Business Standard

Nayak Committee report: Spotlight on PSE governance

The board of directors does not have adequate incentive to implement an effective vigil mechanism

Asish K Bhattacharyya 

The recently released report of the Reserve Bank of India's (RBI) committee set up to review governance of the boards of banks in India, chaired by P J Nayak, brings to focus the question of autonomy to public sector enterprises (PSEs).

The terms of reference of the committee included review of the regulatory compliance requirement of the boards of banks, the working of these boards, regulatory guidelines on bank ownership/concentration, and an examination of board compensation guidelines. The report deliberates, at great length, the governance of public sector banks (PSBs). Although, the report deals with the banking business, which is a riskier commercial activity than non-finance business, observations of the committee on the governance of PSBs are equally applicable to the governance of non-finance PSEs.

PSEs were created as instruments for achieving development goals by investing capital in sectors that were of strategic importance and infusing capital in those sectors that could not attract private capital, or due to unattractiveness of the sector at that point in time.

Similarly, private banks were nationalised to achieve development goals. The government continues to use PSEs, including PSBs, for achieving strategic and development goals.

The report has revived the debate on whether government should engage in commercial activities. It has not recommended privatisation of PSBs. But adoption of the governance structure, which is recommended by the committee, will result in indirect privatisation.

Any decision on privatisation should be based on proper evaluation of whether a PSE has lost its relevance as a development instrument. For example, it might be appropriate for the government to exit from the airlines industry but to continue to invest in airports that are of strategic importance but unable to attract private investment due to lack of commercial viability.

The Nayak committee has recommended the government shareholding in PSBs be reduced below 50 per cent to allow more autonomy to banks and to distance the government from the governance of banks.

The report argues that the reduction in government shareholding below 50 per cent will free the bank from external vigilance emanating from the Central Vigilance Commission, from the Right to Information Act (RTI), and from government constraints on employee compensation.

This will allow banks to function more efficiently and effectively on commercial considerations. The report states that more competitive public sector banks will enhance financial returns to the government with no effective dilution of control.

I am uncomfortable with these observations. Should the government stay invested in a commercial enterprise to earn attractive return on investment? The answer is no. The government should continue its investment in a PSE only if it serves public interest. The argument that the government's control will not get diluted with dilution of ownership is not tenable.

If a PSE functions solely based on commercial consideration, the government will not be able to use it as an instrument to achieve strategic and development goals. A shareholder group with less than 50 per cent voting right cannot use the resources of a company to further its interest unless it is able to manage the composition of the board of directors and is able to induce the board to give primacy to its interest. This is against good corporate governance.

The Companies Act and Sebi Corporate Governance Code aim to ensure that the interest of a particular shareholder group does not get primacy in corporate decisions.

Decisions should benefit the company. It is absurd to assume that private investment will work to achieve larger public goals voluntarily, unless it is commercially expedient to do so.

Vigilance and RTI mechanisms enforce accountability. Therefore, public derives benefits from those two mechanisms. The Nayak committee's observation implies the implicit costs of those mechanisms exceed benefits derived from them.

This is a serious observation. If, those mechanisms are constraints for the efficient functioning of PSEs, they are constraints in the efficient functioning of the bureaucracy and other government departments. It is true that the vigilance mechanism often leads to harassment for genuine errors of judgment. Moreover, vigilance cases often drag on for years resulting in a huge damage to the professional career of honest employees.

There is a case for reviewing the vigilance mechanism to reduce its dysfunctional effects. The report suggests that the board of directors should take the responsibility for implementing its own vigil mechanism.

Theoretically, it is a sound proposition. But the board of directors does not have adequate incentive to implement an effective vigil mechanism. Only a large shareholder has sufficient incentive to implement the same. Therefore, dilution of accountability for the use of public money, which will remain invested in PSEs, is not desirable. The government should not reduce investment in a PSE below 50 per cent if it still serves public purpose. If a PSE has lost its relevance as an instrument to achieve development goals, it should be privatised. There is no mid-way.

The author is a professor and head, school of corporate governance and public policy, Indian Institute of Corporate Affairs; advisor (advanced studies), Institute of Cost Accountants of India and chairman, Riverside Management Academy Pvt Ltd

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First Published: Sun, June 22 2014. 22:33 IST