Good governance in India

Good governance, the lack of it, its necessary application specifically and urgently to the Indian economy was the subject of the conversation at last Tuesday’s meeting with guest speaker Adil Zainulbhai. After receiving the Rotary Club of Bombay’s Ramkrishna Bajaj Good Governance Award for 2018-19, Adil self-deprecatingly joked that one had to be in good governance for at least 20 years to be eligible for such an award. In fact, he has been in it much longer. After all, good governance is not a thing to be practised only in the boardroom but a goal to be worked at throughout one’s working life.

Adil kicked off his talk by thanking Rotarians. As a young IITian in 1970, he had gone to the U.S. as a Rotary scholar. He had taken a gap year from IIT to do this and gone as part of an exchange student programme. This had changed his life and he was grateful to Rotary for the opportunity.

He then went on to clarify that his speech was going to be short and he hoped that the session would be more interactive in nature with plentiful questions from the audience. In this, the members did not disappoint him.

 

Adil’s position is unique – his views and actions on governance come from his experience with the private sector (he
is presently on the board of Reliance Industries, L&T, Cipla, Network 18 and a series of foundations). He has also
been part of the Quality Council of India, a semi-government institution, for over four years. This has given him
a view from the other side. In fact, one could even say that it has shown him what governance looks like in context of statesmanship and the nation.

It was time for the nation to take its economy seriously and change its governance to keep up with the modern times, Adil emphasised. He said, “…in a few years, India will be a $5 trillion economy. We will want to be ready. Ours is one of the most successful economies on the planet and our institutions must be run in a way that makes sense for an
economy of that size.”

Adil said the issue was complicated in India by the fact that India was one of the few countries in the world which had promoter-led companies. He explained, “Quite often, people feel that the promoter and promoter families treat
the company as their own company.” Adil felt it was upon the board and the directors to create an environment of trust between people and the company.

Another issue was that a large proportion of India’s companies were owned by State or Central Governments. The Central Government, he said, has 186 public sector units market cap is 1 million crore: “What is the governance of these because many of them are publicly listed? What do minority shareholder rights have to do with the government
institutions? How they are governed and how is the board of directors looking at that?”

“Many institutions that were once regarded as having outstanding governance,” he said, “did not fulfill the governance that we expected of them.” Adil cited examples with consequences as far-reaching as the scandals of IL&FS,
ICICI, PNB, Fortis and Religare, which, he said, are only now being exposed.

“GOVERNANCE IS NOT UP TO THE LEVEL THAT WE WOULD LIKE IT TO BE. PEOPLE ARE ALWAYS WORRIED THAT WHETHER IN PRIVATE OR
PROMOTER-LED COMPANIES, THERE IS SOMETHING GOING ON THAT THEY ARE NOT QUITE COMFORTABLE WITH.”

Examples of bad governance were to be found everywhere, whether in India, USA or UK, he expanded. “Look at companies
around the world,” he pointed out. “Companies that we thought were fantastic at governance were turning out to have done things that didn’t make sense. In Japan we recently saw the failure of governance at Nissan and Renault.” Adil listed other names: Kobe Steel, Volkswagen, Uber, Facebook, and Rolls Royce.

Besides these, cautioned Adil, anyone considering the role of directorship had to consider all their duties. He
said, “Read the duties of the director carefully. If you do, you might just decide that you don’t really want to become a director. Those of you who follow the news will remember that in the case of Nirav Modi, he had three directors for his US company, Firestone, who were professionals from Pepsi, Coca-Cola and American Express. When the case against Nirav was brought, the accounts of all these three directors were locked up. This is the risk. First read what is required. Having said that, if nobody wanted to be a director, I don’t think we would have good governance, so we need to step up and try and do what we can.” The board of directors, said Adil, were signing upon a piece of paper that said that they were saying that company engaged in everything in a legitimate and legal way and the financial control systems of the company did not allow anyone to cheat within the company. “So, if you are signing that, and somebody in the company did something that was not right then you, as a director, are liable for that. A director has to spend quite a lot time looking, with a keen eye, at the accounts and financial systems.
The board of directors has the right to engage independent accountants, legal staff or any other staff to look at
anything they are uncomfortable with. Very few do it but as a director you have a right to ask the auditors of the
company to engage other accountants to look into any acts that you think don’t follow financial control systems. But how many directors would actually spend the time to do that? This is one of the issues that we are facing in trying to get very good directors who actually understand financial systems and the law.”

Adil then made some suggestions:
1. “Many of the things that worked in the past will not be acceptable going forward. SEBI and MCA will hold everyone to a very high standard. So, let us try and do something ahead of the curve. We need to put in a culture of governance within the organisation.”

2. “Strengthen the role of independent directors on the board. Whether there are promoter directors or executive
directors, they must be balanced with a very strong set of independent directors who are not afraid to challenge and
question.”

3. “In India, historically, we try to put in a strong dose of punishment along with incentives. In reality, I think we do not put enough incentives to make people work correctly.”

Many helpful tips emerged from the questions put to Adil. For instance, referring to IL&FS, Adil said: “You have to separate bad decisions from fraud. Bad decisions will occur, it is part of business, but when it leads to fraud, that is a different question. The government standard should require that there be no fraud. And, as we are experiencing with IL&FS, there were many areas where there was fraud. And even if there was no fraud, there wasn’t sufficient disclosure either. The sad part is, everyone in the bazaar knew that something was wrong. Nobody could explain exactly what was wrong or may be some people could. Yet it continued for quite a few years.”

“Another part of governance is about catching bad governance early enough to change it. Presumably, if, at IL&FS, the
issue had come to the surface two years ago then the chances of fixing it would have been much better and the systemic risk to the industry would have been a lot less.”

“One of the things we are very good at in India is at changing laws after the crisis. So, I have no doubt that the combination of IL&FS, ICICI and others will lead to a fundamental change of laws that will affect all of us.” On independent directors being held responsible for the failures of the company, he said: “Part of the reason that the Government and SEBI have put so much pressure on independent directors is to try and create some counterforce that forces good governance in companies. They want independent directors to take a tough stand. For example, in all the companies I am involved in, we look at every single related party transaction and we separately ask the auditor to certify the basis upon which the related party transaction was done and personally certify that everything is done correctly. The directors can start putting in place a culture of accountability. For example, in L&T, every single accident that results in fatality is discussed by the board. And, as soon as we started discussing it at the board, the level of safety went up. But it is impossible to know everything going on. However, what the law says is: are you paying sufficient attention to ensuring that there is a financial system in place that roughly makes sure that things are going according to plan?”

When asked about incentives for good governance, Adil said: “The number one incentive today is the fact that a reasonable amount of stock in Indian companies is owned by foreign companies and foreign direct investment. If you look at the pattern of investment, they give a premium to companies with good governance. You can’t be seen as having good governance without actually having good governance. So that is the biggest incentive. If investors give a premium for good governance, then everybody will start approving good governance. Actually, in the last 10 years, many companies have become known for having better governance than others and therefore they are getting a premium. Tata, Infosys, HDFC and others have a premium for getting good governance.” “Secondly, the MCA and SEBI are trying
to ensure that the independent directors are truly independent. In some of the biggest scams that have occurred,
independent Board members were not really independent.”

“OVER TIME, WE WILL NEED INDEPENDENT BOARD MEMBERS WHO ARE STRONG AND KEEP ASKING QUESTIONS. THE MARKET RECOGNISES THIS GOOD GOVERNANCE BY GIVING A PREMIUM TO SUCH COMPANIES.”

“You can see it happening in some industries where they had individual lapses but overall, there has been good governance.”

How do you decide on an independent director opportunity? Adil answered: “I don’t join the board unless I know the person very well. All the boards I am on, I have known the people for 20 years. So, if you know the person and trust the people there, have a straight conversation before joining, saying that you are going to ask all sorts of questions. Talk to other Board members who have been there before. If the refrain in the marketplace is a little bit
like when everybody knew about certain companies then you might not join.”