indian family-managed companies: the corporate...

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INDIAN FAMILY-MANAGED COMPANIES:THE CORPORATE GOVERNANCE CONUNDRUM

EXECUTIVE SUMMARY

The subject of corporate governance is one that is getting lot of attention in business and corporate circles not only in India but also globally. The subject assumes overwhelming importance in India since listed companies have to meet a SEBI deadline of December 31,2005 to comply with the revised requirement under clause 49 of the listing agreements. The original date for full compliance was April 1,2005 which was extended considering the industry request. While companies have been continuing their efforts to meet the deadline, despite difficulties in achieving the necessary proportions of independent directors, the recently released Irani Committee report under the aegis of Department of Company Affairs(DCA) has only helped to add confusion.

Turning to the corporate governance scenario in Family Managed Companies (FMCs), the recent amicable settlement of the feud between Ambani brothers of Reliance was welcomed by the business community and the Government alike. However, it has thrown open a number of governance issues for debate especially in widely held , family promoted joint-stock companies where public holding/outside holding far outstrips the family holding. While companies in the developed world like UK,US etc have been successful in delineating management from ownership , the scenario in India has a lot of ground to cover in this aspect. With the family having a number of berths on the board and at the same time holding positions in management give rise to issues of conflicts of interests too.

In this context, the paper tries to address and find answers to the following important questions:

Whether the Board of Directors in FMCs have been playing a constructive role?

Whether independent directors are independent in the real sense? What shall be the proportion and whether there is shortage of people of right caliber, who can take up such responsibilities?

Who should regulate the structure part of corporate governance-SEBI or DCA?

How does India compare with some of the developed nations and developing nations?

What steps towards best & next practices can result in India assuming leadership in

corporate governance?

The study was conducted with companies that are included in the Sensex (30 companies) as sample. The purpose is to help corporates to evolve better practices , policy makers to evolve pragmatic policies and academicians to further their research in this direction and also everybody concerned to indulge in director development activities.

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Introduction A very large percentage of publicly listed Indian companies are family promoted and managed. Nearly a third of the Sensex companies can be said to be family promoted, controlled and managed. Please remember that these are big companies in India which just by the very size of them must have grown out of the family’s boundaries and controls. While there are still a large number of companies in the developed world which were originally family promoted and managed but a good percentage of them have succeeded in clearly delineating management from ownership. They consciously take a backseat when it comes to management enjoying only the fruits of ownership. This has helped them to reduce any conflicts of interest. However, the situation in India leaves much to be desired. The promoters are actively involved in the day-to-day management and run the enterprises as their private property even when their holding is low in comparison with outside holdings. Regulatory framework in India on corporate governance is in the form of a clause mandated by SEBI in the listing agreement between the company and the stock exchange where the company’s shares are listed. While countries like US, based on their bad experiences in the recent past has chosen to taking the extreme step of enacting a law for making companies behave better on corporate governance front, we have decided to adopt a middle-of-the-road path in the form of a clause in the listing agreement between the company and the stock exchange where the company’s shares are listed.

But, of late there has been discussion and debate on the subject since Securities Exchange Board of India (SEBI) has fixed a deadline of December 31,2005 for companies to meet the revised Clause 49 guidelines. While deliberations and debates were taking place among corporates about difficulties of meeting the deadline, a whole lot of questions were thrown open to the family managed corporates when the feud between the Ambani brothers became public and was later on “amicably” settled sending waves of relief in the corporate and government circles. The debates and discussions during the period has brought to the fore more issues than resolving many.

The Current Issues

While there are a number of issues that need to be looked at, let’s try to throw light on five major issues namely

Whether the board of directors of Indian Family Managed Companies(FMCs) have been playing a constructive role in promoting corporate governance

Issues relating to independence of directors- about the directives regarding proportion , the question of real independence, and whether there is a problem in getting independent directors of the right caliber, and in sufficient numbers.

Who should oversee the board structure part of corporate governance, SEBI or Department of Company Affairs(DCA)? (The issue arises because both have come out with recommendations and guidelines which are different and hence create confusion)

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How does corporate governance in India compare with some of those developed countries and comparable developing countries?

What “best” and “next” practices shall be adopted by India to assume leadership in the area?

Now, let us discuss issues one by one.

On whether Boards Of Directors(BOD) of Indian FMCs have been playing a constructive role in furthering corporate governance

One thing that we all shall be proud of is that despite the fact that a large percentage of corporates in India are family promoted and managed, there have been practically no instances of corporate failures due to poor corporate governance. This situation must have arisen from an enlightened behaviour of family promoters who, despite their large shareholding in their companies always considered themselves as trustees of public wealth. Many of the entrepreneurs of earlier era were guided by the principles of the nation’s leaders like Mahatma Gandhi and many were also closely associated with the freedom struggle. While many of the family owned enterprises did yeomen service to the Indian economy in terms of entrepreneurship especially in an economy besieged with controls, it needs to be looked into whether their earlier attitudes and behaviours are necessarily fitting to the current scenario where governance has assumed different and even stringent dimensions. Apart from the general concern to evolve a set of better practices, the recent happenings in India’s biggest private sector enterprise , Reliance Industries Ltd., has created a situation where people tend to believe that everything is not right in the governance area. While a detailed discussion of what happened in RIL is not warranted, let us find out the issues that have been thrown open by the episode.

How could a decision as important as the restructuring or demerger of companies, all publicly held , be taken by an individual ? (Mrs.Kokilaben, mother of Mr. Mukesh Ambani and Mr Anil Ambani reportedly issued a note to inform the media & public about the scheme of settlement). While we all might be relieved that the spat between the brothers has been amicably settled , what business led Mrs. Kokilaben as head of the family ,which was reported to be holding only 34% of the shareholding in RIL, to assume that the demerger was in the interest of the remaining shareholders who account for 66% of the holding? (The latest annual report puts the promoter holding at 46.76% including persons acting in concert). Not even once when the entire episode was enacted ,did the board of RIL show any signs of exercising their power and authority as representing the interests of the larger group of shareholders. And , it seems unfortunate that no shareholder (including institutional holders) raised the question” where was the board?” Anil Ambani might have become a worthy whistleblower on governance practices of family managed companies but do we rightly say that he was passionate about corporate governance till he clears the fog over the 34% holding of the family? The BOD of RIL had six independent directors (institutional nominees included) out of a total of twelve .Why did it not occur to them that they have a fiduciary duty to shareholders to ensure future health of the company? This fiduciary duty actually consists of ten directoral duties listed below (Garrat, 2003):

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1.The duty of legitimacy which stresses the importance of staying within national and international laws applicable.

2.The duty of upholding the three values of corporate governance, namely accountability (to the owner ), openness(honest dealings within and without the board) and probity ( transparency of risk assessment and decision making process to the owners)

3.The duty of trust- directors are charged by law to hold their company “in trust” for the future. In tough times, the directors’ duty of trust becomes highly demanding since some significant shareholders may even wish to quit and run resulting in tension between shareholders and directors.

4.The duty of upholding primary loyalty to the position of director. The moment from one’s election to the position of the director, their primary loyalty must be to the company as a legal entity, rather than to those who appointed them. This could be confusing and frustrating as those who appoint them expect their representatives to always bid on their behalf. The director will hence feel his position highly challenging.

5.The duty of care. Directors must exercise their roles and tasks competently .They must be careful in what they do and how they do and ensure that what they decide is for the benefit for the company, not for themselves. While upholding this duty , directors have to take note that they know what they are meant to be doing. For this, directors must be attending the board meetings with full preparation and involvement and not just for the sake of attending meetings, and be content with holding directorships in limited number of companies. While SEBI guidelines suggest a maximum ten directorships, one has to critically look at this number from the point of view of involvement necessary. In order for directors to satisfactorily perform the duty of care, boards must provide directors with adequate induction , training and development inputs and also should review their performance.

6.The duty of critical review and independent thought. Directors shall be able to make their own judgment on best directoral practices and control systems for the performance and health of the company. They should very clearly understand the difference between directing and managing.

7.The duty of delivering the primary roles and tasks of the board. The director’s role mostly relate to

Policy formulation

Strategic thinking

Supervision of management

Ensuring accountability.

This is where the question whether it is in the right interest to have one person holding the position of the Chairman which makes him the leader of the board and CEO, which makes him the leader of the management arises. Conflicts of interests are likely in addition to a single person having unfettered powers.

8. The duty of protecting minority owners’ interests. While bigger shareholders (like promoters or institutions ) are usually represented on the boards through their nominees, it is always the minority shareowners whose interests get neglected. While the board is not having

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any representation from such minority shareholders, the board as a body is expected to take care of the interests of all shareholders alike.

9.The duty of corporate responsibility. It is the board’s responsibility and duty to see that the company acts as a dutiful corporate citizen by keeping an eye on the triple bottom line- People and Planet in addition to Profit ( the measure of financial performance).They should take care of the environment , people, communities and societies, animal welfare, energy and water usage etc while strictly complying with all regulatory aspects in the above areas.

10.The duty of learning ,developing and communicating. The board has to learn continuously from its decisions and actions to develop and appraise its members regularly and rigorously and to have effective two way communication with management, customers ,suppliers and also regulatory bodies. Many people assume that directorship is the acknowledgement of the end of a long and successful executive professional career and hence a suitable reward .Hence, in general, they succumb to a reasoning that they don’t need to learn and develop them anymore. This sort of complacency may prevent effective functioning of any director. They have to understand that accepting a directorship is not an easy option even in FMCs. When you become a director , the law just looks at the position of the director- they are not concerned whether one is promoter, executive, non-executive or independent. Hence, those who accept directorship must consider it as the start of a new and challenging career. They may require to break away from the old, executive professional behaviour to a more directing approach which includes policy making and strategic thinking. Hence, one has to be willing to be humble to accept the necessity of training, retraining and development to be a thoughtful and effective director. Companies have to ensure that they provide induction, orientation and competence building processes and establish an annual appraisal process.

Now, let’s check whether the BOD of RIL was doing its fiduciary duties. Recent media reports revealed that there were glaring omissions. This is not the first time RIL or the Group has been in the news as far as breaches of governance were concerned. Allegations about their practices have always been in the news throughout all these financially successful and rewarding years. Some of the major lapses have been from (a)not being transparent about the likely major fall in profits at the time of their Series G debenture issue- when profits for the half –year when declared immediately after the issue was only a fraction of the profits projected in the documents related to the issue through(b)embedding a plant inside a plant and evaded payment of duties and(c)the controversial issue of duplicate certificates by Reliance Consultancy Services Ltd. to(d) the recent lack of disclosure of conversion of shares of Reliance Infocomm by Mukesh at a price which was substantially lower than that for RIL. Of course , some of these happened when India Inc had not even heard or thought of governance in a serious manner. But has the scenario been any better even after the CII Code, K.M.Birla Committee recommendations and the consequent Clause 49 of the listing agreement, Naresh Chandra Committee recommendationsand Narayana Murthy Committee recommendations? The company had in fact incorporated a detailed discussion on the policy on business ethics in their annual report in 2003-04.Is ethical practices and corporate governance practices to be limited to rhetoric in annual reports? While there is a general feeling among all experts on corporate governance , prominent among them being Dr. Ram Charan, that mere structural changes will not result in better governance, even on this front many Indian FMCs fail to meet the objective criteria(Charan 1998,2005). Every listed company is supposed to bring out a report on corporate governance under clause 49 of the listing agreement. If one analyses the Corporate Governance reports of even of the prominent FMCs,

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one can easily see that the intention of them is conformance rather than performance. Here are few examples: Mr. M.L. Bhakta has been shown as an independent director on RIL board. While he may meet all requirements stipulated for being classified as independent, is he really independent? He has been on the board of RIL right from 1977(the year in which the company went public) and in all probability must have been a promoter nominee. All reports appeared in the media after his resignation from RIL board during the ownership battle between the Ambani brothers , speak volumes to confirm this. Apart from this, he is also a partner in M/S .Kanga & Company, which acts as Solicitors and Advocates for the company. Is it morally correct for such a director be classified as independent?

Another very interesting example is that of Mr. N.S. Sekhsaria and Mr.A.L.Kapur, being classified as independent directors on the board of ACC. How could Sekhsaria and Kapur, Managing Director and Whole-time Director respectively of GACL, which held about 14% of ACC through its subsidiary Ambuja Cement India Ltd.( then a 60% subsidiary of GACL) , be classified as independent directors on the board of ACC in 2003-04?They had to be nominees of a major(non-institutional) shareholder. Surprisingly, in the latest annual report it is stated that they have ceased to be independent directors pursuant to the acquisition of shares of ACC by the Holdcem Cements Pvt. Ltd, with Ambuja Cement India Ltd. and GACL acting in concert,and thus Ambuja Cement India Ltd., currently holding 34.69% of ACC.

The case of Mr. Nusli Wadia ,who sits on the boards of three Tata companies , namely Tata Steel, Tata Motors and Tata Chemicals and being classified as independent director in each of the three companies is very intriguing. Can we honestly and rightly agree to his being designated independent on the three companies belonging to the same group? May be YES strictly as per prevailing regulations which looks at companies as individual entities. Another very interesting example from Tata group is that of Mr. J.K. Setna , of Tata Motors who was designated as Non-Executive, Promoter Director in the year 2002-03(then Tata Engineering and Locomotive Co.) , was redesignated as Independent Director in 2003-04. Mr. Setna is on the boards of a number of Tata Companies ( both listed and unlisted) including Tata Sons Ltd. Aren’t we given an impression that we are more bent on conformance than performance? While generalization may not be proper, these types of anomalies get noticed as a company becomes bigger: ”Big boys had better be careful. They are being watched even at night”(Dipankar Gupta,2004).

Let’s turn our attention to RIL once again. What has the board of RIL done to promote better governance while the whole family ownership drama was being played? They didn’t do anything at least to the public notice. There were already rumours making rounds that things were not well between the Ambani brothers. What did the board do when the muddy ownership battle went public? Support Mr..Mukesh on the buyback proposal ( presumably an act or effort to divert the attention) rather than deal realistically with the issues facing the company and the larger group of shareholders outside the family? Can we say that the board played a constructive role? In fact, the whole episode presented a wonderful opportunity for India Inc to tell the whole world that we can take leadership in the area of Corporate Governance. We should have been thankful to the glorious, not at all painful in the conventional sense, opportunity to sit up and take a serious note of the advances we could make in the area while in most of the developed world like US and Europe, the opportunities arose after devastating and painful corporate failures like Enron, WordCom, Tyco and Parmalat. The board of RIL could have taken a proactive role in settling the dispute between the brothers rather than leaving it to the family since they had a fiduciary role to protect the interests of the entire shareholders including outsiders who held

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66% .It is high time that boards of FMCs play a more rigorous and constructive role rather than just be playing a passive role. When shareholders , many of them not rich, put in their money , it is the duty of board and management to be responsible to those shareholders. Many an embarrassment like Anil writing to Ministry of Finance and SEBI could have been avoided. Are we waiting for a severe and painful crisis to occur before we embark on reforms and renewal? Please take note that if corporations fail to reform and change their behaviours, the Government or regulators will be forced to enforce laws which will be severe and laden with stricter conditions.

While every expert subscribes to the view that mere structural changes of the board are not going to have any major impact on the governance front, FMCs have not been taking adequate care to create credibility in the minds of investors and public. A cursory scan of four Tata companies in the Sensex reveals that three of them have promoter nominees on the audit committees. And, as far as the fourth company is concerned, the independence of one member (Mr.J.K.Setna, on the Tata Motors board, discussed earlier) is questionable. Tatas have always been on the forefront of holding high values built on solid ethical business principles. All these companies have enough numbers of independent directors ( at least on the face of it) to man the audit committees. Audit committee is the one committee that is expected to be independent of management and rightly so. Can we still say Indian FMCs are playing a constructive role in promoting better corporate governance?

On the issues relating to Independent Directors

Now, let’s move to the issue of independence of directors. In the case of any FMC, as the size increases, more capital is needed and the number of outside owners increases. It is in such situations that professional management becomes essential and the family thinks of separation of management from ownership which in fact laid the foundations for modern corporate governance needs in the West. There is no managerial mechanism which guarantees good governance by just appointing the so-called independent directors. We need courageous members who perform their fiduciary duties and are willing to take the CEO and the management to task. A checklist for independence and governance will not guarantee an independent mindset and good corporate governance. Even some of the instances mentioned earlier, may entirely conform to the structure and form requirements, but the substance is lacking. While conformance with rules is necessary, that will never guarantee trustworthiness.” The culture of a corporation is what determines how people behave when they are not being watched” according Tom Tierney, a former Managing Partner of Bain & Co.(Economist, July 27,2002) Companies like Enron, WorldCom and Parmalat failed because of such cultural disasters, led by none other than their leaders.

As per the current provisions of Clause 49 of the listing agreement, companies shall have 50% independent component if the Chair is full time or executive and one-third in case the Chair is non-executive. This itself is a very confusing condition in an FMC situation. Take the case of a company like Tata Motors, belonging to the Tata group. Ratan Tata was Executive Chairman of the company till sometime back. In pursuit of the famous Tata retirement policy for directors drafted by him, he relinquished the post on attaining 65 years and became Non-Executive Chairman. The Clause 49 stipulates the independent component based on whether the Chairman is Executive or Non-executive. But, does Mr. Tata’s relinquishing the Executive Chairman’s post and becoming Non-executive Chairman change any of the power equations within the company? And for quite a number of years after he relinquished the executive post, there was no Managing

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Director/CEO for the company till it was recently conferred on Mr. Ravi Kant. This is the scenario in many FMCs. Had Clause 49 stipulated the requirement of Independent Directors based on the Independence of the Chairman, it would have made more sense.

Companies complain about the lack of availability of good independent director material. Who should be blamed for this? Industry itself. If you have a person like Nusli Wadia sitting on three major Tata companies for continuous stretches of nearly thirty years, how do we expect well-trained and groomed director material to be available for India Inc to grab? Hitherto companies had a tendency to overload good director material with too many directorships. This should change. Companies shall look at below board level like Vice-Presidents, General Managers etc for board positions. Select the “right and functional” rather than the “best and the famous”. Of course, don’t expect them to be effective and contribute overnight. They were/are hard core managers and will become good at directing only after necessary orientation and training. Such people shall be given about two years for making worthwhile contributions. Such independent directors shall be put under a senior independent director for proper guidance. This aspect of director development is a grey area in our boardrooms. None of the companies report any initiative in this . Since director skills are essentially different from managerial skills, such orientation and development are must.

On who should handle what regulatory responsibilities

Now, let’s turn our attention to the issue regarding who should handle what regulatory powers regarding corporate governance or what shall be the fine division regarding the regulatory powers between bodies like SEBI or DCA. While SEBI has a bigger role to play in the practices and processes of governance, the structure for governance shall be vested with DCA. Since SEBI has actually nothing to do with structure or formation or composition of the board such aspects shall vest with DCA since all incorporation regulations are monitored and controlled by DCA. Hence, any recommendation or guideline regarding the structure part such as formation of board, independent component, committees etc shall come under the purview of DCA and not SEBI. As of now, companies are confused regarding which guidelines they have to follow-DCA guidelines(as per the recently published Irani Committee recommendations) or SEBI guidelines (Clause 49). SEBI says that there is no controversy about mismatches in the two guidelines but maintains that companies have to meet the Dec 31,2005 deadline for implementing Clause 49.

Practices in major developed and developing countries

A set of practices in major developed countries like US, UK and Germany and comparable developing nations like Brazil, Malaysia and Indonesia based on Legal Framework, Regulatory Bodies, Institutional Bodies, Board structure, Corporate Governance Codes, Disclosure & transparency, Director development activity & Corporate Governance Rating alongwith that of India are given in Annexure 1 for enabling a comparison of the Indian practices with them.

A comparison between practices in India and other countries included in the study(Ref Table 1 ,Page 41 )

An analysis and comparison of the practices in other countries , we can observe that our governance practices are very much on par with most of the developed nations like US &UK. Of all the countries examined in our sample, only US has chosen to enact a Law specifically aimed at Corporate Governance. Majority of other countries have the corporate governance as part of

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the listing agreements with the stock exchanges and/or under the general commercial laws. Most countries have evolved codes out of necessity to improve governance in a changing global economic scenario and they have usually come from industry rather than from Regulator or Government. In India too, as we all know the first initiative was from an industry body, namely,Confederation Of Indian Industry, CII. Whether it is apt to assign corporate governance ratings to companies, especially in view of the shortcomings which were unfolded earlier in the paper is still debatable, three of the rating agencies in India have evolved Corporate Governance rating methods. While our disclosure and transparency practices have considerably improved, there are still grey areas like ownership details .Reports while showing ownership details continue to mention “persons acting in concert” with the promoter holding.

The one major area where we have a lot of ground to cover and which needs immediate attention is director development activity. While making it mandatory may not be in the best interest of the process, the companies and institutions shall form a body to continuously impart training and development programmes to improve the quality of directors and the board processes and practices. An initiative like Indian Association of Corporate Directors, on the lines of NACD in US, can assume this responsibility.

US has chosen to enact a law in the form of Sarbanes-Oxley Act, mainly because that was required to create confidence in the minds of the investors and public in view of the high profile failures like Enron and WorldCom, which resulted in wholesale erosion of confidence in thewhole governance process that prevailed till then. Let the Indian industry be proactive and implement the “best” and try “next” practices to prevent any instances of governance failures and prevent such ”draconian” laws to be thrust upon them by fine tuning their behaviours in the boardrooms.

Steps towards best and next practices

Promote independence of thought and practice Promoters have to promote and encourage independence of thought among not only independent directors but also among all. Once the company becomes public, the promoters should consider themselves as trustees on behalf of the entire shareholders and be concerned about what is best for the company than what is best for themselves or the family.

The regulators also shall not be overly concerned about fixing a percentage for the independent component since structural independence need not necessarily result in independence of thought & practice. Too many checks and balances on the board on the pretext of better governance will only be self-defeating. Any excessive concerns with restraints or the negatives of corporate governance can prevent all parties from taking positive steps. For example, too much of emphasis on risk management can kill the very risk taking mindset that is essential in any entrepreneurial venture.

Act out of volition India Inc shall take voluntary initiatives to evolve better practices.Why not form a self-regulatory organization covering all the directors of public limited companies to evolve best and next practices, communicate them through continuous interaction , training ,orientation etc. As already suggested earlier, an Indian Association for Corporate Directors (IACD) constituted on the lines of National Association of Corporate Directors(NACD) can take steps in this direction by setting performance standards for corporate directors and boards.

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Auditors and independent directors shall not have any other pecuniary relationshipsAuditors of company firms should not have any pecuniary relationship not only with the company where they are auditors, but also in any other company belonging to the same group. Analysis point to many such instances. Similarly, independent directors also shall not undertake any assignments pecuniary in nature with their companies and also refrain from taking up directorship in group companies.

Evolve a Management Philosophy and make it known to public In every company where family/promoters have significant stakes, say 25% or more, let the promoters declare their management philosophy in the annual reports. In a globalization scenario, family managed companies have to craft strategies to compete in the global marketplace. When the companies are small, their informal structure definitely helps in quick decision making. But, as size increases, they may find it extremely difficult to continue the earlier ways of managing and strategizing. Hence they need stronger governance models and management philosophy to prevent any family problems affecting business and for smooth succession plans.

Regulator/s to play a constructive role The regulator /s shall also play their roles constructively. Tichy and Cardwell has identified three distinctive ways of leadership exercising /drawing power in an organization(Tichy and Cardwell 2002) .One is through coercion where the leaders use power to enforce decisions and fear of punishment forces others to indulge in execution. The second one is utilitarian where offer of incentives by leaders tempt others to execute. The third one is the normative method where leaders inculcate a culture based on a solid value system and others act in the best interest of the company because they believe that it is their responsibility and duty. Coercion can have problems since it is leader-dependent and once the leader disappears from the scene the entire structure or process can collapse. Incentives have a motivational limit beyond which they won’t work. When incentives become right, it loses its value or charm. It could also prove costly over long term. Hence, the best way for the leadership of regulatory bodies is to take necessary steps in creating a value-based governance system. In this normative way , the practices and processes continue in spite of the changes in leadership because that has become a part of the culture. Both industry and regulators need to have clarity on the advantages of such a scenario.

Have a paradigm shift in approach to corporate governance While the management framework has undergone change from one of Strategy, Structure and Systems to People, Process and Purpose and management process itself has undergone a paradigm shift from one of Constraints , Contract, Control and Compliance to one of Stretch, Trust, Support and Discipline even in organizations of bigger size, it is not clear why the same has not happened in a smaller organization like Board(Ghoshal and Bartlett 1997). For this, boards have to become learning boards, have clarity of their roles and duties, be able to question established premises, and operate as a cohesive unit. Regulators should also understand that rules can’t substitute for character. Initially, the regulators can think of creating grouping like A0 for companies that excel in Corporate Governance and offer them incentives in the form of reduced listing renewal charges, tax exemptions etc. Such a system prevails in Brazil, where Sao Paulo Stock Exchange(BOVESPA) recently (2000) created a new listing agreement called “Novo Mercado”(New Market). Participation in the “Novo Mercado” is voluntary, but companies willing to have their

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shares traded in this segment must undertake to comply with corporate governance standards and disclosure requirement more stringent than those applicable to traditional segment. ”Novo Mercado” segment has two entry levels: Level One concern basically disclosure rules and a free float of 25% whereas Level Two requires Level One disclosure conditions plus annual reports conforming to US GAAP or IAS and a unified term of one year for board members. Please note that out of about 400 companies listed on BOVESPA, only 26 companies are listed in Level One, only 3 are listed Level Two and only two in “Novo Mercado”.

Independence shall mean real independence Independent directors should not hold any shares in the company. Even they shall not be issued options. It is improper to reward them in options on the pretext that they will align themselves with the shareowners. There is an irony in the whole approach to shareholding by independent directors. The regulation today prescribes that independent directors shall not hold more than 2% because regulators feel that the independence will be lost(or they will align more with shareholders with reasonable percentages and hence develop vested interests).At the same time regulators have toed the corporate line that independent directors will be more aligned with the other shareholders if they hold shares in the company. Then what is the sanctity of this 2%?

Pay the Independent Directors well Independent directors shall not accept many directorships thereby diluting their involvement in each of them. Recently Mr. Pramod Bhasin, CEO of Genpact, while speaking at the CII Corporate Governance Series in Delhi highlighted this point(Business Line ,September 23,2005). Independent directors should restrict their directorships to maximum of three to four if they want to contribute well to each company. But there is one hitch as of now. Directors who are not engaged otherwise, need to take up a number of directorships to maintain a reasonable standard of living which they were used to while they were in executive capacities since even in some of the large companies they get paid a pittance. For example, in a company like RIL, the highest amount an independent director (since he is a member of a few committees too)earns is Rs.0.58 millions as against the CEO compensation of Rs.217.2 millions. The remuneration must be in line with the efforts put in by them. Assuming that the average CEO puts in at least 14 hours a day, the independent director shall be compensated for the approximate number hours he is expected to be involved for the preparation and attendance in the board/committee meetings at the same hourly rate of the Chief Executive. For a company like RIL, this works out to be something between Rs.4.25 millions and Rs.6.375 millions assuming that a director has to put in nearly 100 hours without any committee memberships and 150 hours with committee membershipsconsidering preparation, travel and attending meetings. It may please be noted that there are much smaller companies like Ucal Fuel, Godrej Consumer Products, Sun Pharmaceuticals etc which pay decently to non-executive directors. Of course, there is prestige associated with directorship of RIL or other bigger companies. But the risks are also high. Of course, one may not subscribe to Infosys’s practice of paying very high to the Non-executive directors(almost 85% of the executive directors’ remuneration in the year 2003-04 and about 60% in the immediate past year) in which case it could be said that the Non-Executive directors may develop vested interests, but decent compensationto restrict their number of directorships so as to devote attention and get involved

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wherever they have memberships need to be worked out. It must also be noted that directors’ remuneration need to be directly related to the company’s financial performance and aligned to rewards to shareholders and employees.

Have a written charter The board should have a written charter for corporate governance practices which shall be published. The duties, responsibilities and powers of all different classes of directors shall be clearly articulated. The charter should cover all areas of board and governance related aspects like role of the board, information needed & its format for delivery, monitoring process, fixing of CEO evaluation criteria, CEOcompensation, evaluation of other senior executives and their compensation, annual review of firm’s performance, frequency of board meeting and committees, review of directors and board as a whole etc. For example, in any company generally audit committee should have met more often than the full board. But, if we analyze a sample of companies from Sensex, very few like ITC, Tata Motors, Tata Power, RIL have conducted more audit committee meetings than full board meetings.

Review the performance A performance review shall be initiated for the board. Self evaluation of the board as a whole and of individual directors shall be instituted as a process. The frequency of evaluation can be at least one per year. Peer review also shall be part of the process.

Leaders should set exemplary standards for behaviours Corporate leaders ,while performing their duties as directors , should also set examples for others. We do notexpect a leader like K.M.Birla, who chaired the first ever committee set up by SEBI on corporate governance, to miss board meetings and AGMs ( and that too for three continuous years) in a company where he is designated as independent director.Companies have also to set example by making it clear in their governance charters regarding the response of the board to such actions(or inaction?) on the part of directors.

SEBI shall create awareness among all the constituents Regulators like SEBI should tryto initiate steps to create more awareness among investors and public about advantages of good corporate governance. Most of the investors including institutional investors do not raise any questions on governance matters in any of the shareholders’ meetings because they are only concerned about the gratification of their return expectations in the near term rather than sustained performance of the company and long-term wealth creation. Even in the case of RIL, no reports have appeared in the media about any shareholders( including institutional shareholders) raising queries about the issues of ownership and governance. The basic tendency in any group or organization is to cover up truth in the pretext of harmony. SEBI and investor associations shall take proactive steps to educate investors to have a questioning mindset as and when they feel that things are not well. Remember that Mr. Rudolph Guiliani, former Worshipful Mayor of New York, was successful in drastically reducing crimes by cleaning up the suburban railway stations and other public places (Guiliani 2002). This shall be a lesson for any leadership and regulatory agency. Stress on the negatives or too many restraints will only encourage companies to find out ways of circumventing them. Good governance necessitates acting in a trustworthy fashion. Corporates will succeed only if it is trusted by all its stakeholders. Mere compliance with rules will never guarantee trustworthiness .No checklist can guarantee integrity .A checklist approach helps in instituting mechanisms

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for avoiding legal liabilities and not necessarily in acting ethically and with character. Too much of stress on avoiding mistakes, will result in lack of worthwhile effort on improvement and nobody will try out new things and ways. Prudence than checklists shall be the guiding principle. There is no magical way to improve governance overnight. Regulators and boards themselves shall show “aggressive patience “ to use an oxymoron(Ulrich ,Kerr and Ashkenas, 2002 ) ie they should aggressively monitor that change processes are in place but show patience to wait for the results of change. They should try to spread the message that good corporate governance brings real economic and social benefits.

Corporates to act proactively We have a history of industry heritage built on solid foundations of trust and trusteeship well explained to us by people like Mahatma, taken forward by legends like JRD, and currently being guided by people like Narayana Murthy , Azim Premji etc. Why should India Inc wait for legislation to force them to behave? They should behave better out of volition rather than compulsion. India can provide leadership to the rest of the world in this area which will also encourage big foreign investors to turn to India in flocks and contribute to the faster growth and development of the economy.

Conclusion

While no instances of corporate failures due to poor corporate governance have been reportedand there exists a number of outstanding examples of family managed companies with enlightened leadership, , the recent happenings have opened a pandora’s box with respect to corporate governance practices in India. FMCs in India have to go a long way forward to create a new paradigm in their journey to adopt best and next practices. Changes shall voluntarily come from the corporates and boards. They should take proactive steps in creating an independent mindset in the directors by sustained director development activity. The regulators shall work on positives rather than stressing on negatives. They should initiate steps to create awareness among companies and boards, investors and general public to make them understand the importance of good governance. Both regulators and corporates should understand that improvement in performance is more important than conformance to regulations and eagerness to avoid legal liability. Everyone should understand that good governance practices are essential for global investors to turn to India which will help us in accelerating the growth of the economy.

References

1.Annual Reports of companies included in Sensex and Nifty for the years 2002-03,2003-04 and 2004-05.

2. Bhasin, Pramod, speaking at CII Governance Series, ”What The Boards Would Be Facing In The Coming Years”, Business Line, September 23,2005.

3. Carter, Colin B., Lorsch, Jay W., Back To The Drawing Board, Boston, Harvard Business School Press,2004.4. Charan ,Ram, Boards At Work:How Corporate Boards Create Competitive Advantage, San Francisco, Jossey-Bass, 1998.

5. Charan, Ram, Boards That Deliver: Advancing Corporate Governance From Compliance to Competitive Advantage, San Francisco, Jossey-Bass, 2005.

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6.Chaudhry, Nagendra V., (Ed.), Corporate Governance: Principles and Paradigms, Hyderabad, ICFAI University Press, 2002.

7. Garrart, Bob, The Fish Rots From The Head: The Crisis In Our Boardroom: Developing The Crucial Skills Of The Competent Director, London, Profile Books,1996.

8. Garrat, Bob, Thin On Top: Why Corporate Governance Matters and How To Measure and Improve Board Performance , London, Nicholas Brealy Publishing,2003.

9. Ghoshal, Sumantra, and Bartlett, Christopher A., The Individualized Corporation, New York, Harper Business,1997.

10.Giuliani, Rudolph W., with Kurson, Ken, Leadership, London, Little Brown , 2002.

11.Gupta, Dipankar, Ethics Incorporated, Delhi, Harper Collins India, 2004.

12.Harvard Business School, Harvard Business Review on Corporate Governance, HBS Press, Boston,2000.13. Kumar T.N., Satheesh, (2005), “ The Reliance Board Meet and The Buyback Decision:Skirting The Real Issues”, Effective Executive, Feb-Mar 2005(Vol. VII,no.02),pp 41-42.

14. Kumar T.N., Satheesh,(2005)” How Independent Are Independent Directors?“,Indian Management, May 2005(Vol. 44,No. 5),pp 66-71.

15. Kumar T.N., Satheesh,(2005) “Managing The Managers: Reforming The Corporate Boardroom”, Effective Executive, May 05(Vol. VII, No. 4), pp 54-59.

16. Kumar T.N., Satheesh,(2005) “ Reinventing Boards”, Indian Management, September, 2005(Vol. 44,No.9), pp 118-126.

17. Shultz, Susan F., The Board Book: Making Your Corporate Board a Strategic Force In Your Company’s Success, Chennai, East West Books, 2003.18. Suryanarayana, A. (Ed), Corporate Governance: The Current Crisis and The Way Out,Hyderabad, ICFAI University Press, 2005.

19. Tichy, Noel M., Cardwell, Nancy, The Cycle Of Leadership, New York, Harper Business, 2002.

20. Tierney, Tom, quoted in “When Something Is Rotten” The Economist, July ,2002(Vol.364, No.8283),pp 53

21.Ulrich,Dave, Kerr, Steve, and Ashkenas, Ron, The GE Work Out, New York, McGrawHill, 2002.

22.Ward, Ralph D., 21st Century Corporate Board, 1997, New York, John Wiley & Sons, Inc.23. Waring, Kerrie, and Pierce, Chris(Ed.), The Handbook of International Coprporate Governance, London, IOD/Kogan Page, 2005

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Annexure 1

A.Developed World

1.United States.

A. Legal framework :1. Based largely on incorporation laws in different States with commonality achieved through the Model Business Corporation Act(MBCA) published by American Bar Association (ABA).

2.Public Accounting Reform and Investor Protection Act,2002(Sarbanes –Oxley Act)

B. Regulatory Bodies :1. Securities and Exchange Commission(SEC)

2. Stock Exchanges( Amex, NASDAQ and NYSE)

C. Institutional Bodies :1. National Association of Corporate Directors(NACD)

2. American Bar Association (ABA)

3. Association of Corporate Council

4. The Business Roundtable(BRT)

5. Council of Institutional Investors(CII)

6. Institutional Shareholder Services (ISS)

D. Board Structure 1.Unitary

2.Independent audit , compensation and nomination committees

E. Codes : Evolved by institutional bodies

F. Disclosure & Transparency: Laws centre around disclosure and it is the major means of achieving transparency.

G. Director Development Activity: NYSE, NASD,NACD,ISS active in development.

H. Corporate Governance Rating :1. ISS Corporate Governance Quotient(CGQ)

:2.Governance Metrics International (GMI) rating

:3. Standard & Poor(S&P) rating

2.United Kingdom

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A. Legal framework : Common to England, Wales, Scotland and Northern Ireland

1.Essentially a common law system

2.European Union laws also followed

3.Listing Rules

4.Company Law 1973

B. Regulatory Bodies :1.Financial Services Authority (FSA) / UK Listing Authority (UKLA)

2.Financial Reporting Council (FRC) and its subsidiary Financial Reporting Review Panel (FRRP)

3.London Stock Exchange (LSE)

C. Institutional Bodies :1. National Association of Pension Funds (NAPF)

2.Confederation of British Industry (CBI)

3. Institute of Chartered Secretaries and Administration (ICSA)

4.Institute Of Directors (IOD)

D. Board Structure 1. Unitary.

2. Separation of Roles of Chairman & CEO.

3. Compensation, Audit and Nomination Committees with majority independent directors

E. Codes :1.Cadbury Report(1992)

2.Greenbury Report (1995)

3. Hampel Report & Combined Code (1998)

4.Turnbull Report (1999)

5. Higgs Report & Revised Combined Code (2003)

F. Disclosure & Transparency: Centre around remuneration , reporting and audit.

G. Director Development Activity: 1.IOD

2.3i

3.ICSA

H. Corporate Governance Rating: Not available

3.Germany

A. Legal framework :1. The introductory Act to Civil Code

2.The Civil Code

3.The Commercial Code

4. The Insolvency Act

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5.The Law on Limited Liability Companies

6.The Stock Exchange Corporation Act

7.The Law on Control and Transparency in The Corporate Sector(1998)

8.The Law on the Registered Shares and The Relief of the Exercise of Voting Rights (2001).

9.Law concerning Supervisory Board’ Access to Information and Independence of the Company’s Auditors.

10.The Capital Raising Promotion Act.

11.The Law of Limited Liability Partnership.

B. Regulatory Bodies :Sole entity responsible is The District Court- Commercial Register

C. Institutional Bodies :Not present

D. Board Structure :Two-Tier-Supervisory Board with Employee representation

-Management Board(the executive)

E. Codes :a. The Berlin Initiative Code (2000)

b. The German Panel Rules(2000)

c. The Cromme Commission Code(2000)

F. Disclosure & Transparency: Accounting Principles based on Commercial Prudence

G. Director Development Activity: Very few organized ones

H. Corporate Governance Rating :A Score Card for German Corporate Governance developed

by The German Society of Investment Analysis and Asset Management(DVFA)

B.Developing Nations

1.Brazil

A. Legal framework :Brazilian Corporations Law(Law 6404 of 1976, and amendments Law 9457 of 1997 and Law 10303 of 2001); Directors not personally liable ;Fiscal Council is necessitated by law which monitors the acts of the board members and the officers and reviews the management accounts and reports.

B. Regulatory Bodies :The Brazilian Securities and Exchange Commission(BSEC).

C. Institutional Bodies :1.Sao Paulo Stock Exchange(BOVESPA)

2.The National Economic & Social Development Bank (BNDS)

3.The Instituto Brasileiro de Governance Corporation(IBGC).

D. Board Structure :1.Unitary

2.Committees are rare

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E. Codes :1.Code of Best Practices (evolved by IBGC)

2.Recommendation on Corporate Governance (CVM)

F. Disclosure & Transparency: Audited financial statements to be published.

G. Director Development Activity: Mostly under IBGC’s initiative and large numbers of

Directors trained since 1998


2.Malaysia

A. Legal framework :Based on UK Common Law Principles

1.The Companies Act ,1965

2.The Security Industry Act (SIA),1983

3.The Securities Commission Act(SCA)1993

4.Kuala Lumpur Stock Exchange (KLSE) listing requirements

B. Regulatory Bodies :1.The Securities Commission(SC)

2.Kuala Lumpur Stock Exchange(KLSE) 3.The Companies Commission of Malayasia(CCM)

C. Institutional Bodies :1.Malayasian Institute of Corporate Governance (MICE) 1998

2.The Minority Shareholders Watchdog Group(MSWG)2001


2.Audit,Nomination & Remuneration Committees

E. Codes : The Malayasian Code on Corporate Governance(2002)

F. Disclosure & Transparency:1.Annual reports and quarterly financial statements

2.Statement of Internal Controls

3.Conformation to IAS

G. Director Development Activity : 1.Mandatory Accreditation Programme (MAP) for directors of listed Companies. All directors of listed companies must

have undergone MAP training.

2.Corporate Directors Training Programme(CDTP) launched in 2001 and those who attend CDTP are exempted from MAP

3.Continuing Professional Education (CPE) offers regular training for directors.


3.Indonesia

A. Legal framework :Based on Dutch Legal System- The Limited Liability Company

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Law(1995)

B. Regulatory Bodies :1.Bank of Indonesia(BOI)(for banks)

2.Jakarta Stock Exchange(JSE)

3.Surabaya Stock Exchange(SSE)

4.Capital Market Supervisory Agency(CMSA)

C. Institutional Bodies :1.National Committee for Corporate Governance Policies

2.Forum for Corporate Governance in Indonesia

3.Indonesian Institute of Corporate Governance.

4.The Indonesian Society of Independent Commissions

5.The Indonesian Institute for Corporate Directorship.

6.Indonesian Transparency Society

D. Board Structure :1.Dual Board Structure- The Board of Commissioners(Supervisory Board)

-the Board of Directors(Executive Board)

2.Audit Committee mandatory; remuneration & nomination committees desirable

E. Codes :Guidelines by National Committee for Corporate Governance Policies

F. Disclosure & Transparency:1.Audited annual reports mandatory

2.No disclosure on internal controls

G. Director Development Activity: Half- a –dozen institutions offer training programmes but no

mandatory requirements


C.India

A. Legal framework :1.Companies Act, 1956, and the amendments therein over the years, administered by DCA

2.Securities Contract (Regulation)Act ,1956(SCRA)

3.Sick Industrial Companies (Special Provisions) Act,1985 (SICA)

4.Securities and Exchange Board of India (SEBI)Act,1992

B. Regulatory Bodies :1.Department of Company Affairs(DCA)

2.Securities and Exchange Board of India(SEBI)

:3.Reserve Bank For India (RBI) for banks

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:4.Stock Exchanges [Bombay Stock Exchange(BSE),National Stock Exchange(NSE),and other Regional Stock Exchanges which have become more or less defunct]

C. Institutional Bodies :1.Confederation of Indian Industry(CII)

2.Institute OF Directors(IOD)


2.Audit Committee with majority independent directors mandatory. Remuneration and Nomination committees desirable.

E. Codes :1.The CII Desirable Code(1998)

2.K.M.Birla Committee Report (2000)

3.Naresh Chandra Committee Report (2002 )

4.Narayana Murthy Committee Report (2003)

F. Disclosure &Transparency :1.Audited annual reports mandatory

:2.Quarterly financial statements

mandatory

G. Director Development Activity: Not impressive

1.National Foundation for Corporate Governance Set Up under the aegis of DCA

2.Corporate Governance Orientation Programme for Corporate Directors by IIM, Bangalore

3.Asian Centre for Corporate Governance, established by Mahendra & Young Knowledge Foundation

H. Corporate Governance Rating :1.Credit Rating and Information Services India Ltd.(CRISIL)

2.Investment Information and Credit Rating Agency Ltd.(ICRA)

3.Credit Analysis & Research Ltd(CARE)

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Annexure 2.

A.Core topics comprising Corporate Governance Quotient(CGQ) by ISS (US)

1.Board structure and composition

2.Charter & By-law provisions

3.Laws of the State of incorporation

4.Executive & director compensation

5.Qualitative factors, including financial performance

6.D & O stock ownership

7.Director education

B.DVFA German Corporate Performance Scorecard (GERMANY)

Evolved on the basis of following items. The percentages in brackets show the weights allocated for the item.

1.Corporate Governance Commitment(10%)

2.Treatment of the shareholders at the general meeting(12%)

3.Co-operation between Supervisory and Management Board(15%)

4.Compensation elements & conflicts of interest at the management board level(10%)

5.Compensation elements and conflicts of interest at the supervisory board(with reference to conflicts of interests , qualification standards for members and expert committees) (15%)

6.Transparency with reference to regular and equal information provision to shareholders(20%)

7.Reporting & auditing the annual financial statements with reference to accounting & auditing standards(18%)

C.Corporate Governance rating from CRISIL (INDIA)

Ratings: GVC 1to GVC8

Factors rated

1. Management Capabilities

2.Financial transparency & disclosure

3.Influence of majority shareholders

4. Board composition & effectiveness

D.Corporate Governance Rating From ICRA(INDIA)

Ratings: CGR 1 to CGR 6

Factors considered

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1.Shareholding structure

2.Governance structure & management processes

3.Board Structure & processes

4.Stakeholder relationship

5.Transparency & disclosures

6.Financial discipline

E.Corporate Governance Rating from CARE (INDIA)

Ratings: Two categories:1.CGR 1 to CGR 6

2 CGV 1 to CGV 6.

Factors considered

1. Board composition & functioning

2.Ownership structure

3.Management structure

4.Shareholder responsibility

5.Financial prudence

6.Statutory & regulatory compliance

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