Systems of Corporate Governance in India

A good corporate governance has always been an issue since the companies started using stock market to meet their financing needs. The history of East India Company (EIC) suggests how the first publicly listed companys indulgence in trade and accounting malpractices led to the widespread public protests and demand for reform A unique similarity of such corruptive practices has been observed even after 400 years and repeated in modern corporates like Enron and WorldCom

Systems of Corporate Governance in India

Executive greed, rampant corruption, insider trading and appalling governance practices were all there. East India Company, where the seeds of the modern day Board were first sown, fared miserably in Corporate Governance front Even then the importance of practicing Corporate Governance principles was not played down Let us look at through various systems of Corporate Governance in India

Systems of Corporate Governance in India

India has a very long history of commercial activity and has always been a major source of many of the worlds most sought-after products. The Corporate India has a long history of its Coporate Governance Systems. Broadly speaking, the corporate governance practice in vogue at different points in time may be studied under three groups The Managing Agency System ( 1850-1955) The Promoter System (1956-1991) The Anglo-American System ( 1992 and onwards)

Systems of Corporate Governance in India The Managing Agency System was an age-old system, which began in 1850. In the year 1956 after independence, Government of India in order to restrict the abuse of powers and ill-effect caused by the Managing Agents, adopted many corrective measures and provisions in the companies Act 1956. The importance of Managing Agency system almost diminished with the introduction of the Act of 1956

Systems of Corporate Governance in India

A major contribution to the rise of the modern corporates in India was the institution of the Managing Agency System. The first Managing Agency System was introduced way back in 1809. During the same period further developments took place in the legal front, resulting in the enactment of the first Indian Companies Act of 1850, followed by amendment in 1857 providing for limited liability. Managing agents initially in India were British merchants as the initial entrepreneurs who brought necessary financial and managerial resources together in a bid to make very high profits

Systems of Corporate Governance in India

They served three basic functions: First, they started new companies and sold most of their shareholding when the companies became successful Second, since they had managerial expertise to run the companies, they were appointed to manage and control the existing companies based on managing agency contract. Third, they provided important financial functions as managing agents, due to their ability to attract new investors, to secure bank loans etc., This made the Managing Agency System attractive to the investors in joint stock companies as at that time the credit system was not fully developed and the money and capital markets were virtually non-existent

Systems of Corporate Governance in India Indian Managing Agency system emerged in and around Bombay and Ahmedabad mostly merchant families like Parsees and Gujaratis, who focused on cotton and textile industries and earned high profits through managing agency contracts. Subsequently, between 1920 and 1930 entrepreneurs like Tata ventured out into new areas and Marwari community also emerged.

Systems of Corporate Governance in India

The characteristics of governance under the Managing Agency System are twofold. The formal mechanism of control is through the managing agency contract Macro economic situations of control and governance. The managing agents were able to exercise control over the managed companies through Agency Contracts There were binding provisions in the contract, such as unlimited terms of tenure, heavy penalties for dismissal of the agency which ensured the inability of the shareholders to remove them

Systems of Corporate Governance in India

The Managing Agents used to exercise the function of corporate governance along with their wide powers towards investment decisions, appointment of directors etc Under their stewardship, many companies did not have Boards or did have puppet boards to their advantage. The Managing Agency system became dominant and increased its strength from 75% in 1936 to 95% in 1955 of the industrial companies in India Underdeveloped macro-economic situation and unorganized capital and money markets, absence of stock exchanges etc gave the managing agents great opportunity to step in to fill the void. Lack of a strong credit system gave the Managing Agents opportunity to play a key role in securing working capital for managing companies Absence of government regulations against abuse of the power also helped the Managing Agents to exploit the situation to their advantage

Systems of Corporate Governance in India

It was ownership of the managing agency that enabled them to maintain a control over managed firms. This ownership was in the nature of partnerships predominantly restricted to family relations A family business house was usually dominated by a Karta to be in control of several managing agencies, each of which used to manage several joint stock companies Other mechanisms adopted by managing agents to ensure corporate control over the managed companies by discouraging shareholder activism and continued practice of multiple directorships within the companies etc. These agents consolidated their empires by taking over existing firms or floating new firms with a minimum contribution of their own capital Thought it has its drawback, the managing agency system made a significant contribution to the economic development of the country at a stage when investment potential was very low and the capital markets undeveloped. The system also was abused and its significance was lost.

 Multiple Directorships Held by Leading Indian Industrialists Name No. of Companies F E Dinshaw 65 P D Thakurdas 42 P C Sethna 34 N B Saklatwala 29 F C Ebrahimbhoy 26 L Samal Das 26 H P Mody 14

Systems of Corporate Governance in India

Systems of Corporate Governance in India Industrial Policy Resolution, 1948 was the first major policy statement issued by Government affirming roles of both State and the Private Sector for development of the economy Industries (Development and Regulation) Act, 1951 was another significant legislations providing for the legal basis for industrial licensing scheme.

 Evaluation of Managing Agency System A) Shareholder rights-Shareholder control- Maximizing shareholder value The criticism of Managing Agency system was that the Agents did not respect basic rights of shareholders. To minimize shareholder participation, the Agents established the firms, sold them to new shareholders but retained management control through various means like interlocking directorships, inter-corporate investments, stringent stipulations in managing agency contract making virtually impossible for shareholders to remove them, calling annual general meetings at very short notice and inconvenient times etc.

Systems of Corporate Governance in India

 The Agents never bothered to maximize shareholder value and used to fix their remuneration at a very high percentage of profits of the firm and hefty perks by way of office allowances, leading to conflict of interest between managing agents and shareholders Financial irregularities in running the companies was another area of concern. The following were the general irregularities in managing agency system Improper inter-corporate transfers at the cost of shareholders Advancing companies fund elsewhere as unsecured loans Investing fund of listed companies including banks and insurance companies to acquire controlling interests in other firms with high liquid assets

Systems of Corporate Governance in India

Systems of Corporate Governance in India

Transferring the assets of the public companies to closely held companies and the converting them into private companies and thereafter private companies into liquidation Intentional non-declaring of dividends of the companies genuinely making profits and forcing the other shareholders to sell their shares at falling share price and then again cornering and buying those shares for declaring huge dividends thereafter Operating in the black economy Appointing sole purchasing agents Speculative activities

Systems of Corporate Governance in India

In most of the cases, there was lack of professional management, absence of professional education and technical training in the system In many managing agencies, it was almost family ties not professional competence that determined who could manage the firm. There were few exceptions like Tata sons and Birla brothers who were among the first to appoint professional managers and directors from outside into the boards of managed companies and who attempted to cultivate a reputation for honest business practices and sought to protect the interests of their shareholders.

Systems of Corporate Governance in India

Market competition Did Managing Agency System encourage behaviors opposed to the logic of fair market competition? The activities of firms contributed to economic concentration, which is evident from the pattern of management and directorships of firms. A study in 1950-51 indicated that nine leading Indian Industrial families held nearly six hundred directorships or partnerships in Indian industry, with Dalmias and Singhanias alone holding two hundred of these positions One hundred individuals were found to hold one thousand seven hundred directorships, thirty of them holding eight hundred six directorships. Top ten of them were holding four hundred directorships. Six hundred industrial concerns were controlled and managed by thirty-six managing agency houses, of which only two hundred fifty companies were controlled by nine leading British agency houses

Systems of Corporate Governance in India

Number of Companies Managed by Leading British Managing Agencies Name No. of Companies (Directorship) Andrew Yule 50 Mcleod 40 Martin Burn 26 Duncans 26 Octavious Steel 24 Martin Burn 21 Jardines Henderson 20 Gilanders Arbuthnot 20 British India Corporation 20 TOTAL 247

Systems of Corporate Governance in India

Despite the government policies to build a much wider economic base, economic concentration had continued to increase in this period. During 1951-58 gross capital stock of companies controlled by top four industrial complexes (Tata, Birla, Martin Burn and Dalmia-Jain) increased by 100% and 31% of the funds to these companies were distributed by financial institutions and banks in which large business houses were well represented on the boards of these institutions.