My case study group at Harvard Business School had one common question for our joint lunch session. After listening to an invited lecture by a board member of a leading investment bank that almost midwifed the global financial crisis, we were confused on the inability of the combined wisdom of the entire board to see the imminent coming of a great crisis? One of my classmates at HBS questioned this in class to receive an unconvincing reply. Why is this relevant now?
Think ‘corporate scams’ and we begin to think names like Enron, WorldCom, Tyco and other erstwhile popular American corporates that gained notoriety because of their monstrous fraud. The global citizenry was shocked that such scams happened in America, which is supposed to be the role-model for buzzwords like governance, ethics, shareholder value maximisation, etc. The Sarbanes-Oxley Act (SOX) of 2002 was hence created to set foolproof standards for all US public company boards, management and public accounting firms. Did things get better?
As per the FBI’s Financial Crimes Report to the public at the end of financial year 2011, the FBI was still pursuing 726 corporate fraud cases throughout the United States, several involving losses to public investors that individually exceed $1 billion. Despite SOX and the hyped corporate governance standards the number of corporate fraud pending cases saw a 37 per cent increase in the last five years. With all types of frauds in financial institutions, securities & commodities, mortgages, healthcare, insurance, money laundering, etc, taken into account, the aggregate number of such pending cases at the end of 2011 was 10,211 as against 9,054 in 2007. The number of Suspicious Activities Report filed by federally insured financial institutions rose from 46,717 in 2007 to 93,508 in 2011. These frauds involve one or more of these: fraudulent accounting, illicit transactions, kickbacks, tax violation, reckless board-member decisions, etc. The numbers do not include already committed frauds that have been investigated and results accomplished. The FBI’s accomplishment during 2011 resulted in indictments, restitutions, recoveries, fines and forfeitures totalling a staggering $12.10 billion. This is just for the year 2011 and imagine the potential aggregate value of FBI’s 100 per cent accomplishment! Definitely good news for the starving American economy. I am not going to present the CBI’s score card in India but draw a different parallel on the blind and theoretical approach towards governance standards in India.
The appropriateness of corporate governance standards lies in the appreciation of the fundamental character of an entity. The lack of such an appreciation will only lead to painting all things black or persuasively seeing a spotless white canvas black. Travelling back in corporate history, the scams that have made huge sound and substance are from the board rooms or CEOs of listed companies that have many ‘outside experts’ as directors. The ‘skyscraperic’ trend of the scam-worm is testimony to the fact that DNA of promoter is more important than cosmetic changes in governance rules. The concerning issue is the wrongful expectations of right consequences based on faulty inferential logic. The faulty logic is that listed companies owing to SOX or equivalent governance laws are less susceptible to frauds while privately held companies which are owned by a closely held group are scam-worthy due to the lack of a ‘professional board.’ Neo-reformists’ policy decisions based on this erroneous assumption creates more harm than good to the system. The American or western corporate fabric is woven fine with stories of CEOs being hired and fired just like Indian housemaids are. A scam hit company’s CEO shamelessly resigns or is fired and the ‘professional board’ puts the blame on lack of proper governance and appoints another CEO conveniently. Will things remain the same in the Indian context if the owner was the CEO?
The Institute of Directors (IoD) conducted a detailed study in 2010 and laid out 14 corporate governance principles for unlisted companies in the UK. It also dealt on the sensitive chord of how privately held companies are uncomfortable with external members in their board. The best they would like to have as an interim step is an external advisory committee. Before maturing to induct one or two outsiders in their board to fill gaps, if any. The IoD never visualises the total transfer of control to a group of external members and definitely not when the closely held owners are highly qualified themselves. The reason from an Indian perspective is that many owners of privately held firms, whether he is a CEO or not, are prepared to sacrifice their life for the companies. A majority of the privately held companies in India is family-held and it is the family’s reputation that is at stake and promoters of family-owned corporations will fight till death to save the reputation. Will CEOs of listed companies do it? Cannot say with same certainty. That is why scams are almost non-existent in privately held companies that have an inherently high value system. Also, family-owned listed companies like Bajaj, TVS, Murugappa, Godrej, etc, have never made news for scam reasons.
Recent policy moves in critical social sectors to usurp control and power from privately held entities are disturbing. In the name of governance and standards, there is benevolent pushing of external members and Shylockian unreasonability in limiting family members on the board. There is no disagreement on the need for transparency and governance in privately held companies. However, preventing Harvard or Stanford or Oxford-educated graduates with rich knowledge and experience from being board members because they belong to the same family is an unreasonable and arbitrary exercise of power. Policy-makers should prescribe qualifications to become board members and ensure that promoters adhere to high standards of governance. The government should constantly monitor the same and take action against erring entities. It is unfortunate that protagonists of such neo-reform models are wiping out the apple farm instead of removing the rotten apples. They should be mindful of the fact that quality of governance is of paramount importance than the insignificant issue of family members being on board. In short, family members are not governance outcastes.
S Vaidhyasubramaniam, is Dean, Planning & Development, SASTRA University