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A Critical Analysis of Contrasting Shareholder Ownership and Control

The author, Mayukh Mandal, is a law student at West Bengal University of Juridical Sciences.


Over the past few decades, India has witnessed a fairly expansive and growing corporate sector. With a significant share of Indian investments being featured in corporate stocks nowadays, it becomes important to undertake an examination of the Indian approach to devising corporate laws and governance, that have organically taken shape in the recent past. This paper, specifically studies the conceptual distinction between the idea of shareholder ownership and shareholder control, as has been manifested in the Indian legal framework. It seeks to understand the notional nuances of the concepts, while also paying attention to the syntax of the applicable laws. Drawing from a quintessential example, the paper undertakes a critical analysis of the existing provisions, in an endeavour to highlight the multifarious loopholes that may prove to be fatal in practical scenarios. Finally, with an aim of encouraging adequate reforms, the paper engages in a comparative analysis of the corresponding laws of the United States, and seeks to make felicitous suggestions in this regard.



Introduction

The corporate sector in India has grown significantly in recent years as a result of the rise of globalisation and an open economy. It is so important that it serves as the economic backbone of India, accounting for up to 53% of the country's GDP.[1] This is perhaps one of the reasons why more people are becoming interested in owning stock in corporate entities. However, just because a shareholder has shares in a firm does not mean that he or she has authority over the firm's operations.


In the Companies Act, 2013, ‘Control’ has been defined as “control" shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner;[2]


According to the definition of "control" in the Companies Act of 2013 read along with the democratic process of involvement in corporate governance, only the shareholders who own a majority of shares in a company can exert ownership and control over the company.


Since the firm is owned by shareholders, they should technically be the ones in charge of the firm's affairs. However, in today's corporate environment, particularly in public companies, shareholders are dispersed in terms of geographical proximity, interest, and shareholding quantity. The number of shareholders in such corporations is often large, with a higher proportion of minority shareholders. As a result, reaching a unanimous consensus is extremely difficult. As a result, in any decision-making process, the business legislation demands the consent of a majority percentage of shareholders. This means that whoever can obtain the necessary number of votes, either by his own holdings or by a shareholders’ agreement, can effectively control the firm. This is the fundamental distinction between shareholder ownership and control.


However, the moot question is whether there is any difference between shareholder ownership and control in India. If not, whether such a separation is possible in future. The aim of the paper is to answer this very question.


A Broad Overview of Benefits of Separation between Ownership and Control

It's critical to understand why a separation of shareholder ownership and control is desirable before evaluating the likelihood of such a split. Prominent scholars like ‘Berle and Means’ have suggested that separating ownership and control contributes to successful corporate governance.[3] This is because, in such instances, the Board makes decisions in the best interests of the firm as a whole, rather than in the best interests of individual shareholders.[4] Critics further believe that such a separation is unavoidable and necessary due to the procedure and operation of modern public corporations. Furthermore, the separation of ownership and control is justified because the Board of Directors' Managers and Directors are professionals and specialists who are better suited to run a business than any shareholder. Furthermore, it is exceedingly improbable that shareholders will be entirely neutral and act solely in the company's best interests. Furthermore, the suppression of oppression and mismanagement in the company will be aided by the independent functioning of management and the Board, particularly in the context of exploitation of minority shareholders.[5]When there is no shareholder control, management and directors can more efficiently strike a balance between the interests of majority and minority shareholders. Apart from that, critics of shareholder control argue that mismanagement can be effectively regulated by the market since managers and directors' abuse of authority is limited and prevented by market forces.[6]


Whether there is any Separation between ownership and Control (Analysis of Existing Indian Laws)

Given the ownership structure of Indian corporations and the flaws in the Companies Act, 2013, the author believes that there is no separation between control and ownership in India. If we look at the numbers, we can see that Indian corporations have a fairly concentrated shareholding. A single influential shareholder or a group of shareholders, who are usually members of the same family or the government, generally possess the majority or dominating interest.[7] These shareholders are frequently members of the company's promoter group. In the last 15 years, promoters' average stake in Indian enterprises has ranged from 48 percent to 50 percent. Another characteristic of Indian companies is that they frequently consist of a set of companies controlled by a single shareholder or group of shareholders.[8] As a result, not only are most companies controlled by their promoters, but the same promoter organization also controls a huge number of corporations.


Since most Indian companies have concentrated shareholding, whoever holds the majority stake, whether a promoter group or the government, has the right to appoint the Board of Directors in a fashion that benefits them.[9] When it comes to appointing directors to the board of directors, they have a significant say. The promoters frequently propose senior members of management, and key managerial personnel frequently represent the promoters. As a result, the Board continues to be significantly weaker than the promoters.[10]


However, what enables such an arrangement to exist in Indian companies is the question. According to the author, it is the existence of loopholes and grey areas in present corporate legislation.[11] The provisions relevant to the appointment of Directors and the composition of the Board of Directors are highlighted in this context.


· The Grey Areas relating to Independent Directors

One may argue that having Independent Directors on the board maintains the board's independence and prevents any form of shareholder control or mistreatment of minority shareholders.[12]


A company's Board of Directors must include a suitable mix of executive and non-executive directors. Non-Executive Directors are experts and professionals who interact with the company's business on a part-time basis, whereas Executive Directors are full-time workers of the organization. Non-executive directors should make up at least half of the board of directors of publicly traded corporations.The Companies Act of 2013 and the LODR Regulations both require unlisted and listed companies to nominate a minimum number of independent directors to their boards of directors.[13] Because the requisite number of independent directors is depending on the status of the Chairperson, the regulations for listed companies are more stringent. If the chairperson is a non-executive director, the requisite number of Independent Directors is one-third of the total number of directors.[14] When there is no regular non-executive chairman or the chairperson is a promoter or a promoter's relative, independent directors shall make up at least half of the total number of directors.


The Companies Act 2013 lays down a detailed and well analysed definition of ‘Independent Directors’ under Section 149 of the Companies Act, 2013[15]. The inclusion of onerous regulations for the selection of independent directors, as well as a detailed definition of the term "independent director," gives the illusion that current company law is sufficient to prevent majority shareholders from abusing their authority.However, a closer examination of the regulations reveals that, while they prevent executive directors from creating a majority on the board, the laws governing director appointment and nominations diminish their impact. For example, the appointment of directors is decided by a majority of shareholders at a general meeting.[16] Additionally, each director's selection is decided through a separate voting process. As a result, the democratic process of appointing directors allows majority shareholders to leverage their majority position to nominate someone who supports their interests. Apart from that, the notion of "independent directors" contains various flaws. Persons who are close acquaintances (but not relatives) of the promoters or shareholders, for example, are eligible to serve as independent directors.[17] Furthermore, the requirement of no significant financial transactions in the previous two or three years may not always be sufficient for all instances. There may be instances where, despite the fact that the transaction occurred four years ago, the promoters and majority stockholders are still represented by the same person.


Analysis of India’s Corporate Structure through the ‘Tata-Mistry’ Dispute

The ‘Tata-Mistry’ dispute is an example of a real-life situation where the board is largely controlled by the promoters.


· Factual Scenario relating to the Dispute

The Tata Group is the quintessential example of a huge, promoter-owned business in India. Mr. Cyrus Mistry argues that he was never given the opportunity to carry out the duties of a Chairman on his own due of constant involvement from Mr. Ratan Tata, who was then the Tata Group's "Emeritus" Chairman.[18] This statement alluded to another key issue, namely the establishment of posts such as director emeritus, chairman emeritus, and so forth, which are largely held by promoters.[19]


· Legal Standpoint relating to the Dispute

The law is absolutely silent on the rights, responsibilities, powers, and benefits that come with such positions. It's also dubious whether such an"emeritus chairperson" has any fiduciary responsibilities to the corporation.[20] Furthermore, the ease with which directors can be dismissed from the board was highlighted when Tata Group removed an Independent Director who expressed a viewpoint that differed from that of the majority shareholders. It brought the weakness of Indian company boards to the fore once more.[21] Even the Securities and Exchange Board of India (SEBI) believes that such a requirement is exorbitant, given that most large Indian corporations' shareholdings are concentrated in the hands of promoters, and the majority of retail investors play a very passive role in the company's management or the removal of an independent director through a resolution.[22] This dispute also exposed one of the techniques used by majority shareholders to render any Board action ineffective without breaking the law. When it became clear that Mr. Mistry would not be removed as chairman due to likely support from the Independent Directors, Mr. Ratan Tata sought the company's shareholders and asked them to vote to remove him. The Board adopted this strategy because Mr. Mistry's candidacy for Chairperson would be jeopardised if he were removed from his directorship.[23]


A Comparative Analysis of the Corporate Framework between India and USA

In comparison to the United States, India's corporate governance framework is somewhat distinct. The shareholding arrangement is more dispersed there, and the boards have more influence.[24] Large public firms with highly skilled and experienced members on the Board of Directors, as well as widely dispersed shareholders dealing with equities in well-developed and highly liquid securities markets, characterise the US economy.[25] Because the needs of American public firms are so enormous, a small number of wealthy investors could not meet them, the shareholding structure is dispersed. In fact, the US corporate governance structure is regarded as so ideal that other economies have begun to abandon their old corporate structures in favour of the US corporate governance model.In the United States, shareholders do not interfere with the Board's operation and allow it to operate autonomously. This technique is common because investors are more concerned with the value of the stocks they own than with the growth of any particular company.Institutional activity, on the other hand, has risen dramatically in the United States over the last three decades. However, such interventions have traditionally been limited to "crisis" situations, therefore it can be stated that shareholder interference in the business of public firms in America is unexpected.[26]


Concluding Remarks: A scope for Reform

In light of the foregoing discussion, it may be argued that, unlike in the United States, India's corporate governance system is geared to benefit promoters and majority shareholders.Furthermore, because India is a developing country, the majority of the public corporation's financial needs can be met by a small group of investors. As a result, in India, there is no distinction between majority shareholders and promoters in terms of shareholder ownership and control. A lack of separation creates a two-fold issue. Firstly, the shareholders' constant meddling in the board's operations can have a negative impact on the corporation's success because they are less equipped to operate the business than those who sit on the board. This, in turn, will have a detrimental impact on the country's GDP[27]. Second, the threat of retaliation against minority shareholders can be a significant deterrent to international and Indian investors, resulting in a cash shortage for corporate operations. This, in turn, may have an impact on the economy. The legislative and executive branch, on the other hand, has attempted to bring about certain reforms in order to improve the situation.


For example, SEBI overhauled the corporate governance standards in 2014 by amending clauses 49 and 36B of the Listing Agreement.[28] The amended corporate governance provisions have now been included into LODR regulations. Furthermore, SEBI approved the advice of the Kotak Group, a corporate governance committee, in order to update corporate governance regulations in 2018.For example, the maximum number of directorships that a person can hold has been reduced. The qualifications for independent directors have been broadened. As a result, a person's independence will now be judged on both a subjective and objective basis. The risk management committee, the remuneration and nomination committee, and the audit committee have all been given more responsibilities.The amendments were incorporated into the SEBI LODR Regulations of 2015. However, these restrictions only apply to publicly traded firms, which implies that unlisted businesses' boards and minority shareholders are still exposed to minority shareholder and promoter control.[29] Even in the case of publicly traded enterprises, reform is still in its early stages, therefore the future of corporate governance in India is still dependent on the whims and fancies of a few wealthy promoters and shareholders.


[1] Ministry of Finance, Press Information Bureau, Contribution of various sectors to GDP, (May 2021), available at http://pib.nic.in/newsite/PrintRelease.aspx?relid=186413 [2] The Companies Act, 2013, § 2(27). [3] Adolf A. Berle and Gardiner C. Means, The Modern Corporation and Private Property, (New York: Harcourt, Brace & World, (1932) 1968). [4]Ibid. [5]Ibid. [6]Y. Zhao, Nomination and election of independent directors: from Anglo-Saxon style to Chinese practice, 3 Comp Law 32 (2011). [7]The separation between ownership and control in companies: a key to success? Law Right, available at https://www.law-right.com/the-separation-between-ownership-and-control-in-companies/#_ftn1 (Last visited on May 31, 2021). [8] A. Galani& N. Rehn, Related Party Transactions: Empowering Boards and Minority Shareholders to Prevent Abuses, 2 NLSIR 20 (2010). [9] S. Mathew, Hostile Takeovers in India: New Prospects, Challenges, and Regulatory Opportunities, 1 Columbus Law Review 3 (2007). [10] V. Umakanth, A Cautionary Tale of the Transplant Effect on Indian Corporate Governance, 1 NLSIR 21 (2009). [11]Vanshaj Jain, Who Will Watch the Watchmen? A Study of the Law of Self-Dealing Transactions by Company Directors, available at http://www.nlsblr.in/uploads/3/7/6/7/37673841/03.pdf (Last visited on May 31st, 2021). [12]Varottil, Umakanth and Naujoks, Richa, Corporate Governance in India: Law and Practice (2016). in Linda Spedding (ed.), India: The Business Opportunity (Lucknow: Eastern Book Company, 2016), pp. 289-342. available at https://ssrn.com/abstract=2951705 (Last visited on May 31st, 2021). [13] SEBI (Listing Agreement and Disclosure Requirements) Regulations 2015, reg. 17(1)(a). [14] SEBI (Listing Agreement and Disclosure Requirements) Regulations 2015, reg. 17(1)(b). [15] The Companies Act, 2013, § 149(6). [16] The Companies Act, 2013, § 152(2). [17]The Companies Act, 2013, § 162. [18]Poonam Rajharia& Dr. Bhawana Sharma, Corporate Governance in India Evolution, Issues and Challenges for the Future, 2 International Journal of Scientific Research and Management 12 (2014), available at https://ijsrm.in/index.php/ijsrm/article/view/1096 (Last visited on May 31, 2021). [19]Ravi Krishnan &Shrija Agrawal, Cyrus Mistry’s E-Mail Warns of $18 Billion Writedown at Tata Group, Livemint (October 27, 2016), available at http://www.livemint.com/Companies/29Hsv3bCEppKxLxw10cI0L/Cyrus-Mistry-in-email-to-Tata-Sons-board-says-group-face.html. (Last visited on May 31, 2021). [20]George Mathew & Khushboo Narayan, Tata Boardroom Battle: Spat Raises Pertinent Questions, The Indian Express (November 8, 2016), available at http://indianexpress.com/article/business/companies/cyrus-mistry-tata-group-tussle-tata-shareholders-corporate-governance-4316569/(Last visited on May 31, 2021). [21] Priya Garg, The Tata Corporate Governance Episode: The ‘India-Specific’ Issues and Concerns, India Corp Law(September 3, 2017), available at https://indiacorplaw.in/2017/09/tata-corporate-governance-episode-india-specific-issues-concerns.html (Last visited on May 31, 2021). [22] Suresh P Iyengar, SEBI Accepts Tata View on Corporate Governance Issues Raised by Mistry, Business Line (January 22, 2017), available at http://www.thehindubusinessline.com/companies/sebi-accepts-tata-view-on-corporate-governance-issues-raised-by-mistry/article9496336.ece. (Last visited May 31, 2021) [23]UmakanthVarottil, Appointment and Removal of Independent Directors: Need for Reform?IndiaCorpLaw (December 25, 2016) available at https://indiacorplaw.in/2016/12/appointment-and-removal-of-independen.html (Last visited on May 31, 2021). [24]Cheffins, Brian R., Does Law Matter? The Separation of Ownership and Control in the United Kingdom, ERSC Centre for Business Research, University of Cambridge, Working Paper No. 172. (2000) available at SSRN: https://ssrn.com/abstract=245560 or http://dx.doi.org/10.2139/ssrn.245560 (Last visited on May 31, 2021). [25]Bratton, William W. and McCahery, Joseph A., Comparative Corporate Governance and the Theory of the Firm: The Case Against Global Cross Reference, Faculty Scholarship at Penn Law, 832(1999) available at https://scholarship.law.upenn.edu/faculty_scholarship/832 (Last visited on May 31, 2021). [26] Michael P. Smith, Shareholder Activism by Institutional Investors: Evidence from CalPERS, The Journal of the American Finance Association (1996) available at https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261.1996.tb05208.x (Last visited on May 31, 2021). [27] La Porta, R., F. Lopez-de-Silanes., A. Shleifer, and R. Vishny, Ownership around the world, Journal of Finance 54, 471–517 (1999). [28] SEBI, Corporate Governance in listed entities – Amendments to Clause 36B and 49 of the Equity Listing Agreement (17 April 2014); SEBI, Corporate Governance in listed entities – Amendments to Clause 49 of the Equity Listing Agreement (15 September 2014). [29]OishikBagchi and Ashima Gulati (Khaitan& Co.), The SEBI Board Meeting on The Adoption of The Kotak Committee's Recommendations on Corporate Governance, Mondaq India (April 2018) available at http://www.mondaq.com/india/x/690198/Corporate+Governance/The+Sebi+Board+Meeting+On+The+Adoption+Of+The+Kotak+Committees+Recommendations+On+Corporate+Governance (Last visited on May 31, 2021).


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