Corporate Governance and Shareholder Activism

In this article, Pradipta Nath discusses Corporate Governance and Shareholder Activism.

Introduction

The word ‘Corporate ‘means an organization or an association of person, who work together to attain a common goal. The most unique feature which set a corporate different from other is that the ‘common goal’ is linked with making profit. Hence, mere an association of person will not form a corporate. To look it like a corporate it has to be engulfed with the following features: –

1. Organized – Unless an association of person is organized, it cannot attain the goal.
2. Vision and mission – Like say the association of persons will have to share common vision and mission.
3. Common goal – The association of person should work together for the attainment of common goal.
4. Profit – Whatever the vision and mission may be, but the main feature has to be that it should be linked with making profit and not loss.
5. Investment – In order to attain the common goal, the organization must have entered into business with an amount, better known as ‘Investment’.
6. Policy – The organization must be not following the whims of its own. The organized feature has to be backed by a well structured policy, which is followed by the organization.

In India, the corporate obtain registration under the following laws –

1. Municipality Act – These are State specific Acts, on which the entrepreneur took registration for obtaining Trade License and carrying out business.
2. S&E Act – These are also state specific Act. The organization has also need to take registration under these Acts provided on completing certain eligibility conditions.
3. Welfare Laws – These are often called as the Labour Laws. The organizations also need to obtain registration under the welfare Acts which are implemented and executed time to time by the Government.
4. Companies Act – This is the most important Act concerning to the Corporate. The Organization gets registered in the Registrar of Companies under the Companies Act.
5. Limited Liability Partnership Act – For the purpose of ease of doing business, the Government in-order to attract more young entrepreneurs introduces the LLP Act. An important feature of this Act is that though the registration process is not guided by the Companies Act, but the registration process has been entrusted with the ROC of Companies Act.

The reason why the Corporate obtain registration under the above mentioned laws because of legal sanction. Here it is noteworthy to mention that here also in this case we are getting the ‘Rule of Law’ concept. As if anybody wants to start a corporate, it has to obtain registration under the Laws of the land else the law will impose legal risk on the body.

One of the other objectives of taking registration is that the Government ensures that the body follows the sets of rules and regulation which the statute refers.

CORPORATE GOVERNANCE

So after analyzing the definition of Corporate, the term governance implies to the act or manner by which the Corporates are governed or administered. As it has been discussed before that the corporate cannot run or do form rules whatever it likes, at the same time if rules are made by the individuals of the organization there may dispute arise, so the Government determines the modes of running the business through its legislature in the form of ‘Corporate Governance’. But that doesn’t mean that the corporate will constrain itself within the rules of governance by the Government. It may make rules which are better known ‘policies’, but need to ensure that the statute referred governance are followed.

‘Return’ is one of the features of Governance through which the Government monitors on the deeds of the Corporate that whether it is following the framed rules and regulation and working ultra-vires.

Who’s responsible for governance

In simple the corporate governance is the way through which the Company is regulated and the main who are entrusted with the responsibilities are the Directors. The Directors of the Company direct the CEO of the Co. on various aspects to run the Co.

The corporate governance can be further explained in the Model is furnished below: –

1. F – Fairness

The Corporate Governance ensures Fairness. As the individuals who manage the business are after all the representatives of the members or the shareholders.

The rules and regulation as enumerated in the Statutes ensures that the funds are spend in attaining the actual goal of the organization and not spend in the personal use of the members who are entrusted with the management of the business. In case the ‘fairness’ is lost the corporate governance provides means to enforce the fairness.

2. A – Accountability

The corporate governess also provides for filing returns under the different statutes. Like in the LLP Act, it provides for engaging a ‘designated partner’ who will be responsible or accountable for all the statutory compliances.

In the Companies Act the Directors are the one who are accountable for conducting of the business from the view point of the objective for which the business was set up.

In the Factories Act the ‘Occupier’ is the one who is responsible for ensuring health and safety inside the factory.

3. T – Transparency

Governing a business is useless unless there is transparency. The accountable will have to provide evidence of their fairness as and when want for by the stakeholders. In a Company, the maintenance of books of accounts, whistle blower policy, etc may serve to some extent

OBJECTIVES OF THE CORPORATE GOVERNANCE

1. Focus: The main objective of the business does not get diverted to something worthless so good governance ensures the focus.
2. Predictability: If risk is often monitored at regular intervals, then the risk can be easily predicted or forecasted.
3. Transparency – Corporate governance ensures transparency so that the belief and trust do not get deflected. The stakeholders get a clear cut picture on maintenance of books of accounts.
4. Accountability checks frauds and prevents from abusing the power of the Directors or the Authorized Signatory.
5. Efficiency & Effectiveness: The good corporate governance ensures efficiency and effectiveness of the Organization. The profit of the organization gets higher due to enforcement of transparent and good governance.
6. Stakeholder’s satisfaction: The stakeholders are not meant to say only the shareholders, but also the employees, Government, Society and the environment at large. Efficient and transparent governance provides satisfaction to the stakeholders.
7. Compliance of Law: If any Company has implemented good and effective governance, it implies that the Co. has been complying with the rules and regulation of the Authority.
8. Ethics: Corporate governance standards not only set goodwill in-front of the foreigners but also set an ethics into the business world which is beyond the law.

Listing Agreement – Clause 49

In order to enforce the law of Corporate Governance the ‘Listing Agreement Clause – 49 plays an important role.

The fact is that if any Limited Company wants to raise fund from the general public at large, it needs to issue share through getting enlisted from the SEBI authorized or recognized like BSE, CSE etc.

HISTORY OF CLAUSE 49

The reason why it is called Clause 49 because it is not any section of any Act but a provision of an agreement which was first referred in the year 1992 the CII or Confederation of Indian Industry brought the concept that the corporate governance should follow an ethics. While the Corporates wants to get enlisted in the recognized stock exchanges, it needed to sign an agreement with the Stock Exchanges. In the agreement there it contains a clause which is better known as the ‘Clause – 49 Listing Agreement’.

Thereafter in the year 2006 Mr. Narayana Murthy of INFOSYS revised the Clause – 49 Listing Agreement when the USA just passed few years back the SOX Act (Sarbanes-Oxley Act, 2002), which influenced the whole corporate sectors very much. The principles behind the Act were readily very much accepted by the Corporate Fraternity.

Afterwards around the year 2015-16 the SEBI – LODR Regulations came, which uplifts the Corporate Governance more than before stated in the Companies Act. The clauses of the Listing Agreement are now has been a part of the SEBI –LODR Regulations and the beforehand Clause – 49 which uses to be around 20-25 pages reduced into only 2 pages after the enactment.

So, if we analyze the corporate from the view point of stakeholders than it gives an implication as the diagram depicted in the form of a Triangle Preferential Hierarchy here under also known as 3 Ps:

So we see that a corporate governance do not limit itself to administration of the business but also signifies ethics which kept profit at the last and give emphasis to People and Philanthropy. The philanthropy or better known as the CSR or Corporate Social Responsibility, which the Companies Act laid down in Schedule VII. But the contents therein are illustrative, not exhaustive and hence not limited to that. Therefore the Cos. which are engaged into the recent ‘Swach Bharat Abhijan’ are also doing their Corporate Social Responsibility.

The Companies Act makes it mandatory for the Co. to expense 2% of their three years profit which makes: –

1. Making profit of Rs 500 Cr.
2. Making profit of Rs 100 Cr.
3. Making profit of Rs 5 Cr.

Shareholder’s Activism

To begin with the Shareholder’s Activism, we will, first of all, know the meaning of Activism and shareholders.

The shareholders are the owner of the Co. They engaged the Directors to run the business and to look that the business ethics is not infringed. Business ethics not only mean the Statutory Compliances but beyond that, mean to say the right moral duty of the Directors, responsibility, accountability and Fairness. In a company where there are many shareholders, it becomes necessary to protect the interest of all the stakeholders. The shareholders are considered as the owner of the company, the managers control the company and the Directors give them direction on the administration of the Company. As the shareholders are unable to participate in decision making or nevertheless practically it is not possible to monitor or supervise the daily activity of the Co. also may be due to collective action problems. In such a case, the lack of minority shareholders participation augurs to the benefit of controlling shareholders, and managers appointed with their concurrence.

Activism, on the other hand, means the awareness, the fight against any odds or wrongs, participation, interference in the activities with an intention to prevent wrong. Since the cost of coordination among minority shareholders is high, these shareholders are either abstain from voting or merely vote in favour of management (or controlling shareholders as the case may be). The continuous oppression of the rights of shareholders (especially minority shareholders) evolved the concept of Shareholders Activism in India.

So, we find that where there is any wrong or fraud, activism plays it own role of action. And when in any Co. the members are divulged into frauds, the other shareholder can prevent it through active protest in any form in accordance with the law.

The famous Fraud case in the Indian Corporate history is the Satyam Fraud Case, where one Mr Raju the promoter of the Co. made some financial frauds. He showed that the finance were been utilized whereas in actual terms there was not finance invested or utilized. The PWC Audit firm, one of the most renowned audit firms in India did the audit and actually encouraged the fraud by not highlighting that in the audit. In consequence, the share price of Satyam which use to be somewhere Rs 120/- got reduced to Rs 12/- within 10-15 minutes. It actually shocked the shareholders of the Co. For this reason not only Mr. Raju was criticized and faced trial but also the famous Audit Firm PWC was roughly criticized and penalized.

Here would like to say that if the Satyam had followed the Business ethics or the Govern the Corporate in its true ability neither he nor the shareholders would had faced so much trouble and ashamed.

Modes of Shareholder’s activism

1. Participation of the Shareholders in the management of the business :-

Though it sound impossible, but the shareholders can easily make a sense by self awareness, like through inspection of the audit report, the balance sheet. Where it is doubted that any funds were used for personal gain, the shareholders can blow the whistle and inform other shareholders for its prevention and putting pressure.

2. Exercise of the Voting right

This has been a wonderful mechanism to preclude the wrongs or whims of the Directors in the hand of Shareholders. The Companies Act 2013 enumerates the e-voting rights. S.108 of the Act states that the Central Government may prescribe the ways towards e-voting. Generally the shareholders, who are based far from the Co. where it is situated, will find more comfortable if the vote are casted via email or any other electronic form.

3. SEBI E-voting right recognition

Even the SEBI makes it mandatory through its 2012 amendment and states that where in cases of the listed Cos. it will be mandatory for them to make arrangements for e-voting rights and ensure that no shareholders are deprived of their voting rights[1].

4. Prevention from the related party transaction

In order to understand this point, we first of all need to know the meaning of the related party transaction. It means, where the Director or any management member makes secret profit or makes any financial gains without the knowledge of the shareholders. Example: –

1. Director of the Vatsal Ltd. a listed Co. make an agreement and provides a consultancy service or order to M/S GIGA Pvt. Ltd. where Mr. A is the owner.
2. Director of the Vatsal Ltd. entered into an agreement and purchased raw materials from M/S Khushi LLP, where his brother in law and wife are the partners.
3. Section 188 of the Companies Act 2013, provides that the related party transaction can take place if the same has been taken approval from the Board of Directors. The contracts which will be entered while in the related party transaction should be reported in a report which has to be validated from the Board of Directors to the Shareholders stating the justification on entering to the very contract or transaction.

And whereas the related party transaction has been entered into without obtaining resolution from the Board, then within three months from the date of agreement, it has to be put in-front of the Board for its decision. In case the resolution is taken that the contracts or the transaction will not be sanctioned then the contracts remains voidable at the instance of the Board of the Directors and the authorized signatory or the Director who entered into the transaction will stand personal indemnifier to the company[2].

5. Recourse from NCLT

As per S.245 of the Companies Act, 2013, any member whose right is getting infringed or are prejudicial to the interest of the organization due to the act of the Director can made an application before the Company Law Tribunal asking from its intervention. It is note-worthy to mention that the application U/s 245 may not only bear the compensation against the Directors or the management of the Company but also against the audit firm who assist the Company to mislead or fabricated false audit statement in an unlawful and wrongful manner[3].

• 241(2) of the Companies Act also provides that if in the opinion of the Central Government the affairs of the Company has been conducted or is conducting in a manner which is prejudicial to the public interest, then it may on suo-moto apply before the NCLT and pray for its prevention or such other orders in the interest of Justice[4].

Mandatory disclosure of financial statement

The shareholder’s activism and awareness are the two side of same coin. Because after all if the Management has been mandated to make aware of the financial statement, it will indirectly or directly put them in pressure and they will be afraid to make any decision on their whims and will.

In this junction, the Securities Exchange Board of India had come up with a circular which provides that the Companies who are into providing services on ‘Assets Management’ or the Mutual Fund Companies should share their financial statement in their official website and the general policy of the Company in respect to its administration. This had actually enabled the shareholders or the stakeholders to become aware of the position of the Co[5].

7. Directors appointed by the small shareholders
8. Section 151 of the Companies Act, 2013 provides for the appointment of Director to represents their rights. It requires the Companies which are listed, need to have or include one Director nominated and elected by the small shareholders in such terms and manner as prescribed by the Central Government in this purpose[6].

Small shareholders means a shareholder holding shares of nominal value of not more than twenty thousand rupees or such other sum as may be prescribed by the Central Government in this regard.

8. Activism by the Foreigners

The proxy advisory firms have started growing since 2010. The proxy advisory firms use to recommend on the corporate proposals relating to various listed Cos. in India. These include but not limited to appointment of Directors, engaging of auditors, mergers and accusation; as a result of which the management remains always in pressure and nevertheless can ignore the presence of the small shareholders.

9. Recourse under the High Courts of India

Like how the minority shareholders approached the Hon’ble Bombay High Court against the Cadbury India Ltd. and where the Hon’ble High Court directed the Co. to pay Rs 2,014.50 per share to buy back its stock, 50% more than its original offer of Rs.1,340 made in 2009 to its minority shareholders.

In 2012, Children’s Investment Funds filed many cases against the Coal India Ltd. and against the Union to prevent the company from signing fuel supply agreements with the private firms due to the price was lower than the market prices. Children’s Investment Funds also raised question on the pricing policies followed by Coal India Ltd.

10. Recourse under the Labour Welfare provisions

The stakeholders where feels that the welfare provisions as laid down by the legislators are been deprived off, they can approach to the labour inspectors or the Commissioner or even the Labour Tribunal or Court to save their rights. Like the payment of Bonus Act state to provide bonus out of the profit made by the Co. and it’s a statutory mandatory bonus.

Conclusion

1. The Companies Act 2013 and the SEBI Rules has ensured a better Corporate Governance.
2. The role of the lenders may be limited as to the financial aspect of the Co. is concerned, but the private equity players and the large shareholders groups can give a wonderful corporate governance and shareholders activism as well.
3. A 2014 report on corporate governance in Asia by the ‘Asian Corporate Governance Association’ ranked India seventh out of the 11 Asian markets, suggesting that the country still lags behind peers in setting and implementing governance standards where at the same time Hong Kong and Singapore has jointly emerged as topper in the list.
4. Though the condition of India in respect to the corporate governance has improved from 2012 onwards due to tightening of the statutory norms by the regulators and self awareness of the shareholders.

[1] Security And Exchange Board of India, Amendment to the Equity Listing Agreement – Platform for E-Voting by Shareholders of Listed Entities, Circular CIR/CFD/DIL/6/2012 (Jul. 13 2012)

[2] Companies Act, 2013, S.188

[3] Companies Act, 2013, S.245.

[4] Companies Act, 2013, S. 24(2).

[5] Securities and Exchange Board of India, Circular for Mutual Funds, SEBI/IMD/CIR No 18 / 198647/2010 dated 15^th March 2010.

[6] Companies Act, 2013, S.151.

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