Author: Hansaja Pandya
College: Gujarat National Law University
A recent wave of investor activism in India was witnessed when the Institutional Investor of Fortis Healthcare pushed for removal of the company’s 4 directors due to continuing record of low sale proceeds and siphoning of funds by its promoters. The Institutional Investors also appointed the new non-executive directors and reconstituted the entire board to ensure better governance and growth of the company. And thus, as rightly pointed out by Monk and Minow, institutional investors constitute one of the three pillars of corporate governance because they have a significant capacity to influence the board to adopt good corporate governance practises.
Having realised the role played by Institutional Investors in Corporate Governance, Securities & Exchange Board of India (SEBI) enacted the Stewardship Code in December 2019 (Code). This Code is a transposition of the UK based stewardship policy of 2012. Transposition and emulation of stewardship principles of another jurisdiction in India will disturb the Indian corporate structure as no two jurisdictions have identical experiences. In light of this, this article seeks to analyse the downside of transposing a United Kingdom (UK) based stewardship code in India by answering questions like whether the Code will actually be put into practise? Or will it simply make a policy statement? Will the stewardship principles be put into action? What are possible challenges, loopholes and lacunae in the Code?
Negative Impact of the Code:
The Code is about to have certain adverse impacts on the Indian corporate structure due to the unthought transposition of UK style Stewardship Code in India.
The first problem that arises out of this rash and unthought adoption is that the UK Stewardship Code primarily focuses on the ‘Shareholder approach’ which primarily aims at benefiting the clients of the investors. This means that, investors will only deem it appropriate to intervene and prevent a management decision from coming into action if the cost of active engagement is justifiable, reasonable and proportionate to the benefit acquired from safeguarding the client’s interest. Adopting this cost-benefit analysis to study the impact of the Code brings out two rippling consequences:
On the brighter side, the motivation to protect their clients will push the institutional investors to actually bring the provisions of the Stewardship Code into action. It will not only remain a written law, but will be seen practise. Although the influence of institutional investors will be limited because of the concentrated shareholding patter in India giving power to the promoters and insiders of the company. But even within this limitations, the institutional investors will now be empowered to take steps to ensure good corporate governance practises as a matter of right having a legal backing. Investors will expend the cost required in monitoring and intervention to the extent it is necessary to protect the interest of their client by practising the stewardship principles and ensuring that the investee companies engage in responsible governance practises.
But on the flip side, cost based intervention will prevent the investors from intervening when the cost of intervention exceeds the gains to be achieved. Investors will simply look for affordable alternatives like exiting that company, redeeming or recouping their investment or claiming damages based on the contract, rather than fulfilling their stewardship obligations of intervention and monitoring. These alternatives seem even more feasible and easy in the Indian context where institutional investors usually hold very little stake in the investee companies which are dominated by the promoter shareholding. This inhibits the establishment of a fine and a responsible system of corporate governance for which the stewardship code was enacted. The only way to avoid this potential downside from occurring is to expand the scope of ‘stewardship’ to include promoter/insider/family-based shareholders and make it obligatory for them to act as stewards of the company.
Another circumstance that raises the chances of intervention and monitoring by investor, when their cost exceeds the benefits of stewardship, is that the Stewardship Code, 2019 is silent about the punishment, fine, penalty that the investors must serve or bear when they fail in their duties. Lack of penalty provisions averts accountability on the part of investors and ultimately affects the effectiveness of the Code. This is the biggest loophole for the investors to escape from their stewardship duties and if this happens the code will not be able to correct or improve the corporate governance environment in India. IRDAI and PFRDA Codes serve as a note of caution as in these codes too there were no penalty provisions significantly inhibiting their effectiveness. Slow rise of stewardship and activism on part of insurance companies and pension funds evidently reflects the failure of IRDAI and PFRDA Codes.
Open-endedness of the Code is the other unruly hitch that slackens its effectiveness. The Code is open ended in itself providing endless opportunities for institutional investors to innovate and design strategies for monitoring and intervention with the investee company. While this is a boon for the investors, on the flip side, it may prove venomous as no uniformity may be maintained. For instance, different institutional investors of the same investee company will have different thresholds and monitoring strategies which will restraint the formation of a united front against the malpractices and governance failures of the investee company. Such an instance will further aggravate the governance issues in the Indian context where already, the institutional investors hold minuscule proportion of voting or bargaining power. Even if prominent institutional investors do hold majority stake, it becomes divided amongst various investors with varied and diverse intervention, monitoring and voting policy. Given the above circumstance, the open ended Stewardship Code will not do much good to encourage investor activism in India. Institutional investors lack uniform stewardship practises which hinder them from acting together in times of corporate governance failures. The IRDAI and PFRDA stewardship Codes were also open ended. This might be the foremost reason why they failed to deliver the desired results. Given these concerns and concentrated pattern of shareholding in India, institutional investors will become more vigilant than ever in order to make the difference.
On one side, institutional investors have an inherent motivation to act as stewards in order to protect their clients as prescribed in Principle 2 of the Code. This inherent motivation will ensure that the stewardship principles are actually implemented and it does not merely remain a dead law. But this motivation faces various hurdles like influence and dominance of promoter/insider/family-based shareholding that may silence the voices of institutional investors in certain cases. Another hurdle that slackens the motivation of the investors is the lack of penalty & uniformity in policies due to open-ended codes.
The Code of 2019 was expected to automatically check and balance the system of corporate governance and allow Institutional Investors to engage with the investee company in circumstances of poor financial performance of the company, corporate governance related practices, remuneration, strategy, risks, leadership issues and litigation. But to the contrary, it has been witnessed that in many cases institutional investors fear raising voices or when actions are taken, they are supressed by the investee company. The fear may retard the effectiveness of the Code.
While this is not the first time SEBI has propounded guidelines to establish a robust corporate governance mechanism, the Code does not reflect the experience and maturity. It requires a major overhaul while it is still new and becoming.
Global experience has evidenced that Stewardship Codes improves the public disclosure policies and also outlines Investor obligations in several crucial areas of governance – conflicts of interest, voting, monitoring and engaging with the investee company, and the consideration of ESG factors. In order to ensure that the SEBI Stewardship Code of 2019 actually translates into this global experience, there are certain modifications required which have been analysed in the III and final part of this article.