The rather exotic sounding, corporate governance actually means something quite simpleaccountability. The principal objective of corporate governance is to protect the interests of minority shareholders and investors from any arbitrary or self-enriching actions of promoters and senior management. In spirit, its very similar to the principle of accountability of governments in a democracy. Remember, that democratic government can never be about the tyranny of the majority. Good corporate governance is the key to ensuring the maximum value to the firm in the long run, just as good governance in democracy is key to a prosperous country.
Accountability in corporate management is not dissimilar to accountability in the sphere of government in a democracy. Think of individual ministers as members of senior management, Cabinet as the board of directors, ruling political parties as promoters, parliament as the AGM, and voters as the stock markets. Now, lets identify the different layers of accountability.
The role of senior management in a company is to formulate policy and strategy. This is what individual ministries do in government. All major proposals that come out of management meet their first check-point at the Board and its various committees. The Cabinet and its various sub-committees play the same role in government. The promoters of a company are usually represented in both the board and management, just as members of a ruling party occupy positions in cabinet and ministries. Given the sometimes over lapping interests of management, promoters and directors, (same parallel in politics) one can see how accountability may be weakened.
That is why modern company laws and market regulators insist on the presence of independent directors on all company boards. In India, Sebi makes it mandatory for all listed companies with executive chairmen to have a minimum of 50% of independent directors on the Board. These directors are not related by family to promoters, and should not have been associated with the firm in any capacityincluding external auditing or legal advisory rolesin the recent past. In theory, the presence of these independent directors should prevent inexplicable, dishonest and nepotistic, promoter enriching decisions, like the one made by the Satyam Board.
The only problemSatyam was already following Sebi directives and had the necessary number of independent directors. Some of them were very eminent peopleKrishna Palepu, a Harvard corporate governance guru, Vinod Dham, the father of Pentium, TR Prasad (former cabinet secretary, GoI) and Rammohan Rao, Dean of ISB. What prompted men of such eminence to vote unanimously in favour of what was a massive corporate heist? Promoters are only expected to act in their self-interest, so it is the independent directors who must take more flak than the discredited promoters.
The problem of independent directors is very complex. For one, they are appointed by the promoters and are usually known personally to promoters. They are paid handsome feesPalepu reportedly receives around Rs 1 crore a year from Satyam. Many would argue that this compromises independence. But why should independent directors work without feeafter all they are expected to spend time and effort keeping track of the companys business, or else they will be accused of not being careful enough. If independent directors have to work pro bono, they may not have the incentive to be vigilant. However, if a particular independent director develops a tough reputation, boards may simply not hire him or her. Its a complicated vicious cycle. In government the parallel can be drawn with theoretically independent authorities like the CAG, CVC, and even some market regulators. While conferred with independence, these authorities are appointed by the government they are supposed to hold accountable. They are paid their salary by, and get benefits from, the government. Many aspire to get other jobs when they are finished with one. All of which ends up compromising some independence like that of independent directors. So this second line of accountability (after Cabinet or non-independent directors) is less effective than one would want, and there is no easy way to strengthen it.
The third line of accountability for corporates is the AGM, for governments, parliament. Their effectiveness is often limited in the Indian systempromoters usually hold a majority in an AGM (though not in Satyam), just like a ruling government holds a majority in Parliament.
This is why the fourth and final line of accountability is critical. For corporate governance, this is the stock market where investors vote with their money. Satyam was pounded in the market after its awful decision. In a well functioning market, the next step will be a takeover of the family stake in Satyam. Even if the latter takes time, the battering Satyams stock has received will serve as a warning to other promoters and managementsthey cant get away with plain bad corporate decisions. In democracies, voters are the last line of accountabilitybad governments get booted out while good governments get another term. As long as this last line is working, the system will survive. People have faith in Indian democracy even though governments are often corrupt and incompetent. Similarly, the stock markets battering of Satyam will reinforce faith in Indian capitalism and corporate governance systems even if one bad egg is shown up.
Importantly, there is a case to be made for a larger share of company stocks to be traded on the market, which will strengthen the stock markets disciplinary rolethats what allowed the market to punish Satyams minority promoters.