Dilemma of Corporate Governance in India

Kedar Kaushik

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Satyam’s case is the new major entry in scams list. Since independence Indian Public
has witnessed number of scandals in high places beginning with Jeep Scandal -1948,
Mudgil Case- 1950, Mundhra Deal, HDW Deal-81, Hawala Case-1985, Bofors scandal
-1987, Harshad Mehta Scam -1992, UTI Scam and many cases of cooperative banks
scam, excessive debt financing laced with fraud and so on but no significant
punishment was awarded to the guilty, which has lured more people to resort to such
malpractices to make faster money. Now the position is that every day we hear one or
the other scam, particularly corporate cheating and duping the common man with their
baseless offers but attractive to public.

Corporate corruption and Political corruption are now going hand in hand. But it is seen
political corruption when highlighted makes sensational news in media whereas
corporate corruption is pushed under the carpet in the name of Approval of
Shareholders in AGM and Shareholder’s democracy. Though Satyam’s case has been
taken as an exception where the independent directors and shareholders have shown
their real worth yet Small investors are again the looser. It seems to be a good
beginning and will prove a milestone in Corporate Governance in India.

The major questions here is that why the Financial Institutions and Bankers are failing
in recoveries from these so called promoters involved in scandals, they are very prompt
to recover the small amounts from the poor farmers, shopkeepers and common man.
This situation indicates the definite involvement of the officials of these financial
institutions/bankers in this kind of scandals.

Moreover, Teeth less legislation and weak regulators are watching the situation as silent
spectators though they have drastic laws to order the closure of such companies,
leading total loss to the small investors, but there is no case where the assets and
property of the promoters/ owners/directors of these companies have been ceased and
they have been sent to jail

At Corporate level we face the following dilemma.

The Regulatory Dilemma:

The problem of Corporate Governance in India is mainly of abuses of the company’s

resources by the so-called promoters of the companies. The question, which remains
unresolved is, how to control the promoters who exploit the minority shareholders? Most
of the directors on these boards are the family members, friends or relatives of these
owners. Therefore, one cannot expect these directors to control the actions of the
owners or promoters who have provided them with the chair of director. As the boards
seem to have become accountable only to the owners instead the total shareholders,
who will protect the interest of small investors/shareholders? SEBI, CLB, SIFO and
Ministry of Corporate affairs have become only the law makers, but where are the
investigating agencies who can have a regular watch on these fraudulent cooperators.

This means, for ensuring effective corporate governance we need the outside forces. In
the present scenario, the out side forces, which can play vital role in disciplining the
Dominant Shareholders and facilitate corporate governance can be (1) Regulatory
Authorities like Department of corporate affairs, Company Law Board and Securities
Exchange Board of India, (2) Capital Markets i.e. Financial Institutions and Corporate
Debt Providers

Though Ministry of Corporate Affairs has made stringent rules for accountability of
boards, transparency in business dealings and full disclosures of the business facts
and financial health of the companies yet in practice the regulators are confined only to
broad prescriptions / coercive powers like ordering the closure of the companies or
initiating enquires into frauds which leave little scope for discretionary actions and the
corporate governance problems remain ill-suited to this style of regulations.

Capital Markets on the other hand lacks the coercive power enjoyed by the Regulators
but have the ability to make business judgments and to distinguish between what is in
the best interests of the company as a whole as against what is merely in the best
interest of the owners.

Public sector financial institutions that hold large block of shares in Corporate India
have proved to be passive spectators. Nominee Directors of these
Institutions could have played a better role by improving the performance of the Board
room and keeping a pulse on the financial health of the company. They must remember
the fact that the Management derives all its powers from the Board and the Board is not
dependent on management for taking its decisions. But in real practice, we all know
how Boards normally function in our country? They get their reward as a job to some
relative in the company or a profitable contract. In the name of shareholders
democracy, glaring abuses of corporate governance have been defended, since these
were sanctioned by so called resolutions of the general body meeting of the
Shareholders where hardly any small shareholder was present.

It is evident that boards are powerless in front of owners/promoters to prevent such

abuses. Company Law board provides for factual disclosures by the
Companies while going for the General Body Meeting resolutions, which can be vital
element in the ability of the capital market to exercise its discipline on the issues of
capital. SEBI has taken a number of initiatives in the area of investor protection. Like
disclosure on the performance of other companies in the same group, particularly, those
companies, which have accessed the capital, markets in the recent past. As per SEBI ‘s
guidelines in most public issues promoters are required to take a minimum stake of
about 20% in the capital of the company and to retain these shares for a minimum lock-
in-period of about three years but where there is no identifiable promoter group this
condition will not apply.

The capital market lacks the coercive power of the regulators but it can impose against
an offender by restricting its ability to raise money from the market.
Denial of Capital Market access is a very powerful sanction. So we need more efficient
and vibrant Capital markets.

In highly competitive and global environment, business decisions are required to be

taken quickly and smoothly. Regulatory intervention and review would often imply a
micro-management of routine business decisions and make a travesty of a free
economy and end up running the companies by remote control. Thus companies would
become an extended arm of the state. It is expected from the Regulators to be confined
to a few clearly defined prohibitions and restrictions that require minimal exercise of
regulatory discretions and not stand in the way of many legitimate business
transactions.

Therefore, it is difficult to decide how far the regulators should go in interfering with the
normal course of corporate functioning as some of the provisions of company law are
drastic remedies suitable only for the gravest cases of miss-governance.

Shareholders’ Democracy vs. Protection of Minority Shareholders

The main objective of the Corporate Governance is to protect the legitimate rights of the
Minority Shareholders and balancing the right of minority shareholders against the
principle of shareholder’s democracy, which represents a misguided analogy between
political governance and corporate governance that is contractual in nature, whereas
corporate governance is at bottom of a matter of enforcing the spirit of this contractual
relationship. The essence of this contractual relationship is that each shareholder is
entitled to a share in the profits and assets of the company in proportion to his/her
shareholding and management and Board have a fiduciary responsibility towards each
and every shareholder of company and not just towards the owners/promoters. To
overcome this problem the company Law board considers providing of some directors
of the company to be appointed by the Central Govt. or by proportional representation.
This request can be made by 100 shareholders or from 10% of the shareholders by
number or by value. To assure the true shareholders’ democracy, it also needs effective
participation by small shareholders through cost effective way of waging a proxy
Campaign. It will enable dissenting shareholders to collect proxies from others and
prevent measures, which are prejudicial to the minority shareholders

For the purpose of Corporate Governance, We can broadly divide the Indian Corporate
Sector in three Categories:

1. Public Sector Undertakings or Govt. owned/controlled Companies (PSUs)

2. Multi National Companies or MNCs

3. Private Sector (Public Ltd and Private Ltd Companies)

Each of these groups ails with their own corporate governance problems
Public Sector Undertakings or Govt. owned/controlled
Companies (PSUs)
Excessive Govt. Control & No role for Remuneration Committee/Audit Committee

PSUs are merely the extended arms of the Central or State Govts. The Administrative
Ministry or Department concerned virtually exercises complete control over the
operations of these companies. In the deregulated economy these structures are
incompatible for efficient and successful operation of PSUs.

The Boards of PSUs have got very little or no say in the selection of CMD/CEO or
Managing Director or in the composition of the Boards, which are mostly chosen from
Sr. Officers of the Administrative Ministry or department. They take the decisions on
behalf of the Govt. CEO/CMD is selected by PESB on the recommendations of the
concerned Ministry and approval of the Cabinet Committee for appointments. Nominee
directors of the financial institutions are seen as working passive spectators. So, the
question of going against the CEO/CMD by Board normally does not arise.

The Department of Public Enterprises (DPE) or appropriate Govt. fix the remuneration/
compensation Package of the CEO of a PSU with the approval of the Committee on the
basis of the category of particular PSU i.e. A, B. C or D. Thus, there is no role left for the
Remuneration Committee in PSUs.

Audit of PSU’s is looked after by the Comptroller and Auditor General (CAG) hence,
there is a little scope for an Audit Committee to add to what the CAG does. So the
Board is pushed to the function of managing rather than the function of directing.

Consequently, the board is not allowed to play a meaningful strategic role since all the
vital decisions are taken with the consent of the head of the concerned
ministry/department.

But in PSUs the Board can play a highly obstructive role if it chooses by opposing the
CEO on operational matters as major operating decisions are brought to the Board for
decision making on operational matters.

Govt. can improve the performance of their boards by appointing neutral professionals
as independent directors on the boards of PSUs. Gujarat has already implemented the
scheme of appointing professional independent directors on its PSUs boards.
Evaluation of Performance of Boards should be made compulsory. Job and role of the
directors must be defined and accountability should be fixed. It may also consider
appointing cross ministerial directors on the boards to reduce the direct control of the
concerned ministry to some extent on the working of the boards.

Multi National Companies or MNCs

Most MNCs in India operates through subsidiaries which are not 100% owned by the
parent company. Initially, these MNcs were required to issue shares at low price to the
Indian public to comply with law but with the liberalization regime, now they can hold the
equity case-to-case basis from 51% to 100%. These regulations have created severe
corporate Governance problems in several key areas.

Allotment of preferential shares to relatives of the owners at low price

MNCs raised the foreign stake by issuing shares at deep discounts, in some cases
these allotments are even at a price of less than one tenth of the market price, which
results into large loss to the minority shareholders. The parent companies with their
majority shareholding are able to get the resolutions passed and with the explicit
consent of the shareholders in general meeting. When govt. tried to prevent such
preferential issues these MNcs called it an assault on “Shareholders democracy”.

Transfer of assets between group companies in the name of Structuring of

business:

Another Corporate Governance problem arises where the MNCs has two subsidiaries in
India in one of which it holds a higher stake (say 90%) while in the other it holds a
smaller Stake (Say 51%). The manner in which the MNC structures its business in India
between these two subsidiaries is riddled with problems as far as the minority
shareholder is concerned. These MNcs have been alleged of transferring the most
profitable businesses from the 51% subsidiary to the 90% subsidiary at very low prices
which resulted into large loss to the minority shareholders of the 51% subsidiary who
equally contributed in the past to the investments to build up these businesses to their
current domination position.

Payment of Services and Royalties to closely held group companies

Another dilemma is about the payments that parent companies increasingly demand for
all the services they provide to their subsidiaries including collection of royalties for the
use of a brand which was assiduously cultivated by Indian companies through decades
of advertising paid for in part by the minority shareholders, who watch in dismay as the
royalties knocked off a sizeable chunk of their earnings of the company.

Private Sector (Ltd and Private Companies)

Problem in Limited / private Ltd. companies/ Family Business Groups is more complex
compared to PSUs and MNCs. They are the real majoritry Share holders with less
equity holding, as the promoter’s shareholding is spread across several friends and
relatives as well as corporate entities. It is very difficult to establish the total effective
holding of this group, which may be well below a majority stake and even in some cases
the promoter may not be the largest single shareholder. But the large chunks of shares
held by the State Financial institutions (Who play the passive role and act on the
behest of their political masters) makes the promoters the Major Share Holders and
help them play the games to get general body approvals.

Development of Black economy

Problem of a large parallel black economy has developed in India for long now where
transactions are carried out in cash and are not recorded in the books of accounts. This
practice is cheating the minority shareholders and Govt. on their legitimate dues. This
unaccounted wealth is creating black economy. Cases have been traced where bogus/
Benami companies are created and insider trading is affected to divert the funds from
the Profit making companies to the new companies created for this purpose only. Also,
cheating is done by paying salaries on bogus pay rolls.

Why only financially sick companies and no financially sick Promoters?

This is enough to understand the real picture of Corporate Governance in India. It is to

be hoped that tax reforms, deregulation and competition would gradually reduce the role
of black money to the point where it is confined to isolated cases of Corruption. There is
a great need to understand that the time has come to cut through the questionable
practices, indefensible management attitudes to stakeholders and penetrable non-
disclosures in their bid to integrate themselves to match the best global competitive
standards.

For ensuring effective Corporate Governance standards and minimizing the misuse of
shareholder’s fund by the promoters it becomes the duty of the .regulators / Govt to
further amend the Companies Act for restricting the number of directors from the
promoters quota to only two and make it compulsory to appoint minimum 3
professional directors in addition to the nominee directors by Financial Institutions.
Appointment of Audit Committee must be made compulsory for all Public Limited
companies irrespective of their paid up capital or turnover. International Accounting
Standards must be implemented by all the companies in India. Auditors should be made
accountable for wrong certification of accounts. Erring auditors should be punished and
banned. All transactions involving more than Rs.50 lacs should be brought to the board
for approval and cash transactions of more than Rs.1 lac should be banned for all the
companies irrespective of PSU, MNC or private status.

Permission for Cross Transaction involving transfer of assets/ funds from one company
to another group companies should be allowed for reasonable and justifiable reasons
with the prior permission of the appropriate Govt.

No person should be allowed to become director in more than 5 companies. The bank
accounts, Assets and Property of the persons involved in scam/scandal should be
ceased and auctioned in public to recover the losses. Such persons should not be
allowed to vote, contest any kind of elections hold any official position in companies.
More stringent punishment should be given to the financial offenders by amending the
laws of the land to ensure the sickness of the offenders instead of sick companies.
Provisions should be made to keep away the fraudulent people from corporate
operations. Registrar of companies should take all care before issuing the registration
certificate and must ensure that all legal requirements have been fulfilled as per the
Companies Act. They also be made responsible for any violation.
Finally, Corporate Governance only as good as people around the table
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The author of this article is a student of MBA(EFT) IVth

Semester, ASODL, Amity University, Noida