Independent Directors: The Role and the Test of Independence
Independence is a position rather than a qualification: nothing about a director's livelihood, history or loyalties gives them a reason to side with management or with the controlling holder against the other holders. There are two directions to be independent in. The first is checked from a record. The second leaves a trace only in what a director did, and most companies publish no such trace.
What is one of these people actually there for?
A definition of independence is easy to find and explains nothing on its own. The purpose comes first.
The earlier treatment of how companies are governed sets it out in a single move, and that move is worth carrying here in its own words. Every governance structure, it says, is a way of putting someone who answers to the owners between the money and the manager. And independence, in that same treatment, is the rule about who is allowed to do the looking.
Put plainly: an independent director sits on a board of directorsThe people the holders elect to keep watch over a company for them. They hire the top managers and can let them go, they sign off the big decisions, and they answer back to the holders. so that at least one person in the room has nothing to lose by asking the awkward question. Not more expertise, though expertise is welcome. Not a delegate sent by the smaller holders. A delegate is attached to one group, and the seat exists to be attached to neither. Somebody whose next year does not get worse if the answer to the awkward question is embarrassing.
Here is the same idea a long way from any company. Two branches of a household are dividing a plot of land between them and somebody has to hold the measuring tape. The families do not ask a cousin from either branch, however good that cousin is with a tape. The tape goes to a neighbour with no stake in the plot. And the moment they learn that the neighbour's son is marrying into one of the branches, they go and find a different neighbour, without anybody suggesting the first one was dishonest. Nothing about the neighbour's skill changed. The neighbour's position changed.
How many such directors a listed company must carry, what the definition of independence is in law, the committees that must exist and the route a dealing with a connected person takes before approval are all set in the Companies Act, and in the listing requirements written by the Securities and Exchange Board of India. The requirements move. The wording in force sits with the Ministry of Corporate Affairs and with the Securities and Exchange Board of India, and that is the wording to go to when the question comes up, with the date it was read set beside anything carried away.
1. What is an independent director on a board of directors actually for?
Independent of whom, exactly, and how many directions does that run in?
A director is independent when nothing about their livelihood, their history or their loyalties gives them a reason to side with management or with the controlling holder against the other holders. Everything below rests on one observation: there are two directions to be independent in, and it is easy to check only one.
The first direction is independence from management: not an employee, not a supplier, and not a former executive with old friendships in the building. The first direction is the one most people mean when they use the word. The word separates an executive directorA director who is also an employee of the company, holding a job in it such as managing director or finance director, and paid for that job., who runs part of the company and draws a salary for doing so, from a non-executive directorA director who sits on the board but holds no job inside the company and runs nothing in it day to day., who sits on the board of directors without running anything inside it.
The controlling holder usually decides who gets put forward for the seat in the first place, and that makes independence from the controlling holder the harder of the two tests. A person can sit comfortably in the first direction and nowhere near the second. The gap between the two is not hypothetical, and the case below works it in full.
The case belongs to Aravalli Agro Foods, an invented listed snack maker. The board of directors at Aravalli Agro Foods carries eight people: Devika Rathore chairs it and is its managing director, one further executive director sits alongside her, two non-executive directors come across from the controlling side, and four independent directors are led by Suresh Menon, an invented retired banker who chairs the Aravalli Agro Foods audit committee. Four of those eight were placed on the two directions, and of the four only Suresh Menon, of Aravalli Agro Foods, is independent of both. Prakash Iyer, also of Aravalli Agro Foods, never worked at that company, has been Devika Rathore's friend since college, and was put forward by her three terms running. He passes the management test outright. A checklist that tests one direction will call Prakash Iyer of Aravalli Agro Foods independent without hesitating.
2. A retired professional never worked at the company, has been the controlling holder's friend since college, and was put forward by her three terms running. Where does that person sit?
Why is the second direction so much harder than the first?
Here is the question almost nobody asks after meeting the two directions. How would each of them actually be tested, and with what document in hand?
The first direction is a matter of record. Whether somebody was an employee, whether the firm they run supplies this company, whether they used to sit in the corner office themselves are all things that happened on particular dates and that somebody wrote down at the time. A history settles it. A history is also, conveniently, the kind of document that gets published, summarised and repeated, so a reader outside the company can usually get one.
The second direction is not a fact about a person's history at all. The second direction is a fact about what that person did when it mattered. And conduct is recorded, when it is recorded, in a completely different kind of document from the one that carries a history.
The second direction can be approached from the appointment side without being reached. Knowing who put somebody forward, and who put them forward the time before that, is something real. A person whose nominationThe act of putting a person's name forward for a seat on the board, so that the shareholders can then be asked to elect them. came from the controlling holder three times running is in a different position from one found by a search firm. The nomination record narrows the second direction and never closes it. A person put forward by the controlling holder may still have asked the hard question, and a person found some other way may never have asked one.
So the first direction is answered by who somebody is and the second only by what they did. A checklist built entirely on histories can therefore complete itself without ever touching the second direction.
The difference matters more than it sounds. The two directions are not equally important. The controlling holder can already look after themselves, so at a company with a controlling holder the people governance protects are the other holders. So the party the director would actually have to disagree with, on the day it counted, is the controlling holder. The harder direction to test is also the one that bites.
Out of the boardroom for a moment. A referee has a clean employment record: never worked for either club, no relatives at either, no sponsorship from anybody. The employment record will keep saying the same thing however long it is studied. A different document, the log of close decisions across three seasons, shows every marginal call going the same way. Neither document is lying and neither is incomplete. The two documents are simply about different things, and only the log of decisions is about conduct. A reader holding only the first document has not got a weak answer to the second question; they have no answer to it at all.
3. A complete and clean employment history for a director is in hand. Which direction has been settled?
So where does conduct leave a trace, if it leaves one anywhere?
Three places, and Aravalli Agro Foods is the one business in these notes that publishes them. The board report extract below is the only one of its kind in these notes.
The first place is attendance. The count of meetings the company held is a fact about the company. Attendance is whether a particular director turned up to the ones where something was decided. The second is dissentSomething a director put on the record against the grain: a query raised, a demand for more time before deciding, or a vote the other way, written into the minutes.. The third is what happened to a decision after somebody asked, and that one the extract does not carry at all.
Here is the extract, whole, with the four passes the earlier reading makes over it.
Two cautions travel with that extract, and they are the part most often misused.
One mark proves the room can disagree, so a dissent recorded is not a count that should be high but a count that should be non-zero. And the second caution follows straight from the first: Suresh Menon's two dissents in a year at Aravalli Agro Foods are the only hard evidence anywhere in that extract that an independent director's independence was ever used. Everything else in it is a description of who was there.
Now the third trace, the one that extract does not carry. The third trace is what happened to a decision after somebody asked: whether a price moved, whether a proposal went back for more work, whether it was withdrawn, whether the person with something at stake left the room, a departure the minutes call recusalLeaving the room, and taking no part in the discussion or the decision, because of something personally at stake in the item being decided.. A question with no consequence attached is a question. A question a proposal did not survive is a check.
Accountability leaves marks like these, and their absence is the finding.
4. A board reportThe document a company's directors publish alongside its accounts, describing what the board did over the year. shows one independent director recorded two dissents in the year. How should that be read?
Changing the document held changes which part of the square it can reach
The square below never changes. Its two directions, its labels and the corner where a director is independent of both are held exactly where they are at every setting, and no director is placed on it at any setting. Only the document being held moves. Each of the five settings raises the same question: which part of the square can that document actually place somebody in?
Educational illustration, not a legal test and not a score. The two directions and the corner they define stay exactly where the test puts them, and each setting changes the document rather than the director. A company's own statement that a director is independent is a claim and not the evidence for one, so the first two settings shade identically. Who put a director forward narrows the second direction and does not close it, so the band at that setting is drawn open at both ends. The opening setting is the position of a business whose directors nobody has published.
5. The panel steps through five documents. On how many of them does the corner where a director is independent of both become reachable?
What would have to be published before anybody outside could test it?
Six items rather than a paragraph. Each one is a thing a real person could go and ask a real company for. None of them is a rule anybody has to supply.
One, who put each director forward, and who put them forward the time before. Two, how long each has served and whether the tenureThe length of time a person has already served in a seat, counted from the day they first took it. was renewed by the same people who granted it. Three, whether they came, meaning attendance at the meetings where something was actually decided rather than a count of meetings held. Four, whether anybody, ever, put a query or a demand for more time or a vote the other way on the record. Five, what happened to a decision after somebody asked. Six, what each director is paid by this company and by anybody connected to it.
A list with no purposes attached reads as a wish, so here is what each item is for. Items one and two reach the second direction from the appointment side and narrow it, and narrowing is not settling. Items three, four and five reach it from the conduct side, and they are the only three that can settle anything. A person can be paid by a company they never worked for, so item six reaches the first direction from the side a plain employment history usually misses.
A list of six things that would be needed is a finding, and a judgement built without them is a judgement about the reader's own confidence rather than about a board of directors. The list of six goes in front of somebody who knows the company and gets argued through line by line. A score holds nothing inside it to disagree about, so nobody can argue with one.
The panel above steps through five of these documents. The same five read as follows.
| The document in hand | What it can place a director in | Published for the businesses used here |
|---|---|---|
| The bare fact that a board of directors exists | Neither direction | Yes, more than once, and it names nobody |
| The company's own statement that a director is independent | Neither direction | No |
| The director's employment and supply history | The first direction only | No |
| A record of who put them forward, and who did so before that | The first direction, and it narrows the second without closing it | No |
| A record of what the director did | Both directions, and the corner becomes reachable | No |
Read the middle column downwards and the first two rows say the same thing. Adding a company's own description of its own director changes nothing at all about what can be established. The right hand column read downwards gives the same answer four times running.
6. The question is whether a company's independent directors are independent of its controlling holder, and all that is held are the accounts it publishes. What is the honest output?
So where does a reader of these notes actually stand?
Take the six items to the businesses used throughout these notes and report what is there. Plainly, and without apology.
Anjani Stationers Private Limited, made up for these notes and marked as made up wherever it appears, turns paper into school registers. A board of directors turns up in its record more than once, and turning up in a record is not the same as being described. The board approves a machine purchase. A dividend gets put to it. A payment threshold is agreed with it. The board may put a name forward for the statutory auditor, and the members do the appointing. And at a business of that size, the record says, no separate audit committee sits apart from it. Read every one of those together and not a single person on it can be named. Its size, its members, who put any of them there, its chair and its meeting rhythm appear nowhere. All six items are blank.
Bhavani Register Works is promoter run. The people who set it up are still the ones running it and most of the shares are still theirs, rather than the place being run by managers hired in from outside. Its output is 1,50,000 registers a year, all to one specification. Nowhere in these notes was it given a legal form, and that was on purpose: giving it one would draw out a filing, and a filing would draw out a figure that nobody anywhere published. All six items are blank there too.
Setu Bazaar is a marketplace rather than a company form, and it carries no owner, no founder, no holder and no manager anywhere in these notes. The question does not arise for it at all.
Say the uncomfortable part in the open. Hedging it would be worse than useless. Six blank items is the ordinary position, and nobody is at fault for standing in it. Most companies in India, by a very long way, are not listed, produce no board report at all, and were never asked by anybody to produce one. A private company that publishes nothing about its directors has concealed nothing. A reader who wants the second direction tested at such a company is asking for a document that mostly was never written, and it was never written because nobody was ever asked for it.
Where composition is met, where every independent director was appointed on the controlling holder's nomination, and where no dissent has ever been recorded, the honest answer to whether that company is well governed is unknown at best.
Composition and independence are read on two different instruments, and a reader holding only a composition figure is holding the instrument that cannot reach the question.
7. A private company publishes one sentence saying it has a board of directors and nothing further. What does that establish about its independent directors?
What goes wrong when somebody fills in a board of directors from the shape of the company?
An investor checks that a company's board of directors carries the required number of independent directors, ticks the box and stops. At that company every independent director was appointed on the controlling holder's nomination, no dissent has been recorded in five years, and a large dealing with a connected person was approved in eleven minutes. The checklist tested composition and the record tested power, and the first was checked while the second was the answer.
The failure below is the same error with no checklist available at all.
The analyst who filled in a board of directors from the shape of the company
An analyst is looking at a private register maker. The record says a board of directors exists, and says so more than once, always in passing and always while describing something else. Nobody publishes any of it. Nothing lists the directors, nothing records an attendance and nothing records a dissent.
The analyst reasons carefully, and in a straight line. The company is a small private one run by the person who founded it. So its board of directors will be that person and people she chose. So there will be no independent director sitting on it. So the second direction fails, and that is a governance weakness to carry forward into the file.
Four steps. Each one plausible on its own. And not one of the four is disclosed anywhere.
Be precise about what took place. The first explanation to suggest itself is the wrong one. No document was misread. No arithmetic slipped. There was no document. A private company run by its founder may have any board of directors at all, including one with people on it who would say no. A shape was read as evidence, and a shape supports every one of the four steps without establishing a single one.
Now the cost, and it lands in one identifiable place rather than as a vague worsening. The finding was manufactured, and a manufactured finding behaves exactly like a real one. The finding goes into the file. The finding becomes a premise. Every later decision this business takes gets read against it. Six months on, the analyst is asked what the board of directors of this business looks like and answers out of the file rather than out of anything published, and by then the answer has been repeated often enough to feel like something that was checked.
And now the part that repays a moment. The inference was plausible, and that is what made it dangerous rather than obvious. An implausible guess gets challenged in the first review. A reasonable one gets adopted, and afterwards nobody reading the file can tell which sentences were read and which were reasoned.
The fix is not a sharper inference. A thing nobody published is not a finding, and the honest output is a list, set down in writing, of everything that would need publishing before this could be settled.
What four lines should travel with any claim that a director is independent?
How a lender, an analyst or a household investor actually uses this
Whenever the word independent arrives attached to a particular person, four lines go under it in this order. The four lines take a minute, and they work for an analyst building a file, for a lender working out who actually signs off on the borrowing, and for somebody at home holding a few hundred shares with twenty minutes to spend.
One, independent of whom. Write both parties out by name rather than leaving the adjective standing alone. A claim of independence with only one party named is half a claim, and it is usually the easy half.
Two, what document settles that. Then which of the two directions the document in hand can actually reach. Of the four, this one buys the most for the least effort.
Three, what did this person do. Did they come, did they ask, and did anything change after they asked.
Four, what would I have to see that I have not seen. The fourth line turns a blank into a request rather than into a conclusion, and it is the line the analyst in the failure never wrote.
A claim of independence with all four lines blank is a title rather than a finding. Line two alone would have stopped that failure, and it would have done so without anybody learning a single new fact about the business.
8. A company's board of directors carries every independent director the composition asks for, all of them nominated by the controlling holder, and no dissent has been recorded in five years. Is that company well governed?
What comes from India here, and what is left out on purpose?
From India come the currency, the digit grouping that counts in lakh and crore, the company forms written as Private Limited and as Limited, the Indian use of the word promoter, and the fact that whatever is required of a board of directors, and of the independent directors on it, is written into the Companies Act and into the listing requirements.
A copied requirement goes stale without announcing it, so whoever relies on the copy is the last to hear that it moved. The requirements live at the Ministry of Corporate Affairs and at the Securities and Exchange Board of India. The wording is to be pulled as it stands on whatever day it is actually needed, with that day noted beside anything carried away.
The mechanism itself belongs to no jurisdiction. Independence runs in two directions in every market on earth. A history settles one of them everywhere. And conduct is the only thing that settles the other anywhere. The six items would be the six items in any country anybody cared to name.
Where this guide stops. Four things belong here: what independence is for, the two directions it runs in, why the second can only be read from what somebody did, and what would have to be published before anybody outside could test it. Everything else a reader reasonably arrives with is answered elsewhere, and the table says where.
| Arrived wanting this? | Then read |
|---|---|
| A count of independent directors, a legal definition, a required committee, or the route a dealing with a connected person takes before approval | Written into the Companies Act and into the listing requirements, both of which move. Handled where the rules are themselves the subject. Pull the wording as it stands, and note the day. |
| Everything a board of directors controls, and the way a committee splits up the looking | The Board: Composition, Committees and What It Controls |
| What a promoter is, and why that classification behaves as it does here | The Promoter: A Category That Shapes Indian Corporate Governance |
| Reading a register, and the next question a holding makes worth asking | Institutional Ownership: What the Register Tells You |
| Both of the gaps that open up between whoever runs a business and whoever funded it | The Agency Problem: When Managers and Owners Diverge |
| Those readable signals taken in sequence, as a procedure rather than one by one | How to Analyse Ownership and Governance Signals |
| Where a business put its money, and what its year did afterwards | How Capital Allocation Shapes Long-Term Business Outcomes |
| Any score, any rank, any verdict on whether a business is well governed | Nowhere in these notes. No score, rank or verdict comes back from any of them. |
Who is named below, and why does not one row carry a number?
| What is named | What sits with it, and on what footing it is named | Site |
|---|---|---|
| Ministry of Corporate Affairs | Here sits the Companies Act 2013, and with it the provisions touching the board of directors, independent directors, the audit committee and dealings with connected people. | mca.gov.in |
| Securities and Exchange Board of India | The requirements that attach once a company's shares are listed, among them what such a company must then report about the composition of its own board of directors, and how a dealing with a connected person gets approved. The requirements move, so the wording is to be pulled as it stands when the question comes up, with that day noted against anything carried away. | sebi.gov.in |
| The examples and the quoted material above | The board of directors, the four directors, the committee and the board report extract set out above all belong to a listed snack maker made up for an earlier reading in these notes, and to no company that trades anywhere. The six rows of the disclosure card come back blank for the businesses used throughout these notes, and that is a fact about what anybody publishes and not an editorial omission. | finmaverick.com |
Aravalli Agro Foods, Devika Rathore, Suresh Menon, Prakash Iyer, Anjani Stationers Private Limited, Bhavani Register Works and Setu Bazaar are invented.
Educational material. Not advice on any investment, tax, budget or market position.