Shareholder Activism Article

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CORPORATE GOVERNANCE

THE CHARTERED ACCOUNTANT october 201211 2 www.icai.org

Should Shareholder Activism in

India Be A Mere Reality or AbsoluteNecessity?

The world is a dangerous place, not because of those

who do evil, but because of those who look on and do

nothing- Albert Einstein

How Did the Concept Evolve?With the growth of Indian economy at a decent

pace, the issues relating to corporate governance andaccountability are becoming increasingly important.Gone are the days when shareholders (minority in

particular) were mostly content with receiving regular

What shareholder activism really means is, a revolutionary action for exercising their

democratic right to effect social, environmental and corporate change and to build better,more sustainable business which in turn help the corporations become better governedbusiness overall. There are numerous weapons in the activist armoury that empower thestakeholders to involve themselves in setting the situation right, whenever they are of theview that the company in which their nancial and physical capital are invested is beingmanaged in an unethical/inefcient/ irresponsible manner and that may endanger safety oftheir investment and risk their personal reputation and respect. Unlike in the western world,where there is strong shareholder activism, the concept that was enjoying its infancy forseveral decades, seems to be growing from baby steps to youthful strides in India. This articlediscusses different aspects of shareholder activism in India. Read on to know more

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CA. H. Ghosh

(The author is a memberof the ICAI, workingas Joint Director in theInstitute. He can be

reached as [email protected])


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THE CHARTERED ACCOUNTANT october 2012 11 3www.icai.org

return (interim/nal dividend) on their investment

and having convenient exit option of realising theircapital along with comparable appreciation. Simply,with provision of those two facilities cum exibilities,

they seldom bothered about the FAT (Fairness,Accountability and Transparency) factors of corporategovernance and were hardly interested to know howtheir company was functioning or controlled by whomand what pragmatic measures need to be adoptedto safeguard their investment at least to ensure itsconsistent return and to protect the company from

probable failures due to bad management.Now, they are more concerned about investment

security and corporate sustainability with specialemphasis on certain fundamentals such as, safety and

reliability of products that their company produces,prot (not how much but how such) maximisation

and market capitalisation, social and environmentalcare, faster and better movement of their companyto achieve global recognition, strategic managementto reduce risk, broadening of brand value and image

building, improving corporate culture and employeeloyalty with respect to human rights and importantlyenhancing effectiveness of enterprise governance.

In fact, with the aid of regulatory power providedby laws of the land, the shareholders, be it singly orcollectively, can now assert their democratic right

by challenging the board decision, demanding pollon a resolution or calling extraordinary generalmeetings to resolve issues whenever they come acrossirregularity or inconsistency in the functioning patternof the company or the management falls short of theirexpectation. Exercise of such articulated action opento the shareholders, in short, refers to shareholderactivism. Ideally such right should be exercisedresponsibly, putting aside their ego and bearing inmind the best interest of the shareholders, stakeholders,employees, environment and the community at large.

At the heart of shareholder activism is the quest for

value, yet the empirical evidence suggests that effectsof such activism are mixed.

How Far the Concept of Shareholder Activism is

Organised in India?Unlike in the western world, where there is strongshareholder activism, the concept that was enjoyingits infancy for several decades, seems to be growingfrom baby steps to youthful strides in India. The proxyadvisors, in those countries, offer proxy advisory andsolicitation services that may enhance effectivenessof activist coalitions campaign. Active investors areclearly inuenced by the recommendations issued

by such advisors to vote for or against a proposal. Inparticular, their recommendations encourage passiveshareholders to vote in favour of proposals put forward

by an activist coalition. In that line, the (two) proxyadvisory rms like In-Govern and Institutional Investors

Advisory Services (IIAS) are aiding the developmentof the (shareholder activism) idea for improvement incorporate governance practices in India.

There are several instances of shareholder activismin India. In the wake of consistent strike at its ManesarPlant, the worried investors of Maruti Suzuki dared totake the step of talking directly to the representativesof workers unions while its stock price slipped to 52week low. At the behest of the minority shareholders,

the Crompton Greaves had to give a commitmenttowards selling a R270 crore jet that it bought duringthe period of disappointing prot to an unlisted group

company. While the state owned institutional investor,LIC, increased its investment up to R3,500 crore invarious tobacco companies, an NGO, working forcancer patients, raised its voice and questioned overthe ethics and irony of such acts and the investor wasat the receiving end.

What is Share (Stake) holder Activism All About?Shareholder activism (in fact, shareholderengagement), in short, refers to exerting articulated

pressure by exercising democratic power provided tothe shareholders as owner/monitors of the companyto inuence its behaviour. The active participation of

shareholders in their companys operations can ensurebetter management, less frauds, superior performanceand improved corporate governance. By virtue ofcorporate democratic rights provided to them, theshareholders can raise concerns over economic,environmental even social issues in the annual or othergeneral meetings. Shareholder activists generally

include public institutional funds, unions, religious

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In India, there are primarily four avenues which

ensure that debt holders and equity holders can

exercise exit or voice opinions to make company

management accountable. These include the

Companies Act 1956; the SEBI Act 1992, and various

regulations prescribed by the SEBI; a market for

corporate control and active participation by

fnancial institutions and institutional investors.


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institutions, universities, foundations, environmentalactivists and human right groups. Shareholder activismcan be exercised through proxy battles, publicitycampaigns, shareholder resolutions, litigation and

negotiations with management.

What are the Possible Ways to Make It WorkEffectively?With the support of legal and institutional framework,the enlightened shareholders have pursued a muchexpanded and increasingly sophisticated series oftactics in their effort to monitor the corporations, inwhich they have invested, including everything from

public lobbying to quiet, rigorous, behind the scenenegotiations. In fact, the traditional board centricmodel of corporate governance now seems insufcient

and tends to gravitate toward a paradigm that includesan increased role for shareholders. Shareholders nowhave greater access to proxy voting process. They cannominate dissident board candidates along with theselected management nominees. Active investors mayseek or avail services of proxy advisory professionalsand can vote for or against a proposal. And they cancommunicate among themselves. In short, shareholdersnow have a greatly enhanced opportunity to involvethemselves in company operations.

Regulatory Options for Stakeholders to MakeManagement Accountable?The main objective of the Companies Act is to ensurethat the interests of the creditors and shareholdersare adequately protected and that the shareholdersare adequately represented in the management of acompany. Since the day to day business of a companyis controlled by the board of directors, it is, therefore,important that corporate boards can inuence how

well a company is run and functions. Enlightenedshareholders, supported by a legal or institutionalframework, can provide the necessary bulwark against

discretionary behaviour of management. In India,there are primarily four avenues which ensure that debtholders and equity holders can exercise exit or voiceopinions to make company management accountable.

These are the Companies Act 1956; the SEBI Act1992, and various regulations prescribed by the SEBI;a market for corporate control (in the post economicreform scenario, regulation for substantial acquisitionof shares ensures transparency in operations, equity anddisclosure of material information to parties concerned)and active participation by nancial institutions and

institutional investors. There are rules that allowminority shareholders to take certain remedial actionif they believe that they are being oppressed by themajority shareholders, and the company is indulging inmanagement of resources in a way that causes prejudiceto the interest of the company and the public.

Is shareholder activism controversial?Those who favour the concept argue that companieswith active and engaged shareholders are more likelyto be successful in the long term; yet many reformerswho are uncomfortable with this decentralised, marketdriven change, argue that pluralistic change is divisiveand disruptive to corporations, boards, and eveninvestors. They propose instead a peaceful solutionthat imposes a rigid process, vests power in a few

arbitrary hands, and shuts down the opportunity fordebate, contention and argument. Though, no changeat all is better than the wrong kind of change, we needto promote this decentralised, market driven approachand ght those who would replace democracy with

bureaucracy.

How does Shareholder Activism work in France?In general, Shareholder Activism in France is a multi-stage process, which only in certain circumstancesis escalated to the most hostile stage. The stages areillustrated below. Target Selection: The rst stage involves target

selection from a portfolio of rms. The choice of a

target could be driven by a number of considerationsrelating to underperformance, governance, socialor environmental issues.

Private Engagement: The second stage, known asbehind the scenes or Private engagement activismconsists of collaborative informal communicationactivities (e.g., Private meeting with CEO and theChairman or meeting with board members.)

Public Engagement: In contrast, the third stage

becomes confrontational as a result of the refusal

The market for shareholder activism in India is at

a nascent stage. There are no large shareholders

associations that can monitor and exercise control

over corporations. The central problem in Indian

corporate governance is not a conict between

management and owners as in the US and the UK, but

a conict between the dominant shareholders and

the minority shareholders.

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THE CHARTERED ACCOUNTANT october 2012 11 5www.icai.org

by the target management to accommodate thechanges sought by the activists. This stage refersto proxy voting process to support a shareholder

proposal or to contest a management proposal at the

shareholder meeting. It may also be characterisedby activities such as media coverage, lobbyinginitiatives, and a proxy battle.

Hostility: Finally, the fourth stage is characterisedby the most hostile degree of activism and cantake the form of a publicised exit by a dissatised

shareholder, a takeover attempt, and/or a lawsuit.There are documented positive correlations

between legal actions and calls for ExtraordinaryGeneral Meetings (EGMs) of shareholders. In

particular, when executive remuneration is theissue, shareholder activism appears to be mostexpressed through AGMs, through the courts or byling a complaint with the authority appropriate.

A recent (TCI) case on shareholder activism related to CILdispute may attract wider corporate governance issuesand if not resolved deftly, may call for involvement ofthe UN Trade CommissionOne of the partners at The Childrens Investment FundManagement, TCI, remarked- We have a strongrecord of activism in many countries and just because

no one has done this in India before doesnt mean its

not going to work. Importantly, TCI that holds nearlytwo percent of the Coal India Ltd. (CIL) share, largestholding after the Government of India, has commencedlegal action after its repeated attempts to engage withCIL and the Government had failed. Certain concernssuch as, Government involvement in the pricing ofcoal (CIL sells much of its coal under fuel supplyagreements at up to 70% discount to market rates),contravention of two international agreements for the

promotion and protection of investment, failure on thepart of CIL Board to stand up for the interests of the

company and protecting the interest of the minority

shareholders leading to breach of duciary duties,lack of leadership at CIL since IPO are the few tomention that TCI has alleged. That partner even wenton saying- The implications are huge and potentiallyvery detrimental to India if they dont follow through

in a sensible fashion. If they choose to list a company

they have to treat minority shareholders with respect.The instant impact of those allegations is that theindependent directors of CIL opposed Fuel SupplyAgreements (FSAs) with nearly 50 power units and

perhaps the Coal Ministry of the Government has nobetter option than to suspend signing any such FSAsin March 2012.

Why Shareholder Activism in India is Not GainingPopularity?The market for shareholder activism in India is ata nascent stage. There are no large shareholdersassociations that can monitor and exercise control overcorporations. The central problem in Indian corporategovernance is not a conict between management

and owners as in the US and the UK, but a conict

between the dominant shareholders and the minority

shareholders. The board cannot even in theory resolvethis conict. But, how can one, even in theory, envisage

a board that can discipline the dominant shareholdersfrom whom the board derives all its powers? Inreality, the problem of dominant shareholders arisesin three large categories of Indian companies. First,are the Public Sector Undertakings (PSUs) wherethe Government is the dominant (in fact, majority)shareholders and the general public holds a minoritystake (often as little as 20%). Second, are the Multi

National Companies (MNCs) where the foreign parentis dominant (in most cases majority) shareholders.Third, are the Indian business group where the

With a view to strengthening control mechanism,

improving the governance standard and protecting

the interest of investors and minority shareholders,

in particular, the Companies bill prescribed a lot of

new provisions. These include introduction of the

concept of corporate social responsibility; proposal

of provisions in respect of vigil mechanism (whistle

blowing); introduction of the concept of independent

directors, etc.

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promoters (together with their friends and relatives)are the dominant shareholders with large minoritystakes, Government owned nancial institutions hold

a comparable stake and the balance is held by the

general public.That apart, there is a lack of active long term

investors such as pension and hedge fund institutions;in comparison as in India, investors usually setsight on short term gains. The Indian market holdsthe history of limited institutional ownership with

promoters including Government holding majoritystakes followed by retail investors and institutions.Moreover, India suffers from a problem of too manyregulations. Investors have little faith in the system ashigh litigation cost is involved; manipulative ways areadopted by the promoters sometimes, which makes ittough for activist shareholders to survive.

What are the Ways Forward?With a view to strengthening control mechanism,improving the governance standard and protectingthe interest of investors and minority shareholders, in

particular, the Companies bill prescribed a lot of newprovisions and a few are cited below.

Concept of corporate social responsibility isbeing introduced

Provisions in respect of vigil mechanism

(whistle blowing) proposed Concept of independent directors introduced In addition to Audit Committee, various

committees like Nomination and RemunerationCommittee and CSR Committee have been

prescribed Exit option to shareholders in case of dissent

to change in object for which public issue wasmade

Specic disclosure regarding effect of merger

on creditors, key managerial personnel,promoters and non-promoter shareholders isprovided

The Tribunal is being empowered to providefor exit offer to dissenting shareholders in caseof compromise or arrangement

Valuation by registered valuers mandatory forcertain actions like issue of shares to personsother than existing shareholders, acquisition/selling of assets on non-cash considerationsto Directors/persons related to Directors,valuation at the time of merger/amalgamation,

purchase of shares held by minority

shareholders by majority shareholders

Acceptance of deposits from public subject toa more stringent regime

Central Government to have power to prescribeclass or classes of companies which shall not

be permitted to allow use of proxies Provisions that a person shall have proxies

for such number of members/ such number ofshares as may be prescribed

Provision for class action suits to provideminimum number of persons who may applyfor such suits and safeguards against misuse ofthese provisions

Right of an investor to claim to continue

even after transfer of the amount to InvestorEducation and Protection Fund (IEPF)

Statutory status to Serious fraud InvestigationOfce proposed

ConclusionThe shareholder activism, in its softest form, should

be of prescribing suggestions on strategic issueswherever really needed to ensure sustainable successof a publicly traded company. Since shareholderactivism is a situation specic action, there cannot be

one size fts all formula. In fact, there are numerousweapons in the activist armoury with diverse powers;its application therefore, should be invoked wisely to

bring about the social and cultural change peacefully,leading to satisfaction of all stakeholders. Finally, letthe share (stake) holders use that democratic power inright spirit for better governance of corporations. Letus conclude by remembering the words of wisdomof the Comptroller and Auditor General of India, MrVinod Rai, No business can be sustainable unlessbased on probity and integrity. do not succumb to

the temptation of short term gainsnothing wrong will

go unnoticed for long.

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