Timely response in governance

Commentary on misgovernance dwells on misdemeanour, but perpetrators often do not demonstrate malintent. There are plenty of smoke signals, however, before every episode

When there is a governance malfunction, both the error and the timeliness of response come under public scrutiny.

Commentaries on governance usually dwell on misdemeanour and are often presented as being of a gross nature. Despite recommendations by the Cadbury Committee in the UK, the Sarbanes-Oxley Act in the US, and Sebi regulations in India, misgovernance cases keep recurring. Maybe there are aspects beyond regulations and logic at play. 
 

Usually, the perpetrators are depicted as evil-eyed plotters. It may be true in some cases, but doubtful in some others. While some do demonstrate malintent, many are examples of “escalating entanglement” — a cycle of mistakes to cover up one initial mistake. It is often not easy to separate bad intent from entanglement.
 

In the Tata Finance episode of 1999-2000, was Dilip Pendse a congenital crook? Many knowledgeable folks feel that he perhaps did one trade too far in pursuit of his vaulting ambitions and initial wrong bets. To make up for that fault, more unwise deals may have been done, until the whole matter pivoted out of his control. Nonetheless, the result looked like malintent.
 

The same has been stated about Ramalinga Raju and the Satyam case in 2008. Those infotech professionals, who knew him, insist that he was no scheming crook. His was a genuine rags-to-riches story. At some stage, most likely, his ambition exceeded his grasp, leading him to real-estate deals that sank him along with his boat.  The Cafe Coffee Day episode of 2019, which was sparked by the tragic suicide of founder V G Siddhartha, bears some resemblance to the Satyam episode.
 

In many such sagas, with hindsight, it turns out that people in the ecosystem around the person had observed a behaviour change in the person, but they did not treat the change as a smoke signal. I like to refer to such early signals as prodroma, which means advance signals. Prodroma always precedes the unravelling of events. Acting on early signals averts the scale of the disaster.
 

In 2019, there was the case of Gautam Thapar and his company, CG Power and Industrial Systems Ltd. Originally a professionally-run and highly-competent organisation, the company used to be known as Crompton Greaves. Mr Thapar assimilated Crompton into a clutch of companies, grouped together under the name of Avantha Group.
 

CG Power had an exemplary board with outspoken independent directors. The board was ever watchful, and the directors invested their time in what they believed to be a prized company of the future.  In 2019, the independent directors noted that the apparently improving Ebitda did not result in commensurate cash flows and profit before tax. They treated this as a smoke signal.
 

The risk and audit committee, steered by independent directors, delved into the details through what can be termed as “healthy scepticism”. They were astounded to stumble upon surprise after surprise. Despite their diligence and professionalism, they never knew about these earlier. Meanwhile, what was visible in the public domain was that the stock price of the company had shrunk by 70 per cent of its value just a few months earlier.
 

There was a complex web of related parties, which means inter-connected subsidiaries. There were many loan transactions among those companies.  In every listed company board, the independent directors will never know the details of the domain or transactions that company managements will know. This asymmetry of knowledge is a fact of life. Yet, independent directors are expected to be watchful! The only way is to acquire a smell of the place and sense smoke signals ahead of the fire breaking out.
 

The risk and audit committee was confronted with a web of transactions among related companies, which were glibly explained by the operating management through some slick arguments. The slickness of the arguments militated against the common sense of the independent directors, who delved further. After a 13-hour meeting, which lasted until 4 am, they were startled to realise the facts that emerged: That the total liabilities of the company and the group were understated by, hold your breath, Rs 1,990 crore and Rs 2,800 crore, respectively; that the advances to related companies was about Rs 2,657 crore, not Rs 131 crore, as had been officially reported in the accounts; that these, and other such unauthorised transactions had been undertaken by certain employees, resulting in a huge impact on the company financials.
 

The board blew the whistle on itself when it convened soon after. The promoter-chairman was sacked from chairmanship, the regulatory authorities were invited in, and the painful cleaning-up process, based on fairness and law, started. The company now has found its place with a responsible new ownership.
 

Several cases are known to be characterised by early signals, but those are sometimes ignored. Two major banes found among many Indian corporate groups are (i) too many subsidiaries, accompanied by (ii) related-party transactions.
 

In past columns, it has been argued that board directors must exercise healthy scepticism and be watchful for advance signals — prodroma. Unfortunately, there can be no fixed rule to determine the precise moment when the advance signals must be acted upon.
 

Board alertness and intuition play an important role. Reflecting and acting on signals is essential. Certainly, ignoring signals is not a sensible option.

The writer is an author and a business commentator. www.themindworks.me; rgopal@themindworks.me