'Poor Corporate Governance' is like "Corona-virus" infection killing your Company

'Poor Corporate Governance'  is like "Corona-virus" infection killing your Company

By:

Vijay Sardana
Member, CDAC, SEBI
Public Interest Director on Stock Exchange
 Independent Director on Financial Services Company
Advocate, Delhi High Court

Who is responsible for destroying once well-known high flying companies like Yes Bank, IL&FS, DHFL, Jet Airways, Karvy Broking, Satyam, ADAG, Unitech, Global Trust Bank, CG Power, Cox & Kings, JP Group, Altico, etc? 

What was the common element in all of the above in their downfall? All had a very high profile, highly educated, experienced top management but very poor corporate governance.

With the amount of digitization in the financial world, all black sheep will be exposed in the coming days. This will open the opportunities for New India. 

Have you insulated your company from the same infection?

When the promoter considers his company as his asset or his family asset and ignores symptoms and signals from various sides, the problems start. Like coronavirus, it may take time to surface. Sometimes, it may be too late by then.

Family-run firms and many list companies tend to believe that principles of good corporate governance do not concern them. This is a mistaken view. The bigger question is how to convince them.

After recent episodes, corporate governance has become an industry–and a growth one at that. Many audit firm, legal firm and consulting firm are looking at corporate governance just as compliance formality and misleading the promoters away from its true intention. Too many superficial discussions are happening all over. Policymakers and investor groups seem to love it. But do the real decision-makers – business owners and corporate managers – actually need or want corporate governance? If the answer is no, why should we expect them to buy into it?

Most corporate governance experts concentrate their attention on symptoms and not the cause of the problem. In place of building a strong team, many corporate governance experts treat owners and managers as if they are sitting opposite to each other. For example, divergent incentives of managers and shareholders, Disclosure rules are intended to stop managers from inflating company performance, Boards of directors are established to guide managers’ a business strategy, to monitor their reporting systems and to ensure that managers do not overpay or entrench themselves at shareholder expense, related party transactions should be avoided, and many such examples exist. Very often the same rules do not apply to the promoter family members.  

What happens when the owner is the manager?

Family-run businesses account for more than 85% of all firms in many parts of the world including India. Such businesses make up to 500 largest companies in much-developed economics.

In a family-run, the firm, a single person or group enjoys a controlling interest and can appoint family members as managers, or can unilaterally appoint, monitor, compensate and fire third-party managers. This situation may threaten minority shareholders with exploitation, but offers the controlling family the best of both worlds: it can run the business as it sees fit and gambles, at least partly, with other people’s money.

As a consequence, if the purpose of corporate governance is to constrain managers and control shareholders, one may well ask whether a family-run firm would ever really want it?

The answer to this question is “yes”, but not necessarily for the reason most commonly given: better access to capital. One often hears the argument that, when investors refuse to put their money in companies with bad governance, the cost of capital for such companies goes up, making them uncompetitive. Eventually, so the argument goes, the owners/managers of such companies must either mend their ways or go out of business.

Can money alone save businesses?

No. Study all NPA accounts in India in the last 5 years. No one was short of funds. Most of them have excess money than what they wanted for their projects. Then, why they all failed as organisations.

Firms can obtain external financing in several ways besides issuing shares to the public, such as reinvesting profits, borrowing money or selling shares through private placements. In such cases, providers of non-public sources of capital (banks, pension funds, insurance companies, venture capitalists, private-equity investors, etc.) expect to look out for themselves. They will want to secure their loans with company assets, to be able to accelerate repayment of loans if the company’s performance falters and to review books and records directly. They will seek direct assurances from the company’s auditor and officers or personal guarantees from the company’s owners. They will demand the right to approve major transactions or money transfers. For these capital providers, typical corporate-governance practices, such as board review of transactions between management and the company, board committees, non-executive directors, or separate CEO/board chairmen, hold little interest. This may look effective but the fact is bad governance do not respect the source and type of capital.

Why India’s Economy & the investment climate is looking weak?

Studies indicate that the stronger a country’s corporate governance, the more robust its capital markets and the higher its level of external financing as a percentage of GNP. However, while these findings may persuade policymakers, but at the level of the individual family firm the slogan “embrace corporate governance to access capital” is not a priority for them. For many such promoters, the control over the business operations and freedom to decide at will, like a king of a princely estate, are the key motivators to come to the office every day.

Corporate Governance can address Succession Disputes:

It is not the business growth or money which bothers promoters. The most difficult time for promoters comes when they have to work on succession planning. In many family businesses, who will take charge after the current leader, is the biggest issue. Fortunately, effective corporate governance is the only way forward. Succession issues resonate strongly with business owners. While the founder of the family-run firm might believe that raising money or diversifying wealth will never pose a problem, one thing he does know for sure is that someday he will die.

The most common question which many promoters face are:

· Will his children be interested in running the business?

· Are they capable enough to lead in the changing world?

· Will they get up as early, stay as late, and work as hard as the founder did?

· Will my family members support my decision when it comes to succession?

Conflict can only be resolved by proper corporate governance:

Keeping a business going across generations is hard. Global studies indicate that only about one in six family-run firms survives to the third generation. Failure to maintain the family business can stem from any number of causes.

I have personally seen, the internal conflict between those relatives enjoying both salaries and dividends and those receiving only dividends. Jealousies emerge as some family employees rise higher than others or work less hard for the same pay. Even father giving more importance to one son over the other can lead to cracks in management. Managers find themselves incapable of firing an under-performing the subordinate who is a child or a sibling or a cousin. Sometimes it becomes very difficult to know who is a decision-maker. Many directors operate like actors and the actual power string is somewhere else.

Can the family business survive in the era of the Industrial Revolution 4.0?

As the business grows and markets evolve, finding sufficient managerial talent and experience within the family becomes harder. Where the family decides at last to hire an outside manager, failure to motivate and monitor him can damage or destroy the business. Competent managers leave when they see family politics is interfering and hurting business. The situation becomes more complex when professional managers don’t know who in the family the well-wisher of the organisation is. The same problem is also visible in many families dominated listed companies.

Corporate governance goes to the heart of these problems, though many family-run firms have never thought of it in these terms. Families need corporate governance both to operate the business and to promote family harmony. This means putting in place decision-making and monitoring procedures that are open and fair, as well as possibly hiring non-family members as advisors, managers and directors.

Coronavirus infection difficult to treat, if not diagnosed early:

It is not an overnight exercise, and often, by the time need for corporate governance has been recognised, family relationships or the business’s prospects have deteriorated beyond repair.

Family-run businesses can represent the work–and the wealth–of several generations. If business owners want to preserve, enlarge and pass on this legacy, they need to make corporate governance a family affair.

No individual should be superior to the system developed based on good corporate governance principles. This is the only way to assure that the family business will continue to flourish.

Therefore, the Coronavirus of Business World is "Poor Corporate Governance". The only way to protect your company from dead is by strengthening your quarantine system, means good corporate governance, to prevent the entry of pests and virus i.e. vested interests at all levels.

For more discussion and the way forward, please feel free to contact the author.