Sucheta Dalal :Minding investorsR17; interest is the key thing (21 April 2003)
Sucheta Dalal

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Minding investors’ interest is the key thing (21 April 2003)  

The revelation of newer corporate scandals have galvanised investor activists in America to push for some basic changes in corporate structure and responsibility. The focus is on two major issues. The first is the ‘tax traitor’ campaign ( against companies registered abroad to avoid taxes. Americans believe that companies have manipulated policy making to create far too many legal tax shelters abroad.

In a recent article, Business Week magazine quotes a Harvard University study saying that US companies avoided paying tax on nearly $300 billion of income in 1998. And that individuals account for 86.3 per cent of the federal income tax collected while companies pay only 13.7 per cent. Secondly, investor activists such as CorpGov.Net are lobbying hard for ‘shareholder democracy’ or the right, for all shareholders to nominate director candidates to the board through management proxy cards. Although the first issue is not directly relevant to Indian investors, the second has several interesting dimensions in our context.

On the one hand, corporate India feels that any further restrictions, conditions or suggestions with regard to the appointment of independent directors and their term of office through the corporate governance code would amount to excessive interference with the functioning of companies.

On the other hand, the Union Labour Minister Sahib Singh Verma has come up with the ridiculous proposal of a mandatory 25 per cent worker representation on company boards. Verma obviously is unconcerned with the niceties of good governance codes, confidentiality requirements and insider trading rules.

Also, nobody has bothered to tell him that independent directors on the board are expected to ensure that management serves the best interest of all stakeholders. Worker participation in bank boards has existed for decades and achieved nothing, not even better governance; their participation on corporate boards is bound to be a similar failure. Curiously, corporate India has not reacted strongly to Verma’s proposal. But his move only strengthens the demand by some investor activists for minority shareholders to have representation on the on the board of directors. Section 265 of Companies Act allows for proportionate representation on the board of directors, at the discretion of the company. However not a single company has permitted minority shareholder representation on the board.

The real issue is whether an independent director is more effective in serving shareholders’ interest when elected by a constituency of minority shareholder. Or conversely, whether independent directors appointed by management are incapable of being truly independent and representing minority interests, despite the fiduciary responsibilities mandated by the corporate governance code.

The independence of independent directors is indeed often questionable. After all, it is not merely a question of knowledge and financial ability; independent directors have to be willing to use these effectively and assert themselves on behalf of other stakeholders. But even if independent directors fail to fulfil their mandate, are minority shareholders capable of appointing better directors?

Let us consider the situation. For starters, even if minority shareholders are allowed to nominate their representatives to the board, how will it work in practice? Retail investors in India are a disparate bunch spread across a vast geographical mass. It is nearly impossible and far too expensive for a minority director to canvass support across the country.

Could investor associations step in and take on the task of canvassing retail investor votes in even 500 out of the 6,000 odd listed companies in India? It is difficult. India has 23 recognised stock exchanges, but only a dozen investor associations registered by Sebi. Most of these are cash-strapped, have just over a 100 members each and it is doubtful if all of them together could collect enough of proxies and muster up adequate support to have their nominees elected. Most investor associations are often managed by only one or two individuals and do not have the infrastructure to support such activism.

In the US, there is a suggestion that anyone seeking directorship should hold between 3-5 per cent of the company’s capital. Were we to adopt this view, it would only allow large insurance companies or mutual funds to nominate their representatives on the board. But this was already being done through the concept of ‘nominee’ director.

In fact, the Narayana Murthy committee on corporate governance has recommended scrapping the ‘nominee director’ concept and said that the institutional representatives would have to be elected by the general body and shall represent the interests of all shareholders.

Moreover, it is well established that the nominee directors have only ever asserted themselves under political direction (the ITC and Escorts cases are good examples), or to protect the interests of lending institutions. If we exclude institutional nominees, then the only ‘minority’ shareholders capable of being elected corporate board are large individual investors/speculators. I doubt they have any inclination to play guardian angel to the retail investor community. Prof Manubhai Shah, a well-known investor activist has another suggestion. He suggests that Sebi, in consultation with ‘enlightened institutions and individuals’ should prepare a long list of individuals who are capable of representing investor interest and ask companies to pick their ‘independent directors’ from this list. This suggestion is probably simple to implement, but with due respect to Prof Shah is a bad option.

Politicians, power brokers and regulators would love the opportunity to pack the ‘eligible candidates’ list with their chosen nominees and find ways to pressure companies into foisting their favoured nominees on the boards of blue companies. This has already happened at nationalised banks for years. A variety of political fixers and defaulters are on bank boards representing constituencies such as farmers or savers. They use their positions as go-betweens for politicians and to pressure managements into clear loans, waive pre-conditions or push for promotions and transfers. Clearly, the corporate sector, as well as investor activists, needs to demonstrate some far-sightedness. The refinements suggested by the Narayana Murthy Committee are hardly onerous to warrant corporate protests. On the other hand, investor activists too should be more concerned about getting a fair deal for investors rather than having their nominees of corporate boards. They have to give the concept of independent directors a fair chance before deciding that management appointees will not protect their interest. Otherwise, they will only create an incentive for more companies to buy back their public shareholding and delist from stock exchanges.

-- Sucheta Dalal