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Wednesday, December 08, 2021

Business case for governance

A balance can be found — between demands of shareholders and interests of society.

Written by Vikram S Mehta |
Updated: December 2, 2019 10:20:08 am
Good governance, corporate governance, CSR, social responsibility, cororate social responsibility, indian express The chant of ‘good governance’ is fundamentally hypocritical, it is suggested.

Good governance is a chant heard in every boardroom and management discussion. The phrase has not been precisely defined. It is varyingly interpreted but common to all interpretations is the understanding that it means transparent, fair and ethical corporate behaviour, the full and accurate disclosure of financial and operational information and the adherence to the letter and spirit of the law. People start arguing when the somewhat nebulous concept of “social responsibility” is added to the chant. It then falls upon corporate management to define this phrase and to find a pathway that balances the demands of the shareholders for maximum dividends and capital appreciation with the pressures to contribute to societal welfare. The search for this pathway is what has prompted this article.

The benefits of “good governance”, however imprecisely defined, has been quantifiably established. The “Reputation Institute”, an NGO, estimates that intangibles like reputation make up approximately 81 per cent of a company’s value and a “strong reputation yields 2.5 times better stock market performance” compared to the overall market. One could debate the methodologies behind these calculations but the central message is indubitable. Well-governed companies have easier access to capital, they pay lower interest rates, secure better credit terms and attract the best and brightest of talent. Good governance is good business.

The message is further reinforced by the anecdotal evidence of the prohibitive costs of “poor governance”. The whistleblower allegation of a breach in the disclosure of financial data by the management of Infosys is a case in point. The market cap of the company dropped by about Rs 50,000 crore in one trading session. The twists and turns of the IPO of the Saudi government-owned oil and gas company Aramco is another example. The Saudis had valued their company at around $2 trillion. Their financial advisers, however, came back after testing the market with a valuation of $1-1.2 trillion. They told the Saudis that the discount was, inter alia, because of perceptions of opacity in the Saudi governance structure. The Crown Prince of Saudi Arabia was not pleased and decided to pull back the IPO from the European and US markets.

Few question the business case for good governance. But many wonder how exactly it can be delivered. How, it is asked, can management be motivated to balance the interests of the shareholder with that of society when the incentive structure is skewed disproportionately in favour of short-term financial performance? The chant of “good governance” is fundamentally hypocritical, it is suggested. And will remain so until a process is engendered to create a balanced incentive structure that motivates the generation of financial returns through societal welfare than the current structure that regards one as a trade off for the other.

There is no one size fits all response to this conundrum but a tale from 6,000 years ago may offer guideposts for stakeholders of governance to initiate such a process. Gilgamesh was the king of the Sumerian town of Uruk in 4,200 BC. He was a courageous leader and a builder. He had created, by all accounts, a remarkable city with wide boulevards, open spaces and excellent public facilities. He was, however, an unabashed tyrant. No one was safe from his roving eyes. He treated the citizens of Uruk as his personal chattel and trampled on their rights like a wild bull. In despair, the people appealed to Anu, the principal deity of the Sumerian pantheon. The goddess responded by creating an exact double of Gilgamesh. His name was Enkidu. He was Gilgamesh’s equal in every respect — strength, vision and character. They fought and whilst Gilgamesh did eventually prevail, it was not before Enkidu had checked his worst excesses and secured his agreement to work together to restore peace and harmony to Uruk. Thereafter, the two cooperated and collaborated as partners.

In the context of corporate governance, this epic contains two messages. One, to get otherwise competing forces to work together, all parties must converge on the same page and have comparable powers and authority to check and balance each other into collaboration and cooperation. And two, a new world (“peace in Uruk” or “ balanced incentive” structures) cannot be created as an event. It is a process. All stakeholders must appreciate they are on a journey and they will reach their destination only if they learn to work together despite their differences.

These two messages should be internalised by the four divergent and often competing stakeholders that bear on corporate India. One, the management, which is the custodian of operational performance. It is driven, understandably, by the objectives of short-term financial metrics. Two, the independent directors (ID) who have a fiduciary obligation towards the minority shareholder as well as a strategic responsibility to facilitate long-term growth and profitability. Three, the regulator whose role is to prescribe the rules and procedures of governance and to enforce them through broad-based juridical authority. And finally, the government, which is the law maker and, more pertinently in the context of governance, the agency for bringing corporates into the developmental net.

Currently, each of these stakeholders chant the same mantra of “good governance” but they operate autonomously within their own spheres. There is no formal forum that brings them together. The management and the IDs do, of course, face each other at the quarterly board meetings, but the interface is constrained by the board agenda and time. The Gilgamesh solution would recommend that these spheres be perforated. It would posit that, squeezed between the demands of the shareholder, on one side, and the expectations of society on the other, there is a passageway that balances the interests of the shareholder and society. And that the four stakeholders should find this space and move into it as co-equal and collaborative partners. They will not find it easy given their differences but if they did so, they could eventually flip the current zero-sum dilemma of governance into a positive sum outcome of balanced incentives.

The writer is chairman and senior fellow, Brookings India

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