The most useful thing about a principle is that it can always be sacrificed to expediency.
— W Somerset Maugham
Business leaders talk piously about it. Regulators have codified it into a list of dos and don’ts. Various government departments and state-funded organisations have wanted to set up departments of excellence and institutions around it. As a choice of seminar topic, it usually goes very well. It has extended the agenda of professional institutes and has even been a global movement of sorts. “It” is corporate governance. And, like all other do-gooding ideas, it is often in and out of fashion.
The high season for corporate governance is when scams break out of bear markets. Think of Enron and Worldcom after the 2001 bear market, or Satyam after the 2008 bear market. We are then suddenly swamped by a tidal wave of corporate morality. But it also makes an appearance when there is an isolated event of “misgovernance”, as it is doing now with the Escorts issue. The Nanda family-promoted Escorts has just increased its voting control to 41.1 per cent from 31.7 per cent through a complicated cross-ownership amalgamation and merger proposal. The scheme was passed on May 29.
If this is detrimental to the shareholders, as it seems to be, it is worth asking what the institutional investors and eminent independent directors were doing about this supposedly self-serving move of the Escorts management. Escorts has been a lousy investment for two decades and more — but, for whatever it is worth, Life Insurance Corporation has a 2.95 per cent stake, Reliance Capital 8.02 per cent and Sundaram Mutual Fund 3.38 per cent. Other investors include Barclays Capital Mauritius, Fid Funds Mauritius, Credit Suisse, Macquarie Bank and Dimensional Emerging Markets. Independent directors in the company are some of India’s finest names: Dr M G K Menon, Dr S A Dave and S C Bhargava. Independent directors are supposed to bat for minority shareholders — or, at least, to not act against their interests and side with promoters. Institutional investors are supposed to act in favour of their own investors — who are, indirectly, also minority shareholders. If there is a conflict of interest with promoters, they are not supposed to take the promoters’ side. Indeed, it would be logical if they ganged up with independent directors. Apparently, neither the independent directors nor the institutional investors have acted on these principles. The promoters won, though we don’t know yet who voted for or against the resolution.
Is this new, alarming or egregious? Do independent directors act independently and are institutional investors active in cases of misgovernance? Here are some hard facts about governance.
Most companies in India (or elsewhere) are controlled by either families or the state or, in rare cases, charismatic professionals.
The best companies have excellent independent directors. But they really have no role to play on governance issues. After all, these are the best companies we are talking about.
Most other boards (regardless of whether they are controlled by family, state or individuals) select their “independent” directors and present the names to shareholders who usually do not vote on the proposals. The promoters have their way. The selection is a subtle process: the promoters choose well-known names who would not upset the promoters’ interests. If they protest, a new set of independents can be found. The directors selected know their role and who calls the shots.
Good independent minds are rare. But why is it that this small number of truly independent people – honest retired bureaucrats, top professionals – are rarely asked to be on boards? The answer is obvious.
Institutional investors have only one job to do: invest in companies that can make their investments grow. If the company does anything to jeopardise the possible future value of their investment, they can protest — but, really, the only thing they can do is sell and get out.
This sums up the reality in not just India but all over the world. If you think I am being cynical, here is one example. In 1998, Walt Disney’s profit grew by 45 per cent under the charismatic Michael Eisner. Who was gracing the Disney board? Eisner’s personal attorney, personal architect, the principal of the elementary school where Eisner’s children studied, and a couple of former Disney chairmen. Large pension funds were unhappy with the board — never mind the results and the stock price. They wanted independent directors, defined as someone with “no present or former employment by the company, or any significant financial or personal ties to the company or its management”. Disney believed that the definition was too restrictive. So much for governance.
I have deliberately chosen this example. This wasn’t a third-world state-owned value destroyer (like Shipping Corporation) or a family-owned business from Asia. This was a great value creator, outstanding innovator, owned widely and run professionally. And Escorts? One of the worst examples of large Indian companies of the nineties. Some 22 years ago, the stock price was Rs 100. At eight per cent compounded, Rs 100 investment in fixed income becomes Rs 544. Instead of a five-fold rise, at the time of writing the stock price was Rs 65, a 35 per cent decline in 22 years! Hero Honda is up 900 times during this period; Mahindra & Mahindra, 600 times. Escorts, the bikes and tractor major of the early nineties, has been left biting the dust. What are the illustrious independent directors doing in this kind of company? The answer is obvious. And if Sundaram, LIC and Reliance find Escorts a great investment, surely a bit of a self-serving move by the promoter doesn’t change the earnings prospects of Escorts, which alone drives stock prices over the long run. I cannot see if there is anything more to this. Just watch whether the directors walk out or the big investors sell over this issue. If they do, that would be new, not their silence.
If that’s all there is to this, what about the dozens of reports mandating good corporate behaviour, scores of seminars each year, speeches, white papers and dissertations on corporate governance? A lot of hot air.