March 3, 2009

Keeping promoters on the leash

Issue 24 - Mar 2009

R Vaidyanathan

IN THE wake of the massive fraud by the promoters of Satyam Computers, one of India’s biggest IT firms, there has been a lively debate about the issues pertaining to corporate governance in the Indian context. The issues relate to accounting practices, role of auditors, the role of the Board (particularly that of independent directors), the role of bankers and regulatory bodies like SEBI. The critical issue in corporate governance which India has copied from the Western paradigm is that the regulatory framework should be in a position to prevent managers from abusing their power in running corporations.
This is achieved by strengthening the accounting framework: disclosure practices and auditing standards; and shareholder activism. The framework also aims to reduce information asymmetry and minimise insider trading. In other words, in the Western context, the aim of regulation is to prevent abuse of the corporate resources by managers who are expected to be agents acting on behalf of the share holders.
Publicly listed companies in the United States are manager-run, and shareholders can and do initiate class action suits for any misdemeanours committed by the managers. Shareholders, including institutional shareholders do not hesitate to replace existing CEOs and other top executives if they think that the company is not run as per their mandate. CEOs are on their toes in trying to mee the expectations of the shareholders. While they are paid astronomical sums they can be, and are,  removed by shareholders for incompetence or malfeasance.
In India, the promoters are the management group in family-owned companies and a large segment of publicly listed companies are family owned. In the Indian context there is a  need to focus on preventing abuse of authority by the promoters rather than by the managers. Promoters call the shots in the organisations even though some of them may not hold even a simple majority in terms of shareholding. It is not uncommon to see promoters holding 15 to 20 percent of the shareholding having complete control of the affairs of the company. This is possible since the remaining shares may be widely held by small investors, or the institutions who own even a significant chunk of the shares acquiesce to the decisions of the promoters.
Hence the need in the Indian context is to prevent corporate power from being abused by the promoters rather than by managers. Of course, India has also followed the system of ‘independent directors’ for listed companies as in the West, but the nature of independent directors is circumscribed by Indian tradition and history. Most of the independent directors are ex-bureaucrats or ex-bankers. Independent directorship is more a favour conferred for past favours rendered to the company or in expectation of future benefits. Unfortunately the basket of candidates is also not very large given that India has nearly 8000 listed companies. This means that rather than having a  separate chairman, most have the offices of chairman and managing director vested in the same person.
Community and regional affiliations also play a role in appointing independent directors. For instance in Satyam, it cannot be termed as purely fortuitous that all directors save one were from the same region or even the same community as Ramalinga Raju, the promoter. While nominally, these directors were independent as visualised in regulations, it cannot be said that they were really independent if the issue is independence from the promoter families. The families will be comfortable with ‘independent’ directors from their own regional or community group. The family may also prefer an ex-bureaucrat or an ex-judge to provide an aura of respectability to the board. Of course, if the ex-bureaucrat is from the same region or community all the better.
It will be appropriate to modify the governance regulations taking in to account Indian realities. The promoter should be compelled to declare the nature of the impact of his actions on his other family-related businesses and certify to the board that it is as per laws and regulations. Today the promoter recuses himself from any agenda items pertaining to his interests and is absent from voting. It should be the other way round. On items before the board that involves the promoter and his family, he should certify and be present to vote. This will, to some extent, put the fear on the promoters since their actions are certified by them before other directors discuss it or look in to it.
Also it is required for institutions to play a more proactive role. For instance, but for the reaction of American Depository Receipt (ADR) prices in the US market and the strong resentment of some of foreign institutions, the Satyam management and promoters would not have rescinded their dubious decision to transfer the perhaps non-existent cash from Satyam to Maytas, a company owned by Mr Raju’s sons.
Corporate governance is a function of history, culture and extant social mores rather than rules and regulations in any society. In the Indian context, there is a need to stress dharma, or  duties along with rights and regulations.

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