Article
Corporate governance includes providing assurance to
stakeholders within and outside the organisation that their interests are
protected by management on a sustainable basis. This noble objective makes the
Boards of listed companies responsible to absorb more mature governance
practices. Therefore, the market value of a corporate entity is a collective
perception of the stakeholders about its governance practices.
At present it appears that each day headlines announce
another bank failure in the United States arising from the sub-prime/cash crunch
fallout. It is inevitable that organisations across the world will be
significantly impacted by the resulting financial slowdown. Based on the media
reports, banks globally have taken sub-prime/cash crunch-related write-downs to
date totalling $ 500 billion including $ 250 billion from investments made in
Collateralised Debt Obligations (CDOs) in respect of Residential Mortgage-Based
Securities (RMBS) which have since ‘gone bad’. When these initial shocks subside
and legal actions are taken against the parties involved in the CDOs to recover
losses, no doubt questions will be raised about the code of corporate governance
in these organisations (arranging banks, portfolio managers, issuers,
professional advisers and rating agencies) — whether senior managements were
greedy and whether independent directors and advisers had abetted this greed. It
is unclear at this time to what extent our Indian banks will be shielded from or
exposed to the events unfolding in the United States, Europe and elsewhere.
Governance in family-owned companies :
Numerous listed companies in India continue to be family
owned or controlled. Most need better governance structures to thrive in an era
of globalisation. A key objective of successful corporate governance in these
organisations is to protect the interests of minority stakeholders, since
decisions are generally in the interests of preserving and growing family wealth
without necessarily benefiting minority stakeholders. In several mature
economies, stock markets are sceptical about family-owned businesses. When
family members are not bickering, it is thought they are looking after their own
interests rather than those of the business.
With deregulation in India and the increased number of
multinational corporations lining up to enter our country, many family-owned
businesses find that they are unable to match the multinationals in size,
strategy, leading-edge management techniques and spending power. Large
family-owned businesses in India should shift to strategies that will enable
them to compete more successfully and prosper in a changing environment. To
pursue any meaningful strategy, they need stronger governance models to prevent
the family bickering from damaging the business, help them attract and retain
professional management talent, and provide for a smooth succession plan to the
next generation.
Indian laws and regulations are complex, subjective and
confusing. They provide opportunities for family-owned businesses to feather
their nests. The ownership structures and shareholding patterns are left for the
families to decide, and minority shareholders do not have enough say in those
matters.
An advantage of family-owned businesses is their quick
decision-making capability, since most decisions are driven by the family’s
vision. However, it can be a disadvantage when adapting to the changing business
environment, since the majority of family-owned businesses have rigid and
inflexible goals. Another feature is that the performance of a family-owned
business generally reflects the consistency of the family’s thought process
where any conflicts could have a direct impact on its functioning.
Succession planning is poorly done in many Indian
family-owned organisations, since this may have extreme consequences like
fracturing the group into smaller pieces, changes in strategies or vision, and
consequent changes in policies which may adversely affect other stakeholders.
Family-owned businesses tend to have informal governance structures aimed
primarily at complying with laws and to make it possible for the business to
deal with the family’s concerns. As a result, many such businesses cling to the
family’s traditions, especially those that carry on its name and secure its
position in the community.
Most Indian family-owned businesses have long-term strategies
and are diversified in various industries, a throwback to the licensing days of
the ‘raj’. This approach usually means better sustenance and continuing benefits
for the minority stakeholders. The risk of losing family wealth also prevents
these companies from taking excessive risk and decisions are taken after lengthy
deliberations, albeit within the family’s key decision-makers.
The way ahead :
The Asian financial crisis in the late 1990s compelled many
countries, including India, to improve corporate governance. India now requires
listed companies to have independent directors and audit committees. Securities
laws and listing requirements of stock exchanges have been toughened, regulatory
authorities have more powers, and the media are more probing. Yet progress with
corporate governance is patchy. There are still a large number of listed
companies that appear to be unconvinced of the value of good governance. Laws
and regulations are not enforced rigorously and trained accountants and
management professionals are in short supply. Boardroom practices will not
change overnight, so regulators need to be patient.
Corporate governance laws and regulations are important because they set the platform for change. However, given the vast differences in ownership structures, business practices and enforcement capabilities, merely copying corporate governance codes from the U.S. or Western Europe Is a mistake. Nevertheless, the temptation to do so, prompted by foreign institutional investors, private equity firms and foreign-aid donors, is high. For example, the requirement under clause 49 to have the majority of directors as truly independent is unrealistic given the acute shortage of independent directors in India. In addition, non-compete and confidentiality clauses in contracts are difficult to implement, so companies are hesitant to give independent directors too much insight into their performance and strategy for fear that this information may be used against them. It is therefore better to enforce basic governance rules vigorously in India than to promote requirements that breed a ‘check-the-box’ attitude or go unheeded.
Government regulations, clause 49 and alignment of the legal framework in India with global regulations provide a greater degree of control over the governing boards of family-owned companies, making them more accountable and attentive to market demands. Disclosure requirements and auditing practices are also improving, as India moves closer to harmonising its accounting standards with IFRS. Quarterly reporting is now mandatory for listed companies, although it is dubious whether this truly improves corporate governance if the underlying numbers are unreliable.
Although India has strengthened her accounting standards and adopted minimum corporate governance rules via clause 49, she lags behind in enforcement. This is because business and politics are generally still intermingled, and the mechanisms for conflict of interest resolution are underdeveloped. Further, the government’s need to promote short term economic growth makes them reluctant to pester large businesses to protect minority shareholders.
One would expect investors and creditors to pressure Indian companies to comply in letter and in spirit with clause 49 rules. In practice, however, most of India’s domestic and foreign investors are reluctant to challenge management and would rather sell their shareholdings without making a fuss. It would be good for investors to be more vocal in support of corporate governance reform and more willing to question management. Many independent directors too are naive about their fiduciary duties and view their directorships as offices without real responsibility. They therefore need to be educated. Bodies like KPMG’s Audit Committee Institute are dedicated to providing independent directors with a forum to exchange information and knowledge with other independent directors, and support to enhance audit committee practices and processes.
To be fair, there are some Indian listed companies that have embraced corporate governance reforms. Infosys Technologies Limited, for example, discloses the extent of compliance with multiple corporate governance codes, reconciles its financial statements with various accounting standards (including U.S. GAAP), and its board has a majority of independent directors as well as independent audit, nominations and remuneration committees.
More common however are Indian companies with basic governance structures, such as boards with a few truly independent directors, but fall behind in actual board governance. Many boards follow the letter rather than the spirit of clause 49. To move to the next level, they should behave differently by asking management challenging questions, setting corporate strategy, monitoring risk management, contributing to CEO succession plans, and seeing that management meets their performance goals. Many Indian corporate titans publicly speak of the benefits of better corporate governance. But they also know that in the short term many practical barriers and hindrances block necessary changes. New forms of boardroom behaviour will take more time to become entrenched.
Sustainability :
Progressive organisations need to demonstrate that they are aware and concerned about their socio-economic responsibilities in addition to their profit orientation. Organisations also need to contribute to improve the environment. The emergence of this thinking stems from sustainability being a global concern and organisations that contribute to sustainability of environmental and human resources are seen as responsible corporate citizens. So sustainability is an important element of corporate governance for any listed entity’s growth.
Factors contributing to the emergence of sustainability as an important corporate governance element:
- The focus on the environment is due to increasing global concern on carbon emissions, resource diminution, global warming and other environmental threats. Society believes that corporate entities should take responsibility for conserving the environment and its resources by maintaining a healthy balance between increasing profits and saving our planet.
- ‘Value’ today is perceived more in terms of the intangible assets of an organisation. An organisation aiming at continuous growth needs to build intangible assets like reputation, goodwill, a corporate image that depicts socio-environmental awareness, brand value and human capital. Thus market value is a function of an organisation’s ability to sustain its intangible assets in complex and competitive market conditions. Boards should monitor the sustainability of intangible assets in addition to other governance aspects.
- Stakeholders now determine market sensitivity by assessing those who continuously supervise the entity’s corporate culture. The definition of ‘stakeholders’ broadly includes consumers, suppliers, government agencies, compliance boards and investors, who collectively and continuously assess an organisation’s ability to deliver value to its stakeholders. Thus sustainability is a strategic issue that requires the board’s attention.
- Governing bodies and regulators have begun to monitor organisations’ contributions to society and the environment in addition to their economic contributions. Businesses planning to tap the global capital markets need to adopt global governance practices which marry an entity’s contribution to sustainability of our planet and people with its ability to generate profits in the long run.
Emergence of the ‘triple bottomline’:
The ‘triple bottomline’ concept was introduced by Shell. The term describes the three essentials to assess an entity’s performance in the 21st century – People, Planet and Profits. An organisation’s contribution to society with regard to these three essentials is a gauge of its sustainability in the long term. A balanced contribution among these three aspects is seen as an indicator of a responsible organisation, with developed corporate governance practices and a positive corporate image among its stakeholders.
‘People’ refers to the society in which the entity functions ..The organisation’s practices should promote harmony and well-being of the social elements. This includes humanitarian labour policies, timely payment of wages, improved working conditions, and contribution to social initiatives like education and healthcare. Organisations have also started contributing to primary producers and other non-profit initiatives.
‘Planet’ refers to sustainability of natural resources like air, water, forests and minerals. Conservation of energy, reduction in generation of hazardous wastes, use of bio-degradable components and reduction of carbon emissions are initiatives taken by entities to pursue environmental sustainability. The less harm caused to the environment, the higher is the positive impact on the triple bottomline.
‘Profit’ not only refers to internal profits of the organisation in the accounting sense, it includes economic benefits enjoyed by society at large due to the organisation’s activities.
Markets perceive sustainable organisations as those who ensure that the negative effects of their operations are balanced by the positive effects of their social and environmental contributions.
Conclusion:
My personal views on the way ahead are to :
- Develop a code of governance specifically for family-controlled companies that are not as stringent as clause 49.
- SEBI and stock exchanges to be more responsive to changes in the environment to ensure timely disclosure.
- Indian organisations to develop an image that positions them as well-governed enterprises that protect the minority stakeholders’ interests on an ongoing basis.
- Sustainability should become a key focus of corporate governance, with the corporate governance report including how entities have responded to their social, economic and environmental responsibilities.
