Why shareholders need to be good stewards

Speaking at an NSE event a few years ago, Marco Brecht, then professor of finance at the Université libre de Bruxelles, highlighted that regulatory attitudes towards obtaining the right balance between managerial discretion and shareholder interests vary widely across the world. This is despite having broadly similar governance frameworks.

At the core of this balancing act is the age-old principal-agent problem. It arises since there often is a conflict in priorities between the owner of an asset (shareholder) and the person to whom control of the asset (management) has been delegated. Professor Brecht went on to illustrate how different jurisdictions approach this, by contrasting the degree of delegation of decisions to boards. There is, in other words, no consensus on what shareholders should vote on and what they should delegate.

In the United States, the shareholders delegate most powers to the board, which makes all decisions. For example, the remuneration of the executive board is determined by the directors and not by shareholders. There have been attempts to give this right to shareholders, but progress has faltered — the consensus view being that executive compensation is far too complex to be left to shareholders! This has given way to “say on pay or SOP”. SOP serves as a soft signal, allowing institutional shareholders to react to compensation structures and thereby sway the board’s perspective. Another instance of the primacy of the board is the recent director reappointment vote in Twitter Inc. Egon Durban, failed to secure a majority of the votes cast, but the board did not accept his resignation, asking him to continue. This American approach helps explain the focus on board composition and independent directors not just in governance literature, but in practice.

In Germany, shareholders appoint a supervisory board that appoints the management, which then makes most decisions with the consent of the supervisory board. The degree of delegation in the UK is more moderate because shareholders in the UK retain quite a lot of decisions for which they cast direct votes.

In India, this degree of delegation is relatively modest. Shareholders retain most of the decision-making power with themselves, even as there is a strong case for a high level of delegation to the board. The argument in support being that as family’s own a large piece of the pie, and typically also manage the business, what is good for them as the largest shareholder should be good for all other shareholders. Conversely, the argument for limited delegation is that business families use their dominant shareholding to push through resolutions that benefit them at the expense of the remaining shareholders. So, having shareholders as the final arbiters on most decisions is desirable. Our regulators fall in this second camp, and most decisions are pushed to shareholders.

Institutional Investor Advisory Services lists 28 items needing shareholders’ approval before management can act. Some are understandable, like permission to raise more equity (dilutes stake of existing shareholders), approve borrowing limits (contains risk), approve appointing and compensating the promoters’ kith and kin (how many family members are needed to change a bulb?). Others less so. These will include approving hiring and paying branch auditors, signing off on the fees paid to cost auditors, approving a company charging a fee to deliver some documents to a shareholder, or approving the extent of borrowings via non-convertible debentures, even when it is within the borrowing limits approved. It is not clear why all these need shareholder approval; some can safely be delegated to the boards.

Deciding whether to vote for or against is never easy with many rules and regulations adding to the complexity. Some approvals need more than 50 per cent shareholders (simple majority) to support, some more than 75 per cent (special majority) and still others by a majority of minority, before managements can act. These need a revisit. For example, “promoters” get to vote on their own salaries. Given that family shareholding is on average at 55 per cent, these resolutions mostly carry. Such resolutions need to be moved to the majority of minority.

Second are the byzantine set of regulations that sit alongside. An example being one-third of the non-independent directors needing to retire each year. This results in some directors retiring every alternate year and in the extreme, every year. This could not have been the intent. Many like these need to be reviewed.

There are then the additional checks that are stipulated. For example, a board committee reviews and approves related party transactions before placing them to shareholders. Or the process that is expected to be followed for appointing an independent director. Based on resolutions placed, it appears that many companies — not all— pay mere lip service as definitions get stretched by the auditors and lawyers. Clear, unambiguous guidance may be needed. 

Then, there are instances where regulators need to ratify a decision or sign-off, for example in appointing the CEO of a bank, a stock-exchange, or a media company (as investors suddenly discovered), or the Comptroller and Auditor General appointing an auditor in a public sector undertaking. The shareholders in these instances have a role, but not the final say.

Even as the broader ecosystem works to mend these anomalies, we must recognise that our regulatory regime is based on a relatively modest degree of delegation to boards. Shareholders are collectively responsible for driving business and must learn to be good stewards. They have to be more demanding of information from companies, more questioning about the processes and governance structures companies have in place and more clear-headed regarding how they vote. The buck stops with them.

The writer is with Institutional Investor Advisory Services India Limited. The views are personal. @AmitTandon_in