss of half a billion dollars. Later it was revealed through investigation that there were misstatements of around $11billion. The fiscal expense which the company thought will last for future were capitalized which was just opposite of what they were suppose to do. WorldCom scandal was undoubtedly thought to be a greatest failure of corporate governance. And then questions aroused that what were the independent directors/watchdogs, the accounting department, the board of directors up to? Didn’t they notice such a major mistake?
The further investigation in this scandal gradually cleared those entire set of questions and it was found that it found that the main factor behind the scandal was the business strategy of WorldCom’s CEO, Bernie Ebbers.
Bernie Ebbers in the initial years was focused on achieving high growth rate though acquisitions. He used the WorldCom shares for paying the amount of acquisitions he bought. He had increased the value of stock by fraud. It is said that the strategy of acquisition reached it maximum level with the acquisition of MCI Communication which had two and a half times more revenue than WorldCom. The fraud was caught in 2000 when WorldCom was forced to leave out the proposed merger with a company called “Sprint” due to some sort of trust issues. This was the time at which the CEO thought of showcasing the increase in revenue of the organization which anew led to the tampering of financial statements and moved the company in complications. “During this time, Wall Street had continuing expectations of double-digit growth for WorldCom. After all, they had achieved so much in such a relatively short period of time”. [By Theodore F. Di Stefano; Aug 19, 2005 7:00 AM]
Ebbers in order to showcase its company performance as expected by Wall Street went for the auditing of the company’s financial records to satisfy it. The chief executive of the company didn’t feel the need of first managing several acquisitions which it had possessed over a period of time which was very much required for the company at that point of time. It is also believed that he did this all for improving his financial condition to and therefore had to repeatedly show the “Growing Net Worth to avoid marginal calls on his own WorldCom stock that he had pledged to secure loans”. [By Theodore F. Di Stefano; Aug 19, 2005 7:00 AM] And after the investigation was done Ebbers was given life imprisonment by the court.
The Board of directors also had the same share in the scandal as that of Ebbers. The BoD would have simply stopped the company from moving into such type of complications but it did not and therefore suffered. WorldCom proved to be a great example of governance failure. “The bankruptcy clearly stated it as fault of senior management as there were lacks of effective checks and balances done by them.”[By Theodore F. Di Stefano; Aug 19, 2005 7:00 AM]
The bankruptcy court later gave several recommendations to the company in which it clearly encouraged the requirement of active and non-executive directors and committees, a corporate culture which follows the ethical code of conduct as illustrated in the ethics pledge that the senior management and other official sign.
Conclusion
And thus we may conclude that the need for independent directors have grown up with emergence of several scams in the corporate world. The companies today require more risk management techniques and senior management who works independently and effectively. The independent directors play an important role in an organization.