Pratip Kar: Do multiple directorships matter?

Feb 8,2014

Recent media reports suggest that the Securities and Exchange Board of India (Sebi) may limit the maximum number of companies in which a person could serve as an independent director to five, which is below the limit of ten permitted in the yet-to-be-in-force Section 165 of theCompanies Act 2013. The extent to which the measure would materialise depends on the view the Sebi board takes on the matter; but the media reports have certainly discountenanced the corporate sector and understandably ruffled more than a few feathers. The disagreements have been on all-too-familiar grounds like 'the proposal being contrary to the provisions of the Companies Act 2013', 'the companies would face difficulties in finding good directors on account of their supposed paucity', 'a case of overregulation', 'leave it to the directors and companies to decide because they are rational and professional', and so and so forth. Bemusing as the arguments may be, collectively these articulate somewhat imprecise concerns about boardgovernance - and, on a close examination, seem to embed cognitive biases which often lead to systematic and predictable errors. The more pertinent concerns are: domultiple directorships matter? And, if so, what should the limit be - and should that limit be set externally or left to individual judgement?

The responsibility of independent directorship is demanding. Good managers who take this responsibility seriously will tell you that to do their job well they have to read the board papers diligently, come well prepared for meetings, do their own research, interact from time to time with senior executives and the CEO outside board meetings, bring their experience, expertise and integrity to bear upon the board discussions, make their voices heard in the meetings and know how to ask 'why' without being confrontational. Analysis of the current director databases in India leaves an impression that such 'serious' directors are vastly outnumbered by 'not-so-serious directors', many of whom have held directorships close to the limit of 20 or 15 as permitted under the Companies Act 1956 at different points of time.

Considerable amount of international research is available on multiple directorships. There is one view that claims that directors who serve on multiple boards improve board decision making ability as they have better experience and business connections. But there is an overwhelmingly strong opposite view which says "that directors who overstretch themselves and accept additional seats due to the extra available personal perquisites, tend to spend less time on each individual board, compromise their responsibilities and neglect their duties". Several researchers have argued that in many companies "multiple directors are unable to effectively monitor management because they are overcommitted" and "directors with multiple seats are too busy to mind the business", which creates serious agency problems. They have also found an inverse relationship between the company's performance and the board's busyness.

There has also been research on how multiple directors are chosen globally on the boards of companies. For example, Gerald F Davis observes in his paper, 'The Economy of Multiple Board Membership', that "the results overall suggest that success in the market for directors is determined by social connections and to some degree by compliance with management". The Hungarian physicist Albert-László Barabási, who has revolutionised thinking on how real-world networks work, observes in his book, Linked: The New Science of Networks, that "a sparse network of a few powerful directors control all major appointments in the Fortune 1000 companies".

It would be reasonable to conclude from these discussions that first, multiple directorships in companies is a subject of debate globally; second, the efficacy of too-busy directors who are overcommitted has been called into question; third, directors take up multiple directorships largely in self-interest; and fourth, in several countries there are moves towards restricting the number of directorships. For example, a Consultation Paper of the Prudential Regulatory Authority on Strengthening Capital Standards for Implementing CRD IV has suggested that by July 1, 2014, directors of firms which are significant in terms of their size, internal organisation and the nature, scope and complexity of their activities should not hold more than one executive directorship with two non-executive directorships; or four non-executive directorships. Some European governments are implementing, albeit reluctantly, European Union rules from July this year, to restrict the number of board positions people in systemically important financial companies.

Seen in this perspective, Sebi's proposal to restrict the number of independent directorships cannot be easily dismissed. In India we still have a command-control mindset and are largely rule-driven, so prescription works and may often be desirable. If nothing else, it should weed out the not-so-serious directors and force at least some companies to actively and meaningfully search for serious directors which, contrary to popular understanding, there is no dearth of. Besides, the Standing Committee on Finance on the Companies Bill has, in its 21st Report, observed that Sebi as a sector regulator can set "more detailed or stringent provisions for sectoral companies under their jurisdiction". But is there a magic number for the maximum number of directorships? Possibly not. To get the correct number, one would have to pull a rabbit out of the hat. Globally, even five to seven directorships are being frowned on and data shows that there are very few directors who hold seven directorships or more. Prof Barabási says in his book Linked that Fortune 1000 companies have 10,100 directorships and 7,682 directors, and 79 per cent of them sat on one board, 14 per cent on two boards and only seven per cent on three or more boards.

Two caveats are contextually apposite. Governance reforms generally tend to pin responsibilities on independent directors to help achieve higher standards of governance. But this may not always work and is especially difficult in family ownership of businesses or large state ownership (which is the case in India), because it may not be easy for the boards to resolve the conflict between the dominant shareholder and minority shareholders. Academic literature does not conclusively demonstrate a strong relationship between board independence and firm performance, indeed there is often either negative or no relationship between the two in empirical studies. This is possibly because it is unbeknown how boards perform as boards, how the decision making process in the board room works, and the impact of board- room biases.