Corporate Governance And Shareholder Activism In India.

Abstract

This paper discusses corporate governance and shareholder activism in India, highlighting the Companies Act, 2013, and the SEBI regulations’ impact on promoting good governance practices and protecting the shareholders’ interests. The paper examines future directions in corporate governance, including greater regulation, expanded shareholder rights, and a focus on sustainability considerations, and the role of institutional investors in promoting good governance. The paper emphasizes the need for companies to prioritize corporate governance and stakeholder rights to ensure long-term sustainability and competitiveness and build trust among investors. Finally, the paper concludes that effective corporate governance practices and shareholder activism are essential in promoting transparency, accountability, and responsible investing principles to foster a culture of good governance in India.

List Of Statues And Case Laws

  1. Cyrus Investments Pvt Ltd & Anr. v. Tata Sons Ltd. & Ors.
  2. Vishal Sikka vs NR Narayana Murthy
  3. Larsen & Toubro Limited v. Mindtree Limited

Obective

The objective of this research paper is to analyze the relationship between corporate governance and shareholder activism in India. It aims to examine how effective and efficient corporate governance practices play a key role in reducing the likelihood of shareholder activism, and how this activism can serve as a mechanism for improving corporate accountability. The paper also aims to identify the best practices to balance the interests of shareholders and other stakeholders, that can contribute to long-term success of a company.

Scope

This research paper will focus on the following aspects:

  1. Overview of the Indian corporate governance framework and the Companies Act, 2013.
  2. The role of the board of directors in corporate governance and their impact on shareholder activism.
  3. The significance of shareholder activism in providing checks and balances against the management.
  4. The various types of shareholder activism, such as proxy contests, shareholder resolutions, and litigation.
  5. The benefits and limitations of shareholder activism in improving corporate governance practices.
  6. Best practices in corporate governance that can reduce the likelihood of shareholder activism.
  7. Challenges and future directions for corporate governance and shareholder activism in India.

Introduction

Corporate governance refers to the set of rules, practices, and processes by which a company is directed and controlled. It involves balancing the interests of various stakeholders, such as shareholders, management, customers, suppliers, financiers, government, and the community. Shareholder activism, on the other hand, refers to the actions of a shareholder or a group of shareholders who use their ownership position to influence the management or the board of directors of a company. A corporate form of business is a legal entity that is created by filing articles of incorporation with the government. This legal entity is separate from its owners and is entitled to certain rights and obligations. The corporate form of business provides several advantages to the owners, such as limited liability, perpetual existence, and ease of raising capital. In India, a company can be formed either as a public company or a private company. A public company is a company that offers its securities (shares and debentures) to the public and is required to comply with various regulatory requirements, such as the Companies Act, 2013, and the Securities and Exchange Board of India (SEBI) regulations. A private company, on the other hand, is a company that restricts the transferability of its shares and limits the number of its members. In India, a corporate form of business can be formed by fulfilling the following essential requirements:

  1. Directors: A minimum of two directors are required for a private company, and at least three directors are required for a public company. In case the resolution is taken that the contracts or the transaction will not be sanctioned then the contracts remains voidable at the instance of the Board of the Directors and the authorized signatory or the Director who entered into the transaction will stand personal indemnifier to the company.
  1. Shareholders: A minimum of two shareholders are required for a private company, and there is no minimum requirement for public companies. The maximum number of shareholders in a private company is limited to fifty.
  2. Name Reservation: A name reservation request must be made with the Ministry of Corporate Affairs (MCA) for approval. The name should be unique, and it should not conflict with any existing trademarks or corporate names.
  1. Memorandum of Association (MOA): MOA is a legal document that sets out the objects and scope of the company’s business activities. It also defines the powers and liabilities of the company’s shareholders and directors.
  1. Articles of Association (AOA): AOA is a document that outlines the rules and regulations for the internal management of the company. It defines the rights, duties, and responsibilities of the company’s shareholders and directors.
  1. Registered Office: The company must have a registered office in India to carry out its business operations. The registered office address must be provided during the incorporation process.
  1. Digital Signature Certificate (DSC): The directors must obtain digital signature certificates issued by the Certifying Authorities (CAs) to sign the electronic documents during the incorporation process.
  2. Director Identification Number (DIN): The directors must obtain DIN from the MCA by filing an e-form along with the required documents.
  3. Permanent Account Number (PAN) and Tax Deduction and Collection Account Number (TAN): PAN and TAN are required to file the income tax return and to pay taxes on behalf of the company.

Once all the necessary documents and requirements are fulfilled, the Registrar of Companies (ROC) will issue a certificate of incorporation, and the company can start its business operations legally.

History Of Corporate Governance

The concept of corporate governance dates back to the early 20th century, when the first modern corporations emerged in the United States. The rise of these large corporations created a need for governance mechanisms to ensure that the interests of shareholders were protected and that the corporations were run efficiently and effectively. In the 1930s, the Securities and Exchange Commission (SEC) was established in the US to regulate securities markets and to protect investors. In the 1960s and 1970s, corporate governance gained increasing attention from academics, policymakers, and investors. The major corporate scandals and governance failures of the time, such as the collapse of the Penn Central Railroad in 1970 and the Watergate scandal in 1972, highlighted the need for better corporate governance practices. The concept of shareholder activism emerged during this time, as investors began to use their ownership rights to influence the management of corporations. In the 1980s and 1990s, the corporate governance movement gained momentum, as a result of increasing globalization and the rise of institutional investors. International organizations such as the Organization for Economic Co-operation and Development (OECD) and the World Bank developed guidelines and principles for corporate governance. The Cadbury Report, published in the UK in 1992, was one of the first major reports on corporate governance, and provided guidelines for the UK companies to follow. In India, the concept of corporate governance gained traction in the 1990s, particularly after the liberalization of the Indian economy in 1991. A number of reforms were introduced to improve the corporate governance practices in India, such as the establishment of the Securities and Exchange Board of India (SEBI), the introduction of the Companies Act, 1956, and the establishment of the Ministry of Corporate Affairs in 2004. In recent years, corporate governance has become an important issue in many countries, as a result of the growing concerns about social responsibility, sustainability, and ethical behavior. The corporate governance landscape is constantly evolving, as new challenges and opportunities emerge in the global business environment.

Corporate Governance

India’s corporate governance framework is based on a combination of legal provisions, regulations, and voluntary guidelines. The Companies Act, 2013 is the primary legislation governing the functioning of companies in India. The Act has several provisions that promote transparency, accountability, and good corporate governance practices. Some of the critical provisions of the Act are:

  • Board of Directors: Companies are required to have a board of directors consisting of a minimum number of directors, including independent directors and at least one woman director in a certain class of companies.
  • Separate roles of Chairman and CEO: The Act requires that the positions of the chairman of the board of directors and the CEO/ managing director be separate.
  • Independent directors: The Act mandates the appointment of independent directors on the board of certain classes of companies to ensure that the board functions independently and free from any conflict of interest.
  • Audit Committee: Companies are required to constitute an audit committee consisting of independent directors and provide it with adequate powers to oversee financial reporting, internal controls, risk management, and compliance.
  • Related-Party Transactions: The Act requires that related-party transactions be approved by the audit committee and requires disclosures on such transactions in the company’s financial statements.
  • Vigil Mechanism: The Act provides for the establishment of a vigil mechanism by companies to enable the reporting of concerns related to unethical behavior, fraud, etc.
  • Corporate Social Responsibility: The Act mandates that certain classes of companies have to spend a specified amount on Corporate Social Responsibility (CSR) activities, and report on their CSR activities.
  • MCA-21: An online portal mandated by the Ministry of Corporate Affairs of the Government of India, for electronic filing of compliance documents.

India’s corporate governance framework has been further strengthened by various regulations issued by the Securities and Exchange Board of India (SEBI). These regulations impose several obligations on listed companies, such as disclosures, the composition of the board of directors, appointment of independent directors, etc. The board of directors plays a crucial role in promoting good corporate governance practices and protecting the interests of shareholders. The board is responsible for the overall management and strategic direction of the company, while also ensuring accountability and transparency in its operations. The primary functions of the board of directors include:

  1. Oversight: The board is responsible for ensuring that the management of the company is robust, ethical, and in compliance with laws and regulations.
  2. Strategy: The board is responsible for formulating the long-term strategic direction of the company, approving annual budgets, and monitoring the performance of the company.
  3. Risk Management: The board is responsible for identifying and evaluating potential risks that the company may face and implementing strategies to mitigate them.
  4. Appointment and Compensation: The board is responsible for appointing the CEO and senior management, and determining their compensation in line with company performance.
  5. Shareholder Engagement: The board is responsible for engaging with shareholders and addressing their concerns and queries.

An effective board of directors ensures that the company follows best practices and complies with legal and regulatory requirements. However, sometimes, shareholders may be dissatisfied with the performance of the board and may engage in shareholder activism to demand changes.

Shareholder Activism

Shareholder activism refers to the actions taken by shareholders to influence the management and operations of companies to protect their interests. Activism can take various forms, such as engaging with management, filing shareholder proposals, proxy contests, and litigation. Activist shareholders may demand changes in company policies, board composition, executive compensation, or financial performance. In recent years, shareholder activism has become more prevalent in India, particularly in listed companies. Activist shareholders are pushing for greater transparency, accountability, and better governance practices. The board of directors has a significant impact on shareholder activism, as it is responsible for ensuring that the company follows best practices and protects the interests of all stakeholders. Shareholder activism serves as an important mechanism to provide checks and balances against the management of a company. Activist shareholders seek to influence the decision-making of the company by questioning the actions of the company’s management, proposing changes to corporate strategy, and advocating for best corporate governance practices. This provides an extra layer of oversight to ensure that the management is accountable and aligned with the interests of all stakeholders. Shareholder activism can have several positive effects on the functioning of the company. Firstly, it can help to improve corporate governance practices and ensure greater transparency and accountability in the functioning of the company. This can lead to enhanced trust and confidence in the management of the company. Secondly, activist shareholders can drive improvements in the company’s financial performance by advocating for better corporate strategy, cost reductions, or changes to the management team. Lastly, shareholder activism can prevent or mitigate significant losses to shareholders by addressing risks and issues that might otherwise have gone unnoticed. Some notable instances of shareholder activism in India include:

  1. Tata Sons – Cyrus Mistry Controversy: In 2016, Cyrus Mistry was removed as the chairman of Tata Sons, which sparked a controversy and led to a legal battle. This was one of the most high-profile shareholder activism cases in India, alleging irregularities in the management of the company by the Tata Group.
  2. Infosys – NR Narayana Murthy Controversy: In 2017, NR Narayana Murthy, the co-founder of Infosys, raised concerns over governance issues, particularly the compensation paid to key executives. This resulted in a public spat between the board and Murthy, leading to the exit of key executives.
  3. L&T – Mindtree Acquisition: In 2019, L&T launched an aggressive takeover bid for Mindtree, a leading software services company. This was resisted by the founders and management of Mindtree, leading to a high-stakes battle that ended with L&T acquiring a controlling stake in the company.

These cases highlight the increasing incidence of shareholder activism in India and the significant impact this can have on corporate governance practices and decision-making within companies. Encouragement of shareholder activism can lead to better corporate governance practices leading to better value addition by companies. Shareholder activism can take various forms, and shareholders can engage in several tactics to influence the actions of the company. Some of the main types of shareholder activism are:

  1. Proxy Contests: Proxy contests occur when an activist shareholder nominates their candidates for a position on the board of directors to replace the incumbent board members. The purpose of a proxy contest is to gain control of the company or to pressure the board and the management to change their policies or strategies.
  2. Shareholder Resolutions: Shareholder resolutions are proposals submitted by shareholders at a shareholder meeting. These resolutions can cover various issues such as the appointment of independent directors, executive pay, environment, and social issues, and other corporate matters.
  3. Litigation: Shareholders can take legal action against the company or its management over issues such as violations of securities laws or breaches of fiduciary duties.
  4. Engagement with Management: Shareholders can engage with the management of the company through letters, meetings, or other types of communication to express their concerns or suggestions.
  5. Media Campaigns: Activist shareholders can use the media to publicize their concerns and issues or to put pressure on the management and board to take action.

Each of these types of shareholder activism requires different resources, strategies, and tactics. While some forms of activism are more confrontational, others are more collaborative and seek to build relationships with the company’s management. Activist shareholders can also deploy multiple tactics simultaneously to achieve their objectives. Shareholder activism can play a significant role in improving corporate governance practices, and it can have several benefits for companies and shareholders. At the same time, it also has limitations that need to be considered.

Benefits Of Shareholder Activism:

  1. Improved Corporate Governance: Shareholder activism encourages good corporate governance practices by advocating for transparency, accountability, and ethical behavior by the management and the board of directors.
  2. Increased Accountability: Shareholder activism holds the management accountable for their actions by highlighting issues of interest to shareholders and demanding improved performance and greater shareholder representation.
  3. Enhanced Shareholder Value: Activism can lead to a better alignment of interests between shareholders and management, ultimately leading to better financial performance, higher shareholder returns, and increased shareholder confidence.
  4. Preventing Corporate Scandals: Shareholder activism can help prevent corporate scandals by raising concerns about unethical or financially risky behavior by the management.

Limitations of Shareholder Activism:

  1. Short Term Focus: Activist shareholders may focus on short-term gains, which can harm the long-term health and growth prospects of the company.
  2. Costly and Time-Consuming: Activism can be costly and time-consuming for the company and the activist shareholder, leading to disruptions in the company’s operations and profitability.
  3. Distracting: Activism can be distracting for the management and board, as they may have to spend valuable time and resources responding to shareholder demands.
  4. Narrow Interests: Some forms of activism may be focused on the narrow interests of a specific group of shareholders, rather than the interests of all shareholders and other stakeholders.

Effective corporate governance practices can help reduce the likelihood of shareholder activism by promoting transparency, accountability, and good decision-making. Some of the best practices in corporate governance that can help to prevent shareholder activism are:

  1. Effective Board Composition: A board with a diverse range of skills, experience, and perspectives can ensure effective oversight and decision-making. The board should also include independent directors who can provide an objective view of the company.
  2. Regular Engagement with Shareholders: Companies should engage with their shareholders regularly and be responsive to their concerns. This can help to build trust and prevent shareholder activism.
  3. Robust Risk Management Practices: Companies should have effective risk management practices in place to identify and mitigate risks. This can help to prevent negative events or financial losses that could trigger shareholder activism.
  4. Efficient Communication with Stakeholders: Companies should have efficient and transparent communication channels with their stakeholders to ensure that they are informed about the company’s strategy, performance, and challenges. This can prevent any misinformation or rumors that can trigger shareholder activism.
  5. Strong Compliance Framework: Companies should have a strong compliance framework in place to ensure that they comply with regulatory requirements and avoid any legal issues that can lead to shareholder activism.
  6. Disclosure of Related Party Transactions: Companies should have policies in place for the identification, approval, and disclosure of related-party transactions, and such transactions should be reported in a transparent manner.
  7. Proper Management of Conflicts of Interest: Companies should manage conflicts of interest effectively, particularly with respect to the board composition and related-party transactions.
  8. Sound Corporate Social Responsibility Practices: Companies should adopt and implement sound Corporate Social Responsibility (CSR) practices to earn the trust and confidence of their stakeholders, particularly the ESG (Environmental, Social, and Governance) focused investors.

Future Of Corporate Governance And Shareholder Activism  In India

Corporate governance and shareholder activism have been areas of increasing importance in India over the past decade. The Companies Act, 2013 and the Securities and Exchange Board of India (SEBI) regulations have imposed significant obligations on companies to ensure good corporate governance practices. In the future, it is expected that the focus will shift towards greater transparency and accountability in corporate decision-making, improved oversight and monitoring of executive management, and increased involvement of minority shareholders in the decision-making process. The following are some of the potential future directions for corporate governance and shareholder activism in India:

  1. Strengthening of regulatory requirements: The government and SEBI may enforce stricter compliance requirements for companies, including more detailed and frequent disclosures, annual performance evaluations of directors, and stringent rules on related party transactions.
  2. Greater role for independent directors: The role and responsibilities of independent directors may be expanded to include more effective oversight of executive management and to improve the functioning of board committees.
  3. Enhanced shareholder rights: Minority shareholders may be granted greater voting rights, including the ability to veto key decisions or to initiate class action suits against companies that violate their rights.
  4. Institutional investor activism: Institutional investors, such as mutual funds, pension funds, and insurance companies, may become more active in promoting good corporate governance by engaging with companies on ESG matters and exercising their voting rights more robustly.
  5. Focus on sustainability: Companies may increasingly be held accountable for their social and environmental impact. This could lead to the incorporation of sustainability considerations into the corporate strategy and a greater emphasis on responsible investing.

The Indian corporate governance landscape is dynamic and continues to evolve. It is essential for companies to keep abreast of the changes and to adopt best practices to improve their governance and attract investors.

Conclusion

In conclusion, corporate governance and shareholder activism have gained significant importance in India in recent times. The Companies Act, 2013 and the SEBI regulations have introduced several measures to promote good corporate governance and ensure the protection of shareholders’ rights. With these regulations in place, Indian corporations are transitioning towards more transparent and accountable practices that lead to improved decision-making and stakeholder engagement. The corporate governance landscape in India continues to evolve, and there are likely to be further developments in the future. Greater regulation, enhanced shareholder rights, and a focus on sustainability are some of the potential areas for development. The role of institutional investors, particularly mutual funds, pension funds, and insurance companies, may also evolve, leading to more significant investor activism. In this changing landscape, companies that fail to prioritize corporate governance and stakeholder rights risk losing investors’ trust and opportunities for growth. Companies can ensure long-term sustainability and competitiveness by developing robust corporate governance structures, adopting best practices, and accommodating shareholders’ concerns. Overall, good corporate governance practices lead to better oversight, improved decision-making, and greater engagement with stakeholders. Effective shareholder activism can help achieve these objectives by promoting transparency and accountability and fostering a culture of responsible investing. By embracing these principles, Indian corporations can help build a stronger economy and enhance the country’s reputation as a business destination.

  • Security And Exchange Board of India, Amendment to the Equity Listing Agreement – Platform for E-Voting by Shareholders of Listed Entities, Circular CIR/CFD/DIL/6/2012 (Jul. 13 2012)
  • Companies Act, 2013, S.188
  • The final report of the Committee on the Financial Aspects of Corporate
  • Governance as published in December 1992, chapter 6.
  • Companies act, 2013, S. 149
  • Cyrus Investments Pvt Ltd & Anr. v. Tata Sons Ltd. & Ors.
  • Vishal Sikka vs NR Narayana Murthy
  • Larsen & Toubro Limited v. Mindtree Limited
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