Principles and rules

Last Updated: Mon, Jan 07, 2013 07:04 hrs

Many investors, mostly overseas, have often expressed concerns about India Inc's opaque corporate governance practices. In that context, the Securities and Exchange Board of India's (Sebi's) decision to put the issue of governance under the spotlight is welcome. The proposals aim to make Clause 49 of the listing agreement, which spells out corporate governance rules, relevant. This follows the passage of the Companies Bill by the Lok Sabha last month. The suggestions are intended to make companies more accountable to minority shareholders, who have been affected by certain actions by promoter-controlled firms.

The regulator has done well to suggest that related-party transactions by listed companies should obtain shareholder approval, especially in cases of divestment of shares in subsidiaries. Examples such as the Satyam scandal show how such transactions are widely used by promoters to enrich themselves at the expense of minority shareholders. Many countries such as Singapore, Italy and Israel have provisions mandating immediate disclosure of related-party transactions. The move to make the whistle-blower mechanism a compulsory requirement can also make a huge difference to the corporate governance standards in India. The regulator has proposed that a company must disclose to shareholders and the market the reasons for an independent director's resignation and called for a mandatory limit on how long independent directors can serve on the board. This makes sense since over a period of time, an independent director may develop a friendly relationship with the company and the board. In the process, he may develop a casual attitude towards his responsibility, which could adversely affect the role envisaged for him.

These are all good measures, but will they work? Many of the proposals appear to be biased towards a principle-based approach rather than a rule-based approach. But enforcing principle-based compliance with corporate governance laws is difficult. Companies that have been following sound corporate governance policies will continue to do that; but those with a history of weak practices will find a way to go around the rules. The US' Sarbanes-Oxley rules show an alternative route; though rigid, they leave little room for company promoters to follow innovative practices to enrich themselves.

A big reason why companies have been able to get away with moves that hurt minority shareholders is the indifference of informed institutional investors to such actions. Many investors, including the country's biggest and state-controlled insurance companies, prefer to stay silent rather than raise issues uncomfortable to the management and the promoters. In the latest proposals, Sebi has permitted institutional investors to broadly follow a principle-based approach to voice their views against companies. Currently, mutual funds are required to disclose on their websites their voting record in companies where they have invested. But this activity is done as a chore by most of them, with mutual funds abstaining from voting even if they find any questionable practices. What may, however, help is the mandatory corporate governance rating by credit rating firms, as proposed by the market regulator, which should strengthen monitoring of corporate governance in companies.

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