Monday, September 22, 2008

History Repeats Itself: Whither Governance? (Part 3)

In two previous posts (here and here), we discussed the several corporate governance issues that have been accentuated on account of the current financial turmoil emanating from the U.S. In this post, we examine some of the differences between corporate structures and governance in the U.S. and India.

In India, companies predominantly display concentrated shareholding structures (as opposed to the diffused shareholding structures in the U.S.). Most Indian companies have a controlling shareholder (or group of shareholders). These controlling shareholders take various forms. Most of them are business families. In fact, it has been stated that a “glance at India’s 500 most valuable companies, that together account for over 90% of the market capitalisation of the Bombay Stock Exchange, reveals that about two-thirds of them are part of conglomerates or “business groups””. Others controlling shareholders are the Government itself, as in the case of public sector undertakings, and yet others are multinational companies who own controlling stakes in their Indian listed subsidiaries or affiliates. On the other hand, there are hardly a few companies listed in India that do not have a shareholder or group exercising control over the company.

This concept of a controlling shareholder is further reinforced by the Indian legal regime as well. For instance, the concept of a “promoter” that is prevalent in various Indian regulations does just that. Although the immediate relevance of a “promoter” appears when a company is accessing the capital markets through a public offering in terms of the SEBI (Disclosure and Investor Protection) Guidelines, 2000 or is making an offer (or seeking an exemption) under the SEBI Takeover Regulations, 1997, the concept has wider implications. It demonstrates that the “promoter” has certain legal connotations or attributes that are different from that of other shareholders generally, and hence such promoters undertake an additional role not just as a legal matter but in an overall sense in relation to the control and governance of a company.

What then is the relevance of concentrated shareholding in the context of governance of companies in India? We now turn to the corporate governance factors discussed in the previous post in the background of the financial crisis that originated in the US:

1. No Separation of Ownership and Control

In India, controlling shareholders do have a say in the management and control of the company. Often, controlling shareholders themselves are managers. Alternatively, and by virtue of their shareholding, they do possess the power to appoint their own representatives as managers. Due to their controlling stake, they take a greater role in assessing the performance of the company and usually are on top of the situation as active (as opposed to passive) investors. It is arguable that such direct oversight by controlling shareholders benefits all investors. In other words, what is good for the controlling shareholders is good for the other minority shareholders as well, whose value is likely to be preserved due to the oversight by the controlling shareholders. The problems arising from the separation of ownership and control ought not to appear here.

2. Lack of Director Primacy or Managerial Superiority

Unlike in the U.S., Indian boards are amenable to the wishes of the shareholders. Directors can be appointed and even removed, all through a simple majority as these decisions are required to be taken merely by ordinary resolutions at a shareholders’ meeting. Where directors or senior management do not show performance, they are liable to be removed by the controlling shareholders. This ensures that there is absence of self-perpetuation on the part of the incumbent board and managers.

3. Managerial Pay

The remuneration of directors and senior managers in Indian companies are not comparable to the kind of stratospheric proportions witnessed in the U.S., although Indian pay-scales at the top echelons have seen a steady increase over the years. However, one key difference in India (at least in theory) is that senior management’s pay is subject to shareholders’ approval and also to certain maximum limits in view of Sections 309 and 198 of the Companies Act, 1956. To that extent, shareholders do have a “say on pay” that is mandated by law, unlike in other markets (such as the U.S.) where the decision is largely left in the hands of the boards of directors or their compensation committees.

4. Board Oversight

Unlike the U.S. boards which place a lot of emphasis on board independence, Indian boards consists of a mix of inside directors (such as representatives of the promoters) and outside directors (such as independent directors). This is likely to ensure greater discussion and participation on boards as compared to boards which are loaded with independent directors who tend not to have adequate information so as to participate effectively, and this is especially so during periods of crises as currently witnessed by several U.S. financial institutions.

5. Chairman and CEO

On this count, neither the U.S. nor India mandatorily require a separation of the position of Chairman and CEO. However, in practice, it is found that more Indian companies follow the separation than do the U.S. companies. Hence, in the Indian context, non-executive chairmen of several companies do play a significant role in stimulating more open discussions on boards and also acting as a check on the management of the company (such as the CEO/managing director and other senior managers).

The purpose of this post is to identify some of these key differences in the Indian context that may potentially forestall similar crises in Indian companies, mainly due to the absence of separation of ownership and control. However, it is a different matter altogether that the Indian ownership and governance structures are not necessarily optimal as they often tend to favour the controlling shareholder (such as business families, the Government or multinational) over the interests of minority shareholders, but we shall leave that for another day.

1 comment:

Jorge said...

Thanks for three absolutely wonderful posts! Are these part of any academic piece you are writing on, and if so, can you share a link to that piece once finalized?

Thank you very much