The myth of corporate governance

Dr Bala V. Balachandran, J.L. Kellogg Distinguished Professor of Accounting, Information Management and Decision Sciences, and Founder and Honorary Dean, Great Lakes Institute of Management, Chennai, is an independent director on the boards of several Indian companies. Two years ago, at one of India’s leading companies (the good professor prefers not to name it) on which Balachandran is an independent director, an acquisition strategy was being discussed. The company had begun intense negotiations and had put in an offer, only to be pipped by a competitor who came in from the cold with a higher price. The discussion at the board meeting revolved around whether a renewed offer needed to be made. The directors were veering around to the view that yes, they should go for the kill. Balachandran thought otherwise. “I put my foot down and said no. I told them that it was time to back off as shareholder wealth would suffer if we went ahead,” he said. The board listened and didn’t pursue the deal. With hindsight, stepping back proved to be the right decision. For, as the Kellogg professor points out: “The company that finally did manage to win is today stuck with it (the acquisition).”

Cut to Berjis Desai, Managing Partner at Mumbai-based law firm J. Sagar Associates, who is on the boards of at least six listed companies. Three-to-four years ago, he along with other directors shot down a diversification plan of a capital goods company, even though the promoters were keen on going ahead. The company, he says, had a poor track record of managing a diversified business. Desai, however, admits that very few independent directors make an attempt to short-circuit proposals or decisions of promoter directors.

Indeed, independent directors who stand up against a board or management are as rare as hen’s teeth. After Satyam’s outrageous boardroom antics last fortnight (see Satyam’s Six Deadly Sins, page 38), the B. Ramalinga Raju-promoted company has become everybody’s favourite whipping boy. But fact is that the IT services major isn’t the only Indian company that has given corporate governance the five-fingered salute. The Satyam episode is shocking because of the sheer brazenness of the promoters. But you have to wonder: Are some of the world’s most renowned and most respected minds, who are independent directors mere stooges, used to push through proposals that promoters and managements are keen on?

Walking the thin line In a recent report, Risks to Valuation?, CLSA highlights some ‘permitted but not best practices’ of Indian companies. Excerpts: . Tata Motors has transferred a 24 per cent stake in Tata Automotive Components to Tata Capital and booked profits of Rs 110 crore in Q1 of 2008-09. Management has declined to disclose the valuation methodology. . Sobha Developers changed its accounting norms in Q1 to facilitate revenue being recognised earlier in a project cycle. If the accounting policy had not been changed, the company’s profit before tax would have been lower by 20 per cent. . Jet Airways changed its depreciation policy from written down value to straight line method and wrote back Rs 920 crore into its profit and loss, which helped the company to report profit during the April-June quarter. . Prajay Engineers, a Hyderabadbased developer, reported a loss in its fourth quarter results against expectations of a profit. Reason? The company “lost” records for a project worth 40 per cent of its annual revenues at the site office. . Anant Raj Industries, a north Indian commercial developer, transferred part of one of its projects to a wholly-owned subsidiary and consequently showed equivalent revenues in its stand-alone results.

Rubbish, says a section of independent directors. “People don’t treat independent directors like ornamental pieces. For every Satyam kind of event, there would be 100 other instances where directors asserted themselves and their views were well respected by the board,” says Shailesh Haribhakti, Managing Partner, Haribhakti and Associates, who is also an independent director on the boards of 14 companies, including ACC, Future Capital Holdings and Pantaloon Retail (India).

To be fair to independent directors, there have been instances when they’ve taken extreme action. Recently, a high-profile head of a private equity firm resigned from the board of a Mumbai-based midtier e-governance company. Reason? Commitments made to him by the promoters were not fulfilled; one of them included the appointment of a professional CEO, which never took place even after two years. Moreover, some aggressive plans, which included big contracts from the government, were not in the interest of the company as they involved huge capital expenditure; the director was not in favour of this due to financial constraints of the company.

Indeed, such active participation of independent directors is the need of the hour at a time when some of the biggest names of India Inc. are in a mood to walk the grey line. In a recent report, titled Risks to Valuation?, foreign brokerage house CLSA highlighted some “permitted but not best practices” of Indian companies (see Walking the Thin Line).

But, how much can independent director really do? Prithvi Haldea, Chairman & MD, Prime Database, says: “Independent directors can’t be expected to be the masters of business. They are not clued into the business.” Haldea sits on the board of Nucleus Software, a midtier IT company. “Our role is to protect the interest of minority shareholders in whatever decisions are taken by the management or the board,” he adds. Pradip Shah, Chairman, IndFund Advisors, who sits on the boards of 12 companies, feels there are few options for independent directors if managements don’t take them seriously. “If management continues to ignore (your voice), the only option for an independent director is to step down. You can’t expect them to be panacea for all ills,” says Shah, a market veteran. In the past, he along with other directors defeated the attempt of an MNC to transfer assets to an unlisted company.

There have been boards that have rejected potentially valuedestroying moves. Recently, for instance, the Gujarat government suggested that all PSUs in the state should donate 30 per cent of their profits before tax as charity! The shareholders of at least one company, Gujarat Alkalies & Chemicals, where the government has a 36.7 stake, defeated the proposal. However, another state-owned firm, Gujarat Mineral Development Corp., could do little as the government held 74 per cent in it. But that didn’t prevent shareholders at the company’s annual general meeting (AGM) from raising Cain, which resulted in the AGM being postponed. Several fund managers and institutional investors have made informal requests to the government and the management of these companies to drop the proposal.

UK listing rules . The Chairman must not deal in any securities of the company without notifying the CEO and receiving a clearance from him. If the CEO is not present, then a senior independent director has to be notified. Status in India: Indian rules do not prescribe for any such permission to be taken from the independent director. Chairman/ CEO need to inform the stock exchanges if they acquire more than 5 per cent stake in the company’s shares. . Directors have to make disclosures about pledge of securities/shares of the company. Status in India: No such requirement. Nasdaq listing rules . Majority of independent directors is required on the board. Status in India: Independent directors should constitute one-third of the board if Chairman is non-executive. In a board where the Chairman holds an executive position, half of the directors should be independent. . A director is not considered independent if during the last three years he received any payment in excess of $60,000 other than for board service. Status in India: Clause 49 doesn’t prescribe any upper limit for remuneration. Shareholder approval is a must. . Independent directors must approve director nominations. Status in India: No such requirement. . CEO compensation requires independent directors’ approval. Status in India: No such requirement. Shareholder approval is a must. Source: FSA, NASDAQ, SEBI

As the Satyam case has revealed, active investors can often be more effective than independent directors in persuading managements to change their minds (see Cry Freedom!, page 11). Yet, that’s hardly a case for independent directors to abdicate their roles. “They (independent directors) should constantly monitor their ability to devote essential time so as to be able to discharge their onerous responsibilities. If they can’t, then they should not be on the board,” says V.V. Ranganathan, a former senior partner of Ernst & Young. Recently, he resigned from the board of Zee News as independent director as he didn’t think he would be able to devote enough time to this role in 2009.

P.K. Vijay, MD, Corporate Professionals, an advisory firm relating to corporate governance, suggests regulators (like Department of Company Affairs and SEBI) form a pool of directors; and it’s from this pool that companies should choose directors rather than selecting on their own. Now, that’s some food for thought at the next seminar on corporate governance

—Additional reporting by E. Kumar Sharma