Working Paper 173
Working Paper 173
Working Paper 173
Ekta Selarka
Associate Professor, Madras School of Economics
ekta@mse.ac.in
WORKING PAPER 173/2018 MADRAS SCHOOL OF ECONOMICS
Gandhi Mandapam Road
Chennai 600 025
India
ii
Corporate Governance Practices in India
Ekta Selarka
Abstract
This paper provides the overview of corporate governance practices in India
by providing the institutional background that paved the way for recent
corporate governance reforms and practices since early 2000. We present the
current status of various dimensions of corporate governance structure by
using a sample of CNX 500 companies which are top listed companies of
Indian corporate sector trading on National Stock Exchange. The paper
explores the features of corporate governance practices in Indian firms by
focusing specifically on ownership structure and concentration, board of
directors and its practices, corporate social responsibility, market for
corporate control and finally relationship between corporate governance and
firm performance. The paper aims to provide our readers an overall picture of
corporate governance and starting points for future research in different
facets of corporate governance.
iii
Acknowledgement
I would like to thank the editors and Virtus Interpress to compile and
publish “Corporate Governance in Emerging Economies: Theory and
Practice” where the revised version of the paper is published. Usual
disclaimer applies.
Ekta Selarka
iv
INTRODUCTION
1
For SEBI’s formal definition of a promoter see paragraph 2(1)(h) of the Takeover Code. Also see
Section 8 of listing agreement Clause 35 and Issue of Capital and Disclosure Requirements
Regulations, 2009
1
financing in India. In addition to, since liberalization foreign investors and
private corporate bodies have emerged as large-block shareholders.2
2
Sarkar and Sarkar (2000) provide an informative study on India’s financial and banking sector
development. Goswami (2002); Chakrabarti et. al. (2007) presents the state of corporate
governance pre- and post-reforms.
3
Among other provisions include: Loan to directors or relatives or associated entities (need CG
3
Among other provisions include: Loan to directors or relatives or associated entities (need CG
permission) (Sec 295); Interested contract needs Board resolution and to be entered in register
(Sec 297) ; Interested directors not to participate or vote (Sec 300) ; Appointment of director or
relatives for office or place of profit needs approval by shareholders. If the remuneration exceeds
prescribed limit, CG approval required (Sec 314); Audit Committee for Public companies having
paid-up capital of Rs. 5 Crores (Sec 292A).
2
such codes in the developed countries. 4 The recommendations of the
code were instituted through a new Clause 49 in the listing agreement.
Positive effect of passage of the Clause reflected in stock market gains
for large and medium sized firms (Black and Khanna 2007, Roe et. al.
2006). 5 Since 1997, SEBI has modified the existing takeover code to
facilitate an efficient market for corporate control.
4
The Indian code of corporate governance has been developed from on the international codes of UK
and OECD.
5
SeeVarrotti (2010) available at http://ssrn.com/abstract=163482 for a detailed evaluation of
Voluntary guidelines of 2009. In a related context, Afsharipour (2010) provides an overview and
assessment of the effectiveness of corporate governance reforms in India.
3
governance in India is primarily that of regulating the dominant
shareholder and protecting the rights of small investors. Having realized
this, ongoing reforms are aimed towards encouraging the participation by
other equity holders‟ like foreign institutional investors and increasing the
awareness of small investors. However, on the other hand, Takeover
Regulations relating to creeping acquisitions provide routes, which could
be potentially used by companies to raise promoter shareholding, which
could lead to increased concentration of shareholdings in the hands of
insiders. Most recently, since the enactment of new Companies Act 2013,
the listing agreement with the stock exchanges is now replaced by the
SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015
conforming to the new companies act making the Clause 49 erstwhile.
Table 1 summarises the evolution of corporate governance regulations
over two decades in the country.
4
Table 1: Chronology of Corporate Governance Regulations
Year Authority Outcome
1997 SEBI Substantial Acquisitions of Shares and
Takeovers (SAST)
1998 CII Desirable Corporate Governance: A Code
2000 SEBI Clause 49 of Listing Agreement. Mandatory
disclosure along with Annual Report.
2002 Department of Naresh Chandra Committee Report.
Company Affairs Recommendations about Audit Committee
(DCA) functions and responsibilities
2004 SEBI Revision of Clause 49
2004 Ministry of New companies bill draft
Corporate Affairs
(MCA)
2011 SEBI Revised Substantial Acquisitions of Shares
and Takeovers (SAST) 2011
2013 MCA Companies Act 2013
2014 SEBI Revised Clause 49 conforming the New
Companies Act 2013
2015 SEBI Listing Obligations and Disclosure
Requirements 2015. Clause 49 becomes
erstwhile
Source: Author‟s compilation from various sources.
The Table 2 indicates the distribution of CNX 500 firms that are
listed on National Stock Exchange (NSE) across four ownership groups.
Indian business group firms are firms that are affiliated to a parent
business group. Indian standalone firms are private owned companies.
Foreign firms are either foreign firms that are listed on NSE as a
subsidiary of foreign business group or operate as a standalone entity.
Others include government controlled and joint sector companies.
6
OWNERSHIP STRUCTURE AND CONCENTRATION
Concentration of ownership in the hands of families is a dominant feature
of several countries including India. Family control through pyramids and
cross shareholdings generates a Type II agency problem that is not
generally the case in widely held firms. This is the inter-corporate
transfer of resources among firms to advantage the controlling
shareholder which becomes detrimental to shareholder value if at least
one of the firms involved is a listed company. 6 In India controlling
owners are wealthy families who use control pyramids and cross
shareholdings to exert control over the management. Since 2001, all the
listed companies are required to disclose the shareholding pattern in
accordance with Clause 35 of Listing Agreement. The Clause mandates
the disclosure along two major classes of owners – promoters and non-
promoters respectively. Promoters are controlling shareholders who are
either individuals or corporate bodies. In case promoters are individuals
these are directors and relatives holding who are in control of the firm.
Non Promoters are non-controlling shareholders. These are Institutional
Investors, corporate bodies and investors from public. Institutional
investors are classified among domestic institutional investors - Banks
and Financial Institutions, Mutual Funds, Insurance Companies and
Foreign Institutional Investors respectively. Corporate bodies include
venture capitalists, Indian companies registered outside India. Public
shareholding includes shareholding by Indian public. Table 2 presents the
ownership structure across major owners between a time period of 2008-
2016. It can be observed that Indian corporate ownership remains
concentrated with controlling shareholders retaining full control over
management by virtue of their ownership. Relatively smaller shareholding
by non-controlling outsiders makes the issue of shareholder activism in
India questionable.
6
For detailed discussion on Tunnelling see Johnson et. al. 2000.
7
The Table 3 describes the average percentage of voting rights
held by controlling and no-controlling owners of CNX 500 firms in India
that are listed on the National Stock Exchange (NSE). Controlling owners
are individuals as well as corporate entities that are in control of
management and non-controlling owners are outsiders with no control
over the management decisions other than voting rights. Non-controlling
shareholding is further classified into shareholdings of banks, financial
institutions other than banks, mutual funds, insurance companies and
foreign institutional investors. Finally non-controlling public shareholding
includes high net worth individuals and other small investors from Indian
Public.
8
financial institutions which limits the use of voice or exit as governance
system.
Trust (n:%)
2016- 1:3.83%
Source: Author‟s calculations based on Shareholding Pattern obtained from the stock
exchange as of March 2016.
10
corporate governance literature that poor enforcement and weak
protection to small investors in developing and emerging economies are
the main arguments in the literature for concentrated shareholding and
control in hands of few dominant investors, in mitigating classical7 agency
problems between managers and shareholders (Shleifer and Vishny
1997). Type II agency problem identified in concentrated ownership
structure is that between outside shareholders and the controlling
shareholder(s), which can expropriate corporate resources via
transactions between other corporations controlled by shareholder(s)
(Villalonga and Amit 2006). Among non-controlling owners, institutional
investors held significantly larger stake in group-affiliated firms. However,
the difference has reduced over a period of time especially since the
enactment of new Companies Act 2013 which came into effect in April
2013. Public shareholding remains marginally higher for standalone firms.
7
Separation of ownership and control is the basis of corporate governance literature referenced in the
thesis by Jensen and Meckling (1976).
11
Table 4: Distinguishing Features of Ownership Structure of Group Affiliates and Standalone Firms
in India
12
Under concentrated ownership structure which is a norm rather
than a rule (LaPorta et. al. 1999) outside block holders may exercise
effective governance by presenting a potential threat for takeover
(Holderness et. al. 1999). Even if the block holding for separate investors
is less, a takeover threat can be erected through co-ordination among
large block holders. For example, Companies Act in India empowers
shareholders with 10 percent voting rights to appeal in case of
oppression or mismanagement. To explore the status of outside block-
holding, we identify non-controlling investors who hold at least 5 percent
and report the average ownership of such block-holdings in Table 4. We
also report the minimum and maximum number of blockholders to
understand if possibility of co-ordination exists in India.
Consolidation of Shareholdings
Any acquirer (including promoters) who is holding more than 25 percent
but less than 75 percent of voting rights in a firm is required to make a
mandatory open offer bid to shareholders to acquirer more than 5
percent of shares. Such an open offer is required to be made for at least
26 percent.
Voluntary offer
A concept of voluntary offer has been introduced in the Takeover
Code of 2011, by which an acquirer who owns more than 25 percent but
less than 75 percent, is entitled to voluntarily make a public
announcement of an open offer for acquiring additional shares subject to
their aggregate shareholding after completion of the open offer not
exceeding the maximum permissible non-public shareholding. Such
voluntary offer would be for acquisition of at least such number of shares
as would entitle the acquirer to exercise an additional 10 percent of the
total shares of the target company. This would facilitate the substantial
shareholders and promoters to consolidate their shareholding in a
company.
70
60 Change in
50 control
40
30
Consolidatio
20 n of
10 ownership
0
2004-05
2007-08
2015-16
2000-01
2001-02
2002-03
2003-04
2005-06
2006-07
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
2014-15
Years
Source: Author‟s compilation of data from various issues of SEBI Bulletins and Handbook
of Statistics
16
When we look at the value of these three types of acquisitions
consolidation of shareholding, even few in numbers, are significantly
large transactions followed by change in management (Figure 3). This
shows the takeover premium which is expected to be higher when
acquirer is already in control and or bidding to consolidate further.
Among the acquirers making an open offer for consolidation mostly
include foreign and high promoter-ownership firms towards consolidating
their ownership in their listed subsidiaries.
17
Figure 3: Trends in Value of Tender Offers According to Objectives
4.01
change
3.51 in
manage
Value in Rs. Mn ('000)
3.01
ment
2.51 consolid
ation
2.01
1.51 substan
1.01 tial
acquisiti
0.51 ons
0.01
2004-05
2005-06
2013-14
2000-01
2001-02
2002-03
2003-04
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2014-15
2015-16
Years
Source: Author‟s compilation of data from various issues of SEBI Bulletins and Handbook
of Statistics.
Automatic Exemptions
Inter-se transfers among immediate relatives, subsidiaries, holding
company, promoters and persons acting in concert are exempted from
mandatory bid. In addition, increase in shareholdings through rights issue
is exempted subject to the conditions highlighted in the Takeover Code
2011. Figure 4 indicates that number of exemptions is significantly higher
but their value is significantly lower than that in tender offers. Since the
advent of new Takeover Code in 2011 SEBI evaluates exemptions on
case basis.
18
Figure 4 shows the year-wise distribution of tender offers
completed between March 2001 and March 2016. Automatic exemptions
are provided by SEBI to allotment of inter-se or preference shares. Since
2011, SEBI does not provide statistics on automatic exemptions and
provide case by case details. Primary axis shows the value of tender
offers and automatic exemptions. Secondary axis on the right side shows
the number of tender offers and automatic exemptions.
5 450
4.5 Value of
Number of offers and exemptions
400
tender
4 350 offers
Value in Rs. Mn ('000)
3.5
300
3 Value of
250
2.5 automatic
200 exemption
2
s
150
1.5
No of
1 100 tender
0.5 50 offers
0 0
No of
automatic
exemption
Years s
Source: Author‟s compilation of data from various issues of SEBI Bulletins and Handbook
of Statistics
19
Since the maximum permissible non-public shareholding in a listed
company is 75 percent consolidation of shareholdings might result in
eventual delisting of shares if most of the minority shareholders trade in
their shares. Most recently, SAST Regulations 2015 have been amended
by SEBI to introduce Delisting offers to provide a way to acquirers to
delist the company by declaring the intention to delist at the time of
public announcement. Such a delisting will be triggered in accordance
with the provisions of SEBI Delisting regulations 2009. One of such
provision is when public shareholding reduces below 10 percent through
consolidation.
20
executive directors who belong to the promoter group which is by
definition controlling owner group that can exercise control over the
management by virtue of their ownership. Independent directors are the
directors who are independent as per the revised definition of
independent directors in the Listing Agreement Clause 49. Nominee
directors are the representative directors of institutional investors.
21
Table 6 reports the distribution of companies and average
percentage of independent directors across types of board chair. The
table shows that most of the CNX 500 firms have appointed an executive
chairman of the board but do not maintain 50 percent of the board
independence. On the other hand, board independence exceeds 50
percent where promoter occupies the board chair position. Also, overall
board independence has increased since 2008 irrespective of board chair
positions.
23
Directors' Remuneration Practices
Executive directors‟ remuneration is governed under Companies Act of
India. Section 197 of the Companies Act, 2013 prescribed the maximum
ceiling for payment of managerial remuneration by a public company to
its managing director whole-time director and manager which shall not
exceed 11 percent of the net profit of the company in that financial year
computed in accordance with section 198 except that the remuneration
of the directors shall not be deducted from the gross profits. A director
may receive remuneration by way of fee for attending the
Board/Committee meetings or for any other purpose as may be decided
by the Board with maximum ceiling prescribed in the Companies Act
2013. Listing Agreement Clause 49 made a recommendation of
constitution of nomination and remuneration committee (NRC) to
formulate the nomination and remuneration policy and recommend such
policy to the board. All members of NRC are recommended to be non-
executive directors, with the chairperson and at least 50 percent of such
directors being independent directors.8 Table 8 provides a striking
picture that until very recently, most of the India‟s largest companies
lacked nomination committee.
8
Section 178 (1) of Companies Act 2013 prescribes the following: The Board of Directors of every
listed company and such other class or classes of companies, as may be prescribed shall constitute
the Nomination and Remuneration Committee consisting of three or more non-executive directors
out of which not less than one-half shall be independent directors: Provided that the chairperson of
the company (whether executive or non-executive) may be appointed as a member of the
Nomination and Remuneration Committee but shall not chair such Committee.
24
Table 9: Number of companies with Nomination and
Remuneration Committee with Independent directors
Year No. of companies
2008 43
2011 63
2014 211
2016 468
Source: Author‟s calculations based on data from CMIE database PROWESS
SHAREHOLDERS’ ACTIVISM
Minority shareholder‟s rights were protected from Oppression and
Mismanagement in the Indian Companies Law. Recently, the new
Companies Act 2013 has specifically added two provisions to empower
minority shareholders against the controlling shareholders.
1. Introduction of Class Action that allows minority shareholders to
institute a class action against the company as well as against
the auditors of the company. 9
9
For more details see Section 245 of Companies Act 2013
25
2. Any related-party transaction that is not done in the ordinary
course of business and is not at an arm‟s length will need
approval of minority shareholders by way of a special resolution.
In addition to, the shareholders who are related or interested
parties in the aforementioned transaction are not permitted to
vote in resolutions relating to payment of brand fees or
management fees to majority shareholders. 10
10
See Section 188 of Companies Act 2013
11
Few examples include the following: In 2014, 94 percent of non-promoter shareholders voted
against related party transactions of Panacea Biotec with PanEra Biotec. In 2014, shareholders
voted against the excessive remuneration of former managing director of Tata Motors.
26
dissent as only 23.57 percent percent of promoter votes were cast in
favour of the resolution reappointing Mr. Vishal Sikka as managing
director and CEO of Infosys Ltd and increasing his compensation.
Among the first set of studies include Khanna and Palepu (2000),
Sarkar and Sarkar (2001), Selarka (2005) and Pant and Pattanayak
(2007). In general the accepted evidence is that there is non-linear
relationship between ownership concentration and firm performance
which is driven by trade-off between entrenchment by insiders and
alignment with outsiders. There is also an argument that large
institutional investors do not co-ordinate even if they form a block
together (Black et. al. 1994). Selarka (2005) explores this issue of
coordination between top two outsiders in Indian companies and finally if
the effect depends on whether these outside shareholders are
institutional investors, financial institutions, foreign investors or other
corporations. She includes a wider set of mechanisms, such as identity
and ownership of outside block shareholders holding at least 5 percent of
total equity of the firm. The study provides a closer look at the role of
institutional investors to see if these investors align their interests to
constrain the insiders from expropriating corporate resources especially
when these investors hold significant voting rights. These studies
demonstrate the benefits of concentrated ownership over expropriation
effects associated with high insider stakes. 12
12
For more details on concentrated ownership and firm performance see Chapter 4 in Sarkar and
Sarkar (2012)
27
Using a sample of MandA, Bhaumik and Selarka (2012) examine
the impact of mergers, takeover and acquisitions on firm performance
and draws conclusions about the impact of concentrated ownership and
entrenchment of owner-managers in an emerging market context.
Finally, to understand the role of differing governance structures of
business groups and standalone firms, Chacar and Vissa find that
business group affiliation results in greater persistence in poor
performance than standalone firms.
28
2013 does not define the CSR but provides the list of activities
that can be included by companies in their CSR activities.
2. Along with other committees, CSR committee should be formed
and chaired by an Independent Director. In addition, the
Companies Act 2013 also revises the definition of independent
director and the board independence requirement.
3. SEBI‟s mandate for listed companies, starting with the top 100
firms, to describe measures taken by them along the key
principles enunciated in the „National voluntary guidelines on
social, environmental and economic responsibilities of business,'
framed by the Ministry of Corporate Affairs (MCA).
13
For detailed discussion about the evolution of CSR and development of legal framework see
Bhaduri and Selarka (2016). The book presents exhaustive study on evolution of CSR practices in
India and also provides a comprehensive study of development of legal framework recognising
CSR as an economic issue.
29
independent directors does not affect the CSR even though univariate
analysis suggests that firms with higher proportion of independent
directors spend on an average more on CSR activities.
REFERENCES
30
Confederation of Indian Industry (CII) (1998), “Desirable Corporate
Governance: A Code”, Available online at
www.mca.gov.in/Ministry/latestnews/Draft_Report_NareshChand
ra_CII.pdf
Khanna, Tarun and Krishna Palepu (2000), “Is Group Affiliation Profitable
in Emerging Markets? An Analysis of Diversified Indian Business
Groups”, Journal of Finance, 55 (2): 867-91.
31
Raithatha Mehul and Surenderrao Komera (2016), “Executive
Compensation and Firm Performance: Evidence from Indian
Firms”, IIMB Management Review, 28(3):160-169.
32
Sheifer Andrei and Robert W. Vishny (1997), “A Survey of Corporate
Governance”, Journal of Finance, 52(2):737-83.
33
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