Promoting Good Corporate Governance in India Through Institutional Investors' Activism: Concerns and Steps Forward

The Stewardship Code, 2019 came into effect on 1 July 2020, and has been adopted by a majority of the institutional investors in India. Institutional investors are primarily responsible for diligently investing their clients’ money to yield profits. However, stewardship responsibilities also encompass a duty of care that institutional investors must exercise towards the upkeep of the corporate governance of their investee companies. To analyse the potency of institutional investors’ activism fuelled by these responsibilities, data from the annual general meetings (AGMs) of the top 10 Nifty-50 companies, over a period of four years, is studied. Data reveals a general sense of opposition towards the (re)appointment of directors and rarely auditors. Unfortunately, the lack of uniformity, fewer shares coupled with absence from meetings, neutralises any activism. Hence, Stewardship Codes can be inferred to be mere tokenistic transplantations meant to attract foreign investors with a negligible bearing on the corporate governance regime of the Indian companies. Though the results of our study cannot be applied as it is on the entire universe (all listed public companies), we believe that this paper presents several inconvenient facts and hence can serve as a background for future research to study the overall institutional investors’ contribution towards the upkeep of the corporate governance of their investee companies.

The Codes

Twenty years ago, the Securities and Exchange Board of India (SEBI) introduced Clause 49 of the Equity Listing Agreement. These were India’s nascent steps in the development of a corporate governance regime. Despite warning from the Kumar Mangalam Birla Committee against transplanting legislations from first-world countries, Clause 49 embodied the principles enshrined in the Cadbury Report, United Kingdom (UK). In fact, it was later amended to reflect the Sarbanes-Oxley Act, 2002 of the United States (US) (Varottil 2009). Twenty years later, India still continues to transplant laws from developed nations with little regard to its applicability in the Indian context.

The Stewardship Code, 2019 is SEBI’s latest endeavour for tightening the noose of corporate governance on companies via institutional investors. SEBI alongside the Insurance Regulatory and Development Authority of India (IRDAI) and Pension Fund Regulatory and Development Authority (PFRDA), recently promulgated a list of “stewardship responsibilities” under the aegis of Financial Stability and Development Council (FSDC) in December 2019. All mutual funds and all categories of AIFs (as stipulated under Regulation 2(1)(b), SEBI Alternative Investment Fund Regulation, 2012) are required to mandatorily comply with the principles laid down in this code. These responsibilities are restricted to the listed companies wherein these institutional investors hold equity. However, it must be noted that this is not India’s first foray into Stewardship Codes. In 2017, the IRDAI issued the Guidelines on Stewardship Code for Insurers in India, aimed at elucidating the stewardship responsibilities of the insurance companies in India. This was followed by the Common Stewardship Code by the PFRDA, aimed at pension funds in 2018.

Umakanth Varotill (2020) has shed light on the conspicuous similarity in the principles embodied by the above-mentioned Codes and the homage paid by all of them to the UK Stewardship Code of 2012.  The three Stewardship Codes bestow upon the institutional investors, the duty to monitor their investee companies, to formulate a clear policy for voting and disclosure, to collaborate with other institutional investors, when necessary, to manage conflict of interest, and to formulate and publicly disclose a policy for undertaking stewardship responsibilities (Varotill 2020). However, owing to the contrasting shareholding patterns between India and the UK, doubt arises about the efficacy of this assortment of regulations in aiding the institutional investors in regulating the corporate governance in India.

Importance of Institutional Investors’ Activism

Berle and Means, in 1932, predicted institutional investors to be the force that would erupt in the face of shareholder apathy and help reinforce the separation between ownership and management. However, owing to the rise of companies with concentrated shareholding, the Berle and Means model of the corporation failed to hold ground (Cheffins 2018). Shareholder activism hence became crucial for upholding good corporate governance practices (McCormack 1998). In the Indian context, the phenomenon of “family capitalism” is rampant with promoter-driven companies holding the controlling stake (Majumdar 2020). The independent directors have the power to bring to the forefront any abuse of power by the board of directors and voice the concerns of the minority shareholders. Unfortunately, in companies with concentrated shareholdings, majority shareholders can appoint and replace most of the directors on board and, by extension, manage the operations of the company (Majumdar 2020). Thus, independent directors become more likely to owe their allegiance to the promoters (Varotill 2009). This is where the role of institutional investors with their larger shares as opposed to retail investors becomes crucial in regulating corporate governance. Their financial literacy, access to resources in the form of proxy advisory firms and fund management not only aid them in monitoring the companies where they hold stakes but also ensure that their fiduciary duty to their investors is upheld (Djankov et al 2008).

TABLE1: Institutional Investors’ data from Nifty-Fifty Companies

Data sourced by authors from the BSE website based on the official disclosures by the companies. The data from the top 11 Nifty 50 companies (bases on market capitalisation) are analysed, excluding Kotak Mahindra Bank owing to the inaccessibility of public records for its AGM 2017.

Institutional Investors’ Behaviour in Top 10 Nifty 50 Companies

SEBI has highlighted the growing importance of institutional investors in the capital markets as the stimulus for the implementation of the Stewardship Code, 2019. It is, hence, apposite to study the voting pattern of the institutional investors in the top 10 Nifty 50 companies of India. We have analysed data from the last four years since the first list of stewardship responsibilities was promulgated in 2017. The effect of these Stewardship Codes on the activism of the institutional investors helps gauge the proximity between prescription and practice.

As of November 2021, AMFI has stated that institutional investors control assets worth Rs 38.45 lakh crore, in India. Despite this increase in the overall assets, the shareholding pattern in the public listed companies is mostly concentrated, with the majority of the shares in the hands of the promoter group. The institutional investors’ shareholding in India's top 500 listed companies still mostly falls under 30% of the total ownership (OECD 2020). In contrast, the UK exhibits 63% ownership in the hands of the institutional investors in the listed companies (OECD 2019).

According to the Companies Act, 2013, passing ordinary resolutions only requires a simple majority and special resolutions needing three times the total votes cast against the resolution. However, the data from our sample reveals that all of the 407 resolutions were passed primarily because of promoters favouring the same, despite opposition from the institutional investors in varying proportions (Table 1).

Our study of the data from these companies’ AGMs has indicated that 100% participation, coupled with 100% votes in favour of a resolution from the promoter group (mostly) nullifies the effect of any institutional investor opposition. With the exception of the AGMs conducted by Reliance Industries, the institutional investors always opted for remote e-voting and the participation percentage for the institutional investors ranged anywhere between ~70%–90%. The lowest participation percentage was observed at 59.776% in 2017, for Hindustan Unilever. Ironically, this was also the year when PFRDA issued the first Stewardship Code. The highest participation percentage was 93.61% for ITC in 2019, whereas promoters maintained a 100% participation in almost all AGMs (BSE 2020). The presence of three regulatory Codes in 2020, did not have a drastic effect on the participation percentage for the institutional investors as they mostly maintained a similar gradient to what was observed in the preceding years (Table 1). Unlike the promoter group, the institutional investors fall short on the participation front as well as in exhibiting unanimity while voting against a resolution. Institutional investors favoured the passing of some resolutions with 100% votes (declaring dividends, adoption of financial statements, etc) (BSE 2020). In the AGMs for Axis Bank in 2017 and 2019, the Institutional Investors opposed the resolutions for the appointment of Usha Sangwan as a rotational director with 54.257% and 46.642% of the votes cast by them in opposition. Despite ~71% shares being held by the institutional investors group in Axis Bank, lack of unanimity amongst them resulted in the passing of both these resolutions with 100% votes from the promoter group favouring this appointment. The lack of cohesion and participation further weakens any control institutional investors might successfully exercise in the corporate governance of the company.

Albert O Hirschman’s 1970 treatise titled Exit, Voice and Loyalty is still congruous with the behaviour exhibited by the institutional investors during the AGMs. A majority of the resolutions are passed with little to no opposition, exhibiting the investor’s “loyalty” (Table 1). The exercise of the “voice” option by the institutional investors is most evident against the appointment and reappointment of the directors, executives, rarely auditors and resolutions pertaining to their remuneration (Table 1). The most consistently high percentage of opposition was observed in the resolutions of Bharti Airtel (Table 1). Despite the 36.312% votes polled by the institutional investors present, being against the appointment of Manish Kejriwal as an independent director, the resolution was passed (BSE 2020). All the promoters voted in favour of this appointment, passing the resolution with a massive 92.545% overall votes in favour (BSE 2020). This trend is observed in almost all the resolutions which were heavily opposed by the institutional investors. In a special resolution, for the reappointment of Deepak Parek as a non-executive director in Housing Development Finance Corp, 24.856% of the institutional investors voted against the same (Table 1). Despite the absence of any promoter group in the company, they were unable to prevent the reappointment. The foreign proxy advisory firms advised the foreign institutional investors against such appointment, for Parekh already served as an independent director for eight different companies (Sinha 2018). However, some Indian proxy advisory firms advised voting in favour of this resolution. The lack of consensus in governance decisions amongst the various institutional investors further erodes their controlling power.

Issues and Potential Solutions

An analysis of the companies above makes it evident that multiple legislations emulating the essence of the UK Stewardship Code, 2002 may have been transplanted in the hopes of attracting foreign investors to invest in the Indian markets. However, in actuality, the potency of the same in buttressing India’s corporate governance regime is feeble.  Foreign institutional investors have flocked to Indian markets, but there is a need to bridge the gap between their corporate governance strategies and that of domestic institutional investors (Shah 2019). Foreign proxy advisory firms may not have a comprehensive understanding of the ground reality of the Indian corporate governance regime, which complicates any chances of cohesion in their advice and that of domestic proxy advisors (Guha et al 2020).

Furthermore, SEBI has been tightening the leash around proxy advisory firms, as is evident from its report of Working Group on Issues Concerning Proxy Advisors (2019). While there is a need for regulations to ensure that proxy advisory firms act in the best interest of the stakeholders of the company, tethering their hands with over-regulation might lead to the adoption of a subdued, safer approach while meting out advice. Gilson and Gordon (2019) argue that the current institutional investors are “rationally reticent” with diversified portfolios and competing stocks which further impedes them from effectively participating in the governance of a company. Drucker (1976) argues that institutional investors should secure the most profitable outcomes for their clients with diversified portfolios and not interfere in the management of the companies.

Nevertheless, ensuring good corporate governance practices might aid in ensuring a better return for their clients. The Stewardship Code, 2019, mentions that institutional investors must bear “greater responsibilities towards their clients.” Although this was one of SEBI’s reasoning for stacking multiple responsibilities on their shoulders, the implication of this has been the opposite. Stewardship responsibilities do not put an embargo on the ability of the institutional investors to exit the companies. Soon-to-exit institutional investors may not always act in the best interest of the company and are more likely to give their mechanical seal of approval on the promoters’ resolutions (Gilson and Gordon 2019). In the absence of any penal provisions for non-compliance with the stewardship responsibilities, such soft laws might cease to generate the desired result in the Indian context (Varottil 2020).

However, there is light at the end of the tunnel. In 2012, proxy firms advised investors to raise issues against the classification of Shapoor Mistry as an independent director in Tata Consultancy Services. Post this, he was categorised as a non-independent director in the 2013 Annual Report (Ingovern). In 2015, Maruti Suzuki, united together to have the management rework terms of a related party transaction before approving the same (Raj 2015). In 2017, the investors failed to come to a resolution for the sale of JK House below the market price by Raymond to its promoters (Shah and Vasan 2017). Exit and considerable dissent from the institutional investors dampens the reputation of the company, affecting their future investments. This might indirectly incentivise the companies to act in the best interest of their stakeholders. However, such prominent instances of shareholder activism are not the norm in India (Coutinho 2020). There is a need to foster an environment in the corporate culture that promotes continued activism.

Conclusions

The sheer transplantations of these stewardship responsibilities have largely been unsuccessful to bring about considerable changes in the corporate governance practices by institutional investors. Lack of consensus, fewer shares coupled with allegiance to their investors, enfeebles their activism. Not every institutional investor might have the dispensable resources to appoint proxy advisors. To cure this information asymmetry, an Institutional Shareholders’ Committee for all categories of institutional investors might be the key. A common forum to discuss potential governance predicaments and strategies can be extremely efficacious (Potter 1995). Despite encouraging institutional investors’ cooperation (when necessary) by the Codes, such permanent collaborative actions between the institutional investors may draw the attention of the watchdog under SEBI (Substantial Acquisition of Shares and Takeovers) amended Regulations, 2020 under “persons acting in concert” (Guha et al 2020). It is the need of the hour to provide regulations for the establishment and functioning of a common forum to combat this reticence amidst a concentrated shareholding pattern in India. This transplantation might just be the key to unlock the true potential of the other transplanted legislations in India so as to bridge the gap between the expected and experienced.