The Fundamentals of Corporate Governance

The role of corporate governance is to ensure long-term viability, to steward the company to fulfil its potential while adhering to high ethical standards.

THE Satyam issue is a good opportunity to harvest rich insights into the fundamentals of corporate governance. In discussions on governance, one question that doesn’t normally get the attention it merits is: on whose behalf is the company governed? Whose company is it, really? 
    

The top-of-the-mind response is that a company is governed on behalf of the shareholders. 
    

The course of events at Satyam throws up enough doubts about this answer. First, there has been such a massive dumping of shares and change of ownership, that only a small percentage of those who held Satyam shares in November are shareholders today. Second, it would be incorrect to think the government appointed an independent board only to protect the interests of shareholders, most of whom have bought shares relatively recently at a throw-away price. Among the various stakeholders of any company, the shareholders tend to be the least loyal — selling their holdings at the first sign of trouble. It would be more appropriate to view shareholders as suppliers of money and liquidity rather than as owners. It is clear that the company is not governed only for the benefit of the shareholders. 
    

Is the company then governed on behalf of the employees? Protecting the jobs and interests of the 53,000 employees at Satyam was clearly one driver for the quick government intervention. However, providing employment cannot be the primary purpose of any organisation. As an example, suppose half of Satyam’s customers decide to cancel their contracts, will the Satyam board still continue employing all the staff? So the company is not governed on behalf of its employees. How about the customers? Satyam has an impressive roster of international customers. The need to continue servicing large international clients as well as protect India’s IT reputation must have played a role in the government’s decision to act fast. Just as with employees, it is possible to build a case that a company does not exist purely for the benefit of the customers. 
    

Whose company is it then? One view that has taken root of late is the concept of a stakeholder — a term encompassing the shareholders, customers, employees, suppliers and the society at large. It could be argued that the company is governed on behalf of all stakeholders. While this idea holds some appeal, it fails on two counts. First, what happens if the interests of various stakeholders are in conflict? Second, there is a constant churn of shareholders, employees, customers and suppliers. The nature of the company’s business constantly changes —requiring new employees as well as servicing new customers. When the composition of stakeholders is constantly evolving, how do the ‘governors’ actually decide the best interest of each of these stakeholders? 
    

The only idea that appeals to me is that the company does not really belong to anyone. You govern the company for the company’s own benefit. This is justified based on a pure statutory position that the company is a distinct legal entity, independent of any shareholder or any other stakeholder (a principle established by the House of Lords in the famous case of Solomon vs Solomon & Companyin 1897). 
    

Arie de Geus in his book The Living Company takes this idea further. He is of the view that the only powerful way of looking at a company is as a ‘living organism’, an organism with its own destiny much the same as any living person. The role of governance, then, is one of stewarding the company to achieve its full potential. This is quite similar to a parent guiding and shaping his or her children to be the best they can be in their chosen field of endeavour. 
    

Borrowing these powerful ideas, the answer to the question ‘Whose company is it anyway’ is: no one’s. A company is a unique and distinct individual with its own DNA and destiny. The role of governance, according to me, is three-fold: 

• Ensuring the long-term health and viability of the company; 

• Stewarding the company to fulfil its potential and to become as great as it can be; and 

• Adherence to the highest standards of ethics, statutory compliance and social responsibility 
    

Governments function effectively by distributing power. Most evolved democracies distribute power between the legislature, the executive and the judiciary. Further, an independent press (the fourth estate) is critical to keep these institutions honest and functioning effectively. While this may impair speed and efficiency, it seems to be the most effective mechanism for running countries thus far. 
    

So what are the parallels to corporate governance? In the case of Satyam, there was an undue concentration of power with the founders, disproportionate to their low shareholding. The board was far less independent than required. The core issue, clearly, is balance of power. While individual leadership is a key ingredient of success, visionary leaders know how to enrol a larger team, not just within the company but also in the form of independent board members and advisors, to distribute power and empower their companies to grow independent of themselves. They understand institutions can be built only if they become more important than their leaders. How then do we achieve balance of power within a corporate context? I see a clear parallel between the pillars of government — the legislature, executive and judiciary — and their corporate equivalents for good governance. 
    

The board of the company is, in effect, the legislature. The board’s primary responsibility is to steward the company to achieve its full potential. While, in theory, the board is elected by the shareholders, its job goes beyond catering to only the shareholders. The board balances the needs of the shareholders, employees, customers, vendors and partners, and society at large. This is similar to our expectation of an elected representative, say an MP. While the MP may have been elected from a specific constituency and a specific party, his responsibility goes beyond those constituencies to the country as a whole. Just as the legislature makes laws to govern a country and its people, the board lays down policies that govern the way the company is run. 
    

The management of the company is obviously the executive branch, similar in role and function to that arm of the government. Working under the broad policy, vision and direction of the board, the management team is accountable for meeting the mutually agreed upon goals and objectives, in line with the ethics and values of the company. While the legislature has a more broad-based structure ideal for policy making, the management team has to be more hierarchical and result-focused to ensure efficient execution. It is this separation that helps a company cater to the larger good while retaining execution disciplines. 
    

The role of the judiciary is to interpret the laws laid down by the legislature and apply them to specific disputes. Currently this function is discharged by the board itself on internal company issues, and by the regulatory bodies and the courts when they relate to the laws of the land. As an example, if the company has disputes relating to income tax, the appellate authorities and the tribunals form the first level of judiciary, with the high courts and Supreme Court stepping in if the issues cannot be resolved. In my view, the judicial role of the board is not as welldeveloped and is often at the root of many corporate governance failures. One possible approach is to strengthen the corporate governance committee and ensure its charter includes a systematic review of company performance on all fronts across stakeholders. Given the size and complexities of today’s corporations, it may even be worthwhile, under the relevant legislation, to turn over the judicial role of the board to another body — the judicial board. 
    

The governance committee can play the role of an independent press by taking a proactive approach in seeking stakeholder feedback, facilitated by external agencies. This goes beyond the whistleblower policies envisaged by today’s governance guidelines. 
    

The Satyam episode has allowed us to look at the fundamental aspects of corporate governance: on whose behalf the company is governed, and how we can distribute power to ensure the longevity and effectiveness of the institution. 

Source: The Economic Times, Mumbai, 16/03/09