Introduction: –
In every company, there is a separation of ownership and control of the company which means that the company is owned by one person and controlled by another person. This is because most of the time the owners of the company do not have enough time and knowledge to run and look after the daily workings of the company hence, they delegate the work and management of a company to someone qualified to do that. The delegation of work sometimes results in a conflict of interest between the shareholders of the company i.e., owners and the managers of the company i.e., controller, such conflict of interest is known as ‘Agency Problems’. In layman’s terms ‘Agency Problems’ means a situation where the agent works towards achieving his own goals and interests rather than working towards the goals and interests of the owners. I believe this topic is of sufficient interest to the legal community because the existing laws related to the ‘Agency Problem’ are not sufficient and has loopholes in them. Hence through this paper, I will try to shed some light on the issue of ‘Agency Problems’, loopholes in the solution provided by the government to tackle the Agency Problems and how could we solve them.
Agency Problem: –
According to the paper “The Essential Elements of Corporate Law,”[1] there are in total three types of conflicts which could be termed as ‘Agency Problems’ and these conflicts are: –
1. The conflict between shareholders and managers – In most cases the shareholders of a company i.e., the principal do not have enough time and enough knowledge to run the company hence to delegate the work they hire managers i.e., agents. Since the job is delegated to managers the owners of a company are constantly in fear to ascertain whether the managers are working towards achieving company goals, or they are working towards achieving their personal goals.
2. The conflict between majority shareholders and minority shareholders – Shareholders are further divided into majority shareholders and minority shareholders. Majority shareholders are the shareholders who own the majority of shares and as a result, their vote has a higher value. Due to this, the interests of minority shareholders are overlooked, and the managers of the company i.e., the Board of Directors take a decision that is favorable to majority shareholders. As a result, the majority shareholders have the power to manipulate the company’s decisions at the expense of minority shareholders. With respect to India, this type of conflict is more prevalent because the majority of the companies are owned by few families.
3. The conflict between shareholders and the corporations’ other constituencies – Most of the time the owners in an effort to achieve their personal goals overlook the company’s goal and what might be beneficial for the future of the company, in the process of doing that they don’t optimally utilize all the resources and the corporations’ other constituencies such as creditors, its workforce and its customers.
There are numerous reasons due to which “Agency Problems” occur in a company, and the reasons could be: – the owner i.e., the principal of the company provides the money to the managers i.e., agent and desires profit in return and is ready to take greater risks for greater investments whereas managers of a company are inclined towards safer alternatives, other reason could be lack of participation in the day to day activity of the company from the owners’ side which puts managers in a position where they could easily use the money for their benefit rather than for the benefit of the company, another reason could be the lack of transparency and communication of information since the owners do not play an active role in the functioning of the company they are not made aware of all the information and updates and are provided with the information which the managers deems necessary, which obviously puts the managers in an advantageous position.
Corporate Governance: –
To minimize the extent of Agency Problems the government has implemented various laws which makes it necessary for the management of the company to release the company report, its financial condition to the public to increase transparent communication. The government through the enactment of the Securities and Exchange Board of India (hereinafter referred to as SEBI) regulations of 1992 grants the authority to SEBI to conduct a regular inspection in all the companies that enlisted in the Bombay Stock Exchange and National Stock Exchange. The Companies Act, 2013 made serval modifications and brought much-needed changes such as: – section 92 of the act makes it necessary for all the companies to upload the annual report of the company for the public, section 149 which makes it mandatory for the appointment of at least one independent director, section 169 of the act which gives shareholders the power to remove the director, section 177 of the Act makes it mandatory for every company to have an audit committee, and section 203 which makes it necessary for every company to have a company secretary, to name a few.
Loopholes in them: –
Implementation and introduction of all these laws are a welcome change which has lots of benefits with it but there remains a huge problem because the Indian government after the 1991 ‘liberalization, privatization, and globalization of the economy “unwittingly borrowed corporate governance mechanisms from the developed jurisdictions where the companies mostly have a dispersed shareholding pattern, whereas in case of India private enterprises continued to be the exclusive domain of few families who could override the red tape of the license raj era for running their business”[2] and keep on taking advantage of minority shareholders, which rendered several sections of the Companies Act 2013 rather ineffective because of the existence of loopholes in them. Some of the loopholes in the corporate governance were brought to the attention after the promoters of Tata Sons Ltd. proposed to remove Mr. Cyrus Mistry from the position of director of Tata Group companies. The whole incident brought the focus on the loopholes present in sections 149 and 169 of the Companies Act 2013. The intention behind having section 149 which makes it mandatory for a company to have at least one independent director, was to have a person in a position who gives a fair and unbiased decision. But this does not usually happen because of the various reasons such as: – usually the majority shareholders appoint their relatives, friends, or someone who has previously given decisions in their favor, as an independent director. Another reason could be the fact that the majority shareholders have the power to appoint and remove independent directors and hence in most cases independent directors give decisions in favor of majority shareholders. The proposal to remove Mr. Wadia from his position of independent director in Tata Sons Ltd companies after supporting Mr. Cyrus Mistry is a clear signal of the existence of loopholes in the law. According to section 169 “a company may, by ordinary resolution, remove a director before the expiry of the period of his office after giving him a reasonable opportunity of being heard”[3], this means that a director could be removed from his position through a simple majority of votes given by the shareholders present in the shareholders meeting. “Under Indian company law, significant powers are conferred upon a shareholder who has a controlling stake to fire members of the board of directors. And it is precisely this power that’s being exercised by Tata Sons”[4] to remove Mr. Cyrus Mistry from his position as they have the majority of shares. This not only gives majority shareholders extra power but also which the minority shareholders in a vulnerable position as their opinion does not matter because of the rule “majority democracy”.
The Kotak Committee Report and Suggestions: –
Due to the increase in misappropriation of these laws, SEBI formed The Kotak Committee to suggest modifications in the existing law. The committee suggested numerous proposals such as people holding 20% or more shares of a company should be considered ‘related to each other’ for listing regulations, the board of directors must meet once every year to decide upon topics which are important for the longevity of the company, such as succession and risk management so that the company is well prepared in an adverse situation, it also suggested changes in the eligibility criteria and process of electing an independent director, the committee “also seeks to prevent board interlocks. Thus, if a non-independent director in a company is an independent director in another, any non-independent of the latter company cannot be an independent director in the former, the other significant change suggested pertains to prohibiting the interlocking of boards arising due to the presence of the common non-independent directors on the board of listed companies.”[5] Apart from the suggestions mentioned by the Kotak Committee I believe the rule of “one share one vote” should be replaced with the rule “one person one vote” this will not only stop majority shareholders from running the company on their terms but also would place minority shareholders on an equal footing where their opinions will be heard.
Conclusion: –
This article mainly focuses on the concept of “Agency Problems”, their types, and the reason for their occurrence. After researching it led to the conclusion that to overcome the shortcomings of the present law the government in addition to the Kotak Committee Report should consider the suggestion of ‘one person one vote’ rule and should constitute another committee to figure out loopholes in the present law before anyone uses it for their benefit.
References
Armour, J., Hansmann, H., & Kraakman, R. The Essential Elements of Corporate Law What is Corporate Law?.
Poddar, R. (2018, December 14). Kotak committee Report: India’s recognition of its unique corporate governance problem. IRCCL. Retrieved from https://www.irccl.in/post/kotak-committee-report-india-s-recognition-of-its-unique-corporate-governance-problem.
The Companies Act, 2013
Varottil, U. (2016, November 12). The Tata Episode: Corporate governance and the continuing influence of promoters. IndiaCorpLaw. Retrieved from https://indiacorplaw.in/2016/11/corporate-governance-in-india-and.html.
[1] Written by Armour J, Hansmann H and Kraajman R, (November 2009), Harvard Centre for Law, Economics and Business.
[2] Poddar, R. (2018, December 14). Kotak committee Report: India’s recognition of its unique corporate governance problem. IRCCL. Retrieved from https://www.irccl.in/post/kotak-committee-report-india-s-recognition-of-its-unique-corporate-governance-problem.
[3] The Companies Act 2013
[4] Varottil, U. (2016, November 12). The Tata Episode: Corporate governance and the continuing influence of promoters. IndiaCorpLaw. Retrieved from https://indiacorplaw.in/2016/11/corporate-governance-in-india-and.html.
[5] Poddar, R. (2018, December 14). Kotak committee Report: India’s recognition of its unique corporate governance problem. IRCCL. Retrieved from https://www.irccl.in/post/kotak-committee-report-india-s-recognition-of-its-unique-corporate-governance-problem.
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