CORPORATE GOVERNANCE

Relevance of Corporate Governance in Modern India

“Frequently, a man of great fortune, sometimes even a man of small fortune is willing to
purchase a thousand pounds share in India stock merely for the influence which he
expects to acquire by a vote in the court of proprietors. It gives him a share, though not
in the plunder, yet in the appointment of the plunderers of India ... Provided he can enjoy
this influence for a few years, and thereby provide for a certain number of his friends, he
cares little about the dividend, or even the value of the stock upon which his vote is
founded” – Adam Smith, 1776, Book V, Chapter I, Part III, Article 1
ABSTRACT:

Issues of corporate governance have been debated and have raised eyebrows across
various jurisdictions. The most crucial point facing corporate bodies today is the
protection of the rights of minority shareholders, and the prevention of abuse of rights by
the dominant shareholder. This brings to the forefront issues of oppression and
mismanagement. The dominant shareholder may not always be the majority shareholder
– a shareholder holding minimum stake may still be in a position to influence the
decision making to a large extent. Thus this paper is an endeavour to recognize the
corporate governance controls over such abuse of power by the dominant shareholder.
The author recognizes the existing legislation which maintains a strong stranglehold over
the dominant shareholder. The various provisions of Indian Acts help in preventing the
abuse of power by the majority shareholder, and hence establish corporate governance
norms as a means to discipline such dominant shareholders.

INTRODUCTION:

Issues of corporate governance have been debated in the United States and Europe over
the last decade or two. In India, these issues have come to the fore only in the last couple
of years. An important issue in Indian corporate governance is improving the
performance of the Board. But a close analysis of the ground reality in India would force

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one to conclude that the Board is not really central to the corporate governance malaise in
India.1 The central problem in Indian corporate governance is not a conflict between
management and owners as in the U.S and the U.K, but a conflict between the dominant
shareholders and the minority shareholders.

The Board cannot even in theory resolve this conflict. One can in principle visualize an
effective Board which can discipline the management. At least in theory, management
exercises only such powers as are delegated to it by the Board. But one cannot, even in
theory, envisage a Board that can discipline the dominant shareholders from whom the
Board derives all its powers. Some of the most glaring abuses of corporate governance in
India have been defended on the principle of “shareholder democracy” since they have
been sanctioned by resolutions of the general body of shareholders.2 The Board is indeed
powerless to prevent such abuses. Thus, it is self evident that the remedies against these
abuses can lie only outside the company itself.

This paper discusses the role of the regulator through its legislation that helps in
disciplining the dominant shareholder. Therefore, corporate governance comes into play
through the regulator, which indirectly is a practice to prevent the abuse of rights by the
dominant shareholder.

PROBLEM OF DOMINANT SHAREHOLDERS:

The problem of dominant shareholder arises in three large categories in the Indian
companies. They are:

1. PUBLIC SECTOR UNITS (PSU): The government is the dominant shareholder

and the general public holds a minority stake (often as little as 20%). The role of
the Board is wholly irrelevant in the governance of the PSUs today. It has very
1
Mariassunta Giannetti & Luc Laeven, ‘Corporate Governance: Shareholder Discipline
or Entrenchment of Control?’, October 25, 2007 c.f.
<http://www.voxeu.org/index.php?q=node/650> \
2
Jayant Rama Varma, ‘Corporate Governance in India: Disciplining the Dominant
Shareholder’, IIMB Management Review, October-December 1997, 9(4), pp. 5-18 c.f.
<http://www.iimb.ernet.in/review>

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 little say in the selection of the CEO or in the composition of the Board. The
government as the majority shareholder takes these decisions through the
concerned ministry with the help of the Public Enterprises Selection Board. The
Board cannot fire the CEO nor can it vary his compensation package. As far as
audit is concerned, again the dominant role is that of the Comptroller and Auditor
General (CAG). There is very little that an Audit Committee could add to what the
CAG does.3

2. MULTI-NATIONAL CORPORATIONS (MNC): The foreign parent is the dominant

shareholder. Government regulations have required most MNCs in India to
operate through subsidiaries which are not 100% owned by the parent. The
Government liberalized the law in the 90s and now 51% is permitted in most
industries while 74% or even 100% ownership is allowed in some cases. These
regulations have created severe corporate governance problems in several key
areas. There have been allegations that the most profitable brands and businesses
have been transferred from the long established 51% subsidiary to the newly
formed 100% subsidiary at artificially low prices. This implies a large loss to the
minority shareholders of the 51% subsidiary who have contributed, in equal
measure to the investments that were made in the past to build up these
businesses.4

3. INDIAN BUSINESS GROUPS: The promoters (together with their friends and
relatives) are the dominant shareholders with large minority stakes, government
owned financial institutions hold a comparable stake, and the balance is held by
the general public. Because the promoters’ shareholding is spread across several
friends and relatives as well as corporate entities, it is difficult to establish the
total effective holding of this group. Also, the promoters may not hold majority
stake, but may exercise control through political and governmental influence.

3
Ibid.
4
Gérard Charreaux & Philippe Desbrières, ‘Corporate Governance: Stakeholder Value
Versus Shareholder Value’, Journal of Management and Governance, Volume 5, Number
2 / June, 2001, pp. 107-28.

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 Another important corporate governance issue is that of mergers and restructuring
of companies in the same group. The valuation of two group companies for the
purpose of merger may be perceived to be biased in favour of one of the
companies.5 Mergers are subject to approval by shareholder bodies of both the
companies, and hence the dominant shareholder may be in a position to
manipulate price.

CORPORATE GOVERNANCE THROUGH THE REGULATOR:

As discussed in the previous section, the regulator helps in disciplining the dominant
shareholder through the control it exercises over corporate entities. Regulators face a
number of difficulties in tackling the problem of corporate governance abuses by the
dominant shareholders. In many cases, it is difficult to decide how far the regulator
should go in interfering with the normal course of corporate functioning. However,
despite these issues, the regulator controls the dominant shareholder through legislation:

1. COMPANY LAW: provides a check on abuse of rights in three ways: protection of

minority rights, special majority and information disclosure.

Protection of Minority Rights:

Company law provides that a company can be wound up if the Court is of the opinion
that it is just and equitable to do so.6 This is the ultimate resort for a shareholder to
enforce his ownership rights. Rather than let the value of his shareholding be frittered
away by the enrichment of the dominant shareholder, he approaches the court to wind
up the company and give him his share of the assets of the company.

Special Majority:
Another safeguard in the company law is the requirement that certain major decisions
have to be approved by a special majority of 75% or 90% of the shareholders by
5
YRK Reddy, ‘Enforce Corporate Control’, The Financial Express, September 15, 2007,
c.f. <http://www.financialexpress.com/news/enforce-corporate-governance/217020/0>
6
Section 433 – “Circumstances in which company may be wound up by Tribunal”.

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 value. This may not be an effective safeguard where the dominant shareholders hold a
large majority of the shares so that they need to get the approval of only a small
chunk of minority shareholders to reach the 75% level.

Information Disclosure:
Company law also provides for regular accounting information to be supplied to the
shareholders along with a report by the auditors. It also requires that when
shareholder approval is sought for various decisions, the company must provide all
material facts relating to these resolutions including the interest of directors and their
relatives in the matter.

2. SECURITIES LAW: Historically, most matters relating to the rights of shareholders

were governed by the company law. Over the last few decades, in many countries,
the responsibility for protection of investors has shifted to the securities law and
the securities regulators at least in case of large listed companies. In India, the
Securities and Exchange Board of India (SEBI) was set up as a statutory authority
in 1992, and has taken a number of initiatives in the area of investor protection.
The securities laws regulate the abuse of rights by dominant shareholders, again
in three ways: information disclosure, insider trading and take-overs.

Information Disclosure:
SEBI has added substantially to the company law requirements of disclosure in an
attempt to make these documents more meaningful. One of the most valuable is the
information on the performance of other companies in the same group, particularly
those companies which have accessed the capital markets in the recent past. 7 This
information enables investors to make a judgment about the past conduct of the
dominant shareholder.

Insider Trading

7
Supra note 2 at p. 2.

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 Most instances of insider trading have nothing to do with the dominant shareholder.
Many of them involve small trades by junior employees who come to know of price
sensitive information. In a few instances, insider trading may be indulged in by
directors and other senior employees. However, the interesting cases are large scale
trades by the dominant shareholder. Market gossip has long speculated on the
prevalence of such trades in the build up to large mergers especially between group
companies. Some promoters have merged small companies in which they have a large
stake into a larger more widely held company at a swap ratio which is highly
unfavourable to the widely held company. However, SEBI still has not passed
guidelines in this respect, and this area of corporate governance remains unregulated.

Take-overs
Instead of directly exploiting all the privileges that his controlling block gives him,
the dominant shareholder can choose to sell his entire holding to somebody else. In
ordinary market conditions, he can expect to get a premium over the market price.8
But the take-over regulations in India require that the dominant shareholder share this
privilege with the others. The acquirer of a controlling block of shares must make an
open offer to the public for at least 20% of the issued share capital of the target
company at a price not below what he has paid. This prevents the dominant
shareholder from enjoying the premium.

CONCLUSION:

This paper has discussed the problem of the dominant shareholder and provided the
existing regulatory framework to counter this problem. The solution is to improve the
functioning of vital organs of the company like the board of directors. The problem in the
Indian corporate sector is that of disciplining the dominant shareholder and protecting the
minority shareholders. A Board which is accountable to the owners would only be one
which is accountable to the dominant shareholder; this complicates the problem and the
regulator needs to address such issues.

8
As in the Satyam-Maytas case.

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Still, there remain a number of things that the government and the regulators can do to
enhance corporate control: mandatory disclosure of information, regulation to promote an
efficient market, reforms in bankruptcy laws etc. Therefore, though corporate governance
has been a powerful tool in the hands of the regulator to discipline the dominant
shareholder, the latter always has a mechanism to avoid such regulations and influence
the Board. In order to check this, Indian corporate governance norms need to be
strengthened.