Making Boards Work

Businessworld, April 19,2010 carries a panel discussion on the subject, with R.C. Bhargava, Chairman, Maruti Suzuki, Arun Duggal, Chairman, Sriram Transport Finance Company, Ashley Summerfield, Managing Partner, Global Board Practice, Egon Zehnder International, Rajeev Vasudeva, Partner, Egon Zehnder International as panelists and moderated by BW’s Consultant Editor, Ashok V. Desai. (Making Boards Work, Round Table, corporate governance) The theme of discussion was “Unleashing The Potential Of Boards. Unfortunately, the presentation does not give any new ideas or thinking or inputs for the practitioners as to how to unleash the potential. We do not know whether discussion on these lines had taken place but the presentation does not give any indication of it. Most of the panelists have expressed their experience as board members without giving any hint to whether these boards were able to unleash the potential of the board. Of course, Arun Duggal mentions about the quality of the Infosys board and its processes but there is no mention about any other company or their best practices towards achieving the aim of unleashing the power of the board.

Very interestingly Ashley Summers suggested a model in which he considers the board as a manufacturer of wisdom and the CEO as the customer. According to him, the question is :is the board making a product that the CEO wants to buy? I don’t know whether this is a right approach. Doesn’t it indirectly say that the board has to sell a product(suggest a decision ) suited to the CEO or the one which he likes. While the board has an advisory role with reference to the CEO, and the CEO might be enthusiastic to receive the advice, please note that the CEO is also a board member and he has a role to play with respect to the company which is created as an entity, although artificial. The board(including the CEO) has to work towards what is best for the company, which is into certain economic activities, which will impact a number of stakeholders and other beneficiaries. The board should actually work in the best interest of the company, which may not be always be to the personal liking of the CEO.

While a few suggestions like permitting the CEO to sit on at least one outside board (Rajeev Vasudeva), creating a pool of director candidates from which companies can draw and board meetings beyond four to discuss strategies and plans(R.C.Bhargava) make good sense, an inquisitive reader may not find anything useful that will enable companies to unleash the potential of boards and use them as a competitive weapon.

A new approach to Governance?

HBR South Asia  April 2010 issue carries the excerpts of a research study by Loizos Heracleous, Professor of Strategy and Organization at University of Warwick and Luh Luh Lan, Associate Professor of Law at the National University of Singapore (Governance: The Myth Of Shareholder Capitalism  in Idea Watch. The authors, based on their study,  state that there is no mention  in any of the laws relating to corporate form that the  shareholders own the corporation, created as an artificial entity. Unfortunately, corporate governance theories and practices have always been based on the fiduciary responsibility of directors towards shareholders.  Because of this foundation on which governance theories have been developed, the agency theory assumed predominance.

Personally, I have also  felt that this premise is flawed  because there are other stakeholders like  customers without whom the business of the  corporation can’t even exist, employees who have chosen to invest a lifetime for the company,  suppliers whose  fortunes may depend entirely on the  survival and progress of the organization, the community surrounding the corporation  which will look  up  to the corporation for the betterment of their well being  etc. Investors, on the other hand might not be interested for long except for a handful numbers.  They will be looking for quick  returns on their investments . It is high time we move away from the agency theory of corporate governance as  we did with strategy, where strategies were once thought to be required only in  a competitive environment but today feel that  strategies  are essentially required to meet the firm’s goals and purposes of the firm  and will be required even when firms are operating  in  monopolistic environments.

It is better to move away from the hitherto popular shareholder and stakeholder approaches to a firm approach. A firm or a corporation is an artificial person and that is the essential reason why shareholders have to give it money, entrepreneurs have to provide it with entrepreneurial  capabilities, managers have to to lend their managerial capabilities, employees have to offer their skills, suppliers have to supply their products. If it  had the capability to do all these, it would not have depended on anybody. So, considering that everybody contributes what is required for the corporation and what is best for it, it will grow and flourish and every stakeholder including shareholders  will stand to gain. This point can also be explained with an extreme and hypothetical point. shareholders get importance because they exist. What will happen if the company grows to such an extent that if it builds up reserves sufficient  to buyback all shares outstanding? In such a case, the company will continue to exist everthough  the shareholder  will not be necessary to exist.  Company still needs to be governed eventhough    in such a hypothetical situation the conventional agency conflicts don’t exist. This thinking, eventhough radical, can bring in dramatic improvements in governance.

Arie de Geus, who is credited  by Peter Senge and others with pioneering the concept of the learning organization, is of the opinion that   the problem primarily lies in the fact that  the company is considered to be a mere economic entity and “as a money-making machine” rather than a living organism. According to him, “Corporate law in many Western countries  proclaims the investor, as the capital supplier  and asset owner, to be the carrier of ultimate power:the power to decide the life or death of a company…..But these laws, which give top priority to the rights of shareholders , are based on the assumption that the human elements  are mere extensions of capital assets.”Geus says that the corporate governance that is required today is  one that provides continuity, nurturing the company as a living entity and human community, without absolute power concentrated in the hands of either shareholders or management.He suggests a system of distributed power where there will be safeguards to ensure that  no one interest will prevail.

Independent Directors and “true” independence

On March 27,2010, the Union Minister of Corporate Affairs and Minority Affairs Mr.Salman Khurshid said that “the Government was keen that independent  directors on the boards of companies should be truly independent”(“Independent directors must be truly so: Govt”, Business Line, March 28,2010).Mr Salman Khurshid was  speaking at “Innovision 2010:A Session with Visionary Leaders”, a conference organized by the  CII, Southern region, at Chennai.

How do we assure that the independent directors are truly independent and act as one? Of course the Minister stressed that  it was important that the independent director should be “independent  in a way we perceive an independent mind functioning”. It  is actually a mindset rather than any  lack of pecuniary relationship or relationship in the way the law defines it. According to Ram Charan “the best directors are those who think independently, regardless of their status. In other words, independence is a state of mind, not a resume item”(Boards That Deliver,Jossey-Bass,2005). And according to  Bob Garrat, “Directors are designed to be a group of equals who meet collegially  around the boardroom table under the neutral guidance of the chairman, elected by them as primus inter pares, to agree  the future direction  of the business and ensure  its prudent control. In this strict sense, directors are never executives. The term ‘executive director’ is a legal non-sense  as is ‘non-executive’ or ‘independent director’. A director is a director.”(Thin On Top, Nicholas Brealey,2003). It does not matter whether somebody is designated as independent or independent. Directing  a job different from managing and every director should be concerned about it  irrespective of his/her designation.

There is no assurance that  independent directors  who are independent  in every physical sense of the term need not act independently as we had witnessed in many earlier governance failures at the beginning of the century and  also recently in the case of Satyam. But true structural  independence according to the sense of the term  is also necessary to make outside people believe in them. The company laws or SEBI regulations have lot of inbuilt deficiencies  which companies can exploit and which they have been exploiting. For example  in  the year 2006-07,Bajaj Auto  underwent a demerger process. While all the directors  of the pre-demerger  Bajaj Auto retained their seats  on the board in the post-demerger Bajaj Auto, it was very interesting to see an unusual development. Mr.D.S.Mehta, who was whole-time director  for many years including 2006-07, suddenly got transformed into  a Non-Executive, Independent Director in the year 2007-08. There is no explanation  in the Annual Report  as to how  this change has happened.  The report also did not give any (even brief) bio-data  of the directors. One would have expected  these to be given  considering that 2007-08 was the first annual report  of the company in its new avatar. Bajaj Auto is not alone  and there have been many other companies in which such issues have happened.

According to Clause 49  of  the listing agreement which deals with the corporate governance regulations for companies, an independent director “ has not been an executive of the company in the immediately preceding three financial years” along with other criteria for independence. It is true that SEBI (Clause 49) don’t mention about such possible corporate transformations and the consequent changes  in the board structures.

Having served the company for many years  as a Whole-time Director  there might  be no question about the value  that Mr.D.S.Mehta  could add to the board. But, if that is so,  the company should have retained him as an ordinary Non-Executive Director.

While Bajaj Auto  might have emerged as a newly incorporated entity post de-merger subject to the approval of the High Court  and also be complying with all SEBI regulations  and Company Law provisions in force today, was it “right” from an ethical point of view? While conformance is a must, conformance exploiting the loopholes in laws and regulations will not be respected by any.

Another example is that of Deepak Satwalekar, who   was a Director on the board of HDFC Ltd as ED,  and later MD and left to assume the position of MD at the subsidiary HDFC Standard Life Insurance Co. Ltd in the year 2000.He continued to be a director on the board of HDFC as a non-executive director. He retired from HDFC Std. Life  on November 14, 2008, and suddenly his designation at HDFC gets changed to independent director.  How can such sudden transformations happen? Can he be considered independent in the real sense?

 There are number of provisions in the Company Law and loopholes in the  SEBI regulations which need a closer look to avoid  instances such as above from occurring to create confidence in the minds of investors and general public.  

Governance of Central PSUs

The Union Cabinet on March 25, 2010 decided that the current governance guidelines for the Central Public Sector Enterprises(CPSEs) be made mandatory and made applicable to all CPSEs.(“Governance norms must for all CPSEs”, Economic Times , and “Mandatory governance norms for Central PSUs”, The Hindu Business Line, both dated March 26,2010).The guidelines are stringent that the government itself may find it difficult to implement. But they are less stringent compared to the SEBI guidelines applicable for public companies listed on SEs. The norms suggest that the number of functional directors should not exceed half of the board strength and one-third of the directors shall be independent and the audit committee shall be constituted of minimum three directors and only be headed by an independent director.

While SEBI has a set of guidelines for listed public companies(including PSUs listed on Stock Exchanges),these could not be made applicable to non-listed companies. The question here is which is more public? Are wholly government –owned companies less public than any other public limited company? I feel the other way. Companies which were privatized through a divestment process(where private entrepreneurs/companies acquired substantial chunks of equity like Hindustan Copper, Bharat Aluminium, Madras Aluminium etc) are unfortunately considered to be more public than a 100% government-owned company. It is an irony that a company which is mostly owned by a private promoter(and his associates) like Reliance Capital where the private promoter holds more than 50 % of the equity is considered more public than a company fully owned by government. A wholly-owned government company is fully public as the government has invested public money and acts as a custodian of the public money. And hence the governance norms, if any, shall be more stringent than a privately-promoted public limited company.The board of directors of a wholly-owned government company has a fiduciary duty to the larger public than the board of directors of a publicly listed company towards the limited shareholders of it.

A New Book On Corporate Governance

I have just completed writing a book on Corporate Governance. The book is targeted at  students of management at post-graduate level in various  institutions and universities offering MBA and/or equivalent programmes. It  was  started in the middle of 2008 when the world was passing through the shocks created by the fall of first Bear Stearns and then Lehman Brothers, followed by the financial turmoil which saw the fall of respected names like  AIG, Merrill Lynch, WAMU etc  and  the  Satyam saga involving  siphoning of company funds to the tune of $ 1.5 billion towards the end of 2008 and the beginning of 2009.Eventhough  primarily a text book, all efforts have been made to  make the book interesting to other discernible readers too. I have included real life case studies to cover  all the important areas that fall under the purview of corporate governance, mostly with special reference to India, a strong representative of the emerging economies. The book attempts to discuss the current state of affairs  from a wider perspective and I shall be excused if the reader feels that some of the corporate emperors lose their proverbial clothes when it comes to governance.Everything will appear to look wonderful from outside but a close and deep look inside will expose the deficiencies in the governance of even the so-called  best governed company. My feeling is that there are no holy cows when it comes to corporate governance.Also, it is felt that there is very little that can be achieved by way of external regulations like Clause 49 of SEBI.Can you imagine that there are companies belonging to the SENSEX and NIFTY who do not report the dates of audit committee meetings in their annual reports? Can you believe that an outstanding majority of them conduct audit committee meetings on the same day as board meetings? Do you know that  a large number of them finish audit committee meetings and board meetings  by about 9.30  (on the date mentioned in the meeting schedules) in the morning  and report the quarterly results to the stock exchanges where their shares have been listed? Please read to find out.

The book is scheduled to be released by May 2010.I gratefully acknowledge the contributions of  Ram Charan, Susan Shultz,Bob Garrat,  Jay Lorsch and Elizabeth McIver, Paul MacAvoy and Ira Milstein, Lucian Bebchuk and Jesse Fried,John Harper, Christine Mallin,Robert Ward, Roy Smith and Ingo Walters,Lalita Som,William Dimma, Colin B.Carter and Jay Lorsch, Philip Phan etc etc   who have  influenced my thinking on the subject. Special acknowledgements are due to Adolph Berle and Gardiner Means, Peter Drucker, John Micklethwait and Adrian Wooldridge for enlightening me on the very concept of the company form which while of great advantage and strength shows inherent weaknesses leading to the current issues of the governance of the corporations.

Thanks are also due to my current faculty colleagues at ICFAI Business School(IBS), faculty colleagues at earlier institutions like School of Communication and Management Studies(SCMS) at Kochi and Allama Iqbal Institute of Management(AIIM), Trivandrum for their constant encouragement and support.

I would also like to thank the editorial team at OUP for their persistent follow up and unstinted support and encouragement.

I  strongly believe that this book will add value to the students, academicians and practicing directors.

New Book On Corporate Governance

Disclose and Go forward – A Corporate Governance Panacea?

On Jan 30, Aparna Ravi, a  lawyer practicing corporate and securities law in London , wrote in The Hindu, on the issue of independence of Independent Directors on corporate boards while commenting on the Satyam issue(A question of independence, The Hindu, January 30,2008).She wrote that “the rules of director independence, like most other corporate governance rules, are about process and disclosure rather than about prescribing ways for a board to run the company”.

While disclosure will help the shareholders/investors, and other stakeholders like employees and regulators to be informed specifically about the conflicts of interests of the independent directors, the conflicts remain; they will not be removed or nullified by the disclosures. For example, if an independent director also offers consulting services and gets compensated for such services in addition to his compensation for his being an independent director, disclosing the same in the annual report, while necessary, does not in any way remove the malady of conflict of interests. It has to be decided by the board as to whether this is a good practice and above board. While the policy of Mr.Narayana Murthy of Infosys , “while in doubt, disclose” is good policywise, the emphasis shall be to try limit if not eliminate the instances of such doubts. Disclosures may not be of much help in the case of conflicts of interests; better not to have or enter into deals where there are possibilities of conflicts of interests.

Another problem about disclosure is the even if disclosures are there, how many  uses such information and reacts ?

Shall we take PWC’s letter as an admission of foul play?

PWC, the auditors for Satyam, submitted a letter to the new Board of Directors of Satyam with copies marked to ROC,H’bad, SEBI,RBI, CBDT,BSE,NSE and NYSE, on 13th Jan 2009.There they make statements to the effect that their audit reports and opinions in relation to the financial statements for the audit period should no longer be relied upon. Many have started arguing that this is a proof that the auditors were negligent and might have been party to the forgery that has been going on. I beg to differ.This is because the auditor will only have to audit what the management provides and they very clearly state it.And PWC might not have found anything wrong too, till September 30th, 2008, audited statement(or unaudited if not audited by the firm)for the latest period that is available. But now, when the management itself claim that they had provided wrong information(in conjunction with many other parties like internal auditors, banks etc), why should and how can they contest? PWC was under pressure to respond immediately and they did what was best possible to meet the exigency. The declaration from the auditor shall in no way be taken as evidence that forgery has been happening for years. That conclusion will have to still wait. Forgery or siphoning of funds might have happened after September 30th,2008.

Satyam Part.3.Mr.CEO, we are anxiously waiting for your disclosure letter.After Raju, who is next?

Mr.K.V.Kamath ,CEO of ICICI Bank, while speaking on Satyam to a TV Channel( I don’t remember which but a busiess news channel), said that deliberate frauds created by management is very difficult to detect by others including auditors.That in effect means that shareholders of the company, potential investors,employees and other stakeholders have to wait for the CEO to make a confession, regarding the wrongdoings that he and his team committed in the  company.There are many important fall outs for this.One is, companies can now either dispense with auditors because that is only ornamental. The demand  for CAs and auditing function of the CA firms are going to face lesser demand in future as companies may go for the lowest quote as audit is conducted only because it is mandatory according to statute.Another one is the shareholders, potential investors , employees, other stakeholders and the general public have to wait anxiously for the CEO of the next company  to come out with disclosures of fraud committed by him,his family members or his team of management in the company.

Is it that Mr.Kamath giving an opportunity to the CEOs of companies who might have committed fraud, to form a queue and send a disclosure to their boards, SEs, SEBI and/or other regulators like RBI,IRDA,MCA etc? Or is it justifying the incapability of not only the auditors but that of the independent directors, SEBI etc too? Again, the assumption behind the comment is that whatever Mr.Raju proclaimed in the disclosure has been correct.

The Satyam Story:Part 2

The Satyam Story:A Different Perspective
Nobody has so far come out with any note of approval or dissent on the financial manipulation  claimed to have been purported by Mr.Ramalinga Raju in Satyam . Why everybody in the country show a tendency to believe blindly Mr. Raju’s admission to fraud, simply  relying on the contents of his disclosure?

Everybody in the country seem to believe blindly Mr.Ramalinga Raju’s confession about and admission to fraud, apparently relying on the contents of his disclosure. One has  to look at the issue with an open and inquiring mind. One will find it extremely difficult to convince oneself that the financial statements of Satyam has been forged and that the financial jugglery has been going on for some time. We have hard evidence that Satyam had strength in the two most important areas which are considered to be essential for success for a software solutions provider namely, a great clientele( a number of   Fortune 500 companies figure in Satyam’s  clients’ list)and a head count sufficient enough and capable of delivering quality solutions. Even if we assume that the costs of Satyam were higher compared to other software majors  whose margins ranged from about 17% for Wipro (including FMCG products) to about 26% for Infosys over the last few years, Satyam must have been able to earn decent margins from its projects, and hence definitely profitable. Hence, it is hard to believe that the company was not making money and that the financial statements required to be  forged to show “inflated” profits and strong financial position.

Mr.Raju’s claim that merging Satyam with the two Maytas companies was “the last straw” for Satyam to stay afloat  hence looks unbelievable and totally false. It must be the other way round only. The balance sheet figures as on 30^th September,2008 (if audited) must have been correct. The changes in the financial position might have happened post-September 30, 2008.It is at this time that the real estate  and infrastructure sector started facing serious  problems in India(even though they were making news abroad).Maytas companies might have also faced serious cashflow problems consequent to fall in demand and prices. Real estate companies which have been riding  on the euphoria of unabated rise in land and property prices immediately found themselves severely strapped for cash. Maytas companies might have been no exception. Rajus, who  wanted to save Maytas companies  siphoned off funds from Satyam after September 30, 2008 , tried to wisely play their cards by putting a strategic-looking  proposal to the board for acquiring the two Maytas companies, under the pretext of “derisking”, thereby enabling them to show the money siphoned off to help Maytas companies as paid for equity stake in them. And all these had to happen  before the board meet to consider the  third quarter results as the  Rajus were very much afraid that they could be caught by the outside directors and auditor and that their ploy could be exposed.

 The auditors and the independent directors might  have been unaware of the transactions and the consequent changes in cash position happened after 30^th September. While the independent directors might have gone wrong in clearing the acquisition proposal, they might not have been party to any other wrong doings. But Mr.Raju has cunningly made the independent directors scapegoats  by saying that this forgery has been going on for some time  putting the very diligence and the commitment of independent directors to question. Public and media unfortunately  have started asking  for the blood of the independent directors and auditors, who might not have known what had happened and been involved at all in the whole episode because the whole manipulation and siphoning of funds must have happened in a matter of three months during which time no board meeting or no audit committee/auditor meeting have taken place.The only meeting that took place must have been the crucial and controversial meeting of December  16   , 2008 to discuss the proposal for acquisition of the Maytas companies. Mr.Raju must have been taking an anticipatory bail before the board meeting scheduled for considering the third quarter results, during which the real picture would have come to the knowledge of the Director  Board, and possibly the auditors.

Another question that puzzles many is why there was a delay of  three days in booking the Rajus even after Mr.Ramalinga Raju’s  admission that he committed himself to cheating (amounting to criminal offences under various provisions of law) by forging the financial statements to show profits inflated  by amounts in excess of Rs.5000 crores? Nobody  initiated any step to put him behind bars for the self-admitted criminal offences but waited for a full three days. Was he being given time to develop his story further?

Yet another question is about the role played by SEBI. Mr.Bhave, Chairman, said that the Satyam disclosure was of “horrifying magnitude”.But, has  SEBI, at least by now, studied the financials of Satyam for the last few years to verify any wrong doings or are they still blindly sticking to the disclosures of Mr.Raju? Prof.J.R.Varma, in his blog on financial markets (http://www.iimahd.ernet.in/~jrvarma/blog)  writing on the Satyam scam on 8^th  Jan, expresses a concern on the “willingness of  people to believe a liar’s confession blindly” . SEBI has the mandate to oversee  the governance of companies in addition to their role as a capital market regulator. And it is mandatory for listed companies  to submit their financial statements to SEBI.It is high time that SEBI randomly checks some of the financial reports so that they can take action against erring companies at an initial stage than waiting for a wholesale carnage of the market and investor confidence of the kind happened in the case of Satyam.Mr.T.T.Ram Mohan in an article(Time to rethink governance, ET,Jan 8,2008) suggested that a Board for Audit and Surveillance(BAS) be established with the authority to carry out surprise audit of any listed company above a certain size, on the lines of CAG which provides an additional layer of audit for the PSUs.I feel such a body can be attached to the SEBI considering it’s role in the regulation of corporate governance.

Last but not the least, nobody from SEBI, SEC of US, MCA, ICAI, Research arms of Brokers, investment banks, mutual funds, academics, investor associations, or audit companies has so far come out with any approval or dissent note on the financial manipulation  claimed to have been purported by Mr.Ramalinga Raju, even after five days apparently proving Mr.J.R.Varma correct.

End piece: Isn’t it premature on the part of  Dr.Reddy’s to ask Prof.Krishna Palepu to quit from directorship and on the part of Mr.T.T.Ram Mohan(http://www.ttrammohan.blogspot.com) to indulge in character assassination of him before ascertaining his  role in the whole Satyam scam?