Indian boards of directors are failing; they are not exercising the necessary due diligence and loyalty to shareholders
It is not often that the failure of a board of directors spills so openly into the public domain. But the ICICI Bank board, under the inept leadership of its Chairman, MK Sharma, has manged to make itself the poster child for poor corporate governance in India. It has sullied the reputation of everyone associated with it, the Chairman, the CEO, the independent directors, and the government-nominee directors.
In the other recent board battles in India, most famously in the ones at Infosys and Tata, there were at least some heroes from a corporate governance perspective that emerged in the process, like R Seshasayee or Nusli Wadia. If the chairman, CEO, or the members of the board of ICICI continue after this fiasco, it indicates that even "shame" as a control mechanism has limited efficacy in the country.
Let us distinguish between promoter-led companies and those with diversified stockholding and no controlling shareholder, for the purposes of corporate governance. The problem of corporate governance in promoter-led companies is that the board kowtows to the promoter, as the "independent" directors owe their positions to these promoters. As promoters can vote on independent directors, and minority shareholders don't frequently exercise their voting rights, even with a relatively small shareholding, the promoter is effectively appointing the independent directors.
If an independent director such as a Nusli Wadia dares to disagree with the promoter, he or she is immediately sacked. This has a chilling effect on dissent by independent directors. The promoter is all powerful and minority interests are trampled upon at will. The informal check in such cases is only the benevolence of the promoters, as I have previously noted, if they need to return to the equity markets. The savvier promoters take a long view, and thus protect their reputation among minority shareholders. But, as in any feudal system, the minions are at the mercy of the ruler.
In non-promoter led companies, one worries about the agency problem, where the managers may not align their interests with the shareholders. Without a promoter to oversee their behaviour, the professionals running the firm can enrich themselves at the expense of the shareholders. This is why in the US, where such firms are ubiquitous, a separation is sought between the Chairman and CEO positions. Since a powerful Chairman acts as a check on the CEO, at least on the boards outside India that I have served on, there is often a healthy tension between them. The worry in non-promoter companies is that an all-powerful CEO captures the board and subverts any effective oversight.
Over the years I have observed powerful CEOs deploy various mechanisms to make their boards and Chairman subservient. I will leave the readers to make their own judgment as to which of these were in play at ICICI as the board lost all control and abdicated its responsibilities.
First, there is the problem of the "superstar" CEOs, who through a combination of past performance, charisma, and crafty PR management, have created an aura of dominance around themselves. The board in the face of this CEO is rendered ineffective in its monitoring role. The unconscious story line that plays out on the board is: "Who are we to question a visionary like Ratan Tata, Narayana Murthy, or Chanda Kochhar?"
Second, as the same individuals serve on multiple boards, they have limited time to really understand and investigate the true situation at the firm, and their industry-specific knowledge is inadequate. As a result, independent directors suffer from "information capture". Directors are overwhelmingly dependent on the information that the CEO chooses to provide or conceal. Consequently, directors end up monitoring the actions of the management through the "filtered glasses" provided by the same executives.
Third, and this is by no means an exhaustive list, CEOs effectively make directors complicit though various monetary and non-monetary benefits. The financial incentives for directors, such as compensation and bonus recommendations by the CEO, are well known. Academic research has documented that excess director compensation lowers monitoring of CEOs, reduces CEO turnover-performance sensitivity, and is an indicator of board entrenchment. Overcompensated directors provide CEOs with additional immunity and job security. Furthermore, excess compensation of directors is positively related to the CEO's total compensation, providing evidence of cronyism between CEOs and directors.
The numerous non-monetary benefits are behind the veil. These include jobs at the company or related firms for relatives of the directors, overseas trips to presumably understand far-flung operations and investigate opportunities. But, most importantly, among highly interconnected elites, there is the need to maintain social capital, in order to continue membership in the “club”.
In light of the above, it should not be surprising that the instinctive reaction of the board is to protect the CEO. In a sense, they are protecting themselves. The ICICI board reiterated their support of the CEO immediately as this story of potential misdeeds by Chanda Kochhar broke on the news. Similarly, despite the Central Bureau of Investigations (CBI) raiding the offices of R Venkataramanan, the managing trustee of Tata Trusts, him being named in the FIR filed by the CBI, and the internal emails by Venkat providing evidence of him engaging in lobbying to get the 5/20 rule for airlines removed, Tata Trusts reaffirmed its complete trust in and continued support for the managing trustee (equivalent of a CEO).
Just as at ICICI, the independent inquiry that should have been the appropriate response by the Tata Trust board, will happen only when there is no option because of a public hue and cry. The ICICI and the Tata Trust boards, from the corporate governance lens, have thus become laughing stocks when these cases are presented in any management classroom, and perhaps even in the press.
From a shareholder's (minority shareholders in case of promoter led companies) perspective, Indian boards of directors are failing. They are not exercising the necessary due diligence and loyalty to shareholders by maintaining an intense oversight of powerful CEOs and promoters. The ICICI and Tata boards epitomize this with respect to non-promoter and promoter companies.
At Infosys, the board showed more backbone and attempted to resist the pressure before eventually caving in. This is not a good omen for corporate governance in India. My contention is, as I have made elsewhere, that the more laws and regulations we impose on the boards, the more ability we provide them with to engage in symbolic governance towards external stakeholders. These box-ticking exercises provide a fig leaf to engage in less, not more, robust corporate governance.Disclaimer: Nirmalya Kumar is the Lee Kong Chian Professor of Marketing at Singapore Management University and Distinguished Fellow at INSEAD Emerging Markets Institute. The views expressed here are his own.