Adverse effects of enhanced board independence in the context of concentrated ownership among Indian firms

Independent Directors (IDs) often refrain from dissenting on board proposals or adequately scrutinizing the actions of controlling shareholders to secure their board appointments or maintain personal connections with them. Our analysis shows that when controlling shareholders can influence ID appointments, they will use it to appoint IDs with reciprocal tendencies. We show that when reciprocity-inclined IDs are appointed, increasing the number of IDs on boards worsens the protection of minority interests rather than improving it. Following a game theoretical framework, we examine the interactions between controlling shareholders and reciprocity-inclined IDs to develop an empirically testable hypothesis. We investigate the equilibrium solution of the game on a large sample of Indian listed companies and make a case for prioritizing the quality of independence over merely emphasizing numerical independence. Indian regulators have acknowledged their inability to ensure effective supervision by IDs despite substantial regulatory reforms. We recommend refining the definition of IDs in India to exclude candidates who have served on the board of a related company, strictly prohibit board interlocks, and ensure that IDs are appointed solely through voting by minority shareholders.