Riding the Tiger

As in the United States, India has had its share of monitoring failures in the wake of Clause 49, most notably in the case of Satyam Computer Services, the country’s fourth-largest information technology outsourcing firm. Satyam’s founder and chief executive, Ramalinga Raju, asked his board in December 2008 to approve a $1.6 billion acquisition of two other companies, and after some debate, the board unanimously supported the proposal. Institutional holders, however, revolted against the plan, dumping Satyam’s stock in such a frenzy that the company lost half its market value in a single day’s trading. Their complaint: the targeted companies were founded by the CEO’s sons. Both firms carried the name Maytas—Satyam spelled backward—and both operated in the unrelated industries of infrastructure and real estate, building shipping ports and auto roads, not information highways. Chief executive Ramalinga Raju backed off from the acquisitions, but his reputation was fatally compromised, and several prominent nonexecutive directors resigned, their reputation for vigilance severely damaged.⁶

The story did not end there, though. Just three weeks later, Satyam’s chief executive unloaded a far larger bombshell. In a January 7, 2009, letter to the Bombay Stock Exchange, Raju candidly admitted to phony accounting, inflated earnings, and a claim of more than $1.1 billion in cash, when in fact the company held just $66 million. “What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years,” he explained, and then it “attained unmanageable proportions as the size of company operations grew.” The gap between the real and the reported extended even to employment numbers: the company had publicly claimed that it employed 53,000, but the actual number evidently was some 10,000 less. In the end, said Raju, it was “like riding a tiger, not knowing how to get off without being eaten.”⁷

Raju’s disgrace and Satyam’s fall were fittingly termed “India’s Enron” by many observers. But as spectacular as the collapse was—on both the personal and the corporate fronts—it is more the exception than the rule. Malfeasance charges did not sweep across the Indian business landscape, and the obvious failure of the Satyam board to do even minimal monitoring did not emerge as the Indian norm. Moreover, as much of the developed world plunged into recession, Indian business remained relatively resilient. What some had deemed a liability—India’s distinctive approach to governance—might have even proved an asset.

Ownership and Governance

Corporate governance in India differs substantially from that of the United States in the ownership structure of its firms, with many firms operating under the umbrella of business groups, and a significant number of infrastructure firms owned by the government. The roots of the distinctive way of Indian corporate governance can be traced in part to the very different ownership structures of its largest companies. Most were publicly traded, but the ownership of many remained concentrated in the promoter family’s holdings.⁸ While most large American firms had ownership profiles with a large number of institutional investors each holding a sliver of the firm’s stock—which, taken together, constituted a substantial majority of shares—the ownership of large Indian companies generally fell into four distinct patterns.

A first group included publicly traded companies that had a majority share of their ownership in the hands of a business group, which was in turn controlled by a founding family. Among the most prominent of the business groups were those of Aditya Birla, Godrej, Anil Dhirubhai Ambani, Reliance Industries, and Tata. Most of these groups had established operating companies in disparate industries ranging from software and steel to retail and telecommunications. ⁹ A very few of America’s more notable corporations fell in the general category of family control, often exercising authority through a separate class of stock, as at Ford Motor Company, The New York Times Company, and The Washington Post Company, but none of the American companies operated as a business group in the full Indian sense.

A second group of Indian companies consisted of stand-alone, publicly traded companies such as ICICI Bank—a model far more familiar to American investors. A third group was made up of what might become an increasingly familiar American type as global ownership spreads: publicly traded subsidiaries of multinational corporations, such as Hindustan Unilever. The fourth group, largely unfamiliar to those in Western settings until the financial crisis of 2008–2009, encompassed publicly traded but still largely government-owned companies, such as the State Bank of India, a legacy of the pre-1991 centrally planned economy.

Just as Indian companies differed in ownership structure from many American firms, so did they differ in how owners sought to exercise their rights. For the most part, the largest owners of America’s premier corporations were institutional investors, whose holdings rarely exceeded 2 or 3 percent of total outstanding shares and who, in any event, had proved generally reluctant or unable to exercise their ownership rights.¹⁰ Instead, the U.S. model was premised on an active market for corporate control that imposed an external discipline on the directors’ monitoring of managers. Companies whose boards failed to fulfill their fiduciary duties found themselves subjected to unwanted takeovers in an active and independent equity market, and poor company governance was often punished by hostile acquisition or proxy battles to replace underperforming directors.¹¹

Business-group companies constitute the dominant Indian form, as seen in figure 6-1, and they have often set up long-standing “shadow” boards comprising family-dominated operating committees. As one might expect, the role of the formally appointed boards of such companies was largely diminished in comparison to U.S. boards. Yet we found that whatever the ownership structure, Indian executives generally placed less weight on the board’s monitoring function than was common in the West—at least in part because Indian firms and their directors faced a less active market for corporate control than did their U.S. counterparts. ¹² But to note that Indian boards as a rule monitor less than American ones is not to say that they have a less significant influence on the companies they serve. In this as in so many other aspects of corporate life, the India Way simply conceives of a director’s role in more holistic terms.

FIGURE 6-1

Ownership and control of 500 large Indian companies, 2006

Source: Rajesh Chakrabarti, William Megginson, and Pradeep K. Yadav, “Corporate Governance in India,” Journal of Applied Corporate Finance 20, no.1 (2008): 59–72.

Values-Based Governance

A first indicator of the distinct Indian governance path came when we asked business leaders, “What are the two most distinctive aspects of corporate governance practices in India compared to the U.S.?” As seen in table 6-1, only a handful of the executives—just six of the more than one hundred we interviewed—saw little or no difference in the governance practices of the two countries. Substantial numbers, by contrast, viewed Indian governance in a state of transition or as a distinctive product of the country’s regulatory regime or ownership structure.

The transitional state of Indian governance was well captured by Rahul Bajaj, the chief executive of the Bajaj Group and chair of a committee established by the Confederation of Indian Industry in 1996 to propose governance guidelines. ¹³ “We are behind the U.S.,” he observed, adding that Indian companies were still in the process of borrowing from abroad. At the same time, many of the companies were developing indigenous solutions to the challenges of effective governance in India, and a common theme in their solutions was an emphasis on what some have termed a values-based governance system in contrast to a rules-based approach. ¹⁴ The first is premised on a set of shared values and norms among directors, executives, and regulators on what constitutes good governance. The second is predicated on the assumption that common values and norms are not sufficient and specific rules are therefore required. American governance increasingly became more rules based in recent years, while India followed the values trail.

Socially Responsible Governance

The single most distinctive feature of corporate governance across the Indian companies we studied was this determination to balance the interests of the firm’s diverse stakeholders, all the groups that have a claim on what the company does, including employees, customers, and community. What was especially striking was the emphasis on the broader community, which extended from the immediate vicinity of the business out to encompass the entire nation.

At an international forum in 2006, the chief executive of a well-known American corporation declared proudly that its headquarters happened to be in the United States, but since its manufacturing and sales were worldwide, he did not consider either his company or his leadership role as distinctly American. Few, if any, Indian executives and directors would wrap themselves in such a countryless banner. Though publicly traded and often global in operations, Indian companies were governed in ways that also pointed their decisions toward national purpose rather than eschewing it.

Consider the chairman of the Godrej Group, Adi Godrej. His group’s governance, he baldly stated, was “directed towards the good of the company and not necessarily the good of one or the other of the shareholders.” He added that the Securities and Exchange Board of India, the Indian equivalent of America’s SEC, was properly concerned with protecting minority shareholders—those who were not part of the founding family or the primary owner—from exploitation by the dominant owners. But aside from meeting that obligation, the governing board’s role was to optimize the company’s success, broadly defined. “I think the most important thing in the Indian situation,” he concluded, “is to ensure the corporate governance practices are directed towards the good of the company. If the corporate governance practices promote the good of the company, then all stakeholders benefit.” In keeping with that sentiment, the Godrej Group had constructed schools, medical clinics, and living facilities for employees on a massive scale unknown among American companies, where directors and executives were far more likely to see employee welfare as a drag on shareholder value rather than an asset for company growth.

The Ambivalence of Governance

One of the prices of India’s booming economy and increasing worldwide presence has been pressure to conform to global norms on multiple fronts, including corporate governance. Accordingly, SEBI moved in the direction of stronger rules for protecting shareholder rights. But the changes have not been entirely welcome. While Indian executives generally want to be viewed as world-class players, they are often reluctant to see their boards—and their businesses—become more rules oriented.

At the time of India’s independence, four stock markets were already in operation, though their turnover was tiny by today’s standards. Still, they had established listing and trading requirements, and subsequent legislation further strengthened shareholder protection and financial disclosure. The Companies Act of 1956, for example, held that a company’s financial statements were the responsibility of the governing board, and it made directors accountable for ensuring that the company complied with contemporary accounting standards. But it was not until the reforms of 1991 that India moved toward formalization of its governance system. Driving the effort were both the need to attract foreign investment, which required even greater transparency in financial reporting, and the partial privatization of banking, which also placed a premium on reliable disclosure by borrowing firms. The rapid growth of companies in the wake of the reforms and their own burgeoning need for equity and debt added still another force for formalization.

Recruiting Independent Nonexecutive Directors

The thrust of Clause 49 has been to strengthen the oversight role of independent nonexecutive directors by increasing their numbers on the board, expanding their influence over audit and compensation, and making their role more transparent. Ideally, this should spawn boards devoted to monitoring company managers and protecting shareholder rights. The reality, though, is that Indian board members, more so than their American equivalents, tend to be recruited for almost anything other than their monitoring potential.

When it comes to monitoring management, the thrust of a rules-based approach, independence of thought, should be among the leading criteria, but as displayed in table 6-2, it ranked far down the list in our surveying, with business experience, personal reputation, and professional expertise far ahead of it. Conversely, for values-based governance, with its emphasis on entrepreneurship and collaborating with management, experience and expertise should rank high up on the list, just as they do. While the SEBI regulations pressed for strengthening the nonexecutive directors’ oversight function, the Indian executives reported that when they recruited nonexecutives to their board, they used the opportunity to strengthen the directors’ capacity to work in partnership with them. These attributes of directors were also closer to the entrepreneurial model referred to by Hewlett-Packard director Thomas Perkins rather than the compliance model that Perkins feared had come to pervade the American landscape.

When asked to describe the role that nonexecutive directors play in the boardroom, the Indian executives—many of whom also served as nonexecutive directors of other firms—consistently stressed their value in providing substantive guidance on business issues and virtually never referenced their monitoring function.

Convergence of East and West?

One side of a long-standing academic debate contends that governance practices of large companies worldwide are likely to converge on a set of shared practices. As large companies in major economies search for capital, goes the rationale, they will increasingly enter a worldwide equity market, where they will encounter equity investors increasingly global in scope. Regardless of their originating nation, the major players will acquire a set of shared principles and norms for good corporate governance. The other side of the debate expects only modest convergence at most. Distinct country traditions and national regulations are likely to thwart the global equity-market pressures for convergence, the argument contends, preserving much that is unique and effective in the respective national governance systems. In the end, major players such as China, India, and the United States will each sustain their own ways of governing.²³

As seen in table 6-4, the Indian business leaders were in substantial agreement with the first side of that debate. Asked “Will your governance practices eventually converge with those of the U.S., or will they remain distinct?” slightly more than half concurred with the convergence forecast. Smaller fractions anticipated convergence with the governance models of the United Kingdom or other countries, and just one in ten forecast no convergence at all.

Though a majority of the business leaders anticipated convergence with the U.S. model, some forecast that the U.S. model would at the same time move toward the Indian model as well. One in five of the executives foresaw convergence around a different end point, a global best-practices model, which would include practices from the United States, India, and elsewhere. Not surprisingly, the companies that most anticipated convergence of Indian governance with U.S., U.K, or other non-Indian models were those whose revenues came heavily from international clients. Overall, however, nearly half of the executives believed that Indian corporate governance would retain some of its most compelling features, including its relative emphasis on a values-based approach, and its stress on the worth of human capital as much as stockholder capital.

B. Muthuraman of Tata Steel spoke for many: “I’m not a great admirer of the U.S. corporate governance practices at all. By framing rules, you cannot improve corporate governance. You lay down more rules, and they get broken more.” By contrast, in India, in “improving your value system, you can improve the corporate governance practice.” Many concurred with the call for a continued strengthening of values-based governance norms rather than an imposition of more rules.

Governance at Infosys Technologies

To illustrate many of these themes and to see how they interplay with one another, we briefly consider the governance of Infosys Technologies. While the company clearly met international standards for rules-based governance—it listed itself in both India and the United States—it managed at the same time to build a values-based governance model, and it has worked to draw the best from both models. The Infosys board, for instance, placed a premium on both the independence and the competence of its directors. Independence provided for director monitoring of management; competence provided for director dialogue with management. Directors could thus both hold executives’ feet to the fire and serve as advisers and sounding boards for executive decisions. By virtue of Infosys’s American listing, the board of directors also served to bolster company credibility with investors and customers outside of India.

Infosys Technologies early adopted a rules-based approach to governance. After the Confederation of Indian Industry put forward a set of good governance rules in 1999, Infosys was one of the first companies to embrace them. As a part of a commitment to global best formal practices, Infosys decided also to comply with the Euroshareholders Corporate Governance Guidelines of 2000 and those of the U.S. Conference Board Commission on Public Trust and Private Enterprise. Infosys embraced the UN Global Compact and the governance guidelines of six countries—Australia, Canada, France, Germany, Japan, and the United Kingdom.²⁶ In the same spirit, it adopted the U.S. generally accepted accounting principles (GAAP) well before most other Indian companies, and in listing itself on NASDAQ, it embraced Sarbanes-Oxley as well.²⁷

Infosys’s governance as a result became exemplary by any set of international rules-focused standards. For instance, Crédit Lyonnais, the French financial services company, ranked Infosys as having the best corporate governance of 475 companies that resided outside North America, Western Europe, and Japan. On a 100-point overall scale gauging such issues as reporting transparency and board independence, Infosys scored 91, while the average company scored only 58.²⁸

In keeping with the rules-based model, Infosys also acted to increase its own operational transparency by reporting revenues separately for its major segments, and it brought its board into compliance with SEBI’s Clause 49 requirements. Eight of Infosys’s fifteen directors were independent nonexecutives. The audit, compensation, investor grievance, nominations, and risk management committees were all composed of independent directors.

But Infosys has also been a practitioner of the values-based approach to governance. The directors, for instance, reflect a wide range of expertise from academe, consulting, and industry, with both domestic and international experience.²⁹ “The major value” of the nonexecutive directors, said chairman Narayana Murthy, has been in “asking questions that make us rethink our assumptions. That makes us look at issues we may have missed and think about alternatives.” At a recent board meeting, for instance, the executives and directors debated the synergistic merits of several acquisitions and alliances for the better part of three hours. The board went back and forth on the strategic issues—what were the downsides to combining different company cultures? Would management have the “bandwidth” to manage a proposed acquisition? If it were completed, would the two firms be able to cross-sell their services to each other’s customers?

As the box, “Infosys Technologies Board of Directors, 2009,” shows, five of seven of the executive directors are also cofounders of the company, and two are former chief executives, a practice not well received in the rules-based governance model but ideal from the values-based standpoint because they bring the personal commitments to company values that one expects in founders. Murthy reported that the board’s original design and its many decisions since then have followed the same set of principles that he and his cofounders had used in creating the company to begin with, including the following:

• The softest pillow is a clear conscience.
• When in doubt, disclose.
• Don’t use corporate resources for personal benefit.
• Put long-term interests ahead of short-term ones.
• A small slice of a large pie is better than a large slice of a small pie: the company’s growth depends on management’s sharing profits with all employees.³⁰

The Distinctiveness of Indian Governance

As with human resource decisions, company leadership, and competitive strategy, so with corporate governance. India’s top executives follow a path similar to, yet different from, that of their counterparts in the United States and other countries. Indeed, Dale Berra’s “our similarities are different” might serve as a mantra for the entire U.S.–India business interface.

Among the more notable differences are a stronger sense of social mission, a weaker commitment to investors—especially in responding to their short-term demands—and a higher value on employees and culture. In looking upon their company’s governance, these executives put values at the forefront, with a shared sense of social responsibility that calls for incorporating the interests of all the firm’s stakeholders. The role of family-promoted business groups is particularly distinctive. Those who lead them combine the roles of primary owner, company leader, and prominent citizen, and their firms and their social outreach have served as models for new companies and aspiring leaders.

We can see here an important source of two principal practices of the India Way: the focus on broad mission and purpose, and the holistic engagement with employees. With a greater relative emphasis on values-based governance, Indian business leaders have been less constrained by investor insistence on steadily increasing shareholder value. Greater executive attention thus can be devoted to their company’s contributions to the community and the country, not just their investor returns, and to building their workforce, not just cutting labor costs.

Encouraged by both international investors and the Securities and Exchange Board of India, many Indian firms in recent years have accepted the rules-based model so prevalent in the United States, and with good and practical cause. An early-2000s study found that development financial institutions lent more and mutual funds invested more in companies well governed by SEBI standards.³¹ Yet at the same time, these firms have also embraced the values-based model that has emerged indigenously within India. As the case of Infosys Technologies shows, the two models are not mutually exclusive and indeed should be seen as compatible.

To be sure, adopting the values-based approach without the accompanying discipline of a rules-based model runs the risk of improper management exploitation of shareholders other than the founding family or the primary owner—the temptation, say, to “tunnel,” or transfer cash among companies to prop up a languishing firm within a business group. As in the U.S. and other economies, Indian business can make no claim to being malfeasance-free. But the leaders interviewed for this project make a persuasive case for viewing good corporate governance as a healthy balance of rules-based and values-based principles—a model of India’s own making.