Seminar Paper, 2010
34 Pages, Grade: A+
1. The Chinese concept of director independence
a. Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies (2001)
b. Other Rules and Initiatives
2. Historical background and objectives of the regulation
3. Experience, criticism and suggestions for improvement
1. The Indian concept of director independence
a. Desirable Corporate Governance: A Code (1998)
b. Listing agreement “Clause 49”
c. The Companies Act of 1956 and the Companies Bill 2009
d. Corporate Governance Voluntary Guidelines 2009
2. Historical background and objectives of the regulation
a. Internationalization of Indian corporations and the industry’s leading role in promoting good corporate governance
b. The rivalry between the regulators
c. SEBI’s initiative towards Clause 49
d. The MCA’s initiative towards a revision of the Companies Act 1956
3. Experience, criticism and suggestions for improvement
Appendix : Bibliography
The “independent director” has become a centerpiece of modern corporate governance. However, the concept of “independence”, and the ability of independent directors to fulfill their roles, remains deeply problematical.
No matter where their company is located, independent directors on the board of corporations can fulfill a number of objectives: In a widely held company they can be “shareholder champions”1 protecting all shareholders against opportunistic behavior of company management.2 In concentrated ownership structures they can protect minority shareholders against expropriation by the majority shareholder3 and thereby increase the value of minority stakes. Furthermore, independent directors might assist the state in monitoring the company’s compliance with law and public policy,4 and they can act as outside advisors to the company5 broadening the narrow view of inside directors who may be caught up in day-to-day management. In the course of the discussion on the proper role of independent directors that unfolded in Europe and the United States during the 1980s and 1990s and peaked in the wake of the Enron scandal, rules on director independence have found their way to the corporate governance regimes of developing countries that turned their head to western economies. Particularly in China and India, independent directors have taken their place on company boards, touching upon several of the aforementioned aspects and earning mixed responses from the academic and business community.
What is the current state of Indian and Chinese rules on director independence? What tensions do they address and create? And what can be done to optimize the achievement of their objectives? The goal of this article is to examine the status quo of director independence in the two countries, to put the regulations into their historic and political context, to summarize practical experiences with the new institution, and to point to possible future developments.
The Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies (hereinafter “the 2001 Guidelines”),6 issued on August 6, 2001, by the China Securities Regulatory Commission (CSRC) - the inventor of director independence in China7 - is recognized as the most important and influential measure taken so far by a Chinese regulator in the field of director independence.8
For Chinese listed companies, the 2001 Guidelines assign a minimum of one third of the board seats to independent directors9 and prescribe a comprehensive set of minimum10 independence criteria: An independent director must not be an employee or executive of the company and must have no relations to the company or its majority shareholder “that might prevent [the director] from making objective judgment independently";11 he or she must not hold more than five independent directorships at the same time.12 Basic legal knowledge, “[b]asic knowledge on the operation of listed companies”,13 and at least five years of relevant work experience14 are required. At least one independent director must be an accounting professional.15 An independent director may not hold a position in an affiliated enterprise and not be directly related or otherwise close (“major social relations”) to someone holding a position in the company or an affiliated company.16 Furthermore, providers of “legal or consulting services” to the company or its subsidiaries,17 the holders of more than one percent of the corporation’s shares or of shares in one of the company’s ten largest shareholders,18 and those who hold a position in one of the company’s five largest shareholders or in a holder of more than five percent of the company’s shares19 may not serve as independent directors. Finally, and perhaps most problematic, any person determined by the CSRC is excluded from the office of independent director.20
Generally, independent directors, are under a duty of “good faith and due diligence and care”, they are expected to be “especially concerned with protecting the interests of minority shareholders” and “shall not subject themselves to the influence of the company’s major shareholders, actual controllers, or other entities or persons who are interested parties.”21 Participation in trainings organized by the CSRC is required.22 Indirectly, the 2001 Guidelines also prescribe monitoring duties by asking the independent directors to “express the independent opinion” with regard to: appointment, dismissal and remuneration of directors and senior managers,23 major loans and other transfers of funds from the company to the majority shareholder, to another actual controller or to an affiliated enterprise,24 and, generally, “events that the independent directors considers to be detrimental to the interests of minority shareholders.”25
Independent directors are to be elected by the shareholders after nomination by the existing (entire) board, the supervisory board, or by one or more holders of more than one percent of the company’s shares.26 Between nomination and election, the candidature has to be approved by the CSRC.27 Independent directors may only be removed for “proper purpose”.28 Their unilateral resignation from office is dependent on another independent director coming in, if the number of independent directors would otherwise fall below the mandatory limit.29 The 2001 Guidelines seek to strengthen the independent directors’ position with “special powers” directly assigned to the individual independent director(s),30 rather than by mandatory independent committees with special competences:31 Major related party transactions should be subject to the independent directors’ approval;32 independent directors have the right to propose the appointment or removal of the accounting firm,33 to propose the calling of interim shareholders or board meetings,34 to “appoint the outside auditing or consulting organization independently”,35 to solicit proxies for a shareholders meeting,36 and the right to propose a postponement of a board meeting because of insufficient information in advance.37 Remuneration of independent directors, finally, is determined by the board and approved by the shareholders meeting.38 The 2001 Guidelines do not regulate certain mandatory or excluded elements or types of remuneration.
The general multitude of initiatives and sources of law in Chinese economic law39 is mirrored in the field of director independence by a high number of other laws, codes, guidelines, recommendations and standards with oftentimes unclear bindingness, limited effects in legal practice, and, generally, minor importance as compared to the 2001 Guidelines.
First, the CSRC itself has launched a number of other initiatives in the field of director independence: Three months after the publication of the 2001 Guidelines,40 the CSRC published its Code of Corporate Governance for Listed Companies in China.41 Unlike a stricter earlier draft42, the Code in its final version m]ostly tracks the rules of the 2001 Guidance Opinion, for example, by making minimum numbers of independent seats on the board dependent on “relevant regulations”43 and by degrading the installation of independent committees to a mere option, exercisable at the discretion of the entire board.44 Furthermore, its mandatory character is at least questionable.45
The CSRC Guidelines for Internal Controls for Securities Companies, the CSRC Guidelines for Internal Controls for Fund Management Companies, and the CSRC Measures on the Administration of Securities Companies,46 all issued in the course of 2001 and 2002, contain sector-specific rules on director independence.47 While the latter merely repeats a part of the independence requirements enacted in the 2001 Guidelines, the two other texts simply mention the need to “bring into full play the [monitoring] function of the independent directors.”48
(Banking) Sector specific guidelines have been issued by the People's Bank of China (PBOC): The Guidance on Independent Directors and External Supervisors of Joint-Stock Commercial Banks49 and the Guidance on Corporate Governance of Joint Stock Commercial Banks50, both published on June 4, 2002, are addressed to the banks under the PBOC’s jurisdiction. Like the 2001 Guidelines, the Guidance on Corporate Governance notes the role of independent directors as protectors of minority shareholders.51 Furthermore, independent directors are expected to protect depositors and notify the PBOC of illegal behavior of the bank’s directors or employees.52 The standards set by the Guidance on Independent Directors also overlap in part with the 2001 Guiding Opinion.53 Some passages, however contain stricter rules, like the requirement that one shareholder may not nominate more than one independent director,54 that all independent directors must be financially literate,55 and that a proposal to dismiss an independent director requires a two-third majority vote of the supervisory board.56 The precision of the two texts suggest a binding character, notwithstanding the ambiguous titles.
Contributions to independent director rules also come from the two major Chinese stock exchanges - in the form of Draft guidelines on corporate governance for listed companies (Shanghai Securities Exchange, 2000), Guidelines for the Implementation of an Independent Director System in Listed Companies, and an Instruction on Building Trust by Companies Listed on the Shenzhen Stock Exchange Small and Medium-Sized Enterprises Board (both Shenzhen Securities Exchange, 2001 and 2004) - and from provincial and municipal governments. The texts’ lack of bindingness, precisely formulated requirements and definitions of crucial term, however, prevent them from exercising a meaningful influence.57
Remarkably, the Company Law of the People’s Republic of China, even after the 2005 revision,58 does not contain any significant rules on director independence. The only relevant provision leaves “concrete measures” (particularly, a definition of independence) to the State Council while simply noting that “a listed company shall have independent directors.”59
The appearance of independent directorships as a separate concern of Chinese corporate governance regulation coincides with the enactment of the first securities laws in 1997 regulating the two first internationally significant Chinese stock exchanges in Shanghai and Shenzhen.60 Since then, the Chinese securities markets have mainly served as a means for the government to diversify the capital basis of former state-owned enterprises which went public by reorganizing themselves into joint stock companies.61 Even after taking the entity public, however, the state mostly did not surrender control of the entity to a widely dispersed body of shareholders. Instead, because of both majority ownership of shares and a privileged class of “state shares”, it is only the legal basis of state domination over the enterprises that changed from public law regulation to private shareholder rights,62 leaving behind an extraordinarily high degree of concentrated ownership of Chinese listed companies: In 2001, a study revealed that 84,1% of all listed companies were, directly or indirectly, under state control,63 and still today, the state and its role in the Chinese securities market is, figuratively, described as an “800 pound gorilla in the room”.64
The price that China pays for this structure is a comparatively poor stock market performance and exploitation of minority shareholders by the majority shareholder: Between 2001 and 2005, the “Shanghai and Shenzhen indexes were the world's worst-performing markets out of 77 major benchmarks”65 while the overall growth rate of China’s economy was accompanied by a considerable decline in the aggregate market capitalization of Chinese listed companies.66 The following sharp rise of Chinese stock prices was characterized as “overheated”67 and “more of a roulette wheel”68 even before the worldwide economic downturn surfaced in the second half of 2007. Moreover, majority ownership in China is said to be frequently abused to manipulate financial reporting and to strip the company of important assets.69
The primary objective of the aforementioned regulation to install a “minority shareholder champion” is, therefore, understandable. The majority shareholder’s dominant influence should be restrained, and the corporation and its minority shareholders should be protected from expropriation by the controlling shareholder.70 Related to this and sometimes mentioned as a separate objective are the monitoring of related-party transactions by independent directors71 and the general introduction of “internationally accepted business practices” to the Chinese stock market.72
Other problems and tasks independent directors are supposed to take on include the reduction of corruption,73 prevention of corporate scandals74 and, more generally, serving of the financial market performance is also reported by Cindy A. Schipani, Junhai Liu, Corporate Governance in China: Then and Now, 2002 Colum. Bus. L. Rev. 1, 67-8 (explicitly attributing it to corporate governance shortcomings).
1 Edward B. Rock, The Logic and (Uncertain) Significance of Institutional Shareholder Activism, 79 Geo. L.J. 445, 505-6 (1991) (skeptic about the fulfillment of this promise).
2 Donald C. Clarke, Three Concepts of the Independent Director, 32 Del. J. Corp. L. 73, 81-2, 84 (2007).
3 Clarke, supra note 2, at 80, incl. n.32.
4 Clarke, supra note 2, at 83.
5 Clarke, supra note 2, at 81.
6 English version available at http://www.csrc.gov.cn/n575458/n4001948/n4002030/4064492.html.
7 The CSRC Guidelines for the Articles of Association of Listed Companies of 1997, followed by the Opinion on
Further Promoting the Standard Operation and Deeper Reform of Companies Listed Overseas - jointly issued by the CSRC and the State Economic and Trade Commission (SETC) in 1999 - and by the Draft Rules for Companies Seeking Listing on a Secondary Board (2000) were the first examples of Chinese regulatory activity in the field of director independence; see Donald C. Clarke, The Independent Director in Chinese Corporate Governance, 31 Del.
J. Corp. L. 125, 183-6 (2006); Chi-Wei Huang, Worldwide Corporate Convergence Within a Pluralistic Business Legal Order: Company Law and the Independent Director System in Contemporary China, 31 Hastings Int’l & Comp. L. Rev. 361, 410-4 (2008).
8 Clarke, supra note 7, at 190 (“most comprehensive measure taken to date by the [CSRC] - or indeed, by any
Chinese governmental authority - to regulate internal corporate governance through the institution of the
independent director”); Chi-Wei Huang, supra note 7, at 416; Jie Yuan, Formal Convergence or Substantial
Convergence? Evidence from Adoption of the Independent Director System in China, Asian-Pac. L. & Pol’y J. 71, 75 (2007).
9 Guiding Opinion on establishing the Independent Director Institution in Listed Corporations, section I.3.
10 The Guidelines occasionally allow for the corporation to heighten the independence criteria and duties in their articles of incorporation; see, e.g., sections II.5., III.6., VI.1.f.
11 Id., section I.1.
12 Id., section I.2.
13 Id., section II.3.
14 Id., section II.4.
15 Id., section II.3.
16 Id., section III.1.
17 Id., section III.5.
19 Id., section III.3.
20 Id., section III.7.
21 Id., section I.2.
22 Id., section I.5.
23 Id., section VI.1.a.-c.
24 Id., section VI.1.d.
25 Id., section VI.1.e.
26 Id., section IV.1.
27 Id., section IV.3.
28 Id., section IV.5.
29 Id., section IV.6. For a practical example of the consequences of this condition, see below note 88.
30 It is not one hundred percent clear from the text of the Guidelines whether the special powers are assigned to the independent directors as a collective body or to each director individually. In any event, the special powers require the consent of more than 50 percent of all independent directors to be exercised, section V.2; with regard to a proposed postponement of a board meeting, two independent directors are enough, section VII.1.
31 The remuneration, auditing and nomination committees have to be comprised of at least 50 percent independent directors; however, the board does not have to install them; section V.4 (“…if such committees are set up.”)
32 Id., section V.1.a.
33 Id., section V.1.b.
34 Id., section V.1.c. and d.
35 Id., section V.1.e.
36 Id., section V.1.f.
37 Id., section VII.1.
38 Id., section VII.5.
39 See the critical remarks by Stanley Lubman, Looking for Law in China, 20 Colum. J. Asian L. 1, 33-6 (2006) (“extraordinary disorder among law-making and rule-making institutions”).
40 The year of publication indicated on the cover of the Code (“January 7, 2001”) is obviously a typographical error since the document is published under “No. 1 of 2002” in the official collection of the CSRC. See also Clarke, supra note 7, at 189.
41 English version available at http://www.ecgi.org/codes/documents/code_en.pdf; identical to the “Principles of Corporate Governance for Chinese Listed Companies” cited by Chi-Wei Huang, supra note 7, at 418.
42 See Clarke, supra note 7, at 189.
43 Code of Corporate Governance for Listed Companies in China, section 49. The analyis of Chi-Wei Huang, supra note 7, at 419 (“[A]t least half of the directors should be independent…”), is not supported by the text of the Code.
44 Id., section 52. The comment of Clarke, supra note 7, at 190 (“[B]oards are required to establish certain committees…”) is not supported by the text of section 52 (“The board … may establish…”).
45 See Code of Corporate Governance for Listed Companies in China, Preface (“Listed companies shall act in the
spirit of the Code in their effort to improve corporate governance.”), and Clarke, supra note 7, at 189, n.239 (citing to several Chinese sources).
46 No English versions available.
47 Clarke, supra note 7, at 186-8; see also Chi-Wei Huang, supra note 7, at 415-6 (referring to the draft).
48 Clarke, supra note 7, with references to the official Chinese texts.
49 English version available at http://www.pbc.gov.cn/english//detail.asp?col=6800&ID=41. Identical to the “Commercial Bank Independent Director Guidelines” cited by Clarke, supra note 7, at 181-3.
50 English version available at http://www.pbc.gov.cn/english//detail.asp?col=6800&ID=42. Identical to the “Commercial Bank Corporate Governance Guidelines” cited by Clarke, supra note 7, at 181.
51 Guidance on Corporate Governance of Joint Stock Commercial Banks, art. 30.
52 Id., arts. 30, 31.
53 E.g., the requirement to possess relevant work experience and basic legal knowledge (Guidance on Independent
Directors and External Supervisors of Joint-Stock Commercial Banks, art. I, No. 2, 3) and the exclusion of holders of more than one percent of the company’s shares from the office of independent director (art. II.).
54 Id., art. VIII, para. 2.
55 Id., art. I, No. 4.
56 Id., art. XV.
57 For an overview of the several codes and recommendations and their respective shortcomings, see Clarke, supra note 7, 176-80.
58 English version available at
59 The Company Law of the People’s Republic of China (2005), art. 123. 7
60 Hua Cai, Bonding, Law Enforcement and Corporate Governance in China, 13 Stanf. J. L. Bus. & Fin. 82, 84;
Xiaoli Wan, Zhixiong Zeng, Understanding the Recent Performance of China’s Stock Market, p. 8, Research Paper, China Center for Economic Research, Peking University (2007), available at
http://faculty.ccer.edu.cn/zxzeng/paper/China-stock-market.pdf; incorrect Chi-Wei Huang, supra note 7, at 411 (“In August 1997, the State Council decided to establish the securities exchange markets in both Shanghai and Shenzhen…”).
61 See Hua Cai, supra note 60, at 85, citing to a Chinese source (“[T]he purpose of establishing a stock market was threefold: first, to raise capital for the development of China’s state-owned-enterprises (SOEs); second, to facilitate the reconstruction of SOEs; and, finally, to help improve the corporate governance of the SOEs that are listed.”).
62 For an analysis of the capital structure of Chinese joint stock companies, see Clarke, supra note 7, at 132-3.
63 Gui S. Liu, Pei Sun, Identifying Ultimate Controlling Shareholders in Chinese Public Corporations: An Empirical Survey, pp. 7, 8, Chatham House, Asia Programme Working Paper No. 2 (2003), available at http://www.chathamhouse.org.uk/files/3096_stateshareholding.pdf. On the other hand, concentrated ownership by natural persons is “virtually unknown” in China; Clarke, supra note 7, at 139.
64 Matthew Weinstein, The Independent Director Requirement and its Effects on the Foreign Investment Climate in China: Progress or Regress?, 4 Bus. L. Brief (Am. U.) 35, 35 (2008). Rather misleading in this context Jiong Deng, Building an Investor-Friendly Shareholder Derivative Lawsuit System in China, 46 Harv. Int'l L.J. 347, 348 (2005) (backing up his claim, that the “most striking” feature of Chinese capital markets “is the dominance of individual investors”, only with data on trade activity).
65 The Standard Finance, Beijing to allow short selling, margin trade, July 3, 2006, available at
http://www.thestandard.com.hk/news_detail.asp?pp_cat=22&art_id=22054&sid=8679952&con_type=1. Poor 8
66 Hua Cai, supra note 60, at 85.
67 Xiaoli Wan, Zhixiong Zeng, supra note 60, at 8 (rather with regard to the anticipated future development of the market than to its then current state).
68 Hua Cai, supra note 60, at 85 (citing to an article of the Wall Street Journal from March 2007).
69 Hua Cai, supra note 60, at 85-6; Clarke, supra note 7, at 142; Chenxia Shi, Protecting Investors in China Through Multiple Regulatory Mechanisms and Effective Enforcement, 24 Ariz. J. Int’l & Comp. L. 451, 452 (2007); Chao Xi, In Search of an Effective Monitoring Board Model: Board Reforms and the Political Economy of Corporate Law in China, 22 Conn. J. Int'l L. 1, 30 (2006); OECD, Overview of Governance of State-owned Listed Companies in China, 2005, p. 9, available at http://www.oecd.org/dataoecd/14/6/34974067.pdf.
70 Hu Cai, supra note 60, at 91-2 and 95-7; Clarke, supra note 7, at 148-50; Minkang Gu, Will an Independent
Director Perform Better than a Supervisor? Comments on the Newly Created Independent Director System in the People’s Republic of China, 6 J. Chinese & Comp. L. 59, 60 (2003); Chi-Wei Huang, supra note 7, at 405-6; Sibao Shen, Jing Jia, Will the Independent Director Institution Work in China?, 27 Loy. L.A. Int’l & Comp. L. Rev. 223, 225 (2005); Noëlle Trifiro, China’s Financial Reporting Standards: Will Corporate Governance Induce Compliance in Listed Companies?, 16 Tul. J. Int’l & Comp. L. 271, 287-8 (2007); Weinstein, supra note 64, at 37; Jie Yuan, supra note 8, at 76-7; see also the explicit notion of minority shareholder protection in the 2001 Guiding Opinion, section I.2., and in the 2002 Guidance on Corporate Governance of Joint Stock Commercial Banks, art. 30.
71 Hu Cai, supra note 60, at 118; Clarke, supra note 7, at 172 (citing to Chinese sources).
72 Cie Yuan, supra note 8, at 79; but see Clarke, supra note 7, at 216 (who, strangely, cites the possibility “that stock prices […] already reflect a discount for expected abuse” as a reason why director independence might not work in China).
73 Clarke, supra note 7, at 168 (citing to a Chinese source); Shen and Jia, supra note 70, at 233 (citing the example of a deputy director of a district prosecutor’s anti-corruption bureau being appointed as an independent director); Weinstein, supra note 64, at 37.
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