[Rongeet Poddar is a fourth-year student at WBNUJS, Kolkata.]
The corporate governance regime of a country has to specifically consider the nature of company ownership to incorporate regulation norms to augment the efficiency of the system and reduce agency conflicts. The foremost agency conflict in corporate governance is the Type I agency conflict between directors as managers of the company (agent) and the shareholders (principal). This agency conflict is vertical in nature where the shareholders have to undertake significant costs in the form of incentives and monitoring systems to ensure that the interests of the managers of the company align with theirs. It occupies a position of greater importance in companies which have a dispersed shareholding pattern. In many developed economies, the corporate governance model thus emphasizes on increasing accountability of the management towards the dispersed shareholders through internal mechanisms that insist on greater number of disclosures.
In India, the shareholding of companies, however, is mostly concentrated in a few hands. A significant number of firms in India are family controlled and are almost run like personal fiefdom. The companies in India are promoter driven and interference by promoter-shareholders in management of the company often raises serious corporate governance concerns. There is often no separation of ownership and control with the controlling shareholders themselves taking up management roles. Managerial positions become the exclusive monopoly of family members of the promoter. Directors’ longevity on boards, as a result, is directly proportional to their proximity with dominant shareholders or the promoter group. Thus there exists potential for the exploitation of minority shareholders at the hands of the majority. Corporate governance norms therefore have to be evaluated considering the unique scenario where promoter attributed majoritarian considerations of shareholding patterns trump the Type I agency problems and bring Type II agency issues to the fore. The Type-II agency conflict is characterized by concerns over the controlling group of shareholders riding roughshod over the interests of the others. This conflict is thus horizontal in its ambit.
India, however, unwittingly borrowed corporate governance mechanisms from the developed jurisdictions where companies mostly have a dispersed shareholding pattern. It is necessary to understand that, in India, post liberalization of the economy, private enterprise continued to be the exclusive domain of a few families who could override the red tape of the license raj era for running their businesses. How will the interests of minority shareholders be protected in this new era of promoter-raj in Indian companies? This is something that corporate governance codes from developed jurisdictions will have no answer to. The recent Tata and Infosys episodes have exposed many fragilities of India’s transplanted corporate governance framework which the Kotak Committee Report has tried to acknowledge and rectify.
Since the Indian companies are largely family-run companies with concentrated shareholdings, the promoter groups try to assert their control in multiple ways at the cost of the minority shareholder’s interests. The faulty succession strategies of companies put investor confidence and brand reputation at stake. This results in promoter founders continuing to unnecessarily interfere often in the garb of safeguarding company values and integrity by utilizing the aura of invincibility that they have built up for their roles in setting up successful companies. This absolves them of any scrutiny and makes various internal corporate governance mechanisms such as that of independent directors toothless. Often channels such as the ‘emeritus chairman’ or other roles in the capacity of advisors to wield influence in boards and creating policy paralysis in the company. They create an atmosphere where the spirit of accountability is eroded. Excessive director compensation by the boards at the behest of promoters also creates an unhealthy culture of quid pro quo. The non-pecuniary benefits such as of company jobs to director relatives also add to the cronyism. Overall, this promoter-director nexus is detrimental to the interests of minority shareholders as the directors now act as fiduciaries of the promoter-majority shareholder group. The role of the promoters in the management of the company needs adequate regulation.
Recently, a research study conducted by the Indian School of Business observed how the ownership pattern in listed firms is fairly concentrated in the hands of promoters. In this light, the recent recommendation of the Kotak Committee Report to incorporate a suitable amendment to increase the disclosure standards for related party transactions makes sense, in order to prevent tunnelling practices at the bidding of the promoters. A regulation has been proposed by which all promoters/promoter group entities that hold 20% or above in a listed company will be considered related parties for the purpose of the Listing Regulations. Disclosures of transactions with promoters/promoter group entities holding 10% or more shareholding also have to be made on a half-yearly basis. The Kotak Committee report has also put forward the much needed suggestion that boards should meet once a year to discuss succession planning and risk management. This offers scope for boards to plan efficiently for succession rather than engaging in bitter conflicts that are revealed to the media and in the process erode shareholder value. The proposal to separate the roles of the non-executive chairperson and the managing director or CEO can also turn out to be a beneficial move to bring in more professionally managed companies and reduce promoter dominance in the boards. This is because promoters or their family members often chair the boards of companies while being CEOs at the same time.
The ‘independence’ of independent directors has been under scrutiny as well in both the Tata and Infosys episodes. Promoters of the company have been seen acting in concert with the controlling shareholders, spread across friends and relatives, to appoint independent directors – mostly close friends or relatives. In other cases, promoters often appoint former bureaucrats who had done them favours in the past. This ensures that independent directors do not pose tough questions at board meetings and raise red flags in the interests of the minority shareholders.
The Kotak Committee Report has recently elucidated that independent directors must bring in objectivity to the functioning of the board and improve its effectiveness. The committee had recommended an important change in the eligibility criteria of independent directors so as to exclude persons who constitute part of the promoter group. The other significant change suggested pertains to the prohibiting the interlocking of boards arising due to the presence of common non-independent directors on the board of listed companies. While the former is clear enough in light of the problems highlighted, the latter suggestion creates an additional safeguard. The Ministry of Corporate Affairs has now amended the Companies (Appointment and Qualification of Directors) Rules, 2014 to specify that none of the relatives of an independent director should be in any way “indebted” to the company, its holding, subsidiary or associate company, promoters or directors. The Kotak Committee Report also seeks to prevent board interlocks. Thus, if a non independent director in a company is an independent director in another, any non independent of the latter company cannot be an independent director in the former.
In addition to these recommendations, the Kotak Committee Report could have also considered the potential engagement of minority shareholders in the process of appointment of independent directors. In addition to the ordinary resolution path of cumulative voting by shareholders, there can be specific independent directors appointed by a majority of the minority shareholders. The idea of shareholder democracy can be truly incorporated by insisting on proportional representation instead of going by the standard rule of ‘majority democracy’ in corporate governance mechanisms. The general problem with the rule is the lack of credence given to the specific concerns of the minority shareholders with directors of promoters’ choice. As a result of being appointed by a majority of shareholders, directors on boards are often inclined to take decisions contrary to interests of the minority such as facilitating related party transactions. Proportional representation will ensure that minority shareholders are privy to more information and get more opportunities to put forward their concerns before the board. In the long run, this can minimize the agency conflict between majority and minority shareholders.
On the whole, the Kotak Committee deserves plaudits for initiating an important conversation around India’s Type II agency problem by insisting on incorporating a custodian or trusteeship model of corporate governance to replace the existing ‘Raja’ model of running companies at the behest of promoters or controlling shareholders. It offers an alternative vision by reworking the existing internal corporate governance mechanisms. Perhaps, the Kotak Committee Report can be a starting point for India’s regulators to address the unique problem and, in the process, curb crony capitalism in businesses in the long run.
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