Sucheta Dalal :Minority Representation Vs Board Election (4 August 2003)
Sucheta Dalal

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Minority Representation Vs Board Election (4 August 2003)  

At a time when Corporate India is still resisting a mandatory retirement age of 75 or a fixed term for independent directors on company boards, the debate in America has shifted to empower minority investors to elect their own nominees on as independent directors on company boards.

Following the epidemic of corporate scandals that wracked corporate America and destroyed billions of dollars of shareholder wealth, minority investors have joined hands with large institutions to fight pitched proxy battles to get their chosen nominees elected. NGO groups such as Citizenworks ( founded by Ralph Nader and others in Hong Kong and Korea have registered some significant victories in recent times, although they have also lost many battles because of inadequate proxies.

Their effort received a big boost recently when the Securities and Exchange Commission (SEC) Chairman, William Donaldson endorsed the move to improve minority shareholders ability to nominate board directors. Donaldson said, “It’s a real, necessary companion piece to a much bigger picture I see: a shift, a correct shift, away from a dominance by corporate executives and back to the board.”

The SEC also indicated that it would change the rules to make it easier and less expensive for minority investors to nominate at least one or two directors to the board through the proxy process. Needless to say, American companies are vehemently opposed to minority shareholders stepping into the boardroom; but continuing evidence of corporate scandals and the reluctance of companies to pare down CEO compensation works against them.

Although Donaldson has promised a change in rules this month, investor activists believe that the battle will be more long drawn. But the General Accounting Office’s (GAO) finding that one in ten publicly traded companies had to restate their earnings between 1997 and 2002 because of accounting irregularities, cannot help corporate America’s case.

In India, the situation is a little different. Nationalised banks already have a provision for worker directors on their boards. But their contribution has been mostly ineffectual, barring a few bright exceptions. The Companies Act also pays lip service to the concept of small shareholder representation on boards. Section 265 of the Act has always had a permissive provision for proportionate representation on the board, but no company has acted on this provision in almost 50 years.

Intriguingly, even investor activists are divided over minority shareholder representation for practical reasons. On the one hand, there is Prof Manubhai Shah of the Consumer Education and Research Centre (CERC) who has doggedly pursued the issue for several years. In a dissent note to the N Narayana Murthy Committee on Corporate Governance, he argued that only those directors elected by a constituency of minority shareholders can be defined as Independent Directors and that financial independence ought not to be the only defining criteria. Manubhai even argues for companies to be forced to choose minority representatives from a list of activists, experts and academics prepared by the Securities and Exchange Board of India.

Unfortunately, this suggestion has many problems. The investor movement is not sufficiently developed in India for any NGO to run a nationwide campaign to collect adequate proxies to have their representative elected. The problem is also in choosing the right representative. Should it be someone with a large personal stake, who can be trusted to protect his/her own interest and that of other shareholders? Or should it be someone capable of standing up to powerful company managements? In any case, how do investors go about finding such people and ensuring that they fulfill their fiduciary duties?

Minority shareholder representation can work effectively with the support of large mutual funds and financial institutions. But in India, government owned institutions usually have nominees on company boards who have failed to protect their own interest, let alone those of the minority. Otherwise, institutions merely obey government diktats or use their access to inside information to make investment decisions.

Private and foreign mutual funds are a different category altogether. But so far, they have shown a strange disinterest in playing an activist role (although funds like Templeton have worked with investor activists in Hong Kong and South Korea).

Indian mutual funds probably take their cue from the regulator. At a recent board meeting, the SEBI board, unlike Donaldson of the SEC, chose to defer the Narayana Murthy Committee recommendation to scrap the concept of institution nominees and ask them to seek election through the general body instead.

Since the SEBI board is packed with government nominees, the decision suggests pressure from the government against making financial institutions more accountable to all stakeholders and cutting off their access to inside information.

However, a major policy change in America is bound to have its impact on India and elsewhere. If SEBI aspires for global leadership in improving corporate governance standards, it could do well to pay attention to international developments, rather than worry about insular companies, who want no change in their management practices.

Apart from prising open the boardrooms of corporate America, the SEC is also cracking down on abettors of corporate crime. The $ 225 million paid out by JP Morgan and Citigroup to settle SEC allegations of assisting Enron to manipulate financial statements, is an example. Interestingly, most of this money will, for the first time, go back to Enron and Dynegy fraud victims.

Corporate India is fortunate that investor activism is not powerful enough as yet, to demand a place in the boardroom and to elect the right representatives. But it is time that the corporate sector realises that it cannot have friends and cronies masquerading as independent directors. Nor can they treat board meetings like corporate kitty parties where they network and exchange gossip.

A nine-year prospective term for independent directors (as recommended by the Narayana Murthy Committee) and a retirement age of 75 is the bare minimum that we need in terms of reform. And if corporate India points out that even the Prime Minister of India is 78, then let them agree to have these directors elected by the general body with the management abstaining from the vote.

-- Sucheta Dalal