The Telegraph
Since 1st March, 1999
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- The government must change its attitude to state-owned enterprises

It is good that the chairman of the Oil and Natural Gas Commission has dared to publicly oppose the petroleum ministry's attempt to pack the ONGC board with more ministry officials as nominees and that the minister has overruled the bureaucrats. There are broader issues at stake here than of bureaucratic egos. They relate to corporate governance, managerial autonomy in state-owned enterprises and conflicts of interest when government is both regulator and participant.

The Securities and Exchange Board of India has issued guidelines for listed companies under clause 49 of its listing agreement to be enforced from December 2005. But many private companies started implementing them well over a year ago. This rule requires that a listed company have half its board as independent directors if the chairman is an executive. The rule applies to all listed companies. State-owned enterprises could not be exceptions. Indeed, as the rule maker, the government should have applied it to all its enterprises, listed or not.

But so far, the government has packed the boards of its enterprises with pliable government nominees. Under the definition of independence by Sebi, the proposed amendments to the Indian Companies Act and the J.J. Irani report on it, government nominees even from another ministry, cannot be regarded as being independent. Serving government officers are subject to government discipline and must act according to the wishes of the ministry concerned that exercises the ownership rights of government.

Though the revised amendments to the Indian Companies Act try to dilute this provision, Sebi has been adamant in insisting that its guidelines for listed companies will remain as they are. The ONGC is a listed company with an executive chairperson. The government holds 74 per cent of the shares. With 26 per cent public holding, the company must have seven independent directors out of a total of fourteen. Of the fourteen including the chair, four are nominee directors (including one from Indian Oil). Nominee directors are not independent. They are there to safeguard the interests of the body that nominated them, not those of all shareholders, like an independent director is expected to do. Another three are government nominees of which two are from the petroleum ministry and one from the finance ministry. This number was to be increased to five.

The government was pushing for the director-general of hydrocarbons to be one of them. There are six functional executive directors' positions. Among them two have yet to be filled. Thus, a board already packed with representatives of the principal shareholder, namely, the government, was to get more of the same type. There is no representation for the 26 per cent which constitute other shareholders. Such packing of boards is common to all state-owned enterprises. It is a travesty of good governance. The chair of ONGC was correct in resisting it.

For many years, there have been attempts to improve performance in state-owned enterprises. Multiple objectives for each enterprise, with vague un-quantified 'social' objectives excusing poor financial performance, has been one reason for poor performance. But the most important flaw is the lack of distance between the representatives of the owners, namely, bureaucrats and ministers, and the enterprises. Many solutions were proposed and tried.

The principal one was the memorandum of understanding between the enterprise and its departmental ministry. Each was to set out its targets in terms of what it would achieve in the year and the actions it would take to achieve them. In the case of the controlling government department, the commitments were about the actions it would take that were required to help the enterprise perform its objectives. The MoU has over the years become a mammoth exercise for the enterprise, involving many layers of employees including top management, over many months.

For the government it is now a minor exercise. A junior officer prepares it. There is no longer a commitment that the government will perform on its indicated tasks. The excuse is that no single department can commit for the government since there are so many other ministries whose actions are involved and over whom the department has no control. The MoU as an attempt to distance the government by this process of mutual commitment has failed. Other attempts have not stopped bureaucratic interference and use of the state-owned enterprise as a honeypot to dip into for extra benefits beyond their remuneration. ONGC has recognized this to be a futile paper exercise that diverts employees from their responsibilities. It is reported to have refused to waste any more time on it.

The recent spat about new directors in ONGC also points to a serious conflict of interest. The director-general, hydrocarbons, is the key figure in allocating exploration blocks to parties including ONGC, represents the government in dealing with private companies that have production-sharing contracts with the government, monitors the development of exploration blocks, including the costs, and certifies the reserves claimed as being unearthed by developers. This regulator is not independent of the government as perhaps he should be. But he is clearly a regulator and his sitting on ONGC's board certainly jeopardizes his neutrality between parties. It also makes it possible that sensitive corporate information will reach his competitors. Government officers with such regulatory responsibilities covering the whole industry should not sit on the boards of any of the companies they regulate. This rule must apply everywhere. For example, the power secretary of a state government sitting as a government nominee on the boards of private distribution companies should not be doing so.

Governments have huge investments in state owned enterprises. Some are listed companies; many are wholly under government ownership. Government ownership means that the people of India are the shareholders. Good corporate governance requires that all shareholders are fully informed about the company's performance and that the decisions taken are transparent and in the interests of shareholders. Bureaucrats and ministers exercising authority on behalf of the people over these enterprises need to be conscious of this. Independent directors help in keeping a watch on them to protect the interests of all the shareholders.

They can ask questions that government nominees might not ask because they are part of government. Other nominee directors are not concerned in matters beyond narrow sponsor interests. To an extent, the presence of independent directors prevents the government from undue interference in the decisionmaking process of the state-owned enterprise. It is not a perfect answer since independent directors could also be captured by temptations or connections.

Sebi has a responsibility also to prevent company management from influencing share values against the interest of shareholders. The recent public debate among the communists, the government and the oil companies on revising petroleum product prices after the rise in crude prices is one such example. The huge losses of the state-owned oil companies that are also listed on the stock exchange, and have private shareholding, affect share values. Even if the companies were not listed, the government should not interfere in corporate decisions that affect the value of the company. Instead, it should have a transparent process of determining prices of sensitive products so that everyone concerned knows how price decisions were taken. If it wants lower prices the government can always give cash support.

The government is good at preaching ethics and morality to private companies. It is not as principled in following its precepts in enterprises in which it has whole or dominant stakes.

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