A fair deal for minority shareholders

The 'independence' of independent directors is questionable as they are unlikely stand up for minority interests against the promoter

In 2009, the Satyam scandal shook the market when the company’s chairman confessed that its accounts had been falsified. More recently, it was IL&FS that defaulted on its debt obligations, triggering a liquidity crisis in the financial services markets. While these are prominent corporates that drew public attention, the website of Serious Fraud Investigation Office shows hundreds of companies that have brazenly flouted corporate governance norms without protecting their minority stakeholders.

First and foremost, it is the quality of audit that needs to be questioned for violation of disclosure and corporate governance norms and for hurting the interest of minority shareholders. Next is the turn of the company’s independent directors, along with top management personnel, to face the music. Independent directors are meant to be watchdogs to deter fraud and to ensure balanced decisions during board meetings. One would expect independent directors to be experienced domain experts. Instead, preference is given to political affinity of the individual concerned.

Data obtained by a newspaper under the RTI Act show that our PSUs have a majority of independent directors linked to the ruling party. Of the private sector, the less said the better. Barring a few companies, every chairman wants to pack his board with compliant independent directors that include friends, former colleagues, extended relatives and even neighbours. The “independence” of such promoter-appointed independent directors is questionable as they are unlikely to stand up for minority interests against the promoter.

It is left to the minority shareholders to look after their rights. And to do this, they need to have a say in the appointment of independent directors on listed company boards. Independent directors are the main guardians of minority and public shareholder rights, whose job is to see that the company improves its corporate credibility and governance standards, which they cannot do if they are beholden to the ruling party or corporate promoters for their appointment.

A novelty in India, Israel has provisions for the appointment of independent directors by minority shareholders. The UK has a dual voting structure whereby an independent director’s appointment must be approved both by the shareholders as a whole and by independent shareholders. Minority shareholders should also have a say in the removal of independent directors. The complex process that exists for their removal gives promoters a significant influence in the removal process. Their compensation needs to improve significantly, besides including them in the company’s long-term stock option plans to increase their vested interest as a stakeholder in the firm and making them more trustworthy to minority shareholders.

As it is, minority shareholders’ shares are too small to confer any real power on them or to enable them to exert control or influence corporate action, although they deserve to be treated with candour, honesty, good faith, loyalty and fairness. The opportunity for company managements to do this is provided during Annual General Meetings (AGMs) and extraordinary general meetings which they may attend. Here lies the nub of the problem.

The AGMs provide one opportunity for minority shareholders to express their concerns and ask questions. Remember, it was not rocket science but the absence of elementary audit checks that could not prevent the Satyams, the IL&FSs and the Enrons. When corporate audit is sub-quality, when independent directors cease to be “independent”, minority shareholders — who show a questioning mind, an element of professional scepticism, critically evaluate evidence and are alert to errors and frauds — could potentially ensure good corporate governance.

When the management believes that minority shareholders are only looking for dividends, bonuses and discount coupons, will they allow them to play a guardian role? Will they ensure shareholder questions are taken seriously in the first place? Indian companies — irrespective of whether they are family-run, large and respected, FMCGs or PSUs — manage minority shareholder questions by choosing and limiting the number of questions, by ensuring that the selected ones end up praising the board chairman, wishing him a perpetual tenure, complimenting promoter parents or applauding succeeding generations. Uncomfortable questions are discouraged, tackled and managed.

Fortuitously, SEBI is already trying to reform the system of independent directors, their appointment and role on the board. The SEBI has its task cut out. ‘Minority Interest’ protection mechanisms are required to ensure truly independent directors; minority shareholders must be encouraged to be alert to errors and frauds, ensuring that company boards perform in the company’s interest. Only then can we stop more Satyams and IL&FSs from tumbling out of the closet at periodic intervals.

(The writer is former Executive Director and Member, Board of Directors, BEML)