INDIAN FAMILY MANAGED COMPANIES: THE CORPORATE GOVERNANCE CONUNDRUM BY - GOPIKA BANSAL
INDIAN
FAMILY MANAGED COMPANIES: THE CORPORATE GOVERNANCE CONUNDRUM
AUTHORED BY - GOPIKA BANSAL
ABSTRACT:
Approximately one-third of the
Sensex enterprises are pushed, controlled, and managed by family members[1].
These are large Indian corporations that must have expanded beyond the family's
control and bounds by their size. However, there are still many organizations
in the industrialized world that have been founded and managed by family
members, and a significant number of them have accomplished separating
management from ownership. Unfortunately, the scenario in India is far from
ideal. Even though their stake is small in contrast to other holdings, the
promoters are closely engaged in the day-to-day operation and manage the
businesses as their private property. As a result, this research paper
recognises that there are numerous aspects to consider concerning the role of
the board of directors, selection criteria, and independent director
independence with the help of various case studies. Furthermore, it proposes
that specific efforts be taken to avoid any instances of governance failures in
the Indian sector by being proactive and implementing "best" and
"next" practices.
RESEARCH PAPER:
Corporate governance, as a
subject, has been into recognition in the corporate world and businesses
globally. In India, overwhelming attention is being given to it. Corporate
governance is of utmost importance as a system of rules, practices, and processes
is formed through which a company is controlled and governed. Balance of
interest is maintained between the shareholders, suppliers, executive
management, administrative members, customers, and the community, and it
promotes ethical business practices further toward financial viability[2]. The
listed companies must comply with the SEBI deadline and fulfil the
criteria/requirements given under Clause 49 of the listing agreements[3].
With the corporate
governance scenario at Indian family-managed companies, the organizational
structure and its governance give an appearance of complication. Countries like
the United States and the United Kingdom have successful delineated management
from ownership. However, India is yet to cover the grounds in this regard. The feud
between the known entity of Reliance, the Ambani brothers, is one example that
opens the floor for debate on governance issues and family-managed companies.
On the board, multiple positions are allotted to the family members at the same
time when management positions are held, arising as a cause of conflict of
interest.
In
an Indian family-managed business, when business expansions start, the
structure of power, ownership, and process should be formalized as a priority
to promote professionalism. Thus, separation of management from the control of
ownership is imperative to corporate governance to maximize the benefits
pertaining to it and assure sustainability in business.[4]
Thus,
this paper addresses the issues pertaining in family managed businesses in
India related to corporate governance and classifies such problems broadly into
two-
-
Has the board of directors in Indian family-managed
companies been constructive in promoting corporate governance?
-
Whether the appointed independent directors are truly
independent and problems of finding the right calibre of independent directors
in required numbers.
Thus,
this paper raises the concerns that need immediate attention in Indian
family-managed companies on corporate governance and suggests specific steps to
secure a better corporate world.
BOARD OF DIRECTORS AND THEIR ROLES:
The Indian Family system, a
cohesive force, usually binds individuals to run business with families.
Surprisingly, many corporates are managed and promoted by family, yet news of
corporate failure because of lack of corporate governance and poor results are
minimal to none[5]. The
chief reasoning for this must be the promoters who bring the family having
enlightening behaviour of considering themselves at the position of trustees of
public wealth even when holding huge shareholding in the company.
Family-run
businesses are not limited to India. It is to be noticed that initially,
developed nations also promoted and managed companies in a family setup. Later,
segregation between management and ownership was encouraged in family-owned
companies to willfully utilizes all the benefits of ownership and minimize
conflict of interest and intrusion in decision-making. While in India, the
promoters are proactively part of the daily functioning and management of the
company.
It leads us to the
question- who are the ones who manage a company? It is the directors
whose job is to manage and control the affairs of a company. A group of these
directors in a company is called the Board of Directors. Collectively, it is
the responsibility of this group of directors or board of directors to manage and
protect the interest of its stakeholders.
The next question is, what
happens when ownership is not separated from management in
the family-managed
businesses?
We all are aware that
India is an emotionally driven society, especially when it comes to families.
It is not easy to demarcate these lines. One major drawback of not separating
ownership from management in a family-managed company is the high probability
of making corporate decisions influenced by family emotions.[6]
Another issue is that for non-family member employees, the working environment
is not very pleasing as they could be treated differently from other family
members and the growth prospects for them are limited. All this combined makes
it a hindrance in the growth and development of these companies.
The
governance system is not in its best position in India and is suited to be
explained with the example of Reliance Industries Ltd., (RIL) the most
significant private-sector enterprise. As per the relevant information
available through the issuance of a report from the media made public, the case
raised the question of whether one person could only take an essential decision
as of demerger or restructuring of the company on behalf of the company. Even
though the disagreement was amicably settled between the Ambani brothers, Mrs
Kokilaben, the family's head holding 34% of the RIL shareholding, the decision
to demerge the company was in question; that it was in the interest of the
remaining shareholders holding 66% or not?
The
board of directors in any company hold specific fiduciary duties that need to
be complied with, which consist of the duty of trust, legitimacy, care,
upholding the corporate governance values, critical review, and independent
thoughts, upholding primary loyalty to the director's position, delivering
primary tasks and roles of the board, corporate responsibility, protecting the
interest of the minority owners, and learning, communicating, and developing.
In this case, none of the board of directors during the whole episode took the
duty of exercising their authority and power by putting forth the more
significant number of shareholders' interests.
Not
only this, but even the shareholders were missing in raising the question of
the absence of the board of directors in decision making.
To figure out in the
Company Act, 2013, Section 166 talks about the duties of the directors which
acts as safeguards.
It provides that directors
carry the duty of care for their shareholders. It is their responsibility to
take care that they are taking care of their actions carefully, and
importantly, they should be making independent judgments. Moreover, they should
perform their duties as well as obligations effectively. It is also the
responsibility of the directors to think about the shareholders as a whole. It
should take care of the benefits of the company, employees, and shareholders.[7]
When
we talk about the RIL board of directors performing their fiduciary duty,
glaring omissions have been found and revealed. RIL has been in the news
multiple times for breaching the governance, and allegations of their practices
have been put forth throughout these years of financial success and
rewards.
A
general thought has been built upon corporate governance among the existing
experts; Dr Ram Charan's beliefs are considered to be prominent,
stating that no positive change in results could be found in governance through
structural changes as even now, many family managed companies in India are not
complying with the objective criteria.[8]
As per
Clause 49 of the listing agreement, companies that are listed have an
obligation to form a report based on corporate governance. Through the analysis
of these reports, one can easily find out that the intention of these companies
rather than being on performance is based on conformance. One such example is Mr.
M.L. Bhakta, who has been an independent director since 1977 on the RIL
board, meeting all the requirements for being an independent director.
In
1977, RIL went public, and there are total chances of him also being a promoter
nominee. His independence at his job remains a mark, as when the Ambani
brother's dispute on ownership was going on, his resignation was taken as the
answer. He is also seen to be a partner at RIL’s Solicitors and Advocates, M/S
Kanga & Company.
Another famous example of an independent board
of directors is ACC Limited. Mr. A.L. Kapur and Mr. N.S. Sekhsaria,
independent directors of ACC, were also the whole-time director and managing
director respectively of GACL, which held approximately 14% of ACC by Ambuja
Cement India Ltd., which was its subsidiary. This raised the question of
how the directors could be classified as independent on the board in 2003-04 of
ACC.
Mr. Nusli Wadai is another example,
being a part of three Tata company boards, including Tata Chemicals,
Tata Motors, and Tata Steel. Holding the position of independent director
in all three companies raises suspicion.
Moving back to Reliance Industry Limited, the
board of directors could have been more proactive in taking the stand of
solving the dispute between the Ambani brothers as they held a fiduciary role
to take care of the interest of the remaining shareholders and outsiders who
held 66% shares and not leaving it on the family to settle it.
Thus,
it is time to realize that family-managed companies in India and their board
understand that their responsibility is constructive and rigorous and
performing in a passive role is not sufficient. The duty lies with the
management and the board to be responsible for the money put by the
shareholders. If the failure is on the side of the corporation to create reform
and possess improved behaviour, then the regulators or government will have no
choice but to enforce stricter laws and conditions.
Even
when every expert agrees that board structure modifications will have no
significant influence on governance, no necessary steps have been taken by the
family-managed companies to establish trust in the eyes of investors and the
general public. According to a quick check, three out of the four Tata
businesses in the Sensex are seen to have promoter nominations on their audit
committees. Furthermore, in the case of the fourth business, one member's
independence (Mr J.K. Setna, who sits on the Tata Motors board, as mentioned before)
is in question. The Tatas is seen to be at the frontline of upholding strong
standards based on sound business ethics. On the surface, all these
corporations have quite enough independent directors to staff their audit
committees. The audit committee is the only group meant to be completely
independent of management. Thus, Indian family-managed companies are implied to
play a constructive role.
- ISSUES RELATED TO INDEPENDENT DIRECTORS:
Talking about the second
issue of independent directors, their independence, and the problems of finding
the right calibre candidate for such a position required numbers, we need to
understand that the board of directors is the most critical and powerful decision-making
bod, and its independence is required to ensure good corporate governance
standards. The rising number of corporate frauds in India and the increasing
number of resignations of independent directors necessitate a welcoming change
by reworking existing independent director models. For the first time, the
Companies Act of 2013 (new act) provides guidance on the functions and
standards that independent directors must strive for and maintain.[9]
The
notion of the independent directors and its origins under the current corporate
framework is based on recommendations and proposals made by various committees,
including the Kumar Mangalam Birla committee (1999) and the Naresh
Chandra committee (2002) as well as the Narayana Murthy committee (2003).
The Securities and Exchange Board of India (SEBI)
coined the phrase "independent director" by introducing Clause
49 into the Listing Agreement in India.[10]
"For
the purpose of this clause, the expression' independent directors' means
directors who, apart from receiving director's remuneration, do not have any
other material pecuniary relationship or transactions with the company, its
promoters, its management, or its subsidiaries, which in the board's judgement
may affect the independence of judgement of the directors," according
to clause 49 which provides a comprehensive definition of the independent
director[11]. It
mandates that at least half of the board shall be independent when an Executive
Chairman is available for the company. When a non-executive Chairman is
available, the independent directors should make up at least one-third of the
board of directors. The
non-executive chairman is the only one with which the company, management,
promoters, or subsidiaries have a meaningful monetary tie that could impact the
judgment's independence. By being the company's considerable shareholders,
independent directors cannot have the capacity to own 2% or more of the voting
shares. They are, however, eligible for remuneration with shareholder approval
prior to the decision of the board[12].
There
lies an underlying problem with complying with the independent director's
"independence". The subject is an Indian family-run business that
requires financing as its growth speeds, resulting in rise in the number of
outside owners who may not be family members. This contributes to a focus on
management and ownership separation, which stresses professional management and
lays the groundwork for corporate governance requirements. Independent
directors are selected with the goal of improving good governance. Nonetheless,
it remains a "process" because no guarantee exists through any
administrative technique. The obligation should use the independent director's
fearlessness and openness in calling out those in positions of power to
accomplish responsibilities and fulfil the fiduciary duties entrusted to them.
Going back to the example of Reliance Industry Limited's board of directors,
there existed six of them out of twelve were independent directors at that
point in time and even though it occurred to none that the fiduciary duty
towards the shareholders should be ensured by keeping the company's future
health into mind while taking any decisions.[13]
Independence
and governance are not backed by verification of strong corporate governance.
It is important to emphasize that trustworthiness cannot be assured by
following rules, despite the fact that compliance is required. "The
culture of a corporation dictates how individuals behave when they are not
being monitored," remarked Tom Tierney, former Managing Partner
of Bain & Co.[14]
Companies like Parmalat, WorldCom, and Enron have failed due to
intolerable cultural crises created and driven solely by their CEOs.
Clause 49 currently
stipulates the minimum percentage of independent directors necessary, based on
whether the chairman is executive or non-executive. In an Indian family-owned
business, this provision is a recipe for disaster. One such example to consider
is Tata Motors, a subsidiary of the Tata Group. Mr. Ratan Tata
maintained the role of Executive Chairman for almost 65 years. He resigned from
his previous position as Non-Executive Chairman due to the popular retirement
policy of Tata Group devised by himself for the directors.
It is worth noting that Clause 49 of the listing agreement
distinguishes between the executive and non-executive chairmanships, forming an
independent component. Nevertheless, Mr Ratan Tata's post-movement from
executive chairman to non-executive chairman raised the issue of looking for a
shift in the power dynamic within the corporation. It is also worth noting that
the company had never had a CEO or Managing Director until Mr. Ravi Kant
was recently hired. Many family-owned businesses will use this outline. As a
result, it is necessary to determine if having independent directors should
need to be independent of the chairman would be considerably more widely used
than the present Clause 49 provision.[15]
There
have also been various market complaints about competent, independent directors
not being available. The issue, however, is well within the sector. The reason
for this is that because the expectation of finding well-trained and groomed
director material available for Indian organizations is there, it needs to be
seen that if someone like Mr. Nusli Wadia has worked for three major
Tata firms for over thirty years, it eliminates the opportunity to give someone
else a shot. Companies used to have a bad practice of overburdening strong
director candidates with several directorships, which must change. Companies
need to look for board members underneath the board level, including vice
presidents, general managers, and so on, and focus on finding the
"functional and right" match rather than someone who is "known
and famous."[16]
Expectations should be
reasonable and commensurate to the time frame. The notion of becoming valuable
and productive right away is unrealistic. The members under consideration have
a history of demanding core managers who should be given the opportunity to
grow as directors to improve performance through orientation and training[17]. The immediate result is unlikely to
demonstrate its worth, and such a person should be given ample opportunity to
contribute. A senior independent director must supervise such kinds of independent
directors to ensure effective leadership. This aspect of director development
is a grey area in our boardrooms. In this arena, none of the corporations has
taken any steps. Training and development are essential for directors because
their talents differ significantly from those of managers.[18]
- FUTURE STEPS AND PRACTICES SUGGESTED:
Particular suggestions
should be taken into consideration to build a setup in Indian family-managed
companies where corporate governance is of utmost importance, and the practices
followed are instrumental.
• True
independence must be achieved- Independent directors should not
own any firm shares. They, too, will not be given options. It is unethical to
compensate them with choices under the guise of aligning oneself with the
shareholders. The overall response to shareholding by independent directors is
ironic. Because authorities believe that independence would be lost (or that
they might align more often with shareholders with reasonable percentages and
therefore acquire vested interests), the current legislation stipulates those
independent directors own no more than 2%. Simultaneously, authorities have
agreed with the corporate argument that independent directors will be much more
united with other shareholders if they own stock in the company, questioning
the sanctity of the 2%.
• Independent
Directors should be adequately compensated- Independent directors should not take up too many
directorships, as this will dilute their engagement. CEO of Genpact, Mr Pramod
Bhasin, recently brought this up at the CII Corporate Governance Series in
Delhi[19]. If
independent directors wish to contribute to any business, directors should
limit their directorships to three to four. However, there is currently one
issue. Directors who are not elsewhere employed must take on multiple
directorships to maintain an acceptable quality of life that they were
accustomed to when in executive positions, as even giant corporations pay them
a pittance. For example, in a business-like RIL, the most significant salary an
independent director (who also serves on a few committees) earns is Rs.0.58
million, compared to Rs.217.2 million for the CEO. The compensation must be
commensurate with their efforts. Assuming that the average CEO works at least
14 hours per day, the independent director will be paid around the same hourly
basis as the CEO for the estimated number of hours he will spend preparing for
and attending board/committee meetings.
•
Examine
the performance-. The board will be subjected to a performance evaluation. A
method of self-evaluation for the board as a whole and individual directors
will be implemented. At least once a year, evaluations should be conducted. The
approach will also include peer review.[20]
•
A
sharp divide between business and emotions- Division between emotions and
business is necessary for the effective operation of the company. At the end of
the day, the business should be about competing on a worldwide level with other
businesses, not internal conflicts among members of the same firm, therefore
the obligation of explaining every member's clearly defined tasks to them falls
on the shoulders of the family's leader.
•
Clarity
and transparency in leadership- After the death or incapacity of the former leader, a clear process for selecting the next-of-kin to
transmit the baton must be established. When no
such strategy is in place, it could lead to confusion and anarchy, putting the company's foundations at risk.
•
Democracy-
A healthy and disciplined business practice requires participatory decision-making and a democratically elected board of directors.
Particularly in the case of family enterprises, which are prone to nepotism and
favouritism.[21]
- CONCLUSION:
Although
there have been no known corporate collapses due to inadequate corporate
governance, and several significant instances of family-owned businesses with
visionary leadership, current revelations have unlocked Pandora's box regarding
corporate governance practices in India. FMCs in India have a long road ahead
to implement the best and following practices to establish a new paradigm.
Changes will be made voluntarily by corporations and boards of directors. They
must employ appropriate initiatives to help directors acquire an autonomous
mentality through ongoing director development. Instead of focusing on the
disadvantages, authorities should focus on the positives.”
[1]
Satheesh Kumar, 'Indian Family Managed Companies: The Corporate Governance
Conundrum' (Research Gate, 2022)
[2]
James Chen, 'What Corporate Governance Means For The Bottom Line' (Investopedia, 2022)
accessed 7
May 2022.
[3] Clause
49 of “Listing agreement” deals with the complete guidelines for corporate governance.
[4]
Rishabh Shroff and Saloni Shroff, 'Opinion: Corporate Governance In Family
Businesses' (mint, 2022)
accessed 7 May 2022.
[5]
Soutik Biswas, 'Why Indians Continue To Live In Joint Families' (BBC News, 2022)
accessed 11 May
2022.
[6] Core.ac.uk. 2022.
[online] Available at:
[Accessed 10 May
2022].
[8]
Charan, Ram, Boards At Work: How
Corporate Boards Create Competitive Advantage, San
Francisco, Jossey-Bass, 1998, Charan, Ram, Boards That Deliver: Advancing Corporate Governance From Compliance to
Competitive Advantage, San Francisco, Jossey-Bass, 2005.
[9]
Vrajlal Sapovadia, 'Corporate Governance Issues In Indian Family-Based
Businesses' (Core.ac.uk, 2022)
accessed 5 May 2022.
[10]
Shinoj Koshy, Preetha S and Vandana V, 'The Responsibilities, Rewards And
Liabilities Of Independent
Directors
Will Be Transformed By The New Companies Act' (Nishithdesai.com, 2022)
[11]
Clause 49, Listing Agreement
[12]
Meenu Gupta, 'Independency Of Independent Directors In Corporate Governance'
(Icsi.edu)
[13]
Satheesh Kumar, 'Indian Family Managed Companies: The Corporate Governance
Conundrum' (Research Gate, 2022)
[15]
Satheesh Kumar, 'Indian Family Managed Companies: The Corporate Governance
Conundrum' (Research Gate, 2022)
[16]
Satheesh Kumar, 'Indian Family Managed Companies: The Corporate Governance
Conundrum' (Research Gate, 2022)
[17]
Role Of Independent Directors In Family Business Governance' (Newsletter, 2022)
[18]
Jyoti Bowen Nath Nath, 'Ind Directors On Board Can Help Family-Run Cos Take Off
- Times Of India' (The Times of India, 2022)
accessed 6 May 2022.
[19]
Real Estate and others, 'Is The Board Preparing Your Company For The Future?' (Thehindubusinessline.com, 2022)
accessed 11 May 2022.
[20]
Meenu Gupta, 'Independency of Independent Directors In Corporate Governance'
(Icsi.edu)
accessed 7 May 2022.
[21] Meenu Gupta,
'Independency Of Independent Directors In Corporate Governance' (Icsi.edu)
accessed 7 May 2022.