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Business News/ Opinion / Lessons in corporate governance at Infosys

Lessons in corporate governance at Infosys

Good corporate governance is essential to overcome agency problems and asymmetric information

In order to claim the high ground on corporate governance, it was essential for Infosys to immediately reveal the bad news, especially because the news concerned the actions of the CEO and the board. Photo: MintPremium
In order to claim the high ground on corporate governance, it was essential for Infosys to immediately reveal the bad news, especially because the news concerned the actions of the CEO and the board. Photo: Mint

The events that have transpired at Infosys in recent years have crucial ramifications for the way corporate governance in professionally managed firms shapes up in this country. However, to imbibe the correct lessons, we need to analyse objectively whether corporate governance did indeed worsen at Infosys in the last few years.

To carefully interpret the facts, a conceptual framework is essential. Academic research in corporate governance highlights that good corporate governance is essential to overcome two key problems that plague professionally managed firms: (i) agency problems and (ii) asymmetric information.

Agency problems stem from the fact that as agents of investors, many professional managers pursue their personal interests, even if such personal interest is detrimental to investors’ interests. While exceptions definitely exist to prove the rule, academic research shows that the average professional manager displays the maximum disregard for investors’ interests when setting his and the team’s compensation as well as when undertaking mergers and acquisitions. While compensation pads up their bank accounts, mergers and acquisitions enable the professional chief executive officer (CEO) to run a bigger empire. The bragging rights during the next round of golf or at the local club are often compelling enough for the professional manager to reason that it is not his money after all.

ALSO READ: The backstory to Infosys CEO Vishal Sikka’s resignation

Asymmetric information refers to the fact that professional managers and board members possess significantly greater information than the average investor in these firms. This asymmetry in information is further exacerbated by the fact that—left to themselves—professional managers would aggressively reveal good news and assiduously hide bad news. The temptation to hide bad news can become particularly undeniable amidst agency problems that point a finger towards the board’s or the CEO’s conduct.

Recall our behaviour as children after our performance in an examination was revealed. If we had performed well, we could not wait to share the good news with our parents. However, if we had performed poorly, we would try and hide that bad news. It is only the fear of being caught hiding the bad news that makes us reluctantly reveal the news to our parents. Such behaviour can be condoned in children. However, when professional managers hide bad news from investors, such behaviour provides an important signal about the poor quality of corporate governance in a firm. Conversely, voluntary disclosure of all news—good or bad—signals the high quality of corporate governance in a firm.

ALSO READ: Narayana Murthy’s battle is for the soul of Infosys

In this context, it is crucial to remember that investors expect a typical firm to hide bad news and reveal good news. Therefore, consistently revealing bad news in a proactive manner is crucial for a firm to develop a reputation for good governance. Such reputations are earned through a priori revealing of bad news and not through a posteriori protestations that nothing was hidden or from cheerleaders’ statements about the integrity of the interested parties.

Even when ex-post analyses are conducted by possibly independent firms to verify if information was intentionally hidden, the damage has already been done. This is because the reputation of being a well-governed firm is hard-earned and preserved with considerable effort by being positively different from the pack.

Academic research, especially Nobel Prize winning work on signalling and asymmetric information, highlights this aspect. When the average firm is perceived to be badly governed, signalling good corporate governance requires a consistently high level of effort from the management. Such effort has to be made ex-ante and not ex-post. Of course, the rewards of such ex-ante effort are disproportionately high as well.

ALSO READ: How Nandan Nilekani returned to Infosys

Did the board and CEO of Infosys make the effort to disclose all the bad news voluntarily as soon as it surfaced? No. While the CEO and the board may or may not have worked in tandem to hide bad news, it is definitely clear that they made no special effort to reveal the bad news immediately when it surfaced. In order to claim the high ground on corporate governance, it was essential for them to immediately reveal the bad news, especially because the news concerned the actions of the CEO and the board. Given the widespread perception that agency problems are endemic in corporations across the world, the CEO and the board had to take the initiative to provide evidence disproving this perception.

Some commentators have argued that Infosys needs to change its “conservative culture" to compete in the US market. Two concerns spoil this argument. First, did Infosys not compete successfully in the US market for close to three decades while retaining its “conservative culture"? Second, and even more importantly, an aggressive business strategy and an aggressive culture of merit should not be confused with aggressiveness in corporate ethics or corporate governance. In fact, good corporate governance pertains to aggressiveness in disclosure, especially when the news is bad and when it concerns the management or the board.

Finally, let us not use the messenger’s motive as an alibi for ignoring the important message: Good corporate governance requires diligent adherence to principles that remove the twin perceptions of agency problems and asymmetric information.

Krishnamurthy Subramanian is associate professor of finance at the Indian School of Business, Hyderabad.

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Published: 06 Sep 2017, 12:21 AM IST
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