Preface:
- 4
PART – I:
1.
Background
- 5
2.
The State and State Controlled
Enterprises
- 9
PART – II:
3.
Board
Structure and Control Dynamics – A Factual
Position
of Central Public Sector undertakings - 14
PART – III:
4. The
First Principles
- 18
Annexure Recommendations of the 1997 Report on “Corporate Governance and
PSUs”
THE FIRST PRINCIPLES OF
CORPORATE GOVERNANCE FOR PUBLIC ENTERPRISE
Preface
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.
October, 2001
Y.R.K. Reddy
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”.
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.
2. THE STATE AND THE STATE
CONTROLLED ENTERPRISES:
2.1 There has been a universal
belief that the government must restructure its activities and
create market-related incentives and discipline for the enterprises
in its control. Thus,
corporatisation of state undertakings and privatisation have emerged
as the most important methods of improving the efficiency of both
the State and the corporate entities. Consequently, governments
have been announcing the sale of several companies, reducing their
stake in the existing public enterprises and restructuring Government
Departments to become companies.
In the case of co-operatives, the Indian government has
sought to amend the law to enable them to become companies.
Further, international bodies have been advising / pressurising
governments to gradually eliminate subsidies, remove administered
price mechanisms and reduce such other controls/support which
contribute to false/artificial pricing and costs. The alternative,
it is asserted, would perpetuate the moral hazard for the government,
inefficiency in operations and management and the weak monitoring
system. There is increasing convergence of thinking world wide
that:
Ø
Commercial activities should not be undertaken
by the State;
Ø
There should be a clear set of commercial/financially
sustainable objectives without cluttering with social objectives;
and
Ø
Market related incentives and discipline including
the market for corporate control would be necessary for sustainable
economic management and development.
2.2 The framework for the principles of corporate
governance has emanated from such a “world-view” and with the
objective of creating efficient and transparent markets with widely
held private ownership. Understandably,
codes and principles in different countries have tended to believe
that all enterprises will be of one variety only despite the caution
that “one size doesn’t fit all”.
Thus, public enterprises have been treated in the same
manner as the private either with the assumption that what is
good for one is good for the other, or on the premise that eventually
all enterprises should be free of dominant ownership of the government.
2.3
The assumption of free markets with widely
held private enterprises could be insufficient at present for
four reasons:
Ø
During the process of economic reform, several
government departments will need to be corporatised and yet be
under government control, at least in the initial years. This process will be a continuous one as a State may declare one
of its activities as detachable enough from the sovereign function
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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.
THE FIRST PRINCIPLES OF
CORPORATE GOVERNANCE FOR PUBLIC ENTERPRISES IN INDIA
Preface:
- 4
PART – I:
1.
Background
- 5
2.
The State and State Controlled
Enterprises
- 9
PART – II:
3.
Board
Structure and Control Dynamics – A Factual
Position
of Central Public Sector undertakings - 14
PART – III:
4. The
First Principles
- 18
Annexure Recommendations of the 1997 Report on “Corporate Governance and
PSUs”
THE FIRST PRINCIPLES OF
CORPORATE GOVERNANCE FOR PUBLIC ENTERPRISE
Preface
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.
October, 2001
Y.R.K. Reddy
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”.
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.
2. THE STATE AND THE STATE
CONTROLLED ENTERPRISES:
2.1 There has been a universal
belief that the government must restructure its activities and
create market-related incentives and discipline for the enterprises
in its control. Thus,
corporatisation of state undertakings and privatisation have emerged
as the most important methods of improving the efficiency of both
the State and the corporate entities. Consequently, governments
have been announcing the sale of several companies, reducing their
stake in the existing public enterprises and restructuring Government
Departments to become companies.
In the case of co-operatives, the Indian government has
sought to amend the law to enable them to become companies.
Further, international bodies have been advising / pressurising
governments to gradually eliminate subsidies, remove administered
price mechanisms and reduce such other controls/support which
contribute to false/artificial pricing and costs. The alternative,
it is asserted, would perpetuate the moral hazard for the government,
inefficiency in operations and management and the weak monitoring
system. There is increasing convergence of thinking world wide
that:
Ø
Commercial activities should not be undertaken
by the State;
Ø
There should be a clear set of commercial/financially
sustainable objectives without cluttering with social objectives;
and
Ø
Market related incentives and discipline including
the market for corporate control would be necessary for sustainable
economic management and development.
2.2 The framework for the principles of corporate
governance has emanated from such a “world-view” and with the
objective of creating efficient and transparent markets with widely
held private ownership. Understandably,
codes and principles in different countries have tended to believe
that all enterprises will be of one variety only despite the caution
that “one size doesn’t fit all”.
Thus, public enterprises have been treated in the same
manner as the private either with the assumption that what is
good for one is good for the other, or on the premise that eventually
all enterprises should be free of dominant ownership of the government.
2.3
The assumption of free markets with widely
held private enterprises could be insufficient at present for
four reasons:
Ø
During the process of economic reform, several
government departments will need to be corporatised and yet be
under government control, at least in the initial years. This process will be a continuous one as a State may declare one
of its activities as detachable enough from the sovereign function
to merit corporatisation. (For example: Department of Telecommunications,
which has been corporatised as Bharat Sanchar Nigam Limited).
Till this process stops, we will continue to have State-owned
enterprises which may not necessarily have the ideal market related
incentives and disincentives, at least in the short term.
Concurrently, there will be several statutory organisations,
which might be considered as strategic/sensitive and hence not
meant for privatisation at all for some years.
(Ordinance factories, Nuclear Fuel Complex, Universities,
Port Trusts).
Ø
The second reason arises from the possibility
of a transitional control by the government until a new set of
active owners emerges. Such
control by the government may be as a fall back option in case
of inefficient new owners or because the capital markets have
not become mature enough to generate active shareholder monitoring
that would make a positive impact on managerial efficiency. The
“golden share” approach adopted in some countries as an interim
mechanism signifies the existence of a transitory position for
the company before the ideal market conditions emerge.
The
process of privatisation may ensure transferring property rights
to new owners who may be from the general public, employees, other
institutions and corporate entities.
However, mere transfer of property rights does not ensure
that the goals of privatisation have been attained, until sound
corporate governance structures and processes are established
and sustained, covering the transition period. In the absence of a better governance system
and process, including more active and vigilant shareholders,
the goals of privatisation would not be met.
Thus, the government may have to continue a direct control
or indirect monitoring of those companies which are in the process
of privatization till conditions emerge requiring withdrawal of
direct and other contingent controls and contractual obligations.
(The recent penal action against Sterlite group by the
SEBI after the government concluded the sale of its equity in
Bharat Aluminium Company Limited, has raised an important issue
– that of discovery of “corporate turpitude” or criminality before
and after the sale of public stake to a private firm and the role
of the government in such situations.
There are possibilities now of contingent controls that
were not envisaged earlier).
Ø
Thirdly, and relatedly, it has been observed
that in several countries, the privatization process resulted
in transferring the property rights to parties, which are less
efficient and/or less honest than the government’s previous “agents”.
Such new owners may have failed in meeting the long-term
goals of divestment/dis-investment/sale and may have created conditions
that force governments to re-nationalise or take control.
(Jute industry in Bangladesh is reportedly an example).
Ø
Fourthly, there could be a realignment of equity
structure over a period of time in joint ventures between public
and private enterprises whereby the public enterprise gains control
over the management. Such
a change in capital structure may be rare and not a prospect that
government prefers. (For example: the reported move of the public
enterprise Hindustan Petroleum Corporation Limited to purchase
the equity of the house of Birlas in the joint venture Mangalore
Refineries and Petrochemicals Limited and take control of the
management as the Birlas are unable to invest further monies required).
Similarly, a public enterprise may acquire a private firm
or another public enterprise or a government-controlled co-operative.
2.4
Thus, despite the idealism and merit of free
market economy, with appropriate incentive and disincentive mechanisms,
there is a prospect of continued presence of public enterprises
in India, in a large measure and for several years to come. The
“Third Way”, between the unfashionable socialism and the romantic
market fundamentalism may rest on such a prospect.
2.5
The range of public enterprises is vast and
governments’ control varies depending on whether the entity is
a departmental undertaking (like the Railways in the central government);
a state enterprise (e.g. Hyderabad Allwyn); a central public sector
undertaking (like the Indian Oil Corporation or BHEL); a statutory
body at the central or state level (e.g. Unit Trust of India and
the State Finance Corporations); a public sector bank (e.g. the
State Bank of India which was created by law and in which the
regulator also has ownership); a government controlled co-operative
where the de-jure position is countered by the de-facto
control (e.g. Indian Farmers Fertilisers Co-operative; Sugar Factories
).
2.6
The departmental undertakings are government
and yet in competition directly or otherwise for market share.
The railways, post & telegraph and telecommunications are
a case in point. To the extent that they are businesses and have
the characteristics to be separated and made corporations under
the company law, these may be deemed as public enterprise to which
the general principles of corporate governance apply. In the case
of statutory bodies, it is evident that several provisions of
special authorities, accountabilities and Board structures are
inconsistent with principles of corporate governance. The incongruence
becomes glaring where public holds some part of the equity of
such corporations. Similar is the context of the central public
sector undertakings and the Banks where the special rights and
privileges for one owner, even if it is Government, agitate against
the tenets of equitable shareholder rights, under the principles
of corporate governance. The co-operative sector which is expected
to thrive on the basis of voluntarism reflects yet another spectre
of government exercising de-facto control, thus eroding the right
of self-governance to the members.
2.7
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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.
THE FIRST PRINCIPLES OF
CORPORATE GOVERNANCE FOR PUBLIC ENTERPRISES IN INDIA
Preface:
- 4
PART – I:
1.
Background
- 5
2.
The State and State Controlled
Enterprises
- 9
PART – II:
3.
Board
Structure and Control Dynamics – A Factual
Position
of Central Public Sector undertakings - 14
PART – III:
4. The
First Principles
- 18
Annexure Recommendations of the 1997 Report on “Corporate Governance and
PSUs”
THE FIRST PRINCIPLES OF
CORPORATE GOVERNANCE FOR PUBLIC ENTERPRISE
Preface
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.
October, 2001
Y.R.K. Reddy
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”.
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.
2. THE STATE AND THE STATE
CONTROLLED ENTERPRISES:
2.1 There has been a universal
belief that the government must restructure its activities and
create market-related incentives and discipline for the enterprises
in its control. Thus,
corporatisation of state undertakings and privatisation have emerged
as the most important methods of improving the efficiency of both
the State and the corporate entities. Consequently, governments
have been announcing the sale of several companies, reducing their
stake in the existing public enterprises and restructuring Government
Departments to become companies.
In the case of co-operatives, the Indian government has
sought to amend the law to enable them to become companies.
Further, international bodies have been advising / pressurising
governments to gradually eliminate subsidies, remove administered
price mechanisms and reduce such other controls/support which
contribute to false/artificial pricing and costs. The alternative,
it is asserted, would perpetuate the moral hazard for the government,
inefficiency in operations and management and the weak monitoring
system. There is increasing convergence of thinking world wide
that:
Ø
Commercial activities should not be undertaken
by the State;
Ø
There should be a clear set of commercial/financially
sustainable objectives without cluttering with social objectives;
and
Ø
Market related incentives and discipline including
the market for corporate control would be necessary for sustainable
economic management and development.
2.2 The framework for the principles of corporate
governance has emanated from such a “world-view” and with the
objective of creating efficient and transparent markets with widely
held private ownership. Understandably,
codes and principles in different countries have tended to believe
that all enterprises will be of one variety only despite the caution
that “one size doesn’t fit all”.
Thus, public enterprises have been treated in the same
manner as the private either with the assumption that what is
good for one is good for the other, or on the premise that eventually
all enterprises should be free of dominant ownership of the government.
2.3
The assumption of free markets with widely
held private enterprises could be insufficient at present for
four reasons:
Ø
During the process of economic reform, several
government departments will need to be corporatised and yet be
under government control, at least in the initial years. This process will be a continuous one as a State may declare one
of its activities as detachable enough from the sovereign function
to merit corporatisation. (For example: Department of Telecommunications,
which has been corporatised as Bharat Sanchar Nigam Limited).
Till this process stops, we will continue to have State-owned
enterprises which may not necessarily have the ideal market related
incentives and disincentives, at least in the short term.
Concurrently, there will be several statutory organisations,
which might be considered as strategic/sensitive and hence not
meant for privatisation at all for some years.
(Ordinance factories, Nuclear Fuel Complex, Universities,
Port Trusts).
Ø
The second reason arises from the possibility
of a transitional control by the government until a new set of
active owners emerges. Such
control by the government may be as a fall back option in case
of inefficient new owners or because the capital markets have
not become mature enough to generate active shareholder monitoring
that would make a positive impact on managerial efficiency. The
“golden share” approach adopted in some countries as an interim
mechanism signifies the existence of a transitory position for
the company before the ideal market conditions emerge.
The
process of privatisation may ensure transferring property rights
to new owners who may be from the general public, employees, other
institutions and corporate entities.
However, mere transfer of property rights does not ensure
that the goals of privatisation have been attained, until sound
corporate governance structures and processes are established
and sustained, covering the transition period. In the absence of a better governance system
and process, including more active and vigilant shareholders,
the goals of privatisation would not be met.
Thus, the government may have to continue a direct control
or indirect monitoring of those companies which are in the process
of privatization till conditions emerge requiring withdrawal of
direct and other contingent controls and contractual obligations.
(The recent penal action against Sterlite group by the
SEBI after the government concluded the sale of its equity in
Bharat Aluminium Company Limited, has raised an important issue
– that of discovery of “corporate turpitude” or criminality before
and after the sale of public stake to a private firm and the role
of the government in such situations.
There are possibilities now of contingent controls that
were not envisaged earlier).
Ø
Thirdly, and relatedly, it has been observed
that in several countries, the privatization process resulted
in transferring the property rights to parties, which are less
efficient and/or less honest than the government’s previous “agents”.
Such new owners may have failed in meeting the long-term
goals of divestment/dis-investment/sale and may have created conditions
that force governments to re-nationalise or take control.
(Jute industry in Bangladesh is reportedly an example).
Ø
Fourthly, there could be a realignment of equity
structure over a period of time in joint ventures between public
and private enterprises whereby the public enterprise gains control
over the management. Such
a change in capital structure may be rare and not a prospect that
government prefers. (For example: the reported move of the public
enterprise Hindustan Petroleum Corporation Limited to purchase
the equity of the house of Birlas in the joint venture Mangalore
Refineries and Petrochemicals Limited and take control of the
management as the Birlas are unable to invest further monies required).
Similarly, a public enterprise may acquire a private firm
or another public enterprise or a government-controlled co-operative.
2.4
Thus, despite the idealism and merit of free
market economy, with appropriate incentive and disincentive mechanisms,
there is a prospect of continued presence of public enterprises
in India, in a large measure and for several years to come. The
“Third Way”, between the unfashionable socialism and the romantic
market fundamentalism may rest on such a prospect.
2.5
The range of public enterprises is vast and
governments’ control varies depending on whether the entity is
a departmental undertaking (like the Railways in the central government);
a state enterprise (e.g. Hyderabad Allwyn); a central public sector
undertaking (like the Indian Oil Corporation or BHEL); a statutory
body at the central or state level (e.g. Unit Trust of India and
the State Finance Corporations); a public sector bank (e.g. the
State Bank of India which was created by law and in which the
regulator also has ownership); a government controlled co-operative
where the de-jure position is countered by the de-facto
control (e.g. Indian Farmers Fertilisers Co-operative; Sugar Factories
).
2.6
The departmental undertakings are government
and yet in competition directly or otherwise for market share.
The railways, post & telegraph and telecommunications are
a case in point. To the extent that they are businesses and have
the characteristics to be separated and made corporations under
the company law, these may be deemed as public enterprise to which
the general principles of corporate governance apply. In the case
of statutory bodies, it is evident that several provisions of
special authorities, accountabilities and Board structures are
inconsistent with principles of corporate governance. The incongruence
becomes glaring where public holds some part of the equity of
such corporations. Similar is the context of the central public
sector undertakings and the Banks where the special rights and
privileges for one owne | | | |
