Events at Tata Sons show that independent directors are there to support the dominant shareholder rather than protecting the interests of minority shareholders.
Six independent directors at Indian Hotels Ltd. unanimously expressed their support for Cyrus Mistry last week. Mistry was recently removed as chairman of Tata Sons. As the Tata group had signalled that it would like Mistry to step down as chairman of the group companies, the independent directors were, in effect, defying the dominant shareholder (a shareholder who holds the single largest or controlling equity stake in a company but not necessarily a majority stake).
This must be the first action of its kind by independent directors in India. It hugely complicates matters for the Tata Group where Indian Hotels is concerned. It also raises the disconcerting possibility that independent directors at other Group companies chaired by Mistry could act likewise. If that happens, it could make it difficult for the Group to assert its control over those companies as well.
Many have lauded the move by the independent directors at Indian Hotels. It would be premature, however, to view it as signalling a new trend. We need to face up to the fact that the corporate governance model, which has been borrowed from the Anglo-Saxon world, suffers from serious infirmities, more so when applied to the Indian context.
In the Anglo-Saxon model of the company, we have professional managers accountable to dispersed shareholders. Incredible as it may sound, although the board of directors is supposed to represent shareholders, the latter had, for very long, little or no say in appointing directors. The board of directors was self-selecting and self-perpetuating. Directors were chosen by the management and it was almost impossible for shareholders to have any say in the matter.
In the US, management would send out a ballot or proxy containing its list of directors. Shareholders could say ‘yes’ or they could abstain – they could not say ‘no’. Even if 99% of the shareholders abstained, the names proposed by management would go through.
There has been some improvement in the situation in recent years. The mechanism of independent directors has been created, the presumption being that these directors will act independently of management and in the interests of the body of shareholders.
Independent directors are chosen by a nomination committee consisting entirely of independent directors. In practice, however, the CEO has an important say in the selection of independent directors. No nomination committee would like to induct a director whom the CEO is not comfortable with.
Shareholders have, in the recent past, been permitted to the names of independent directors in the list proposed by the management but the conditions for doing so are so stringent that it rarely happens. Thus, the mechanism for selecting independent directors remains unsatisfactory even in the Anglo-Saxon context. So much for ‘shareholder democracy’ there.
When applied to the Indian context, this model’s limitations are even more severe. In India, we have a dominant shareholder (often described as ‘promoter’) pitted against other shareholders. This happens in all the three forms of listed companies that are to be found here: private companies, public sector companies and multinationals. The professionally managed firm is a rarity in the Indian context.
There is always potential for conflict between the dominant shareholder and the other shareholders. Indeed, the point that Mistry makes in the recent controversy at the Tata group is that Ratan Tata may have been acting in ways that do not serve the best interests of other shareholders.
In his angry letter to the board of Tata Sons, Mistry suggests that his own instinct was to exit costly overseas acquisitions that had led to a huge pile of debt at the group and were not generating enough cash. He indicates that closing down the Nano project would have been the right thing to do at Tata Motors. He says that he tried hard to prevent the entry of the group into the aviation business.
In short, Mistry’s contention – one that resonates well with many investors – is that he was trying to push through decisions that would have benefited the broad body of shareholders in the Tata group. The dominant shareholder came in the way because his decisions amounted to dismantling some of the Tata legacy or rejected some of Tata’s pet projects.
In such a situation, the independent directors are supposed to safeguard the interests of minority shareholders. But the limitations to this mechanism in the Indian context should be all too apparent. It is the dominant shareholder who appoints ‘independent’ directors. In large companies, these directors are very well compensated – say, upward of Rs 50 lakh. In return for this largesse and all the prestige that goes with being on the board, the independence of the ‘independent’ directors become suspect. How are they expected to question, challenge and even oppose the dominant shareholder?
In his letter, Mistry makes embarrassing disclosures. Two of the independent directors once left a board meeting in order to receive instructions from Ratan Tata, holding up the board meeting for almost an hour. The nomination and remuneration committee of Tata Sons had only recently lauded his performance – and yet two of the three independent directors on the committee voted for his removal.
If Mistry’s statements are correct, what transpired at Tata Sons highlights the reality about independent directors in the Indian context: they are there to carry out the dominant shareholder’s bidding. They cannot be counted upon to protect the interests of minority shareholders.
The unanimous support that independent directors at Indian Hotels Ltd. have expressed for Mistry’s leadership is unlikely to change this reality. If anything, it will ensure that hereafter promoters appoint only those they can completely rely on as independent directors.
Most independent directors come from a shallow pool of serving and retired corporate executives or professionals (such as lawyers and chartered accountants) with close links with the corporate world, and bureaucrats. Following the move at Indian Hotels, we can expect this pool to shrink even further. Only those who enjoy the full confidence of the promoter will hereafter get appointed as independent directors.
If the mechanism of independent directors is to be meaningful in our context, we need radical reforms. It cannot be that the dominant shareholder alone appoints independent directors. All important stakeholders – institutional shareholders, minority shareholders, large lenders and employees – must have a say in the appointment of independent directors.
To start with, we could mandate that 50% of the independent directors be appointed by entities other than the management or the dominant shareholder. It’s only when the selection of directors is independent of management or the promoter that we can expect active questioning and dissent in boards. Only then can we ensure that boards are effective, that the interests of all stakeholders are taken care of.
The board of directors is central to corporate governance. Yet, dysfunctional and ineffective boards are pretty much the norm worldwide. The Mistry affair gives us an opportunity to rethink the composition of boards in India and tackle head-on the conflict between dominant shareholders and other shareholders. It’s for the ministry of corporate affairs, SEBI and the stock exchanges to rise to the challenge.
T.T. Ram Mohan is a professor at IIM Ahmedabad.