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Failure of board oversight
December 27, 2008
Fiduciary comes from two Latin words: fide, or faith, and fiducia, or trust. It refers to one who is bestowed trust and defines a sacred legal and ethical relationship between the fiduciary and the beneficiary.
A director is a fiduciary of a joint stock limited liability company. Even if nominated by the management or the promoters, she is legally appointed by the shareholders.
As a director, especially an independent director, she is expected to oversee the company's affairs, and to ensure two things: First, that management strives to increase long-term shareholder value; and second, that it does nothing which may be inimical to the reputation and value of the company.
Unfortunately, many directors forget who appointed them and, hence, whose fiduciaries they are. Non-executive directors (NEDs) are usually invited to join the board by the promoters or management, often due to prior friendships.
Thus, many NEDs feel that they are de facto appointed by the management -- and need to be more agreeable to management proposals than to be trustees of the shareholders.
This happens especially if an NED has been on a board for a long time. It takes discipline to have a mindset that says, "While I am a friend of the management, my primary responsibility is to be a trustee of the shareholders."
Independent directors -- who are a sub-set of NEDs -- have an even greater responsibility. They are appointed to exercise carefully-reasoned independent judgement on management proposals and strategic directions that companies want to take.
It is not enough for an independent director to satisfy the Sebi checklist given in Clause 49 of the Listing Agreement -- although I know of instances where even this formulaic list has been imaginatively interpreted to satisfy the minimum Sebi requirement of independent directors.
The fact that you (i) are not related to the promoters or senior management, (ii) have not been an executive of the company for the last three years, (iii) are not a partner or executive of the statutory or internal audit firm, or the legal firm that gives advice to the company, (iv) are not a material supplier or service provider, and (v) are not a significant shareholder, may make you 'unrelated'. These don't make you 'independent'.
That requires a very different persona -- one which gives comfort to minority shareholders that you will not only perform the duty with care and reason, but also apply independence of judgement.
Like it or not, such persons are relatively uncommon -- people who demand the right kind of data, read the board papers thoroughly, ask for regular briefs from the management, follow the fortunes of the company through the press and electronic media, take deep dives when the occasions so demand, give enough time and effort to board and committee meetings, and are unafraid of going against the management's wishes if they feel that a proposal may be inimical to the long-term interests of the company and its shareholders.
This breed is as much a rarity in the United States and the United Kingdom as it is in India.
Three other factors muddy the play in India. The first is cultural. We Indians can't say "No" to those whom we regard as our friends. Since the promoters who nominate NEDs and independent directors are friends, the responses to borderline or dodgy board proposals are either gently qualified "Ayes" or elliptical talk that ought to be interpreted as a "Nay" but is never categorically stated as such.
This is especially true for succession planning and compensation in promoter-managed companies. I have rarely seen independent directors stand up and say that the relative who is being proposed to take over doesn't fit the bill and that the promoter must look elsewhere; or that the suggested remuneration is way out of line compared to performance.
The second factor is NED compensation, which cuts both ways. If you pay an NED just sitting fees, it's too much to expect her to give high quality time, effort and care to her board duties.
Equally, if you pay her an amount which forms a significant portion of her annual income, she may be naturally reluctant to call a spade a spade. Both come into play in India: Type 1 error of "Why bother too much when I'm not being paid for my time and effort?" and Type 2 error of "Should I risk a sizeable part of my annual income by strongly disagreeing with management?"
The third is the category of nominee directors -- people nominated typically by lending institutions as a part of loan covenants. In general, they are disinterested. At best, their fiduciary interest is aligned to the institution that nominated them, and not the shareholders of the company itself.
Now, the Satyam-Maytas case. I write here not as an independent director on the board of a competing company, Infosys [Get Quote], but as a public advocate of corporate governance.
To me, this has been a staggering case of a related party transaction. Satyam's [Get Quote] promoters own only 8.74 per cent of the company's shares, and manage the listed entity.
Despite representing such a tiny percentage of the stock, it proposed using $1.6 billion of Satyam's cash to buy 51 per cent of Maytas Infra for $1.3 billion, and 100 per cent of Maytas Properties for $300 million. Over 36 per cent of Maytas is owned by the promoter's family.
Forget valuations, or the strategy of an IT company wanting to de-risk by purchasing infrastructure assets. It was a massive related-party transaction.
Irrespective of law, good corporate governance demanded that such a proposal be rejected by the board or, at best, be first sounded out to the FIIs and FIs, who together owned almost 61 per cent of the stock. It wasn't. The denouement: Embarrassment, poor denials and tragic-comic about-turns.
But there is a silver lining. Institutional shareholders and the press are now flexing their muscles. This is the second instance in recent times where FIIs and the media have forced management to rescind decisions that are inimical to shareholder interests.
That's great news. Because, Clause 49 can never be a watchdog. The press and institutional investors can. And must.
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