Shareholder Primacy in India: So Near and Yet So Far!

following guest post is contributed by Professor
Bala N. Balasubramanian
, who is an Adjunct Professor at the Indian
Institute of Management, Ahmedabad.][1]
The scholarly debate on primacy among the
shareholders, boards and the executive in corporate governance is
intellectually as challenging as it is yet inconclusive, although more recent
trends around the world would seem to suggest at least a glacial tilt towards
shareholders’ supremacy. This post attempts to explore the issue with specific
reference to India and its listed corporate universe.
A.        Some
Measures Supporting Shareholder Primacy
Indian company law incorporates several
measures that aim to establish shareholder primacy over the corporate board and
the executive. Some of these (with illustrative comparisons with some developed
market jurisdictions) are enumerated below.
Right to Elect and Remunerate Directors
As is quite well known, the fundamental
format of the corporation makes it impossible and indeed even undesirable for
all shareholders to actively participate in management; instead, shareholders
elect a small group of people trusted for their “integrity” and “competence” as
directors to protect and promote their interests, guiding and
overseeing the executive management, and to periodically report back on the
company’s state of affairs. The directors thus elected incur, consequently, a fiduciary
or trusteeship obligation to act in the interests of the company and all
its shareholders. The components of this right include choosing fit and proper
candidates to act as directors, expecting their independence from
operating management so as to promote fair and objective supervision, approving
appropriate executive and directorial compensation, and so on. Some of the
distinguishing features of Indian company legislation and regulation are

Directors are to be elected individually and not collectively as a “slate”
proposed by incumbent board and management in the United States (US) until

Director candidates’ profiles are to be circulated to shareholders for
assessing suitability;

Objectivity and independence of at least a third of the board is required by
statute (unlike say in the US where the requirement of majority of the board to
be independent is prescribed by listing regulations, and “controlled companies”
are exempt from the requirement of majority of the board to be independent; additionally,
such “controlled companies” are also exempt from independence requirements with
regard to their compensation, nomination, and governance committees);

Executive compensation is to be approved by the shareholders individually for
each whole time director including the managing director (unlike in the US where
the Compensation Committee of the board is authorised to finalise and approve
such compensation). This US position is undergoing a change in recent times,
thanks to the ‘Say on Pay’ movement that sought greater empowerment of
shareholders in this matter; as yet, the ‘say on pay’ vote by shareholders is
only advisory and not binding on the company unless its management and board
choose to act on the advisory votes;

Statutory ceilings on non-executive directors’ compensation individually and in
the aggregate (not to exceed 1% of net profits of the company if there is a
managing director, whole time director or ‘manager” and 3% in any other case) help
to contain such expense within reasonable limits (unlike in the US where no
such limitations apply as long as the company’s remuneration policy for
directors and certain other details are disclosed to shareholders in the annual

Prohibition of stock option grants to independent directors is aimed at
promoting independence levels (unlike in the US);

Statutorily providing for board diversity by mandating at least one woman
director on the board (although several countries in continental Europe and
even the United Kingdom (UK) have, or are fast moving towards, such provisions
(with the European Parliament having approved a draft directive to have 40%
representation for the under-represented sex on listed company boards in member
countries); the US (barring the State of California effective 2016) does not as
yet  have any such mandate (companies however are required to report to
shareholders whether they consider diversity in board composition and if yes,
how they implement it);

Statutorily enabling election of a ‘Small Shareholders’ Director’ to protect
their interests (although the idea may be conceptually flawed, since once
appointed a director from whichever constituency, the person’s fiduciary
obligations extend to the whole company and body of shareholders, not limited
to the constituency that elected him or her). There are no comparable provisions
in the US or other developed markets.
Right to Protect Holdings Equitably
Shareholders’ rights to peaceably hold,
dispose or otherwise deal with their holdings can be vitiated under certain
circumstances such as when preferential issues of capital are made to some but
not all the shareholders, or when mergers or acquisitions take place, or when
there are changes in the ‘control’ of the company, and so on.  Some of the
legislative or regulatory provisions in India seeking to protect shareholder
interest are undernoted.

Fair price discovery methodology mandated based on market prices over a period,
in case of offers to buy out shares from holders so inclined to sell (the
relatively small and shallow trading operations may render these mechanisms vulnerable
to manipulation by vested interests, but if they succeed even to a limited
extent they would be welcome);

Mandatory offer to buy up to some prescribed percentage shares from
willing shareholders in case of acquisitions and/or change of ‘control’ of the

In the event of ninety percent of the capital having been acquired by the
majority shareholders, the remaining ten percent shareholders can be squeezed
out whether or not they wish to sell their holdings. The law provides for fair
and reasonable price to be paid to the concerned shareholders.
Right to Credible and Comprehensive Feedback

Entitlement to receive annually detailed financials and reports of directors.
Disclosure requirements in India are probably the most comprehensive among
comparable and developed markets;

Right to appoint independent statutory auditors vested in shareholders at their
annual general meetings, unlike many other jurisdictions where the audit
committee of the board decides on the appointment and remuneration of such
auditors. Auditor independence criteria and rotation are other topics
statutorily covered in India;

All subsidiary company accounts and financials need to be audited individually
and summary results made available to the shareholders of the holding company,
with full audited accounts being made available on holding company websites
 (unlike in jurisdictions such as the US where unlisted subsidiaries’
accounts need not be audited separately or made available to holding company
Right to Protect and Determine Business Purpose,
Continuity, and Solvency

Restriction on the powers of the board in respect of selling, leasing, or
otherwise disposing of the whole or substantially the whole of the undertakings
of the company;

Restriction on borrowings aimed at preventing undue financing risk of the
company without specific shareholder concurrence by a super majority for
borrowings beyond the aggregate of the company’s paid up share capital and free

Restrictions and disclosure of contributions to political parties;

Contributions in excess of prescribed limits, to charitable and other funds to
be approved by shareholders;

Modifications in the objects clause in the charter documents may not be made
except with the approval of shareholders by a special (super majority)
resolution through postal ballot (to provide for widest possible access to all
shareholders). Companies with unspent money from an IPO are also required to
offer an exit option to dissenting shareholders.
Right to Agitate against Oppression and Mismanagement

Eligible shareholders (at least 100 in number, or at least 10% of the total
number of shareholders, or holders of at least 10% of the issued share capital
including preference capital if any) may seek legal redress in case of alleged
oppression of shareholders or mismanagement of the company, prejudicially
impacting the interests of the company or its shareholders;

Central government has been vested with powers to carry out inspections and
investigations on the basis of a special resolution of the shareholders or a
report from the Registrar of Companies, or in public interest. Similarly,
government’s Serious Fraud Investigation Office is also empowered to undertake
investigations in appropriate cases.
Right to Reasonable Protection from Tunnelling

A common method of unfair expropriation of shareholder wealth by controlling
shareholders is through related party transactions favouring the controlling
shareholders at the expense of other absentee shareholders. By prohibiting such
shareholders from exercising their votes supporting resolutions on such
transactions at shareholders’ meetings, interests of shareholders not in
operational control are safeguarded since only they can by a majority approve
or reject such transactions;

Audit committees are required to review and approve or reject all related party
transactions; although this requirement imposes a very onerous responsibility
on audit committee members, it provides a valuable oversight mechanism to
filter out abusive related party transactions, protecting other absentee
shareholders’ interests.
B.    Shareholder Primacy in India: Fact
and Fiction
While these and other such measures clearly
indicate the legislative intent of protecting and promoting shareholder primacy
in key areas of company governance, whether these translate in to reality is a
moot question. There are several reasons why these measures are rarely utilised
optimally to their full potential, some of which are undernoted.
Attendance and Voting at Members’ Meetings

In general, votes are exercised at members’ meetings in person, or by proxies
present at the meeting. Attendance at such meetings thus assumes great
significance. Traditionally, only a fraction of the shareholder population
takes the trouble of attending meetings, either because their miniscule
holdings do not merit or justify the time and effort involved or they simply do
not have the expertise to meaningfully participate in such meetings;

To incentivise attendance (as well as to minimise and manage any potential
shareholder hostility), companies have often offered some freebies but even in
such cases, it is not unusual for many shareholders to collect the freebies and
depart without participating in the proceedings, or just be mute spectators.

To obviate this deficiency at least in respect of key resolutions coming up for
approval, a system of postal/electronic ballot has been introduced for some
years but even this appears to have had limited success due to continuing
retail shareholder indifference; but a regulatory mandate covering mutual funds
(but not other institutional investors as yet) regarding disclosure of voting
details with reference to their investee companies has led to a significant
increase in their voting participation. 
Investors Apathy and Impact of Crony Capitalism

Many institutional investors, especially in the foreign institutions category,
believe their relatively small holdings (in their overall portfolio) in the
companies do not justify the cost of monitoring and evaluation of governance
practices, and participation in voting. To some extent, emergence of proxy
advisory firms appears to have persuaded at least some of them to more actively
participate in members’ meetings in recent years. Blatant breach of basic
governance norms of course do attract their intervention (as in the case of
Satyam Computers) but even then, the time consuming and costly processes of
navigating such interventions through the Indian judicial system often act as
major deterrents;

Large domestic institutional investors largely are owned or controlled by the
State and hence their voting decisions are as often as not likely to be
influenced by political compulsions of the incumbent government. Traditionally,
business and government nexus or crony capitalism has worked to their mutual
advantage both in the field of policy making and in operational facilitation (here). As a general rule, governments of
the day in India have tended not to upset incumbent managements of companies (as
for example, in the case of (now Lord) Swraj Paul’s unsuccessful attempts to
take over DCM and Escorts, two of India’s vintage companies in the nineteen
eighties). Manifestation of this basic policy of calculated non-interference
usually takes the form of such institutions abstaining from participating in
meetings or voting on key resolutions, paving the way for incumbent management
or the “establishment” to cope with any serious challenge
C.        Strengthening
Shareholder Primacy
Maintaining a tenuous equilibrium of
constructive tension among shareholders, boards of directors, the executive and
the controllers is an important mechanism for establishing good governance in
companies. Any effort to further strengthen the level of good governance will
need to address both the inhibitors and the gaps in the governance structures.
Following are some areas where further scope for improvement likely exists.
Enhancing Institutional Investor Participation in Company
Institutional investors do have their
accountability and trusteeship obligations to their own stakeholders and in
that context likely owe it to them to actively participate in their investee
companies’ governance processes to contain governance risk premiums such
companies’ securities suffer. The Stewardship Code dealing with such
institutional investors may be revisited to explore further strengthening of
its provisions to promote greater investor participation in such matters.
Independent Directors towards Enhanced Contribution
Having introduced the undoubtedly valuable
institution of independent directors in board governance, it is probably
opportune now to take some further legislative initiatives to strengthen the
voice of independence at the board level (here)
Following are some of the measures that may help in that direction:

Certain key proposals and decisions to require affirmative approval of a
majority of all independent directors (whether or not present or participating);

Quorum requirements for board and committee meetings to require the presence of
a majority of the independent membership of the board or the committees. The
newly introduced requirement of presence of at least one independent director
at board meetings is a good beginning but its utility is likely limited since
it applies only to board meetings called at short notice.
Countervailing Controlling Shareholders’ Inappropriate
Board and director “capture” is a
well-established phenomenon that impairs good governance; to shield the
institution of independent directors from the debilitating effects of such
practices, some structural reforms may be necessary in countries like India
where concentrated corporate ownership and dominant control are the rule rather
than the exception. Following are some of the measures may help in this

Recommendations of the nomination committee for induction of new independent
directors to be approved by a majority of only the independent directors on the
board (whether or not present and participating) for tabling at shareholders’

Resolutions electing new independent directors at shareholders’ meetings to be
approved by a majority only of shareholders not in operational control, with
controlling shareholders not participating in the voting (such a restriction on
voting rights has already been accepted in principle in case of related party
transactions). This measure is justified on the basis that one of the major
role of independent directors is to monitor executive performance to ensure
wealth is created and created wealth is passed on to (or held for) all the
shareholders of the company; in electing such directors with a surveillance role
over the executive, it is not unreasonable to disempower shareholders in
management whose activities are to be so supervised, from voting and
influencing the  election of such independent directors;

Independent directors “resigning” mid-term during their tenure to be required
to explain the reasons for their decision to the shareholders at an immediately
following members’ meeting for approval by a majority only of non-controlling
shareholders. Barring extenuating personal circumstances, such “resigning”
directors may also be required to be present at the members’ meeting and
respond to any questions from the non-controlling shareholders.
Pretty much the same reasoning also applies
to the appointment of independent statutory auditors whose role by definition
is to objectively examine the affairs of the company and report to shareholders
on the true and fair status of the financials. Accordingly, it would not be
unfair to require that their appointment at the general meeting of members be
approved by a majority of non-controlling shareholders, with the controlling
shareholders’ votes not being reckoned. Auditors’ resignations or proposals for
their replacement may also similarly be required to be subject to approval of
the majority of non-controlling shareholders, with such auditors being required
to explain their viewpoint to them.
D.        Towards Better Governance in a World of
Concentrated Corporate Ownership
It is apparent from this discussion that Indian
corporate law leans towards protecting and promoting shareholder primacy even
while recognising other stakeholder interests and  offering substantial
freedom to the boards and the executive to carry out their responsibilities.
The sting in the tail however is that many of these wholesome provisions are
frustrated partly out of non-controlling shareholders’ own indifference and
partly by gaps in measures aimed at containing self-serving controlling
shareholders in pursuit of their illicit objectives. Of course, there will be,
and indeed are, examples of excellence even now of controlling shareholders
with exemplary concern and behaviour towards absentee shareholders and their
interests but regrettably they are relatively a small proportion of the total
corporate population. This post has enumerated some of the measures that may
help to bridge these gaps and take the country closer to better standards of
governance in the corporate sector.   
As a general rule, excessive and invasive
legislation is not a preferred option in a free market economy and it would be
ever more desirable if corporations were to adopt such measures on their own
and distinguish themselves from the rest. Sadly, experience
in most countries has shown that corporations tend to respond to mandates than
exhortations. Affirmative action in respect of having due share of women on
corporate boards is a telling instance of legislation over persuasion being the
more effective method of achieving objectives as observed in continental Europe
and the UK in recent decades. Nevertheless, the recommended measures may
perhaps first be introduced on a “comply or explain” basis and depending upon
the level of observed compliance in practice over a two or three year period,
and be made mandatory if found necessary.
N. Balasubramanian

Assistance provided by Jitendra Nath Gupta and
Stakeholder Empowerment Services is gratefully acknowledged

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.

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