India’s progress in public enterprise reform has been admittedly modest. The familiar issues of multiple roles of the Government, the agency problem, contractual incompleteness, and information asymmetry continue to affect adversely the potential of this sector. Yet the public enterprises will continue to dominate the economy for several years to come. It is inappropriate to believe that the argument of public vs. private has been settled conclusively so as to imply the gradual disappearance of the state owned enterprise.  Despite the notable fatigue and cynicism that has set in, the reality is that Indian public enterprises need reform both in the policy conditions and the internal structures and processes.

The popular codes and principles on Corporate Governance are, in most parts, relevant to public enterprises. At the same time, they appear incomplete, as they have not addressed the special features of governmental control systems, which impinge on the quality of governance. I had occasion to raise the critical diversities in the governance systems of the widely held private firms and the state owned enterprises in the Commonwealth and the need to develop a more relevant set of principles for the latter.  The SCOPE had commissioned a study in 1997 on this issue and had suggested in October 2000 that we prepare a document afresh for wider discussion. This report is the outcome of the initiative of the then Secretary-General of SCOPE and the subsequent support lent by the Forum for Policy Promotion, Hyderabad.

The report uses a wide framework for the definition of public enterprises covering state level and central level companies; statutory bodies; Government trusts; departmental undertakings and state controlled co-operatives. The objective of the report is however, limited to:

“Developing an approach and the first principles for improving the conditions for good corporate governance in public enterprises in India”.

I recognize the difficulty in implementation of several of the first principles.  This is indeed the case with any type of principles.  Yet, there is need to build consensus on the non-negotiability of a few foundations on which the edifice of good governance in PEs can be built.    

The report discusses in Part – I the special features of the state controlled enterprises.  In Part II, the central public sector undertakings have been taken up for closer attention by debating the typical structure of the board, the process of decision-making and dynamics of control in them.  This will help in assessing the major infirmities in policy and legal conditions that affect the quality of corporate governance in the most visible and sizeable segment of the public enterprises, which is in competition with private sector players. Part III contains the First Principles with brief annotations.

I have benefited greatly from interactions with international specialists and several documents of the Commonwealth Association for Corporate Governance. I also acknowledge with gratitude the comments and helpful suggestions on an earlier draft, from several friends, policy makers and academicians.

Y.R.K. Reddy
October, 2001                                                                                            

PART–I

1.1.              Corporate governance has reached centre-stage in the global agenda.  The principles and codes evolved in several countries have furthered the cause of efficiency, transparency and equity particularly in the interest of the shareholders.  Sustainable shareholder value has become the mantra for corporate immortality translating eventually into welfare of the society.

1.2.              The debate and effort in the arena of corporate governance has been tilted mostly in favour of the publicly listed and widely held companies.  It is possible that three factors have determined this inclination in the debate on corporate governance so far.  First was the study of Berle and Means, which had referred to the shifting of control when a company’s ownership gets dispersed.  The idea underscored the need to create and activate structures and processes by which the owners can ensure appropriate governance and management.  The problem identified was not of efficiency of capital in itself or of ownership but the possible divergence in interests between management and the dispersed owner (or some ownership vis-à-vis the rest). The influence of this study on subsequent principles and codes is evident from the arguments for separation of the position of the chairman from that of the chief executive and for induction of independent directors.

1.3.              The second factor is the Cadbury Committee’s report, which has been widely acclaimed and emulated despite its limited set of terms of reference. The London Stock Exchange constituted the committee.  The report dealt with the financial issues of the publicly listed companies in the London Stock Exchange. The Cadbury code addressed the prominent concerns of corporate failures and became the mother of all codes in several ways. Most other capital markets and their regulators adopted similar recommendations, albeit, given by locally appointed committees and commissions.  The effort, in sum, appears to be towards more efficient regulation through amendments to listing agreements and company laws as well as updated standards of accounting, reporting and disclosures.  A comprehensive solution to the Berle and Means propositions appeared to have been found through changes in board structures, processes, shareholder rights, reporting, disclosure standards and legal remedies.

1.4.              The third factor has been the hope of market efficiency as an ultimate solution to corporate conduct and performance.  This implied creation of a market for control of the company and freely entering and exiting owners who make their decisions on the basis of returns.  This factor, which has been experiencing a long and bullish run, implies aggressive corporatisation, privatisation and undiluted focus on shareholder value.

1.5.              These three factors have influenced the environment for good corporate governance in the developed world where capital markets are vibrant.  The codes and principles derived from this experience appear to be influencing the developing countries in terms of sensitisation to the need for good governance.  This is particularly so in countries where capital markets are expanding briskly.  In the process, however, major business/commercial segments of the economies in the developing world are not covered by the corporate governance regulatory net or have found the principles less rewarding in practice.  These are agencies, which carry out commercial activities, but operate under the control of the government and those, which are, incorporated public enterprises.  In these economies, public enterprises, listed and unlisted, dominate over the private sector listed companies in terms of contribution to GDP, capital employed, income, employee strength, social impact and possibly, as is being asserted lately, even in profitability.

1.6.              The Standing Conference of Public Enterprises (SCOPE), New Delhi, had recognised in 1996, the need to examine the corporate governance issues relevant to the public sector undertakings in India i.e. those companies in which central government has equity of 51 % and above.  It was recognised that the codes, which were referred to (Cadbury's and the Confederation of Indian Industry’s at that time), were most appropriate to the private sector and that the infirmities in the public enterprise governance needed a devoted attention.  An attempt was made to address the special conditions of the central public sector undertakings, which are also publicly listed and traded on the stock exchanges, and Yaga Consulting prepared a report titled “Corporate Governance and the Public Sector Undertaking” in October, 1997 (see Annexure).

1.7.              The report, derived from the perspectives of several industry leaders and academicians, highlighted a multitude of issues and recommendations to improve the quality of corporate governance.  It was made prior to the Kumar Mangalam Birla Committee report and the changes effected by the Securities and Exchange Board of India in its listing agreements.  The Kumar Mangalam Birla Committee report, like the Cadbury Committee, had limited its perspective to the typical private sector company – the composition of the committee reflects the tilt to this sector.   Subsequent developments also affirm this limitation.  (For instance, the dangers were not noted, of separation of the positions of Chairman and Chief Executive in the case of public enterprises. Such a separation has proved to be an incentive for political leaders to get nominated by the Government as independent Chairman. Further, in the interpretation of independence, the Securities and Exchange Board of India preferred to treat, by a separate clarification, nominees of Financial Institutions/Foreign Institutional Investors as independent even though they are equity holders.  However, the civil servants who are government nominees in public enterprises by virtue of government’s ownership are not considered on the same footing.)

1.8.              Besides the central public undertakings, there are several other entities – the state level public enterprises, state controlled co-operatives, organisations created by special statutes, joint ventures of state and central governments, departmental undertakings, companies promoted by developmental financial institutions of the government and the like, which are currently in commercial activities or are pursuing potentially commercial objectives.  All these public enterprises have greater potential impact on the society than the private sector due to the higher degree of ripple effect.  In the developing world, the returns from good corporate governance in these enterprises should exceed those in the private fold. Obviously, there is a strong interface between good governance and corporate governance in the context of public enterprises as the latter are often used and perceived as instruments of public policy. 

1.9.             It is against this backdrop that the need for a special perspective was recognised and a request made by the then Secretary General, Standing Conference Of Public Enterprises, New Delhi, to Yaga Consulting to prepare a note with the objective of:

 “Developing an approach and the first principles for improving the conditions for good corporate governance in public enterprises in India".

It is against this backdrop that the need for a special perspective was recognised and a request made by the then Secretary General, Standing Conference Of Public Enterprises, New Delhi, to Yaga Consulting to prepare a note with the objective of:

The term “Public Enterprise” here has the broad international meaning covering various types of state owned/controlled enterprise. The listed and the unlisted government companies, the central and the state level corporations, public sector banks, insurance and FIs, co-operatives and department undertakings are included in the term. The principles, if accepted, will obviously imply several operational difficulties, pulls, pressures and dilemmas. However, the attempt is to identify and gain consensus on the pillars for good corporate governance without being daunted by the potential controversies or operational barriers. Though this report is specific to India, the principles may be of relevance to several developing countries.  These would also reflect and reinforce the Commonwealth Association on Corporate Governance Guidelines, which had adopted an inclusive approach, relevant to the developing world   and the OECD principles, which reflect the long-term vision of active, transparent, accountable and efficient markets

1.10.           The report discusses in Part – I the special features of the state controlled enterprises.  In Part II, the central public sector undertakings have been taken up for closer attention by debating the typical structure of the board, the process of decision-making and dynamics of control.  This will help in assessing the major infirmities in external conditions that impinge on the quality of corporate governance in one of the most visible and sizeable segments of the public enterprises, which is in competition with private sector players. Part III contains the First Principles with brief annotations.

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THE FIRST PRINCIPLES OF CORPORATE GOVERNANCE FOR PUBLIC ENTERPRISES IN INDIA Yaga Principles for PEs This report is by Dr. Y.R.K. Reddy – Chairman, Yaga Consulting Pvt. Ltd., who has been researching on Corporate Governance with special reference to Public Enterprises and Banking. He has insight into board functioning as an independent Director on the Boards of several organisations in public, NGO and private sectors. He was earlier a full time Chair Professor of Strategic Management and Chairman of Human Resources Area with the Administrative Staff College of India, a Visiting Fellow at the LSE and at FES, Bonn. He is currently a Distinguished Professor for the Institute of Public Enterprise and a visiting professor for the ASCI.  He has been a resource person for the Commonwealth Association for Corporate Governance in South Africa, Malta, Kenya, Malaysia, Sri Lanka, Tanzania, and London.He is a member of the Working Group of the Commonwealth Secretariat on Corporate Governance in Financial Sector. He has contributed several papers on Corporate Governance to international conferences and guest edited the Special Issue On Corporate Governance of ASCI's Journal of Management (1998) and co-edited a book titled “Corporate Governance in Banking and Finance Sector”(Tata McGraw-Hill, 2000). Vikas Publishing, Wiley Eastern, Spade Publications, FES and Tata McGraw-Hill have published his other books, written and edited. He has training and consulting expertise in Strategy and Strategic Human Resource Management spanning a large number of organisations in India, South Asia and the Middle East and several years` experience in the corporate world.