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Vidya Rajarao: Activism helps improve corporate governance

Shareholders can now take control of board resolutions to protect interests

To call oneself an activist is quite fashionable these days and to be characterised as an activist shareholder is a badge of honour. In India, shareholder activism has gained prominence through proxy voting, presence of institutional investors and changes to the regulatory framework. However, the question remains as to whether such activism improves corporate governance?

Since the dawn of liberalisation, government, companies, stock exchanges and institutional investors, both domestic and foreign, have either voluntarily or through legal means taken several measures to empower and disseminate information to shareholders as part of improving corporate governance standards. The government, realising the need for abundant foreign capital, has empowered Securities and Exchange Board of India (Sebi) to improve transparency in corporate India. Many corporate entities have professionalised their management teams and are disseminating more information than legally required to better communicate with shareholders. Stock exchanges are conducting investor camps to educate and empower individual investors. Investment professionals, foreign and domestic institutional investors are demanding that companies adopt best practices to publish information required for valuation.

As custodians of small investors, mutual funds are also playing their part in making their voices heard in boardrooms. Sebi has asked mutual funds to publicly disclose the “rationale for voting decisions” on a quarterly basis. This public disclosure has raised awareness and encouraged shareholder activism from a number of small investors. The rise of a number of proxy advisory firms which had been nonexistent before liberalisation are also instrumental in highlighting the concerns of shareholders and forced boards of companies to respond in a positive way.

Sebi is also in the process of closely working with Reserve Bank of India to ensure that disbarred entities are cut off from raising funds from gullible investors. Both Bombay Stock Exchange and the National Stock Exchange have introduced stringent standards for new listings that have greatly increased retail participation in the capital markets. Further, the grievances and issues of small shareholders are being heard in boardrooms through the e-voting mechanism.

Activist shareholders have secured a significant victory by demanding that listed companies and public companies that meet certain criteria nominate at least one lady director on the board. Research has clearly shown that companies with women directors have better corporate governance standards than the ones that are managed entirely by a male board. This is a welcome step and consistent with global trends in corporate governance.

It is true that the board of directors and audit committees are increasingly independent and vote their dissent towards proposals put forth by management. In addition, shareholders are also exercising their right to vote through a dissent, especially when economic metrics were not achieved. This is particularly true with respect to resolutions that propose increased compensation when financial performance was stagnant or below par. For example, shareholders rejected a proposed increase in executive compensation at Tata Motors. In another instance, shareholders rejected several resolutions connected with United Spirits Limited entities or purported to benefit United Spirits chairman. The courage to dissent has been fuelled both by regulatory changes and the presence of advisory firms that encourage shareholders to record their dissent at AGM.

The 2013 Companies Act empowered minority shareholders to a large extent by introducing several mandatory requirements. For example, the concept of class action lawsuits has been introduced and minority shareholders can file a class action lawsuit against the Company. Further, small shareholders of a listed company can now appoint a director to represent their interests on the board. In addition, related party transactions have come under greater scrutiny by either the audit committee or board and in some cases, shareholders’ approval through a special resolution wherein an interest party cannot vote.

The trend in shareholder activism is not new as such shareholders have long held sway and become marquee names in developed economies, especially US and UK. The SEC’s ‘say on pay’ rules generated tremendous support and opposition in equal measure in the US. Cancellation of golden parachutes, rollback of bonus and performance incentives became common at listed companies. Merger and acquisition transactions were also impacted through hostile takeovers, forced divestments of non-profitable or core businesses and the use of the ‘poison pill’ were vociferously criticised. Similarly, in the UK, shareholders have vetoed several executive pay packages and M&A transactions. The euro area has also seen shareholder actions on executive pay and auditor appointments.

In summary, we should welcome shareholder activism as it improves corporate governance at companies. Shareholders can now take control of board resolutions, protect their interests, rather than the interests of a few shareholders or management and veto actions that are detrimental to the long term interests of the company and its shareholders.

The article appeared in the Financial Chronicle. The article can be found here.