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Opinion | Company boards should not decide payments to independent directors and auditors

When the selection and fee payment of  auditors, credit rating firms and independent directors is decided by the management/promoter shareholders, it is obvious that their loyalty will be towards the latter.

April 04, 2019 / 10:12 AM IST
Representative Image

Representative Image

Kunj B Bansal

Among the many stakeholders in a company, which would include owners, customers, management, employees, government, lenders and so on, the ones that have a high impact through relatively low involvement are independent directors, auditors and credit rating agencies.

In the recent past, there have been multiple controversies and questions raised regarding the roles of these three important stakeholders. The general perception is that they are not working in a fair manner resulting in a feeling of helplessness for the minority shareholder.

One prominent example is the AAA rating assigned to IL&FS till the very day of its default. That was the case with Amtek Auto too a few years ago. In case of Vakrangee, its auditors withdrew overnight without any clear explanation resulting in a significant loss to shareholders. Another famous example is the clean chit given to Chanda Kochhar by the ICICI Board before things went out of hand.

These are but a few instances. It is noteworthy that all these companies had a proper board with independent directors. What were these independent directors doing? Where do their loyalties lie?

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Well, the selection of these stakeholders and the payment for their services is made by the company. In other words, it is decided by the management or promoter shareholders. Going by the principal-agent relationship concept, it is obvious that their loyalty will be towards the management or promoters. Minority shareholders do not figure anywhere in the picture.

Sure, there is the formality of auditors’ and directors’ appointment being ratified at a shareholders’ meeting. However, we all know what say minority shareholders have in such ratifications.

So, what is the solution to ensure that these stakeholders behave independently and treat all shareholders on equal footing?

The simplest solution is that their payments should not be handled by management or shareholders. Ideally, their payments should be handled by an independent third party, say SEBI. It is a no brainer that the company will fund   their payments but the authority and mechanism of such payments should be taken out of its hands. Therefore, companies should deposit all the fees related to these agencies – credit rating fees, auditor fees and independent director fees -- with a third party  that will handle all such payments.

Doubting Thomases will raise a lot of questions on the mechanics and execution of such a structure but there is nothing that cannot be handled. Laying out a full blueprint for such a mechanism is beyond the remit of this article, but here are a few basic principles that can be applied:

All such service providers can be rated in different categories (say 1 to 4) based on their size, track record, experience, staff strength, brand etc. This rating can be done by companies themselves, the peers of such service providers, directors, and minority shareholders. The rates to be paid for services can be decided based on the ranking. This rating system and payments can easily apply to credit rating firms, auditors and independent directors.

Companies can have the freedom to choose the agency they want to work with based on their size, affordability, experience and track record. However, since that chosen agency will not be dependent on payment from the company, it will be expected to be strongly independent. Despite this safeguard, if an agency slips up or commits any lapses, that is likely to have an immediate impact on its rating forcing it to be careful, unbiased and non-partisan.

To be sure, this may not be a fool proof system from day one. However, once adopted, it will keep getting refined in due course of time just like other systems.

The system will also enable adoption of compulsory retirement/ rotation of auditors which is not getting implemented. It will also lead to compulsory retirement of independent directors and ensure that individuals adhere to the regulatory ceiling on directorships.

In today’s digital world, such a rating system and its implementation can easily be handled online. A repository of individuals available for directorship, their ranking, past track record etc. can be made public. That can be done for  auditors and credit rating agencies too. In fact, once accepted, this system can also be extended to valuation agencies and lawyers working on corporate matters.

Without such an independent payment mechanism, it is chimerical to expect complete neutrality from an agency whose financial fortunes are not independent. Such an idea might seem far-fetched, but remember that the emergence and success of NSE, at a time when investors were at the mercy of broker cabals controlling stock exchanges,  is the biggest example of such change. It is time for another radical change.

Bansal is partner and chief investment officer at Acepro Sarthi Advisors, an investment advisory firm. Views are personal
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