Thursday, April 17, 2008

Directors’ Duties During Times of Crises

The unexpected market conditions in recent times have rocked corporate boards world over. Healthy companies have begun to declare less satisfactory results, while the unlucky one’s face extinction. Companies are increasingly being exposed to liabilities towards shareholders, creditors and other counterparties, and consequently, directors of such companies are having to face difficult conditions in which to exercise their judgments on such boards.

In this context, the Harvard Law School Corporate Governance Blog carries a memo titled Corporate Governance Update: Advice for Directors in Complicated Times: The Fundamentals Still Apply prepared by Wachtell Lipton, that contains some practical advice and a set of dos and don’ts to directors on corporate boards. While the memo has been prepared in the context of US law (specifically Delaware), it is set in quite general and user-friendly terms and its principles would apply across jurisdictions, including in relation to directors on Indian companies.

Corporate Governance and the Indian Derivatives Saga

While on the issue of corporate governance and the role of boards in financial crises, an article by Govindraj Ethiraj in the Business Standard makes for interesting reading. Specifically, it laments the inadequacy of controls and the failure of corporate governance in companies that entered into complicated derivatives transactions without adequately appreciating the risks involved in those. It further adds:

“How did it happen? I am not sure but a good question to ask is when. My understanding is that companies have been steadily stepping up their exposure to currency swaps and the like for at least four years now. Over time, as the stockmarkets (which bolster sentiment) have held their own and the prospect of any downside risk appeared more and more distant with every passing day, chief financial officers (CFOs) of companies have got braver.

One key driver appears to be the desire to cut down on interest costs. Not surprisingly, banks have played a role here, structuring products that got more exotic by the day. One consultant I spoke to said he challenged most CFOs to make “head or tail” of the complex derivative contracts that they had signed, on behalf of their companies. Maybe shareholders are also at fault for not asking but the fact is that no one paid attention or more likely didn’t care as long as the bottom line was fine.

It’s possible many companies did keep their boards informed and made the appropriate references in their balance sheets. Though this does seem unlikely, even if they did, then as I mentioned earlier, no one was watching. It’s also possible that some companies are in violation of law. Either way, shareholders must perhaps shoulder some part of the blame.

To conclude, is this another Enron waiting in the wings? Not quite but it does raise some fundamental questions on what companies do with their shareholders’ funds. It’s also about how when the good times roll, everyone forgets to look at the figures closely. There is something in the original Cadbury committee definition of corporate governance. If I remember correctly it said, “Corporate governance is the system by which companies are directed and controlled.”

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