Listed firms need a governance model that tackles issues unique to India
Rajesh Begur is founder and managing partner at ARA Law

Last week saw Infosys chief executive Vishal Sikka resign from the company after a prolonged clash between its initial promoters and the board over the management's policies. Not long ago, we were privy to a similar issue with the Tata Group: Nusli Wadia, one of the Tata Group’s longest-serving independent directors, and Cyrus Mistry, the first non-family chairman of Tata Sons, were ousted. Beneath the surface of these corporate wars, however, are the broader questions regarding Indian corporate governance, which conforms to the letter of the law but falls short in spirit.

A quick look at Indian corporate history brings to the fore loopholes that have led to innumerable scams and governance failures, and reactionary legal changes introduced to tackle these deficiencies. However, even with multiple such checks in place, the situation appears as fragile as ever with news of corporate governance failure becoming commonplace. While challenges to corporate governance are as routine globally (think Enron) as they are domestically, and as grave in the unlisted space as they are in the listed, the scope of this article has been limited to the latter for the sake of brevity.

Are recent issues a sign of weak boards?

As dynamic as these issues are, one thing that can be said with certainty is that the board of a company plays a very important role in making or breaking a company’s governance. The events on the Tata and Infosys boards have revealed certain fractures. One, how independent is the institution of the independent director in promoter-driven companies? Two, how tolerant is a board of a company's management decision with regard to policies on remuneration or related-party transactions?

Suffice to say that the removal of a director, including non-executive directors, from an Indian company requires only an ordinary resolution. While this power of the shareholders is an extension of the principle of shareholder democracy, it is questionable if its purpose is duly served. The Indian corporate landscape primarily consists of promoter-driven companies. In that, whether an ordinary resolution represents the will of all the shareholders uniformly is doubtful. In a recent instance, an independent director was removed from the board even though retail investors voted against the ouster. The promoters, who held over 30% stake, voted in favour of the removal.

Further, in a company where the promoter finds it easy to muster 50% of votes on a resolution with relative ease (as is often the case), it is only reasonable to ask how an independent director can ensure integrity in his actions if his position on the board is subject to the collusion of a simple majority. If resolutions can be moved by a simple majority, what does that say about the independence of the board?

The other issue is the power of a board to challenge management policies, be it the severance packages of management executives, or more generally, the management’s say in a company's affairs. Oftentimes, the same person heads the board as well as the management – a practice as local to newly found startups as it is to established corporate giants. It is here that questions on the strength of governance mechanisms emerge again. A strong management may override the board, especially in corporations where the same person heads both the offices.

Is the Anglo-Saxon model fit for Indian companies?

The Indian governance model is designed after the Anglo-Saxon model of governance. The voluntary code floated by the Confederation of Indian Industry in 1998 and the recommendations made by the Birla and Narayana Murthy Committees bear striking similarities to the Sarbanes-Oxley Act, the Cadbury Report and other leading Anglo-Saxon corporate governance statutes.

In the Anglo-Saxon models, board directors dominate and shareholders serve as controllers. The model is designed primarily to reconcile the conflict between the two. But while this model works well for more developed western jurisdictions, it is, as can be seen, not the best suited for the Indian corporate climate.

In typical Anglo-Saxon jurisdictions, corporate governance norms are aimed at disciplining the management and reducing the ‘gap’ between the management and dispersed shareholders. India, on the other hand, presents a more unique problem – the dominance of majority shareholders. Hence, perhaps the efforts towards corporate governance in India are aimed at the wrong gap. Secondly, Anglo-Saxon models are inherently designed at taming over-powered boards. India offers a different environment, wherein the rule of the majority shareholders prevails over that of the boards.

So, should India shift to some other model of governance such as Japanese, continental, or German, or should we abstain from relying on foreign models for inspiration, and instead develop a more organic and relevant-to-India governance system?

Again, it is debatable whether the law needs a reform or the participants need a healthier spirit. One problem with over-prescription of compliances and duties (as is the case in India), is that compliance gets limited to merely being a check-box exercise rather than a pro-active collective effort to adhere to the intent of the law.

The way forward

In the wake of these issues, the Securities and Exchange Board of India (SEBI) recently issued a "Guidance Note on Board Evaluation", prescribing the parameters against which a director may be evaluated. While the note may bring more clarity regarding a director’s performance in case he is removed, the utility of the evaluation mechanisms is limited. There is no obligation for a company to furnish reasons as to why a director’s removal is being requested. There is speculation that SEBI may amend the law in this regard: the voting requirement may be raised to a super majority.

Minutes of the SEBI International Advisory Board Meeting show that the regulator has noted the corporate governance challenges in India. More recently, SEBI has also set up a 21-member committee under the chairmanship of Uday Kotak to recommend changes to the governance framework in listed companies.

However, as seen in the past, such measures have not been very fruitful. One reason, as has been pointed out in this article, could be the undue reliance on foreign law, which at most times, does not seem to fit the Indian scenario. A second reason – more domestic – is a lack of pro-active desire for good governance.

It will be a welcome change if the regulators and legislators instituted a governance model that tackles the unique issues present in the Indian context. However, what would be more welcoming is a change in the temperament of the corporate community itself, because governance is more a natural process than one which the law can command. Good governance is a balance of integrity, ethics and a strong value-system, but are our expectations too high?

Rajesh Begur is founder and managing partner at law firm ARA LAW. Pranav Tolani is an associate at ARA LAW. 

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