India: The Relevance of Corporate Governance in the National Economy - Indian Experience

Last Updated: 4 January 2005

By R S Nambi

Introduction:

Corporate governance has reached centre-stage in the global agenda. The principles and codes evolved in several countries have furthered the cause of efficiency, transparency and equity particularly in the interest of the shareholders. Sustainable shareholder value has become the mantra for corporate immortality translating eventually into welfare of the society. Corporate governance can be defined as the way the management of a firm is influenced by many stakeholders, including owners / shareholders, creditors, managers, employees, suppliers, customers, local residents and the government. Different economies have systems of corporate governance that differ in the relative strength of influence exercised by the stakeholders and how they influence the management.

Business Scenario

Looking at conventional firms, management will usually have an informational advantage over other stakeholders and hence the need for corporate governance. Good corporate governance means governing the corporation in such a way that the interests of the shareholders are protected whilst ensuring that the other stakeholders’ requirements are fulfilled as far as possible. For example, it means that the directors will ensure that the company obeys the law of the land while still remaining in business. The Board’s power is still based more on personal politics than good governance.

Availability of Right Information

Corporate governance is all about governing (running or managing) corporations (incorporated businesses). By their nature large incorporated businesses are usually owned by one group of people (the owners or shareholders) whilst being run by another group of people (the management or the directors). This separation of ownership from management creates an issue of trust. The management has to be trusted to run the company in the interest of the shareholders and other stakeholders. If information was available to all stakeholders in the same form at the same time, corporate governance would not be an issue at all. Armed with the same information as managers, shareholders and creditors would not worry about the former wasting their money on useless projects; suppliers would not worry about the customer not fulfilling its part of a supply agreement; and customers would not worry about a supplier firm not delivering the goods / services agreed. In the real world of imperfect information, each agent will use whatever informational advantage they may have.

The OECD Principles

The OECD Principles of Corporate Governance cover five aspects:

  • The rights of shareholders
  • The equitable treatment of shareholders
  • The role of stakeholders
  • Disclosure and transparency
  • The responsibility of the board

These principles can be used by a nation state to design its own corporate governance rules. Auditors may use them to assess the adequacy of any corporate governance regime in the absence of more immediate standards.

Framework for corporate governance

The debate and effort in the arena of corporate governance has been tilted mostly in favour of the publicly listed and widely held companies. The shifting of control when a company’s ownership gets dispersed underscores the need to create and activate structures and processes by which the owners can ensure appropriate governance and management. The second factor addressed the need for more efficient regulation through amendments to listing agreements and company laws as well as updated standards of accounting, reporting and disclosures. The third factor focussed on market efficiency as an ultimate solution to corporate conduct and performance.

The codes and principles derived from this experience appear to be influencing the developing countries in terms of sensitisation to the need for good governance where capital markets are expanding briskly. In the process, however, major business/commercial segments of the economies in the developing world are not covered by the corporate governance regulatory net or have found the principles less rewarding in practice.

The framework for the principles of corporate governance has emanated from such a "world-view" and with the objective of creating efficient and transparent markets with widely held private ownership. Understandably, codes and principles in different countries have tended to believe that all enterprises will be of one variety only despite the caution that "one size doesn’t fit all". Thus, public enterprises have been treated in the same manner as the private either with the assumption that what is good for one is good for the other, or on the premise that eventually all enterprises should be free of dominant ownership of the government. The role of Governments as market regulator has been widely accepted and competition laws are emerging for protecting the people.

Indian Experience

A recent example is the resignation of three Global Trust Bank (GTB) directors, including the head of its audit committee. For instance in its heavily qualified audit report, the auditors have pointed to the accounts being prepared on a going-concern basis, despite a substantial erosion of net worth, based on the bank’s future capital infusion plans. The reappointment of Auditors was an issue and the apex bank has opted for change even ahead of the AGM. In tough situations, Indian independent directors only resign; that too, citing illness or personal reasons as their excuse, but never a difference of opinion with management.

The Standing Conference of Public Enterprises (SCOPE), New Delhi, had recognised the need to examine the corporate governance issues relevant to the public sector undertakings in India i.e. those companies in which central government has equity of 51 % and above. It was recognised that the codes, which were referred to (Cadbury's and the Confederation of Indian Industry’s at that time), were most appropriate to the private sector and that the infirmities in the public enterprise governance needed a devoted attention. The report, derived from the perspectives of several industry leaders and academicians, highlighted a multitude of issues and recommendations to improve the quality of corporate governance. In any developing world, the returns from good corporate governance in State Owned Enterprises should exceed those in the private fold. Obviously, there is a strong interface between good governance and corporate governance in the context of public enterprises as the latter are often used and perceived as instruments of public policy.

Developing an approach and the first principles for improving good corporate governance in India:

Unfortunately, the corporate governance issues are not entrepreneur driven but are imposed on them by the markets. As regards the Public sector undertakings, some initiatives were made. The term "Public Enterprise" here has the broad international meaning covering various types of state owned/controlled enterprise. The principles, if accepted, will obviously imply several operational difficulties, pulls, pressures and dilemmas. However, the attempt is to identify and gain consensus on the pillars for good corporate governance without being daunted by the potential controversies or operational barriers. These would reflect and reinforce the long-term vision of active, transparent, accountable and efficient markets.

Ownership and corporate governance:

There has been a universal belief that the government must restructure its activities and create market-related incentives and discipline for the enterprises in its control. Thus, corporatisation of state undertakings and privatisation has emerged as the most important methods of improving the efficiency of both the State and the corporate entities. Further, international bodies have been advising / pressurising governments to gradually eliminate subsidies, remove administered price mechanisms and reduce such other controls/support which contribute to false/artificial pricing and costs. The alternative, it is asserted, would perpetuate the moral hazard for the government, inefficiency in operations and management and the weak monitoring system. There is increasing convergence of thinking world wide that:

  • Commercial activities should not be undertaken by the Sovereign
  • There should be a clear set of commercial/financially sustainable objectives without cluttering with social objectives; and
  • Market related incentives and discipline including the market for corporate control would be necessary for sustainable economic management and development.

Market Responsiveness:

The assumption of free markets with widely held private enterprises could be insufficient at present for four reasons:

  • During the process of economic reform, several government departments will need to be corporatised without losing control, at least in the initial years. This process will be a continuous one as a State may declare one of its activities as detachable enough from the sovereign function to merit corporatisation.
  • The second reason arises from the possibility of a transitional control by the government until a new set of active owners emerges. Such control by the government may be as a fall back option in case of inefficient new owners or because the capital markets have not become mature enough to generate active shareholder monitoring that would make a positive impact on managerial efficiency. The "golden share" approach adopted in some countries as an interim mechanism signifies the existence of a transitory position for the company before the ideal market conditions emerge. The goals of privatisation would be attained only when sound corporate governance structures and processes are established and sustained. In the absence of a better governance system and process, including more active and vigilant shareholders, the goals of privatisation would not be met. Thus, the government may have to continue a direct control or indirect monitoring of those companies which are in the process of privatization till conditions emerge requiring complete withdrawal.
  • Thirdly the privatization process resulted in transferring the property rights to parties, which are less efficient and/or less honest than the government’s previous "agents". Such new owners may have failed in meeting the long-term goals of divestment/dis-investment/sale and may have created conditions that force governments to re-nationalise or take control.
  • Fourthly, there could be a realignment of equity structure over a period of time in joint ventures between public and private enterprises whereby the public enterprise gains control over the management. Such a change in capital structure may be rare and not a prospect that government prefers. Similarly, a public enterprise may acquire a private firm or another public enterprise or a government-controlled co-operative.

The governments' control system reflects, inter- alia, the inherent conflict of roles of the State – as a regulator, owner, adjudicator and executive - and divergence in applying the principles of corporate governance among different entities and at different levels of ownership. The multiplicity and ambiguity of roles has helped the State in using public enterprises as agents of political interest than public policy. Subsidy to consumers or targeted sections at the cost of the public enterprise, as also special grants and bail-out packages, have offered reasons, even if misplaced, for continued special controls and rights.

The infirmities in governance architecture in the case of public enterprises appear to arise mainly from:

  • The current powers to create, develop, renew and restructure the governing board and its members and their variance with the typical widely held public corporation.
  • The powers specially created or exercised by the government, which are not in consonance with the transparency ideal and other generally accepted principles of good corporate governance.
  • The lack of logic for continuation of these powers in the interest of independence in the governing board, its integrity, accountability and transparency.

A close examination reveals that the government has a massive task before it to create the enabling conditions that would improve the quality of corporate governance across the public enterprise system and in its transition to becoming market oriented.

Good Corporate Governance - Road Ahead:

Good corporate governance in public enterprises implies attention to issues larger than those of law and stock exchanges. They need to address the principles of government and public enterprise relationship and create the fundamental pillars based on which the governing board can become effective. The principles, codes and best practices for boards will become far more attractive and effective once these fundamentals are agreed upon and instituted.

  • The Government should review the legal status of all organisations controlled by it so as to separate those which can carry out commercial activities as companies following the market discipline and those that will continue as a sovereign function of the government.
  • The government should draw up a consensus based comprehensive policy of privatization, of both companies and other entities, delineating those, which will continue to be State-owned, the method of disengagement and the process of disengagement.
  • The government should bring about greater transparency by fully accounting for subsidies and price controls imposed on public enterprises, and achieving the desired social and development objectives through governments` budgetary provisions and related mechanisms.
  • The government should give up direct control over public enterprises by restructuring/rationalising the role of departments overseeing these undertakings.
  • The government must separate its ownership role and let public corporations be governed by the same structure of controls as that of any other company. The laws giving special status to public enterprises or special controls over them must be amended / annulled.
  • Parliamentary/Legislative Assembly control over public enterprises should be limited to interaction with the body exercising the ownership rights of the Government.
  • The government should assess and re-capitalise the public enterprises to ensure that the cost of social burden on a historical basis is made good on a one-time basis after adjustment for special grants and concessions given, if any.
  • Ownership rights of the Government should be exercised by specialised bodies to be created for that purpose.
  • The body exercising the voting rights should actively structure, create, develop and renew the governing board ensuring highest qualities of leadership, enterprise, integrity and judgement.
  • Governments must ensure that persons who are or were members of parliament or legislative assemblies be excluded from occupying positions of chairman or members of the governing board of a public enterprise, thus extending the spirit followed in the case of central public undertakings.
  • The position profile and specifications of chairman, chief executive and members of the governing boards should be approved by the governing board and shareholders in advance and through the expert advice of external bodies.
  • Listed public enterprises will have to follow the mandatory requirements of the Company Law and the stock exchange regulations. All other public enterprises should follow the relevant CACG or OECD principles that would foster independence, integrity, transparency and accountability, of the governing board, protect the rights of shareholders and engage the stakeholders.
  • Each public enterprise should develop a best practice manual for board processes, procedures and formats which may include, inter-alia, the profile of board positions; recruitment, selection, induction, training processes; conduct of board meetings; dealing with conflict of interests, disclosures, accounting and reporting requirements; evaluating board members; remuneration and renomination.
  • Public enterprises should ensure that individuals chosen for appointment as directors are either properly accredited, when such facility is available, or be formally trained in corporate governance practice.

Conclusion:

Though noteworthy progress has been achieved, clarity at policy making levels are needed to sustain the progress and to gather further momentum. The education and capacity building of regulatory structures would also help. The road is still far ahead to catch up with West.

The author is a consultant on the panel of World Bank and partner with M/s. RSN & Associates, Chartered Accountants, Chennai,. The firm is on the panel of World Bank Group and ADB.

© Copyrights reserved by RSN & Associates, Chartered Accountants, Chennai, India.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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