Fix the corporate governance leaks

Good governance eludes and evades the Indian corporate polity. It is elusive because the people who comply and judge are the same. It is evasive because there is no credible mechanism to nail the offenders.

Corporate governance is expected to be achieved through a set of codes in the form of board composition, approval processes on items of importance, and oversight of committees of the board.

Statutory auditors of the companies are required to certify ex-post that the actions taken by the Boards are as per the code. Notwithstanding such elaborate mechanisms, corporate governance in most Indian corporates leaves much to be desired.

Many family-run businesses in India, which are listed on exchanges, continue to think that the business is primarily and substantially controlled by them and listing is incidental to their business. The company management and controlling shareholders are not obliged to the minority shareholders. Even the listing compliance under clause 49 of the listing agreement has become merely a box-ticking ritual.

The RTP dimension

It is pertinent to identify the key ingredient of corporate governance that needs to be fixed. In a report of World Bank and IMF, ‘Doing Business 2012”, one of the important parameters against which India was assessed was “protecting investors”.

Thankfully, we were rated 46th amongst 183 countries, although in the overall rating we were 132nd among the 183 countries rated.

One single important dimension considered to test the efficacy of protecting investors was RPTs, i.e. related party transactions. It was further broken into three more indicators, namely, extent of disclosure, extent of directors’ liability and ease of shareholders’ suits.

It is observed that the disclosures are not immediate; the approval processes do not require the consent of minority shareholders; the liability of directors is not specifically provided under the provisions of Companies Act; and finally, it is no easy task for the shareholders to sue the company or its directors or its management. Information needed to file a suit is not adequately available, leave alone the pace of judiciary.

Abusive RPTs are the bane of effective corporate governance. There is no reason why corporate governance cannot be attained if this malady is fixed.

PROPER REGULATIONS

It is the legal obligation of the Boards of the companies and the management to discharge their responsibility towards all shareholders, including minority shareholders. No RPT can be justified if it causes damage to the interest of common shareholders, irrespective of the quantum of damage.

If it is abusive in nature, which benefits only selected shareholders, especially the controlling shareholders or the management, it must be declared void ab initio , irrespective of the approval process enshrined in the corporate governance code or under company law.

Therefore, SEBI may make a regulation for prevention of abusive RPTs a la insider trading regulations. Such regulations will empower SEBI to examine abusive RPTs and annul them if found damaging to minority shareholders. Even the legal process will be expedited.

PORTFOLIO MANAGERS

Among RPTs, the compensation to the management is a contentious issue, as no guidelines are prescribed by law (except limits), nor are any objective principles followed by the Board of Directors.

Therefore, the management, especially those which are also controlling shareholders, liberally grant to themselves a hefty reward devoid of justification. Here, we may take a leaf out of PMS regulations on fees and charges.

A PMS (portfolio management services) manager has a fiduciary responsibility to the members of the PMS and is therefore liable much in the same way as the management of a company to its members.

Under the PMS regulations of SEBI, it was prescribed that for profit-sharing or performance-related fees, a hurdle rate or benchmark must be crossed. Similarly, a high watermark principle is to be adopted for charging performance-based fees, which will ensure that only incremental growth is rewarded.

Both these principles can be applied by the remuneration/compensation committees of corporates for rewarding the managements.

Notice to the shareholders for approval of compensation merely lists out the pay and perks and variable compensation, but does not speak about the broad targets to be achieved by the management for being eligible for the compensation package.

Under the listing agreement the companies may be directed to adopt a transparent compensation policy that suits the industry in which the company operates while keeping in mind the principles laid down for regulations of fee and charges of portfolio managers.

The disclosures on RPTs need to be immediate and in certain types of RPTs it must be ex ante .

RPTs such as mergers/demergers acquisition of business, payment of royalty, including valuation reports if any, may be put out in public domain for shareholder comments before they are considered by the Board of directors.

The institution of independent directors, which was created to check mate or to re-balance the governance in listed companies, must ensure that the information on RPTs put out in public domain is adequate for the Committee to take a decision.

INDEPENDENT DIRECTORS

The institution of independent directors also requires to be strengthened along the lines of public interest directors in exchanges and depositories.

Independent directors must have a fixed term and it cannot be left to the whims/pleasure of the controlling shareholders. They can be removed only with the approval of SEBI or national exchanges.

The quorum for the meeting shall be complete only if an independent director (at least one) is present in the meeting. Independent directors shall be liable to vacate office if they remain absent for three consecutive meetings of the Board or do not attend 75 per cent of the total meetings of the Board in a calendar year.

If the companies are required to amend the articles of association to provide for such framework for independent directors, SEBI may direct the companies accordingly.

Notwithstanding such governance framework being in place, the fear of law catching up with wrongdoing will be felt only if there is an external monitoring mechanism in place. SEBI and national exchanges may conduct a corporate governance audit on a random basis to check the efficacy of the system.

It will strengthen investor confidence and improve valuations in the marketplace.

(The author is MD & CEO of CDSL. Views are personal.)

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