From zero to 3 in one year – proxy advisory firms have hit the headlines and how! Their presence, most felt this AGM season, as recommendations to vote ‘for’ or ‘against’ company resolutions have come in thick and fast. So who are these scrutinizers of corporate consciences? Self-appointed guardians of shareholder rights? What is their governance philosophy? Why should companies and their investors take them seriously? Today on this episode of The Firm, we bring you The Activists!
Doshi: In this special edition we examine the purpose, philosophy and popularity of proxy advisory firms. With me are the founders of all three. So in order of creation, Shriram Subramanian, Managing Director of Ingovern, India’s first proxy advisory firm. Founded in June 2010, Ingovern has a total team size of eight and boasts of Former Infosian, Mohandas Pai as advisor and investor. Corporate governance expert, Shankar Jaganathan is also an advisor to the company. In his earlier avatar InGovern founder, Shriram Subramanian offered technology consulting services to foreign proxy advisory firms.
Subramanian: I had experience globally; consulting to global asset management firms and I had seen how they behave as responsible investors, how they engage with companies on a yearly basis. They send annual letters on governance or their expectations to their investee companies every year. Then I thought such an experience or such an institution is not there in India where institutional investors act responsibly. So then I thought the need for a proxy advisory firm exists.
Doshi: From credit ratings to governance ratings, Amit Tandon, formerly a Fitch and now Founder & Managing Director of IIAS- also founded in 2010 - Institutional Investor Advisory Services or IIAS has drawn well-known investors like the Bombay Stock Exchange, Axis Bank, HDFC, ICICI Prudential and Tata Investment Corporation. A staff of 12 covers 300 listed companies under the supervision of Former Ambuja Cement’s Managing Director, Anil Singhvi and his co-founder, Amit Tandon- the Former Managing Director of Fitch Ratings India.
Tandon: Sitting at Fitch one was looking at a lot of instances where companies were doing certain things and acts. As a rating agency, it wasn’t impacting the rating very much and that bought to the fore that slowly governance is moving center stage and if India were to attract capital, some of these issues need to be addressed head-on rather than brushed under the carpet. So we just spoke about this idea to a couple of large investors who were there in domestic market. We spoke to entities like the Bombay Stock Exchange, who have a frontline regulation role as far as corporates are concerned and all of them seemed to like the idea and they all come in with equity investments in the company and that’s pretty much how it happened.
Doshi: Also with me JN Gupta, Former Executive Director at Market Regulator, Securities and Exchange Board of India (SEBI) and now Founder of India’s third proxy advisory firm, SES. Stakeholders Empowerment Services or SES is a not-for- profit company. SES was founded in May 2012 by three IIT Kanpur graduates- not from the same batch- Amarendra Singh, Arjun Gupta and his father and former SEBI Director, JN Gupta. Former SEBI whole time Director, MS Sahoo plays advisor to SES.
Gupta: My SEBI experience gave me an idea that there is a lot of gap in India and maybe world over also in what we preach what we practice and the corporate governance was one area where we found that maybe there are rules and regulations but whether they are being followed in spirit or not is not there. So I felt there is a need to educate and empower the investor who will be in a position to make sure that whatever are the laws, they are enforced. Certainly we will not call ourselves activists. We will call ourselves educationists.
Doshi: It is interesting you brought up the issue of complying with laws, not just technically but in spirit because that allows me to pick up the first issue that I want to in this discussion and the purpose of this discussion is to look at governance from the eyes of your three firms. I think the one common area or rather the three common areas that all your reports have covered are independent director tenure, audit firm tenure and remuneration and let me start with independent director tenure.
No Indian law or regulation prescribes any limit on the tenure of independent directors. The MCA’s voluntary code suggests six years and a non-mandatory provision Clause 49 recommends 9. All three proxy advisory firms do not consider directors to be independent if their tenure exceeds 9 years.
Tandon: Our view when we spoke to people, spoke to directors, spoke to companies is that after 9 years, the ability of a person to contribute to the discussion tends to come down a bit because of the familiarity. The second thing which caused us to take this view is that once you have been there for 9 years, you have been a part of certain decisions which the company has taken and then you would find it very difficult to go back and say we decided something in 2007-08 and it was the wrong decision. So having been a part of that decision, you tend to take ownership over the decision and if its kind of not worked out the way you wanted to, its very difficult for you to then turn back and say I am going to reverse the decision and therefore we felt 9 years is a reasonable length of time for people to continue as independent directors on the board. Having said, we understand that someone could turnaround and say I have had this person on the board for 12-13 years. We believe they genuinely contribute to the discussions; they genuinely help us out with the strategies….
Doshi: So what do you do in cases like that?
Tandon: In those cases, we tell companies that you should bring on someone else, another independent director so that the balance between the independents and non-independent…(Interrupted)
Doshi: So classify this gentleman who has been on your board for several years and you want to retain him as non-independent and bring on someone else on your board?
Tandon: Bring on someone else on your board.
Doshi: May I assume that that is the broad philosophy that all three of you follow?
Subramanian: Agreed; see the independence could also be questioned on other counts apart from just tenure because there could be conflict of interest. We have seen in your programme itself, brought out about a month ago, how some people are with law firms and some solicitors… (Interrupted)
Doshi: Several lawyers whose law firms then provide services to these companies as well but just short of the limits set out by the law.
Subramanian: We brought out more than 30 such instances.
Doshi: I agree with the position that all three firms are taking but companies are likely to argue you by saying listen, we understand you expect spirit but the law requires this much, we have gone the full length of the law. Why would you then start raising issues about whether we are classifying the right kind of director as independent or not and creating doubt in the minds of our shareholders because if that is the case, change the law. It could happen with companies.
Gupta: As I told you initially, that is not with the compliance with the law alone. The whole corporate governance is an issue of ethics. Today when you say independent directors…(Interrupted)
Doshi: But ethics is today say you all are taking the cue from the voluntary code which says 6-9 years or clause 49. Tomorrow another proxy advisory from would say, listen to me, the hard limit is four years, how do you draw the line?
Gupta: I agree. Let us go one-by-one. What are the parameters for shareholders in general to judge whether the director is truly independent or not. When you have no communication from the company on a board meeting in one resolution, other resolution, what is the behavior of the directors, now every resolution is at par unanimously. I have yet to come across an issue in my home also and in my office also where on a single issue the entire community agrees. So till such time there is some other means of communication to show that this director has been independent, has an independent mind, you have to have a parameter of association in terms of number of years.
Doshi: How do you decide when the law doesn’t require a term?
Gupta: I am coming to that. The new Company Bill has said 5+5 years to tenure- so the company bill also recognizes ten years. So now should we wait for a thing to become law or –(Interrupted)
Doshi: As a company, I could complaint that you are creating doubt in the minds of my shareholders.
Gupta: I am not saying the company is bound to accept or the shareholders are bound to accept; what we are saying is we are educating. Education is the process where I am telling you this is my opinion and this is the right thing; whether you agree with me or not, it is that person’s point of view.
Doshi: Mr Subramanian brought up the issue of several independent directors whose firms - either law firms or audit firms- provide some services to the company but short of the legally objectionable limits. What are some of the other instances that you have seen in your experience of scrutinizing reports where independence has come under question not just because of tenure?
Tandon: One of the things we find is that you have a set of directors who are kind of repeated in group companies. A good case in point is if you look at Bajaj Auto, Bajaj Group, there are – if you kind of look at the independent directors and you look at the listed companies in the group, you would find that someone like Nanoo Pamnani and Mr Balaji Rao are there on four group companies. You go down the list and look at the list and you would find that some members who are on the board of Bajaj Auto are on the board of two other group companies. So we find that look if you got the same set of directors who are kind of repeated in all the group companies, then you kind of wonder whether are they truly independent or is it just because it is convenient to have them there, you have decided to persist with them.
Subramanian: Even within the same group, there are instances where we came across- one in Godrej wherein somebody has been an executive director in a group company, now he is classified as an independent director on another group company when they joined the board. So the fact is that independence is compromised because there is no cooling off period from the time he or she was an executive director and now is classified as an independent director.
Doshi: I think there are several instances based on your reports, you have raised the issue to do with Ravi Kulkarni on the board of Tech Mahindra as an independent director even while he was on the board of Mahindra and Mahindra, that is one. Then the issue of Shapoor Mistry being on the board of Indian Hotels as an independent director and Indian Hotels has come back with the response to us saying that the law allows us to do this.
Gupta: That is not the right response. Nobody is questioning appointment of Mr Shapoor Mistry on the board of Indian Hotels.
Doshi: As independent directors. They are saying that the law allows us.
Gupta: Law does not allow.
Doshi: Because he was appointed as independent director before Cyrus Mistry –
Gupta: No, the independence is not cast in a stone, independence at each and every moment is what is independence.
Doshi: That is a fair point.
Tandon: The other issues we kind of bring up is one is attendance of directors- we find that and what we do is we kind of understand if people are not there for one year, attendance is low in any particular given year; so we then go back and look at what it is in the last few years and see what it is.
Doshi: One of your reports you pointed out that Analjit Singh on the Dabur board has not attended –(Interrupted)
Gupta: He attended the first meeting when he was appointed and in last four years he has not attended any meeting.
Doshi: And yet he was up for reappointment this year.
Gupta: So on Cummins board, Mr P Dasgupta is an independent director and he has attended only one meeting of vote, one AGM and one audit committee meeting- all happened in one day and imagine he would travel from Delhi to Pune and go back the same day; so 15 minutes for each meeting or something like this. So this is a compliance only for the tick-box approach compliance.
ICAI recommends that all listed companies rotate audit partners once every three years but no such recommendation applies to their audit firms, yet all three proxy advisory firms recommend that shareholders vote against the reappointment of any audit firms if its tenure has exceeded five-six years.
Subramaniam: Again it comes back to adhering to the letter of the law which most companies will have done but not adhered to the spirit. The spirit of good corporate governance…(Interrupted)
Doshi: It’s a similar principle…
Gupta: Little bit more because when you say Director, then there are 7-8 directors so responsibility is divided. Auditor has the most important responsibility because it is one single firm which is doing audit. It is not spread over 7-8 auditor. So we are more restricting there rather than independent director.
Doshi: Besides tenure have you had other issues with regards to auditor independence?
Gupta: One is a partner, the other is that we have found that today I am the auditor, tomorrow another one from syndicate is the auditor, then next person is auditor. So within the group….(Interrupted)
Doshi: So this happens within the big four I would imagine because they are the ones who have syndicated…(Interrupted)
Gupta: Yes, we consider them as the same audit firm….(Interrupted)
Tandon: And finally the audit fees. The Institute of Chartered Accountants has said that there needs to be a mix of 50% between audit and non-audit fee and there are instances where the non-audit fees is substantially more than the audit fees.
Doshi: But that is allowed within the law yet, frowned upon as bad governance practice, that’s right?
Tandon: That’s right.?
Gupta: There is one more issue that many companies do not give proper disclosure of audit and non-audit fees. They give it in such a mix form that it is very difficult for a common person to analyze it unless and until you ask for the clarification from the company.
Tandon: And also the items which are there and also what is classified as audit and non-audit - my understanding is that if you want a group consolidation to be done then that is not treated an audit fee. So my sense is that that is pretty much a part of the audit fee and therefore that reclassification needs to take place at the institute level where they say that which fees is what.
Doshi: So a guideline on what qualifies as audit and what is qualified as non-audit and better disclosures, more detailed disclosure of how you want to do this. What I do want to do is now, one by one, talk to each one of you on what you think are some of the interesting issues which have come to your attention outside of some of the general issues that we have covered.
Subramanian: One of the huge things is employee stock option plan (ESOPs) and ESOP pricing, changes in terms of ESOPs. For e.g. look at OnMobile; in February this year they came out with a postal ballot which repriced ESOPs. So how do investors vote when it is a repriced ESOP- the exercise price was some Rs 240 or something, repriced to Rs 60…(Interrupted)
Doshi: But what do you expect in an environment like this where market values are declining every single day?
Subramanian: Agreed, so the norm is that you reprice the ESOPs and reissue the ESOPs technically and do not reprice without extending the tenure, without extending the other parameters. So it should be as if that the options have expired and now you are making a new issue of ESOPs.
Gupta: I wouldn’t agree with that even. Your question is that how do you see that the markets are performing but how do you compensate the ordinary investor who has also taken….(Interrupted)
Doshi: But an ESOP is a part of remuneration policy.
Subramanian: No, it rewards performance.
Doshi: Yes, performance.
Subramanian: But suddenly you changed the performance parameters to suit the management’s…(Interrupted)
Gupta: I could have bought a share hoping that Shriram is a head of a company. He has taken ESOP at Rs 240. So I said that Shriram is ready to invest money at Rs 240 I would have put in Rs 240 money. Now the market has gone bad. It could have gone bad because of economy or it could have gone bad because of his or his team’s performance. He compensated by pricing it from Rs 240 to Rs 60; where do I go.
Tandon: There need to be very compelling reasons for the ESOPs to be repriced otherwise we do believe since it’s a part of the compensation structure it should be left…(Interrupted)
Doshi: So broadly speaking when it comes to repricing, you recommend vote against unless you see compelling reasons for that repricing.
Tandon: One of the thing we would like to see is far more clarity in the way the resolutions are drafted. I find that the explanatory notes are often shorter than the resolution itself. The resolution it self is kind of all enabling so if someone wants to borrow money, if say debt, equity, FCCB, QIB…(Interrupted)
Doshi: But tell me if you were running a company you cannot go back to your shareholders every time you move from one instrument to another?
Tandon: I understand, you are living in a market which is extremely dynamic, which is changing on a day to day basis but then what I would expect is that as far as the explanatory notes are concerned, you need to give some more clarity. It is saying that if we raise the entire amount through equity - this is the dilution. If we raise the amount through debt – this is what happens to our key ratios…(Interrupted)
Doshi: So more explanations.
Tandon: So for more explanation and I can understand if I am sitting in a company I also want a resolution which kind of lets me do whatever I want at whichever time and the markets are complex and dynamic. So we need to recognize it but having said you just cannot have one line saying that I can do everything.
Doshi: So point well taken, resolutions need to be drafted better, written more simpler, shareholder friendly manner and explanations need to be more robust.
Tandon: We are also quite kind wary about things which don’t make their way to the resolutions. One of the things we don’t like is, on the comment about shareholders is payments of royalty, that is something again it is not a part of the resolution.
Doshi: Most recent case or instance has been the Bombay Dyeing case where the group has imposed a royalty on all group companies. But I think there is a clear distinction between why Tata companies pay to use the Tata name and why Bombay Dyeing group companies pay to not use the Bombay Dyeing name in that sense, right?
Tandon: But they are paying for being the part of Bombay Dyeing, the Wadia Group is what my reading of it is and that is one. The second is paying for shared services, now if I am a company, I would rather go to whoever is giving me the best legal advise rather than being hemmed in to use the services of a particular legal firm…(Interrupted)
Doshi: These are disclosures that are not being made?
Tandon: There is a disclosure saying that there is an agreement.
Doshi: But the details of the agreement are not available.
Tandon: But more than that it is not something which is coming to shareholders to vote, so that is.. (Interrupted)
Doshi: It is a business commercial decision- do shareholders need to vote on something like this, will shareholders really be able to exercise this question on whether you should be sharing services of a law firm or a technology provider?
Tandon: Sure, no but what were we saying, I guess the issue is a set of controlling or the controlling shareholders taking an advantage at the expense of minority investors, that is the central point were the company is given a free choice, would they have taken the same decision and is it necessarily in the best interest of the company.
Doshi: Let me move to you and ask you, what have you noticed as maybe a practice that caught your attention, that is not in the best standards of governance but that is practiced by several companies?
Gupta: There is a tendency in many companies and especially in the Indian pharmaceutical companies that the family pays themselves a hefty salary and the instances are Apollo Hospitals, Divi’s Laboratories. In Apollo Hospitals, five family members on the board…(Interrupted)
Doshi: But salary remuneration is all laid out in terms of maximum limits. So if they are not crossing the maximum limits…(Interrupted)
Gupta: I agree but for Apollo Hospital they have to appoint five full time executive directors on the board including chairman and now with the 7 billion population of the world, they can zero on only five competitive executive people in the family.
Doshi: So the five executive directors are all the family members. But maybe the family is closely involved in managing the business.
Gupta: But that means competence for managing hospitals is centered in the entire globe with only five members.
Doshi: No, it is a promoter run company.
Gupta: That is where I am saying we have questioned the role of nominating committee.
Doshi: Do you have a problem with who occupies the position or do you have the problem with the pay or the remuneration they are taking on?
Gupta: I have a problem with the system because how the nomination committee has a role of identifying the suitable people- it is impossible for me to understand that how come the nomination committee which is supposed to be independent has zeroed on five competent from the same family and in 7 billion population, they didn’t find a single other competent person. That to me is ridiculous.
Doshi: I will give you the last quick word on how you see this space evolving- whether you see companies responding to all the stimuli you are putting out there and whether you see investors truly using your reports to vote because currently institutional investors in this country are mute.
Gupta: This is the new industry, so there is a seeding time, it is a gestation time that will be there. Gradually, people will start using it, companies will start believing it because when you create a differentiation in the market between good, ugly, bad, excellent and then investors start investing on that basis, they will notice. So a time will come for this industry - may not be one month down the line but certainly one year-two years down the line, this industry will be successful because investors will be bound to use this type of services.