Board games

Q&A: Krishna Palepu

Krishna Palepu is a powerful advocate of good corporate governance. While there is a lot to be said for taking the higher moral ground, the Ross Graham Walker professor of business administration, senior administrative dean and director of research at Harvard Business School makes an even more compelling argument when he points out the business rationale. "Good governance can be a competitive advantage in an emerging market where rules are not so strictly enforced. You can build an inherently powerful corporate brand on that basis," he points out.

Palepu offers a simple, single-point agenda for companies that want to build their reputations "" keep your promises. Customers and business partners will find it economically beneficial to do business with you "" no hedging, no protracted negotiations and less stringent due diligence. In India recently to conduct Harvard Business School's first executive education programme here, Palepu spoke extensively to Meenakshi Radhakrishnan-Swami on corporate governance, the role of the board and how to build a global enterprise in India. Excerpts:

Are corporate governance issues in India and other emerging economies different from those facing the rest of the world?

Yes, for two reasons. To begin with, enforcement is not very strong in emerging economies, so good corporate governance becomes a choice more than a requirement. In the West, corporate governance strategy is by regulation, in emerging economies, there has to be deliberate decision-making at the top.

The second issue relates to the board. The pool of talented independent directors is typically smaller in emerging economies because people are connected to each other, often competing with each other. Also, emerging economy companies need to learn about best practices from across the world, so they need a global component in the board.

Are multinational boards relevant to all companies or only for those that are looking at overseas markets?

Corporate governance has two components. One is preventing the downside: you want to create transparency, ensure internal controls to decrease the probability of fraud, ensure regulatory compliance.... The other is more about creating an upside and the role the board can play in collaborating with the CEO and through that process, enabling the company to make the right strategic decisions and choices.

In India, generally, the view of corporate governance has been dominated by the first concern. But if you want to recruit talented people to your board, you need to sell them the upside story, not the prevention of downside story.

Talented people want to join boards to share in the success story of making the company great. Therefore, companies that want to use the board as a strategic think-tank are making more progress on corporate governance than companies that want the board only to give them credibility.

When you have a mix of domestic and international people on the board, you get a rich discussion in the boardroom. The imperative to be world-class and, therefore, to be informed about best practices from across the world can be there for any company, whether it is trying to compete in India or all around the world.

So there's no distinction in that sense. But if you think the role of the board is to introduce you to customers or business partners then, of course, it helps to have international members on the board, particualrly, if you are doing business overseas.

But I don't see that as the role of the board at all. The main role of the board is to act as a sounding board for the CEO and increase the odds of good strategic decision-making.

Is there a case to be made for a multi-disciplinary board as well as a multinational one?

Yes. What you want in your boardroom is a diversity of perspectives and skills. You want to have enough people to man the audit committee, people who know compensation and human resource management and people who are good at strategy. In addition, you also want some people who can think analytically and some who are action-oriented. And those are not the same type of people.

This is the reason why in the US, academics are invited onto boards. Academics can analyse problems, critique them and give advice. But they are not action-oriented. So you want CEOs of other companies to be on the board, to be pragmatic and ensure there is a bias for action. You can't have only one or the other.

You make a strong case for independent directors. But wouldn't insiders better understand an organisation's compulsions?

Absolutely. If there is a disagreement between the board and the CEO on a strategic move, the board should always give the benefit of the doubt to the CEO. Of course, then the board should also hold the CEO accountable and if he gets it wrong, it should replace him. You can't ask the CEO to implement a strategy he does not believe in.

Of course, while the CEO does have more information about the company, it doesn't mean you should always give him carte blanche. The CEO and the top team have information and experience, but they also wear blinders because they are steeped in the company.

When there are changes in the marketplace and you need to look around the bend, the board actually may be better than the managment. It has objectivity and doesn't have a vested interest in the business model and past decisions.

It is not the role or the capacity of the board to come up with ideas "" strategic ideas always have to come from the managment. But the board can ask enough questions to test the logic and thereby improve the quality of those decisions.

How does the Indian experience of dealing with change compare with that of other emerging economies?

This is not just about emerging economies. Incumbents always have difficulty with change. Take the computer industry in the US. After the invention of the PC, all the mainframe computer companies, except IBM, died. It is not easy for existing companies to keep up when the world changes in a dramatic way.

Also, there is the issue of ambition. There are two ways to think about what your goal should be: thinking "What should be our share of the opportunity" as opposed to thinking "How much did I grow yesterday and, therefore, what is my capacity to grow?" This is another area where companies with history are at a disadvantage. They compare with past performance.

As markets become dynamic, the returns to being a dominant player become higher. But Indian companies have traditionally emphasised profitability over growth, because cost of capital is very high. They can be even greater if they say they will emphasise profitability just a little less, if that gives them tremendous opportunity for growth.

If you are making 30 per cent return on equity, 20 per cent is still very good, as long as you are beating cost of capital. And if, as a result, you can become a $10-billion company as opposed to being a $5-billion company, that's a much better tradeoff. Your heft and size matters a lot for brandname building and for getting attention on a global scale .

I see Indian companies moving slowly in that direction. The question is, are we changing our ambition consistent with the possibilities in the marketplace?

Is there any commonality of strategy between companies looking at opportunity and change in the right way?

To begin with, it is leadership that sets this high bar and speaks of orbit-changing, rather than incremental moves. Then, you have to first have a solid, reliable and profitable operating model. You can't make aggressive moves if you have issues with your core business or if it's wobbly. The third is, you need to benchmark your ambitions on a global scale "" think what is big scale relevant to the world, not India.

Is the globalisation of companies in emerging economies different from how the advanced world globalised?

What is going on today is best compared with what was happening when the US was globalised in the 19th and early 20th century. American companies had the luxury of enormous and growing domestic markets. So many of them built world-class companies by just being in America, like Coca-Cola, General Motors, and Wal-Mart. Only then did they go overseas.

It's tempting to confuse building a world-class company with building a multinational company, but they are not the same. Wal-Mart grew up in rural Arkansas, which is almost like a third-world country. But it stuck on and built a store in Boston "" which is an advanced market for the Wal-Mart people "" only 30 years later.

Predominantly, Wal-Mart's business is rural and semi-urban North American markets and there's so much business to be had there, so why bother with the urban markets? That's a good strategy.

Indian and Chinese companies are more likely to succeed in their globalisation effort if they think like American companies "" recognise that they are sitting on a big domestic market and, therefore, build a first-class company that takes advantage of the domestic consumer or talent market.

ITC and Bharti are heavily focused on the domestic market. Indian IT companies are heavily focused on the overseas markets but are building huge talent pools here and are learning to manage those talent pools. Each concentric move inside India is like reaching out to another country. And you can repeat the process because you have to touch 1 billion people in this country. We are fortunate to have that asset and conceding it in the quest for overseas opportunities is a mistake.

Why, then, are Indian companies still rushing overseas?

Most of the elite in India are urban-oriented. They are comfortable with doing business in the metros. Once these markets are saturated, they automatically think, "Why not go to Budapest?" because that also looks like Bombay, rather than Jabalpur. Distribution is difficult and infrastructure is poor in rural and semi-urban areas. Companies naturally think, "Do I want to do that or is it easier to go overseas?"

Still, for some companies, it must make sense to look overseas for growth....

I'm not saying companies should have zero overseas presence. It is important for companies to operate in demanding environments and learn. You should also go to other emerging markets to get scale. In the process, if there is limited bandwidth and resources "" managerially, not financially "" you need to make choices.

But don't hollow out your domestic market focus. There is a big prize here and others are trying to discover it. If you don't consolidate your home base, you are vulnerable.