Corporate Governance Front in India

7/27/2019 Corporate Governance Front in India

1/3

THINGS appear to be moving fast on the corporate governance front in India. It is heartening tonote the urgency and seriousness with which reforms are taking place. More important, theinitiatives are from the corporate sector itself, and not being forced by the Centre. The KumarMangalam Birla Committee recommendations have been accepted by SEBI, and are in their lastphase of implementation.

The Naresh Chandra committee

formed by the Finance Ministry

has given itsrecommendations, and the same are under implementation; the Narayana Murthy Committeereport shows that significant progress has been made by the corporate sector after theintroduction of Clause-49.

The report is in public domain for comments and suggestions. The Companies (Amendment) Bill2003 has been tabled in Parliament to improve corporate governance for non-listed companies too.Moreover, there is a general awareness on the need to clean up the corporate sector throughregulatory reforms.

While the reforms appear to be moving in the right direction as far as the legislative structure isconcerned, this alone will not raise the corporate governance standards in the country.

Legislation can only bring about structural reforms, that of process need the corporate sector'sactive participation complemented by training and the market's involvement.

This will help corporate India understand the benefits of being proactive in good governance.Interventions are required on three fronts: The reforms relating to corporate boards with emphasison training interventions; increased role for shareholders, particularly the institutional ones; andpromoting comprehensive rating system to bring market forces into action.

Strengthening corporate boards

Recently boards have received flak for the collapses of some highly reputed corporationsworldwide. This brings to the fore the important question of their effectiveness. In the currentbusiness environment where intangibles rule the roost, it is important for corporations to ensure

that their reputation is not affected.

It is, thus, not surprising that all the committees set up in India for reforming and improvingcorporate governance practices have given a lot of weightage to improving the boards.

Including independent directors, separating the role of th CEO and board chair, setting up of boardsub-committees, and regulations on board size and meeting frequency are some interventions forpromoting board effectiveness.

Independence is often considered to be the panacea for board problems. While the KumarManglam Birla Committee recommended that at least one-third of the directors be independent,the Naresh Chandra Committee raised the level to 50 per cent, and also made the definition ofindependence stricter.

The Narayana Murthy Committee further upheld that board independence is crucial for itseffectiveness.

While independence is necessary, it too is not enough. The directors should have a strong businesssense, as well as the capability and the willingness to contribute to strategic decision-making.

Considering the paltry compensation or the sitting fees that independent directors receive in mostcompanies, will it be possible to attract such directors?

Even if such directors are found will they be motivated enough to discharge their fiduciary duties?

This highlights the importance of training newly inducted independent directors as well as the

senior ones

to understand the philosophy behind their responsibilities.


2/3

This is a mammoth task, as pointed out by the Naresh Chandra Committee report which estimatesthat restructuring the corporate boards of even the listed Group A, B1 and B2 companies willrequire more that 15,000 new independent directors.

It is not surprising that to address the issue of quality contribution from the independent directors,the Companies Bill has also made it compulsory for them to undergo training from a government

approved institute within 18 months of appointment.

Promoting shareholder activism

Institutional shareholders control a large percentage of equity in listed Indian firms and are alsosignificant lenders. The Kumar Mangalam Birla Committee recognised the role of financialinstitutions (FIs) in Indian corporate governance, but recommended against including nominees ofthese institutions on corporate boards a suggestion endorses also by the Nararayana MurthyCommittee.

The institutional shareholding in the top 500 companies by market capitalisation was in excess of16 per cent in 2002. This shareholding represents the percentage of equity shares held bydevelopment financial institutions, State financial institutions, insurance companies and mutual

funds. In the US, institutional investors control 46.7 per cent of corporate equity and of this 20 percent is controlled by pension funds, such as CalPers and PSERS. These institutions wereresponsible for promoting shareholder activism there.

While research in the US shows a higher institutional shareholding contributing positively towardsshareholder value through better control on a firms' management, evidence from a study done bythe author on the Indian corporate sector shows a reverse trend. This, in itself, is an indicationthat the FIs in India are not taking an active part in improving corporate governance standards.

It is well accepted that market is the biggest force promoting corporate governance. Smallshareholders can move away from the company that is not doing well, but for large investors it isnot that easy.

The FIs being block holders, thus, have more incentive to ensure that a company resorts to valuemaximising strategies. Unfortunately, they do not appear to be doing this. As most Indian boardsare dominated by business families, the FIs need to play an activist role in demanding greater

transparency and accountability in their decisions. In addition to playing a more active role inboardroom deliberations, the FIs can also promote corporate governance by exerting influence onthe Government and regulatory bodies.

Promoting corporate governance ratings

The fact that corporate governance cannot be improved solely by legislation brings to focus theimportant role of ratings. The phenomenon of corporate governance ratings is still in its infancy inIndia.

The two major credit rating agencies have already come up with their corporate governance ratingproducts, but the companies opting for these are few. CRISIL has come up with Governance andValue Creation Ratings (GVC) largely based on the S&P CG ratings while ICRA has introducedits instrument Corporate Governance Rating (CGR) based on Moody's.

Another agency, Fitch India, is in the process of coming up with a rating. Recently CRISIL gave thehighest ratings (GVC-1) to HDFC, HDFC Bank and Hero Honda and second level to Dabur, whileICRA gave a second level (CGR-2) to ITC and Godrej.

Corporate governance ratings have the ability to achieve what regulations and codes cannot.

They enable investors to evaluate companies better. However, these ratings will serve their realpurpose only if complemented by institutional investor activism. The pressure from institutionalinvestors will force companies to get themselves rated.


3/3

However, investors should take the ratings cautiously and not depend solely on these ratings tomake investment decisions. It is a fact that rating agencies in the West were not able to predictthe impending collapse of corporates, such as Enron, WorldCom and American Airlines, and hadgiven good ratings to their corporations.

Indian rating agencies should learn from their counterparts in the west, and continuously review

and upgrade the criteria on which the ratings are based.

Moreover, it is necessary that the rating agencies should take into account the adherence to theprinciples behind indulging in good corporate governance, and do internal research rather thanbasing the ratings on published information.

On aspects such as executive/senior level hires, executive compensation, performance management

systems and projects, PSU management and boards should have complete autonomy. Barring policy

matters and matters of national interest and the government should minimise its involvement

Maharatna, Navratna and Miniratna PSUs that are listed should lead the way in implementing the

Ministry of Corporate Affairs (MCA) voluntary guidelines on corporate governance. PSUs should be

leading the way rather than follow the private sector ?To help foster that PSU boards are focused on

the leading substantive issues, alternative mechanisms such as a two-tier board structure and

introducing board performance assessments should be actively To maximise their input, on

executive directors on PSUs should be drawn from the private sector and adequately compensated

on par with their private sector counterparts. Sitting executive directors in well run PSUs should be

encouraged to assume non-executive director roles in state PSUs and the smaller/unlisted/not so

profitable PSUs ?PSU CMDs should be actively consulted and engaged in the selection and

appointment of nonexecutive directors on PSU boards which does not happen consistently

enough. The role of the Public Enterprises Selection Board (PESB) warrants reconsideration in this

context ?The government should deal firmly with non-compliance of corporate governance norms

by both listed and unlisted PSUs. Unambiguous disclosures of the compliance levels achieved and

clear accountability for compliance are important prerequisites to achieve this ?

The government should clearly and unambiguously set out its ownership policy and how it may

apply in matters that have ramifications for minority shareholder

Documents

Corporate Governance Front in India