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India
“Land of the Unexpected”
BUS 42108-81: Corporate Governance
Winter 2017
Team: “Nothing Changes Until Something Hyderabad Happens”
Ian Adams
Noah Fireman
Amber Holzmeister
Meredith Lawrence
Joseph Michalak
Catherine Napier
Shaun Nikore
Monica Tian
“We pledge our honor that we have not violated the Honor Code during this homework”
Executive Summary
India is the largest democracy in the world by population. This has led India to become
the largest stock market in the world in terms of publicly listed companies. With such a
large financial market, it is critical for the Indian economy and society to have strong
corporate governance procedures to protect the interest of shareholders and the public.
Corporate Governance is the policies and procedures that govern the relationship
between shareholders, directors, and managers in a company. These are generally
defined in a legal document such as a corporate charter or company bylaws and are
bounded by the applicable laws.
India has had a rich and vibrant history; however, India’s Corporate Governance has
been more or less stagnant until the early 1990s. It was during this time period several
major corporate governance initiatives launched in India. The formation of the
Securities and Exchange Board of India (SEBI) was created in 1992. This authority is
still present today and is in charge of regulating the capital markets. Soon after, the
Confederation of Indian Industry (CII), India’s largest industry and business association,
created a voluntary code of corporate governance procedures in 1998. This voluntary
code enabled private sector, public sector, and financial institutions corporate entities to
address concerns from the public around transparency and the protection of all
investors, even small ones.
These actions were followed up by the SEBI, which created Clause 49. Clause 49 was
a result of a large corporate scandal that shook the Indian stock market. The regulation
asked every firm above a certain size to implement regulations that strengthened the
role of independent directors serving on corporate boards.
India’s corporate governance is built on a strong Anglo-Saxon model. However the
biggest risk in the Indian system is rooted in corruption and scandals. The primary
difference between US and Indian corporate governance is the problem with
enforcement, which hinges on disciplining company management and making them
more accountable.
While corruption in India will be hard to overcome, we believe India has the ability to
reduce corruption in the future through technological progress and economic prosperity
for all.
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1. Prepare a chart for your country that answers the following questions:
Chairman of the
Board
Either an independent director or a director employed by the company
Board Members
Either independent directors or a directors employed by the company
Shareholders
Have equity or preference shares in company along with participating rights
Capital
Represented through debt and equity costs. Average cost of equity capital is
15%. Capital is represented through IRR over CAPM.
Labor
Local, firm-level or industry-level trade unions are affiliated to larger
Federations. The largest Federations represent labor at the National level and
are known as Central Trade Union Organisations.
Contracts
As soon as a contract is executed with the Government in accordance with
Article 299, the whole law of contract as contained in the Indian
Contract Act comes into operations. Applications of the private law of contract
in the area of public contracts may result in cases of injustice.
Minority
Shareholders
Have additional rights beyond standard shareholders which include the right to
do the following: requisition in a general meeting, approach the
courts to cancel variation of rights and approach the Company Law Board in
case of oppression and mismanagement.
CEO Power
High power and more optimism than non-Indian CEOs, according to PWC
Director Power
High power and requirement to attend at least one meeting per year;
governance modeled through the Indian Companies Act of 2013, which
requires that directors act in good faith. Public directors have a lot of power
and certain limits on them - including how many meetings they must attend per
year, who is on the audit committee, understanding financial statements, etc.
Are rare due to prevalence of founding families with dominant shareholding
positions, the necessity of obtaining onerous government approvals for foreign
Hostile Takeovers acquisitions and provisions in the Indian Takeover Code that favor promoters.
Rate of Return
An annual rate of return between 15%-20% would be considered very
successful. In recent years, mid-cap companies have seen the highest
rates of return.
Radical Change
Radical change is difficult since 70% of India is rural and these individuals
typically feel less affected by political/corporate decisions. Therefore power
has not changed recently. Additionally the importance of religion prevents
major change (i.e. cows are able to roam free).
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Gini Coefficient Comparison Chart
Source: http://www.livemint.com/Politics/mTf8d5oOqzMwavzaGy4yMN/IMF-warns-of-growing-inequality-in-India-and-China.html
According to the IMF, India’s Gini coefficient as of 2013 hovers around 52, indicating the
wealth disparity is quite large.
2. Compare the favorable and unfavorable differences in the corporate
governance laws, regulations and practices of your Country selection with
those of the US.
India has certain requirements regarding the types of members it can have on their
boards, which the U.S. does not have. One of these is that all boards are required to
appoint at least one female board member. Another requirement is related to the
number of outside directors there must be. When the Chairman of the Board is from
outside the company, then ⅓ of the directors also must be from the outside. When the
Chairman of the Board is from within the company, then ½ of the directors must be from
the outside. India is setting a great precedent with these requirements and more
countries, including the U.S., should follow in their footsteps. Encouraging gender
diversity, as well as the inclusion of outside directors, will make boards more wellrounded with a variety of experiences and perspectives. It’s important to have multiple
viewpoints, especially when ethical challenges arise.
Another favorable difference is that all board members must be able to read financial
statements. US companies do not have that requirement, but this may be helpful in
ensuring everyone could potentially be able to serve on the audit committee, if needed.
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An unfavorable difference is that in India, audit committees must have at least ⅔ of
independent directors. In the United States, audit committees are required to consist of
100% independent directors. Especially on the audit committee, we’d argue that more
independence is greater than less.
Further, Indian companies navigate through both state and central rules and
regulations, which can be a challenge and reduces the ease of working in India (as
opposed to the United States).
One Indian director also has to live in the India within the last calendar year, which is a
unique requirement to India.
3. How well do your country's Corporate Governance Practices comply with
the OECD Corporate Governance principles?
Because India is a relatively new economy to the world stage, the last decade has been
a time of rapid change and progress within India’s corporate governance structure.
Effective 12/31/2005 - the SEBI’s Clause 49 developed many principles similar to, and
in fact a precursor of, those found in the United States’ Sarbanes-Oxley Act. After a
conference with the OECD in 2011, the Indian Companies Act of 2013 (“Companies
Act”) seeks to address some of the changes that were identified by the OECD.
Currently, the legal structure in India presents some issues for Corporate Governance.
The SEBI exists as a regulatory body, but has faced some delay in developing action
plans for enforcement of rules. Additionally, enforcement of laws in India involves
navigating several legal systems - the Anglo-Saxon tradition of corporate law in India,
and the religion-specific laws in the rest of the country’s legal structure.
The Companies Act has improved many aspects of Shareholders’ Rights, including
some increased disclosure requirements, and requiring that the audit committee have a
supermajority of independent directors and oversight to Related Party Transactions
(RPTs). However, there is still much work to be done, including additional disclosure of
conflicts of interest, especially as related to RPTs. Also, generally, minority
shareholders do not share equitable rights and access to information as those available
to the majority (controlling) shareholders.
Aside from concerns related to minority shareholder protection, other stakeholders face
issues within India. Currently the laws related to resolving insolvent companies in India
are plentiful and contradictory, which prevents timely resolution, and debt recovery is
very low.
Finally, the Companies Act and Clause 49 create additional rules requiring board
independence, oversight of reporting by independent directors, and membership and
term limits for board members, there are still concerns related to the enforcement of
these rules.
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Overall, India has made many strides into codifying some of the best practices for
Corporate Governance as described by the OECD into its law, but we would like to see
additional strides made in the transparency, disclosure and enforcement realms, as well
as increased regulation on board independence as described in the next section.
4. What changes does your country still have to make to achieve the OECD
principles?
While reforms enacted in the last decade have greatly increased compliance with the
OECD principles, there remain some areas for improvement within the OECD
framework. Most notably, the SEBI is still working to determine “effective enforcement”
of governance changes, including those from the Companies Act of 2013. Additionally,
due to the closely held nature of Indian companies (either through family-owned or
state-owned holdings groups) there still exist issues related to RPTs and the rights of
minority shareholders. The Companies Act of 2013 addresses some of these issues
(based on the audit committee oversight of RPTs and e-voting); however we would like
to see further and more enforceable rules related to these items. Additionally, we would
suggest greater disclosure around RPTs.
5. What are the risks of investing in your country?
We have identified five key risks associated with investing in India:
Political
India suffered political instability in the sense that no dominant party emerged causing a
lack of coalition government. However, stability returned after 1999 with strong and
healthy coalition government emerging. All political parties agreed that foreign
investment plays a critical role in the Indian economy. Therefore there is a low chance
of political instability in the future for India; it doesn’t pose many risks for foreign
investors.
A stable and supportive regulatory environment is critical to drive growth in the Indian
automotive industry. Similar to the United States, regulations and government initiatives
will play a critical role to drive demand in the Indian automotive industry. The
Government has launched many new programs such as “Make in India” and “Skill
India”. In addition, we are seeing social and environmental concerns around pollution,
congestion and safer transportation being addressed.
However, while the Indian government is improving the business environment, there still
needs to be clearer guidelines and a road map for regulations. This is especially
important since the automotive industry is capital intensive and requires long-term
planning. Thus, a stable policy regime is critical to drive growth.
Economic
a. Inflation and Currency
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The rupee has experienced a strong devaluation compared to the dollar since the
financial crisis in 2008. Estimates indicate that for 2017 the rupee will remain relatively
stable. For foreign investors, a weak rupee allows for cheap M&A and sourcing
strategy. However, a weak rupee will hurt domestic consumption for foreign affiliates
who would like to sell into the Indian market. From the period of 2008 to 2016, the
Indian Rupee went from a low of 40 rupees per dollar to today at 65 rupees per dollar.
USD to INR Chart
Source: http://www.xe.com/currencycharts/?from=USD&to=INR&view=10Y
b. Labor
Over the past few years, there have been several incidents of civil unrest, violence and
strikes in India. As the second largest risk for foreign business operating in India, this
risk can cause a business to lose millions of dollars. An example of this is the strike in
Maruti’s Manesar plant, which resulted in a 10% decline in operational productivity of
the firm. This type of risk is important for any firm that relies heavily on labor in
automotive manufacturing.
Bribery / Corruption and Corporate Fraud
For foreign investment, bribery corruption and corporate fraud risk is now recognized as
the number one risk in India. Several major frauds and scandals have been uncovered
in the past few years. Property theft and internal corporate financial frauds are
especially prevalent. These risks pose the highest threat to India when seeking strategic
partnerships with suppliers and outsourcing firms. We highly recommend our firm to
“watch and wait” for the short term and seek local expertise/know-how if we decide to
enter India in the near future. Larger multinational firms have the ability to be selective
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with suppliers and can put in place proper policies and procedures when deciding to go
abroad.
Intellectual Property / Legal
In India, corporate financial information can vary in quality based on firm. The
institutional framework has a few weaknesses. Intercompany transactions run
appreciable risks in unstable and inefficient environments. Additionally, registration of
patents, trademarks, designs and copyright can take several months or even years in
India due to considerable backlogs at the IP registries, requiring the need to plan well
ahead of entering the market.
Consumer Behavior and Tastes
Our final risk is based on the behavior and tastes of the Indian consumer. Even though
India is large in terms of aggregate population, there is a high concentration of wealth.
Currently, there are 27 million individuals who fall into the urban middle class category
and the 0.43 million wealthy individuals who earn an income greater than $250,000 a
year.
With wealth concentrated at such high levels in these two categories, it is important to
be in tune to the consumer tastes and demands of this population segment. For any
company entering into the Indian market, it will be crucial to see if their existing product
abroad will need to be adapted for the tastes of this small segment of the market.
6. What does your country need to do to make its stock market safer for
investors?
The financial markets in India consist of two major exchanges, the National Stock
Exchange (NSE) and Bombay Stock Exchange (BSE). These two exchanges account
for 99.9% of all equity order flow.
Until 1992 the BSE was a monopoly. During this time, the BSE was highly inefficient,
expensive, and participated in manipulative practices. This had a tremendous impact
on market participants, their confidence was eroded and they were highly
disadvantaged.
As stated above, the economic reforms of the early nineties created four new
institutions: The Securities and Exchanges Board of India (SEBI), the National Stock
Exchange (NSE), the National Securities Clearing Corporation (NSCC), and the
National Securities Depository (NSD). The National Stock Exchange was introduced as
a competitor to the BSE and was formed as a limited liability company owned by public
sector financial institutions. As of today, the NSE accounts for roughly two-thirds of the
stock trading in India while the BSE accounts for one-third of all equity trades. Public
Companies listed on both exchanges are subject to regulation from the SEBI.
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The National Securities Clearing Corporation is the legal counter-party to net obligations
of each brokerage firm, and thereby eliminates counterparty risk and the possibility of
payments crises. This is similar to how clearing firms operate in the United States. This
entity utilizes similar mechanisms to the United States clearing firms, which require
collateral and trade flow monitoring during market hours. The NSCC, duly assisted by
the National Securities Depository, has had an excellent record of reliable settlement
schedules since its inception in the mid-1990s. This is a crucial element to a wellfunctioning stock market exchange.
There are over 6,000 companies listed and traded on NSE and/or BSE. While the
market capitalization of trading on the Indian stock exchanges is much lower than the
market capitalization of trading in the United States, it is important to note that the
volume of stock trades on BSE/NSE is roughly equivalent to the aggregate of the US
Stock Exchanges. Similarly, the number of derivatives trades on NSE is comparable to
US derivatives exchanges. The market volume (number of trades) is an important
indicator, as it is a good measure of investor interest and participation in equities and
equity trading within a country. This puts pressure and incentivizes corporations to
improve their corporate governance procedures.
Outside of the normally accepted risks in participating in equity markets, there are a few
recommendations we suggest the Indian Stock Market needs to do to assure
shareholder confidence. With a strong foundation to build on, the Indian Stock Market
should continue to regulate and provide a reliable way for all market participants to
exchange stocks. This requires the need to continue vigilant and strong enforcement by
the regulatory authorities. This will reduce corruption and continue to build confidence
in the Indian stock exchanges.
7. For the next five years, would you prefer to invest in your country or in the
US?
India is a large and growing economy with large upside potential and would be a missed
opportunity not to invest in India. For the last three-year India’s GDP has consistently
grown by 6.9% or more. Further, The International Monetary Fund (IMF) predicted that
India would retain the status of fastest growing economy until 2020. India has also
shown an improvement on the World Bank’s latest ease of doing business report (from
134 in 2015 to 130 in 2016), and the current government set itself an ambitious target of
getting the ranking within the top 50 by 2017 which also indicates that investing in the
country should be easier too. These factors indicate that while there could be some risk
as the market fully matures, there will likely be a higher return over the long-term than
with an investment in the US.
While there are many headwinds and challenges to investing in India, as the world’s
fastest growing large economy, there is enormous risk to staying away. Whereas the
U.S. market for automobiles is mature and a flat or shrinking market, the same industry
in India is growing at 9% per year. And, by 2025, India will be the world’s most populous
country, with the largest workforce, and the youngest country on the planet.
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India has a robust laws and regulations in place and is moving in the right direction on
governance. Enforcement is decidedly lacking currently, but the future is bright. Further,
many of the issues around consolidated ownership that negatively impact corporate
governance in India do not have substantial bearing on foreign companies who coming
in to manufacture in the country, since the ownership structure of our company will not
change.
Because of its importance as an emerging economy and as a growing center for auto
manufacturing in Asia, we believe the benefits outweigh the risks inherent in India’s
corporate governance system. While we should invest in India, we should approach the
situation with clear eyes and ensure that we also tailor our approach to the country
specifically. After all, the Indian governance framework remains a significant challenge.
In particular, our business should invest in robust monitoring and compliance efforts to
reduce the likelihood of concerns related to fraud and related party transactions (RPTs).
By maintaining transparent business practices, we should be able to reduce the impact
of RPTs. Further; we should also hire an Indian CEO of our Indian subsidiary, and
invest in R&D and product development in the country.
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Bibliography
Sources for Question 1:
● http://us.practicallaw.com/7-615-1126#a660172
● E&Y
● https://en.wikipedia.org/wiki/Labour_in_India
● http://www.legalservicesindia.com/article/article/liability-of-state-in-contract-and-intorts-2000-1.html
● http://us.practicallaw.com/7-615-1126#a660172
● http://www.pwc.in/assets/pdfs/publications/ceo-survey-2016/19th-annual-global-ceosurvey.pdf
● http://www.ey.com/Publication/vwLUAssets/EY-companies-act-13-keeping-pacewith-board-governance-evolution/%24FILE/EY-companies-act-13-keeping-pacewith-board-governance-evolution.pdf
● http://cblr.columbia.edu/archives/10900
● https://myinvestmentideas.com/2015/10/top-10-best-performing-sip-mutual-funds-toinvest-in-2016/
● http://economictimes.indiatimes.com/marketstats/pid-127,pageno-1,sortbyr1week,sortorder-desc,period-r1week,fundtypeid-1.cms
● https://www.forbes.com/2009/05/19/india-elections-continuity-opinions-contributorscato.html
Sources for Questions 3 and 4:
● Principles of Corporate Governance. The Organization of Economic Cooperation
and Development. 2015
● https://blogs.cfainstitute.org/marketintegrity/2014/05/08/corporate-governancereform-in-india-gauging-impact-on-investors/
● https://www.researchgate.net/publication/228119459_An_Overview_of_Corporate_
Governance_Reforms_in_India
● http://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf
● http://www.sebi.gov.in/commreport/clause49.html
● http://blogs.wsj.com/briefly/2016/05/12/what-indias-new-bankruptcy-law-means-theshort-answer/
Sources for Questions 5, 6, and 7:
● https://www.gov.uk/government/publications/overseas-business-risk-india/overseasbusiness-risk-india
● http://www.goldmansachs.com/our-thinking/pages/macroeconomic-insightsfolder/rise-of-the-india-consumer/report.pdf
● http://www.investopedia.com/articles/stocks/09/indian-stock-market.asp
● http://download.nos.org/srsec319new/319EL18.pdf
● http://www.ey.com/Publication/vwLUAssets/EY-making-India-a-world-classautomotive-manufacturing-hub/$FILE/EY-making-India-a-world-class-automotivemanufacturing-hub.pdf
● India’s World Bank ranking on ‘ease of business’ will improve further: Arun Jaitley,
The Economic Times, 29 October 2015.
● India’s Economy. KPMG.
https://assets.kpmg.com/content/dam/kpmg/pdf/2016/06/India's-Economy-Kotra.pdf
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● Opportunities & Challenges in the Indian Market: Lessons learned from Dutch
Companies in India. Kingdom of the Netherlands.
● NACD Principles.
https://www.nacdonline.org/files/PDF/KEY%20AGREED%20PRINCIPLES%202011.
pdf
● Industry Data. Wall Street Journal. http://online.wsj.com/mdc/public/page/2_3022autosales.html
● Automobile Industry in India. India Brand Equity Foundation.
http://www.ibef.org/industry/india-automobiles.aspx
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