The issue of corporate governance has once again come into a sharp focus globally due to the financial meltdown starting with the Sub prime crisis in the United States and spreading all over the world. The essence of corporate governance is ensuring transparency in the operation of the business enterprises so that accountability for decision taken is fixed. The accountability is to ensure that the interest of the investors and the stakeholders covering customers, suppliers, employees and the society at large including environment are safeguarded. The current financial meltdown arose as a result of unregulated speculation on the issue of sequestering the risks leading to an unprecedented economic crisis comparable to the great depression of 1929-30. In the ultimate analysis, the root cause of the crisis can be traced to lack of transparency on the basic issues like the risk involved and the failure to protect the interest of the investors and the stakeholders. In this perspective, the current financial crisis all over the world is a case of massive failure of corporate governance.
While this issue is engaging the attention of the central Bankers, financial policy makers and the leaders in the world, we in India have been particularly shocked by the massive fraud committed by the 4th largest IT company in India, Satyam Computers which was an icon and a model of India’s success in the new knowledge economy. I would, therefore, focus attention on the immediate problem of corporate governance we are facing in our country and any reaction to it has a person connected with some of the leading public limited companies as a Director or a Chairman.
The two issues strike me as been relevant. The first is, is it possible to rethink our entire approach to the issue of corporate governance in the country and device a better regulatory system that will ensure the scams like the Satyam scams are avoided in the future. The second issue is more personal. I am an independent Director in a couple of companies and the issue of the role of the independent Directors as the watch dogs and trustee of the minority share holders in the board of the enterprises has been subject of debate in the context of the Satyam crisis. How independent can Directors be? And what directions could they give to the board?
We may begin by examining whether it is possible to device a system of governing the operations of business enterprises in such a way that scams like Satyam do not occur again in the future. One thing that the great Satyam scam has exposed is how poor is our system governing business enterprises that it allows scope for massive frauds. . Is it possible to devise a sure-fire formula to prevent future Satyams?
The idea is a non-starter. Everyone knows that crooks are always clever and can beat the system. Nevertheless it is possible to design systems for regulating business enterprises which can reduce greatly the scope for such frauds.
This is based on a fundamental appreciation of human nature .Frauds are the results of a combination of dishonesty and crooked intelligence. Very few people are honest by conviction. The rest modify their action depending on the rewards and punishments so far as honest behaviour is concerned, provided by the system.
The current focus of the debate in the media seems to be on divising more regulations. Are our regulations adequate? Do we need more regulators and control? Sarbanes Oxley was the direct result of a shock administered to the New York Stock Exchange by the Enron scam. All it did was to add a lot of paperwork and box ticking. It even led some companies listed in the NYSE to migrate elsewhere.
A whole lot of other issues ranging from lack of transparency in operations, corruption due to the businessman-politician nexus and conflicts of interest are being raised.
Another major issue being discussed is the role of the independent directors. Can these directors really safeguard the interests of the stake holders and act as watchdogs against malpractices?
The Satyam scam is an excellent opportunity to think through the fundamentals of what ensures good corporate governance. In the ultimate analysis , corporate governance requires three things. The first is transparency in operations which creates an environment to discourage malpractices. The second is ensuring accountability for all decisions taken and the resulting consequences. The third is safeguarding the interests of the investors and other stake holders like the customers, suppliers, employees and the society at large including the environment.
The objectives of corporate governance are sought to be achieved by the rules and regulations framed by authorities for running of business enterprises and the capital market. The structure of management of enterprises especially the board of directors, is another important aspect of regulation.
But when the chips are down what is the reality? An enterprise observes the ethical principles of integrity if the promoters or the top management believe in these values and practice them in their life. Icons like Narayanamurthy of Infosys or Tatas exemplify this basic fact.
It is obvious that the average promoter or manager may not have such high standards of ethical behaviour. The best way to ensure that those who run business enterprises observe the principles of good corporate governance is to design rules and regulations in such a way that the management of an enterprise will find that being honest is better than being clever and dishonest.
The first requirement for such a system is a set of rules and regulations which make transparency in operations mandatory and unavoidable. Narayanamurthy spelt out the basic principle “when in doubt, disclose”.
Effective use of technology to build an audit trail is the next requirement. This ensures that records cannot be easily tampered with.
Prompt and condign punishment for violation of the rules and regulations by a single focused regulatory agency is the third requirement.
The Satyam scam has shown that we do not have such an integrated focused agency. This is a big lacuna which needs to be filled urgently if we are to avoid future Satyams.
If we can introduce a three point system for governing enterprises in place of the present one with its plethora of regulatory agencies and the cacophony of investigating authorities, the Satyam scam would have served a valuable purpose in helping to build an effective system to ensure better corporate governance. We can then look forward to a cleaner and more globally competitive corporate India
We may now examine the issue of the role of the independent Directors. An important issue that the Satyam scam has brought into sharp focus is the role of the independent directors in the board of a public limited company. They are an important part of the current structure of business enterprises to ensure good corporate governance in today’s economy where the market is the ultimate arbiter of performance.
Satyam had some of the most respected and credible names on its board as independent directors. Then how could such a scam take place under their very nose? How independent were they? What directions did they give to the company’s management?
These questions strike a chord in the hearts of many who are functioning as independent directors in the different companies today. What is it that an independent director can do to influence the affairs of running a company? As Gurcharan Das, the former CEO of Proctor and Gamble said in a TV show is being an independent director a mug’s game?
The most important role of an independent director is safeguarding the interests of the stakeholders in a business enterprise with particular focus on the minority share holder. One rule of thumb I would suggest is that an independent director should ensure that all the decisions taken by the board are ethical, but then what is an ethical decision?
Norman Vincent Peale, the author of the bestseller – The Power of Positive Thinking, and Kenneth Blanchard the author of the bestselling One Minute Manager, have suggested in their co-authored book –‘The Power of Ethical Management,’ a three point test which can be applied to any decision to check whether it is ethical or not.
The first question is : is it legal? If the decision violates any law it is ipso facto not ethical.
The second question is : is it fair to all parties concerned? If a decision taken is legal but does not provide equitable benefits to all parties concerned with it then it is not ethical.
The third question is the one which is the test of conscience. If the decision taken is made public will it cause embarrassment to the enterprise and the management?
The independent directors can use the three point test to check whether every issue decided by the board of management passes this test. If this test had been applied the 16th December 2008 decision of Satyam to acquire Maytas it would have failed.
What else can an independent director do? As a retired civil servant and an “expert” in ignorance on many subjects, I will say that one can use the label of ignorance itself to ask basic elementary questions about any issue being decided in the board. If the management cannot reply clearly and in an intelligible manner, one can suspect mischief.
An independent director can act as a watchdog to check unethical behaviour of the management by these two questioning techniques. Additionally, he can contribute to the board based on his experience in a specific field by providing an outsider’s perspective.
The best precaution that an independent director can take is to check the background of the company and its promoters and ensure that they do not have a tainted background. A further precaution is to ensure that at least one of the persons on the board is known to the independent director as an upright person whom he can trust.
The current hysteria in the media following the Satyam scam may hustle the authorities into a knee jerk reaction to adopt a sledgehammer approach to regulation like what happened in the United States after the Enron scam leading to the enactment of the Sarbanes Oxley Act. This resulted in too much of paper work and the migration of some companies from New York Stock Exchange to elsewhere . It is necessary to revisit the basic principles of fiduciary and vicarious responsibility before amending the regulations.
As mentioned earlier, perhaps the most important step to be taken is to have an integrated agency which would quickly investigate and ensure condign punishment on the guilty in cases of corporate frauds. Just look at the plethora of market regulators ,investigation agencies and legal authorities jumping into the Satyam fray apart from the ubiquitous politicians !
Corporate governance, it is now obvious, is not an ethical or moral or an academic issue. It is very much an issue affecting the real world operations of the enterprises in the global economy. What is more it affects practically all the people in the world. It not only the stakeholders and the investors in enterprises are concerned but the society as a whole is also affected and could be the victim of the malpractices in the corporate sector.
It is said that out of evil cometh good. Let us hope that the current financial meltdown and massive frauds like Satyam may be helpful in devising a better system of corporate governance in the years to come leading to cleaner, more healthy and more honest business enterprises.
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