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.
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.
ReplyDeleteIn 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.
ReplyDeleteI 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.