 "Hetal Dalal")
Institutional Investor Advisory Services (IiAS), a proxy advisory and research firm, recently came out with a guide for shareholders to address redressal-related issues in India. Hetal Dalal, chief operating officer, IiAS, tells Sudipto Dey that regulators have not taken sufficient cognisance of perceived lack of governance in public sector undertakings that makes them the weakest link in the evolving corporate governance landscape. Edited excerpts:
The government appears to be lax when it comes to following corporate governance norms in the appointment of independent directors to PSUs, including the banks. Does this skew the corporate governance reform process?
Non-promoter shareholders in India are now an empowered lot and have begun to get more vocal. Over the past year, we know of 37 resolutions that have been defeated, including those presented by PSUs (Coal India and SAIL). PSUs have indeed been laggards as far as governance norms are concerned. Our research shows that 90 per cent of PSUs (in the S&P BSE 500) did not have adequate representation of independent directors. This has percolating effects on the composition of board committees as well. In extreme cases like ONGC, the nomination and remuneration committee had just one member. Additionally, PSUs also need to focus on building board diversity. Most of the board comprises current or former bureaucrats, who are conditioned to government diktats. This limits the PSU boards' ability to separate the goals of national policy from the strategic and operational goals of the company. The perceived lack of governance comes at a price - PSU stocks have, over the past five years, traded at a discount to benchmark indices. Moreover, the regulators have not taken sufficient cognisance of the issue - PSUs have neither been penalised, nor censured for this non-compliance. That PSUs are trailing in corporate governance dilutes the seriousness of the governance agenda. In fact, compliance levels of corporate India are better. Median representation of independent directors on boards of S&P BSE 500 companies is close to 50 per cent, although in PSUs it is below 10 per cent.
Do you see the government's recent thrust on ease of doing business could lead to dilution in governance standards?
The government, in its effort to improve the ease of doing business, has diluted some provisions of the Companies Act 2013 relating to governance practices. Yet, Sebi's focus on investor protection has acted as a counter-balance to such efforts. For example, take the case of the provisions pertaining to related party transactions: the government, through the Companies Act 2013, lowered the resolution passing threshold to 51 per cent from 75 per cent, and allowed related but non-interested parties to vote. However, while Sebi aligned itself with the passing threshold of 51 per cent, it maintained that all related parties cannot vote on related party transactions, thus ensuring that a catalogue of promoter-owned holding companies cannot sway the decision on such a resolution.
In the unlisted space, especially for start-ups, investors are usually more discerning: they tend to hold material stake in the companies and push for board representation. Most shareholder agreements provide such shareholders with controlling rights - these may be positive or negative controls. Therefore, shareholders themselves have designed pre-emptive rights at the time of investments. Despite these rights, it is difficult to freely exit such investments. Therefore, at a practical level, shareholders in unlisted companies are better placed using engagement, negotiation and persuasion tactics to assert their rights rather than legal ones.
What is your advice to PE investors when it comes to dealing with issues of governance in investee companies that are mostly private?
PE investors have had some difficult years. The $60 billion invested between 2003 and 2011 is ripe, but an estimated 50 per cent of the investment has not yet seen an exit. This is despite a good 2015 during which PEs have returned an estimated $5 billion to their investors after exits. Because private equity investors have historically invested largely in unlisted companies, they need to focus on positive engagement while addressing conflicts.
PEs usually have to address conflicts when promoters in investee companies deviate from plan (in terms of performance, investment or business strategy), or undertake related party transactions that are not in the interest of non-promoter shareholders, or where exit-related conditions are not being met. The legal enforcement for corporate contracts is weak in India and arbitration is typically used to test the counterparty's patience. Therefore, PE investors must avoid a breakdown on relationship with the promoter, unless there is no other alternative.
Though the provisions relating to class action suits (Section 245 of the Act) are yet to be notified, could the time-consuming legal process deter shareholders from taking this route?
Class action suits have had success in other markets. They are powerful mechanisms for both shareholders and depositors to not only assert rights but also claim reparation. In India, this process is yet to be tested. Once the section is notified and shareholders begin using it, the gaps in the practical implementation of the regulation will come to light.
The Ministry of Corporate Affairs will likely make suitable amendments then. But, the government needs to speed up the creation of the NCLT (National Company Law Tribunal), which has been an impediment to notifying regulations relating to class action suits. Once the section is notified, the potential threat of a class action suit itself may well act as a deterrent to corporate malfeasance.
