India’s corporate governance challenge16 min read . Updated: 03 Jan 2017, 02:17 AM IST
In the wake of the Tata-Mistry battle, a discussion on the role of independent directors, higher levels of transparency and fairness and many other prickly issues
The Ratan Tata-Cyrus Mistry boardroom battle has cast the spotlight on the quality of corporate governance in board-managed companies and highlighted the need for a wider, robust debate around the role of independent directors, higher levels of transparency and fairness, and many other prickly issues.
Founding Fuel organized a public conversation, in partnership with BOOM Live, around the wider governance lessons from this ongoing, unseemly controversy. The panellists were Sanjeev Aga, business leader and independent director; Subroto Bagchi, former chairman of Mindtree Ltd and chairman of Odisha Skill Development Authority; and Sanjoy Bhattacharyya, managing partner at Fortuna Capital.
The conversation was anchored by Indrajit Gupta, co-founder of Founding Fuel. Edited excerpts:
As you watched each of these events unfold, what were some of the thoughts passing through your mind?
Aga: It almost appears to me now as if there is a fundamental contradiction in the way India governs its corporations and it had to surface. Unfortunately, it surfaced in one of India’s best-known groups, but nevertheless, it had to—if it had not been this, it would have been something else. If not this year (2016), it would have been next year.
Broadly, India has largely borrowed the philosophy of American corporate governance in our new Companies Act. There is a large influence of Sarbanes Oxley (the Sarbanes-Oxley Act of 2002), which is rooted in a very disaggregated shareholding context, with a large number of shareholders and almost the complete absence of these animals which we have in India called promoters. It’s not just promoters. There are conglomerates and conglomerates lead to promoters within promoters, there are cross-holdings. And as you have in the case of the Tatas, above the conglomerate you have trusts which have their own governance. Many other companies in India would have subsidiaries, which themselves would be listed. So, there is a huge cascading hierarchy.
Now we are, nominally, supposed to follow the Sarbanes-Oxley philosophy, which means a shareholder is a shareholder and therefore you have concepts like independent directors and how things should be governed and how a committee should be formed.
But let’s look at the reality of India. We are still a promoter-driven kind of mindset. They could well be listed companies with public shareholders and foreign institutional investors. They could be taking funds from banks, which are also one of the promoters. But in the way we approach—the way I as a manager would approach or you if you are working (there)—you still think of it as “owners". This is our mindset. It is not just the so-called owners themselves, but it is the employees, the customers and banks. The banks will ask for a lien on promoter shares, or they will have earmarked allocations for business houses.
So, we have a fundamental contradiction. You pretend to be something and you are something else and then it surfaces—it had to surface. Therefore, someday, good will come out of this, because it bought to the fore contradictions and once you see them, you can address them.
Bhattacharyya: I think Sanjeev’s point is very well taken because what he is touching upon is the need to differentiate clearly and understand the different roles between ownership, management, and how that affects control. In a simple sense, I think that’s where a large part of the problem lies. Here it is complicated by the fact that there are layers upon layers. Tata Sons actually doesn’t own shares—the shares are held very often by a bunch of investment entities or various other entities, it’s not as if Tata Sons holds all the shares in the Tata companies. So, there are multiple shareholders. But Tata Sons is some kind of a body which exercises oversight on behalf of a family which set up many of these companies.
In that context, what is the role of Tata Sons? Do they have control or are they more in the nature of setting out a philosophy, a set of values, which are shared across the group and then implemented perhaps in different ways by the operating managers?
Two other things strike me very vividly—and they are really the essence of how companies need to be run for the best interest of all owners.
One is the issue of succession planning, which is very important when you have companies which have been set up by families and you have to handle the transition, sometimes, from being totally run by family members, to a context where professional managers come in and begin to differentiate the role that they play vis-à-vis the role family members play—and it can be done extremely well. Asian Paints, for instance, has three families who own the company, but they have an incredibly strong core of management professionals.
Another thing is capital allocation—in a sense, it is actually the only responsibility that the absolute top management team has, and which is very visible in this Tata affair. How you make decisions which then result in the way capital gets allocated to different priorities and the consequences of that in the longer term define how a business evolves. Capital allocation really is at the heart and soul of what this debate is all about. In India, unfortunately, I think, we don’t believe that very often those discussions on capital allocation need to be open and transparent, they need to be rooted in logic rather than sentiment, and they can be open to different interpretations in terms of your time horizon.
Bagchi: It is a very awkward time to have this conversation because when we talk of the Tata vs Mistry issue here, the players overshadow the discussion. So, for a moment, I would like to stay away from whatever is breaking news right now. I would like to step back and ask myself what are some of the things that we should be thinking about? I think as a nation we tend to feel devastated whenever devastating news comes. Particularly when we feel that people in high places, for whatever reason, are falling short, we mourn the whole thing and think about just in terms of personalities. I think it is a good idea to step back and look at systemic issues. What occurs to me is that some systems are too large to be governed. It could happen in government, or a large private sector company, or a non-profit entity, or a public sector company.
Are we building systems that are way too large to be governed? Is it humanly possible to govern anything so large? And when we expect some people to do that—leave aside public controversy—at the end of the day, you have 24 hours and you must sleep for eight hours. Your brain can hold only so much information, so much briefing by aides. How is it humanly possible for people to take care of so much and yet stay on the right side of things?
The second issue that comes to my mind repeatedly is, can law be a substitute for character? The moment we talk about corporate governance, the mind races towards, is there effective, adequate amount of controls? Are there enough laws? Is there enough governance on governance?
There was a question from one of our readers around the whole idea of unlisted companies, as Tata Sons is, exercising control over the agenda of public limited companies like Tata Motors and Tata Steel. That raises visions of the old management agency model.
Bhattacharyya: Well, yes. I think first of all, it’s a throwback to the past. The difference with the primarily British managing agencies was that they also had a far greater element of ownership. So, if you look at Martin Burn Company or Balmer Lawrie, all of them typically controlled more than 50% of the companies for which they were appointed managing agents. Here that is not the case—point No. 1.
Point No. 2, the responsibility of the operating companies and the relationship that they have with Tata Sons—if Tata Sons is to be the (entity that) determines how operating companies behave—it’s not clearly delineated so that shareholders can understand what these responsibilities are. And I don’t think they are consistent within the group, so different companies behave very differently in terms of how they look at major priorities and decision-making.
And third, there needs to be greater transparency. It’s not as if the managing agency system is necessarily bad. You can help a lot of companies do things with certain things pooled in a managing agency, which works for the interests of a broader group, but it needs to be done in a way that everyone understands what is being done and why it is being done. Here, I think the challenge is that people don’t understand that—why different things are being done and whether they have been thought through adequately.
Sanjeev, I wanted to come to you on the role of independent directors because that has certainly come up very strongly in this case. You have seen independent directors at IHCL, that’s the Indian Hotels, act and behave very differently from the directors at Tata Sons. Tata Sons remains an unlisted company and therefore independent directors don’t necessarily have to show their hand. But, when you are heading a public limited company as you are in IHCL’s case, you had to step up and inform the shareholders where you stood. How do you see this play out?
Aga: Normatively, it is not complicated at all. You must do what is right for all stakeholders. In fact, everyone is supposed to be independent because your fiduciary responsibility is to the corporation. But more so if you are called “independent", you carry a higher burden.
No. 2, you are responsible to your own conscience. It is very clear as to what is right and what is wrong.
But we don’t live in a perfect world and these are the kinds of contradictions which will surface. Are the independent directors across Indian corporations equipped in terms of experience, perspective, maturity and character? Because suddenly, one fine day, the independent director has become much more important. Are they equipped to play the bigger role that is tasked upon them? That is a new set of challenges which may surface with another issue maybe two years later. But as of now, I would say that normatively I think what the independent director should do is very clear. It could well happen that two sets of companies may differ and if that is an honest point of view, then that is fine.
Bhattacharyya: There is something very interesting in the Bible about this. It says, whose bread you eat, his song you sing.
Normally, as Warren Buffett puts it, and he should know reasonably well, there is no such thing as an independent director. That species is in the imagination of people who want to create a sort of system that apparently serve a purpose, but in reality it is very different. And we have an incredibly funny, or odd, situation here where some would say that the independent directors are not singing the song of the people who are giving them their bread.
Aga: We don’t know who is giving the bread.
Bhattacharyya: That’s right, that’s really the issue. It goes back to the concept of “independent directors". In a way, Sanjeev has really answered that question: who appoints the independent directors? If you look at the US and shareholder activism, the first thing the shareholder activist does is, he asks for the slate of directors to be changed. There is no such provision in Indian law. The managing director and management team propose or invite names which then get approved and become independent directors.
All of you made the point that we are moving away from just a compliance view of governance to a much more robust, trusteeship view. Can we explore some of those things, where to your mind the needle has certainly moved? You talked about greater levels of transparency, putting information in the public domain, you spoke about the regulation of the Companies Act.
Aga: The new Companies Act had too many frightening things around compliance, onerous requirements which in the wrong hands can be counterproductive. But a more constructive view is that the new Companies Act has caused the relatively better governed companies to govern themselves slightly better. Sometimes in the process of ticking the boxes you exercise greater rigour and a greater process.
However, if you want to improve governance, there is no point making the top 10% another 10% better. It is the bottom 90% where you have to make an impact. In fact, if the gap in governance becomes very high, you have a competitive contradiction because the badly governed companies compete with the better governed companies and lead to a negative spiral. The new Companies Act doesn’t do anything to change that.
Bagchi: My feeling is that we have a long way to go.
A few things come to my mind and one is that there is inadequate linkage between the corporate world and the academic world. Inadequate real-time, high-quality, high-intellect linkage and mutual listening, which I think is a very important thing to have.
I agree with Sanjoy when he said that how independent is an independent director, after all he’s been invited and you have to have a certain amount of homogeneity (without which you are not) collectively invested in the future of the organization.
But the independence is really about one, the ability to ask critical questions, which is both a competence issue and an honesty issue. The second is the responsibility of dissent—where will you say, no, I don’t think so?
So how much critical questioning, how much responsibility of dissent—by the way I am not saying right to dissent—is institutionalized in India?
I think we have a long way to go on that. All these things happen where there is a high amount of linkage and a high quality of linkage. You only read autobiographies of great people in India. You only read about this group or that group. But on a real-time basis, you don’t get enough well-thought-through pieces of wisdom, which can help us to step back and deal with the character issue, without which it will really be a moot question.
Bhattacharyya: One other issue which has changed significantly in the last 10 years is how independent directors are compensated. So if you serve on the boards of five or six pretty large companies and you exercise independence within what is a conventional framework, you could get fairly rich. So it is not easy to be independent today.
One needs to think about compensation. This whole façade that if you set up a committee and the committee has independence, the system works very well—because it doesn’t. In reality people are gaming the system. So you appoint me to your compensation committee, to your related party transaction committee in company A. There are two people, A and B. A appoints B. B appoints A to his company. Is this governance?
On the Twitter poll we had also asked what people believe would propel corporate governance to center stage in India Inc. Would institutional pressure propel corporate governance; whether new stricter regulations would; or the role of independent directors? 48% believe that institutional investor pressure will…and I can see Sanjoy laughing.
Bhattacharyya: It is just like Alice in Wonderland. Institutional investors live and die by the sword. You underperform for one month, for three months, you lose money. You don’t have the time to be patient. The only way you can exercise real constructive pressure on companies to bring about change is if you are not judged by your short-term results. All Indian institutional investors are evaluated in the very short term. So how are they going to exercise pressure? We don’t have any culture of investor activism in this country. It is the activist who can create serious pressure because they are committing their own money. In Apple they said you’ve got to pay dividends back to us because we own $3 billion of Apple stock. You give it to us, otherwise we will move a resolution to make you change your board. But in India we don’t have any of that. We have LIC (Life Insurance Corporation of India), the mutual funds. One more thing which people should realize is, if the investor doesn’t like what he sees, he can sell. So why is he bothered about (corporate governance)?
Sanjeev, there is a comment from Ashok Kumar Pandey who served at Tata Steel for many years. He worked for 27 years with the Tata group and spent almost a decade at Bombay House. He says, “Never did I feel I was working with a promoter-driven organization. Later on in life I did work for a promoter-driven organization, where I felt a stark difference in the way a professionally managed company works vis-à-vis a family of a promoter-driven organization." Any thoughts on that?
Aga: I am not even for a moment saying that promoter driven is inferior to a professionally managed. For many generations people were very happy to serve with the Tata group and I am sure that will continue. To extend from one headline event to a general (idea) about the masses of people and the managers and officers and workers, is too much of an extrapolation. So I agree with him.
But when Subroto and Sanjoy were talking, the thought occurred to me—you asked what is going to improve things. I don’t have an answer, but let me put to you the problem a little differently. Corporate governance is poor because poor corporate governance pays in India.
If I were to look at how to attack this problem, I would first see how to make bad governance start hurting.
Bhattacharyya: Implicitly what Sanjeev is saying is, the second step is how do you make good behaviour pay off. I think both are very important in the sequence which he has suggested. Therein lies the root of—on a longer term structural basis—beginning to find ways that we can do something substantive to improve governance.
If you were to look at the pecking order of priorities to change this narrative around corporate governance, where would you first attack?
Aga: Here my thinking has evolved and changed over the last 10 years. I used to give a lot of importance to external (factors). I would have demanded more of the government, the lawmakers, the courts, the regulator and the tax authorities. I don’t know whether I have become cynical because that hasn’t happened, or because it doesn’t work, but I think there’s nothing like change which comes from within. What I am trying to say is, it is easy for me as an ex-manager to criticize the government, the bureaucracy, the courts, the media, but it is very hard for me to name and shame a fellow manager. You have to develop a good system of (whistle-blowing), apart from demanding greater transparency of board decisions. Finally, I come back to the point I made earlier, that change will not happen unless you lift the bottom 80%. Here you have to find a way of intervening that the original promoters and managers don’t have a veto right on who comes in as independent director.
Watch the unabridged discussion on foundingfuel.com