The Tata Episode: Corporate Governance and the Continuing Influence of Promoters

It is generally understood that corporate governance norms ought
to address agency problems between various actors in a company. Moreover, in
companies with concentrated shareholding, the agency problems between
controlling shareholders (referred to in India as “promoters”) and minority
shareholders tend to be rampant, and hence corporate governance measures need
to be targeted to address that agency problem. The corporate governance regime in
India has considerably evolved over the last two decades, culminating with the
enactment of the Companies Act, 2013 and the SEBI (Listing Obligations and
Disclosure Requirements) Regulations, 2015. These recent reforms have tended to
display greater focus on the potential conflicts between promoters and minority
shareholders, i.e. the agency problem of the kind that is prevalent in India.
While there has been some euphoria surrounding a strengthened corporate
governance regime in India, recent events surrounding the Tata group expose
some chinks in the armour. The purpose of this post is to place some of these
developments in the backdrop of the Indian corporate governance regime, and to
put some of its features to test.
Removal of Directors
The motivation for this discussion arises from the move by the
promoter of various Tata group companies, i.e. Tata Sons Limited, to
requisition an extraordinary general meeting (EGM) of these companies for the
purpose of removing Mr. Cyrus Mistry as a director of the company. A removal of
Mr. Mistry from his position as a director would consequentially result in his
ceasing to be chairman of these companies. Those that have already received
such requisitions from Tata Sons are Tata
Consultancy Services
(TCS), Tata
Motors
, Tata
Steel
, Tata
Chemicals
and Indian
Hotels
.
Not only is such a removal of a director from a company by a
majority of the shareholders permissible, but it also open for a significant
shareholder to requisition an EGM to be convened to enable such a removal.
Under section 169 of the Companies Act, 2013, a director can be removed by a
simple majority of shareholders who are present and voting on a resolution for
the purpose at a shareholders’ meeting. The provision only requires that
adequate chance be given to the director being removed so that such a director
has a reasonable opportunity of being heard, and whose representation ought to
be communicated to the shareholders. Moreover, since such a removal can be
effected only at a shareholders’ meeting, a significant shareholder may
requisition a meeting under section 100 of the Act if the board refuses to call
one. Once such a requisition has been received, the board is compelled to
convene a meeting and, if it fails to do so within a prescribed time period,
the requisitionist can proceed to convene a meeting itself.
Hence, under Indian company law, significant powers are
conferred upon a shareholder who has a controlling stake to fire members of the
board of directors. It is precisely this power that is being exercised by Tata
Sons. Interestingly, among the companies listed above, the promoters have a
majority stake only in one, namely TCS, where they have a 73.33% shareholding.
In this case, the removal of a director is a foregone conclusion. However, in
the other companies, the promoters hold less than a numerical majority of shares
as follows: Tata Motors (33%), Tata Steel (31.35%), Tata Chemicals (30.80%) and
Indian Hotels (38.65%).[1] Nevertheless, since the
remaining shareholdings are dispersed among other shareholders (both
institutional and retail), the promoters may be in a position to muster
sufficient support for the removal of the director. This is because the
resolution requires a majority of shareholders “present and voting”. If a
substantial number of shareholders decide to abstain, that may work in favour
of the promoters. Hence, unless significant shareholders vote against the
resolution for a removal, it would be unlikely that the resolution would be
defeated.
Thus far, there appears to be nothing counterintuitive or
problematic as this phenomenon represents the basic fact of corporate
democracy, i.e. “majority rules”. Hence, there is nothing wrong with the
promoters exercising their power of removing directors. Moreover, the promoters
(as shareholders, and unlike directors) do not owe any fiduciary duties, and it
is well within their means to exercise their powers in their own interest
rather than the interest of the company, the minority shareholders or other
stakeholders.
However, once we transition beyond these basic feature of
corporate law and enter into the realm of corporate governance norms and good
practices, matters become somewhat complicated.
Board Independence in the Shadow
of Promoter Dominance
Last week, I ended a
post
with an optimistic note regarding the manner in which the independent
directors of Indian Hotels acted by taking stance. Similar instances have
occurred to varying degrees in some other Tata group companies, while even more
companies are likely to face similar situations when they meet in the coming
days. However, such an optimism regarding the role of independent directors
seems short-lived, given that one of the independent directors, Mr. Nusli
Wadia, who holds positions in three Tata group companies (i.e. Tata Motors,
Tata Steel and Tata Chemicals) is being given the marching orders, presumably
for his stance in displaying support towards Mr. Mistry as the chairman of
these companies. This portends ominous consequences to the institution of
independent directors in India: toe the promoter line, or you will be shown the
door.
The role of independent directors in family-owned companies is
complex, and may require a different approach compared to other types of public
listed companies. For example, in her article “Guests at the Table?: Independent
Directors in Family-Influenced Public Companies
”, Professor Deborah DeMott
argues:
… Independent directors are
the sole actors at the highest level of firm governance who have the capacity
to bring appropriate detachment to bear in resolving difficult questions that
implicate family ties as well as business necessity, including management
succession and external threats to the firm’s position and separate existence.
Independent directors may help assure the board’s appropriate focus on the
corporation’s business despite the distracting influence or overhang of
frictions internal to the founding family. …
In other words, independent directors may have to navigate
through family-related issues in order to decide on what is best for the
interests of the company, and its shareholders and stakeholders as a whole.
While this is the ideal scenario, the reality is that
independent directors operate in the shadow of the promoters. That is because
independent directors can be hired and fired like any other directors, and
hence they may have the tendency to be beholden to management. Those who raise
difficult questions may either be removed, or their tenure not renewed. This
deficiency in the corporate governance norms (despite considerable
strengthening) leaves the independent director institution exposed. The
proposal for removal of Mr. Wadia from three Tata group companies is a signal
to all directors that they should either not take sides or (if they do) take
the side of the promoter, failing which the continuance of such director on the
board will be untenable. This entirely defeats the purpose of board
independence. As I have argued
previously
, the board independence mechanism is such that independent
directors effectively act at the pleasure of the promoters. If so, how does the
mechanism help address the agency problems between the promoters and minority
shareholders that are prevalent in countries like India that display
concentrated shareholdings?
Although one may have dismissed these claims as being
theoretical, the Tata group episode has turned it into reality. While the
removal of independent directors for taking a stance against promoters has been
discussed as a possibility, this is the first time (as far as I am aware) where
an independent director is being removed from a high profile company in India.
Of course, there have been disagreements on the board in the past, and
directors may have resigned, but such a removal is an extreme scenario. If Mr.
Wadia’s removal is indeed effected by the shareholders, it may send strong
signals against board independence in India, and this may have significant
repercussions against corporate governance.
The Role of Non-Promoter
Shareholders; Conclusion
The requisitioning of EGMs in the above Tata group companies
effectively puts the ball in the court of the shareholders. A lot will depend
upon how participative the institutional and retail shareholders are. As
discussed above, the exercise of franchise by the non-promoter shareholders
could determine the outcome of the proposal to remove the directors in respect
of all companies, except for TCS (where the promoters hold a majority of the
shares). The institutional investors will be key players. If they abstain from
voting, as several may very well do, the game will be played into the hands of
the promoters who will be able to muster enough support to pass the
resolutions.
Ultimately, the non-promoter shareholders might act in what is
best in the interests of the company (and therefore their own interests),
perhaps keeping in mind the long-term prospects of the company. To that extent,
this episode would be a test for shareholder activism in India. One hopes that
the non-promoter shareholders, particularly those of the institutional type,
will exercise their votes taking into account the proposals of the promoter and
defence put forward by the directors who are being removed.
Although it might be too early to predict an outcome, the events
thus far provide sufficient lessons for the state of corporate governance in
India. It appears that the powers of promoters continue to be strong even after
the recent reforms, and institutions like independent directors are susceptible
to being outweighed by the influence of the promoters. To be sure, the
existence of concentrated shareholding is not undesirable on its own. Promoters
do bring considerable value, and the benefits they derive as shareholders would
also be available to the other shareholders. What matters is the manner in
which the promoters exercise their power. The goal of corporate governance
norms in such a scenario ought to be to ensure that the promoter-owned
corporate system creates efficiencies that confer benefits a net benefit to all
shareholders (including the minority shareholders) and to the company as a
whole (including other stakeholders), and to avoid inefficiencies that cause a
net reduction in value. But, as is usually the case, the means as are important
as the end.



[1]
The shareholding patterns of the various Tata group companies have been
extracted from information available in filings made to the BSE.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

1 comment

  • Selectively (not in the same order):
    ..

    “This portends ominous consequences to the institution of independent directors in India: toe the promoter line, or you will be shown the door.”

    "While this is the ideal scenario, the reality is that independent directors operate in the shadow of the promoters."
    ….
    "While there has been some euphoria surrounding a strengthened corporate governance regime in India, recent events surrounding the Tata group expose some chinks in the armour."

    …..

    "To that extent, this episode would be a test for shareholder activism in India. One hopes that the non-promoter shareholders, particularly those of the institutional type, will exercise their votes taking into account the proposals of the promoter and defence put forward by the directors who are being removed."
    ……

    To abruptly share own perception:

    Certainly, this write-up makes for an interesting, but brain- teasing reading;interesting, in that brings to sharp focus the inevitable conflict of interests between individuals or groups having an active role to play in the subject episode. But nonetheless is brain teasing, for the premise of independent directors acting as a unified group- with a view to safeguarding the larger interests of the company, and at the same time of the rest of the stakeholders as a body, excluding the promoters, -is possible, in practicality, does seem to suffer from a faulty assumption.

    In the context,it will be worthwhile to read through, with the same breath, another long piece of writing @
    http://www.lawyersclubindia.com/…/Judicial-independence-of-… [http://www.lawyersclubindia.com/articles/judicial-independence-of-dependent-judiciary-367.asp/&h=taqho6muvaqel3ci8yjqv-tge7etgyde3qxqgjnwwtrscfw&enc=azpbeodgyb_6ob38zam2kdofummbymtzsrdith-dzdezdsdg8dmvst51nsllmt3yra81-6bodkx_ug4h3ea6pchyuvutxnouf6tnl78w2tzbdcakqkq0ztx_fwdratokttopdin2u5og1cflbtde3iffxmcu0-ei_5zcma1ltp0gojq0lume6wi9vfqmzuilw5nzjchuilptoefraf-_h8gk&s=1_green]

    As viewed,the attempt of its learned author is to discuss whether at all it is not but illusory to imagine the 'judges' , acting individually or as a class, functioning independently, despite the undeniable actual fact of they being dependent on the institution of 'judiciary', a creation of the nation's constitution.

    Undeniably though, it is quite an intelligent, insightful and erudite exposition of what are the several multifaceted factors which affect or afflict the most vital requirement of judges / judicial independence.

    One personally believes, more or less like or similar considerations do inescapably come into play in any other field; and 'corporate world' / its governance could be no different in material respects.

    Anyone of eminence, with legal expertise, if were to have a different perspective, is desirably welcome to share thoughts.

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