Governance Conundrums

G(C)=[(P(C))²×√(S.G÷BOD)]+ P(BOD)

Governance of Companies [G(C)] is the squaring of performance(P(C))² multiplied by the root of system of governance by the Board of Directors(S.G÷BOD), to which is added the performance of the Board of Directors [P(BOD)]

“The relationship between companies and their shareholders has never been more important than it is today. Open communication as well as trust in both management and the board are critical to building long-term relationships with investors, which allow companies to stand out amongst an ever-increasing range of global investment options.” (Tom Farley, President NYSE, Forward to “NYSE:  Corporate Governance Guide”)

Infosys continues to be in the headlines of Pink Papers and transparency of governance continues to be an issue which was deliberated in the previous blog. The Governance in general, and the composition and role of the Board of Directors, in particular, is the focus of all such opinion leaders. Some developments post last week events have further sharpened the debate on the Governance Structure and the system of Corporate Governance prevalent in the Company. The changes to the constitution to the Board is reminiscent of the communist Politburo era of USSR. There seem to be deals and counter deals between various groups without any hint of what is at stake and what is being staked in these deals.

Whatever the status the only forum to haul up the Board or any of its directors or the CEO in a company is the meeting of Shareholders and any other mechanism inherently reflects the lack of confidence in the legal process laid out in Company Law. One of the oldest Corporate law precedents is the case of Foss Vs. Harbottle, of which the only rule that remains undiluted till date, in spite of many legal amendments to protect minority shareholder rights, is that in any corporate action, one of the parties to the action should be the company itself and what the company can do, cannot be appropriated by the individual shareholders.

cartoon on Board

(Source: Click here)

Basically, Governance, as we have seen, is the aggregation of processes and systems. In this company, there have not been any visible changes in the processes of governance but only some change of personalities. Now if the grouse is on the system, then those who consented at the time of exit of Promoters to these processes are equally responsible as any other. If it is about individuals, the system of governance that has been handed down as legacy is at fault since any system should be -Personality-neutral.

There is the more fundamental question about how much of the “Systems and Processes” or “Checks & Balances in governance” relevant for Stakeholder Value. Long term stakeholder value enhancement which is the objective of Governance is better ensured by focussing on Operational Issues than on processes. In fact, when there was a change at the helm in 2014 in Infosys, the change was projected as an effort to enhance and diversify the revenue stream to sharpen the competitive edge of Infosys. Let me go back to ‘Buffet Smriti’ to see how he approaches the issue of Long-term Stakeholder value creation:

 Financial staying power requires a company to maintain three strengths under all circumstances: (1) a large and reliable stream of earnings; (2) massive liquid assets and (3) no significant near-term cash requirements. Ignoring that last necessity is what usually leads companies to experience unexpected problems: Too often, CEOs of profitable companies feel they will always be able to refund maturing obligations, however large these are. In 2008-2009, many managements learned how perilous that mindset can be.

Here’s how we will always stand on the three essentials. First, our earnings stream is huge and comes from a vast array of businesses. Our shareholders now own many large companies that have durable competitive advantages, and we will acquire more of those in the future. Our diversification assures Berkshire’s continued profitability, even if a catastrophe causes insurance losses that far exceed any previously experienced.

Next up is cash. At a healthy business, cash is sometimes thought of as something to be minimized – as an unproductive asset that acts as a drag on such markers as return on equity. Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent.

American business provided a case study of that in 2008. In September of that year, many long-prosperous companies suddenly wondered whether their checks would bounce in the days ahead. Overnight, their financial oxygen disappeared.

At Berkshire, our “breathing” went uninterrupted. Indeed, in a three-week period spanning late September and early October, we supplied $15.6 billion of fresh money to American businesses. We could do that because we always maintain at least $20 billion – and usually far more – in cash equivalents.” (Page 34 of Warren’s letter on Berkshire Past, Present and Future)

Ironically one of the last decisions of the Board, which has effectively been superseded, was to distribute Cash to the tune of Rs. 13,000 crores. Added to this, there are reports that the promoters who have taken up the cudgels for improving governance are putting up their shares to the tune of Rs. 2000 crores for Buy-back. This again runs counter to yet another Buffet Mantra, who talking about commitment of the promoters for the Company said in his Owner’s Manual (Point No. 2 of Broad Economic Principles) thus: “In line with Berkshire’s owner-orientation, most of our directors have a major portion of their net worth invested in the company. We eat our own cooking.

Charlie’s family has the majority of its net worth in Berkshire shares; I have more than 98%. In addition, many of my relatives – my sisters and cousins, for example – keep a huge portion of their net worth in Berkshire stock.

Charlie and I feel totally comfortable with this eggs-in-one-basket situation because Berkshire itself owns a wide variety of truly extraordinary businesses. Indeed, we believe that Berkshire is close to being unique in the quality and diversity of the businesses in which it owns either a controlling interest or a minority interest of significance. Charlie and I cannot promise you results. But we can guarantee that your financial fortunes will move in lockstep with ours for whatever period of time you elect to be our partner. We have no interest in large salaries or options or other means of gaining an “edge” over you.”

As we have seen Governance is neither a simple mathematical aggregation of processes and systems nor the result of the chemistry of individuals manning such processes and systems but it requires a sustained effort to promote a corporate culture of tenacious working to ensure sustained enhancement of stakeholder value. The cause of Governance will get stymied if it is used as a corporate football to be kicked around for diversion through amusement, to hide the Cloak and Dagger machinations of Board Room politics. The last of this series will be on Legal aspects of the episode on what may, might or can unfold.

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