Corporate governance: Does India need new regulations?

The World Bank’s Ease of Doing Business Report 2018 ranks India fourth among 190 countries in ‘protecting minority shareholders’. The US is ranked at 42 and the UK at 10. The average ranking of the high income OECD (Organisation for Economic Co-operation and Development) region is 47. India’s rank was seven in 2015, eight in 2016, and 13 in 2017. The ranking is primarily based on the strength of legal infrastructure and institutions established to prevent the use of corporate assets by company insiders for personal gain. India’s ranking shows it has robust corporate governance infrastructure, institutions and regulations. However, regulators, experts and investors are not happy with the corporate governance standard on the ground. 

In conferences and discourses, experts and regulators express concern on this. The Securities and Exchange Board of India (Sebi), which in September 2015 issued the Sebi (Listing Obligations and Disclosure Requirements) Regulations, is so concerned that it appointed a committee, headed by Uday Kotak, to suggest how to enhance the standard at corporate governance of listed companies. The gap between prescription and practice suggests enhancing of regulations does not necessarily improve the standard. 

In the preface to the Kotak Committee report, Uday Kotak mentions two styles of running a company: The ‘Raja’ (monarch) model and the ‘custodian’ (trusteeship) model. In the former, promoter interest, i.e. self-interest precedes those of other stakeholders. In the custodian model, promoters, boards and management wear the hat of trustees and act in the interest of all stakeholders. Kotak writes that Corporate India needs to move towards the custodian model. No one can contest the proposition. The moot question is whether enhancing of regulations will move corporate India in that direction. Quite likely, it will not. 

The average promoter’s shareholding in Indian listed companies is a little more than 49 per cent. It is higher in smaller companies. A promoter’s portfolio of investment is diversified much less than that of the average public investor in the company, as the promoter invests a large part of the family wealth and other resources in the company.  So, the promoter’s investment is exposed to higher risk than those of average public investors in the company. It is natural that the promoter will not like a strong and independent board to supervise the management led by the promoter’s nominee. Promoters prefer an advisory board than a supervisory one. The average shareholder is happy so long as one gets the expected return. They are more concerned about the standard of family governance than whether the company is complying with corporate governance regulations in spirit, as weak family governance adversely affects growth and sustainability of a company, due to disagreements and disputes. It is not a surprise that promoters take the ‘tick-in-box’ approach. Therefore, more regulations regarding the composition and role of the board of directors, independent directors, board committees, etc., are unlikely to improve the standard of corporate governance in family-managed businesses, which dominate the Indian corporate sector. 

Implementation of the committee’s suggestions regarding disclosures and transparency, financial reporting and audit, and shareholders’ participation in meetings will improve the quality of governance and shareholder participation only in those companies which interest analysts and institutional investors. Shareholders of others will incur the additional compliance costs without significant benefits from new regulations. 

Enhancing of regulations increases the compliance cost. This could be quite significant (relative to profit) for smaller listed companies. The number of companies with listed equity capital on the BSE is 5,140, of which 1,179 are suspended and 3,961 are available for trade. Business Today’s data on the top 1,000 companies (in terms of market capitalisation or m-cap) reveals the average m-cap of the 1,000th company (October 2015-September 2016) was Rs 349 crore and its total of assets, income and profit (all data for 2015-16) were Rs 398 crore, Rs 268.57 crore and Rs 18 crore, respectively. This shows the increase in the compliance cost would adversely affect the profitability of the bottom 3,000 companies. 

More regulations can wait. Effective implementation of existing regulations by regulators, particularly those relating to disclosures and transparency, quality of financial reporting and audit, will improve the corporate governance standard in practice. With the m-cap of S&P BSE 500 companies nearly 93 per cent of the total m-cap on the BSE, it may be debated whether a simple corporate governance code be formulated for companies not in the top 500 companies list.

The author is adjunct professor, Institute of Management Technology, Ghaziabad)
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