Wednesday, October 10, 2012

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 26th 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.


  1. Interesting post. Best course of action is for individual shareholders to stay away from this company as the promoters are extracting a disproportionate amount of the profits.

  2. In addition to what has been suggested on the regulation side I feel that it will be most effective if shareholders and more particularly institutional shareholders dump shares of such companies.

    I am not very sanguine about the ability of independent directors to check this problem. It is only a rare enlightened company that will select truly independent directors and such companies are unlikely to do things like this in the first place. Of course considering that FIIs had no objection to related party transactions in the Satyam case one is not sure whether investors even institutional investors are serious about governance.