Unethical Management Biggest Source of Misgovernance

By GovernanceToday
In eGovernance
April 7, 2015

Over last couple decades, corporate governance (CG) has emerged as a focal concern for policy makers as big companies have collapsed across the world. While not many big failures have taken place in India, there is hardly any scope of complacency. To understand the various issues involved, Governance Today spoke to Prof. J.P. Sharma, HOD and former Dean, Department of Commerce at the Delhi School of Economics. Edited excerpts:
Prof. J.P. Sharma, Delhi School of Economics

Prof. J.P. Sharma,
Delhi School of Economics

Corporate governance is still a relatively lesser known area in Indian business arena. Could you throw some light on its origins and growth?

CG is a huge subject; it has various angles to it, such as regulatory, codes, reform, ethics, CSR etc. Let me give you a broad picture so you can see the issue in totality. Till about two decades back, this subject was relatively unknown in any part of the world. The matter assumed significance when in 1991, all of a sudden three major UK corporates collapsed. These were Maxwell Communications, one of the largest publishing houses, Bank of Credit and Commerce International, the seventh largest bank of the world and Polypack, one of the largest textiles companies of the world. The failure of such huge companies forced the UK government to come into action, which set up a committee under Sir Adrian Cadbury to find out what went wrong and what should be done. The committee submitted its report in 1992 and made some 19 recommendations which were accepted by the UK government. The UK government incorporated these recommendations in the listing agreement as governance problems are mostly in listed companies as public has stake in them. After Cadbury committee report, numerous recommendations have been made across the world. Broadly, companies across the world have been complying with these recommendations.

But again, during the three year period between 2000 and 2002, around two dozen major companies failed, primarily in the US. Prominent among these firms were Enron, Tyco, Global Crossing, Adelphia, and even the largest accounting firm of the world, Anderson. Elsewhere, big corporations such as Swiss Air, Vivendi France, Daewoo Korea, Parmalat Australia etc. failed. The primary problem that came to light was the collusion between management of these companies and auditors. As most companies failed in the US, the American government came into action and assigned the job of looking into the matter to Paul Sarbanes and Michael Oxley. Based on their recommendations, the US government enacted the Sarbanes Oxley Act in 2002. The world, including India adopted the provisions of this Act in-toto.

You have worked extensively on Satyam collapse. Could you share your opinion on what went wrong with it?

Well, Satyam is an intriguing case. Satyam was complying with all CG laws. In fact, it was awarded the Golden Peacock, the highest award for good corporate governance in 2008 and just months later, it failed. That caught my attention and I decided to study what went wrong with the company. It took me about 9 months to complete the study, which was completely a personal endeavor. I presented my study in a conference on corporate governance in University of Birmingham.

The company was set up in mid-1987 when RamalingaRaju returned from the US. The family was involved in five lines of businesses, namely spinning and weaving, constructions, homes, aquaculture and finally shoe upper. Raju prevailed upon the family and consolidated the business under two areas of IT and constructions. The IT venture was stated with just 20 employees. The company went public in 1991. This company was the fastest growing company and RamalingaRaju was awarded the IT man of the year award in the year 2000. The company won the Golden Peackok award in Sept 2008 and in Jan 2009, it failed.

The problem in the company started in 2008 when on Dec 16th it announced the buyback of two of its subsidiaries for USD 1.6 billion. The share prices of Satyam crashed by 55% and another 14% next day. Four out of six independent directors resigned. The World Bank, one of the largest clients, withdrew its contract and charged the company for data theft, blacklisting it for eight years. The Chairman of the company has no option but to put in his papers; he resigned.

Broadly, Satyam is a classic case of CG failure. It is a classic example of unethical conduct. Four bodies were looking into Satyam’s case; CBI, local police, Enforcement Directorate (ED), Serious Fraud Investigation Office (SFIO) and Security and Exchange Commission (SEC) USA. According to ED, this family had floated 350 fake companies. Now, even if you have some common directors, you need hundreds of directors at least. So, the family put gardeners and drivers on the directors of these companies. As per the ED findings, documents of these companies were found at places other the registered office these companies. The family opened six accounts in London, transferred huge amounts to these accounts and within a short period, those accounts were closed. This says about the culture. It was also found that bribery was very common in the company.

The company was complying with every norm, it was rated very high by rating agencies, but still it failed. How? The answer given by Sh Narayan Murthy of Infosys is noteworthy. He said that any company promoting feudal characters is bound to fail. Any company that encourages democratic values is to succeed and progress. I feel human character is a major issue in all companies. So, Tatas have their own style of functioning that reflects the characters of founding members of the company, and so is the case with Infosys.

Besides unethical conduct which other crucial factors were there in the Satyam saga?

Besides unethical conduct, another big problem was accounting. According to SFIO, the company had fixed deposits of about Rs. 3,300 crores. But in reality, deposits of only Rs. 9.96 odd crores were found. So where is the rest? Fake FDs indicate collusion of banks with the company promoters. Further, there is an angle of insider trading. The family of RamalingaRaju offloaded its holdings long before the closure. The family’s stake came down from around 25% to 3.4% when the company was sold. Sebi has now taken action against the promoter family under insider trading issue.

Then, the conduct of board of directors is also suspect. Incidentally, the two promoter directors were not present in the meeting in which the decision to buy the two subsidiary companies was taken. So despite being independent as per book, they are at par with other directors in terms of remuneration. As such, their interests are clearly linked with those of the promoters. In my study published in my book in 2010-11, I recommended that the remuneration of independent directors be changed with a sitting fee. Second aspect is that of appointment of independent directors. As it is, independent directors are nominated by promoters. This could cause problems. So, I suggested that there should be a body which could prepare a panel of eminent people from which the chairman can pick up names. Both the recommendations have been taken care off in the new Company Law 2013.

Not many companies have failed in India. Why?

Surprisingly, despite suffering from similar problems, not many corporate failures have taken place in India. This is because for an Indian entrepreneur, his business is part of his identity. The concept of a company being separate from its promoters is not taken beyond accounting in our country. So, Indian promoters are emotionally much more engaged with their companies than western promoters who do not maintain such an emotional attachment with the companies floated by them. The basic issue here is that most of the companies in India are either family or friendly managed. For example, in TCS, promoters have 74% stake; in Wipro, Premji family holds nearly 80%. Only exception is Infosys where the promoter’s stake is hardly 16%. The promoters in India treat companies as their fiefdom and which has not been noticed in the developed part of the world.

What about auditors?

From my studies, I have found that a major source of problem is the collusion between management and auditors, which is all pervasive, regardless of the size of the company. In my study I recommended like directors, auditors should also be rotated. I am very happy that the new Company Law has provided for rotation of auditors every five years, besides rotation of audit firm every ten years. This is a good move and I support it.

Could you share your opinion on the reforms brought in by the new Company Law?

Broadly, the new Company Law undertaken reforms on concepts, incorporation of a new company, management of a company, on e-governance, CSR and finally on the winding up of a company. On conceptual front, the one man company has been introduced in the country. Secondly, the Key Managerial Personnel (KMP) concept has been introduced. When Satyam failed, regulators could not take action against managerial personnel because the company law had no such provisions. Now, under the new company law, the CE, CFO, even the Company Secretary has been named as KMPs. Very often it happens that in case of a corporate fraud, each person of management goes scot free because there is nothing that nails a specific person. Now, in case of any default or fraud, those KMPs will be held responsible.

On incorporation front, the entrenchment clause has been introduced according to which, in order to protect the interests of minority shareholders, near total approval is required on matters which impact minority shareholders.

Further, on governance front, the provision for having at least one female director is a positive development as studies show globally that company with higher women participation on board are better governed. European companies are leaders in this regard; they have sizeable number of women on boards of companies.

It has been found that sometimes, the entire board of directors was of non-resident status. This used to create a lot of governance related problems, especially while interacting with regulatory authorities. So, the new law mandates that at least one director would have to be resident for better compliance.

Then there are numerous initiatives in area of e-governance. For example, now notices and agendas can be sent through email. E-voting and meeting through video conferencing have been introduced. Electronic circulation of documents have been allowed. These are all progressive provisions.

In case of CSR, we are perhaps the only country of the world where it has been put in statute, elsewhere, these are either in form of guidelines or norms or part of listing agreements. While in France and Indonesia, it is in law, but in a very loose form against India where it is very tough and specifically designed.

The new Company Law has introduced Class Action Lawsuit. How do you look at it?

Class Action Lawsuit is a very powerful concept in many developed countries, including the US. In India, there used to be only the provisions for damages, not of compensation, which has been brought about by this new provision. In my study published in my book, I had recommended the introduction of this concept in India which I am glad has been brought about. So, under the new provisions, in case of a fraud, if 100 or more shareholders/depositor holders file a case against the management, the tribunal can award compensation and interestingly, there is no limit to the compensation. In case of Satyam, the new management settled a multi-million dollar class action suit filed against the company in US. So, this provision helps even the smallest shareholders.

Prof. J.P. Sharma (born 1951) is a Professor of Law & Corporate Governance in the Department of Commerce, and currently Head, Department of Commerce, and former Dean Faculty of Commerce & Business at the Delhi School of Economics, University of Delhi. In the last over 40 years of his academic career, he has held several academic and administrative positions. He has authored 15 books and around 100 research papers/articles published in several national and international journals of repute. His book titled “Corporate Governance, Business Ethics & CSR” had its review written by Sir Adrian Cadbury who in 1992 gave the world its first code on corporate governance. He is/has been Visitor’s (President of India)/Central Government Nominee on the University of Allahabad, BHU, NEHU, Sikkim, Tripura and HNB Garhwal University. Prof. Sharma is the recipient of “Shiksha Gaurav Puraskar” awarded by the Centre for Education Growth and Research, New Delhi. He is a Fellow Member of the ICSI and Member of several other professional bodies including ILI, ISTD, IMA, ICPS, and ICA. He is the Member of the Governing Body of St. Stephens College, Shri Ram College of Commerce (SRCC) and is/has been the Member/Chairman of IP College for Women, PGDAV College, and Guru Nanak Dev College under Delhi University. In 2012, he was invited by the Department of Management at the King’s College, London to deliver special lecture to PG students. In 2011, he was invited by the London based World Council for Corporate Governance & IOD to address the delegates in a three day Global Convention-cum-GOLDEN PEACOCK awarding ceremony held in London.