Executive Primacy in Corporate Governance

The Case of Jindal Steel and Power

Corporate governance literature is replete with debates on board and shareholder primacy: in countries with predominantly concentrated ownership and management control structures, a third claimant also needs to contended with: the executive management, which is part-principal (because they are the dominant shareholders) and part-agent (because they are managers running the day to day business). There is an influential school of thought that believes in shareholder primacy on key directional matters relating to their corporations, with boards serving their interests within the overall framework set out in their charters, with the right to intervene to dictate course corrections when they deem it necessary. The opposing camp is convinced that the shareholders’ job is to elect a slate of directors and thereafter it is that board which assumes primacy in running the business in the best interests of the company and its shareholders without any interventions; and it is the board in fact that would decide what is good for the shareholders say for example in a takeover situation and advise them accordingly to accept or reject the offer.

We now compound the situation by introducing a third claimant, a hybrid of both shareholders and the board. When some shareholders (usually referred to as promoters in India since often they are the initiators of the business and its corporatization) assume operational control as well of the corporation, they seek to usurp primacy from the board as well as the general body of shareholders! The rest of the board in that event has the onerous task of protecting the other shareholders’ interests not just from the traditionally ‘greedy’ managers but from a powerful group of managers masquerading as shareholders when it suits them!

It is in this backdrop that the case of Jindal Steel and Power (JSP) in 2012 is discussed here.  JSP, a listed company with a market capitalization of some R.s 40,000 crores had a consolidated sales revenue of Rs. 18350 crores and net profit of Rs. 2100 crores. The Jindal family owned some 58.97% of the voting equity, with institutional investors and others owning the rest. Naveen Jindal, the chairman and managing directors of the company had his board delegate to him the authority to determine the compensation of all whole time directors, by whatever name called, and the resolution came up to the members’ generl meeting on 26^th September, 2012 where it was passed , on a poll, with “the requisite majority.” (For more details, please see an earlier post titled, Can the Board delegate any of its core functions?). Passing of this resolution was by itself no surprise since the Jindal family had more than a majority of votes to carry it through; what it brings up for debate again is the issue of how far is it fair for any shareholder to vote on  a resolution at a shareholders’ meeting when he or she was an interested party in the decision, as was the case here. Naveen Jindal’s remuneration for the year was a staggering Rs. 73.5 crores, reportedly the highest paid to any corporate CEO. The next highest pay in the company was Rs. 2.78 crores to the Group Vice Chairman. On a peer comparison, Tata Steel with roughly four times JSPL’s net profits paid its CEO Rs. 6.5crores in the same period.

How doe address some of these developments in corporate behavior in India especially bearing upon the (ab)use of dominant or majority voting power of controlling shareholders at general meetings even in respect of matters where they or their representatives are beneficiaries? Can the institution of independent directors provide some solutions and what we can do to enable that institution to be more potent than Is the case at present?

Several measures have been suggested and are possible to restore a semblance of credibility and trust in the corporate format of business organization. For this some key enablers are required to strengthen the board systems and to bring in greater equity to members’ meetings. Some of these are:

·        Contrary to the mistaken belief that the institution of independent directors is incapable of delivering to its potential and expectations, it certainly can if it is invited by enlightened promoters, and even in case of others less convinced if it is appropriately enabled. At present, regulations inflict the institution of independent directors on listed  companies (and soon many others as well if the Companies Bill awaiting parliamentary approval becomes law), but after that there is no attempt to make it work effectively. For example, a board meeting could be duly held and critical decision taken without  any independent director being present so long as the requisite (usually small) number of other non-independent directors is present. Similarly, even when some independent directors are present, a meeting with more non-independent directors could overrule and approve resolutions by a majority. In either case, the institution of independent directors, even if competent and willing is frustrated in achieving its objectives. Two simple initiatives could help in remedying this situation:

o   Modify the quorum requirements of a duly constituted board meeting to require the presence of a majority of the independent directors on the board

o   For decisions on key matters (to be prescribed), require not only a majority of votes cast at the meeting but a majority as well of affirmative votes of the total number of independent directors on the board (and not just of those attending). This would ensure that no decisions of major import are approved without the independent directors having been provided an opportunity to exercise their objective judgement on such matters in the overall interests of the company and its shareholders 

·        The second initiative would address the voting regime at members’ meetings.

o   Amend the Companies Act to provide that notwithstanding any other provision in the Act, interested shareholders’ voting rights at general meetings of members will be restrained in case of resolutions where they or their relatives or associates are concerned or stand to benefit; then define “interested parties exhaustively to include close family, associates, partners and entities over which they have control or substantial influence

 It is the established norm that all shareholders in a class enjoy equality of treatment in voting in proportion to their shareholdings. But, when the consequences of certain proposals before the members negatively impact some of them but not others, or when the proposals are in the nature of material related party transactions between the company on the one hand and some shareholders or their representatives and associates, where they become interested parties, then equity demands that such “interested” shareholders abstain from voting on such resolutions leaving them to be decided upon by the other shareholders. Some of the transactions that would be covered by this initiative would be issues like acquisition or merger of group subsidiaries or affiliates with the parent (as was the case with Satyam not too long ago), material contracts with firms where the interested shareholders are beneficiaries, appointments of interested shareholders or their relatives and associates as directors or senior executives and fixing of their compensation, and so on. As an example, if such a provision was in place, it is doubtful if JSPL’s resolutions as indicated earlier and their CEO’s compensation would have been approved because as interested parties, their 58.97% shareholding would not have counted and if a majority of the rest did not like the proposals, they would have been rejected.

This concept of interested shareholders and the need to restrain their voting power at general meetings of members on matters where they stood to benefit was mooted more than a decade ago in a government appointed committee report submitted in 2000 (and certainly safely archived in the records of the Ministry of Corporate Affairs, but still remembered because the present author happened to be the drafting member of that committee!) but nothing much was heard since then despite representations to various committees on corporate governance and law reforms. Finally, the Irani Committee in 2005 accepted it as a good corporate governance practice but stopped short of recommending legislation. In 2011, SEBI belatedly took cognizance of the value of such a measure and recommended to the government to incorporate it suitably in the pending Companies Bill, but one will have to await the 2012 version of the bill when it is introduced in parliament.

Around the world, executive compensation has been and continues to be an emotive issue. More and more regulatory discipline is being imposed on corporations whose boards and compensation committees are required to explain their compensation policies and how the proposed compensation packages of their top executives have been computed and justified. From an advisory say-on-pay movement in the US that began a few years ago in the wake of reactive legislation in the US, countries like the UK have moved to mandatory voting by shareholders on executive pay. Of course, none of them have thought fit to constrain “interested shareholders” from voting on their own pay proposals mainly because both in the US and the UK, concentrated dominant ownership and control of corporations are not as widely prevalent as in countries like India. The special circumstances relating to ownership and control in India therefore call for special provisions to ensure fair play and accountability. One hopes such measures would be brought in sooner or later because these will be the principal building blocks of trust and confidence in India as a preferred investment destination.

Can the Board Delegate any of its Core Functions?

The Case of Jindal Steel and Power

On the 26^th September 2012, the annual general meeting of members of Jindal Steel and Power Ltd (JSPL), a listed company with a market capitalization of some Rs. 40,000 crores, approved “with requisite majority” an ordinary resolution (among others) enabling the company’s promoter chairman and managing director, Naveen Jindal to approve from time to time the remuneration of all whole time directors (including his own since as managing director he qualifies as a whole time director). As a matter of collateral interest, the annual compensation of the CMD was some Rs 73.5 crores, reportedly the highest CEO pay in the country (comparatively, industry peer Tata Steel with a net profit of some Rs. 8,000 crores (roughly four times JSPL’s figure of a little over Rs. 2100 crores paid its CEO some Rs. 6.5 crores in the same period). 

According to a company filing dated 29^th September 2012 (accessed from the company’s web site), seventeen persons including proxies representing the promoter group and twelve persons including seven proxies representing 299 shareholders (out of 130,000 plus shareholders in all) were present at the meeting held at the registered office of the company at Hisar, the family’s ancestral city with a population of around three hundred thousand in the Northwestern state of Haryana, some 160 KM west of New Delhi. The company’s consolidated revenues for the year ended 31 March 2012 were Rs. 18,350 crores (previous year Rs. 13,193 crores).

In thousands of publicly listed corporations around India (and probably elsewhere), this farcical manifestation of corporate democracy is played out with all the accompanying trappings: a chairman’s speech, reading of the auditor’s reports, approving financials, “electing” directors and so on. Of course, there is enough scope for those so inclined (usually for want of anything more worthwhile) to make flattering speeches (in the hope of collecting some crumbs of favours later on) or asking “difficult” questions (if only to prove their forensic skills were second to none). At the end of the day, amidst the reverberations of “your company” and “your directors” from the dais, the meetings are closed with the directors having stoically borne their annual day of reckoning without much damage and get on to business as usual until the following year.

Was there anything unique then about the Hisar meeting? Indeed yes. Probably for the first time in recent Indian corporate history, a record of sorts was made there that arguably challenged many canons of corporate behavior, responsibility and ethics. Let us consider the resolution in question (according to the notice, the board of directors had commended all proposed resolutions to the s including this one to the shareholders for approval). [Author’s italicized comments in square parentheses}

“Resolved that … Chairman and Managing Director of the Company be and is hereby authorised to revise, from time to time, remuneration of Wholetime Directors of the Company, by whatever designation they are called, by way of annual increments or otherwise.

[Could this be construed to permit more than one such revision in a year?]

“Resolved further that the increase in remuneration in case of each such Wholetime Director, at every time, should not exceed 100% of their respective Cost to Company (CTC) immediately before the revision.

 [Thank God, but since more than one revision in a year is permitted, and for example, if there were to be quarterly revisions at the maximum 100%, the annual impact might be a staggering 1600% of the year-beginning cost to company!]

“Resolved  further that where in any financial year during the currency of tenure of such Wholetime Directors, the Company has no profits or its profits are inadequate, the Company will pay remuneration by way of basic salary, performance based target variable pay, benefits, perquisites, allowances, reimbursements and facilities as determined in the above mentioned manner.”

[What this means is whether or not the company makes enough profits, executive compensation to whole time directors including the managing director will continue regardless, without let or hindrance!}

Three issues (at least) come up for discussion: first, could the board approve a delegation of one of its fundamental functions to someone else and commend it for shareholder approval; second, assuming there is no question that the expression “whole time director” in the resolution would for this purpose include the whole time managing director as well, is it fair and equitable for an individual, howsoever objective he or she might be, to set his or her own compensation; and third, given this action is in the nature of a related party transaction in respect of his own remuneration, and in respect of other whole time directors, he is vested with a beneficial authority that enhances his personal sway and influence over other whole time directors, should the promoter be allowed to vote on this resolution at the general meeting.

Let us however consider the following:

Ø  An elementary principle of corporate governance is the recognition of goal-incongruence between the shareholders (principals) and the executive (agents) in terms of respective interests; the board, as trustees of all shareholders (especially the absentee shareholders since the controlling shareholders being present on the scene could rationally be expected to take care of their own interests), are obligated to oversee and mitigate any such material expropriation by the executive of any created wealth and all wealth-creating assets to the detriment of shareholders. Executive compensation is a material source of such potential undue diversion of funds and resources and hence around the world, if anything, oversight and control mechanisms to reign in executive compensation are being strengthened by legislation as well as listing regulations. In such an environment, does the board have within its jurisdiction, legally and ethically, the power to delegate such an important fiduciary duty and especially to the executive itself whose actions it is supposed to oversee?

Ø   If there is a Compensation Committee the onus of determining compensation numbers is vested in that committee which in best practice should comprise of a majority, if not wholly, of independent directors. In the absence of a Compensation Committee (in any case the JSPL Compensation Committee is reportedly only for deciding stock options!), it would follow the whole board and especially its independent directors would have that responsibility. Vesting that crucial authority to someone else and especially to the managing director of the company who in that capacity is equivalent to a whole time executive director would, arguably, seem to border on abdication, and not delegation of a fundamental responsibility. It would be interesting to ascertain how many of the independent directors were present at the meeting approving this resolution and how were they convinced they were serving the interests of all shareholders in approving this resolution.  Equally, it would be interesting to find out whether any of the directors dissented with this resolution at the board meeting and whether such dissent was asked to be recorded in the board minutes.

Ø  While a person being allowed to determine his own compensation and hold the board accountable because he was acting within the authority granted to him by the board, is thus repugnant to even the minimum requirements in equity and fairness in any legal regime, the authority so granted in respect of other whole time directors is equally bad in concept. What can quite easily be overlooked in such situations is the underlying reality that whole time directors have a dual role to play with distinctly different responsibilities and accountability. As employees of the company, they are subordinate to the CEO or Managing Director but as directors, they are not subordinates but equal members on the board. Their accountability in their role as directors is to the board, the company and to all the shareholders. Because they are part of executive management and as such are broad brushed together as “agents” with incongruent goals likely militating against the interests of shareholders, it is the duty of the board (and its Compensation Committee) to exercise oversight control over them and their remuneration. As it is, it is extremely difficult at a personal level for subordinate executives to express any view not in conformity with the views of their hierarchical executive chief at board meetings but to have their compensation also being decided by such a chief without scope for any role for the board cannot but compound their problems and make them virtually just numbers at meetings for purposes of required  support and votes to ensure the “party line” is strongly represented numerically (since the extent of shareholdings does not add weightage to the individual directors at board meetings.)

Ø  But this handicap is removed when matters go to the general meetings of members where each shareholder’s vote has a weightage proportionate to the size of his/ her shareholdings. In a sense, this concept of weighted votes in members meetings has been justified on grounds of the differential equity risks such shareholders undertake. (It has not always been so however, and this convention has evolved over time but that is a story by itself). The issue of relevance to this discussion however is whether exercise of votes by persons who are parties to, and beneficiaries of decisions at the meeting, is legitimate and equitable. As the law of the land stands today, there is no question about their legality. But it is not difficult to see how those with substantial voting power (not necessarily majority voting power because not the full complement of shareholders representing all the 100% of votes can ever be present at these meetings) and suitable connections to influence some block holders like financial institutions can get their way at these general meetings even if it meant they were the beneficiaries to the exclusion or detriment of some or all the other shareholders. In the case of JSPL, it is not surprising that the promoter group with 58.97 % of the company’s equity would not, and did not have any difficulty in having the resolution approved by the required majority. Unlike other resolutions, this particular resolution was not passed, as is usual in most cases in such meetings, by “show of hands” but on a poll even though the result was a foregone conclusion with the promoter group voting in its favour. There is no information in public domain as to whether any or all of the institutional shareholders who held 28.20 % of the equity exercised their franchise against the resolution if only to register their protest.

Is this the kind of corporate governance that this country should be delighted with? Is this the manner in which independent directors ought to be protecting the interests of the shareholders not in operational control? Does the regulatory responsibility cease with forcing such independent directors on companies, whether they like it or not? These and other related questions will be addressed in another forthcoming post.