Institutional EYE

Commentary on Corporate Governance Issues

Shareholders have the power to compel change

October 24, 2017

A change is underway in the Indian markets. Investors want their voice heard. In recent times, shareholders have asked for board seats: Unifi Capital asked for a board seat in Alembic Limited, and Florintree Advisors has asked for a board seat in PTC India. And, in extreme cases, shareholders have asked for complete board refreshment: India Horizon Fund together with IDBI Trusteeship moved the Delhi Bench of the National Company Law Tribunal to seek the ouster of Religare Enterprises Limited’s board for mismanagement and oppression of minority shareholders. In response to the leadership crisis at Infosys, mutual funds wrote a joint letter to Infosys’ board members asking them to consider bringing Nandan Nilekani back. Retail shareholders are not getting left behind: they have asked for the removal of audit committee members in Ricoh India, and written an open letter to Raymond’s board accusing the company of resource wastages through unwarranted asset acquisitions. Several retail shareholders are also asking more discerning and tougher questions to boards in general meetings.

 

This change has been brought on because of several reasons.

 

India’s equity markets are structurally changing, which makes them ripe for shareholder activism. Today, over 30% of the equity is held by institutional shareholders, and with promoters holding a dominant 50%, institutional investors have little room for the Wall Street walk. This compels more engagement between investors and companies. Recent successes of engagement too have bolstered investor confidence. Getting Maruti Suzuki to change the contours of its Gujarat plant transaction took almost 20 months (from 2014 through till 2015) but compelling Infosys’ board to bring back Nandan Nilekani took all of one week - a reflection of how sensitive some Indian companies are to the market clang.

 

India ranked 13th on the protection of minority interest in World Bank’s Doing Business Report 2017. A large part of that is a function of regulatory changes. While recent regulations have created expectations of behaviour and disclosure for corporate India, these have also decisively empowered minority shareholders, and compelled asset managers to exercise their fiduciary responsibility. In making the mutual fund industry disclose the rationale for every single vote on shareholder resolutions, the regulators in effect compelled the industry to act. The PFRDA has also asked pension fund managers to coordinate their views on shareholder resolutions and vote uniformly. Abstention by mutual funds and pension on voting on shareholder resolution was down to 11% in FY171 – an incredible achievement from a few years ago when voting was not even on their agenda. In the most recent regulatory diktat, IRDA has asked insurance companies to articulate a stewardship code, and operationalize it from October 2017. This creates an opportunity for India’s single largest investor, Life Insurance Corporation of India (LIC) to use its heft for the benefit of all shareholders.

 

While the government has been consciously pushing regulations to improve governance standards, it fails to walk the talk where state-owned enterprises are concerned. Although these entities are listed, they continue to hold themselves accountable only to their respective ministries, or to the Parliament – and there is a tacit acceptance of that by most investors. Several state-owned enterprises in India do not have enough independent directors on their boards and some of these boards even lack gender diversity. Disclosure levels in shareholder notices too are poor: in several instances, state-owned enterprises have not disclosed the tenure and remuneration of executive directors’ (re)appointment. This is an element that needs to change, especially given that state-owned enterprises (including banks) carry about 10% weight in the Nifty 50 index.

 

It is only stricter and faster enforcement of regulation that will pre-empt companies from violating the basic requirements of good corporate governance. According to World Bank’s Doing Business Report 2017, India ranked 172nd in enforcing contracts. Enforcing regulations is similarly weak. Beyond the expansion of the judiciary system, there needs to be more capacity building at the regulators’ levels. Stock exchanges, which play a quasi-regulator role, have technology-based tightly knit surveillance systems, but could consider strengthening manpower levels to resolve the trigger-based alerts of their surveillance systems in a more timely manner.

 

Companies’ focus on voluntarily and continuously improving governance standards will come once there is an evident governance-premium built into the price-earnings multiple. For that to happen consistently, there needs to be a comparable basis for measuring corporate governance levels of a company. A first step in that direction has been made with the launch of the Corporate Governance Scorecard for India – an IFC-BSE-IiAS joint initiative. Companies are currently using the scorecard as an internal benchmark, but it will soon become a comparable barometer for the investor community.

 

Indian markets are at the cusp of a new wave of shareholder activism. The new shareholder is now active, discerning, and engaged. Class action suits are just a while away, and one win will bring minority shareholders closer to the board table. Companies need to be ahead of the curve and begin actively listening to their shareholders.

 

A modified version of this article was published in the anniversary issue of Fortune India in October 2017.

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