Artificial Intelligence - A Friend Or Foe In Good Corporate Governance
Author: LawSphereX
Category: Corporate & Insolvency
Published:
Updated:
ARTIFICIAL INTELLIGENCE: A FRIEND OR FOE IN GOOD
CORPORATE GOVERNANCE
Arshit Srivastava, ICFAI Law School, Hyderabad Harsh Sinha, ICFAI Law School, Hyderabad Introduction In today's complex business environment, boards of directors struggle with fragmented policies, unstable economic conditions, and growing shareholders' demands. These aspects necessitate a wider variety of information and experiences for well-informed decision-making, but dealing with these difficulties has made the process more dynamic and demanding. Boards believe that implementation of advanced technologies can be a way around. Hence, in order to synthesize complex information and find the best answers, boards adapt and accept cuttingedge technologies that address the complex elements at hand and make well-informed decisions that are in line with the desires of all concerned parties.
1 The former Chief Justice of India, Dipak Mishra, said, “The future of any new-age technology lies in the regulations that govern them. Artificial Intelligence (AI) promises a high growth potential in a number of sectors,” at the first International Conference on Law and Regulation of Artificial Intelligence. 2 Artificial intelligence has transformed human dialogue and decision-making, infiltrating our daily lives in numerous ways, from weather forecasts to genomic mapping. However, the integration of AI in the corporate world remains uncertain, particularly at a time when the importance of good corporate governance is emphasized. AI and algorithms are transforming how firms operate and reshaping many elements of corporate operations. The consequences of AI implementation, such as its impact on decision-making processes and interactions, raise ethical and privacy concerns.
Corporate governance becomes paramount in ensuring responsible AI utilization, striking a balance between its benefits and potential risks. Robust governance mechanisms, encompassing risk assessments, ethical guidelines, and continuous 1 OECD, The Impact of the Coronavirus (COVID-19) Crisis on Development Finance, OECD Policy Responses to Coronavirus (2020), https://www. oecd. org/coronavirus/policy-responses/the-impact-of-the-coronaviruscovid-19-crisis-on-development-finance9de00 b3b/. 2 Suranjali Tandon, Covid-19 and Dividends in India: To Distribute or Not to? ,BloombergQuint (Apr. 20, 2020), https://www. bloombergquint. com/coronavirus-outbreak/covid-19-and-dividends-in-india-to-distribute-or-not-to.
monitoring, enable organizations to harness AI's potential while mitigating associated pitfalls. By promoting responsible AI use, corporations can foster shareholder trust, drive innovation, and achieve sustainable growth in the modern business landscape. 3 These new technologies have the ability to either allow for wholly algorithm-controlled enterprises or merely increase operational effectiveness. AI integration in boardrooms has the potential to enhance directors' responsibilities and benefit shareholders significantly. Businesses may access new levels of innovation and efficiency by utilizing AI, ushering in a new era of wise decision-making and transforming corporate governance. 4 The Onus of Directors Corporate law grants companies certain unique characteristics, one of which is the notion of separate legal personality.
This concept establishes that a company possesses its own distinct identity, separate from its managers, employees, and shareholders. Although a company is recognized as a legal entity, it is an artificial construct without a physical existence or independent consciousness. Hence, it requires a human agency to operate effectively. This leads to the delegation of management responsibility to a Board of Directors elected by the shareholders. The Board of Directors plays a crucial role in decision-making and governance, as they are granted fundamental authority to oversee the company's affairs. Given their responsibility for managing the company's day-to-day operations, the decisions made often involve complexities. 5 As per Companies Act, 2013 (Act), section 2(10) provides for a Board of Directors. This board is responsible for all the functioning of the company.
Directors, as defined under section 2(34), are persons appointed by the board of the company. The Government of India issues a Director Identification Number (DIN) for being appointed as a director. Here, although the Act does not explicitly lays down any qualifications for the appointment of a director, the fact that the Act expressly specifies that only an individual may be named as a director precludes the induction of an AI director into the boardroom. In order to have the rights of decision-making, one must abide by section 166 of the act, which provides for the Duties of directors. 3 Rongeet Poddar, The Prospect of AI in the ‘Virtual’ Corporate Boardroom, India Corp. L. (May 12, 2020), https://indiacorplaw. in/2020/05/the-prospect-of-ai-in-the-virtualcorporate-boardroom. html. 4 Barry Libert et al. , AI in the Boardroom: The Next Realm of Corporate Governance, MITSloan Mgmt. Rev.
(Oct. 19, 2017), https://sloanreview. mit. edu/article/ai-in-the-boardroom-the-next-realm-of-corporategovernance/.
5 James Manyika et al., What Do We Do about the Biases in AI?, Harv. Bus. Rev. (Oct.25, 2019),
https://hbr.org/2019/10/what-do-we-do-about-the-biases-in-ai
As per Section 166(3), A director of a company shall exercise his duties with due and reasonable care, skill, and diligence and shall exercise independent judgment. This mere statement excludes the possibility of inclusion of AI in the board room at the same level as of a Director. Methods of Inducting AI Delegatus non-protest delegare notion has a lot of ascendancy over the Board of Directors in India. According to this rule, once a person has been given the power to make decisions by a higher authority, that person cannot further delegate the power unless specifically authorized by the original delegation. According to Section 179(3) of the Act, the Board of Directors may assign authority by passing a resolution at a board meeting.
Only after this authority may be delegated to the managing director, manager, any other firm major officer, or the chief executive officer of a branch office. However, if taken literally, neither machines nor artificial intelligence (AI) can be classified as pertaining to any of the aforementioned groups. The Act stipulates in Section 152 that a person or group of people must be designated as directors. As a result, it does not appear practical to use AI for the delegation of decision-making power. At present, there are three ways to include AI in boardrooms: Assisted, Augmented, and Automated. The allocation of decision-making authority between humans and machines is where these strategies diverge. Answering the basic question of whether AI should be used to support, supplement, or completely replace human decision-making can help you choose the correct implementation.
Assisted Assisted intelligence functions within well-defined input-output constraints and depends on ongoing human input and intervention. Its primary goal is to improve people's and organizations' current practices. While assisted AI can offer facts and insights. End users have the final say in all decisions. 6 In a model with assisted AI, specific operations could be delegated to AI to support the Board of Directors' decision-making. This approach makes sure that the AI's function is assisting rather than independent and that human directors continue to be in charge of making the final decisions. 7 6 Kimberley Mok, MIT’s New AI Data Extraction System Teaches Itself by Surfing the Web, The New Stack (Jan. 11, 2017), https://thenewstack. io/mits-new-ai-data-extraction-system-teaches-surfing-web/.
7 Allison Ryder, Augmentation Versus Automation: AI’s Utility in the Workplace, MITSloan Mgmt. Rev. (June 19, 2017), https://sloanreview. mit. edu/article/augmentation-versus-automation-ais-utility-in-the-workplace/.
Augmented Augmented intelligence refers to collaborative decision-making between humans and machines. Machines, through the usage of advanced analytics and visualization tools, generate detailed suggestions for humans to make prompt decisions. Unlike assisted intelligence, which is limited to applying predetermined solutions through pattern recognition, augmented intelligence employs both pattern recognition and model building. Simply put, it combines data and knowledge to propose new solutions. 8 Automated Autonomous intelligence is regarded to be the most advanced form of implementing an AI model. Here, the AI takes over all the powers along with the decision rights and operates without any human intervention. It is programmed to produce the information in such a way that the machines function independently, without the need for human interference.
9 Acceptance of AI by Other Jurisdictions: A Closer Look Across various jurisdictions, company directors are obligated to uphold a duty of care. In Australia, as per section 180 of the Corporations Act, directors and officers of a corporation must exercise their powers and fulfill their duties with the level of care and diligence that a reasonable person would apply in the same circumstances if they were holding the same position and responsibilities within the corporation. In essence, directors are expected to act prudently and diligently, considering the best interests of the corporation and the responsibilities associated with their specific roles. Under Hong Kong's Companies Ordinance, section 465 establishes the duty to exercise reasonable care, skill, and diligence for company directors.
Along similar lines, the Company Law of China, specifically Article 147, provides that directors, supervisors, and senior managers carry the responsibilities of loyalty and diligence toward the company. Article 147 establishes two fundamental duties for directors and other managerial personnel: the duty of diligence and the duty of fidelity. Directors and managerial staff are expected to exercise
8 Derek Rice, Assisted Intelligence vs. Augmented Intelligence and Autonomous Intelligence, FedTech
Magazine (Jan. 21, 2020), https://fedtechmagazine.com/article/2020/01/assisted-intelligence-vs-augmentedintelligence-and-autonomousintelligence-perfcon 9 Preetipadma, How are Assisted Intelligence and Augmented Intelligence Different?, Analytics Insight (July 29, 2020), https://www.analyticsinsight.net/assisted-intelligence-augmented-intelligence-different/.
diligence in their actions, demonstrate a reasonable level of care, and act in the best interests of the company. In 2014, Deep Knowledge Ventures (DKV), a Hong Kong-based venture capital firm, added an AI called Validating Investment Tool for Advancing Life Sciences (Vital) to its Board of Directors. Vital was tasked with assisting in investment decisions, using its algorithm and vast datasets to analyze complex trends beyond human comprehension. While Vital had observer status and aided in automating due diligence, it did not have the voting rights of a corporate director, as it did not hold official status under Hong Kong's corporate laws.
Another AI tool named Aera was launched by a tech company where the Board of Directors can ask questions about their company and receive proactive recommendations, but the decision to implement this recommendation would be the prerogative of the Board of Directors. Alicia T, an AI tool, was appointed as a member of the board by a Finnish tech company, Tieto. In India, It can be reasonably inferred that every director shall exercise independent judgment while discharging their duties and responsibilities. The Indian courts have provided very limited dicta as to what constitutes independent judgment, whereas the UK courts have gone a step ahead and postulated that independent judgment means “the judgment of the director is independent in the sense of it being his own judgment”.
Therefore, it can be said that directors can use AI tools for deriving relevant data as well as information to arrive at an independent business decision, as long as the decision-making is not solely delegated to such AI tools. Good Corporate Governance Today, corporate governance is ostensibly viewed as an impregnable tenet of corporate law worldwide. Corporate governance is “the system by which companies are directed and controlled. ” Companies have a significant effect on a nation because they generate job opportunities and contribute to the economy. Decisions made by the 10Board of Directors are complex and have a significant effect on the company’s operation and, inevitably, on its shareholders.
As a result, owing to their role in carrying out a company’s day-to-day functions, the composition, and role of the Board of Directors, including their decision-making powers, unquestionably have a significant impact on a company’s governance. Thus, if Indian companies were to venture into these uncharted waters of inducting AI in the boardroom, it 10 Barry Libert, AI in the Boardroom: The Next Realm of Corporate Governance, (May, 22, 2020, 10:00PM) https://sloanreview. mit. edu/article/ai-in-the-boardroom-the-next-realm-of-corporate-governance/
becomes imperative to conduct a deeper analysis in order to understand its implications and its compatibility with the principles of corporate governance. 11 The Organization for Economic Co-operation and Development (OECD) formulated the OECD principles in 1992 to assist governments in developing an effective legislative, regulatory, and institutional framework for corporate governance. The fundamental guiding principles of corporate governance on the basis of which these principles were drafted are fairness, transparency, and accountability. These are also known as the pillars of corporate governance. 12 Fairness The term fairness corresponds to treatment that is free of bias. In the context of a company, it entails treating all shareholders, particularly minorities, impartially and equitably, alongside providing requisite remedies and recourse for any misconduct.
In terms of fairness, while AI fails to eliminate human bias and is hampered by the complexity of quantifying a subjective attribute like fairness, at the same time, it has the potential to stimulate the function of an independent director. 13 Transparency In the context of corporate governance, transparency refers to a company’s duty to provide transparent disclosure to shareholders. Companies must ensure that timely and reliable information about their organization is disclosed. This information must be made accessible to shareholders and must be tailored to outsiders while keeping the corporate confidentiality standards in mind. 14 In terms of transparency, AI has the potential to eliminate information asymmetry.
Further, it has the ability to improve transparency by upholding truthfulness, timeliness, and completeness 11 Financial Reporting Council, Report of the Committee on the Financial Aspects of Corporate Governance ¶
2.5 (1992)
12 Mukul Gulati, Board of Directors: The Importance of Good Corporate Governance in Family Run Businesses, The Economic Times (Aug. 1, 2020), https://economictimes.indiatimes.com/small-biz/hr-leadership/leadership/board-of-directors-the-importanceofgood-corporate-go vernance-in-family-run-businesses/articleshow/77297720.cms
13 OECD, Corporate Governance: Improving Competitiveness and Access to Capital in Global Markets: A
Report to the OECD by the Business Sector Advisory Group on Corporate Governance (1998) 14 Reuben Binns, On the Apparent Conflict between Individual and Group Fairness, in Conference on Fairness, Accountability, and Transparency 514, 520-523 (ACM New York, 2020)
while ensuring information accessibility. However, the reasoning behind the decisions taken by an AI cannot be observed, thereby mitigating transparency. 15 Accountability The principle of accountability is central to corporate governance. The rationale behind handing over the reins of a company, officially recognized as a separate legal entity, to management, who are legally mandated to be individuals, was to prevent the misuse of the company’s limited liability structure. Individuals comprising the management are held accountable for the duties assigned to them. 16 The implementation of AI has had a significant impact on this principle, as directors can use it to avoid responsibility by claiming a generalized dependence upon it.
Furthermore, reliance on AI may raise privacy concerns due to the large amount of data stored; this may result in the evasion of liability due to the absence of a data privacy law in India. Conclusion and Suggestions Upon analyzing the legal ramifications of AI in the corporate sector of India and categorizing various approaches to AI implementation, it is evident that incorporating augmented or autonomous intelligence into the Board of Directors is prohibited under Indian corporate law. This restriction arises from the fact that only individuals satisfying other criteria can be appointed as directors. The underlying intention of this limitation is to uphold accountability, which can be compromised when an artificial entity, such as a company, is appointed as a director, as it lacks personal attributes.
17 For these reasons, assisted intelligence, as discussed above, can be introduced in the Indian boardroom. This achieves a perfect equilibrium entailing quantitative and qualitative analysis by balancing AI’s efficiency in processing data beyond human capacities and a human’s ability of diversified learning. This is also permissible under the existing law since the implementation of assisted intelligence does not entail the delegation of any power, and neither occupies a seat in the boardroom. It thus functions as a consultative model and leaves the final decision to the 15 Securities and Exchange Board of India, Corporate Governance in listed Companies— Clause 49(I)(A) of the Listed Agreement, SEBI/CFD/DIL/CG/1/2004/12/10 (Issued on Oct. 29, 2004) (India) 16 Akshaya Kamalnath, The Perennial Quest for Board Independence: Artificial Intelligence to the Rescue? , Harv. L. Sch.
Forum Corp. Governance (May 1, 2019), https://corpgov. law. harvard. edu/2019/05/01/the-perennial-quest-for-board-independence-artificial-intelligenceto-the-rescue/.
17 Nicky Burridge, Artificial Intelligence Gets a Seat in the Boardroom, Nikkei Asia (May 10, 2017),
https://asia.nikkei.com/Business/Artificial-intelligence-gets-a-seat-in-the-boardroom
directors. Furthermore, to ensure that accountability is not subverted, the use of AI should not be attributed to the standard of care. Rather, the purpose of the directors should be judged based on whether they were justified in using AI in the manner that they did, with minimal insight into AI’s decision-making patterns.18 18 Yavar Bathaee, The Artificial Intelligence Black Box and the Failure of Intent and Causation, 31 Harv. J.L. & Tech. 890,937 (2018)