Reform, and the Enterprise That Serves Two Masters

What the reform agenda actually proposes, and the governance problem an officer is most likely to face in person: the state-owned enterprise.

The Kotak Committee and the direction of reform

SEBI constituted a committee on corporate governance under Uday Kotak which reported in 2017, and its recommendations shaped the subsequent tightening of listed-company obligations. It is worth knowing not as a list to reproduce but for the direction it establishes.

The recommendations addressed board composition and functioning, including minimum board size, the proportion of independent directors, limits on the number of directorships one person may hold, and the separation of the roles of chairperson and chief executive so that the person leading the board is not the person the board must supervise. They addressed information and evaluation, requiring better material for directors, board performance evaluation, and separate meetings of independent directors.

They also covered disclosure, including of related-party transactions, board skills and the reasons for a director’s resignation, a small requirement with real force since a director leaving over a disagreement is a signal outsiders should receive. Further recommendations concerned audit quality, shareholder participation including electronic voting, and risk management.

The unifying logic is worth stating in an answer: nearly every recommendation attempts to make the board genuinely capable of challenging management, by improving who sits on it, what they know, how they are assessed, and what outsiders can see. That is the same objective pursued in Chapter 16 through published criteria and recorded reasons, applied to a different institution.

Public sector undertakings: two masters

The governance problem an officer will most likely encounter personally is the state-owned enterprise, and it has a structure of its own. A PSU is a company, subject to company law and often listed, and it is also an instrument of government policy owned by a ministry.

The resulting difficulty is not corruption but conflicting mandates. The board owes duties to the company and to all its shareholders, including minority public investors; the ministry has policy objectives that may not maximise commercial value. Where a PSU is directed to price below cost, invest in an unremunerative location, or absorb an obligation for public reasons, the public purpose may be entirely legitimate while the commercial interest of the company and its minority shareholders is damaged.

The honest analysis, and the one that earns marks, is that this conflict cannot be abolished, because it follows from state ownership itself. It can only be made transparent. Where government requires a PSU to pursue a non-commercial objective, the direction should be explicit, recorded and compensated, so that the cost of the policy is visible in the public accounts rather than concealed inside the company’s performance. Undisclosed cross-subsidy is what makes PSU performance impossible to assess and management impossible to hold responsible.

Autonomy, appointment and accountability

Three further difficulties recur. Boards are frequently dominated by government nominees and serving officials, so independent scrutiny is limited, and independent director positions may remain vacant for long periods. Operational autonomy is constrained by approvals required for decisions a comparable private company would take itself, which slows response and diffuses responsibility until it is unclear who is answerable for a result.

Appointments and tenure are the third. Where senior appointments are delayed, made on short tenures, or influenced by considerations other than capability, the effect on performance is direct: an executive with two years remaining will not begin work that takes five, and an organisation that cannot plan beyond the next appointment cycle will not invest in anything durable.

The reform agenda follows from the diagnosis. Professionalise boards with genuinely independent members appointed through a transparent process; fill vacancies promptly; define clearly which decisions belong to the board and which require government approval, and reduce the latter; set objectives in advance through a documented performance agreement covering both commercial and public-purpose goals; and make appointments and tenures predictable. None of this is exotic, and the obstacle has never been the absence of proposals.

A case: the officer on the board

Consider an officer nominated to the board of a state enterprise. Management proposes a transaction with a company connected to a person of influence. The papers arrive the previous evening, the valuation is asserted rather than demonstrated, and the chairperson indicates that the matter has been discussed at higher levels and approval is expected.

Every failure mode in this chapter is present: late papers, inadequate information, an implicit instruction, a related party, and pressure to treat approval as a formality. The correct course is procedural rather than confrontational, which is also what makes it defensible. Ask for the valuation basis and the process by which the counterparty was selected. Request deferral to the next meeting on the ground that the information is insufficient for the decision, which is a statement about the papers rather than about anyone’s motives. Ensure the request and the reasons are minuted, since Chapter 16 established that the recorded reason is the most effective discipline available. If the transaction proceeds regardless, record dissent.

Notice that none of these steps requires accusing anyone. They require insisting on the process the board exists to apply, which is both the strongest position and the safest one. That is the practical meaning of governance, and the note on which Part IV of this book closes: institutions do not fail because rules are absent, they fail because someone stops applying them and nobody objects on the record.

What the officer regulating a sector should take from this

Most candidates will never sit on a board, but many will regulate, license or purchase from companies. Four working principles follow from this chapter and are worth carrying into an answer on regulation generally.

First, regulate the structure, not the sentiment. Assurances of good intent are unverifiable and cost nothing to give. Requirements about who decides, what must be disclosed and who must approve are verifiable and change behaviour. Second, ask who bears the loss if the firm is wrong. Where the answer is depositors, small suppliers, employees or the public, the case for intervention is strong regardless of how well governed the firm appears.

Third, watch for the failure of gatekeepers rather than only the conduct of the firm. If auditors, ratings and boards are all signalling health, that is not independent confirmation when each of them is paid or appointed by the entity being assessed. Fourth, be sceptical of good results. As Part 1 argued, weak governance is concealed by growth and revealed by its absence, so the moment to examine an institution is when it is performing well and nobody wants the scrutiny.

Where Part IV has brought us

These four chapters have followed a single argument. Chapter 15 established that dilemmas are largely manufactured by institutional conditions rather than by defective individuals. Chapter 16 set out what can be built to change those conditions: design that reduces the occasion for wrongdoing, transparency that makes conduct visible, accountability that attaches consequences, and leadership that demonstrates the standard. Chapter 17 has tested the same propositions in a different setting and found them holding.

The convergence is the point. A company and a district administration face the same underlying problem, that authority has been delegated to people whose principals cannot easily observe them, and both arrive at the same family of remedies: separate the decision from the interest, require reasons to be recorded, make information available to those who can act on it, and ensure that the person who checks does not depend on the person being checked.

Part V now turns to the specific mechanisms through which this is done in public administration: codes of conduct and codes of ethics, the citizen charter, work culture, service delivery, information sharing, accountability and the use of public funds. Chapter 18 begins with the instrument this chapter has repeatedly invoked, and asks what separates a code that governs conduct from one that merely describes it.