The Hindu Business Line : Conflict between dominant and minority shareholders

Following the amendment to Clause 49 of the Listing Agreement, some issues, such as a more rigorous definition of independent directors, are now being given more attention.

MR MONISH CHATRATH, LEADER (NATIONAL MARKETS), GRANT THORNTON

While the term corporate governance has found a place in the annual reports and media advisories sent out by India Inc., ground realities are very different. Governance, for most companies, starts and ends with forming committees. The skeletons in the cupboard come out for all and the sundry to see during times of earnings misses, corporate developments and information-sensitive deals. So much so for CG, as it is called.

Is the board of directors doing its job, then? “The board is not really central to the corporate governance malaise in India.

The central problem in Indian corporate governance is not conflict between the interests of the management and owners as in the US and the UK, but more in terms of a conflict between the dominant shareholders vis-À-vis minority shareholders” says Mr Monish Chatrath, Leader (National Markets), Grant Thornton, New Delhi.

In a candid interaction with Business Line done over the email, Mr Chatrath tells us why there is an imminent need to bring about increased transparency through better disclosures and a moral recognition of responsibilities that companies need to discharge in the best interests of all stakeholders, not just a few.

Edited excerpts from the interview:

Could you tell us what is corporate governance, in its true connotation? How has it evolved over the past few years?

Corporate governance relates to the ethical framework, the moral framework and the legal framework within which management decisions are taken. This is an all-pervasive process which links an organisation’s management, board, shareholders, regulators, auditors and other stakeholders, while providing a structure for establishing and achieving the objectives of the organisation.

However, this is not a new concept. Some prominent corporate governance developments began in the UK in the late 1980s. In the early 1990s, this gained further momentum in the wake of corporate scandals such as Polly Peck and Maxwell.

Certain financial reporting irregularities led to the establishment of the ‘Financial Aspects of Corporate Governance Committee’ led by Sir Adrian Cadbury in the early 1990s. The resulting Cadbury Report published in 1992 outlined a number of recommendations around the separation of the role of the chief executive and chairman, balanced composition of the board, selection processes for non-executive directors, transparency of financial reporting and the need for good internal controls.

This led to the publication of the Rutteman Report in 1994 on ‘Internal Control and Financial Reporting’ and in 1995, following concerns about directors’ pay and share options, the Greenbury Report recommended extensive disclosure in annual reports on remuneration and also the establishment of a remuneration committee.

In January 1996, the Hampel Committee was established to review the extent to which the Cadbury and Greenbury Reports had been implemented and whether the objectives had been met. The Hampel Report led to the publication of the Combined Code of Corporate Governance (1998) covering areas relating to structure and operations of the board, directors’ remuneration, accountability.

Higgs and Smith Reports were published in January 2003 followed by the Tyson Report on the recruitment and development of non-executive directors. The recommendations from the Higgs and Smith Reports led to changes in the Combined Code of Corporate Governance which was published in July 2003.

There were a few landmark reports for corporate governance in India too…

Yes. In India the Kumarmangalam Birla Committee gave its recommendations on corporate governance in 1999 and this was followed by the Naresh Chandra Committee report in 2001. Subsequently, the Narayana Murthy Committee Report of 2004 and the JJ Irani Committee Report of 2005 set out the foundation on which Clause 49 was revised.

What has been your experience with Indian companies? How ‘CG-bound’ are Indian corporates?

In India, there has been fair bit of discussion on making the board responsible for the introduction of corporate governance practices. This is doubtless an important issue, but a close analysis of the ground reality in India shows that the board is not really central to the corporate governance malaise in India.

The central problem in Indian corporate governance is not a conflict between the interests of the management and owners as in the US and the UK, but more in terms of a conflict between the dominant shareholders vis-À-vis minority shareholders.

Though one can in principle visualise an effective board, which exercises independence objectively, there is only so much the board can do to resolve such conflicts in practice.

Has focus on growth put issues such governance on the back-burner?

In today’s business environment in India, companies themselves are seen to be seeking greater autonomy of operation and opportunity for self-regulation with minimal compliance costs. At the same time, there is an impending need to bring about increased transparency through better disclosures and a moral recognition of responsibilities that companies need to discharge in the best interests of all stakeholders.

A significant number of the listed companies in India today also presume that their investor community would have a better perception of the state of governance, once a company has demonstrated compliance with revised Clause 49.

About composition on the company board, can you review Clause 49 for us? How often do you see independent directors expressing ‘dissent’ against board decisions?

Following the amendment to Clause 49 of the Listing Agreement, some issues, such as a more rigorous definition of independent directors, are now being given more attention.

While the perception on the ability of independent directors to express divergent views may exist, the actual situation appears to be changing fairly rapidly in India. Our experience has indicated that independent directors on boards of listed companies in India, are increasingly becoming more active and cognisant of the Clause 49 requirements.

Are independent directors far more dynamic in other countries?

In various other countries, independent directors are increasingly seen to be constructively challenging and helping develop proposals on strategy while also scrutinising the performance of management and monitoring the reporting of performance.

Some of these directors are taking additional steps to satisfy themselves on the integrity of financial information, the adequacy of financial controls and the robustness of the systems of risk management. Some companies have also entrusted the responsibility for determining appropriate levels of remuneration of executive directors to independent directors on their board.

What stops Indian directors to monitor situations with the same tenacity?

While comparing practices across countries it is important to appreciate that cultural, political and economic norms influence the way in which a society approaches corporate governance and its impact on board leadership, management oversight and accountability. The challenge for policymakers in India is to reach an appropriate balance of legislative and regulatory reform, taking into consideration international best practices that augur well with the growth climate in India while also fostering greater enterprise and enhancing competitiveness in a manner in which this can stimulate further investments.

So, are you satisfied with the disclosure levels of Indian corporates? Indian companies have not yet moved on to international financial reporting language; could this be proving to be a debility as far as corporate governance is concerned?

Over the years, though significant efforts continue to bring Indian accounting standards in line with international practices, various aspects still need to be synchronised with international accounting practices and International Financial Reporting Standards (IFRS). The requirement for public interest entities in India to comply with IFRS from April 1, 2011, is a positive development, which seeks to ensure high quality financial reporting and reporting transparency.

That being said, it is important for any modifications in the regulatory and compliance framework in India to be contemplated in manner that makes them amenable to clearer interpretation and consequent effective application. This will not only promote an industry-friendly and progressive environment, that provides a framework for better governance, but the same will also foster and facilitate fast economic growth.

What is the particular (read successful) approach to deal corporate governance?

There is no ‘one size fits all’ approach to corporate governance. A number of countries (particularly in continental Europe) tend to adopt an inclusive ‘stakeholder’ approach where companies are considered ‘social institutions’ with responsibilities and accountability, not just to shareholders, but to employees and the wider community in general.

This contrasts to the UK and the US where there is an emphasis on creating wealth for shareholders. However, while approaches in individual countries may differ, there appears to be a global appreciation of the OECD’s generic corporate governance principles of responsibility, accountability, transparency and fairness.

Is independence in boardrooms becoming rare?

An implicit sense of ethical business conduct needs to be the cornerstone of the corporate governance sphere. Good governance requires the interests of the promoters and shareholders to be protected through the board and for the board itself to play an important oversight role vis-À-vis the management.

As the head of the management the CEO needs to report in directly to the board. To be able to establish a clear, independent and objective management, wherever practical, chairmen and CEOs must not only be independent of each other, but also must not have influencing interests (past or present) which can create conflicts or which can potentially cloud their judgments. Ironically, though there appears to be an increasing trend towards showing independence, in the absence of clear guidelines, actual ‘independence’ still continues to be difficult to establish.

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