Performance and institutional investors

Updated: Feb 22 2006, 05:30am hrs
The concept of independent directors has generated a considerable amount of debate. Though most companies have complied in letter, the spirit is still far away. Even then, independent directors will deliver little value; they would always be insiders. And retail shareholder activism is yet to take off in India. Experience of several developed countries shows it is for institutions that are better placed than most others to play a leading role in monitoring corporate governance in their portfolio companies, and that failure to exercise their rights results in losses for their investors.

Very little has been discussed in India about the role of institutional investors in corporate governance. In the past, most investors were individuals, and could manage to engage with the companies only at the annual general meetings. The scenario has changed. Not only have institutions become major shareholders (holding more than half of the floating stock of the actively traded listed companies) but also represent larger retail investors monies (mutual funds manage over Rs 200,000 crore). So, they have an active role to play, especially as they have a fiduciary responsibility and other flanks of corporate governance are weak.

The universe of institutional investors can be broadly divided into two. One, institutions with a clear public good dimension, as they represent the common persons money. These include mutual funds, domestic financial institutions, provident funds, insurance companies and banks. Two, FIIs (foreign institutional investors) and venture capitalists, representing both public and private investors.

There are two aspects of this debate. One, institutional investors role in the corporate governance of their portfolio companies; two, corporate governance among themselves.

A World Bank recent survey with respect to India shows that most domestic mutual funds take a passive role in the corporate governance of their portfolio companies. They rarely, if ever, review the agenda of shareholders meetings, do not attend shareholders meetings or convene informal meetings with the management. Insurance companies and banks are only marginally more active. FIIs are a shade better.

Significantly, all of them support the incumbent management. Most institutions are myopic investors, uninvolved in corporate governance. They prefer that contentious matters be resolved behind the scenes. Even the best chief executive of an institution is not willing to be an activist or be perceived as one. Little wonder, we have not seen a mutual fund vote against a resolution or take a company to the media or to the court.

Independent directors can deliver little value, they would always be insiders
Regulations focus on minimising litigation, not investors informed decisions
Institutional investors can play an active role, but are passive and myopic
The time has come when institutional investors should intervene to shake up boards of under-performing companies and promote best practice guidelines for the structure and composition of boards of directors, executive remuneration and other matters. Participation by shareholders adds value; venture capitalists willing to invest ideas, and money, outperform the market. An active role by an institutional investors would help create wealth and fulfill the corporate social responsibility.

In recent years, considerable work has been done, both through legal and regulatory measures, to improve corporate governance, but enforcement remains a key challenge. Institutional investors, by their influence and knowledge, can enforce compliance in spirit.

We should recognise that government regulations are inherently inefficient. Regula-tors, monopolist by nature, but subject to political and public scrutiny, often seek comfort in rules and process. This is seen in prospectuses and information memoranda, where the overriding objective is to minimise the risk of litigation. Helping the intending investor to make an informed decision is a secondary goal. The investor is drowned with information but starved of knowledge. Large investors are better placed, which is why informed and active institutional investors operating in a free market are the best regulators.

The institutions can no longer be passive equity managers. They need to address issues such as voting by institutional investors (including circumstances when institutions vote against management and their views on confidential voting and compulsory voting); monitoring of corporate governance practices by companies; liaison with other institutions; views on the structure and composition of boards of directors (including independent directors and separating the roles of chairperson and CEO); use of board committees; director and executive remuneration; and barriers to institutional investor activism.

Mutual funds, for example, have a fiduciary responsibility to their members to improve the performance of their portfolio. They should have a more active and objective scrutiny of the companies they are invested in. Investor meetings and lunches have to give way to conference calls, group emails and video conferences.

There is also an urgent need to focus on the corporate governance of institutional investors themselves. These must become more transparent and accountable. They need to disclose their corporate governance and voting policies and voting records. They should also disclose material conflicts of interest, which may affect the exercise of key ownership rights. In the US, proxy votes made by mutual funds must be publicly disclosed. They should mandate disclosures of who owns what on a single website and put out the disclosure inverselywhat is owned by whom.

Corporate governance is, and should be, about performance and not conformance! In other words, it is a means to an end, not an objective in itself. It is now up to institutional investors to lift their performance. Time is not far when we will have the lead plaintiff provision of the US, under which large shareowners can be named controlling parties in class-action shareholder suits.

The writer is managing director, PRIME Database