Rethinking Director Assessment: A Critique of the Online Proficiency Self-Assessment Test (OPSA Test)

By Debashri Chowdhury (4^th year, BBA LLB (Hons.), United World School of Law, Karnavati University) 

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Introduction

Corporate governance is essential for ensuring transparent and ethical business conduct. The independent directors play a pivotal role in fostering effective corporate governance, ensuring that the interests of shareholders and other stakeholders are adequately represented. Thy assume a significant role in addressing the governance challenges and are seen as the monolith of good corporate governance.

The stipulations outlined in the clause 49 of the listing Agreement provides the parameters of an Independent Director. As per the clause, “for the purpose of this clause the expression ‘independent directors’ means directors who apart from receiving director’s remuneration, do not have any other material pecuniary relationship or transactions with the company, its promoters, its management, or its subsidiaries, which in judgment of the Board may affect independence of judgment of the directors.”[1] This means than an Independent Director is someone who does not have a pecuniary relationship with the company or related persons, excluding sitting fees, even though they are the member of the Board of directors.

The law mandates that a company board must consist of one-third to half of independent directors and the companies have to find these independent directors from the databank which is maintained by the Indian Institute of Corporate Affairs. Any person who is willing to become an independent director is mandatorily required to submit their profile to this databank. However, in order to be well equipped to be a member of the board of directors, they have to get a hold on subjects such as securities law, accounting etc., and pass an online proficiency self-assessment test (OPSA) with a minimum score of 50 percent in aggregate.

This aspiring independent director is required to pay a compulsory fee ranging between Rs 5,000 to Rs 25,000 for inclusion of their name in the databank. According to the rules, a person should pass the test within two years from inclusion of their name in the databank. Persons who have an experience for at least three years as directors or KMPs of listed companies and those who have worked at senior levels in SEBI, RBI etc, and advocates, chartered accountants, company secretaries, cost accountants with ten years of practice are exempted from taking this test.

Even though government sees this test as an effective solution to curb the inadequate knowledge of independent directors, there are several limitations that the test is not serving to, which are quintessential for having actual “independence” in the board. Few of the limitations of this test are highlighted below.

Shortcomings of OPSA Test

Structural Bias- The OPSA test fails to recognize the structural biases in the appointment process wherein the appointed independent directors are not always “independent”. For example, some nominee directors may have affiliations as paid advisors or even consultants to a company or be employed by an institution that receives some kind of financial support from the firm.[2] Not only that, but often the CEO and the independent directors are friends or social acquaintances.[3] Usually the CEO is the one who plays a critical role in the nomination and it is highly unlikely that they will choose directors who will oppose them. Independent directors still show an inclination towards the firm’s CEO and the directors seem paralyzed in presence of powerful CEOs.[4]

Inadequacy of time- The test does not account for the time constraints faced by the directors since independent directors may have commitments as a full-time employee for a firm or they may be simultaneously hired by several other firms.[5] As a result of this part time engagement, independent directors lack time[6] and hence cannot devote most of their time to one single firm on whose board they work. This lack of time limits their ability to look precisely into financial and other business matters related to the companies, thus lowering their effectiveness as corporate monitors.[7]

No incentives- The test overlooks the minimal shareholding and lack of incentives for the rigorous monitoring. As laid down in the provisions that independent directors do not have any ownership interest in the firm, it is obvious that independent director will not be financially impacted by the performance of the firm. Many of the independent directors hold very insignificant amounts of their firm’s shares, thus, giving a little to no incentives to monitor carefully.[8] Also, since the KMPs influence the process of recruiting directors, independent directors again have hardly any incentives to perform their monitoring tasks strictly.[9]

No clarity about roles- The test fails to address the ambiguity which persists around the role of independent directors. According to a survey conducted,[10] independent directors consider themselves first and foremost as a strategic advisor to the promoters and management of the company. One of the directors even said, “independent directors are not there to prevent management from taking decisions”. While at least one director acknowledged that service on the audit committee likely required a “watchdog” mentality. All the other independent directors who were interviewed expressed strong sentiment that they could not be expected to serve as “watchdogs” in an environment where the potential for significant reputational damage, the scope of liability is so high and undefined. “We are damn scared,” summed up one director.

Applicability of knowledge- The business environment is complex and is subject to constant changes. A test that is based on static knowledge may not be able to capture the nuances of real-world situations, it might be able to measure the independent director’s knowledge of corporate governance principles but it cannot assess their ability to apply that knowledge in real life under pressure situations and make sound decisions.

False sense of security- Such a test may carry a false sense of security among the shareholders leading to an overestimation of the vigilance exercised by the independent directors.

Two-year exemption- A person can appear for the test within two years of including their name in the databank, this means anyone can function as a director for two complete years without actually passing the test. This fails the very purpose of the test. Ideally as per the requirement one should pass the test and then be appointed as a director.

Addressing the limitations: Alternatives to the OPSA test

Th test which was designed to assess the proficiency of the independent directors does not prove to be very efficient in itself and in response to the limitations the proposed alternatives aim to address the shortcomings highlighted in the paper and enhance the effectiveness of independent directors:

Minority shareholder participation: Participation of minority shareholder in the election of independent directors can have several advantages. Firstly, minority shareholders will be able to get representation on the board of directors[11] since they are unable to get it in the usual voting process. Secondly, independent directors will be truly independent of management and controlling shareholders and thus they would be accountable to the minority shareholders since they have been elected by that group.[12] And lastly there is empirical evidence which supports minority shareholder participation in director elections by the way of cumulative voting.[13]

Cumulative voting-

This method will help in ensuring that the minority shareholders will be able to elect such number of independent directors as is proportionate to their shareholding in the company, this will help in reducing the control of the majority shareholder in the process. A shareholder can cast all his votes in favor of a single candidate, this way the candidate might have a chance of being elected depending on the total number of candidates that are available in the pool.

A simple formula which can be used for this is:[14]

N= (x-1) (d+1) / V

Wherein,

N equals to the total number of directors who can be elected

x equals to the number of votes that are exercised by a shareholder

d equals to the number of independent directors to be elected

v equals to the total number of votes that are exercised in the independent director election.

One drawback to this method is that it only works if the board of the company is relatively large which thus would be in need of a larger body of independent directors. However, this method allows both the majority as well as the minority shareholder to elect independent directors depending on the proportion of their respective shareholding. This method may create three different classes of directors:

1. Executive or promoter
2. Independent directors elected through majority shareholders
3. Independent directors elected through minority shareholders

This hence creates a diverse board which represents interests of different stakeholders and hence no shareholder interest is not attended to.[15]

Voting by majority of the minority shareholders-

As mentioned about the drawback of voting by cumulative method, voting by majority of the minority shareholders comes as an effective tool to combating the drawback of the prior method. Here only the minority shareholders will be entitled to vote and elect independent directors. Since there will be no participation of the majority shareholders, neither the management nor the majority shareholders will be able to influence the appointment. This method comes handy when the number of independent directors to be appointed are small in number. This will not only place accountability for the independent directors towards the minority shareholding but also will help in actual representation of the minority shareholders on the board of directors.

Process for renewal and removal-

The method for renewal of the independent directors should be same as that of the appointment mentioned in the above paragraphs. The process of removal should be given due importance because even after appointment of independent directors by minority shareholders the majority shareholders still have the power to remove them through simple removal voting, thus still having an influence. For this, the removal policy should be strict and one of the steps could be that independent directors can only be removed with a super majority like three-fourth or two-third majority of shareholders voting for the resolution. This makes sure that they are removed only in severe conditions and not just because they are not serving the interest of the majority shareholders.

The traditional method of nominating independent directors from personal connections should be done away with and rather be replaced with establishing a nomination committee to select independent directors on their merit and expertise. This step would be more effective in monitoring the management and also protecting the interest of the shareholder.[16] Further limiting the number of board positions held by an independent director will help them fulfilling their duties and providing meaningful decisions[17], this will encourage them to have sufficient time which they can dedicate to the company affairs. Companies can also look forward to adopt a flexible meeting arrangement thus, allowing more participation and retention of independent directors.[18] Introducing a performance-based compensation for the independent directors can be useful to improve corporate governance.[19] This can be done by linking a portion of their compensation to the company’s long-term performance thus, aligning their interest with that of the shareholders.

Conclusion

The role of independent directors in ensuring ethical business conduct and transparency, and thereby encouraging effective corporate governance, is undeniably of utmost importance. While the Online Proficiency Self-Assessment Test (OPSA) is designed to check the suitability of independent directors, its limitation hinders to achieve true independence in the board. In addition to the duties of directors, independent directors must have a special duty to protect the interests of the minority shareholders where such rights are obviously expected to come in conflict with the rights of the majority shareholder, as no such duty is mentioned in the current Indian law. Minority shareholders’ rights should be protected through monitoring by independent directors. Any breach of these duties should lead to appropriate remedies. Even though the law mandates the companies to maintain independent audit committee nothing has been said about establishment of independent nomination committee, which is one course of action suggested in the paper. In moving forward, a holistic approach that combines regulatory measure, participation of shareholders and merit-based appointments can contribute to a governance framework that would reflect the principle of transparency, accountability and ethical conduct.

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[1]SEBI | Corporate Governance in Listed Companies – Clause 49 of the Listing Agreement, Securities and Exchange Board of India, https://www.sebi.gov.in/legal/circulars/oct-2004/corporate-governance-in-listed-companies-clause-49-of-the-listing-agreement_13153.html (last visited Nov. 20, 2023).

[2] S. Bhagat & B.S. Black, The non-correlation between board independence and long-term firm performance, SSRN Electronic Journal (1998), doi:10.2139/ssrn.133808.

[3] L.D. Solomon, Restructuring the corporate board of directors: Fond hope: Faint promise?, 76 Mich. L. Rev. 581 (1978), doi:10.2307/1287821.

[4] R. Morck, Behavioral Finance in Corporate Governance – Independent Directors, Non-Executive Chairs, and the Importance of the Devil’s Advocate, NBER Working Paper No. 10644 (2004), http://www.nber.org/papers/w10644.

[5] L.D. Solomon, Restructuring the corporate board of directors: Fond hope: Faint promise?, 76 Mich. L. Rev. 581 (1978), doi:10.2307/1287821.

[6] C. F. Chou, Are Independent Directors Effective Monitors in Taiwan-A Theoretical Analysis, 8 NTU L. Rev. 49 (2013).

[7] A. Shivdasani & D. Yermack, CEO Involvement in the Selection of New Board Members: An Empirical Analysis, 54 J. Fin. 1829 (1999).

[8] S. Bhagat & B.S. Black, The non-correlation between board independence and long-term firm performance, SSRN Electronic Journal (1998), doi:10.2139/ssrn.133808.

[9] C.L. Wade, What Independent Directors Should Expect from Inside Directors: Smith v. Van Gorkom as a Guide to Intra-Firm Governance, [2006] SSRN.

[10] S. Bhagat & B.S. Black, The non-correlation between board independence and long-term firm performance, SSRN Electronic Journal (1998), doi:10.2139/ssrn.133808.

[11] W. Campbell, The Origin and Growth of Cumulative Voting for Directors, 10 Bus. Law. 3 (1955).

[12] J.N. Gordon, Institutions as Relational Investors: A New Look at Cumulative Voting, 94 Colum. L. Rev. 124 (1994) [hereinafter Gordon, Cumulative Voting].

[13] S. Bhagat & J.A. Brickley, Cumulative Voting: The Value of Minority Shareholder Voting Rights, 27 J.L. & Econ. 339 (1984).

[14] S. Bhagat & J.A. Brickley, Cumulative Voting: The Value of Minority Shareholder Voting Rights, 27 J.L. & Econ. 339 (1984).

[15] D.C. Langevoort, The Human Nature of Corporate Boards: Law, Norms and the Unintended Consequences of Independence and Accountability, SSRN Electronic Journal (2000), doi:10.2139/ssrn.241402.

[16] M. Bhaumik & V. Singh, The Role of Independent Directors in Corporate Governance: A Theoretical and Empirical Analysis, 19 Corp. Governance 476 (2007).

[17] S.K. Mittal & P.K. Jain, The Role of Independent Directors in Corporate Governance: A Study of Indian Companies, 13 J. Emerging Market Fin. 1 (2012).

[18] A.M. Abdallah & N.A. Wahid, The Role of Independent Directors in Corporate Governance: A Literature Review, 29 J. Accounting & Pub. Pol’y 369 (2010).

[19] S.K. Mittal & P.K. Jain, The Role of Independent Directors in Corporate Governance: A Study of Indian Companies, 13 J. Emerging Market Fin. 1 (2012).