The issue of principal-agency conflict is not new to management literature. The conflict refers to how the decision of a 100% owner-manager differs from that of, say, a 50% owner-manager, inflicting hidden costs upon the company.
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To provide an overtly simplistic example, a manager who owns the company entirely may travel economy class, have a smaller office and a thinner carpet. But if the manager owns only 50% stake in the company, he is more liable to fly first class, have a larger office and a thicker carpet because he pays only 50% for those luxuries, the remaining 50% being footed by somebody else. This additional cost—simplistically put—is the cost of principal-agency conflict.
Needless to say, if the owner-manager owns only 8% of the company, the cost of principal-agency cost can seriously increase—potentially to billions of dollars in the form of wealth transferred to related parties—as we have seen recently, because 92% of the bill is footed by other shareholders.
One of the important reasons why companies are required to have independent directors on board is to minimize such principal-agency conflict. These are also the reasons why independent directors are expected to be more diligent towards related-party transactions because one of the expectations from them is that they will act as a check against high principal-agency conflict.
Companies may meet the requirements of the independent members on their boards in letter or in spirit. Independent members may carry out their obligations in letter or in spirit. Perhaps, what differentiates a well-governed company or a genuinely independent director from the not-so-well-governed company or not-so-independent director is the difference between the letter and the spirit.
We have witnessed it all recently in the case of Satyam Computer Services Ltd, and the market has spoken about what its perception of these issues is. It could well be that on paper, nobody may question the credibility of a set of independent board members on a corporate board. And yet, if a decision running into billions of dollars is concluded in minutes and reversed overnight, the due diligence exercised by the independent directors comes into question.
In a recent case, we even saw three of them resigning even though the those remaining did not see a necessity for similar action. More unpalatable facts have come to light in this case, with stringent action taken by none other than the World Bank.
The developments raise some troubling issues. One thought that greed and poor corporate governance was the exclusive preserve of the licence-permit raj companies.
One thought our IT sector was the best face of Indian corporate sector. One wonders if a company should have the right to conceal the name of the valuers in a deal involving related parties. Or whether promoters on the management seat of a company can have the right to conceal the fact that they have pledged their shares with banks.
One also thought that having eminent academics from the world’s top business schools as independent directors provided some degree of comfort to the investors. One thought a company with a large holding from financial institutions somehow will be better governed. One listened to the lectures of professors in eminent business schools with such awe. One expected so much more from such academics in their roles as directors on boards. One wonders, given the handsome compensation independent board members receive, shouldn’t the regulators lay down more stringent and more formal expectations from the independent directors to hold them more accountable for their lapses?
It is perhaps time the Indian corporate sector as a whole sat up and asked itself some searching questions.
We have been routinely listed among the most corrupt countries in the world in virtually all surveys. Recently, we were listed as the fourth most corrupt country in the world in offering inducements outside our own boundaries, even without the World Bank’s indictment of one of our top companies. Could it be that from being victims of political and bureaucratic corruption at home, we are after all proactively corrupting officials elsewhere? Wouldn’t the actions of even one of us impact all of us collectively? Who should make the first move towards reversing the trend of our corruption? Do companies have a role in nation-building and setting benchmarks? Could companies succeed where our politicians and bureaucrats have failed us?
V. Raghunathan is a former professor at the Indian Institute of Management, Ahmedabad. These are his personal views. Comment at theirview@livemint.com