With the emergence of proxy advisory firms in India institutional shareholder activism is on. This, if pursued in right spirit, would go a long way in bringing good corporate governance practices and protection to the shareholders in the Indian corporate world
Some of the recent incidents in the Indian corporate world mark a very distinct trend in the Indian corporate history i.e. the emergence of institutional shareholder activism. This trend, if it takes the correct course, will go a long way in infusing a sense of greater responsibility qua social, environmental and corporate governance issues in our publicly traded companies because it protects the rights of the investors and more particularly minority shareholders.
In one of such events this year the Children’s Investment Fund (TCI), UK based hedge fund, which holds around 2% stake in Coal India Ltd. (CIL), in the first, in June 2012 accused CIL of not acting in the interests of the shareholders. As it, in particular found, the Issue of CIL being ordered by the Govt. of India to sign fuel supply agreements (FSAs) to guarantee a supply of at least 80 per cent of the commitment for a period of 20 Years with power producers well below market rates exactly opposed to the interests of the shareholders.
Besides TCI’s crusade, newly incorporated Proxy Advisory Firms like In Govern and Institutional Investors Advisory Services (IIAS) really radicalised the scenario with their voting advisories against some of the leading corporates like Reliance, Wipro and Vedanta etc. The two firms advised qua the appointment of independent directors, reappointment of auditors and mergers. These proxy advisory firms aim at assisting institutional investors who have financial or reputation exposure to public companies in advising the participants in the Indian capital market with independent opinions, research and data on corporate governance issues so as to enhance the shareholders value and keeping the corporations on a short leash.
Thirdly, though not clearly a case of institutional shareholder activism yet an event which is definitely a milestone in the protection of shareholder rights, a PILwhich was filed in Hon’ble Delhi High Court whereby legality of SEBI’s ‘consent order’ mechanism was challenged on the ground that it, though well intentioned, was only helping the rogue elements in the corporate community to violate securities law in the country flagrantly and then were managing to go scot free by getting their irregularities compounded without admission or denial of guilt. This PIL forced the capital market regulator i.e. SEBI to amend its ‘Consent Order’ guidelines.
All these incidents mark a very distinctive trend which would infuse a sense of purpose in the minority shareholders to realign themselves and fight for their rights and a sense of responsibility in the publicly traded corporations towards their shareholders.
Shareholder activism engages management of companies and works as a check and balance between promoters and investors. Shareholder activism could help prevent a global economic crisis as institutional investors and well-informed retail shareholders can question practices of company management during periods of excesses. This is true especially during periods of excess liquidity like was the case in year 2008. Shareholder activism also keeps management on their toes and could correct questionable management decisions.
Not always. Good corporate governance is in itself not enough for preventing such economic crises, as there are other factors that impact the economy. Other stakeholders to economy like the government, regulators, quasi-governmental organizations, etc. could also contribute to an economic crisis.
The crisis of 2008 was driven by excess liquidity and bad risk management. There was perverse incentive for banks, home owners, mortgage companies, regulators and other stakeholders to continue to ride the boom of 2003 to 2008. Banks could have been governed better; some banks (notably Canadian banks) escaped the 2008 crisis unscathed.
The Companies Bill 2011 has some clauses that should promoter shareholder activism. The provision ofClass Action Suits seeks to empower minority shareholders. The Companies Bill 2011 will definitely change many areas – like tenure of Independent Directors, rotation of Auditors, etc. – and usher in better corporate governance. However, more needs to be done. Good shareholder activism is helped by an environment where good management is rewarded and bad management is punished. Some key areas which go hand-in-hand with shareholder activism to promote better corporate governance are:
The board of directors who has the responsibility to hire, fire, compensate, and monitor top management is under fiduciary obligation towards shareholders. The demand for activism arises when boards fail to perform these tasks. In a paper titled “Determinants of shareholder activism in emerging markets” Camila Yamahaki of Middlesex University states that: “Shareholder activism,… occurs when “shareholders make use of their rights in order to monitor, and sometimes influence, how the companies they invest in manage environmental, social and governance (ESG) issues”. So in a nutshell it is the monitoring and engaging and influencing of companies by their shareholders to see whether their companies are acting towards the maximization of shareholders’ wealth by observing the corporate governance norms or not. And in the event of any failure onthe part of the companies in abiding by such norms they can make the boards of the companies to be accountable to them by way of many methods prominent among them being proxy voting and bringing pressure upon corporates by way of media.
Shareholder activism is always necessary to ensure the establishment of democratic institution in any Company and to make sure that management is always on their toes so far as accountability to them is concerned. It ensures a tab on the activities of the management , promotes corporate governance activities and can play major role in ensuring that the world doesn’t witness another global economic crisis as of 2008. Active participation by shareholders will ensure management take decision in the overall interest of the Company,deploy suitable control and checks to counter fraudulent activities and maintain balance of power within the organization so that any person individual whims and fancies doesn’t supersede overall interest of the company. Even though a shareholder’s power may be limited but their continuous activism can be effectively used to change the direction of companies and sometimes even avert crisis situations.
Corporate Governance is all about creating well defined processes and implementing best practices in an organization leading to transparency in action and accountability therein. According to many studies, the lack of corporate governance has acted as a catalyst for the economic crisis with the highlights being on matters such as remuneration, shareholder activism and Board participation. Though it can be said good Corporate Governance can implement checks and balances in an organization which can prevent frauds and crisis but it cannot certainly stop them from happening. Any crisis or fraud owe its birth to the never ending aspirations and greed of human beings and no governance measure can overcome the same but can only create systems to measure and control it.
Highlighting the importance of good corporate governance World Economic Forum’s global competitiveness report 2011-12, states that “The recent global financial crisis, along with numerous corporate scandals, has highlighted the relevance of accounting and reporting standards and transparency for preventing fraud and mismanagement, ensuring good governance, and maintaining investor and consumer confidence. An economy is well served by businesses that are run honestly, where managers abide by strong ethical practices in their dealings with the government, other firms, and the public at large. Private-sector transparency is indispensable to business, and can be brought about through the use of standards as well as auditing and accounting practices that ensure access to information in a timely manner.
It plays a role in a firm’s ability to access capitalthe four factors which play a critical role regarding that are (1) the Strength of auditing and reporting standards, (2) Efficacy of corporate boards, (3)Protection of minority shareholders’ interests and (4) the Strength of investor protection are the most important factors.
In a paper titled “Success of Shareholder Activism: The French Case”, Carine Girard, Associate Professor, Audencia Nantes School of Management while reflecting upon the options before dissident shareholders views that in some cases they may use an exit strategy by selling their stocks in the firm. In other cases they may remain silent and vote with their feet, or become active and attempt to influence managerial decisions by use of a voicestrategy. In most cases, rational shareholders will become active if the expected benefits of the influential activities exceed their expected costs.
Camila Yamahaki in her doctoral thesis on this point maintains that Sullivan and Mackenzie (2006) categorize the Shareholder Activism strategies into: (i) dialogue or engagement, in which companies meet with investor to discuss the firm’s strategy, how the firm plans to meet its objectives, issues related to CSR and corporate governance, and so on; (ii) the use of voting and other formal rights, including attending annual general meetings to ask questions, proposing shareholder resolutions, exercising voting rights and calling extraordinary general meetings; (iii) collaboration with other investors through formal coalitions in which investors present a unified voice; (iv) benchmarking, to compare company performance on different ESG issues and encourage companies to improve their performance; (v) media communications to allow investors to communicate their views to company directors and their advisors; and (vi) the ability to influence share price through the buying and selling of shares, as the threat of takeover is recognised as important to focus the management’s attention to shareholder value.
“If we want genuine shareholder activism in India, the role of institutional investors should be expanded: From being a “fund manager” merely to a responsible, active and enlightened shareholder, in the companies they have invested in. Appropriate laws and guidelines may be framed for ensuring their participation in a transparent manner. Institutional investors have the wherewithal to do it, small and retail investors don’t, and are too scattered in our vast country to have any impact. Secondly capital market regulator has incorporated an elaborate process for good corporate governance in clause 49 of the listing agreement. But, it (and stock exchanges) doesn’t monitor it, resulting in flagrant violation of the norms, with Kingfisher being one of the latest examples. SEBI has done precious little to make the errant airline or directors fall in line. Thirdly, investors are not empowered, under the SEBI Act and Companies Act, to force the errant managements to behave or to defend themselves against willy and fraudulent corporations. Besides, the self regulatory system, on the whole, has been a resounding failure globally with few exceptions. So institutional shareholders role should be expanded and made mandatory and retail investors or investor associations can play a supporting role according to their capacity. “
Ms. Sucheta Dalal, the eminent journalist and columnist in the field, maintains that a frequent allegation about proxy advisors, in the US, is that, like rating agencies, they have a conflict of interest if they accept consultancy assignments from companies. While Proxy advisors deny the charge and claim Chinese walls exist between advisory and consultancy businesses. The proxy advisory firms, in the US, have come to wield so much influence that now the corporate world wants them to be regulated as the integrity and accuracy has become questionable over the years. And it is what Indian proxy advisory firms will have to watch themselves out against. The power and influence of proxy firms emerges from the fact that the law requires US companies “with more than $75 million shares trading publicly must let shareholders cast a nonbinding vote on whether they approve of the company’s pay practices.” This simply means that proxy advice can directly affect the fortunes of top management by simply issuing negative advisory. While companies need to get a 75% approval for their resolutions, studies have indicated that negative advisories can sway as many as 20% of voters. Ms.Dalal maintain that “Some companies, such as Disney, General Electric, Northern Trust and Tyco International, have even challenged their negative advisories. In January this year, The Center on Executive Compensation, an advocacy group representing some of the biggest companies (including IBM and McDonalds), wrote to institutional investors seeking their support in monitoring proxy advisory firms. The letter expressed concern that proxy advisors had “gained undue, and generally unchecked, influence over the pay practices of companies.” It asked institutional investors to take additional steps to ensure that “proxy advisory firm recommendations are accurate, tailored to individual companies, unbiased and truly supportive of sustained long-term returns to shareholders.” Corporate America wants the opportunity to comment on recommendations and correct factual inaccuracies before they are released to institutional investors.” So much so that the Securities and Exchange Commission has also put out a discussion paper on the issue, raising questions about accountability, ability and conflict of interest—among others.
On the issue Mr. Pawan Kumar Vijay, opines that the Companies Bill 2011 provides for larger participation of shareholders in company meetings by providing for determination of quorum for meeting based on strength of members in Company and allowing Companies to go for postal ballot in respect of large number of decision as opposed to what it is currently.Some major decision which requires consent of members by ordinary resolution has been mandated to be passed by special resolution. Another very significant provision has been provided whereby a company, which raises money from public through prospectus and still has any unutilized amount out of the money so raised cannot change its objects unless a special resolution is passed by the company and other requirements of advertisement and exit opportunity to dissenting shareholders is complied with thus increasing the role of the shareholders. There was no such requirement under the Companies Act 1956.
In addition to the above, decisions related to related party transactions andinvestment or loan to any other person under certain circumstances has to be approved by the shareholders by way of special resolution. Also, companies cannot accept deposit from persons other than its members and approval of shareholders will be required for the acceptance of the same. Such deposit can only be accepted subject to complying with necessary conditions
Another important provision introduced in the Bill is that relating to class action suits which can now be instituted by a specified number of members against the company except a banking company.
Even though it is noted that many provisions have been made part of the new Bill to increase shareholders’ activism in the activities of a company, from a practical point of view, one observes that shareholders do not take active interest in the activities of the company and this is probably one of the reasons why shareholder activism in India is yet to see better times.
So in conclusion it can be said that overall its a welcome trend provided it does not suffer from the ills (conflict of interest) above noted Shareholder Activism more so institutional one ably supported by proxy advisory firms the corporate decisions of publicly-listed companies remain focused on shareholder welfare. As they guard against “companies packing their boards with pliant yes-men as independent directors” in the words of Ms. Dalal in her article as referred above, “India needs to encourage proxy advisory services, but it is important to ensure that issues of conflict, regulation and compensation are addressed right now, while it is a nascent business”.
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