A Brief Conceptual Background
The discourse on corporate governance has been garnering considerable attention in the public domain in India, mainly due to the introduction of the Companies Act, 2013 (“Act”), the steps being taken by the Securities and Exchange Board of India (“SEBI”) in promoting governance, and the escalating activism of shareholders and proxy advisory firms (“PAFs”) in the public markets.
The corporate governance regime in India has been implemented mostly reactively, thus far. One of the reasons could be the prevalence of the family-owned businesses in India which present a distinct and additional set of governance concerns such as safeguarding the interests of minority shareholders, the fiduciary duty (if any) of the promoter(s) to minority shareholders and the duties of the board of directors in conflict situations. As such, this feature may have effectively prevented Indian regulators from adopting the governance frameworks implemented in more evolved jurisdictions like the UK or the USA. Even Germany, where the corporate ecosystem is comprised of large family-owned businesses like India, could not have an appropriate reference point for Indian regulators, given the board structures there. To elaborate, German corporations have adopted a two-tier board structure whereby representation is mandatorily available to employees on the upper tier (supervisory) board. As such, this prevalence of family owned concerns could have been one of the reasons why the Indian corporate governance regime has largely remained prescriptive and reactive.
What Has Changed
India’s corporate governance regime has evolved significantly in the recent past. This can be attributed largely to the following reasons.
- The Act & its Push For Stakeholders’ Model
In line with global best practices, the Act has mandated a definitive shift away from the shareholder model of governance to the stakeholder model. In contrast to the shareholder model (which emphasizes the corporation’s responsibility to make profits and enhance shareholder value), the stakeholder model is centred on the principle that the corporation is responsible to a wider set of stakeholders, and companies and directors must work to balance the interests of these stakeholders. This has manifested itself in various provisions of the Act, which we may separately examine in the future. An extension of this principle of stakeholder governance is probably also the introduction of provisions for class action suits under the Act. In effect, this mechanism has sought to create an enforcement mechanism and a stricter framework of accountability with respect to management and operations of companies, enhancement of the quality of financial reporting, and allocation of responsibility.
- SEBI Initiatives
In the listed company space, SEBI has been regulating corporate governance and has assumed the mantle of being India’s governance watchdog. SEBI brought corporate governance to the forefront of public discourse by constituting two separate committees to examine India’s corporate governance landscape – the Kumar Mangalam Birla Committee (2000) and the Narayana Murthy Committee (2003). The concept of ‘majority of minority’ approval, which also finds place in the Act, was also first introduced by SEBI. SEBI’s influence has also permeated into India’s exchange control regime – the Ministry of Commerce and Industry co-opted SEBI’s definition of ‘control’ into the FDI Policy. Recognizing the uncertainty that industry and stakeholders have been grappling with, SEBI is now considering adding bright-line tests to determine the acquisition or existence of ‘control’, another move aimed at creating transparency in the governance of public listed companies.
Additionally, following the failure of a large number of listed companies to comply with the mandate to appoint women directors on their boards, the stock exchanges have imposed fines on non-compliant companies, strongly suggesting that these organizations have started taking their enforcement role more seriously.
- The Role of Investors
Traditionally, given the ownership structures of Indian companies, institutional investors have primarily acted as a counterweight to promoter influence. Financial investors today seem more willing to initiate proceedings against the promoters, directors and external advisors in court, be it on allegations of accounting fraud or mismanagement. Two prominent examples in the Indian context in this regard would be (a) the proceedings by India Equity Partners against the promoters of Fourcee Infrastructure on allegations of accounting fraud; and (b) the proceedings by the Children’s Investment Fund against the directors of Coal India for breach of fiduciary duties and failing to perform management functions with adequate skill and care. Equally interesting is the action initiated by Bain Capital against Ersnt and Young for allegedly advising them to invest in Lilliput Kidswear on the basis of financial statements audited and certified by Ersnt and Young. As such, whilst investors become increasingly litigious, one expects that this will raise sufficient concerns within the management of the company and its promoters for ensuring acceptable levels of corporate governance.
- The Rise of PAFs
PAFs emerged with the greater regulation of institutional investors by the Securities and Exchange Commission (“SEC”) in the United States. When the SEC made it mandatory for institutional investors to vote on all items in their companies’ proxy statements, PAFs firms stepped in to carry out market research and make recommendations on such proxy proposals. PAFs today remain very influential in the United States and institutional investors are heavily reliant on their recommendations when voting. The sphere of influence of PAFs in India is less apparent but evolving rapidly. Although there is insufficient empirical data to show how adverse recommendations may have influenced decision-making in Indian companies, it is clear that conceptually PAFs play a key role in promoting dialogues on governance, usually by getting companies to respond to negative voting recommendations.
A prominent example of the role of Indian PAFs could be the negative recommendations that Indian PAFs had made regarding Maruti Suzuki’s proposal to procure auto parts from a manufacturing plant owned by Suzuki, instead of manufacturing them for captive use. Whilst the stakeholder sentiment stood changed when Maruti Suzuki published its rationale for the decision and shareholders approved the proposal with significant majority, the role of the Indian PAF and its recommendations in this context was interesting to note.
What Lies Ahead
Given that one of the main objectives of amending India’s corporate law was to improve corporate governance, compliance under the Indian regulation has taken on a lot more meaning than it used to hold before. The focus on good governance is not going to die out, especially with investors willing to pay a considerable premium for good governance in a competitive investment climate. Given this, companies and strategic investors need to be well-equipped to deal with the new challenges that the public scrutiny and discourse on good governance will inevitably bring. In today’s environment, good governance is a legal and commercial necessity for any company seeking to raise capital or attract meaningful and mature investors.