[The following guest post is contributed by Professor Bala N. Balasubramanian, who
is an Adjunct Professor at the Indian Institute of Management, Ahmedabad]
is an Adjunct Professor at the Indian Institute of Management, Ahmedabad]
Recent developments at the Tata Group in
general and Tata Sons particularly have shaken corporate India in terms of standards
of good governance in companies. The group had meticulously built a reputation
over the years for ethical and responsible corporate behavior that went far
beyond the basic mandatory compliance requirements. Almost overnight, that
reputation appears to have taken a beating after the news that the board of
Tata Sons (the parent company of the group) had removed its chairman, Cyrus
Mistry (CM) from his position for his non-performance; and the return, albeit
temporarily, of the immediate past chairman, Ratan Tata (RT) as the board
chief. Unsurprisingly, this was responded to by CM questioning his removal and
highlighting several process and governance related deficiencies, besides also
‘exposing’ many bad management decisions in the company and its associates
during the reign of RT as board chair. This latter charge is unlikely to pass
muster as CM was himself on the board when those decisions were taken
(apparently with no evidence of recorded dissent by him), and even more
importantly, the judiciary is usually loathe to second-guessing business
decisions unless some palpably fraudulent intent behind such decisions was apparent.
As for the board decision to replace its chair, it would seem at least legally
to be in order since such power does indeed vest in the board; if there are
some procedural lapses, clearly they could perhaps be rectified without any
collateral damage to the decision itself.
general and Tata Sons particularly have shaken corporate India in terms of standards
of good governance in companies. The group had meticulously built a reputation
over the years for ethical and responsible corporate behavior that went far
beyond the basic mandatory compliance requirements. Almost overnight, that
reputation appears to have taken a beating after the news that the board of
Tata Sons (the parent company of the group) had removed its chairman, Cyrus
Mistry (CM) from his position for his non-performance; and the return, albeit
temporarily, of the immediate past chairman, Ratan Tata (RT) as the board
chief. Unsurprisingly, this was responded to by CM questioning his removal and
highlighting several process and governance related deficiencies, besides also
‘exposing’ many bad management decisions in the company and its associates
during the reign of RT as board chair. This latter charge is unlikely to pass
muster as CM was himself on the board when those decisions were taken
(apparently with no evidence of recorded dissent by him), and even more
importantly, the judiciary is usually loathe to second-guessing business
decisions unless some palpably fraudulent intent behind such decisions was apparent.
As for the board decision to replace its chair, it would seem at least legally
to be in order since such power does indeed vest in the board; if there are
some procedural lapses, clearly they could perhaps be rectified without any
collateral damage to the decision itself.
More than the legalities of the
situation, the case has attracted attention in the media and the markets
precisely because this happened at the Tata group, something not expected from
the bellwether beacon of good governance. And as more allegations and
counter-allegations were traded by the warring camps, even inappropriate actions
and decisions that would have otherwise been overlooked as minor got
exacerbated under public scrutiny. Boards of some of the big listed group
companies deciding to retain CM as their chair and expressing their confidence
in his leadership and so on have not helped the Tata cause either. One is also
left with the uneasy feeling as to whether what was now in public domain could just
be the tip of a rather huge and potentially dangerous ice berg, not only in the
Tata group but across the board in the listed company population in the
country, dominated as it is by similar concentrated ownership and dominant
control regimes.
situation, the case has attracted attention in the media and the markets
precisely because this happened at the Tata group, something not expected from
the bellwether beacon of good governance. And as more allegations and
counter-allegations were traded by the warring camps, even inappropriate actions
and decisions that would have otherwise been overlooked as minor got
exacerbated under public scrutiny. Boards of some of the big listed group
companies deciding to retain CM as their chair and expressing their confidence
in his leadership and so on have not helped the Tata cause either. One is also
left with the uneasy feeling as to whether what was now in public domain could just
be the tip of a rather huge and potentially dangerous ice berg, not only in the
Tata group but across the board in the listed company population in the
country, dominated as it is by similar concentrated ownership and dominant
control regimes.
The focus of this post is to analyse
some of the governance related issues that are discernible in this episode and
to explore whether there may be a case for further regulatory interventions.
some of the governance related issues that are discernible in this episode and
to explore whether there may be a case for further regulatory interventions.
Board vs Shareholder Primacy
The issue of primacy in corporate
governance is a much debated topic; if shareholders are the principals (in the agency theory
construct), then the body of directors they elect must be accountable to them
and this position is fortified by the fiduciary
obligations that the directors owe to the company to act in the interests
of all its shareholders. On the other hand, the board ought to have
freedom to act (through and with the assistance of the executive) in the
interest of the company and its shareholders (and in India, now, also other statutorily
specified stakeholders); this must necessarily limit shareholder interventions
to the bare minimum. Even so, Indian corporate law, overall, tends to lean more
strongly towards shareholder primacy on many issues than for example the comparable
situation in the US.
governance is a much debated topic; if shareholders are the principals (in the agency theory
construct), then the body of directors they elect must be accountable to them
and this position is fortified by the fiduciary
obligations that the directors owe to the company to act in the interests
of all its shareholders. On the other hand, the board ought to have
freedom to act (through and with the assistance of the executive) in the
interest of the company and its shareholders (and in India, now, also other statutorily
specified stakeholders); this must necessarily limit shareholder interventions
to the bare minimum. Even so, Indian corporate law, overall, tends to lean more
strongly towards shareholder primacy on many issues than for example the comparable
situation in the US.
If the principal shareholders (the
several Tata Trusts) with a commanding majority equity holding in Tata Sons
wished to exercise their primacy to decide who should be the board chair, the
best forum would have been a shareholders’ meeting (to remove CM as a director
and consequently as the board chair), but that did not happen. The principal
shareholders apparently had CM removed from chairmanship by the company’s board
of directors. Prima facie the board
was well within its rights to do so, but if media reports were to be believed,
that decision was based on the fact that the principal controlling
shareholders, the Tata Trusts had lost confidence in CM. The question is how
did the unaffiliated, “independent” directors on Tata Sons board conclude that
CM was not fit to be their board chair any longer. Were they being swayed by
the views of the controlling shareholders? Were they discharging their fiduciary duty to the company to act in
the interests of all the
shareholders of Tata Sons while removing CM from chairmanship or were they (as
happens when directors are “captured” by the controlling shareholders or the
executive management) serving the interests of the controlling shareholders alone?
It is axiomatic that the directors of a company ought to perform in the
exclusive interest of its shareholders even if that meant not aligning with the interests of the “group” or the “parent”
company. Did the directors of Tata Sons conscientiously decide that the
continuance of CM as the board chair would militate against the interests of
the company and all its shareholders? If they did, and if they had convincing
reasons to do so, It would be difficult to question their decision or to
second-guess their motives unless some prima facie evidence was offered to the
contrary.
several Tata Trusts) with a commanding majority equity holding in Tata Sons
wished to exercise their primacy to decide who should be the board chair, the
best forum would have been a shareholders’ meeting (to remove CM as a director
and consequently as the board chair), but that did not happen. The principal
shareholders apparently had CM removed from chairmanship by the company’s board
of directors. Prima facie the board
was well within its rights to do so, but if media reports were to be believed,
that decision was based on the fact that the principal controlling
shareholders, the Tata Trusts had lost confidence in CM. The question is how
did the unaffiliated, “independent” directors on Tata Sons board conclude that
CM was not fit to be their board chair any longer. Were they being swayed by
the views of the controlling shareholders? Were they discharging their fiduciary duty to the company to act in
the interests of all the
shareholders of Tata Sons while removing CM from chairmanship or were they (as
happens when directors are “captured” by the controlling shareholders or the
executive management) serving the interests of the controlling shareholders alone?
It is axiomatic that the directors of a company ought to perform in the
exclusive interest of its shareholders even if that meant not aligning with the interests of the “group” or the “parent”
company. Did the directors of Tata Sons conscientiously decide that the
continuance of CM as the board chair would militate against the interests of
the company and all its shareholders? If they did, and if they had convincing
reasons to do so, It would be difficult to question their decision or to
second-guess their motives unless some prima facie evidence was offered to the
contrary.
Role
Confusion
Confusion
CM was the executive chairman which
meant he was also the CEO of Tata Sons. There is usually some confusion between
the roles of Board chair and CEO when the two jobs are combined in one person.
If CM’s “performance” was found unsatisfactory, as Tata Sons avers,
the question is whether he was sacked as CEO (and collaterally as board chair)
or was his performance as board chair unsatisfactory.
meant he was also the CEO of Tata Sons. There is usually some confusion between
the roles of Board chair and CEO when the two jobs are combined in one person.
If CM’s “performance” was found unsatisfactory, as Tata Sons avers,
the question is whether he was sacked as CEO (and collaterally as board chair)
or was his performance as board chair unsatisfactory.
If the proximate cause for dismissal was
his failure as board chair, then the mandatory performance evaluations should
have highlighted this deficiency, in which case his removal could have been
more civilly handled than by an abrupt dismissal. If his performance as CEO was
unsatisfactory, then the Remuneration and Nomination Committee would have
discussed it with him and recorded in the minutes; even then the removal could
have been more orderly than was the actual case. Of course, the Tatas have
maintained this removal was not as abrupt as is made out and had been brewing
for some time, but CM has denied such was the case!
his failure as board chair, then the mandatory performance evaluations should
have highlighted this deficiency, in which case his removal could have been
more civilly handled than by an abrupt dismissal. If his performance as CEO was
unsatisfactory, then the Remuneration and Nomination Committee would have
discussed it with him and recorded in the minutes; even then the removal could
have been more orderly than was the actual case. Of course, the Tatas have
maintained this removal was not as abrupt as is made out and had been brewing
for some time, but CM has denied such was the case!
There may be a strong case for companies
as well as the media to use in all reporting and communications the appropriate
designation depending upon its subject or context: this would require the
person to be referred to as the CEO or Managing Director in respect of all
executive matters, leaving the title ‘Chairman’ to be used only in regard to
board related matters being reported upon.
as well as the media to use in all reporting and communications the appropriate
designation depending upon its subject or context: this would require the
person to be referred to as the CEO or Managing Director in respect of all
executive matters, leaving the title ‘Chairman’ to be used only in regard to
board related matters being reported upon.
Controlled
Company Governance
Company Governance
The third dimension of these
developments relates to the governance of “controlled” companies,
especially where they are listed or deemed equivalent in law. The concept of
controlled companies is well recognised in the US regulatory regime and in some
other jurisdictions but in most of those countries such “controlled” companies
are the exception, but in India (and a vast majority of other countries around
the world) where concentrated corporate ownership is predominant, such
companies (like Tata Sons and its subsidiaries including many of the
affiliates) they are the rule. The challenge now is that in the interests of
harmonisation with global (read US) best practices we are trying to apply the
rules of a diversified share ownership regime to a predominantly concentrated
share ownership dispensation. This approach inevitably leads to a situation
of what the famous economist John Galbraith had called “innocent frauds” where
gaps between conventional wisdom and actual reality are consciously accepted
and ignored! Regulatory requirements in countries such as, for example, Canada
(another jurisdiction with a predominantly concentrated ownership regime) may
offer some more appropriate options to cope with such comparable situations.
developments relates to the governance of “controlled” companies,
especially where they are listed or deemed equivalent in law. The concept of
controlled companies is well recognised in the US regulatory regime and in some
other jurisdictions but in most of those countries such “controlled” companies
are the exception, but in India (and a vast majority of other countries around
the world) where concentrated corporate ownership is predominant, such
companies (like Tata Sons and its subsidiaries including many of the
affiliates) they are the rule. The challenge now is that in the interests of
harmonisation with global (read US) best practices we are trying to apply the
rules of a diversified share ownership regime to a predominantly concentrated
share ownership dispensation. This approach inevitably leads to a situation
of what the famous economist John Galbraith had called “innocent frauds” where
gaps between conventional wisdom and actual reality are consciously accepted
and ignored! Regulatory requirements in countries such as, for example, Canada
(another jurisdiction with a predominantly concentrated ownership regime) may
offer some more appropriate options to cope with such comparable situations.
Concept
of Corporate Parents
of Corporate Parents
Fourth, the concept of
“groups” is well accepted in India now (unlike in the hey days of our
left-of-centre orientation in the 1950s and 60s when “large” business
houses and concentration of economic power were anathema) and one cannot escape
the reality of controlling parents or shareholders having a greater and quicker
access to privileged and often price-sensitive information, and managerial
influence on the subsidiaries and associates in the group. If the Tata trusts
were receiving information from Tata Sons and other companies in the group, it
will be nothing but a natural consequence of their control over management (and
no different to multinational parents or the government ministries receiving
briefings and information from their subsidiaries and associates); the natural
corollary is that in such controlled companies, we are bound to have
“agency type II” issues (protecting the interests of minority
shareholders not only from the hired executive but also from co-shareholders in
management control) besides the usual type I problems ( protecting the
interests of the shareholders from the hired executive, as in case of dispersed
ownership regimes).
“groups” is well accepted in India now (unlike in the hey days of our
left-of-centre orientation in the 1950s and 60s when “large” business
houses and concentration of economic power were anathema) and one cannot escape
the reality of controlling parents or shareholders having a greater and quicker
access to privileged and often price-sensitive information, and managerial
influence on the subsidiaries and associates in the group. If the Tata trusts
were receiving information from Tata Sons and other companies in the group, it
will be nothing but a natural consequence of their control over management (and
no different to multinational parents or the government ministries receiving
briefings and information from their subsidiaries and associates); the natural
corollary is that in such controlled companies, we are bound to have
“agency type II” issues (protecting the interests of minority
shareholders not only from the hired executive but also from co-shareholders in
management control) besides the usual type I problems ( protecting the
interests of the shareholders from the hired executive, as in case of dispersed
ownership regimes).
It would be unrealistic to ignore the
inevitability of such a situation; at best, regulatory requirements may help contain
the potential abuse of such privileged access by the controllers. To some
extent, this is already being attempted on issues like insider trading but to
expect that parental influence could be totally eliminated would be bordering
on being myopic.
inevitability of such a situation; at best, regulatory requirements may help contain
the potential abuse of such privileged access by the controllers. To some
extent, this is already being attempted on issues like insider trading but to
expect that parental influence could be totally eliminated would be bordering
on being myopic.
Block
Holders not in Operational Control
Holders not in Operational Control
Fifth is the issue of inter-se relationships between block holders who are in
management control and those that are not; in Tata Sons, there is one such
significant player, the Shapoorji Pallonji group which reportedly owns some 18%
of the equity. In theory, such outside block holders have the potential to play
kingmakers, opening up avenues for special rent-seeking from the controlling
shareholders. CM was and is in a catch-22 situation, belonging as he does to
the Shapoorji Pallonji group and yet in a management position in the company. State-owned
Life Insurance Corporation is another block holder being an institutional investor;
its independent judgment on such matters will most likely be presumed to be
subject to government intervention. It is not a simple coincidence that both RT
and CM had written to / met with the Prime Minister immediately after the event
(here again, the parent’s primacy issue is obvious). The chances are that such
institutional investors, unless directly impacted, will take a neutral stand
and abstain from voting (as indeed, post these developments in the parent
company, LIC reportedly did in the shareholders’ meeting of one of the Tata
companies, on the issue of removing CM from its board of directors).
Institution
of Independent Directors
of Independent Directors
Not unexpectedly, the role of
independent directors on the boards of Tata Sons and some of the other large
listed group companies has had to face up to adverse comment. Such directors
are nearly always in the unenviable position of being “damned if they do and
damned if they don’t” and one should stoically bear this proverbial Cross! One
possible regulatory improvement is to mandate that such independent directors
be elected by a majority of the non-controlling shareholders. There is
conceptual merit in this proposal since a major (even if not the only) role of
such directors is to ensure that the controlling shareholders do not unduly
abuse their advantageous position. While such a regulation would strengthen the
bulwark of the institution of independent directors, it may not be an
impregnable shield against “capture” of directors by vested interests; and yet,
to the extent it can help in containing (even to a limited extent) such
undesirable practices, it will be a welcome step.
independent directors on the boards of Tata Sons and some of the other large
listed group companies has had to face up to adverse comment. Such directors
are nearly always in the unenviable position of being “damned if they do and
damned if they don’t” and one should stoically bear this proverbial Cross! One
possible regulatory improvement is to mandate that such independent directors
be elected by a majority of the non-controlling shareholders. There is
conceptual merit in this proposal since a major (even if not the only) role of
such directors is to ensure that the controlling shareholders do not unduly
abuse their advantageous position. While such a regulation would strengthen the
bulwark of the institution of independent directors, it may not be an
impregnable shield against “capture” of directors by vested interests; and yet,
to the extent it can help in containing (even to a limited extent) such
undesirable practices, it will be a welcome step.
To
conclude
conclude
As undisputed reputational leaders, Tatas
cannot avoid bearing the reputational consequences of any slippage from the
high norms they had set for themselves virtually from their inception. The
extent of such reputational erosion and its impact on group companies is hard
to predict; one thing is certain: redressing this slippage and regaining the
reputational high ground will be time–and-effort-consuming.
cannot avoid bearing the reputational consequences of any slippage from the
high norms they had set for themselves virtually from their inception. The
extent of such reputational erosion and its impact on group companies is hard
to predict; one thing is certain: redressing this slippage and regaining the
reputational high ground will be time–and-effort-consuming.
– Bala N. Balasubramanian