- Introduction
The debate over shareholder activism is essentially a debate over the balance of power between shareholders and management in public companies. But over the years shareholder activism has turned out to be crucial for promoting transparency and accountability in corporate governance. (Bebchuk & Weisbach) However, the absence of effective shareholder activism in India’s corporate landscape remains a significant concern. This paper critically examines the legal and regulatory framework governing shareholder activism in India, and talks about other countries to identify the gaps and challenges. The paper concludes with recommendations for reforms to promote effective shareholder activism and ensure better corporate governance in India.
- Shareholder activism is crucial for promoting transparency, accountability, profitability, and higher valuations
Shareholder activism is crucial for promoting transparency. In 2017, Infosys, one of India’s largest IT companies, faced criticism from institutional investors over its executive compensation practices. The company had granted a large severance package to its former CFO without disclosing it to shareholders. Institutional investors such as HDFC Asset Management and ICICI Prudential Asset Management used their voting power at the AGM to demand more transparency about executive compensation. (Shingade et al., 2022) The pressure from institutional investors led Infosys to revise its executive compensation policy and disclose more information about executive pay in its annual report.
Due to an increase in transparency and accountability within firms, it can improve investor confidence and lead to higher valuations as it should be noted that when firms are more transparent about their operations and financial performance, investors are more likely to invest in them. This can lead to higher valuations over time.
Shareholder activism can help to address environmental and social issues that may be important to stakeholders, which can improve the reputation of the firm and lead to increased profitability. They note that firms with strong environmental and social policies tend to have better reputations among consumers and investors. This can lead to increased profitability over time.
Shareholder activism can help to address agency costs within corporations. Agency costs refer to the costs associated with conflicts of interest between managers and shareholders. When managers prioritize their interests over those of shareholders, agency costs can arise. Shareholder activism can help to reduce these costs by providing a mechanism for shareholders to hold managers accountable for their actions. (Shingade et al., 2022)
Shareholder activism can help to address issues related to executive compensation, board composition, and other aspects of corporate governance that may be important for firm performance. This is because when shareholders are actively engaged in monitoring the actions of managers and directors, they are more likely to demand greater transparency and accountability from these individuals. (Shingade et al., 2022) For example, shareholders may demand more frequent reporting of financial information or greater disclosure of executive compensation packages.
- The Absence Of Effective Shareholder Activism In India’s Corporate Landscape Remains A Significant Concern
There is still an absence of effective shareholder activism in India’s corporate landscape which remains a significant concern, although there has been a rise over the years. While shareholder activism has become increasingly common in other countries, such as the United States and Europe, it remains relatively rare in India.
One reason for the absence of effective shareholder activism in India is the concentration of ownership among a small number of large shareholders as many Indian companies are family-owned or controlled by a few large institutional investors, which can make it difficult for minority shareholders to have their voices heard. (Shingade et al., 2022) And also, many Indian companies have complex ownership structures that can make it difficult to identify who holds significant voting power.
Another factor is that while Indian law provides some protections for minority shareholders, these protections are often weakly enforced. A study by the World Bank found that India ranked 163rd out of 190 countries on its ease of enforcing contracts index. (The World Bank) This suggests that even when minority shareholders do have legal recourse, they may face significant challenges in enforcing their rights. This index is important for investors and businesses because it indicates the strength and effectiveness of a country’s legal system in resolving disputes and enforcing contracts. (Sharma) In the context of minority shareholder rights, the enforcing contracts index is particularly relevant because it measures the ease with which minority shareholders can enforce their legal rights.
More importantly, small shareholders in India tend to rely on regulatory bodies, major competitive shareholders, and financial institutions for their protection. (Sharma) This makes them docile investors who would prefer to exit or remain loyal rather than resorting to shareholder activism.
Lack of effective shareholder activism in India is also due to cultural factors like there is a general reluctance among Indian investors to engage in public disputes with company management or other stakeholders. This reluctance may be due to concerns about damaging relationships or reputations, or simply a lack of familiarity with activist strategies (Shingade et al.)This is also due to several other factors, including cultural norms that prioritize harmony and consensus-building over confrontation, as well as concerns about potential retaliation or negative publicity.
There is an opposing view that the profitability of target firms decreases in the short term after an activist campaign, which suggests that these campaigns impose costs on companies as per an author who used a unique dataset of US activist campaigns from 2002 to 2017 to analyze the effects of different types of activist interventions on target firms.
But the study does not provide a detailed explanation of how exactly shareholder activism leads to decreased profitability, rather it suggests that these interventions may disrupt the firm’s operations, create uncertainty and distraction for management, and increase costs associated with responding to shareholder demands and some proposals put forward by activists may not be value-enhancing or may have unintended consequences that harm the firm’s performance. (Barros et al., 2022)
Other arguments put forth were as follows: Firstly, activist campaigns may disrupt the firm’s operations and create uncertainty and distraction for management. This can lead to decreased productivity and increased costs associated with responding to shareholder demands. Secondly, some proposals put forward by activists may not be value-enhancing or may have unintended consequences that harm the firm’s performance.
Thirdly, the short-term focus of some activist investors may lead managers to engage in earnings management practices to increase their pay-for-performance compensation, which can harm the long-term interests of the company and its shareholders. (Barros et al., 2022) Finally, even if shareholder activists possess appropriate information and knowledge, they may be pursuing their own personal agendas and short-term gains rather than acting in the best interests of all shareholders.
Therefore, while shareholder activism can have positive effects in some cases, there is an argument that its impact is complex and depends on various factors that need to be carefully considered.
- How to minimize the risk of being targeted by shareholder activists?
Maintaining good relations with shareholders: The board needs to balance its role between legislative compliance, corporate strategy, and policy-making. Clarity on the role of the board and its members helps maintain a good relationship between the management and shareholders, which builds shareholder confidence.
Effective communication: Companies should communicate effectively with their shareholders to ensure that they are aware of the company’s strategy, performance, and governance practices. This can help build trust and reduce the likelihood of activist campaigns.
Proactive approach: Demonstrating a proactive approach to addressing shareholder concerns can help build confidence among shareholders and reduce the likelihood of activist campaigns
Strong governance practices: Companies should have strong governance practices in place, including independent directors, effective risk management systems, and transparent reporting
Engagement with stakeholders: Companies should engage with stakeholders beyond just their shareholders, including employees, customers, suppliers, and communities in which they operate. This can help build support for the company’s strategy and reduce the likelihood of activist campaigns. (Khaitan et al.)
- Lessons Can Be Learned From other Countries To Improve and Promote Effective Shareholder Activism In India
Cross-border comparison of shareholder activism in developed countries can help identify gaps and challenges in India’s legal and regulatory framework as there have been successful activist campaigns in other countries, such as the United States, where shareholder activism has become an established force.
Policymakers can study how other countries have balanced the interests of shareholders with those of other stakeholders, such as employees or creditors. For example, some countries have implemented “stakeholder-oriented” corporate governance models that prioritize the interests of all stakeholders rather than just shareholders. . (Bebchuk & Weisbach By studying these models, policymakers can gain insights into how to create a legal and regulatory framework that promotes effective shareholder activism while also protecting the interests of other stakeholders.
Policymakers can examine how other countries have addressed issues such as executive compensation, board composition, and risk management. For example, some countries have implemented regulations or guidelines on executive pay to ensure that it is aligned with long-term value creation rather than short-term profits. Other countries have implemented rules on board composition to ensure that boards are diverse and independent. By studying these approaches, policymakers have already gained and can gain more insights into how to address similar issues in their own country. Policymakers can learn from the experiences of other countries in implementing corporate governance reforms. For example, some countries have implemented reforms through legislation or regulation, while others have relied on voluntary codes or market-based mechanisms. . (Bebchuk & Weisbach) By studying these approaches and their outcomes, policymakers can gain insights into which approaches are most effective in promoting effective shareholder activism and improving corporate governance.
- Lack of indigenous development?
On the contrary it can also be argued that there is lack of indigenous development of corporate governance principles in India may be one of the reasons why India has not been able to avoid corporate scandals like Harshad Mehta, Ketan Parekh, and Satyam. This argument is that because these principles were not developed specifically for the Indian context, they may not be well-suited to addressing the unique challenges faced by Indian companies.
For example, Indian companies may face different cultural, social, and economic factors than companies in other countries. These factors can affect how companies operate and how they are governed. If corporate governance principles are not tailored to these specific factors, they may not be effective in preventing corporate scandals. (Singh, 2017)
In addition, the approach to corporate governance in India has been contractual and economic, which is similar to the approach taken in countries like UK and US. This approach focuses on legal compliance and financial performance as measures of good governance. However, this approach may not take into account other important factors such as ethical behaviour and social responsibility.
Therefore, it is argued that there is a need for more research and development of indigenous corporate governance principles in India. (Singh, 2017) This would involve taking into account the specific cultural, social, and economic factors that affect Indian companies and developing governance norms that are tailored to these factors before taking inspiration from other countries.
- Suggestions to Promote Effective Shareholder Activism And Ensure Better Corporate Governance
While there is no denying that India has some governance norms in the corporate sector but still it has not been able to avoid corporate scandals like Harshad Mehta, Ketan Parekh, and Satyam. There is a need for more research and development of indigenous corporate governance principles in India. This would involve taking into account the specific cultural, social, and economic factors that affect Indian companies and developing governance norms that are tailored to these factors
There is a need for greater awareness among shareholders about their rights and responsibilities. Many shareholders are not aware of their rights as investors or how they can exercise those rights effectively. (Singh, 2017) This paper suggests that more education programs could be developed to help shareholders understand their rights and how they can engage with companies to promote better corporate governance practices
There is a need for large investors to take up a more activist role in the corporate governance of Indian companies. This is necessary to protect the rights of minority shareholders. Additionally, having a substantial equity stake gives financial institutions more power to influence corporate decisions and push for changes that can improve company performance. (SARKAR & SARKAR)Therefore, it is suggested that large shareholders, such as financial institutions, can play an important role in promoting good corporate governance practices and improving company performance.
There are many examples of successful shareholder activism in India, such as the case of Satyam Computers, where institutional investors played a crucial role in exposing the accounting fraud. It is one of the most high-profile cases of corporate fraud in India’s history. In 2009, it was revealed that the company’s founder had inflated profits and assets for years, leading to a massive loss of investor confidence. (Singh, 2017) This case illustrates the need for greater transparency and accountability in corporate governance, as well as the importance of shareholder activism in uncovering fraudulent practices.
Small shareholders can also still play a role in promoting good corporate governance practices by advocating for greater transparency and accountability in corporate decision-making This can include supporting initiatives that promote shareholder rights and protections, such as the right to vote on important issues or the right to access information about the company’s operations. (SARKAR & SARKAR) Small shareholders can also work together to form coalitions or alliances with other investors to increase their collective bargaining power and influence over corporate decisions.
In conclusion, effective shareholder activism is essential for promoting transparency, accountability, and profitability in India’s corporate governance landscape. While there have been some successful examples of shareholder activism in India, such as the Satyam and Tata cases, there is still a long way to go to ensure that companies are held accountable for their actions and that shareholders are able to exercise their rights effectively.
To achieve this goal, it is necessary to strengthen the legal and regulatory framework governing corporate governance in India, increase shareholder participation in company decision-making processes, enhance board independence and improve disclosure practices. Additionally, institutional investors should be encouraged to take a more active role in promoting good corporate governance practices (SARKAR & SARKAR).
By implementing these reforms, India can create a more transparent and accountable business environment that benefits all stakeholders. It is our hope that this paper will contribute to the ongoing discussion on how best to promote effective shareholder activism and ensure better corporate governance in India.
- REFERENCES
- Bebchuk, L. A., & Weisbach, M. S. (n.d.). The state of corporate governance research . Harvard Law School . Retrieved April 9, 2023, from http://www.law.harvard.edu/programs/olin_center/papers/pdf/Bebchuk_652.pdf
- Shingade, S., Rastogi, S., Bhimavarapu, V. M., & Chirputkar, A. (2022, March 23). Shareholder activism and its impact on profitability, return, and valuation of the firms in India. MDPI. Retrieved April 5, 2023, from https://www.mdpi.com/1911 8074/15/4/148
- Barros, V., Guedes, M. j, Santos, J., & Sarmento, J. M. (2022, December 26). Shareholder activism and firms’ performance. Research in International Business and Finance. Retrieved April 9, 2023, from https://www.sciencedirect.com/science/article/pii/S027553192200246X
