The Vexed Issue Of Independent Directors-II- The Solutions

[continued...]

I think one of the policy alternatives that the State ought to consider is by way of tightening the ex post law activation and enforcement.

Say have a law to provide Class action litigations.

Once the Directors know that there are expedited judicial processes to aid the share holders which disperse litigation costs and risks, ex ante, there will be considerable incentives to act in a manner befitting their fiduciary status. The Independent Directors also will be more agile in monitoring the executive component of the Board.

The problem with placing too much reliance on Institutional Share holders to do the monitoring and to let retail share holders to piggy back is that with portfolio holdings, Institutional share holders hardly have any inclination to monitor their agents. (Although there are instances recently where activist hedge funds did a very good job of monitoring. (Sterlite's failed restructuring).

But its not going to be easy to bring a Class action law on the statute books. For one, its going to add to the cost for Corporates. I see an immediate uopward revision in the D& O liability Insurance premium for example. Also, the possibilty of being found party to a law suit at a later date will act as an ex ante disincentive for the Independent Director to accept the post. ( we have a very recent example of Nimesh Kampani in Nagarjuna Finance)

Also, easier access to remedy ex post might lead to ex ante laxity in monitoring the Boards among the share holders. Clearly, the field is ripe for research!

Should the SRO have a say in appointment of Independent Directors, that might be quasi nationalisation ; management rights to an enterprise are after all a form of property.

May be a peer review mechanism that uses reputation costs as a tool for deterrence can be used in appointment of Independent Directors. That will augment the formal deterrence mechanisms that the legal system provides. This is especially because, Satyam showed that investors factor in corporate governanxce standards in the secondary market. We saw the sensex reacting negatively and FIIs pulled ouit their money. The peer review mechanism will act as an ex ante hedge against the Company appointing Independent Directors with suspect affliation.

The Vexed Issue Of Independent Directors

The recent Corporate Governance fiasco at Satyam raises some interesting issues about the Economics behind the law and policy of corporate governance in India. It shows how these issues from behavoural economics remain unaddressed or imcompletely unaddressed under the compliance driven mandate of clause49.

In this piece I argue that the rule based nature of clause 49 makes the framework underinclusive to address the issues similar to those that arose in Satyam.

An analysis of the underlying theme of clause 49 makes it clear that the term "Independent Director" is defined in the context of her proximity to the promoter/promoter group/BOD. That proximity is seen in two contexts: a) familial association b)Association arising from sustained and repetitive interaction.

This theme is a hedge against moral hazard issues. So far so good. The problem however is that, clause 49 does not address the issue of moral hazard entirely.

It fails to address the issue of moral hazard that arises from being repeat players in the same business segment. Let me try and explain this argument:

If an Independent Director has to be professionally competent (and reason demands that he ought to be competent in the vertical that the firm operates in), then the market for Indepedent Directors includes professionals, and academics well known in that vertical. Now, entrepreneurs, precisely because of their lengthy association with the particular business vertical are more than likely to know these actors. Now the extent of affiliation would differ; in some cases, the affliation will not be more than casual; in others, It could go deeper ( For example, It is likely that the academic was earlier a Ph.D. guide of the entrpreneur or a college senior perhaps). Without going in to the specifics then, it is fairly reasonable to imagine that fact matrices may exist where individuals otherwise qualified within the meaning of clause 49 are "Non Independent" by virtue of moral hazard that arises from being repeat players inthe same business segment and also the sorts that arises from associations that are not familial or professional and yet have decided trappings of affinity.

The other side to this argument is that outside of Directors related to the promoter/promoter group, this is the only set of people that have the skill sets to become directors on the Board of companies operative on that vertical. (Say, for example, Vinod Dham on Satyam).

So, if clause 49 were to include this residuary class as well, acute demand supply mis matches msy arise in the market for independent directors. This again may have its own set of problems; It is reasonable to imagine for example that sitting fees might see an upward revision across the spectrum bringing with it assorted problems of agency costs and issues in Directorial remuneration.

Clearly, the quest to have an optimum SOX in India is far from over!

I Got There First!

Thenewgegrotius on October 13, 2008 had advocated that the ECB Norms be eased; well, the revised and liberalised ECB policy is out and there is secular raising of the "All in cost" ceiling. For borrowing from 3-5 years, the raise is by 100 Bps; For the mezzanine slab that is from 5-7, the raise is 150 Bps and the longer maturity slab too has been upped by 50 Bps to 500 Bps.
Now you know why it should help to read me more often. Cheers!

The Curious Case Of "Going Forward"

You hear this phrase when you tune in to CNBC often, Dont you? "Going Forward Mr..... Where Do you see the Market Bottoming Out?" Or may be, "Going Forward, we see a lot of opportunities in ........ space";
My guesstimate is that "Going Forward" and "Upfront" could be the most used terms daily in the Business Circles. So, this post musing about these peculiarly "Finglish" term... " Going Forward"

Let me like put up a list at why " Going Forward" could be so frequently used one.

(you sure know that there is no lack of these "Heuristics" for a finance guy. Take your pick from " Corporate action", "Deal" etc etc.)

1. Think "Going Forward" gives the person a sense of security amidst volatility; When you are uncertain about the time, When the interviewer asks you to take a directional call and you have no clue, you invariably say, "Going Forward...." So, in Structured finance parlance, its like "hedging" yourself against uncertainty ( Much like you buying Options, a volatility product)!

2. It has a lot of strategic sense; generally, you will find this term in MDA section; where the management is tryin to comply and yet not comply :) ( you know, that can be done, So, this is not an Epigram)! So, you want to fool your owners and yet not be held laible in Derivative suit litigations, you use "Going Forward".

3. It is suitably democratic! in the sense that, even if you are a journalist who has little or no exposure to finance earlier but still want to sound as one of the gang, you blurt, "Going Forward. to my mind......." basically, going forward ensures that you have safe haven to park your ignorance in and yet sound meaningful as a prophet.

Gtg Now guys! Bye 4 now... BTW, Going forward, it does look like a lotta posts are coming your way from thenewagegrotius....

By The Way....

Dani Rodrik makes this interesting point in his October 12 post and places the cause of recent Credit squeeze at the doors of the United States treasury not bailing out Lehman Brothers Holdings. Rodrik contends that the treasury should have bailed out Lehman as immediately after that decision Short term paper spreads rose beyond reason and credit markets seized up. Rodrik cautions there is another "Perfect Storm" coming our way. the whole piece can be read here.
http://rodrik.typepad.com

ECB Norms Should Be Eased

hmmm.. thenewgrotius believes another 50 basis point rate cut is in order so far as the CRR is concerned...Anywayz, given that we are still on course for a 7% growth this fiscal, and given that there are little concerns for the real sector as such, think its high time that the RBI and the Finmin take tweaking the ECB " All in cost" seriously. At present, the " All in cost" ceilings are pegged at too low a level to make the ECB window meaningful for Corporates;
The ECB all in cost for a borrowing with a Average maturity of 3-5 years is pegged at 200 basis points above the six month LIBOR. And the same for the Average maturity bracket of 5 year onwards is pegged at 350 basis points above the Six month LIBOR. As we know the ECB end-use includes acquisitions overseas. With recession looming in US, Inorganic growth options have opened up for EM Corporates. But Given the global liquidity crunch, Borrowings have become dearer with the result that it is difficult to peg the "All in Cost" (which besides the Coupon payable, includes all that is foreign exchange expenditure including fees to keep the Credit lines open and other fees payable in foreign exchange).
What that means is opportunities of inorganic growth westwards are denied in times when valuations are dirt cheap! It is time to increase the "All in cost" to make it in sync with the global realities and facilitate domestic expansion and overseas acquisitions...

In The Mean While....

A full 100 basis point cut! Surely if this does not expand demand, nothing will! Anyway, For all those who have exposure to ICICI stock, my commiserations! But am told the stock has not seen bottom yet. Must say the RBI measure of cutting CRR might shore it up; For now, Chanda Kochhar's assurance yesterday seems to be of no avail.