Independent Directors' Roles in Banks

Introduction

Independent directors are viewed to be a solution to various governance issues and agency conflicts, as they act as the fiduciaries of the shareholders and provide oversight over the actions and decisions of the management. In the last decade, in the aftermath of the financial crisis, the role of independent directors in attaining effective decisions without undue managerial influence has gained significant attention. Indeed, most of the regulatory guidelines worldwide require the board to be composed of at most the majority of independent directors. However, the task of defining independent directors has always remained challenging. The most usual way to categorize independent directors is any person who does not have any material relationship with the organization, other than being its director. However, this definition has evolved over a period of time. For instance, according to Clause 49 of SEBI, an independent director “is a person who apart from receiving remuneration, does not have any material pecuniary relationship or transactions with the company, its promoters, its management, or its subsidiaries, which in the judgment of the board may affect the independent judgment of the director”. The requirements prescribed under the Companies Act 2013 seem to be much more stringent than that of the listing agreement as it incorporates various factors, including education, expertise, and voting power, among others to categorize the independent director.

The empirical literature also seems to be burgeoning on analyzing the efficacy of independent directors in mitigating agency conflicts. It is asserted that there exist strong incentives for independent directors such as signaling their reputation and competence to make decisions independently (Johnson et al., 1996; Dalton et al., 1998; Hermalin & Weisbach, 2003). Additionally, independent directors have greater contact with outside resources, which might aid them in attaining their goals (Johnson et al., 1996). Nevertheless, there is no consistency in the relationship between independent directors and bank performance. For instance, Bhatia and Gulati (2020), Nyamongo and Temesgen (2013), Liang et al. (2013), Dong et al. (2017) concluded a positive impact, while Aebi et al. (2012), Pathan and Faff (2013) and Mollah and Zaman (2015) found a negative impact of independent directors on the bank performance.

In this context, the literature highlights the role of different institutional settings (Van Essen et al., 2012; Kumar & Zattoni, 2013; Sheikh et al., 2018) and different measures of performance and independent directors (Bhatia & Gulati, 2021). But another plausible reason for this inconsistency can be the “multiple directorships held by independent directors”. It is asserted that different characteristics of independent directors moderate their impact on the bank decisions (Sharma, 2011; Ferris et al., 2003). The role of busy directors has indeed become a matter of debate in recent years and seeks attention from researchers to empirically assess their impact on various firm outcomes. On the positive side, it is argued that holding directorship in multiple boards provides a certification to the directors of their efficiency in monitoring and advising (Fama & Jensen, 1983), which is referred to as the “reputation hypothesis”. Therefore, they exert a positive influence on the firm monitoring and supervisory outcomes. On the negative side, busy directors are likely to be over-committed and would devote lesser time and effort to monitoring management (Fahlenbrach et al., 2010), referred to as the “busyness hypothesis”. Therefore, busy directors adversely affect the supervisory outcomes.