The question that is much deliberated in corporate governance is the interplay between the board of companies and its stakeholders; namely, the shareholders and lenders to the company. In the words of the Organisation of Economic Cooperation and Development (OECD), ‘corporate governance is defined as “a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and shareholders, and should facilitate effective monitoring, thereby encouraging firms to use recourses more efficiently.”
The eternal question that therefore arises is whether the objective of companies should be solely restricted to profit maximisation or shall other parameters such as governance and long-term objectives, be considered with equal importance while framing strategies. This is particularly relevant from the Indian perspective as a majority of companies in India are still either family-run or promoter-driven. As a result, in the absence of checks and balances safeguarding the interests of employees, institutional investors, and minorities, naturally results in an environment of profit maximisation.
Traditionally, profit maximisation was viewed as the end game by corporations as directors nominated by shareholders would be expected to pursue strategies that would result in the greatest benefits to the principals; namely, the promoters/majority shareholders in the company. However, this dynamic is slowly but surely changing to the enlightened shareholder value approach to corporate governance arising from public pressure in order for companies to expand their scope for the benefit of society as a whole.
While the proponents of the traditional theory of profit maximisation argue that only such an objective would ensure that the board strictly adheres to its duties towards the company and doesn’t exercise untrammelled power, there are others who believe that every corporation owes it to society and its people, apart from the environment. It is for these reasons, the latter school of thought believes that the company should be held accountable if not responsible, beyond the benefit of its majority stakeholders. Take the case of mining in South Africa as explained by Motlanthe, ex-president of South Africa, a high rate of tuberculosis is prevalent due to the presence of silica dust in the air resulting in silicosis.
Without adequate health care facilities in these regions, tuberculosis runs riot thus affecting the health and well-being of the mine workers, who are forced to reside in small and cramped hostels, which further gives rise to the spread of HIV in addition to tuberculosis as mentioned above. Accordingly, it is now argued that companies owe it to stakeholders other than its owners to ensure welfare to the largest group of people affected by it.
Another important factor that is required to be considered in this debate is whether strategies framed by companies should be viewed in the longer run, or should short- term profits regulate its policies. While the short-sighted approach leads to better profits and growth in the short term, it can lead to significant value erosion in the long run. On the contrary, a longer-term and more emancipated approach leads to improvements that finally result in value creation for all its stakeholders over a period and provides for enhancing the life cycle of the company. The United States Supreme Court, while in the determination of a case of corporate donation, has said that a donation to a university results in a fillip to the number of college educated individuals in society, which in turn ultimately leads to a reservoir of scientific and executive talent that ultimately forges growth in industries. Courts have therefore ruled in favour of the longer term objectives in relation to profit generation rather than confine itself to a more myopic view.
The other issue that should be monitored closely is whether profits in the short-run result in situations where companies take calls which engender regulatory scrutiny or scrutiny by courts. The risk appetite in such situations is exacerbated by the end objective of profit maximisation. This is particularly relevant in the financial services space, which has seen multiple instances of systemic fraud, thereby resulting in significant losses to public investments. Take the example of Jordan Belfort, who brokered the sale of securities to the public without adequate disclosure thereby giving rise to the penny-stock scam and market manipulation. While he was indeed tried and convicted for his actions, such reactive measures did not help prevent a significant erosion of investor wealth. In the modern era of corporate governance, it is expected that companies are run on principles that would prevent practices leading to market manipulation and where such instances are identified and weeded out while still at a nascent stage based on monitoring.
Corporate governance has assumed a high degree of importance in India with the market regulator framing the erstwhile listing agreements and the presently prevalent SEBI LODR Regulations (SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. Further, the ICDR Regulations (SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018) have set forth a robust framework in relation to disclosure ahead of securities issuances. Under the SEBI LODR Regulations, the requirement of half or one-third of the board comprising independent directors is aimed at transparency and long-term growth based on sound business practices. All important monetary decisions post ratification by an audit committee comprising a majority of independent directors is aimed at ensuring proper monitoring of financial transactions. Furthermore, a separate remuneration committee for the ratification of payments to executives including promoter controlled directors and managers is another step to ensure that long-term objectives of the company are given due importance as opposed to majority shareholders controlling the remuneration payable to executives. Ratification of related party transactions by the board and shareholders with no voting by interested parties is again a governance measure aimed at ensuring that all transactions are made at an arm’s length.
To conclude, practices based on sound governance principles are increasingly becoming the norm. While it is the objective of every company to ensure that it is profit-making for the benefit of all its stakeholders, maximising profits without adequate checks and balances can only lead to practices that shall result in wealth erosion in the longer run. Profitability with sound practices and a balanced approach ensures longevity of companies in the face of diverse business cycles. Furthermore, corporate social responsibility should not just be based on a must do under prevalent laws but should be ingrained in the minds of managers as only that can result in sustainable development not just for companies but for the society and the state as a whole.
Views expressed by Kaushik Mukherjee, President, Legal, Indiabulls Housing Finance Ltd.