The Hindu Business Line : Directors should reflect on their roles

Thanks to the Satyam fraud, the current state of corporate governance has taken all the beating it can get. ‘How could the directors let this happen?’ is a justifiable reaction, even if we are talking about acts of omission, and not commission. But let us not forget one important fact: If the CEO or a junior clerk wants to fraud an organisation, there is no amount of rules that would prevent it from happening. After all, the world is full of fraudsters who thin k they have an infallible scheme. Many do get caught. Rules and principles never stopped them from trying.

The way corporations are presently structured, the owners (shareholders) have delegated their power and authority to the board. So let us look at the three roles the directors are expected to play.

Three roles for directors

Directors have a control role, which requires them to oversee the running of the company and to ensure it works to the benefit of the shareholders. This role derives its authority from agency theory which explains that the mangers are primarily agents of the shareholders, and thus the directors have a job to ensure that there is no deviation in the interests of the shareholders and that of the managers.

The directors have a service role, derived from stakeholder theory, which suggests that the directors need to interface between the organisation and the various constituencies who are its stakeholders. Finally, the directors have a strategy role, derived from institutional theory, to safeguard the long term interests of the corporation.

In the light of these roles, the governance problem at Satyam is no different from what happened collectively at all the financial institutions in America that continue to be in deep trouble. The same questions are being asked, as to how such highly paid and reputed individuals at Citigroup, Merrill Lynch, Morgan Stanley, and so on could allow investments in sub-prime mortgages and dodgy securities drown their institutions. The simple answer is that the directors individually and collectively failed in their control and strategy roles.

Satyam directors accepted statements that were placed before them because the statements had the signatures of the senior executives. What could they have done differently? If the Satyam directors had the habit of occasionally picking up the phones and talking to senior accounting executives within the organisation, they may have picked up the news that some of the executives had been asked to keep away from some accounts.

This would certainly have sent the directors a warning that something unusual was going on, which they could have probed further or quit if they did not get reasonable replies. If the directors of the big named institutions in the US had wondered about where the corporate profits were coming from they would have fulfilled their strategy roles and have warned management to toe a more reasonable line.

Question of compensation

A lot of focus is on the non-executive directors as being watchdogs in the enterprise. Those non-executive directors who do not take the initiative or an active interest in the organisations on whose boards they serve do it for various reasons that are as old as time. They are friends with the CEO and so do not want to ask hard questions. In a Satyam-type situation where the Chairman/CEO is also the founder, directors would also be suitably overawed and believe that the boss can do no wrong. The excuse that they are busy holding executive positions elsewhere does not hold water since they, after all, are being compensated for serving.

When that compensation goes beyond what would be ‘normal’ remuneration as a director, it gives us another reason why they may not want to rock the boat. One non-executive Satyam director had earned Rs 87 lakh in a consulting contract with the company (and was not listed as ‘independent’ because he had a material relationship and did not meet NYSE standards), apart from his ‘commission and sitting fees’ of over Rs 12 lakh.

A director of Citigroup was drawing $115 million (Rs 575 crore) even ‘without operating responsibilities.’ Can we really expect such individuals to perform the control and strategy roles diligently without letting personal motives colour their views? Directors of these failed governance examples are now quietly slinking away giving various excuses. Among the changes to corporate governance that would help will be those that make directors more accountable directly to the owners. It must be made easier for shareholders to directly nominate individuals for election as directors, submit resolutions, and vote on director and senior management compensation. Let’s not forget that institutional shareholders beating down the price of Satyam stock on the announcement of their unrelated diversification is what made this whole ball of wool unravel.

But that, in itself, puts another wrinkle on corporate governance. With institutions as dominant shareholders of many corporations, how can we expect them to take a long-term view of the company? Aren’t they only interested in short-term stock gains? That further stresses the critical role of the directors in guiding the strategy of the enterprise while negotiating between competing interests.

Right moves by new board

Satyam has a new board, and we need to be hopeful of what they will do. They have been making the right moves of meeting with clients and employees to assure them of actions being taken to safeguard the continued working of the company. Their service role requires them to pay attention to important stakeholders, the hardworking employees who continue to deliver on the company’s commitment to their clients.

But my heart did sink when the new directors said they would leave the choice of the new Chairman to the central government. Why are they behaving like state Congress Committees who routinely leave the selection of the chief minister to the ‘High Command?’ It is to the credit of Mr Gupta, Minister of Corporate Affairs, who pushed the decision back and said it is up to the board to decide who they want as Chairman. So, instead of a set of directors nodding and agreeing to the CEO, are we going to have directors who nod and agree to the Centre? Director independence and credibility is still a long way away!

(The author is professor of international business and strategic management at Suffolk University, Boston, US. blfeedback@thehindu.co.in)

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