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Institutional EYE

Commentary on Corporate Governance Issues

Companies and investors make corporate governance a common cause

The ‘Common-sense corporate governance principles,’ signed-off by 13 CEO’s led by Jamie Dimon of JP Morgan Chase, provides practitioners a how-to guide on governance. These principles are not linked to any regulatory framework making their applicability universal.

In America, the 5,000 or so public (or listed companies) account for a third of the employment and half of the capex. If the US is to continue to sit at the high table "(we) think it essential that our public companies take a long-term approach to the management and governance of their business (the sort of approach you'd take if you owned 100 per cent of a company)". Clearly the health and well-being of listed companies is important for nation building.

With this objective, the chief executive officer (CEO) of some of the largest asset management firms (Blackrock, Capital, Vanguard, State Street, J P Morgan Asset Management and T Rowe Price), a public pension plan (CPP), an activist investor (ValueAct), as well as a few CEOs of some large publicly-owned companies (J P Morgan Chase, Berkshire Hathaway, GE, Verizon and General Motors), last month presented a series of corporate governance principles for listed companies, their boards and shareholders. Called the "Common-sense Corporate Governance Principles", [ ] these are a "framework for sound, long-term-oriented governance".

Most noteworthy about this exercise is companies and investors coming together to jointly focus on governance. For long, markets have assumed that since corporates need to adhere to these, they alone are responsible for their drafting and implementation. But companies need money that investors have, and investors need well-governed companies to invest in.

The applicability of the principles spelt out here is universal and not in any way linked to the regulatory framework. While parts of it are US specific, for the most part these principles can be applied everywhere, including in India, as these are not overly prescriptive in how to achieve goals. An example: A company should not feel obligated to provide earning guidance - and should determine whether providing earning guidance for the company's shareholder does more harm than good.

In the US, management and ownership generally tend to be separated. As a result, the dialogue between a company's shareholders and its management is through the board. Consequently, three sections in the document deals with the board: Board of directors - composition and internal governance, board of directors' responsibilities and later in the document, board leadership (including the lead independent director's role). These talk about not just the composition, election, compensation and effectiveness of the board but also about its responsibilities focusing on the directors' communication with third parties and setting the board agenda. In India, as owners tend to manage their business, the focus on the board is relatively low. However, companies and shareholders are doing themselves a large disservice by not holding Indian board sufficiently accountable.

The other items included are:

Shareholder rights: This deals with proxy access and dual class of shares. I have written about dual class shares earlier ("Governance norms: Direction or diktat"). While the document highlights that dual class is not the best practice, it recognises that there might be circumstances when such shares have to be issued. In such situations, it's desirable to insert triggers when dual shares will cease to exist. It makes a strong case for all shareholders to be treated equally in any corporate transaction - a clear reminder that there is no place for payment of non-compete fees.

Public reporting: This focuses on transparency around financial reporting but also encourages commentary around long-term goals being "disclosed and explained in specific and measurable ways". One of the strengths - and possibly, weakness as well - of the Indian corporate sector is family ownership, which enables owner-mangers to take a generational view of their business. In this context, the recommendation that a company should take a "long-term strategic view, as though the company were private" should resonate with corporate India.

Given that listed companies fall under the tyranny of quarterly reporting, in a separate missive the group has questioned the need for quarterly reporting: but corporations still have some way to gain unbridled investor trust in India, so it's not certain how this one will go down.

Succession planning: Clearly, this is one of the most important decisions the board will take. Unfortunately, the principles enumerated here are sketchy. Nevertheless, the lesson for Indian companies is that boards need to continuously plan succession. More so, because most companies in India are owner-managed, boards tend to have a dynastic approach that tends to favour the bloodline. Indian boards need to learn from their global counterparts and prepare for eventualities, including protecting the company from its owner.

Compensation of management: There are some interesting points regarding CEO compensation. First, that a substantial portion, that is 50 per cent or more, should be in the form of stock options or their equivalent; second, that these should be made at a fair market value or higher, with "particular attention given to any dilutive effect of such grants on existing shareholders".

In India, while owner-mangers do not get stock options, they often forget their wealth is tied to their shareholding in companies and extract huge salaries for themselves. Regarding ESOPs to employees, the prevailing trend is that if the share price has fallen, the exercise price needs to adjust: this only goes towards protecting the downside risk of employee wealth and does not become an incentive for value creation. Independent directors are ignoring that shareholders are starting to vote against egregious pay and ESOP re-pricing, leading to these getting voted down and red faces in the boardroom.

Given their ownership of business, asset managers' role in corporate governance is now critical. They have the ability to influence behaviour and shape outcomes. Therefore, asset managers must act thoughtfully. They must be proactive and raise issues with companies as early as possible, and be constructive in their approach.

Considering the heft of the institutional investors signing on these recommendations, I expect these to gain currency across all markets, including India. And, in adopting them we, too, can hope to achieve what the signatories expect in the US. "(Our) effort will be the beginning of a continuing dialogue that will benefit millions by promoting trust in our nation's public companies.

A modified version of this article written by Amit Tandon was published in Business Standard on 19 August 2016. Read the article by clicking this link or typing the following on your browser:

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