One code good, two codes better?

The Kotak panel recommendations on corporate governance have received significant coverage and a lot of comments ever since it was submitted a month ago. 
 

While many comments have focused on individual recommendations and the practical implications and difficulties, not much has been thought about how these changes, if they come through, would impact the minority investor.

Corporate governance revolves around balancing the interests of different stakeholders. In India, with the promoters dominating the board rooms and controlling managements in a large number of companies, corporate governance essentially boils down to protecting the interests of public shareholders.

However, the tools Indian regulators have often used are the ones imported from the western world, where the owner vs management conflict is more pronounced. 

For example, the institution of independent directors, which was supposed to act as a bulwark against the management, is often reduced to being a handmaiden of the promoters in the Indian set-up.

Another proposal, to bring gender diversity by mandating a women director, has also been largely hijacked by promoters by appointing female family members rather than looking for qualified women in their own organisations.

Given this tendency of the Indian corporate world to beat the spirit of any regulation by following a tick the box approach, the idea of two codes proposed by Ingovern Research comes across as a risk worth considering. 

In its comments to the Kotak panel report, Ingovern agreed with many of the changes proposed by the committee and suggested some alternatives to a few, while disagreeing with some recommendations.

But, overall it suggested that there could be two codes for companies to choose from.

“Many recommendations are prescriptive in nature which presents a risk that companies may not adopt the spirit but undertake a ‘tick-box’ approach for compliance. To avoid this, the recommendations should be categorised into 2 codes: Code of Acceptable Governance and Code of Desirable Governance. This puts the responsibility on the companies themselves as to what Code they desire to adopt. The companies’ choice will also send a clear message to the investors based on which they can make informed investment decisions,” Ingovern said in its report.

The proxy advisory firm did not elaborate which recommendations would go to the “Acceptable” code and which ones would make it to the “Desirable” code. It appears that the “A” code would be less stringent for companies to follow than the ‘D’ code. Interestingly, the 1998 report by a Confederation of Indian Industry task force, which preceded Clause 49, was titled “Desirable Corporate Governance: A Code”.

The challenge is to formulate distinguishable criteria for these two codes in an objective and transparent manner. Some limited brainstorming on this could help flesh things out. Once this is done, the proxy advisory firms itself could be the watchdogs for analysis and reporting on the level of compliance of these codes. If done meticulously, these could be more accurate indicators for investors.

However, in the case of the public sector enterprises, which habitually flout many corporate governance norms on a regular basis, the Kotak panel was not in favour of a separate dispensation. Some of this non-compliance is due to the conflict between the processes followed by the government and the requirements of regulations. 

Such conflict ensures that even a tick the box approach is not practical for these government-run enterprises. Which category of the code would these companies fall in then?

Should there be another set of code for unacceptable standards of governance? Or should it be named the “undesirable” code of governance?