Independent Directors and Auditors; sans Independence!

A refined definition of independence classifies an outside director as independent when he has not engaged in business or professional activities associated with the company and has no personal relationship with insiders including CEO or controlling shareholders. Otherwise, the director is classified as friendly. Auditor independence is commonly referred to as the cornerstone of the auditing profession since it is the foundation of the public’s trust in the accounting profession. The many accounting scandals since 2000 have negatively affected the public perception of auditor independence.

In theory, Independent directors are supposed to be free to dissent from a decision of the majority. The reality is more complex. Directors are connected to one another by business and social connections. This often directs behavior in line with their relationships, more than their concern for the company.

When an audit firm partner serves on a Board or acts as a Consultant to avoid the conflicts arising from being named as a director, he or she is in a business and professional relationship with the board members. If so, how can any of them be an auditor of another company in which such friendly acquaintances serve? Wouldn’t that make the audit partners concerned non-independent? Vice versa, they should be named non independent directors, due to their other professional relationship with the board members’ company.

Corporate governance is about how you ingrain your values and principles into every aspect of doing business. Most independent directors are ‘independent’ from a legal standpoint, however, independence in substance is a different ballgame. The same applies to the auditors too, specially the ones who hob nob with boards in the capacity of directors or consultants paid by the company. Some may argue on the fine line between independent consultant, acquaintance and being friendly.

The value of a good independent director accrues from persons who can challenge the majority and thereby improve the overall functioning of a board. If so, can the so called Consultant or dIrector who is also the auditor of another company related to the board members challenge the majority or dissent for the benefit of the company, without losing independence due to his complex relationships?

Hope readers think that this topic requires more deliberation.


About surenraj

“Views expressed are my own”
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