Board Independence And Financial Distress: Insights From India
Authors: Jhunjhunwala Nandini 
Published: October 2024

Resource Dependency Theory (RDT) posits that organizations depend on external resources to navigate uncertainty and sustain growth, with independent directors in corporate governance acting as key intermediaries, providing expertise, external networks, and strategic oversight. This study employs Panel [Random Effect (RE)] regression to analyze the impact of independent directors on the financial distress likelihood of 20 manufacturing companies listed on the NSE over the period 2019–2024. The findings reveal that firms with a higher number of independent directors exhibit a significantly higher risk of financial distress, reinforcing the notion that these directors aggravate financial vulnerabilities and enhance organizational instability. Background: Corporate frauds like the Satyam and Nirav Modi-PNB scandals highlight the severe consequences of deceptive practices, undermining financial markets and stakeholder trust. These incidents exposed vulnerabilities in governance and risk management, prompting regulatory reforms in India. Weak corporate governance facilitates fraud by allowing insufficient oversight and accountability. Recent reforms under the Companies Act, 2013, and SEBI's regulations aim to enhance transparency and reduce fraud risks. Strong corporate governance would be critical for financial stability, investor confidence, and achieving the "2047 Viksit Bharat" vision. Research explores how independent directors influence the likelihood of financial distress. Materials and Methods: This study investigates financial distress in manufacturing firms listed on the National Stock Exchange (NSE) through a panel data methodology. A random sample of 20 firms was selected to ensure representativeness, covering the period from 2019 to 2024, with banks and financial institutions excluded due to their distinct financial characteristics. Financial distress was assessed using the Altman Z-score, a widely recognized metric for evaluating financial distress. The independent variable in the study is Board Independence, i.e., the total number of independent directors on the Board. The control variables include Profitability, Leverage, and Activity. Panel data estimation techniques were used to address issues of endogeneity and heteroscedasticity. The Hausman test was conducted to determine whether to retain fixed or random effects for the analysis. Results: The Hausman test showed a p-value of 0.0.78 (greater than 0.05) which revealed that that random effect model is appropriate for the analysis. The analysis reveals a negative relationship between board independence and financial distress, indicating that an increase in the number of independent directors is associated with a higher likelihood of financial distress at 5% level of significance. Leverage significantly increases the likelihood of financial distress, while increased operational activity decreases it; Net Profit Margin is statistically insignificant. Conclusion: This finding challenges the conventional understanding of board independence, which is generally seen as a mechanism to enhance corporate governance by providing unbiased oversight, strategic guidance, and external resources