More power to the minorities

Written by Kaushik Dutta | Vikas Relhan | Updated: Jan 12 2012, 08:35am hrs
In recent times, citizens activism on corruption in India has got the attention of the world and has made the political and other establishments take cognisance of the power of these protests. Outside India, the Occupy Wall Street campaign has been taking various countries by storm and has been focussing attention on the excesses by the high priests of the street. Do our current laws empower us to demand our entitlements in a normative manner Or is activism the last resort for protesters, who are seeking redressal for their grievances

Indian laws, in many ways, have focussed on a continuum of the status quo, where the accepted balance of equilibrium is rarely altered, whether by law or by collective action. Most Indian commercial laws are drawn up in line with the best practices in the world but, in implementation and seeking redressal, the rule of law is rather weak. Hence, dispensation of law becomes ineffective when the fear of consequences for a breach of the law is not a deterrent.

Despite the delays in the delivery of justice, Indian investors have rarely resorted to activism when their rights have been compromised. Large institutional investors, who lead this process in mature markets, are relatively quiet in India and no significant measures

of protests against corporate misdemeanours have been initiated by them.

Perhaps the first prominent example of shareholder activism in India was in the case of the merger between Maytas and Satyam. The protest against the merger was led by most of the institutional investors on the grounds of unjust enrichment of the Raju family; fearing a backlash from capital markets and regulators, the decision was quickly reversed by the companies. Institutional investors could be effective in this instance primarily because the Raju family owned less than 10 % of Satyam at that point of time and therefore had fewer voting rights.

However, the usual behaviour of non-promoter investors in India is that of acquiescence rather than activism.

Shareholder activism is a means of assertion of rights by an individual or group of shareholders vis--vis the owners and management of a company. Activism may include say-no-pay proposals, class-suit actions, to exit, private discussion or public communications with corporate boards and management, even putting forward alternative shareholder resolutions and, as a last resort, seeking redressal from regulators and courts. Activism works as a counter-balance when owners or managers have significant entrenchment rights. Entrenchment rights by definition imbue the owners or managers with control of the business by virtue of their ownership and thereby create a channel to increase private benefits of such control.

Stephen Bainbridge of UCLA in his paper Shareholder Activism and Institutional Investors says that efforts to extend the shareholder franchise, principally so as to empower institutional investors, is based on the premise that institutional investors will behave quite differently than dispersed individual investors. Because they own large blocks, and have an incentive to develop specialised expertise in making and monitoring investments, institutional investors could play a far more active role in corporate governance than dispersed individual investors traditionally have done.

However, he concludes that despite such compulsive reasons to do so, even in a mature capital market like the US, institutional investor activism is rare and limited primarily to union and state or local public employee pensions.

Most companies in developed economies have a dispersed shareholding where founding families, individuals or funds rarely have majority ownership as a singular block. People responsible for the management of such companies are often professional managers who have a low ownership and are responsible to the board. Hence, institutional investors, by virtue of their large shareholdings, have an influence in a shareholders meeting on decisions relating to a directors appointment, remuneration, functioning, etc. This power of oversight creates an accountability framework of the board and the management for these investors.

In India, the factors that create high promoter entrenchment include a high concentration of shareholding, lengthy legal enforcement processes and non-substantive rights of outside shareholders. These factors create a power equation that favours the

promoters with an unquestionable position as it relates to the control of a listed company.

As of September 2011, 48% of the listed Indian companies in the BSE 200 had majority shares held by their promoters. The power of these promoters in a shareholders meeting is nearly absolute and hence smaller shareholders, including institutional investors, have a negligible say in matters of operations and governance.

In such a situation, do our laws enable activism so that the minority shareholders can exercise their rights in a fair and effective manner Does the new Companies Bill deliver to the small investors in that regard

The Companies Bill 2011 has introduced a host of focused measures to ensure greater enforcement of the spirit and letter of corporate laws and address their grievances. The Bill proposes a number of clauses that would improve governance through a mechanism that allows smaller shareholders to question decisions of the management, quicker redressal mechanisms and punitive consequences for dereliction of duties for persons in charge of governance including gate keepers, like the auditors.

The Bill looks at the board as a unit of management and oversight of an enterprise, which is primarily responsible to its shareholders. It has provided options to appoint a director representing minority shareholders on the board, create a veto power for independent directors in certain situations, require consent of minority shareholders for appointing an independent director for the second term, etc.

The Bill empowers groups of small shareholders, including private equity investors, to collectively pursue majority shareholders or promoters who act in a manner that benefits only the dominant ones. Such a group of shareholders, if so aggrieved, can file an application with National Company Law Tribunal to restrain the company and its directors from any act that are based on a resolution of shareholders obtained through the suppression of material facts, or that are contrary to the provisions of the Companies Act or any other law. Small shareholders are free to object to any variation in their rights or if the affairs are being conducted in a manner prejudicial or oppressive to any member or prejudicial to public interest with an application to the tribunal and claim damages or compensation, including disgorgement of illegal gains, against all those who were involved in detrimental actions, including class action suits.

The Bill also provides an exit option when shareholders have differing views on a change in object for use

of money raised in an IPO, or disagreement on a variation in terms of contract or objects in a prospectus, or dissenting from scheme or terms of merger.

One significant change the new Bill proposes is keeping shareholder actions outside the purview of the court and placing them within the jurisdiction of the tribunal, which, due to its specialised nature, is expected to

be more efficient and time-sensitive than the court system. The tribunal system has worked very well in income tax and other taxes, labour and other laws; there is reason to expect that tribunals would be effective for corporate laws. A higher speed of enforcement actions reduces the information asymmetry and lowers the overall cost of transactions, which some recent studies done by C Luez of Chicago Universitys Booth Business School, put at as high as 13%. The benefits for India from such enforcement, which ultimately reflects in lower cost of capital will be higher.

The punitive consequences for gross negligence and misstatements, together with higher level of disclosures and regulatory oversight, will make the gatekeepers of the corporate world acutely aware of their positions and this would create a counter-balance on the power the dominating shareholder currently wields. The accountability of the management and owners would undergo a significant shift and their absolute power over the affairs over a company will be restrained.

Kaushik Dutta and Vikas Relhan are members of Thought Arbitrage Research Institute, a not-for-profit company involved in research in corporate governance, sustainability and public policies affecting business