A great deal is being debated about corporate governance in India and elsewhere. The merits and demerits of the fine print and the letter of the law are a subject of discussion among the experts/law makers and regulators.

Perhaps, a better and more practical way to take stock would be to look at some of the current corporate practices that may possibly adhere to the letter of the law, but will be wanting in spirit. Good governance is more of the latter than mere compliance with the technicalities of law. Otherwise, there is the risk similar to that of wrongly correlating the size of the pooja room with the moral values of the house owner.

Some of the currently observed practices that raise serious doubts over the commitment of leading corporates in governance are briefly mentioned below :

These instances are not cases of violation of any law or regulation. Some of these have been specifically blessed by the judiciary/regulators with reference to the applicable laws/regulations. The approach is to evaluate if such practices conform to the spirit of the principles that form the core underlying the concept of salutary governance.

l As part of a restructuring exercise and to unlock the value of the largest software business in India, Tata Sons Ltd. has transferred the said business to TCS Ltd. at a stated value of Rs.2,300 crores. The implicit value of the same business is well over Rs.40,000 crores, based on the price at which the shares have been allotted by the issuers in the recent public issue of TCS.

By virtue of Tata Sons limited owning more than 90% equity of TCS, all the associated economic benefits stay with the former. But the fact of the matter is that historically, several listed companies of the Tata group have contributed to Tata Sons equity at significant premiums from time to time to help Tata Sons have enough resources to augment its shareholding in the Tata Companies. The justification given to the shareholders of these listed companies of the Tata Group then was that these contributors will have an option to unlock their value when TCS business would get spun off and go public.

In the current structure, by valuing TCS at an improbably low price of Rs.2,300 crores (presumably as part of tax planning to save taxes on capital gains) the corporate shareholders of Tata Sons (mostly listed companies of the Tata Group) have no direct/effective access to the wealth of TCS. Nor do they get any exit, as Tata Sons is an unlisted company. A more accepted and tested way of fulfilling the various promises made to the members of the listed companies of the Tata Group should have been to demerge the TCS division and distribute the shares in TCS among all the shareholders of Tata Sons (by replicating the shareholding of Tata Sons in TCS).

This is the method adopted by many Indian companies for separation of businesses that existed as a conglomerate, thereby giving the shareholders of the transferor company an opportunity to retain or exit from the shares of the transferee company (for example, Ramco, Bluestar, Indo Gulf, EID Parry, etc.). Actually, the need to adopt this form of restructuring was more compelling in the case of TCS, since Tata Sons itself being unlisted, the only scope to provide exit opportunity could have been by allotment of shares through a proper demerger process. Apparently, this has not been done as the ownership of Tata Sons is controlled (approximately), 65% by public trusts and 18% by corporates. (This information is obtained from the red herring prospectus issued by TCS.) In the absence of any specific reasoning/details in this regard, it can only be surmised that Tatas did not want the control of TCS go out of their hands, despite availing funding from listed companies. The TCS prospectus has no information on the basis for the valuation of the TCS business at Rs.2300 crores for transfer of the business. While the impact of this approach to demerger on the public trusts (holding shares in Tata Sons) may not be a matter of immediate concern, the deprivation to the shareholders of the widely held/listed companies such as TISCO and TELCO is direct and palpable. It is not clear as to whether and how the Board of Directors of these listed companies have considered this modus adopted by Tata Sons as protective of the interest of the investors in their respective companies.

As observed already, the process may not be falling foul of any law, but a lingering doubt that the ethics (of having to fulfill a legitimate and morally founded expectation of other investors which were voluntarily met by many other enlightened corpo-rates under similar circumstances) may have been brushed aside lightly still remains.

Birlas have removed Lodha & Co., the existing auditors of many widely held companies in the ‘Birla Group’. These are large listed public companies that have an independent audit committee (a prescription handed out by the SEBI committee on corporate governance headed by Mr. Kumara-mangalam Birla, a chartered accountant and the dynamic Chairman of the Birla Group).

While a partner of the said audit firm may be involved in some personal litigation with some members of the Birla family, neither he nor any other partner of the firm has been subjected to any enquiry or found guilty of professional misconduct/incompetence by any competent body/regulatory authority. It is not clear as to how the audit committees of the companies have come to a reasoned conclusion in recommending the decision to change the auditor.

This strikes at the very rationale for an independent audit committee whose duty is essentially to distance any particular group of shareholders (or more importantly, the management/promoter group), from influencing the decision on the vital process of selecting the independent auditor engaged for reporting on performance/governance to all investors.

The audit committee is required to base all its decisions only on factors connected to the corporate entity and in the interest of all shareholders collectively as a body, divorced from any extraneous/irrelevant/personal perspectives. (Of course, it is another matter that the decision of the promoter — Birla Group with its dominant control over the shareholdings in the widely held companies would, in any event, prevail ultimately.) The track record of the institutional investors (financial institutions, banks, mutual funds, etc.) is nothing to write home about and they have also made significant contributions to poor corporate governance in this country.

At the same time, it cannot be overlooked that some auditors have, when faced with similar legal imbroglio, resigned on their own immediately. Nor does this discussion argue against the philosophy of rotation of auditors, but only brings up the issue of the reason and the circumstances impelling the same.

In fact, it is the reasoning adopted by the Board of Directors of the Company, in arriving at the conclusion (as communicated to the investors) that goes against the very principles governing Corporate governance and constitution of Audit Committee, as elucidated by the various expert bodies including the SEBI Committee on Corporate governance headed by Mr. Birla. A reference to the recommendations of the Birla Committee on the need, composition, independence and functions of the Audit Committee will be useful in this regard.

The reasons given by the company to the investors (through NSE) are :

"Indo Gulf Fertilisers Limited has informed the Exchange that in respect of the Will of Mrs. M. P. Birla as a sequel to which the BOD of the company is actively considering the issue of M/s. Lodha & Co., Chartered Accountants, Kolkata, continuing as the Statutory Auditors of the Company. Accordingly, in order to enable the Board to take a definite view in the matter, it has been decided by the BOD that the AGM to be convened on August 10, 2004 has been cancelled. The members will also be intimated about the fresh date of the AGM to be held well before September 30, 2004."

It is clear that the reasoning given by the Board of Directors (BOD) of Indo-Gulf Fertilisers has nothing to do with the ability/willingness of the audit firm in relation to the independent professional discharge of a statutory duty (with respect to Indo-Gulf or any other company). The sudden change in view relates to the same auditors whose appointment was recommended by the same Board all along (including at the time of issue of the notice of the AGM).

The communication from the company to the investors (through NSE, for cancelling the AGM in August 2004) has clearly explained that the sudden change in the views of the BOD of the Company is caused by the legal dispute between the auditor and relatives of the promoter (Birla) Group and no other reason is given. No other explanations as to how the non-removal of the auditor or the civil dispute/legal challenge by some relatives of the Chairman against the auditor has impacted or will impact the quality of audit or whether any new evidence/information on the competence of the auditors was obtained (subsequent to the issue of the AGM notice) are shared by the BOD in its communication. (It is another matter that after the cancellation of the AGM, the retiring auditors have suddenly conveyed their unwillingness to continue and this is something, many would expect, should have taken place much earlier, as a matter of avoiding embarrassments to all, the moment the disputes arose).

If only some other noble reasoning, founded on improving corporate governance (say, the principles of improving the independence of audit function by periodic rotation of auditors) had been adduced by the Board to the investors for recommending the change in auditors, there would have been no scope for any argument on this issue. It is another matter that giving such impressive explanations centering around governance, would not have, in any way, affected the decision to remove the auditor as, in any event, the will of the Promoter Group will be executed by the majority at the AGM.

Nobody can quarrel with the proposition that democratic process always means that the will of the majority will prevail and change of auditors is no exception. But the reasoning given by the Audit Committee/BOD is quite contrary to the very spirit of the logic behind the constitution/responsibilities of an independent BOD of a widely held company, as explained by the Birla Committee.

l The advent of the Accounting Standards concerning consolidation of financial information of parent and subsidiary companies seems to have come in handy to help Indian corporates, most of whom are already chary on sharing information with shareholders, to further obfuscate essential details.

Most of the large corporations have issued consolidated financial statements and have avoided giving individual subsidiary companies’ accounts, based on approvals/waiver by the relevant authorities, of course. The annual accounts of Reliance Industry (for the financial year ended on 31st March 2004) are an example of how details of investments made by subsidiaries can remain undisclosed in the process of complying with the Accounting Standard on consolidation. More than Rs.8,000 crores of investments by subsidiaries are not supported by information that are mandatory if individual accounts were provided.

It is unfortunate that the concerned authorities, who granted such waiver for furnishing individual subsidiary accounts, did not take into account the possibility of such non-disclosure due to the policy followed by them.

Similarly, another Accounting Standard, requiring performance disclosures for individual business segments, intended to provide useful insights for shareholders, has become a casualty of restricted or stretched interpretations, as it suits the occasion, resulting in poor compliance. Again, the case of Reliance Industries is one of the many examples and is highlighted for the not-so-inconsiderable quantum involved.

The company has provided a break-up for two segments alone, petrochemicals and refining, while it is common knowledge that the conglo-merate’s interests span at least half a dozen other sectors ranging from insurance to telecom. Assets deployed to the tune of Rs.28,000 crores are disclosed as ‘others’/‘unallocable’. This non-disclosure represents nearly 40% of the assets of the Group.

This is yet another example of how Government orders giving exemption from disclosure can be made use of to minimise the disclosure of important information, in full compliance with law, that is, without violating the letter of law. This also explains how the exemption orders issued by the DCA can be a legitimate basis for non-disclosures.

For the financial year ended 2003, many large companies (Tisco, Telco, M&M, Ashok Leyland, etc.) committed a strange accounting acrobatics of writing off expenses (carried in the balance sheet, historically, to be amortised over a period in the profit and loss account) to the accumulated reserves, as a one time presentation exercise, ably assisted by the ambivalent provisions of the Company law and the majestic indifference of the Accounting Standard setting body.

None of these companies has thought it necessary to provide in the accounts any remarks of what the net profit would have been if the old accounting treatment had continued, to facilitate comparison/analysis. Nor has the regulatory professional body, charged with the duty to prescribe Accounting Standards, explained its stand concerning such practices, which are now at least two years old.

The government seems not to lag behind the rest of the corporate sector, in practising poor governance in business, as well, in enacting the forced marriage of the two banks, namely, GTB and OBC. Hardly anything has been said about the sacrifice of the (non-government) OBC shareholders. It is strange that whatever the legal powers that RBI has to effect unilateral ‘merger’ of banks, it seems to ignore and ride rough shod over the other shareholders of OBC who possessed these shares on the basis of the performance of the bank and their future expectations, at market related valuation. It certainly appears that it is too far to take the ‘caveat emptor’ principle to hold that the expectations of such governmental action should have been factored in their investment decisions.

Even the important exercise expected of a buyer of carrying out a valuation of any acquisition (GTB) has been bypassed. The shareholders of OBC have no clue of the impact of the merger on their interest. Indeed this risk, germinating from the disregard of the interest of other minority (non-government) shareholders, is common in respect of all investments in public sector banks.

It is bound to rise, even as the news on collapsing banks has now become a common phenomenon. Similar is the approach of the government in dealing with the companies in oil sector where shareholders can have no clue of what the government’s next move could be and very little that happens is market-driven or-related.

The outcome of the valuation exercise concerning a bankrupt bank is not expected to bring any pleasant surprise. (Except for a possible tax break on bad loans, no other value addition can accrue to the shareholders of OCB but even this tax advantage appears suspect as the conditions required to be satisfied to qualify as ‘amalgamation’ under the tax law apparently have not been satisfied).

This is but logical as there were no investors to infuse capital into GTB for the past several years, despite concerted efforts. So, the ability of the forced takeover (of liabilities) to add to the value of OCB may not be discovered by any valuation exercise. If there was any value potential, that could have been used to stall the bankruptcy or to attract fresh investment into the bank ailing for the past four years. It is a case of robbing Peter to pay Paul, with the government playing the role of Robin Hood.

The L&T-Grasim deal involving the former’s cement business, being sold through a convoluted mechanism of arrangement u/s.391 of the Companies Act, 1956, raises many questions — on the role of the Court in approving such arrangements, that of SEBI in having waived the applicability of the takeover guidelines to certain part of the transaction made as part of the arrangement, and equally the role of independent institutional investors (like the FI and mutual funds) in merely following the letter of the law and not looking to the effect of such arrangements on other investors.

The lack of transparency on the part of the Board of Directors in taking the investors into confidence on the rationale for preferring a particular structure to other alternatives is a sad commentary on the lack of institutional mechanism to demand proper accountability from the custodians of the investors’ interest. The passivity of a mass of small investors is largely to do with the absence of an accessible forum to agitate their concerns and these people are effectively deterred by the procedural complexities surrounding the access to Court or SEBI, as the case may be.

The above litany just about scratches the surface and a diligent enquiry will add many more to this. Hence it is time that the actions and inactions of all the constituents (the regulators, law makers, promoters, institutional investors, independent directors, etc.) are debated for their fairness and tested for appropriateness in terms of their relevance to the spirit of the concept of corporate governance. Law and enforcement can never be totally foolproof to address all possible deviations, especially in areas where intentions and impacts matter more than legalistic prescriptions and practices. The need of the hour is to create a disabling environment to limit the scope for practices that comply with law but are far removed from its spirit.

Article by Mr. R. Sekhar & Mr. V. Ranganathan