The board of directors is elected by a company?s shareholders. In case of listed companies in India, the law stipulates that a certain proportion of these should be independent directors. Even independent directors are elected by shareholders, who are thus the supreme deciders of the body that would steer the company.

But, shareholders of a listed company are a dispersed lot. Hundreds of thousands of individuals and business entities own its common stock. Individual investors with an investment of up to Rs 100,000 each accounted for 24% of the shareholding of blue-chip giant Larsen & Toubro, currently a front-runner to buy the tainted Satyam. On an average, 7% of the stock of the Nifty50 companies is in the hands of such small investors.

Disclosures by listed companies made to their Exchanges provide a useful set of data to analyse their ownership pattern. Shareholders are divided into promoters and non-promoters. This is quite intuitive. A group of companies, trusts or individuals belonging to a business house could float a new company. The business house in this case is the promoter of the new company. Other investors into the company are the non-promoters. Non-promoters include an important constituent?the institutional investors.

Normally, the promoter group of the company has a controlling stake. Either the promoters? ownership is over 50% or it has the implicit support of select non-promoter groups. It is this promoter group that dominates the shareholder meetings and therefore determines the constitution of the board of directors, including the selection of independent directors and the statutory auditors. It also selects and determines the composition and compensation of the top management team.

The average shareholder perceives a company to be one run by the promoter. We all identify Tata Motors and Tata Steel with the Tatas and Grasim and Hindalco with the Birlas. The shareholding pattern data show how much such promoter groups own and how much the others own. This throws up interesting lessons.

First, while the distinction between promoters and non-promoters seems appealing, it has some problems as companies mature beyond the interest of their initial promoters. For example, Larsen & Toubro has no class of shareholders that are classified as promoters. The original promoters have sold their shares to others who do not classify themselves as promoters. Similarly, ITC has no promoters. Neither do ICICI and HDFC. The question then is, who determines the board of directors of these companies? Who will ratify or decide that Chanda Kochar should indeed succeed KV Kamath at ICICI? Who will decide the successors to AM Naik at Larsen & Toubro and Deepak Parikh at HDFC?

Are institutional investors engaged in the selection of the next CEO of these companies? Or will the current CEOs select their successors who would then be endorsed by the board and thereafter ratified by shareholders at large? It is quite likely this would be the case, which would work well while we have great men at the helm. But there is no institutional framework to handle the eventuality of the CEO turning out to be a person of low scruples, till institutional investors become active participants in the running of companies. Satyam Computer Services is eerily close to the companies with no promoter shareholding. Satyam has the lowest promoter shareholding amongst the Nifty50 companies.

The promoters of Satyam owned 8.6% of the company as of September 2008.

At this level, it was neatly ensconced between companies that boast best practices in corporate governance. Just above it was Infosys, and below it were the four companies with no promoters. So, what happened to Satyam?s shareholders could easily happen to others unless shareholders take greater interest in who runs the company.

At the other end of the spectrum are companies where promoters own most of the equity. In 29 or in 58% of the Nifty50 companies, promoters own a majority stake. Of the 3,610 companies for which such data was available for September 2008, promoters held a majority stake in 53% of the companies. Thus, in most companies, promoters own most of the stock and, prima facie, this concentration of stock with the promoters is higher in larger companies. It follows that in most listed companies promoters would determine the composition of the board of directors, the selection of independent directors, the selection of auditors and the selection of the CEO and the management team. In reality, promoters determine these even in companies where they do not have a controlling stake.

Potentially, these non-promoter holdings can wield influence in companies where they have sizeable numbers. In the case of Satyam, FIIs owned almost 49% of the equity. They objected to the merger of promoter-controlled Maytas with the company.

Thus, a well-distributed pattern of ownership amongst large and active institutional bodies provides a good check on corporate misgovernance. Small individual owners are ineffective because of their dispersion. But large institutional bodies such as mutual funds, investor companies, banks and insurance companies have the financial and legal wherewithal to understand the ramifications of management actions. Collectively, they also have the voting power to influence decisions. These, therefore, provide a good balance against the unchecked will of the promoter-manager.

If such institutional investors find a place on the board of directors, even a company with a promoter holding of over 50% could remain in check against misgovernance. A diverse set of large institutional owners with a significant stake in the company and a representation on the board of directors would be a better check on the company?s management than any professional or elite oversight body.

How widely held are the Indian listed companies? We answer this question for the Nifty50 companies.

To do this, we measure the index of dispersion of ownership between groups. This is the sum of the square of the shares of 11 ownership groups. These are: Indian promoters, foreign promoters, mutual funds, banks, FIIs, other institutions, corporate bodies, individuals with investments up to Rs1 lakh and individuals with investments over Rs1 lakh, other non-institutions and custodians. An index of 1 indicates that the company is owned entirely by one group and as the concentration of ownership declines, the index also declines.

The inverse of the index of concentration can be interpreted as the effective number of equal ownership groups. We denote this as N. It denotes the number of equal ownership groups that the given ownership structure reflects. Thus, the number 4 for example, indicates that the company?s ownership distribution is the equivalent of four ownership groups with equal ownership (of 25% each). The index of concentration is based on the ownership share of 11 groups. Of these 3?other institutions, other non-institutions and custodians?are not significant. Thus, if a company has a concentration equivalent of 8 equal ownership groups, we may consider the company to have the maximum dispersion in ownership. An N of 1 indicates maximum concentration of ownership.

Of the Nifty50 companies, 12 were as good as owned by a single group. These included 5 PSUs. The danger of bad corporate governance in this group of companies going unchecked is the highest. Promoters control over 75% of the equity in this group. And 14 companies had concentration levels equivalent to 2 equal ownership groups and 8 had a concentration of 3 equal groups. In most of these 22 companies, promoters owned over half the equity. Yet, the concentration was effectively low.

When N equals 4, the share of promoter ownership drops to less than 50%. Interestingly, this list includes Hero Honda in which promoters have a nearly 55% stake. But, this is almost equally divided amongst 2 promoter groups, the Indian Hero group and the Japanese Honda group. FIIs own close to 23%. This is a healthy balance of ownership from the point of view of corporate governance and the value N captures this well.

The immediate inference we draw from this is that while 58% of the companies showed a majority ownership of equity by the promoters, the concentration index shows that the ownership of equity is monopolistic in only 24% of the companies. It would be useful if this dispersion of ownership could be exploited to construct a board of directors that would bring in checks and balances for better corporate governance.

Earlier, I had suggested that the composition of the board of directors should reflect the broad pattern of ownership of the equity of the company. Now, we have an alternate proposal: we can form a board of N groups of directors elected from N shareholder groups, where N is the measure of dispersion of ownership. Thus, promoters of companies such as DLF can effectively continue to have complete control on the board. But, Unitech would have to share the board equally with one more group that may comprise all non-promoters. This substantially reduces the promoters? sweeping powers over the board, the auditors and the top management of listed companies. It ensures that no group dominates the board as it?s necessarily formed of N equal groups formed from shareholders.

Reforming the composition of the board is the most important part of corporate governance. If the board is a fair representation of shareholders and if no single group has a dominant share of the board, then the self-interest of various groups will ensure that no group works against the interest of the rest. Here, we have presented a solution in N groups.

?The author head the Centre for Monitoring Indian Economy