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'Good Corporate Governance Is About Creating Sustained Competitive Differentiation In Market'
Good corporate governance is about creating sustained competitive differentiation in the market to maximize the shareholder value legally, ethically and on a sustainable basis while ensuring fairness, transparency and accountability to every stakeholder of a company – customers, employees, investors, vendor-partners, the government of the land and the community.
Photo Credit : locatory.com
Sanjay Kirloskar, Sunil Kant Munjal, Singhania, Rekha Sethi and delegates, thank you very much for this invitation to address you on this important, topical issue. Even though what I say is based on my experience with and knowledge of listed companies, I believe that these observations hold good even for privately held companies.
The economic reforms of 1991 influenced the listed companies in India in three ways. First, India welcomed a large number of global institutional investors. These investors expected Indian listed companies to raise their financial disclosure to match the level in developed countries like the US and the UK. Second, by abolishing the office of the Controller of Capital Issues, the central government made listing on the Indian stock exchanges an attractive proposition for entrepreneurs. Third, the traditional businesses realized the power of the price-to-earnings ratio. They embraced the wisdom that a Rupee added to the bottom-line of their listed companies would add Rs. 10 to 20 (based on the P/E of their companies) to their personal wealth.
Good governance is about deciding to do the right thing while good management is about doing that right thing well. Good corporate governance is about creating sustained competitive differentiation in the market to maximize the shareholder value legally, ethically and on a sustainable basis while ensuring fairness, transparency and accountability to every stakeholder of a company – customers, employees, investors, vendor-partners, the government of the land and the community. Governance is a reflection of the culture and values of a company’s board and management. Good governance in a company enhances the confidence, trust and enthusiasm of its stakeholders.
Thanks to SEBI, corporate governance levels in India have improved considerably in the last three decades. However, during the last five years there have been a few instances of serious governance deficits. This has created doubts among investors about the quality of corporate governance of Indian companies.
The primary functions of a corporate board include ensuring a robust quality growth of both the top line and the bottom line of the company; protecting and enhancing the reputation of the company; reviewing, critiquing and improving the strategy presented by the management; setting clear KPIs for the CXOs and other officers of the company; recommending a fair and performance-based compensation to the CXOs and other officers of the company after consulting key, knowledgeable shareholders (as it happens in the case of some well-governed companies in the West) and after obtaining the approval of shareholders; creating a succession plan for the CXOs and key officers of the company; identifying risks and taking timely action to mitigate them; putting in place systems of information, control, checks and balances and ensuring that they are working; ensuring full compliance of regulations required by every statutory authority of the land; getting capital and revenue budgets prepared and approved after informed discussions; applying mind, reviewing and approving acquisitions, mergers, dividends, rights issues, bonus shares, and buyback of shares proposed by the management; addressing shareholder grievances in a fair and transparent manner; and installing a robust whistle-blower policy and ensuring its proper functioning to address the complaints of whistle-blowers.
There are three key players in a corporate governance system. The shareholders are the owners of the company in proportion to the number of voting shares they hold in the company. The board of directors is responsible for governance of the company, oversees the management, is appointed by the shareholders, and is therefore accountable to the shareholders. The CXOs and other executive officers form the management of the company, run the business, and report the performance of the company to the shareholders periodically through the board of directors. The primary corporate governance problem is to minimize agency cost. Agency cost is the cost incurred by the management for achieving the objectives of the company as decided by the shareholders. Agency costs tend to be inflated due to the divergence of interest between the managemen and the shareholders. In “professional-managed” companies, such costs manifest as the propensity of management leaders to wring out of a weak board high and unjustifiable compensation for themselves, and to violate the company rules to use company’s resources for their personal benefits and comforts. In the case of “promoter-managed” companies, this problem generally manifests as the asymmetry of benefits created by these owner- managers in their favour and against other shareholders. A typical example would be the use of the funds of a listed company owned partially by an owner-manager to fund the growth of a private company held wholly or to a large extent by the owner-manager, his or her family, and friends. This is generally called a “Related party transaction”. That is, conducting a company’s financial transactions with either a senior management staff or his or her relatives or friends. Generally, such transactions result in inflated costs or financial damages to the company, and favour the other party in the transaction. Many a time, related party transactions involve paying unusually large severance payments beyond the contracted amount to an officer of the company to buy his or her silence. The duty of a board is to apply their mind and prevent such transactions.
I will speak today on a few important issues like making good corporate governance the norm in India; creating a competent and value-based board; senior management compensation; whistle-blower handling; and the importance of transparency with shareholders. I will not waste your precious time on mundane matters since that information is available in various reports and textbooks.
How can good corporate governance become the norm in a company in India? It is simple. We have to create a climate of opinion that respect is more important than wealth and power. Before taking any decision, if the board and the management were to debate whether such a decision would enhance the respect for the company in the eyes of its stakeholders, and whether such a decision would enhance the respect for the decision maker in the eyes of his or her peers, bosses and subordinates, then such a decision is likely to be a good and respectable decision. Such decisions enhance the respect for the company.
How do we create good boards? The first step is appointing a person with competence, character and commitment to be the chairman of the board. Selection of such a chairman is crucial to the success of a board. A board that performed well for a long period under a competent and respected chairman can go astray when led by a morally weak and incompetent chairman. The next step is to bring in a set of accomplished, confident, value- based and independent-minded people with self-respect as board members. In addition, it is a good idea for the board members to be selected based on their expertise in corporate functions like strategy, acquisition, finance, sales, manufacturing, technology, R and D and human resources. These people may be taken through a robust training and certification program on board governance and committee responsibilities. The business-specific part of the program is generally held by the officers of the corporation. The board governance training may be held by external specialists.
Every year, there should be a peer evaluation of each member of the board. This exercise is generally handled by the chairman of the nominations committee. The parameters used for such an evaluation are in the realm of board governance. The chairman of the board then sits with each board member, discusses his / her evaluation, and suggests remedies and improvements. The chairman’s performance review is handled by the lead-independent director.
Managerial remuneration should be based on three principles – a fair multiple of the compensation of the lowest level employee in the company; full transparency on details of such compensation to shareholders; and accountability by linking variable part of the compensation with long term company performance. In some well-run global corporations, the compensation issue is discussed with a few top shareholders before deciding. Then, it is placed before the shareholders for their approval at the AGM or an EGM.
According to Wikipedia, a whistle-blower is a person who exposes information about a secretive, illegal and unethical activity that is supposed to have taken place in a private or public organization. The whistle-blower may be an internal employee or an outsider. While whistle-blowers have been given considerable protection by the law, they may still face protracted legal action, criminal charges and even social stigma. It is very important that whistle-blowers are totally honest in their complaint. Whistle-blowing should not be an act of revenge by a disgruntled employee. The whistle-blower must substantiate his or her complaint with data and facts. Else, they will be guilty of maligning innocent people and harming the reputation of the organization. No whistle-blower has the right to harm an organization on which a large number of families depend for their livelihood. Having put in these caveats, I believe that a corporation must provide total protection to whistle- blowers against vendetta by the bosses.
How should boards address such a complaint? An important duty of a board is protecting and enhancing the reputation of the company and discharging its fiduciary responsibilities. Therefore, addressing a whistle-blower complaint in a transparent and trust-enhancing manner is a must. If the complaint is against a middle or a low level employee, an internal committee consisting of senior employees not connected with the accused and committed to total fairness and transparency should be sufficient.
If the complaint is against any member of the board including the chairman, the CEO, an executive director, or an officer of the company, the tendency of most Indian boards is to investigate such complaints themselves assisted by an outside law firm, and obfuscate the issue. This is not a good idea. You cannot be the judge, the jury and the defendant!
Is there a solution? The boards of some globally-reputed companies totally recuse themselves from the investigation of the complaint in such situations. The top ten shareholders, some of whom may be institutional investors, invite a committee of highly- respected individuals in the society to investigate the whistle-blower’s complaint. The company secretary provides all the resources needed by this committee to conduct a thorough investigation. SEBI may be concerned about the possibility of the friends and sympathisers of a company’s board members and officers being appointed to such an investigating committee. SEBI may take over the responsibility of appointing such a committee. After all, you do not get too many whistle-blower complaints in a year. If the investigation concludes that the board and the officers of the company did not perform their fiduciary duties and contributed to a governance deficit by omission or commission, the investigating committee recommends to the shareholders that a penalty must be paid by the entire board and the concerned officers. Unfortunately, the white collar guilty people in India do not pay any penalty for their crimes and are just asked to resign. This is not a good idea. SEBI must blacklist these board members and officers. The shareholders must vote them out. In addition, the shareholders must claw back 100% of the compensation or the fee received by the board and the officers during the tenure of the incident reported by the whistle-blower. SEBI may consider imposing some additional penalties.
Let me now come to the second important issue in good governance. That is transparency. The directors operate at the pleasure of the shareholders. Therefore, a shareholder has an unalienable right of access to every piece of information concerning an investigation. The full details of the investigation should be provided on the website of the company so that every shareholder has access to it. The investigating committee or its experts should provide every document of the investigation and answer every question. My view is that there can be only two exceptions to this rule. The first is that there should not be any selective disclosure provided to any one set of shareholders. The second is that any business information that provides a competitive advantage to the company vis-à-vis its competitors in the marketplace cannot be disclosed to any shareholder.
I will close with a quotation from President Theodore Roosevelt who said, ‘Americanism means the virtues of courage, honor, justice, truth, sincerity and hardihood – the virtues that made America. The things that will destroy America are prosperity-at-any-cost, the love-of soft living, and the get-rich-quick theory of life’. These are truly immortal words that hold good for all nations. I have hope that our corporate leaders live up to these seminal words.
A lecture delivered at the 47 th National Management Convention (virtual) of AIMA On September 21, 2020 in New Delhi
Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.