When the Naresh Chandra report on corporate governance was released and amendments proposed in the Companies Act, many welcomed it. Jamshed Irani, however, made a practical comment. Legislation, by itself, he said, would not bring about improved governance. In my view, it is the mindset of owners, promoters and others who form the governance of a company which has to change. If legislation was all that was required, India would by now be a socially reformed country, with no dowry, no sexual harassment at work or elsewhere, no child labour, universal education, no discrimination on account of religion or caste, and so on. It is not the existence of a law but the willingness to obey it, and on the part of the state, to enforce compliance, that matter.
It is not as if companies are governed in the best possible way in developed countries. The many reports of corporate misbehaviour by chief executive officers in some of the largest and best-known companies in the United States of America demonstrate the non-compliance of a few. The punishments meted out to those who are caught ensure that more comply than defy.
India has many instances of such non-compliance by managements of the principles of good governance, perhaps on a smaller scale. But rarely has any manager or “promoter” been severely punished. The recent disclosures from Britannia are probably only the tip of a large iceberg, not merely in that company but in many others. Little is disclosed to shareholders since companies fear that the damage might spread and disclose the misdoings by many more in the company including the owner-promoters and the CEOs.
Nor are government-owned companies models of good governance. Many of them are said to have been sources of illegal funding for political parties and individual politicians. Some company executives are said to have diverted large sums to bribe influential figures for securing appointments to plum positions. It is common knowledge that many of them pay for the expenses on telephones and telephone calls, entertainment, five-star hotel accommodation, air conditioners and so on, of important officials in ministries that control them.
Legislation is not going to stop all this. What will make managers more careful are transparency, disclosure, speedy prosecution and trials, and severe punishment. But it can never be stopped altogether. Successful CEOs — like leaders in other fields, with people hanging on to their every word, the media building their image (with some help from public relations agencies), vast powers over everyone in their companies — after a while develop a sense of their invulnerability and indispensability. They begin to feel that the normal laws and mores no longer applied to them. The Greeks called this hubris. Even the legendary Jack Welch does not appear to have escaped this feeling. When he was in charge, GE was considered the greatest company and Welch the most effective manager in history. After he left the company, some skeletons have appeared out of the GE closet and the present CEO has had to manfully pick up the pieces while avoiding any adverse reference to his predecessor.
Will independent directors, audit committees, compulsory cost and secretarial audits, and other new rules introduced by law make a major difference' As many commentators in Britain and the US have pointed out, owners-promoters-CEOs appoint the independent directors. There are growing financial rewards to these directors. Can we expect all of them to be uninfluenced by the money' How independent will they be in expressing opinions when their retaining such rewards by remaining on the boards might depend on the goodwill of the people who invited them'
There is another problem in India. We have over a billion in population, but that does not mean that we have a large reservoir of talented people who can contribute to a company’s better governance. We need to have a clear understanding of the skills we need from independent directors. They are there to ensure good governance. They need not be entrepreneurs. The owner or promoter or the employee-CEO fills that role.
But independent directors, like other directors, must have knowledge and understanding of the social, political and economic environment, corporate accounting and finance, human resources management, experience in discovering the reality behind information given to them, and the mental strength to separate financial rewards from the independence of their opinions. Perhaps a neutral outside* body could scrutinize and prepare a list of all those who might be invited to join a company’s board. Companies might then be forbidden from inviting anyone from outside such a list. This might prevent “grace and favour” appointments and ensure the appointment of qualified people.
But the suggestion that there must be a minimum number of women on corporate boards does nothing to improve the status of women, while it lowers the quality and effectiveness of boards. If there are not many women directors, the reason is our social conditioning that compels talented women to make their careers subservient to those of their husbands. That leaves very few women who have served in senior positions for long enough to be of value as independent directors of companies.
One suggestion that has been made in Britain is that independent directors should have one of them as a second head like the chairman of the company, who can go into any aspect of the company. But this might be diluting the authority and responsibility of the chairman of the board and even of senior managers. What is eminently possible is that independent directors meet by themselves, that they meet operating managers from time to time, and reinforce each other so that they do function independently. Another possibility is to put definite limits to their terms of office so that the temptation of another term on the board does not influence their judgment.
The law now places great reliance on independent audit committees to ensure that all is well with the accounting policies and adherence to them by the company. This may work well in small companies and those with limited diversity of operations. But a large and diverse company has many ways in which accounts could be dressed up for many years to look good. WorldCom did that for many years in the US until they could not continue with their malpractices.
Companies marketing consumer products spend vast sums of money on advertising and promotion. No audit committee is in a position to examine these expenses for their need, adequacy or excess and the quality of the advertising or promotion. Their competence and information will be insufficient. Many marketing decisions ultimately are based on intuition, and audit committees are not supposed to look at accounts with intuition, only at their compliance with policy.
Auditors after the Arthur Anderson-Enron episode in the US have now distanced themselves from responsibility for the accuracy of the accounts that they audit. It is too much to expect independent directors to be able to do so. Ultimately, it is the quality of the CEO and management that will ensure it. Perhaps we could encourage insiders to report malpractices and protect them from vengeance. At the same time we must also be able to deal with those who use the opportunity to sabotage their seniors, a practice quite common in government and the public sector.
There is no magic wand for good corporate governance. It requires a strong base in ethics and values. It demands tough penalties that are enforced quickly, even to the extent of sending thieving CEOs to jail as the US has done quite often. By itself, legislation without severe consequences for violators will take us nowhere. This is particularly the case when large violations by ministers and bureaucrats go unpunished. The corporate executive has poor role models to follow from public life.