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THE DISTINCTIVENESS OF THE INDIAN CORPORATE GOVERNANCE

SHALAJ MRIDUL

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INTRODUCTION

• India became independent in 1947

• Its population amounts to nearly 1.2 billion (almost double of entire Europe)

• It is a complex country where the ideas of corporate governance are still in a very nascent, however, an interesting phase

• It is the 9th largest economy in the world, with a current economic growth rate of 7.0% (2011-12)

• The roots of the corporate structure is colonial in nature and laws are modelled around the common law

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HISTORY• After independence India moved away from its capitalist past towards

more socialistic corporate policies.

• The 1951 Industries Act required all the industrial units to obtain licenses from the central government

• The public sector dominated the economy with enormous state-owned enterprises, dragging India in to a culture of nepotism, corruption and inefficiency, with little accountability of the government

• The Indian equity market was not sophisticated enough to counter the abuse by these companies

• The absence of a corporate governance framework worsened the problem

• While on paper India had probably one of the best investor protection policies, however, enforcement was a major problem

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HISTORY

Post liberalization period (1991)

• The most significant development in the Indian industry has been the development of the Securities Exchange Board (SEBI) in 1992 which has played a crucial role in implementing basic corporate conduct in the country

• Another landmark event has been the adoption of clause 49 into the Listings agreement introducing independent directors

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KEY CORPORATE GOVERNACE ISSUES

• Concentrated Ownership

• Unsophisticated Equity Market

• Vulnerable Stock Markets

• High levels of corruption

• Weak position of independent directors

• Failure of boards

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DRIVING FORCE FOR DEVELOPMENT OF CORPRATE GOVERNACE

• Series of scandals

• Misdeeds by companies

• Impact of globalization

• Privatization

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HARSHAD MEHTA SCAM

• Harshad Mehta a stock broker in 1990’s was considered a stock market superstar due to his stupendous rise in the market

• Was the main reason for the market crash in 1992

• Mehta siphoned off 800-millon dollars from the banking system

• Several key players were arrested, exposing the vulnerability of Indian stock market to manipulations

• This was followed by incidents of companies allotting preferential shares to their promoters at deeply discounted prices as well as those of companies simply disappearing with investors’ money

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POST HARSHAD MEHTA

• Post the widespread scandals in the 1990’s several codes for corporate governance were designed

• The significant ones being the CII code for Desirable Corporate Governance code (1998), the Kumar Mangalam Birla Committee (2000) followed by the Narayana Murthy Committee (2003)

• These led to the development of the clause 49 of the listings agreement dealing with independent directors and the subject of shares transfers

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OWNERSHIP

• Ownership is concentrated wherein 500 largest companies together account for 90% of market capitalization of the Bombay Stock Exchange

• About 11% of companies comprising about 22% of the market capitalization are companies wholly or significantly owned by the Central (Federal) or State Governments; about 20% of companies comprising about 8% of the market capitalization are non-Group companies controlled by Indian promoters; and about 9% of companies comprising about 5% of the market capitalization are non-Group companies controlled by foreign promoters.

• Family run business firms account for 60% while the private sector accounts for merely 20%

• Even in 2005 the shareholdings of promoters in these firms is close 50% in almost 3000 companies

• State owned enterprises account for 20% of market capitalization

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OWNERSHIP (2)

• There has been a shift in the concentration with the entry of domestic and foreign non-promotional investors, however, it is too early to witness a change in the ownership patterns

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INDEPENDENT DIRECTORS

• According to, Omkar Goswami, “the greatest drawback of corporate governance in India is the de facto lack of independent directors on the vast majority of boards. This is not caused by a lack of supply, but reflects the lack of demand, given the prevailing attitude that boards are empty legal constructs that exist solely to justify the perpetuation of existing management.”

• Indian law does not currently require director nominations by an independent nominating committee of the board, thus directors are typically nominated by controlling stockholders

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Clause 49 Listing agreementAs per Clause 49 of the Listing Agreements an ‘independent director’ shall mean non-executive director of the company whoa. apart from receiving director’s remuneration, does not have any material

pecuniary relationships or transactions with the company, its promoters, its senior management or its holding company, its subsidiaries and associated companies;

b. is not related to promoters or management at the board level or at one level below the board;

c. has not been an executive of the company in the immediately preceding three financial years;

d. is not a partner or an executive of the statutory audit firm or the internal audit firm that is associated with the company, and has not been a partner or an executive of any such firm for the last three years. This will also apply to legal firm(s) and consulting firm(s) that have a material association with the entity.

e. is not a supplier, service provider or customer of the company. This should include lessor-lessee type relationships also; and

f. is not a substantial shareholder of the company, i.e. owning two per cent or more of the block of voting shares.

[Institutional directors on the boards of companies shall be considered as independent directors whether the institution is an investing institution or a lending institution.]

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LISTED COMPANIES

• Government plays a significant role in Indian corporate structure, though government companies constitute only 0.3% of the number of companies, these account for 39% of paid-up capital

• There are 10,000 listed companies listed on BSE and NSE, the market capitalization of former being $236 billion, making it the 7th largest exchange in Asia Pacific

• Private sector listed companies account for almost 80% of BSE’s market cap; the remaining

• 20% is made up of listed government companies

• The top 10% of private sector companies (450 firms) account for over 96% of private sector’s market cap

• Freely tradable shares account for roughly 30% of the equity of listed companies

Statistics Omkar Goswami, India The tide rises gradually

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CORPORATE GOVERNACE CHALLENGES IN LISTED COMPANIES

• Fragmented regulatory structure

• Corporate Governance Standards

• Transparency

• Market Integrity

• Director Professionalism

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DEBT AND EQUITY

• Poor bankruptcy laws

• Poor protection of creditors’ rights

• Poor bankruptcy reorganization laws and procedures

Bankruptcy reorganisation of large industrial companies is governed by Sick Industrial Companies (Special Provisions) Act, 1985 or SICA, and the process is directed and supervised by the Board for Financial and Industrial Reconstruction (BIFR)

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BANKRUPTCY

Five fundamental flaws of poorly designed and inadequately implemented bankruptcy procedures are associated with the SICA-BIFR process, namely:

• Late detection

• Cumbersome and time consuming procedures

• Indefinite stay on all claims of creditors

• Debtor in possession

• Violation of the absolute priority rule

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EQUITY DRIVEN TAKEOVERS

• The SEBI has significantly reformed the equity side of the market for corporate control.

• Until the introduction of the Takeover Code in 1997, companies could negotiate takeover deals that frequently left minority shareholders in the lurch

• The code now regulates various aspects of share purchases

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DISCLOSURES

• The Disclosure standards in India are abysmal

• Indian accounting standard do not follow the principles of consolidation

• The penalty and punishment in the Companies Act is a meagre $50 or 6months imprisonment or both

• In reality there has been no imprisonment till date over disclosure

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INSIDER TRADING

Though SEBI clearly defines Insider Trading, it has been difficult to detect due to -

• Existence of middlemen and brokers

• SEBI lacking judicial power

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THE GRADUAL RISE

• Aggressive companies in recent years have made their way to the top rejecting the old and traditional companies existing in India

• Companies like Infosys have led the way in corporate governance standards through swift and structures accounting and disclosure standards

• There has been phenomenal growth in the market capitalization

• The Indian financial press is very strong and growing stronger with years

• India shall move towards full account convertibility in a few years

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THANK YOU