Getting Pro-active On Governance Reform (7 April 2003)
Last week, America’s largest pension fund, CalPERS (California Public Employees Retirement System), announced that it would target six companies for governance reform and put seven others on a watch list for future action. Xerox Corporation topped the list for having what CalPERS said was “one of the most ineffective boards”. Not a single board member was changed even after the company paid a $10 million Securities Exchange Commission (SEC) fine to settle charges over a $6.4 bn restatement of accounts and allegations of financial manipulation.
CalPERS has asked Xerox CEO Anne Mulcahy to “take immediate steps to expand the board by three independent directors and split the position of Chairman and Chief Executive Officer.” Others in CalPERS’ list are JDS Uniphase, Gemstar-TV, Parametric Technology, Manugistics Group and Midway Games. Several of these companies have given lavish compensation packages to top management that are not linked to their performance. In most cases, CalPERS wants companies to seek shareholder approval for executive compensation.
India has no fund comparable with CalPERS in size and influence, since the Unit Trust of India even in its better days was controlled by government and operated through ineffectual nominees on the boards of companies. On the other hand, we have a Corporate Governance Code that is mandated by the Securities and Exchange Board of India (Sebi) and is to be applicable to companies in a phased manner. In 2001-2002, 1,848 companies listed on the Bombay Stock Exchange and 741 companies listed on the National Stock Exchange had to comply with the code.
Sebi analysed the data provided by the two bourses and concluded that compliance with the code is more or less satisfactory. However, the results seem rather patchy to me. For instance, the analysis pertains to only 1,026 out of the 1,848 companies that were to comply with the code. Did the others not submit corporate governance reports? It is not clear. Of these, compliance is high on procedural aspects such as board structure, setting up of shareholder grievance committees and audit committees, but drops significantly when it comes to following board procedures (575), remuneration committees (677) and details on management practices (774).
In the meanwhile, Sebi has a second corporate governance report from the N Narayana Murthy Committee, which has taken the process forward with some new recommendations and fine-tuning of earlier disclosures. While the Murthy Committee report has been released for discussion, I learn the regulator has no power to deal with non-compliance with the corporate governance code. If a company were to ignore Sebi’s mandatory prescriptions and disclosure requirements, the regulator can do little about it. It could, at best, shame companies by publicising their lack of compliance and hope that discerning investors would punish it by dumping the stock.
But that is not good enough. Sebi needs to arm itself with disciplinary powers such as barring companies that fail to comply with the code from accessing the capital market for funds. It should also encourage investors to demand that mutual funds only invest in companies that comply with corporate governance requirements. Such powers are necessary to ensure effective implementation of the next phase of governance rules.
Many of the Murthy Committee recommendations are absolutely in line with global thinking on good corporate practices. For instance, in a speech on March 24, William H Donaldson, Chairman of the SEC, addressed the “distressing array of corporate malfeasance” leading to “seven trillion dollar collapse in aggregate market value of American corporations” in the last few years. He asked corporate board members to “define the culture of ethics” that they expect to embrace; this, he said, should not only cover the procedure for appointing a CEO but “the spirit and very DNA of the corporate body itself”. According to Donaldson, only when the “culture and ethics” is clearly defined can the board decide how to implement it.
The N Narayana Murthy Committee had exactly this in mind when it asked companies to lay down a code of conduct for all board members and senior management. All companies do not have the same ethical standards, and instead of imposing a common code on all, the committee felt that each company should define its own corporate culture and lay down an ethics code within the framework of this culture and Sebi’s mandatory rules. That way, it would only have to live up to its own ethical code, and not one imposed on it by the regulator.
Donaldson also spoke about how, for a long time, corporate America has depended on many of the same sorts of people to fill director slots: CEOs called on other CEOs, friends called upon friends. It is more or less the same in India, with the added complication of ‘nominee’ directors who represent only the interests of institutional shareholders. While the Murthy Committee hasn’t exactly barred the CEO’s friends from populating corporate boards, it has eliminated nominee directors and all those who have a financial relationship with the company.
A third issue that Donaldson raised was also discussed by the Murthy Committee, but didn’t find its way into the final report. It is the question of how many directorships can an individual hold. Donaldson asked each director and the board to “make an honest assessment” of how many boards and committees can an individual serve with dedication and responsibility. From the Murthy Committee’s deliberations, it was clear that the honest number would be far less than the 15 directorships permitted by the rules. I believe that an individual cannot truly serve on more than five boards, with all their sub-committees, and also hold a full-time job. But that is a decision that the Department of Company Affairs should make.
But it is not enough to have a set of globally acceptable recommendations on good corporate governance — the rules are meaningless without the powers to implement them. What better proof than the fact that despite all the corporate scandals and the complex Sarbanes-Oxley legislation, a powerful and activist fund like CalPERS had to threaten action to force good corporate behaviour by companies. -- Sucheta Dalal