Et tu Tata!

Et tu Tata!

Recent developments at the Tata Group in general and Tata Sons particularly have shaken corporate India in terms standards of good governance in companies. The group had meticulously built a reputation over the years for ethical and responsible corporate behavior that went far beyond the basic mandatory compliance requirements. Almost overnight, that reputation appears to have taken a beating after the news break that the board of Tata Sons (the parent company of the group) had removed its chairman, Cyrus Mistry (CM) from his position for his non-performance; and the return, albeit temporarily, of the immediate past chairman, Ratan Tata (RT) as the board chief. Unsurprisingly, this was responded to by CM questioning his removal and highlighting several process and governance related deficiencies, besides also ‘exposing’ many bad management decisions in the company and its associates during the reign of RT as board chair. This latter charge is unlikely to pass muster as CM was himself on the board when those decisions were taken (apparently with no evidence of recorded dissent by him), and even more importantly, the judiciary is usually loathe to second-guessing business decisions unless some palpably fraudulent intent behind such decisions was apparent. As for the board decision to replace its chair, it would seem at least legally to be in order since such power does indeed vest in the board; if there are some procedural lapses, clearly they could perhaps be rectified without any collateral damage to the decision itself.

More than the legalities of the situation, the case has attracted attention in the media and the markets precisely because this happened at the Tata group, something not expected from the bellwether beacon of good governance. And as more allegations and counter-allegations were traded by the warring camps, even inappropriate actions and decisions that would have otherwise been overlooked as minor got exacerbated under public scrutiny. Boards of some of the big listed group companies deciding to retain CM as their chair and expressing their confidence in his leadership and so on have not helped the Tata cause either. One is also left with the uneasy feeling as to whether what was now in public domain could just be the tip of a rather huge and potentially dangerous ice berg, not only in the Tata group but across the board in the listed company population in the country, dominated as it is by similar concentrated ownership and dominant control regimes.

The focus of this post is to analyse some of the governance related issues that are discernible in this episode and to explore whether there may be a case for further regulatory interventions.

Board vs Shareholder Primacy                                                 

The issue of primacy in corporate governance is a much debated topic; if shareholders are the principals (in the agency theory construct), then the body of directors they elect must be accountable to them and this position is fortified by the fiduciary obligations that the directors owe to the company and all its shareholders. On the other hand, the board ought to have freedom to act (through and with the assistance of the executive) in the interest of the company and its shareholders (and in India, now, also other statutorily specified stakeholders); this must necessarily limit shareholder interventions to the core minimum. Even so, Indian corporate law, overall, tends to lean more strongly towards shareholder primacy on many issues than for example the comparable situation in the US.

If the principal shareholders (the several Tata Trusts) with a commanding majority equity holding in Tata Sons wished to exercise their primacy to decide who should be the board chair, the best forum would have been a shareholders’ meeting (to remove CM as a director and consequently as the board chair), but that did not happen. The principal shareholders apparently had CM removed from chairmanship by the company’s board of directors. Prima facie the board was well within its rights to do so, but if media reports were to be believed, that decision was based on the fact that the principal controlling shareholders, the Tata Trusts had lost confidence in CM. The question is how did the unaffiliated, “independent” directors on Tata Sons board conclude that CM was not fit to be their board chair any longer. Were they being swayed by the views of the controlling shareholders? Were they discharging their fiduciary duty to the company and all the shareholders of Tata Sons while removing CM from chairmanship or were they (as happens when directors are “captured” by the controlling shareholders or the executive management) serving the interests of the controlling shareholders alone? It is axiomatic that the directors of a company ought to perform in the exclusive interest of its shareholders even if that meant not aligning with the interests of the “group” or the “parent” company. Did the directors of Tata Sons conscientiously decide that the continuance of CM as the board chair would militate against the interests of the company and all its shareholders? If they did, and if they had convincing reasons to do so, It would be difficult to question their decision or to second-guess their motives unless some prima facie evidence was offered to the contrary.

Role Confusion

CM was the executive chairman which meant he was also the CEO of Tata Sons. There is usually some confusion between the roles of Board chair and CEO when the two jobs are combined in one person. If CM's "performance" was found unsatisfactory, as Tata Sons avers, the question  is whether he was sacked as CEO (and collaterally as board chair) or was his performance as board chair unsatisfactory.

If the proximate cause for dismissal was his failure as board chair, then the mandatory performance evaluations should have highlighted this deficiency, in which case his removal could have been more civilly handled than by an abrupt dismissal. If his performance as CEO was unsatisfactory, then the Remuneration and Nomination Committee would have discussed it with him and recorded in the minutes; even then the removal could have been more orderly than was the actual case. Of course, the Tatas have maintained this removal was not as abrupt as is made out and had been brewing for some time but CM has denied such was the case!

There may be a strong case for companies as well as the media to use in all reporting and communications the appropriate designation depending upon its subject or context: this would require the person to be referred to as the CEO or Managing Director in respect of all executive matters, leaving the title ‘Chairman’ to be used only in regard to board related matters being reported upon.  

Controlled Company Governance

The third dimension of these developments relates to the governance of "controlled" companies, especially where they are listed or deemed equivalent in law. The concept of controlled companies is well recognised in the US regulatory regime and in some other jurisdictions but in most of those countries such “controlled” companies are the exception but in India (and a vast majority of other countries around the world) where concentrated corporate ownership is predominant, such companies (like Tata Sons and its subsidiaries including many of the affiliates) they are the rule. The challenge now is that in the interests of harmonisation with global (read US) best practices we are trying to apply the rules of a diversified share ownership regime to a predominantly concentrated share ownership dispensation. This approach inevitably leads to a situation of what the famous economist John Galbraith had called “innocent frauds” where gaps between conventional wisdom and actual reality are consciously accepted and ignored! Regulatory requirements in countries such as, for example, Canada (another jurisdiction with a predominantly concentrated ownership regime) may offer some more appropriate options to cope with such comparable situations.

Concept of Corporate Parents

Fourth, the concept of "groups" is well accepted in India now (unlike in the hey days of our left-of-centre orientation in the 1950s and 60s when “large” business houses and concentration of economic power were anathema) and one cannot escape the reality of controlling parents or shareholders having a greater and quicker access to privileged and often price-sensitive information, and managerial influence on the subsidiaries and associates in the group. If Tata trusts were reviving information from Tata Sons and other companies in the group, it will be nothing but a natural consequence of their control over management (and no different to multinational parents or the government ministries receiving briefings and information from their subsidiaries and associates); the natural corollary is that in such controlled companies, we are bound to have "agency type II" issues (protecting the interests of minority shareholders not only from the hired executive but also from co-shareholders in management control) besides the usual type I problems ( protecting the interests of the hired executive, as in case of dispersed ownership regimes).

It would be unrealistic to ignore the inevitability of such a situation; at best, regulatory requirements may hope contain the potential abuse of such privileged access by the controllers. To some extent, this is already being attempted on issues like insider trading but to expect that parental influence could be totally eliminated would be bordering on being myopic.

Block Holders not in Operational Control

Fifth is the issue of inter-se relationships between block holders who are in management control and those that are not; in Tata Sons, there is one such significant player, the Shapoorji Pallonji group which reportedly owns some 18% of the equity. In theory, such outside block holders have the potential to play kingmakers, opening up avenues for special rent-seeking from the controlling shareholders. CM was and is in a catch-22 situation, belonging as he does to the Shapoorji Pallonji group and yet in a management position in the company. State-owned Life Insurance Corporation is another block holder being an institutional investor; its independent judgement on such matters will most likely be presumed to be subject to government intervention. It is not a simple coincidence that both RT and CM had written to / met with the Prime Minister immediately after the event (here again, the parent’s primacy issue is obvious). The chances are that such institutional investors, unless directly impacted, will take a neutral stand and abstain from voting (as indeed, post these developments in the parent company, LIC reportedly did in the shareholders’ meeting of one of the Tata companies, on the issue of removing CM from its board of directors).

Institution of Independent Directors

Not unexpectedly, the role of independent directors on the boards of Tata Sons and some of the other large listed group companies has had to face up to adverse comment. Such directors are nearly always in the unenviable position of being “damned if they do and damned if they don’t” and one should stoically bear this proverbial Cross! One possible regulatory improvement is to mandate such independent directors be elected by a majority of the non-controlling shareholders. There is conceptual merit in this proposal since a major (even if not the only) role of such directors is to ensure that the controlling shareholders do not unduly abuse their advantageous position. While such a regulation would strengthen the bulwark of the institution of independent directors, it may not be an impregnable shield against “capture” of directors by vested interests; and yet, to the extent it can help in containing (even to a limited extent) such undesirable practices, it will be welcome step.

To conclude:

In the great Indian epic, the Mahabharata, there is an episode where the righteous and ever-truthful king Yudhisthira was obliged to utter a half-lie to cope with the exigencies of war; as a result, his chariot which reportedly always ran a little above the ground (like an hovercraft presumably!), had to forego that unique trait of greatness and drop down to earth on par with the other chariots of lesser mortals. Events of recent weeks have an uncanny similarity; as undisputed reputational leaders, Tatas cannot avoid bearing the reputational consequences of any slippage from the high norms they had set for themselves virtually from their inception. The extent of such reputational erosion and its impact on group companies is hard to predict; one thing is certain: redressing this slippage and regaining the reputational high ground will be time and effort consuming.