Shareholder Primacy in India: So Near and yet So Far![1]
The scholarly debate on primacy
among the shareholders, boards and the executive in corporate governance is
intellectually as challenging as it is yet inconclusive, although more recent
trends around the world would seem to suggest at least a glacial tilt towards
shareholders’ supremacy. This note attempts to explore the issue with specific
reference to India and its listed corporate universe.
A.
Some Measures Supporting
Shareholder Primacy
Indian company law incorporates
several measures that aim to establish shareholder primacy over the corporate
board and the executive. Some of these (with illustrative comparisons with some
developed market jurisdiction) are enumerated below.
Right to Elect and
Remunerate Directors
As is quite well known, the
fundamental format of the corporation makes it impossible and indeed even
undesirable for all shareholders to actively participate in management;
instead, shareholders elect a small group of people trusted for their
“integrity” and “competence” as
directors to protect and promote their
interests, guiding and overseeing the
executive management and periodically report back on the company’s state of
affairs. The directors thus elected incur, consequently, a fiduciary or trusteeship obligation to act in the interests of the
company and all its shareholders. The components of this right include choosing
fit and proper candidates to act as directors, expecting their independence from operating management
so as to promote fair and objective supervision, approving appropriate executive
and directorial compensation, and so on. Some of the distinguishing features of
Indian company legislation and regulation are undernoted:
·
Directors are to be elected
individually and not collectively as a “slate” proposed by incumbent board and
management in the United States until recently
·
Director candidates’ profiles
are to be circulated to shareholders for assessing suitability
·
Objectivity and independence of
at least a third of the board are required by statute (unlike say in the US
where the requirement of majority of the board to be independent is prescribed
by listing regulations, and “controlled companies” are exempt from the
requirement of majority of the board to be independent; additionally, such
“controlled companies” are also exempt from independence requirements with
regard to their compensation, nomination, and governance committees)
·
Executive compensation is to be
approved by the shareholders individually for each whole time director
including the managing director (unlike in the US where the Compensation
Committee of the board is authorised to finalise and approve such
compensation). This US position is undergoing a change in recent times, thanks
to the ‘Say in Pay’ movement that sought greater empowerment of shareholders in
this matter; as yet, the ‘say in pay’ vote by shareholders is only advisory and
not binding on the company unless its management and board choose to act on the
advisory votes.
·
Statutory ceilings on non-executive
directors’ compensation individually and in the aggregate (not to exceed 1% of
net profits of the company if there is a managing director, whole time director
or ‘manager” and 3% in any other case) help to contain such expense within reasonable
limits (unlike in the US where no such limitations apply as long as the
company’s remuneration policy for directors and certain other details are
disclosed to shareholders in the annual report)
·
Prohibition of stock option
grants to independent directors is aimed at promoting independence levels (unlike
in the US)
·
Statutorily providing for board
diversity by mandating at least one woman director on the board (although
several countries in continental Europe
and even the UK have, or are fast moving towards, such provisions (with the
European Parliament having approved a draft directive to have 40%
representation for the under-represented sex on listed company boards in member
countries), the US (barring the State of California effective 2016) does not as
yet have any such mandate; companies
however are required to report to shareholders whether they consider diversity
in board composition and if yes, how they implement it)
·
Statutorily enabling election
of a ‘Small Shareholders Director’ to protect their interests (although the
idea may be conceptually flawed, since once appointed a director from whichever
constituency, the person’s fiduciary obligations extend to the whole company
and body of shareholders, not limited to the constituency that elected him or
her). There are no comparable provisions
in the US or other developed markets
Right to Protect Holdings
Equitably
Shareholders’
rights to peaceably hold, dispose or otherwise deal with their holdings can be
vitiated under certain circumstances such as when preferential issues of
capital are made to some but not all the shareholders, or when mergers or
acquisitions take place, or when there are changes in the ‘control’ of the
company, and so on. Some of the
legislative or regulatory provisions in India seeking to protect shareholder
interest are undernoted.
·
Fair price discovery methodology
mandated based on market prices over a period, in case of offers to buy out
shares from holders so inclined to sell (given the relatively small and shallow
trading operations may render these mechanisms may be vulnerable to
manipulation by vested interests but if they succeed even to a limited extent, they
would be welcome)
·
Mandatory offer to buy up to
some prescribed percentage shares from willing
shareholders in case of acquisitions and/or change of ‘control’ of the company
·
In the event of ninety percent
of the capital having been acquired by the majority shareholders, the remaining
ten percent shareholders can be squeezed out whether or not they wish to sell
their holdings. Law provides for fair and reasonable price to be paid to the
concerned shareholders
Right to Credible and
Comprehensive Feedback
·
Entitlement to receive annually
detailed financials and reports of directors. Disclosure requirements in India
are probably the most comprehensive among comparable and developed markets
·
Right to appoint independent
statutory auditors vested in shareholders at their annual general meetings,
unlike many other jurisdictions where the audit committee of the board decides
on the appointment and remuneration of such auditors. Auditor independence
criteria and rotation are other topics statutorily covered in India
·
All subsidiary company accounts
and financials need to be audited individually and summary results made
available to the shareholders of the holding company, with full audited
accounts being made available on holding company web sites (unlike in jurisdictions such as the US where
unlisted subsidiaries’ accounts need not be audited separately or made
available to holding company shareholders)
Right to Protect
and Determine Business Purpose, Continuity, and Solvency
·
Restriction on the powers of
the board in respect of selling, leasing, or otherwise disposing of the whole
or substantially the whole of the undertakings of the company
·
Restriction on borrowings aimed
at preventing undue financing risk of the company without specific shareholder
concurrence by a super majority for borrowings beyond the aggregate of the
company’s paid up share capital and free reserves y
·
Restrictions and disclosure of
contributions to political parties
·
Contributions in excess of
prescribed limits, to charitable and other funds to be approved by shareholders
·
Modifications in the objects
clause in the charter documents may not be made except with the approval of
shareholders by a special (super majority) resolution through postal ballot (to
provide for widest possible access to all shareholders). Companies with unspent
money from an IPO are also required to offer an exit option to dissenting
shareholders
Right to Agitate against
Oppression and Mismanagement
·
Eligible shareholders (at least
100 in number, or at least 10% of the total number of shareholders, or holders
of at least 10% of the issued share capital including preference capital if any)
may seek legal redress in case of alleged oppression of shareholders or
mismanagement of the company, prejudicially impacting the interests of the
company or its shareholders
·
Central government has been
vested with powers to carry out inspections and investigations on the basis of
a special resolution of the shareholders or a report from the Registrar of
Companies, or in public interest. Similarly, government’s Serious Fraud
Investigation Office is also empowered to undertake investigations in
appropriate cases.
Right to
Reasonable Protection from Tunnelling
·
A common method of unfair
expropriation of shareholder wealth by controlling shareholders is through
related party transactions favouring the controlling shareholders at the
expense of other absentee shareholders. By prohibiting such shareholders from
exercising their votes supporting resolutions on such transactions at
shareholders’ meetings, interests of shareholders not in operational control
are safeguarded since only they can by a majority approve or reject such
transactions
·
Audit committees are required
to review and approve or reject all related party transactions; although this
requirement imposes a very onerous responsibility on audit committee members,
it provides a valuable oversight mechanism to filter out abusive related party
transactions, protecting other absentee shareholders’ interests
B.
Shareholder Primacy in
India: Fact and Fiction
While these and other such measures
clearly indicate legislative intent of protecting and promoting shareholder
primacy in key areas of company governance, whether these translate in to
reality is a moot question. There are several reasons why these measures are
rarely utilised optimally to their full potential, some of which are
undernoted.
Attendance and Voting at
Members’ Meetings
·
In general, votes are exercised
at members’ meetings in person, or by proxies present at the meeting.
Attendance at such meetings thus assumes great significance. Traditionally,
only a fraction of the shareholder population takes the trouble of attending
meetings, either because their miniscule holdings do not merit or justify the
time and effort involved or simply they
do not have the expertise to meaningfully participate in such meetings.
·
To incentivise attendance (as
well as to minimise and manage any potential shareholder hostility), companies
have often offered some freebies but even in such cases, it is not unusual for many
shareholders to collect the freebies and depart without participating in the
proceedings, or just be mute spectators.
·
To obviate this deficiency at
least in respect of key resolutions coming up for approval, a system of postal/electronic
ballot has been introduced for some years but even this appears to have had
limited success due to continuing retail shareholder indifference; but a
regulatory mandate covering mutual funds (but not other institutional investors
as yet) regarding disclosure of voting details with reference to their investee
companies has led to a significant increase in their voting participation.
Investors Apathy and Impact
of Crony Capitalism
·
Many institutional investors,
especially in the foreign institutions category, believe their relatively small
holdings (in their overall portfolio) in the companies do not justify the cost
of monitoring and evaluation of governance practices, and participation in
voting. To some extent, emergence of proxy advisory firms appears to have
persuaded at least some of them to more actively participate in members’
meetings in recent years. Blatant breach of basic governance norms of course do
attract their intervention (as in the case of Satyam Computers and Steel
Authority of India, to mention a few) but even then, the time consuming and
costly processes of navigating such interventions through the Indian judicial
system often act as major deterrents to
·
Large domestic institutional
investors largely are owned or controlled by the State and hence their voting
decisions are as often as not likely to be influenced by political compulsions
of the incumbent government. Traditionally, business and government nexus or crony
capitalism has worked to their mutual advantage both in the field of policy
making and in operational facilitation (here). As a general rule,
governments of the day in India have tended not to upset incumbent managements
of companies (as for example, in the case of (now Lord) Swraj Paul’s
unsuccessful attempts to take over DCM and Escorts, two of India’s vintage
companies in the nineteen eighties). Manifestation of this basic policy of calculated
non-interference usually takes the form of such institutions abstaining from participating
in meetings or voting on key resolutions, paving the way for incumbent
management or the “establishment” to cope with any serious challenge
C.
Strengthening Shareholder
Primacy
Maintaining a tenuous equilibrium of
constructive tension among shareholders, boards of directors, the executive and
the controllers is an important mechanism for establishing good governance in
companies. Any effort to further strengthen the level of good governance will
need to address both the inhibitors and the intent-practice gaps in the
governance structures. Following are some areas where further scope for
improvement likely exists.
Enhancing Institutional
Investor Participation in Company Governance
Institutional investors do have
their accountability and trusteeship obligations to their own stakeholders and
in that context likely owe it to them to actively participate in their investee
companies’ governance processes to contain governance risk premiums such
companies’ securities suffer. The Stewardship Code dealing with such
institutional investors may be revisited to explore further strengthening of
its provisions to promote greater investor participation in such matters.
Enabling Independent Directors
towards Enhanced Contribution
Having introduced the undoubtedly valuable
institution of independent directors in board governance, it is probably
opportune now to take some further legislative initiatives to strengthen the
voice of independence at the board level (here)
Following are some of the measures that may help in that direction.
·
Certain key proposals and
decisions to require affirmative approval of a majority of all independent
directors (whether or not present or participating)
·
Quorum requirements for board
and committee meetings to require the presence of a majority of the independent
membership of the board or the committees. The newly introduced requirement of presence
of at least one independent director at board meetings is a good beginning but
its utility is likely limited since it applies only to board meetings called at
short notice.
Countervailing Controlling
Shareholders’ Inappropriate Governance
Board and director “capture” is a
well-established phenomenon that impairs good governance; to shield the
institution of independent directors from the debilitating effects of such
practices, some structural reforms may be necessary in countries like India
where concentrated corporate ownership and dominant control are the rule rather
than the exception. Following are some of the measures may help in this
direction.
·
Recommendations of the
nomination committee for induction of new independent directors to be approved by
a majority of only the independent directors on the board (whether or not
present and participating) for tabling at shareholders’ meetings
·
Resolutions electing new
independent directors at shareholders’ meetings to be approved by a majority
only of shareholders not in operational control, with controlling shareholders
not participating in the voting (such a restriction on voting rights has
already been accepted in principle in case of related party transactions). This
measure is justified on the basis that one of the major role of independent
directors is to monitor executive performance to ensure wealth is created and
created wealth is passed on to (or held for) all the shareholders of the
company; in electing such directors with a surveillance role over the
executive, it is not unreasonable to disempower shareholders in management whose activities
are to be so supervised, from voting and influencing the election of such independent directors
·
Independent directors
“resigning” mid-term during their tenure to be required to explain the reasons
for their decision to the shareholders at an immediately following members’
meeting for approval by a majority only of non-controlling shareholders.
Barring extenuating personal circumstances, such “resigning” directors may also
be required to be present at the members’ meeting and respond to any questions
from the non-controlling shareholders.
Pretty
much the same reasoning also applies to the appointment of independent
statutory auditors whose role by definition is to objectively examine the
affairs of the company and report to shareholders on the true and fair status
of the financials. Accordingly, it would not be unfair to require that their
appointment at the general meeting of members is approved by a majority of
non-controlling shareholders, with the controlling shareholders’ votes not
being reckoned. Auditors’ resignations or proposals for their replacement may
also similarly be required to be subject to approval of the majority of
non-controlling shareholders, with such auditors being required to explain
their viewpoint to them.
D.
Towards Better Governance
in a World of Concentrated Corporate Ownership
It is
apparent from this discussion Indian corporate law leans towards protecting and
promoting shareholder primacy even while recognising other stakeholder
interests and offering substantial
freedom to the boards and the executive to carry out their responsibilities.
The sting in the tail however is that many of these wholesome provisions are
frustrated partly out of non-controlling shareholders’ own indifference and
partly by gaps in measures aimed at containing self-serving controlling
shareholders in pursuit of their illicit objectives. Of course, there will be,
and indeed are, examples of excellence even now of controlling shareholders
with exemplary concern and behaviour towards absentee shareholders and their
interests but regrettably they are relatively a small proportion of the total
corporate population. This paper has enumerated some of the measures that may
help to bridge these gaps and take the country closer to better standards of
governance in the corporate sector.
As a
general rule excessive and invasive legislation is not a preferred option in a
free market economy and it would be ever more desirable if corporations were to
adopt such measures on their own and distinguish themselves from the rest.
Sadly, experience
in most countries has shown that corporations tend to respond to mandates than
exhortations. Affirmative action in respect of having due share of women on
corporate boards is a telling instance of legislation over persuasion being the
more effective method of achieving objectives as observed in continental Europe
and the UK in recent decades. Nevertheless,
the recommended measures may, perhaps, first be introduced on a “comply
or explain” basis and depending upon the level of observed compliance in
practice over a two or three year period, and be made mandatory if found
necessary.
[1] Assistance provided by
Jitendra Nath Gupta and Stakeholder Empowerment Services is gratefully
acknowledged
