Independent Director

Updated on March 21, 2024
Article bySourav Sinha
Edited bySourav Sinha
Reviewed byDheeraj Vaidya, CFA, FRM

Independent Director Meaning

An independent director refers to the board member, not the organization, and helps share a neutral opinion as they are not attached to the existing management. Their primary role includes  setting top executive remuneration, assessing any situation related to the corporate finance decision making. They also play an important role in managing and controlling conflicts in the organization.

Independent Director

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Independent Director (wallstreetmojo.com)

Thus, they are not directly related to the operation of the entity but help the entity in improving its standards and overall performance for the stakeholders’ benefit. They give an independent judgement regarding any issue. They should also be up-to-date with the company activities to act in accordance with the best interest of the organization.

Key Takeaways

  • An independent director is a board member who provides an impartial opinion as they are not part of the company’s existing management. 
  • • The key responsibilities of independent directors include setting executive compensation, providing expert advice on financial matters, and resolving conflicts between different parties. 
  • When making decisions, independent directors must also consider Environmental, Social, and Governance (ESG) factors.
  • Independent directors are appointed based on expertise, experience, and qualifications. The presence of independent directors on the board is an important factor in ensuring transparency and accountability. Independent directors can check the management’s decisions and help maintain the company’s reputation.

Independent Director Explained

Independent directors are the part of the board who do not have any direct relation with the daily operations of the company. However, they give an unbiased and independent assessment regarding any issue, problem or conflict related to different areas of the entity’s corporate structure.

The appointment of independent director is important because they act as a guide for the business, improving the corporate governance standards, quality of the process, credibility and accountability towards stakeholders. They also provide their valuable expertise in managing risks at various levels of the organization.

Regarding the independent director eligibility, an individual can be an independent director in up to seven listed entities at the same time. They will not retire by rotation and cannot be included a part of the total directors to facilitate computation of rotational directors.

Thus these kinds of senior independent director are essential in an organization. The board is the decision maker related to any company issue and needs to have enough expertise, experience, skill, and knowledge to handle any situation. This is important so that all stakeholders are satisfied with the company’s performance and can retain their faith which is the foundation of the entity’s growth and expansion.

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Example

Robert M. Kimmitt has served as the lead independent Director for Facebook since March 2020. Before this, Kimmitt has served in several crucial roles, such as Senior International Counsel at Wilmer Cutler Pickering Hale and Dorr LLP, since April 2009. In addition, he had several other associations before that. So, this is chosen as per experience and skill.

Role

Let us look at how the appointment of independent director will facilitate the working of the organization.

  • The most important role is to help set the remuneration of top company executives. It is proven that chief executives of listed companies are highly overpaid. So, this tries to take a neutral decision regarding the correct pay structure.
  • They must provide an unbiased judgment regarding important corporate finance decisions. Also, they should always keep shareholders’ benefits in mind before deciding. Economic, Social, and Governance (ESG) factors must also be considered while making decisions.
  • Act as a middle person between the management and the shareholders. Play an active role in controlling conflicts between the two parties.

Duties

Let us look at the independent director responsibilities and duties in an organization.

The above mentions details point out the independent director responsibilities.

Benefits

Given below are some usefulness of appointment of independent director in the organization.

  • They help guide the organization with the expertise and skill set they have earned over the years. The expertise provide them the necessary ideas and a good understanding of the current condition and take decisions accordingly.
  • They serve as a middle man between the shareholders and management and help resolve conflicts. Again their experience helps them to easily identify the problems and develop a proper solution to settle the same.
  • The senior independent director keeps the top-level executives’ remuneration of the top-level executives as per the industry standards. It is crucial because proper payment will instigate the executives to work to their optimum capacity and learn better ways to increase and optimize their output.
  • They also act as an external auditor and try to find accounting frauds, if any, so that the financial reports display an accurate and fair view of the company’s current financial condition. Again, this is important for the stakeholders interested in the entity’s growth and expansion.

Limitations

  • Often, it is seen that these directors serve as members of several boards. So, they tend to lose efficiency as they do not get time to understand the company’s structure in detail and cannot make an informed decision.
  • Internal management is more aware of the employees of the company and the related parties. So, if an independent director without proper knowledge of the circumstances tries to pass judgment, it will be difficult for the management to run the company.
  • Often, it is seen that in difficult times, these directors quit as they do not want to be involved in legal proceedings. . This might put the company is a difficult situation and the problems might go out of hand without proper and experienced guidance.

Independent Director Vs Non-Executive Director

A  Non-Executive Director Non-Executive DirectorThe non-executive director (NED) is an external member of the company’s board of directors appointed through a letter of appointment and they represents the shareholders interest.read more is a director who is not an organization employee. On the other hand, an independent director is not an organization’s employee but is bound by several other requirements.

 The former cannot hold shares of the organization, whereas the latter can be a shareholder of the organization. There is no such rule for non-executive directors that they are not permitted to buy the company’s shares. .

All independent directors are non-executive, but all non-executive directors are not  same as independent directors. .

Frequently Asked Questions (FAQs)

1. What is the difference between independent directors and other directors?

Independent directors are non-executive directors with no material or pecuniary relationships with the company or its promoters. On the other hand, other directors may include executive directors who are actively involved in the company’s management and non-executive directors who may have material relationships with the company or its promoters.

2. How does an independent director provide a neutral perspective in the decision-making process?

Independent directors provide a neutral perspective in decision-making by bringing a fresh and unbiased outlook to the board. They are expected to provide a balanced viewpoint on matters such as strategy, risk management, and corporate governance. Their independence from the management and promoters of the company allows them to make decisions in the best interests of all stakeholders.

3. Can an independent director be held liable for any misconduct or illegal activities of the company?

Independent directors can be held liable for any misconduct or illegal activities of the company if they are found to have been aware of or complicit in such activities. However, they are expected to exercise their duties in good faith and with due care and diligence and can only be held liable if they breach their fiduciary duties.

Recommended Articles

This article is a guide to Independent Director and its meaning. We explain its role, duties, differences with non-executive directors, examples & benefits. You can also learn more about it from the following articles: –