I find the White Paper of interest for two reasons. First, it seeks to supplement the existing reform process in India that is already underway and one that has culminated, at least for the moment, with the issue of the Corporate Governance Voluntary Guidelines 2009 by the Ministry of Corporate Affairs. Second, and more importantly, it side-steps most of the conventional issues that have inundated the corporate governance discourse in India recently and offers some different perspectives, like a whiff of fresh air.
The goal of the effort is set out as follows:
The aim of the “India White Paper” is to provide officials, financial regulators, listed companies, investors and others with constructive and detailed suggestions for the broadening and deepening of sound corporate governance in India. While India has undertaken numerous reforms in corporate governance over the past decade, especially in the area of company boards, independent directors and disclosure and accounting standards, certain critical areas remain to be addressed—particularly relating to the accountability of promoters (controlling shareholders), the regulation of related party transactions, and the governance of the audit profession.The White Paper states that despite “wide-ranging developments in regulation and policy, what becomes apparent in India is that the reform process has not addressed, or effectively addressed, a key challenge at the heart of the governance problem, namely the accountability of promoters to other shareholders”. In other words, this is recognition of the fact that a large number of governance problems in Indian companies are related to the position of controlling shareholders or promoters relative to that of minority shareholders. The White Paper finds that the overwhelming focus on board reforms is misplaced and is not adequate to deal with these problems:
We believe that reforms are needed in these areas to strengthen the integrity of India’s capital markets and to enhance its goal of becoming an international financial centre. We also believe that improvements in these areas should not be delayed for too long.
In this context, relying largely on independent directors (appointed by controlling shareholders), independent board committees and greater corporate disclosure as the primary mechanisms to check abuses of power by promoters and to safeguard the interests of minority shareholders is likely to prove weak and insufficient (as indeed it did in the Satyam case). Board reform is fundamentally important, and is a major issue of concern to institutional investors, but it needs to be complemented by other regulations that directly address the relationship between controlling and minority shareholders—in other words, a proper regime for the regulation of related-party transactions.However, this is not to discount the value of independent directors; it is just that the White Paper does not address the matter and instead focuses on other issues:
1. Shareholder Meetings and Voting: The White Paper stresses on the importance of reforming the requisite processes in India. It states that voting should be by way of poll rather than show of hands, and that proxies must be allowed to speak at meeting. Greater disclosure is called for in terms of notices and results of meetings. Writ large in this effort is the intention to empower institutional investors (particularly foreign institutions) to obtain a greater role in decision-making at general meetings. The effect of these reforms is that they will enable greater shareholder activism on the part of institutional investors, and overcome any collective action problems on the part of non-promoter shareholders as there could be greater certainty as to the impact that minority shareholders can make at general meetings.
2. Related-Party Transactions: The White Paper’s contribution is this area is welcome as it is an issue that has received inadequate attention yet. Related party transactions (RPTs) tend to pose a significant risk where there are controlling shareholders. The current trend of reforms has been to leave RPT oversight largely to audit committees who focus on RPTs from an accounting and disclosure standpoint. It is no surprise that even the definition of RPT is drawn from the accounting standards (AS-18). More is required. There should be a clear, independent and impartial process for approval of RPTs. To that extent, the White Paper does well to focus on matters such as giving independent shareholders the power to approve large transactions and requiring the appointment of an independent financial advisory and an independent board committee to determine whether the transactions are fair and reasonable to all shareholders. While the concept of independent shareholders has not received much recognition in India (please see a previous discussion on this concept), the requirement of “pre-approval” of RPTs by the audit committee had been suggested by the CII Task for on Corporate Governance, but has not yet been accepted by the Government (at least not in the Voluntary Guidelines 2009).
3. Preferential Warrants: Recognising that this is a stark form of perpetuation of control in companies, the White Paper calls for a prohibition on issue of warrants or other securities to promoters and connected persons.
4. Corporate Disclosure: Suggestions have been made for streamlining the scope and timing of various corporate disclosures so as to bring about greater certainty and transparency. SEBI has already taken some steps in this direction.
5. The Auditing Profession: The White Paper calls for removal of caps on number of audit trainees and audit partners, and encourages consolidation of firms. It also seeks the establishment of an independent regulatory body for the audit profession.
Update – January 21, 2009: I was also pleased to note that Jayant Thakur’s post on this Blog titled Issue of Banning Share Warrants to Promoters – SEBI order finds mention in the White Paper at page 34.