Published on March 3, 2014
2014 IiAS survey Institutional Investors’ Attitudes to Corporate Governance In association with
IiAS Survey 2014 Institutional Investors Attitudes to Corporate Governance 1
Foreword The ownership pattern of corporations in India has been steadily changing. Two classes have increased their shareholding perceptibly over the last two decades: promoters (and this includes multinational parents) and institutional investors. As a result, institutional investors are becoming more engaged with companies and proactive in their scrutiny of corporate governance standards. The increased dialogue is in part because their investors in turn, expect them to do so and in part because regulators are asking them to. Regulations now mandate asset managers to vote and companies now need approval by ‘majority of minority’ for related party transactions, changed disclosure standards and live with increased risk of a class action suit being filed. It is against this backdrop that IiAS that has undertaken its second survey on “Institutional Investors’ Attitudes to Corporate Governance”. This year, the survey focusses on the proposals in the new Companies Act, the SEBI Consultative Paper on corporate governance, the perceptions of corporate governance across industries, as well as a number of case studies that have made headlines in corporate India over the last few months. The survey responses are based on an online poll of more than 70 participants, spread across mutual funds, insurance companies, HNIs and other institutional investors. Participants to this survey have nearly doubled from last year, which reflects the increased focus of investors on corporate governance. We have taken care to ensure that the survey questionnaire provides a fair reflection of the market perception on the role of corporate governance in the overall investment framework. The final message is clear. A majority of institutional investors find a strong relationship between governance and stock return. A governance deficit, in their opinion, can create investment risks and they are therefore willing to engage with the company on critical issues. We would like to extend our appreciation to all the participants for the time and enthusiasm devoted to providing comprehensive responses. We are hopeful that the findings of the survey would make companies more responsive to investor sentiments and pave the way for a constructive and meaningful debate on corporate governance. Amit Tandon February 2014 IiAS Survey 2014 Institutional Investors Attitudes to Corporate Governance 2
I welcome you to the second IIAS Annual Survey on Corporate Governance, which has been sponsored by Reliance Capital Asset Management Limited (RCAM). Securities and Exchange Board of India (SEBI) has time and again emphasized that the institutional investor community is in a position to play an important role in ensuring good and strong corporate governance by actively participating and exercising its voting rights in respect of various proposals/ resolutions, which require shareholders consideration, from time to time. This gives voice to investors who have invested in the capital markets through us and additionally, it also indicates our opinion to other small investors, who may be invested directly. SEBI has also been persistently spreading awareness about the importance of corporate governance and had put into place, various checks and balances through Clause 49 of the Listing agreement (e.g. the composition of the board, setting up of audit committees, remuneration of non-executive and independent directors and disclosures and certifications to be made in the annual reports, to name a few). The new Companies Act, 2013 has also placed strong focus on corporate governance in its widest sense. Shareholder activism is still fairly nascent in India, but the writing on the wall is clear, with the increasing levels of awareness, and the strong regulatory emphasis on independence of boards and auditors on the one hand and disclosures on the other, both shareholders and the general press will get more vociferous about actions taken by Managements, whether they be family-managed or professionally managed businesses. The new Companies Act also reflects this by enabling class action suits. At RCAM, we welcome this trend and we hope that this survey will contribute to further strengthen this movement and drive home the fact that investors will increasingly view good corporate governance and disclosures as strong value creators. Sundeep Sikka Chief Executive Officer Reliance Capital Asset Management Limited Mumbai, February 2014 IiAS Survey 2014 Institutional Investors Attitudes to Corporate Governance 3
CONTENTS Section 1: Perceptions of corporate governance....................................................................................... 5 A. The role of corporate governance in driving investment ....................................................................... 5 B. Relationship between corporate governance and price performance .................................................. 6 C. Perceptions of corporate governance across industries ........................................................................ 9 D. Why governance matters ........................................................................................................................ 10 E. Corporate governance perceptions across companies ......................................................................... 12 F. Corporate governance issues based on different types of ownership and management .................. 14 G. Analysis of companies by type of management .................................................................................... 17 Section 2: Case Studies ................................................................................................................................. 18 A. Executive Appointments ......................................................................................................................... 18 B. Executive remuneration .......................................................................................................................... 20 C. Strategy and valuation ............................................................................................................................. 21 D. Royalty...................................................................................................................................................... 22 Section 3: Shareholder activism ................................................................................................................. 23 Section 4: Opinion on regulatory initiatives of the Companies Act 2013 ........................................... 24 A. Independent Directors ............................................................................................................................ 24 B. CSR Mandate ............................................................................................................................................ 25 C. Auditor Rotation ...................................................................................................................................... 26 D. SEBI: Scheme of Arrangement ................................................................................................................ 27 E. Others........................................................................................................................................................ 27 F. Overall response to Companies Act and its expected impact on governance of companies.............. 28 Section 5: Involvement in governance of portfolio companies ............................................................ 29 A. Shareholder resolutions .......................................................................................................................... 29 B. Engagement between market participants and companies ................................................................. 31 Section 6: Shareholder engagement and the role of proxy advisory firms ........................................ 33 Conclusion ....................................................................................................................................................... 34 Profile of survey participants...................................................................................................................... 35 IiAS Survey 2014 Institutional Investors Attitudes to Corporate Governance 4
SECTION 1: PERCEPTIONS OF CORPORATE GOVERNANCE This section studies investors’ perceptions of corporate governance. We focus on three areas: i. The role of corporate governance in driving investment ii. Perceptions of corporate governance across industries iii. Perceptions of corporate governance across companies. A. THE ROLE OF CORPORATE GOVERNANCE IN DRIVING INVESTMENT Investors driven by industry dynamics Industry growth prospects emerged as the most important driver of investment for institutional investors, with 68% of respondents, followed by a company’s competitive standing in the industry. 63% of the respondents ascribed very high importance to corporate governance of the company. What drives investment? Growth prospects for industry/sector Company's competitive position in the industy/sector Corporate governance of the company 68% Historical stock market performance 6% 63% 31% 2% 63% 29% 4% Important 6% Neutral Extremely important Reputation of promoter/CEO Quality of financial reporting 23% 57% 32% Unimportant 44% 31% 46% 46% 8% 19% Source: IiAS Institutional Investor Survey 2014 IiAS Survey 2014 Institutional Investors Attitudes to Corporate Governance 5
B. RELATIONSHIP BETWEEN CORPORATE GOVERNANCE AND PRICE PERFORMANCE Corporate governance is a very important criterion while investing More than three fourths of the respondents believe that well governed companies will always command a premium to their industry peers. 18% of respondents believed that corporate governance is one of many important determinants of share price returns; conversely just 4% of the respondents felt that corporate governance is unimportant. Investors should therefore be willing to play an active role in improving governance standards in investee companies and thereby improve shareholder returns. More than a quarter of the sample has chosen to invest in a company purely because of high standards of corporate governance: Infosys being the most common investee company. While 74% of the investors polled have not invested solely because a company has high corporate governance standards, 79% of the respondents have refrained from investing in a high growth company solely because of issues of corporate governance. Nearly three fourths (73%) of the investors have exited a company because of concerns over corporate governance. Instances of companies in which high standards of corporate governance was the primary driver of investment Source: IiAS Institutional Investor Survey 2014 (Figures indicate number of investors who invested in the company purely because of its high standards of corporate governance) IiAS Survey 2014 Institutional Investors Attitudes to Corporate Governance 6
How do you view the relationship between corporate governance and share price returns? Well governed companies will always command a valuation premium in their industry 4% 18% Corporate governance is just one of the many important determinants of shareholder return. 78% Industry dynamics and management effectiveness are the most important determinants of shareholder return, corporate governance is relatively unimportant Source: IiAS Institutional Investor Survey 2014 Correlation between Corporate Governance and shareholder returns Have you invested in any company purely because they have high standards of corporate governance? Conversely, have you refrained from investing in a high-growth company purely because of concerns over corporate governance? 21% 27% 26% 73% 79% 74% Yes Have you ever exited a company because of concerns over corporate governance? No Yes No Yes No Source: IiAS Institutional Investor Survey 2014 IiAS Survey 2014 Institutional Investors Attitudes to Corporate Governance 7
Clarity regarding accounting practices emerges as the most important dimension of corporate governance: Clarity in business and accounting practices is considered to be the most important dimension in corporate governance by investors. Fair dealing with clients and suppliers is considered to be the second most important determinant followed closely by balanced board composition with strong representation from independent directors. Compliance and process driven company and remuneration are important determinants while positive impact on community is given the least importance. What is the most important dimension of corporate governance? Clarity in business and accounting practices, and detailed disclosures Fair dealings with clients and suppliers Balanced board composition with strong representation from independent directors Equitable compensation practices Compliance-driven and process-driven company Positive impact on community 39% 41% 19% 47% 9% 11% 26% 9% Extremely Important 15% 11% 47% 28% Very Important 36% 11% Moderately important 28% 43% 11% 13% Unimportant 9% 21% 50% 60% 19% Source: IiAS Institutional Investor Survey 2014 IiAS Survey 2014 Institutional Investors Attitudes to Corporate Governance 8
C. PERCEPTIONS OF CORPORATE GOVERNANCE ACROSS INDUSTRIES We divided the BSE 500 companies into a list of 17 industries, and asked investors to rank these industries on the basis of their perception of corporate governance practices in these industries. We have compiled investors’ responses and arrived at a final corporate governance rating of industries on the basis of investor perception of corporate governance standards in these industries. The results are shown below: Industries with the best governance practices According to our respondents (institutional investors), the IT services industry has the cleanest business practices. It has been rated as the industry with the best governance standards. It is followed by FMCG and consumer products. Pharmaceuticals, Automotive, and Financial Services round off the list of top five industries with best governance practices. Industries with the poorest governance practices When asked to rate the industries with bad governance practices, Investors have overwhelmingly picked real estate as the industry with the poorest governance practices. Comment: Some of the characteristics that define the industries in the top five list are – foreign customers (IT, pharmaceuticals and automotive), actively regulated (financial services), and vigorously competitive (IT, FMCG and pharmaceuticals). There is also limited involvement of the government in awarding contracts and approvals for business activities (especially in the IT industry), and therefore it is difficult to turn connections into profits in these industries. On the other hand, real estate, infrastructure, mining and EPC are industries in which business activities are inextricably linked with the need for regulatory approvals and it is easier to turn connections into profits in these industries. Industries with best governance practices: Top 5 IT Services 137 FMCG and Consumer products 121 Pharmaceuticals 52 Automotive 44 Financial Services Composite governance score based on ratings 35 Source: IiAS Institutional Investor Survey 2014 Industries with poorest governance practices: Bottom 5 -26 Media and Entertainment -29 Composite governance score based on ratings Engineering, Procurement and Construction -58 -81 -151 Mining and metals Infrastructure Real Estate Source: IiAS Institutional Investor Survey 2014 IiAS Survey 2014 Institutional Investors Attitudes to Corporate Governance 9
D. WHY GOVERNANCE MATTERS We have combined the industry-level corporate governance ratings compiled from data reported by the investors, with data of share price returns in these industries to try and see if there is a positive correlation between the two. The universe of companies included in the study is BSE 500. These companies have been grouped into the 17 industries whose CG score based on investors’ responses is available. We have then used the median of the five year share price returns of the companies in each industry as an indicator of share price returns of that industry. Our linear regression model has the composite CG Score of the industry as the predictor variable, and median five-year share price returns of the industry as the dependent variable. We find that there is a significant positive correlation between median industry share price returns and our composite CG score. The linear regression shows an R-square of 40%, implying moderate predictive power in the relationship. Our analysis shows that at an industry level, there is a correlation between corporate governance levels and share price returns. IiAS Survey 2014 Institutional Investors Attitudes to Corporate Governance 10
IiAS Survey 2014 Institutional Investors Attitudes to Corporate Governance 11
E. CORPORATE GOVERNANCE PERCEPTIONS ACROSS COMPANIES Investors were asked to rate the companies with the best corporate governance. The results are presented below: Companies with the best corporate governance Source: IiAS Institutional Investor Survey 2014(Figures indicate percentage of total votes polled) Companies with the best board composition Source: IiAS Institutional Investor Survey 2014 (Figures indicate percentage of total votes polled) Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 12
Highest ranking companies by impact on the community Source: IiAS Institutional Investor Survey 2014(Figures indicate percentage of total votes polled) Highest ranking companies by level of detail in regulatory filings Source: IiAS Institutional Investor Survey 2014(Figures indicate percentage of total votes polled) Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 13
F. CORPORATE GOVERNANCE ISSUES BASED ON DIFFERENT TYPES OF OWNERSHIP AND MANAGEMENT For the purpose of this section, we define five categories of companies based on their pattern of ownership and management: Promoter-managed companies: Companies where the top executive (whether MD/CEO or executive chairman) is a representative of the promoter-family e.g.: Reliance Industries, Bajaj Auto. Promoter-owned, Professionally managed companies: Companies where ownership and management is separated, where the MD/CEO is a professional, while the promoter family representative holds only a seat on the company's board e.g.: Tata Group, Mahindra group Foreign owned companies: Companies which are the Indian subsidiaries of foreign multinational corporations e.g.: HUL, Nestle, Bosch India etc. PSUs: Public Sector Undertakings - companies where the government is a major shareholder. Institutionally owned and managed companies: Companies where the ownership is widely dispersed and no family or foreign shareholder or institution has a majority stake e.g.: ITC, HDFC, ICICI Bank, L&T etc. What are the most important corporate governance issues in promoter managed firms? Opaque related party transactions 76% Risky mergers and aqusitions 54% Poor accounting practices 52% Excessive managerial remuneration 48% Low dividend pay out lack of strong leadership 37% 6% Percentage of respondents rating the problem as a major issue Source: IiAS Institutional Investor Survey 2014 What are the most important corporate governance issues in professionally managed promoter owned firms? Excessive managerial remuneration 45% Low dividend pay out 40% Risky mergers and aqusitions 34% Opaque related party transactions 32% Poor accounting practices Lack of strong leadership 13% 5% Percentage of respondents rating the problem as a major issue Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 14
What are the most important corporate governance issues in MNCs? Opaque related party transactions 58% Excessive managerial remuneration 40% Risky mergers and aqusitions 30% Low dividend pay out 23% Lack of strong leadership 10% Poor accounting practices 5% Percentage of respondents rating the problem as a major issue Source: IiAS Institutional Investor Survey 2014 What are the most important corporate governance issues in institutionally owned, professionally managed companies? Excessive managerial remuneration 61% Lack of strong leadership 29% Risky mergers and aqusitions 26% Low dividend pay out 26% Opaque related party transactions 10% Poor accounting practices Percentage of respondents rating the problem as a major issue 3% Source: IiAS Institutional Investor Survey 2014 What are the most important corporate governance issues in PSUs? Lack of strong leadership 89% Low dividend pay out 20% Opaque related party transactions 20% Risky mergers and aqusitions 17% Poor accounting practices Excessive managerial remuneration 13% 0% Percentage of respondents rating the problem as a major issue Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 15
Corporate governance issues across types of companies: Investors consider lack of strong leadership as the most important corporate governance issue in PSUs. In promoter owned and managed and MNCs opaque related party transactions is the most important governance issue while in professionally managed promoter owned companies’ and in institutionally owned companies excessive managerial remuneration is the most important governance issue. Category Dominant person Concern Promoter owned and managed Promoter Opaque related party transactions MNC Foreign promoter Opaque related party transactions Promoter owned professionally managed Managerial Executive Excessive managerial remuneration Institutionally owned Managerial executive Excessive managerial remuneration As seen from the above table investors believe that corporate governance issues depend on the type of dominant shareholder or person in control. It is perceived that promoter owned and managed companies and MNC use related party transactions like royalty payments, merger and acquisitions, transactions with wholly owned promoter companies. In promoter owned and professionally managed and institutionally owned companies, the management as the dominant person, reward themselves by way of remuneration including stock options. Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 16
G. ANALYSIS OF COMPANIES BY TYPE OF MANAGEMENT The survey finds that professionally managed companies and MNCs have the highest governance standards. While promoter-managed companies account for 50% of all the companies in the BSE 500, they received only 25% of the votes in favour of well-governed companies. Professionallymanaged firms, on the other hand, comprise 24% of the BSE 500, but they polled 54% of all votes for well-governed companies. MNCs too, are over represented in the list of wellgoverned companies. BSE 500 firms by category and vote share in the list of well-governed companies Distribution of companies in BSE 500 Distribution of votes for companies with good corporate governance 50% 25% 24% 54% Promoter 14% 4% Professional 13% 18% PSU MNC Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 17
SECTION 2: CASE STUDIES This section seeks to understand investors’ perspectives on specific corporate governance issues by polling their views on some of the most prominent case studies in corporate India and the world over the last 12-18 months. The case studies are categorized into four broad themes: i. ii. iii. iv. Executive appointments Executive remuneration Strategy and valuation Shareholder activism A. EXECUTIVE APPOINTMENTS Institutions are divided about Narayana Murthy’s return to Infosys as executive chairman Narayana Murthy’s return to Infosys was one of the most hotly debated appointments this year. While some saw it as a necessary act for a company in distress, others saw it as an instance of poor succession planning, and a repudiation of corporate governance principles from one of the best-regarded companies in India. Institutional investors seem similarly divided – around 51% of them approve of the move while the other half disapprove of it. (It should be noted that the resolution to appoint Narayana Murthy was approved unanimously). Foreign institutions have disapproved, domestic institutions have approved: Filtering the responses by type of institution (FII vs DII) reveals that foreign institutions do not approve the move while domestic institutions are largely in favour of the move. How did you assess the return of Narayana Murthy to Infosys 51% 49% How did you assess the return of Narayana Murthy to Infosys Domestic institutions Foreign institutions 56% 44% 40% 60% Approve - the company needs strong leadership Approve Disapprove Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 18
Investors favour separation of the roles of chairman and CEO at JP Morgan 91% of investors believe having Jamie Dimon as both the CEO and chairman is bad for JP Morgan: Corporate governance advocates usually vouch for a separation of roles between the CEO and chairman – the former being answerable to the latter. In some cases, this can be difficult or impractical to implement, and the perceived benefit of having the additional checks and balances may be outweighed by the costs of slower decision making. JP Morgan’s recent troubles with the regulators may have influenced this response wherein 91% of investors are in favor of a separation of roles (CEO and chairman) at JP Morgan. Jamie Dimon serves as both the chairman and CEO of JP Morgan. How do you view this? 9% Bad for the company - concentrates too much power in one man's hands Good for the company - JP Morgan is exceptionally complicated, only Jamie Dimon is capable of understanding the risks and providing leadership 91% Source: IiAS Institutional Investor Survey 2014 Second-generation promoters’ appointment: Investors are neutral on to board at a young age, more favourable to appointments in junior/ middle management 57% of institutions view second-generation promoter executive appointments on a case-bycase basis: 74% of the companies in the BSE 500 are promoter owned, and 50% of the companies in the BSE 500 are promoter-managed. It is not surprising to see promoter’s relatives joining boards at a young age. Majority or 57% of the investors indicated that they are neutral to such appointments and would view it on a case to case to basis. 38% of the respondents felt that such a move would send a wrong signal to markets. It must be noted that in specific cases when such appointments came to shareholders for approval they have been approved unanimously (e.g. Sudarshan Venu in TVS). Unanimous support if second-generation promoters are being groomed in junior or middle management roles: It is worth noting that all respondents responded favourably for promoter relatives joining the junior or middle management levels at a young age. If a second-generation promoter joins the company board in an executive position at a young age (below 30) how would you view this? Negative - Sends a wrong signal to investors 38% Positive - It is better for the company to have a succession plan, than to have no plan at all 57% 5% Neutral - View it on a case by case basis Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 19
B. EXECUTIVE REMUNERATION Remuneration is an area of concern for some institutions Investors neither strongly support, nor strongly disfavor remuneration proposals, irrespective of whether these are in promoter-driven firms or professional firms. 56% of the respondents view that payment of high salaries to promoters for managing their own companies is justified provided they generate returns for shareholders. However 44% of the respondents view such actions as sending send a wrong signal to markets and employees as several of these companies also have a high ratio of executive compensation to total staff cost. Respondents view the remuneration to CXOs of professionally managed and institutionally owned companies such as Larsen and Toubro in a similar way. While 46.6% of the respondents felt that high remuneration to such executives should not be a concern, the remaining 53.4% felt otherwise. FIIs more concerned about remuneration in institutionally owned firms: Executive remuneration has been a contentious issue in developed markets, where most firms are institutionally owned, with several institutional investors using the say-on-pay provisions to voice their disapproval on remuneration matters. This has been reflected in the response of foreign institutions towards executive remuneration in institutionally owned firms. Over 71% of FIIs said that concerns may exist in case of remuneration in institutionally owned companies. How do you view executive remuneration in the following three types of firms? Professionals in institutionally owned companies Professionals in promoter owned companies 47% 53% Not a concern 63% 37% Concerns may exist Promoters in promoter-managed companies 57% 43% Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 20
C. STRATEGY AND VALUATION If a mid-sized company embarked on a business diversification - to unlock the next stage of growth, how would you view the move? Generally approve 48% 53% Generally disapprove If a mid-sized company embarked on a business diversification - to unlock the next stage of growth, how would you view the move? DIIs FIIs 51% 49% 47% Generally approve Investors divided over companies’ business diversification: We find that majority of the investors surveyed do not have a problem with the idea of companies venturing into new areas of business as 52.5% indicated that they would generally approve such resolutions. However, the remaining 47.5% indicated that they would disapprove of such a move. FIIs oppose diversification: FIIs came out a little more strongly in disapproval of business diversifications – with 53% of foreign investors responding that they view such diversifications negatively. Recently, Infotech Enterprises and KPIT Technologies announced plans to diversify – Infotech Enterprises to enter the manufacture of electronics systems and other businesses, KPIT Technologies to start manufacturing of electronic and mechanical goods. Generally disapprove 53% Shareholder approval for transformational acquisitions – a major area of concern: When a company is trying to make a transformational acquisition, should it be mandatory to take shareholder approval? 9% Approval should be mandatory Approval should not be mandatory 91% The recent announcement of Apollo Tyres’ acquisition of US-based Cooper Tire & Rubber Company sent the share prices of the company downhill, unsurprisingly so, given that the allcash transaction deal was at a 40% premium to Cooper's 30-day volume-weighted average price on the NYSE. Apollo Tyres did not require a shareholder approval because the deal was a cash transaction. We polled investors, on whether such transformational transactions should be put to shareholder approval and over 90% of the investors indicated that the approval should be made mandatory for transformational acquisitions, irrespective of whether they are cash transactions or not. Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 21
D. ROYALTY Royalty payments to be linked to sales growth/profits In the report titled ‘Paying the price: Multinationals, Royalty Payments and Minority Shareholders’, IiAS highlighted that royalty and related payments increased by 23.8% to Rs.4952 Cr in FY13 for 25 MNC companies used in the analysis. Of these, five companies Maruti Suzuki, Hindustan Unilever, Nestle India, Bosch and ABB India, remitted Rs.3979 Cr in FY13. 76% of the investors indicated that royalty and related payments are not a concern provided they are linked to sales growth or returns on invested capital. Currently, most companies charge royalties at a flat rate to total turnover or net sales. While 15% of the investors indicated that some form of check should be put up so companies are not free to increase royalty rates, 9% felt that a liberal royalty regime is essential to encourage foreign investment into the country. Foreign owned companies have been increasing their royalty paid to parent companies. How do you view this move? 15% 9% Liberal royalty regime is essential to encourage foreign investment Royalty hike should be correlated with sales growth/ returns on invested capital 76% Companies should not be given the freedom to hike royalty payments Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 22
SECTION 3: SHAREHOLDER ACTIVISM Would you consider initiating or joining a class action suit against a company to address your grievances? 34% Strong support for shareholder activism, class action suits: The Companies Act 2013 provides for filing class action suits against companies. Two thirds of the respondents indicated that they would initiate such actions against the company for the grievances they may have while the remaining stated they will not. 66% Yes No Source: IiAS Institutional Investor Survey 2014 Do you support activist investors when they raise what they perceive as corporate governance concerns? 15% Activist shareholders raising governance issues find support: During 2012, The Children’s Investment Fund filed a lawsuit against Coal India for mismanaging the company. 85% of the respondents indicated that they support such moves by activist investors when they raise corporate governance issues. Only 15% of the respondents stated that would not support activist investors on companies’ governance issues. 85% Yes No Source: IiAS Institutional Investor Survey 2014 How do you view activist investors when they give strategic recommendations to companies? Activist investors are within their rights to make such recommendations 27% 73% Activist investors who have never run businesses in these industries have no right to make such recommendations Activist shareholders making strategic recommendations find support too: Recently, Dan Loeb advised Sony to spin off its entertainment business. On another instance, Nelson Peltz demanded that Pepsico restructure its business into two companies beverages and snacks. When polled for their views on such issues, institutional investors have indicated that they are broadly in favour of letting shareholders make such strategic recommendations. 73% of respondents are in favour of allowing activist shareholders make strategic recommendations, while 27% believed that people who have not run companies in these industries have no right to make these recommendations. Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 23
Source: IiAS Institutional Investor Survey 2014 SECTION 4: OPINION ON REGULATORY INITIATIVES OF THE COMPANIES ACT 2013 AND THE SEBI REGULATIONS 2013 saw a sweeping overhaul of the most significant piece of legislation that governs Indian companies – the Companies Act. Several regulatory initiatives have been introduced pertaining to corporate governance, including an explicit definition of ‘independent director’, among others. SEBI too has sought to revamp clause 49 of the Listing Agreement. This section seeks to understand the responses of investors towards these regulatory initiatives. The broad areas covered in our questions include: i. Independent directors ii. CSR mandate iii. Auditor rotation iv. SEBI Schemes of arrangement A. INDEPENDENT DIRECTORS Support for restrictions on tenure, outside directorships, and compulsory training for independent directors point towards investors’ expectations from independent directors not being met. Support for compulsorily having women directors on boards is weaker, but still above 50%. How do you view the regulatory initiatives pertaining to independent directors in the Companies Act? Restriction on outside directorships Restriction on maximum tenure Training - independent directors Mandate for women directors on boards 83% 2% 82% 18% 69% 51% 16% 9% 21% 22% Approve Do not approve No opinion 28% Source: IiAS Institutional Investor Survey 2014 Restrictions on tenure: The new Act restricts the maximum tenure of an independent director to ten years. More than 80% of investors have approved of this proposal, confirming the view of governance experts that extended tenure compromises the independence of directors. Training for independent directors: Nearly 70% approved of a proposal to provide independent directors with training and a certification program. This proposal has been proposed by SEBI in a consultative paper on corporate governance. Restrictions on outside directorships: Again, more than 80% of investors approved of the new Companies Act proposal to restrict the maximum outside directorships to ten public companies. Investors want the independent directors to bring more focus and see as less as being more. Mandate for women directors on boards: The Companies Act mandates all listed companies to have at least one woman director on board. While 51% of the investors support this view, a substantial 21% do not see any merit; 28% did not express an opinion. The dearth of women candidates may possibly explain this. Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 24
B. CSR MANDATE The business of business will no longer just be business Among the various sections of the Companies Act 2013, Clause 135 has generated the most debate. The Clause 'mandates' spending on CSR to the extent of at least 2% of average net profits during every block of three years for companies above a certain financial threshold. 84% of the investors have approved of CSR. The support for mandatory CSR however, is much weaker – with only 36% of investors openly supporting the move. IiAS found that during FY13, the 51 companies included in the BSE S&P Sensex or the Nifty50 indices, spent Rs.26.6 bn towards CSR activities. This, at an average, accounts to 1% of average PBT of the preceding three years of these companies. Do you support the mandatory CSR spend (2% of profits) proposed by the Companies Act 2013? 16% Support CSR - but it should not be mandatory 48% 36% Support mandatory CSR Do not support CSR Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 25
C. AUDITOR ROTATION To recap the debate, critics of mandatory rotation highlight increasing costs and declining efficiency as their primary objections to any form of mandatory rotation. They argue that the replacement costs for auditors will become significantly high and far outweigh any transparency benefits that may result from the change. In addition, they claim that businesses nowadays are far more complex and the audit process requires a fair degree of familiarity with the internal processes, systems and key risk areas of the company. Periodic rotation therefore will not achieve the intended results and conversely, may end up reducing the audit quality. Corporate governance advocates however, feel otherwise. They believe that vintage auditors tend to develop a certain level of comfort with the company management, thereby compromising the integrity of the audit process. They feel that mandatory rotation will not only bring a fresh perspective on the financials, it will also keep the current auditors on their toes as they will be aware that a new auditor may detect any irregularities in the accounting process. Richard Breeden, a former head of America’s Securities and Exchange Commission, has put it, “When the same incumbent firm has been in place for 100 years, to me that’s not an audit, that’s a joint venture.” Overwhelming support for auditor rotation: Over 90% of the respondents have approved of the auditor rotation requirement of the Companies Act – stipulating that auditors must not hold tenure of over ten consecutive years at a listed company. Extended audit tenure may compromise independence, and the responses show the depth of investor concern about the relationship between companies and auditors Do you support mandatory auditor rotation as proposed by the Companies Act 2013? 5% 3% Approve Do not approve No opinion 91% Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 26
D. SEBI: SCHEME OF ARRANGEMENT 95% of investors support the new SEBI regulations pertaining to Schemes of Amalgamation: The requirements mandate that promoters cannot vote when they are an interested party in the transaction. This means that such Schemes cannot be approved unless a majority of non-promoter shareholders vote in their favour. Given the opacity of related-party transactions in Indian business, this proposal has been welcomed by an overwhelming 95% of then investors. Investors have already begun to act. A recent postal ballot to approve the merger of SEPR Refractories India Limited, Saint-Gobain Crystals and Detectors India Limited, and SaintGobain Sekurit India Limited with Grindwell Norton Limited was voted ‘against’ by a majority of minority investors. The Companies Act, 2013 has also placed restrictions on related party transactions. It has listed a set of items where a special resolution in the general meeting for undertaking RPT will be required. Further no member of the company can vote on such resolution, if such member is a related party. Do you approve of the new SEBI requirement for Schemes of Amalgamation - mandating approval from majority of non-promoter shareholders? 5% Approve Do not approve 95% Source: IiAS Institutional Investor Survey 2014 E. OTHERS Increase in borrowing limits: Increasing their borrowing limits allows companies to carry out their strategic plans for the company without making adequate disclosures and taking permissions from shareholders. While enabling proposals to raise equity are valid for only a year, proposals to increase borrowing limits are valid perpetually. 71% of investors agree that debt resolutions should have a one year time frame Resolutions to raise equity are valid only for a year. Should a similar time limit apply for borrowings? 9% 20% 71% Agree Disagree No opinion Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 27
F. OVERALL RESPONSE TO COMPANIES ACT AND ITS EXPECTED IMPACT ON GOVERNANCE OF COMPANIES Overall response to proposed regulations is mixed: While a majority of respondents (54%) has stated that the Companies Act is sufficient to address corporate governance concerns, a large number (40%) has stated that it is insufficient. In contrast 6% of the respondents took a diametrically opposite view: the regulation is excessive. This scepticism may be because of the notion that the new regulations may inspire only a tick-the-box approach towards compliance and governance rather than far-reaching transformation. Do you believe the Companies Act 2013 will help improve corporate governance in companies? 6% Sufficient to address corporate governance concerns 40% 54% Not sufficient to address corporate governance concerns Excessive regulation Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 28
SECTION 5: INVOLVEMENT IN GOVERNANCE OF PORTFOLIO COMPANIES This section seeks to understand how investors engage with companies in their portfolio, from a governance perspective. This section is divided into two parts: i. Shareholder resolutions ii. Engagement with companies and other participants A. SHAREHOLDER RESOLUTIONS Takeovers, mergers and acquisitions are rated as the most critical shareholder proposals. Not surprising given the uncertainty. These are followed by other strategic proposals like disposals and spin-offs, intra-group mergers and related party transactions. Which category of resolutions do you find most critical? Takeovers, mergers and acquisitions external 66% Intra-group mergers, intra-group loans and other related party transactions 30% 60% Disposals and spin-offs 55% Entering new line of business 31% 53% 43% 2% 4% 0% Extremely important Issue of preferential warrants 39% 31% 46% 11% 9%7% Very important Neutral Somewhat important Re-pricing of stock options 37% Board Appointments 36% 36% 23% 5% Appointment of relatives of Promoters in Executive ranks 33% 42% 16% 9% 40% 14% 9% Source: IiAS Institutional Investor Survey 2014 The list of resolutions most frequently voted against is slightly different, led by related party transactions. This indicates that while investors recognize the high risks with mergers and acquisitions, they are willing to let management follow through on their proposals. Intragroup mergers, and related party transactions, on the other hand, are viewed with greater suspicion. ESOP proposals are also frequently voted down – due to concerns on dilution and impact on profitability. The main issue being raised about mergers and acquisitions is the valuation. Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 29
Which category of resolutions are you most likely to vote against? Intra-group mergers, intra-group loans and other related party transactions 29% Entering new line of business 27% Grant of Employee Stock Options at a steep discount 26% Disposals and spin-offs 24% 65% 11% Often vote against 24% 68% 8% Sometimes vote against Takeovers, mergers and acquisitions external Increase in borrowing limits, issue of debt instruments Re-pricing of stock options Unusually high /low payment of dividend 24% 24% 19% 58% 13% 57% 47% 43% 16% 26% 32% 53% 43% Never vote against 24% 38% Source: IiAS Institutional Investor Survey 2014 What is the main concern in mergers and acquisitions? Valuation 86% Dilution Method of the merger 39% 31% Percentage of respondent citing the factor as a major issue Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 30
B. ENGAGEMENT BETWEEN MARKET PARTICIPANTS AND COMPANIES Do you talk to other institutional investors on critical issues before voting? A majority of respondents have stated that they occasionally consult with other institutional investors on critical issues before voting. Only 21% of the survey participants have never consulted with other institutions on critical issues before voting. 18% 21% Always Sometimes Never 62% How often do you meet the senior management of your investee companies? For companies where shareholding is below significant threshold (below 3% of company's stake/below 5% of asset size) For companies where shareholding is above significant threshold (above 3% of company's stake/above 5% of asset size) 14% 32% 22% 32% Every month Every quarter Every six months 22% 53% 17% 8% Less than one meeting per year Source: IiAS Institutional Investor Survey 2014 Frequent engagement (monthly or quarterly basis) for significant investments: For investments above their significant threshold, 75% of the investors met their companies’ senior management either on a monthly or quarterly basis (outside of earnings calls and other conferences) Occasional engagement (quarterly or half yearly basis) for smaller investments: On the other hand, for smaller investments, the meetings with management were less frequent – with as much as 32% of investors not meeting their investee company even once in a year. More than 50% of investors willing to engage with company directly or indirectly: When faced with a company proposal that they disagree with, nearly 60% of the respondents are willing to engage with the company – either directly (42%) or indirectly after aggregating other institutional shareholders (17%). However, a sizeable share of the respondents (28%) said that they would exit the company. Voting with your feet need not be the only option: 23% of institutional investors indicated that companies have responded positively when governance issues have been raised when a majority did get some kind of a response. Investors may be better advised to actively drive corporate governance in their investee companies rather than stay passively invested or vote with their feet. Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 31
What has been your experience when you have attempted to drive corporate governance in investee companies? The company has responded on select issues 17% Company has responded positively 23% 60% The company has not responded How do you respond to a company's proposal that you disagree with? 3% 6% Engage with the company and try to reach a consensus 6% Aggregate other institutional shareholders and engage the company 42% 28% Exit the company Write to independent directors 17% Work with regulatory bodies Work with proxy/voting advisory firms Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 32
SECTION 6: SHAREHOLDER ENGAGEMENT AND THE ROLE OF PROXY ADVISORY FIRMS Still in a nascent stage Proxy advisory firms are the new players in the field yet a quarter of all respondents said they seek help from proxy advisory firms on a regular basis. This is in large part on account of the presence of international money managers, who often have these firms hard coded into their voting guidelines. Three times this number either don’t use the services of such firms or use them occasionally. The feedback from institutional investors is that shareholder engagement is still in its early days in India. While there have been a number of cases where investors have taken a stand and decided to vote against proposals rather than exit their companies, a majority of institutional investors still prefer to vote with their feet and exit their investments. Other obstacles for shareholder activism include the lack of a supportive regulatory mechanism for legal redress, and a fear of being denied management access, or being termed as negative. Do you seek help from proxy advisory firms to finalize your voting decision? 7% Never 19% 43% Sometimes Often Always 31% Source: IiAS Institutional Investor Survey 2014 Why are institutional investors in India not as active as they are internationally? Activism is still in its evolution stage 85% Institutional investors prefer to exit the investment 51% Being denied management access 45% Regulatory mechanism discourages activism 38% Investors fear being viewed as being negative 34% Investee companies will not invest in debt funds 19% Indian companies rank high in governance 6% Institutional investors are fairly active in India 6% Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 33
CONCLUSION Institutional investors see corporate governance as an important criterion for investing and an important determinant of share-price returns. More than three-fourths of the survey respondents believe that well-governed companies will always command a valuation premium respective to their peers in the industry. Our study of perceptions across industries reveals IT services and FMCG as the industries with the best governance practices, while real estate ranks lowest in the perception of investors. Our analysis of the relationship between the perceptions-based industry corporate governance score and median industry share price returns (5 YR) demonstrates a significant relationship between the two. Higher corporate governance is correlated with higher share price returns. The best-governed companies, according to investor perceptions, include Tata Consultancy Services, Infosys, HUL, HDFC and HDFC Bank, Mahindra and Mahindra, and Nestle among others. Professionally-managed companies and MNCs feature more prominently in this list, as compared to promoter-managed firms or PSUs. Investors have shown strong support for shareholder activism, with nearly three fourths of investors taking the view that shareholders are within their rights to make strategic recommendations to their companies. Investors have supported many specific regulatory initiatives pertaining to independent directors and auditors introduced in the Companies Act. They are also unanimously in approval of the new SEBI regulations that mandate approval from a majority of the non-promoter shareholders for Scheme of Amalgamation with related party. The overall response to the proposals of the Companies Act is less optimistic with around 40% of respondents saying that the regulations may not be sufficient to address corporate governance concerns. External takeovers, mergers and acquisitions emerged as the most critical issue among corporate actions concerning investors. However, the most frequently opposed corporate actions are intragroup mergers and other related party transactions. This indicates that although investors perceive high risks in mergers and acquisitions, they are willing to let management follow through on their plans; they are more questioning of related party transactions. Nearly 80% of investors have consulted with other institutions on critical issues, while more than a quarter of respondents said they seek advice from proxy advisory firms on a regular basis. While nearly 60% of respondents are willing to engage with a company to address concerns regarding corporate governance issues, a sizeable 28% of respondents said they would rather exit their investment in such cases. All these data points indicate that shareholder engagement is still in a nascent stage in India. Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 34
PROFILE OF SURVEY PARTICIPANTS Type of institutions Mutual fund 3% 3% 1% 7% 7% Equity House Private Equity fund 30% Others - family office etc Bank 10% Retail Investor 18% Insurance company 21% Hedge Fund Sovereign Wealth Fund Source: IiAS Institutional Investor Survey 2014 Break-up of domestic and foreign funds 39% Domestic 61% Foreign Source: IiAS Institutional Investor Survey 2014 Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 35
Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 36
About Reliance Capital Asset Management Limited Reliance Capital Asset Management Limited (RCAM) is the Asset Manager to Reliance Mutual Fund (RMF), which is one of the largest Mutual Funds in India. RCAM is primarily engaged in the activities of Investment Management and it also renders Portfolio management services. RMF offers a well-rounded portfolio of products across various asset classes including equity, debt and gold in order to meet varying requirements. RCAM constantly endeavors to launch innovative products and customer service initiatives in order to enhance value for its investors. RCAM is part of Reliance Capital, one of India's largest financial services companies. Reliance Capital has interests in various businesses including asset management, life insurance, general insurance, private equity, stock broking, distribution of financial products, and consumer and industrial finance. Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 37
Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 38
DISCLAIMER ----------------------------------------------------------------------------------------------------------------------------------This document has been prepared by Institutional Investor Advisory Services India Limited (IiAS). This document is provided for assistance only and IiAS shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this document. The user assumes the entire risk of any use made of this information. The discussions or views expressed may not be suitable for all investors. This document should not be reproduced or redistributed or passed on directly or indirectly in any form to any other person or published, copied, in whole or in part, for any purpose. This document is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject IiAS to any registration or licensing requirements within such jurisdiction. The distribution of this document in certain jurisdictions may be restricted by law, and persons in whose possession this document comes, should inform themselves about and observe, any such restrictions. The information given in this document is as of the date of this document and there can be no assurance that future results or events will be consistent with this information. This content is subject to change without any prior notice. IiAS reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IiAS nor any of its affiliates, group companies, directors, employees, agents or representatives shall be liable for any damages whether direct, indirect, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information. All layout, design, original artwork, concepts and other Intellectual Properties, remains the property and copyright of IiAS and may not be used in any form or for any purpose whatsoever by any party without the express written permission of the copyright holders. Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 39
Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 40
Markets Governance Where Markets Intersect Governance About IiAS Institutional Investor Advisory Services India Limited (IiAS) is a proxy advisory firm, dedicated to providing participants in the Indian market with independent opinion, research and data on corporate governance issues as well as voting recommendations on shareholder resolutions for over 300 companies. IIAS provides bespoke research, valuation advisory services and assists institutions in their engagement with company managements and their boards. To know more about IiAS visit www.iias.in Institutional Investor Advisory Services 15th Floor, West Wing, P J Tower, Dalal Street, Fort, Mumbai - 400 001 India. Contact firstname.lastname@example.org T: +91 22 2272 1570-3 F: +91 22 22721574 For Subscriptions: Please write to us at email@example.com or login to our subscription module Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 41
Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 42
CONTACT US Institutional Investor Advisory Services Limited (IiAS) 15/F West Wing, PJ Tower, Dalal Street, Fort, Mumbai 400 001 Tel: +91 22 22721570 – 3 | Fax: +91 22 22721574 Website: www.iias.in Institutional Investors Attitudes to Corporate Governance IiAS Survey 2014 43
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