LEGAL ASPECTS OF BUSINESS

SHAREHOLDER ACTIVISM IN INDIA SHORT OF ACTION

Subramaniam S
2013PGPM054

EXECUTIVE SUMMARY
The recent spate of crises afflicting the corporate and financial sectors
around the world has triggered a new wave of corporate governance
reforms, which call for greater empowerment of institutional and retail
shareholders. The need for such reforms cannot be greater than in
India where controlling shareholders, or promoters, dominate the
corporate landscape.

Consistent with reforms in several countries that seek to confer greater

power in the hands of shareholders, the recent

regulatory

developments in India signify a greater opportunity for shareholder

participation in the form of postal ballot, e-voting and the like. The
rapid proliferation of proxy advisory firms, a hitherto non- existent
phenomenon

in

India,

bestows

shareholders with the advice

necessary to exercise their corporate franchise in an informed manner.

The presence of activist institutional shareholders such as private
equity funds and hedge funds has already caused an upheaval in some
corporate boardrooms in India.

While these developments pave the way for a transformation in the

tenor of the governance debate, shareholder activism encounters
certain structural and institutional weaknesses embedded in the Indian
markets. The dominance of controlling shareholders in most Indian

companies operates to dampen the effects of shareholder activism.

The legal system and institutions in India are not conducive to
rendering timely and cost-effective remedies to shareholders who
adopt a litigation strategy to counter managements that are perceived
to act inimical to shareholder interests. This report finds that although
shareholder activism is becoming palpable in the Indian markets, its
impact as a measure of corporate governance enhancement is far from
clear.

Contents
1.

Introduction ................................................................................... 1

2.

Shareholder Activism: The Concept .............................................. 3

A.

Collective Action Problems ........................................................ 3

B.

Defining the Concept ................................................................. 5

3.

Shareholder Passivity as the Starting Point................................... 7

4.

Regulatory Reforms Towards Greater Shareholder Participation ..

..................................................................................................... 11
A.

Voting Methods ....................................................................... 11

B.

Shareholder Meetings.............................................................. 13

C.

Voting as Responsibility ........................................................... 15

D.

Assessing the Reforms ............................................................. 16

5.

Corporate Governance Intermediaries........................................ 18

A.

Proxy Advisors in India: Their Influence................................... 19

B.

Concerns and Possible Mitigating Factors ............................... 21

C.

Other Informational Intermediaries ........................................ 25

6.

Feasibility of Interactive/Combative Strategies .......................... 26

A.

Interactive Strategy.................................................................. 27

B.

Change of Control Strategy ...................................................... 29

C.

Litigation Strategy .................................................................... 30

7.

8.

Evaluating the Impact of Shareholder Activism .......................... 32

A.

Distilling the Evidence .............................................................. 32

B.

Effect on Controlled Companies .............................................. 35

Conclusion.................................................................................... 38

1.

Introduction

The last two decades have witnessed a significant thrust towards

enhanced corporate governance standards in India. While some of
this may be attributable to the globalization of governance practices
that have had their impact on Indian companies, regulatory reforms
spearheaded by the Securities and Exchange Board of India (SEBI) have
also had a role to play. Since 2000, SEBI has required public listed
companies to deploy well-recognized governance structures and
mechanisms. These include an independent board of directors, an
independent audit process, certification of financial statements by the
chief executive officer and chief financial officer, and the like. These
efforts have been embraced by the stock markets that have conferred
a premium towards good governance practices.

At the same time, the existing standards are said to be far from the
desirable, and governance crises such as that witnessed in the
Satyam accounting scandal have underscored this line of criticism.
Given the influence of controlling shareholders in most Indian
companies, one of the significant shortcomings in the current
dispensation is the lack of shareholder activism, particularly amongst
institutional and retail investors that hold minority stakes. This
perceived weakness in Indian corporate governance appears to be
addressing itself through the onset of activist shareholders in the

Indian corporate sphere, whose efforts have been further buoyed by

regulatory reforms. The phenomenon of shareholder activism, hitherto
absent in India, has made its mark rapidly, and has become a force to
reckon with for Indian listed companies.

Consistent with reforms in several countries that seek to confer greater

power in the hands of shareholders, the recent regulatory
developments in India signify a greater opportunity for shareholder
participation in the form of postal ballot, e-voting and the like. The
rapid proliferation of proxy advisory firms, a hitherto non-existent
phenomenon in India, bestows shareholders with the advice necessary
to exercise their corporate franchise in an informed manner. The
presence of activist institutional shareholders such as private equity
funds and hedge funds has already caused an upheaval in some
corporate boardrooms in India.

While these developments pave the way for a transformation in the

tenor of the governance debate, shareholder activism encounters
certain structural and institutional weaknesses within the Indian
markets. The dominance of controlling shareholders in most Indian
companies operates to dampen the effects of shareholder activism.
The legal system and institutions in India are not conducive to
rendering timely and cost-effective remedies to shareholders who
adopt a litigation strategy to counter managements that are perceived

to act inimical to shareholder interests. This report finds that although

shareholder activism is becoming palpable in the Indian markets, its
impact as a measure of corporate governance enhancement is far from
clear.

2.

Shareholder Activism: The Concept

Before examining definitions of shareholder activism, it would be

useful to identify the problem that the concept seeks to address.

A.

Collective Action Problems

In large public listed companies, the public (or non-promoter)

shareholders have relatively small stakes and these do not provide
sufficient incentives for them to act together and form coalitions to
meaningfully participate in decision-making of companies. In the classic
Berle & Means corporation where shareholding is diffused, while the
shareholders are owners of the company, the managers controlling
the company as shareholders are unable to participate in decisionmaking due to collective action problems. Even in controlled
companies, which are predominant in India, collective action
problems prevent minority shareholders from coalescing, which
reduces their effective participation through the exercise of corporate
franchise. In such a case, the lack of minority shareholder participation

augurs to the benefit of the controlling shareholders, and managers

appointed with their concurrence. Related to the collective action
problem is shareholder apathy. Since the costs of coordination
among minority shareholders are high, these shareholders either
abstain from voting or merely vote in favor of management (or the
controlling shareholders, as the case may be).

Due to collective action problems and shareholder apathy, both retail

and institutional investors have historically been passive shareholders.
The evolution of more active shareholders has been fairly recent.
It is only in the 1980s that even developed economies such as the
United States (US) witnessed the phenomenon of active investors,
which began through institutional investors such as pension funds and
other large institutional investors. Unsurprisingly, this field
has attracted academic research only more recently, as compared to
other areas of corporate governance.

With this background, it would be useful to examine how shareholder

activism may be defined, and also to consider various types of
activism.

B. Defining the Concept

Shareholder activism is considered to be a set of proactive efforts [on

the part of shareholders] to change firm behavior or governance
rules. It signifies the efforts on the part of investors to influence the
behavior of management in governing the company. Activist investors
are often viewed as investors who, dissatisfied with some aspect of a
companys management or operations, try to bring about

change

within the company without a change in control.

Activist investors can be contrasted from passive investors, who rarely
participate in corporate decision-making. Passive investors usually
vote with their feet. If they are not satisfied with decisions taken by the
management or controlling shareholders, they simply exit the company
by selling their shares, a practice fancifully referred to as the Wall
Street walk.

There are various shades of shareholder activism, although this report

primarily deals with three. I refer to the first type as participative
shareholder activism. In this type, shareholders assume greater
responsibility

for

participating

in

shareholder

meetings and

exercising their corporate franchise. This way, greater participation by

minority shareholders could have an impact on the outcome of
corporate decisions. Even if the decisions themselves may not be

different because minority shareholders may only have infinitesimal

shareholding in the company, their overwhelming response cannot be
ignored altogether by managements and controlling shareholders.
While shareholders, particularly of the institutional variety, are
demonstrating greater interest in participative activism, legal reforms
in various jurisdictions are utilizing soft law and self-regulatory
mechanisms to encourage greater participation by shareholders in
corporate decision-making.

The second type of activism is more upfront. Interactive

shareholder activism involves the direct engagement by the
shareholders with the management. Large institutional shareholders
seek to interact with the management and obtain an assessment of
the affairs of the company. Such interaction usually takes place
when either the shareholders are unconvinced of the direction adopted
by the management on certain matters, or when the company
undertakes a major transaction (such as a merger) or suffers a
material

adverse effect (such as a significant loss, or other

extraordinary event such as a corporate fraud). Shareholders not

only interact to obtain more information from the management,
but also to convince the management of the strategy to be followed
and changes to be effected to enhance value to shareholders. The
downside of the interactive type of activism is that management and
controlling shareholders are under no legal compulsion to engage

with shareholders, and can simply choose to ignore them. In such a

case, the interactive efforts may not be fruitful.

An extended version of such interactive type brings us to the third

category where shareholders adopt a combative strategy. This involves
efforts to overthrow incumbent management through processes
such as proxy fights or hostile takeovers that result in a change in
control of the company. A more aggressive form involves the initiation
of litigation against the company, its board and management. Certain
types of investors, such as pension funds and hedge funds, have
utilized this strategy more recently in certain jurisdictions like the US to
achieve their goals.

With this background regarding the rationale for, and types of,
shareholder activism, the report now turns to the evolution of
the phenomenon in India.

3.

Shareholder Passivity as the Starting Point

During the initial years since Indias independence, shareholder

passivity was all-pervasive. The equity markets were considerably
shallow, and retail investment in Indian listed companies was
negligible. Although a few leading Indian business houses had listed
companies within their stables, retail investors were unable to make

any dent in the influence of controlling shareholders, who wielded

significant control over their companies due to the substantial
shareholding they commanded. Even if retail shareholders were able to
participate in shareholder meetings and express their views,
managements and controlling shareholders could afford to ignore the
minority voice due to their negligible shareholding in the company and
their consequent inability to affect the outcome of corporate decisions.
The legal regime governing corporate decision-making did not come
to the aid of retail shareholders either. Company meetings had to be
convened at specified physical locations. Several leading companies
had their registered offices in remote locations, which made retail
participation impossible, if not cumbersome. All of these resulted in
passivity among retail shareholders.

On the other hand, certain institutional shareholders such as banks,

development financial institutions (DFIs) and the then largest mutual
fund, the Unit Trust of India (UTI), held larger stakes in companies
in comparison to retail shareholders. It is reasonable to expect these
institutions to exercise their investment oversight more actively.
However, that was not necessarily the case. The banks, DFIs
and UTI were heavily subjected to governmental and bureaucratic
control and influence. Although these institutional shareholders often
appointed their nominees to the boards of investee companies and
also exercised their voting rights somewhat regularly, they were never

perceived as independent investors or as a threat to management and

controlling shareholders. The strong nexus that existed between
government and industry ensured that the management always
enjoyed the support of these institutional shareholders. Hence,
although the institutions exercised greater level of participation than
retail shareholders, their influence as activists was minimal at best.
These influences continued to a large extent post-liberalization in
1991, but the shareholding of such government-controlled banks and
institutions in Indian companies has witnessed a dramatic fall in
recent years, due to which their influence has considerably waned.

A related category of institutional shareholders is foreign portfolio

investors. They invest into Indian listed companies through multiple
routes. Prominent among them is the foreign institutional investor
(FII) route, whereby FIIs may acquire and divest shares in Indian
companies through the stock exchange. All administrative aspects of
the investments are handled through domestic custodians appointed
for the purpose. Although FIIs hold substantial shares in
Indian companies, they have seldom exercised voting rights in those
companies, barring exceptional circumstances.

Another category of foreign investors subscribes to depository receipts

(DRs) in Indian companies instead of acquiring the underlying shares.
Interestingly, investors in DRs have not displayed any keenness at all

in the exercise of voting rights on the underlying shares. As a

matter of law, since it is the depository that holds the underlying
shares, only it can exercise voting rights, and the DR holders do
not have any legal right to vote. A number of different models were
adopted through market practice to address this. In some cases,
voting rights have been conferred on the depository, to be exercised
according to the instructions of the board of directors of the company.
In such a case, the votes of the DR holders shares will be aggregated
with that of the management (and indeed, the controlling
shareholders). In other cases, custodians must exercise voting rights on
the DRs only when that is legally required. Since Indian corporate law
does not obligate shareholders to exercise voting rights, it is not
possible to envisage a situation when voting rights will ever be
exercised on such shares. Only in limited instances are depositories
required to exercise voting rights according to the wishes of the DR
holders. All of these suggest that in case of companies with DRs, the
votes in respect of the DRs are either exercisable in accordance with
the wishes of management, or the DRs have been effectively
disenfranchised. Managements and controlling shareholders therefore
faced virtually no influence from foreign institutional investors, who
either invested directly or through DRs.

Shareholder passivity, both among retail and institutional shareholders,

was the norm following liberalization as well, and continued to be so

10

until very recently. However, this status quo seems to have been
disturbed more lately in the phase after the Satyam accounting
scandal. Not only have the regulators begun to recognize the need
for greater shareholder participation in Indian listed companies, but
investors themselves (particularly financial institutions) have sought
to monitor their investments more carefully. The report now turns to
these developments and their impact on corporate governance in India.

4.

Regulatory Reforms Towards Greater Shareholder

Participation

Over the last decade, regulatory efforts in India have focused on

inducing greater participation in shareholder decision-making. This has
been implemented through a step-by-step approach that addresses
different facets of shareholder participation. These include the manner
of voting, the manner of participating in shareholders meetings, and
whether shareholders might be compelled to cast their votes. Each of
these is addressed below.

A.

Voting Methods

In 2001, the facility of voting by postal ballot was introduced.

This was intended to address the problems faced primarily by retail

11

shareholders who had to attend and physically participate in

shareholder meetings, often in remote locations of the country. The
system of postal ballot permits shareholders to send in their votes by
post instead of personally attending and voting at a meeting. A set of
rules promulgated by the Central Government listed certain resolutions
that are to be mandatorily put to vote by postal ballot. In other cases,
the company has the option to offer the postal ballot facility.

While the postal ballot facility represented a sea change in terms

of providing a better option for retail shareholders to cast their
corporate franchise, it failed to make a serious impact. The postal
ballot facility may have removed some of the procedural obstacles to
shareholder voting, but it was not intended to address the
broader issues of collective action problems and shareholder apathy.
Moreover, since shareholders are unable to participate in the
discussions, and to obtain the benefit of the deliberations in the
meeting before they cast their votes, participation levels have been
found to be extremely low. One report states that the response of
shareholders through postal ballot has been abysmally low at only
about 3% on average.

Given the inadequate functioning of the postal ballot system, more

recent regulatory developments have sought to utilize technological

12

advancements to enhance shareholder participation and voting. On

this occasion, the initiative emanated from SEBI. In July
2012, SEBI amended the listing agreement requiring large companies
to provide electronic voting (e-voting) facilities in respect of matters
requiring postal ballot. According to this new dispensation, the top
500 listed companies on the Bombay Stock Exchange and the National
Stock Exchange are required to provide e-voting facility with effect
from October 1, 2012. Two agencies have already been certified to
provide e-voting platforms. Although it is too early to gauge the
effectiveness of e-voting, it is expected to generate greater
participation by shareholders. For example, the e-voting process is less
costly compared to the postal ballot, and involves less time and effort
on the part of the shareholders as well as the company. However, due
to its reliance on technology, the success of e-voting would depend on
the extent of penetration of computers and the Internet across
the country.

B.

Shareholder Meetings

In order to enable the shareholders to exercise their corporate

franchise in an informed manner, it is important that they are able to
participate in meetings, both to make an assessment as to the
manner in which they should exercise their votes, also to speak at the
meetings and convey their views to enable the other shareholders

13

to exercise their votes in an informed manner as well. Recognizing the

limitations of physical shareholders meetings, the Government of
India has introduced

the

concept

of

electronic

participation.

Companies may now provide the option to shareholders to attend

meetings electronically, through audio-visual means, such that all
persons participating in that meeting communicate concurrently with
each other without an intermediary, and participate effectively in the
meeting. Moreover, companies may provide video conferencing
connectivity during such meetings in at least five locations within
India. At the same time, responsibility is placed on the company and
the chairman of the meeting to put in adequate safeguards to ensure
the integrity of the meeting. Although these measures were initially
intended to be mandatory for listed companies in the period
subsequent to the financial year 2011-12, concerns were raised
regarding the legal validity of electronic meetings in the context of the
Companies Act, due to which such electronic meetings are intended to
be optional for listed companies too.

Since these measures are only optional, and are yet to be fully
effective, they are unlikely to be widely followed. While it is certainly
possible that some of the blue-chip companies will adopt these
voluntary measures, widespread compliance across corporate India
may have to wait.

14

C.

Voting as Responsibility

Shareholding in a company is considered to be a bundle of rights. One

such right conferred is to participate in corporate decision-making
through the exercise of voting power. In this jurisprudential backdrop,
any kind of obligation or responsibility to exercise voting rights is
antithetical to the rights or entitlement-based understanding of share
ownership. Hence, shareholders cannot generally be compelled to
exercise their voting rights in any manner, or at all. This legal
understanding

of

share

ownership

does

not facilitate greater

shareholder participation in companies, the consequence of which is

shareholder passivity.

Although shareholders cannot be compelled to exercise their votes,

regulatory authorities have begun to adopt market-based approaches
to address passivity among institutional investors. In a move that is
somewhat unconventional in the Indian context, SEBI has sought to
exhort a specific type of institutional investor, i.e. mutual funds, to
exercise their voting rights in investee companies in a responsible
manner. In 2010, SEBI issued a circular to mutual funds requiring them
to play an active role in ensuring better corporate governance of
listed companies. Adopting a comply-or-explain approach,

SEBI

requires asset management companies of mutual funds to disclose

on their websites and in annual reports their general policies and

15

procedures regarding the exercise of votes on listed companies.

Moreover, they are also required to disclose the specific exercise of
voting rights in respect of identified matters such as corporate
governance, changes to capital structure, mergers, takeovers, and the
like.

By imposing mandatory disclosure obligations and thereby enhancing

transparency, this compels mutual funds to take a more active and
considered role while exercising their voting rights on companies. It
may no longer be possible for mutual funds to either abstain from
voting or to grant proxies in favor of managements or controlling
shareholders

without

following

reasoned

decision- making

process. This is particularly relevant because institutional investors

such as mutual funds possess significant shareholding (at least in
the aggregate, if not individually) with the power to tip the scales on
key voting matters such as mergers, change of control transactions,
preferential allotments of securities and the like.

While SEBIs circular technically applies only to mutual funds, its

broader message could well pave the way for greater participation by
other types of institutional shareholders.

D.

Assessing the Reforms

16

The regulatory reforms discussed in this section have been

fragmented in nature, but their common theme has been to increase
shareholder participation in meetings and voting. This would
strengthen the hands of minority shareholders, both of the retail and
institutional varieties, by removing various procedural hurdles that
have impeded their extensive participation in the past. By imposing
stewardship responsibilities on institutional investors such as mutual
funds, SEBIs goal has become clearer.

At the same time, it would be imprudent to assume that such

regulatory reforms would by themselves instill greater shareholder
participation. More specifically, institutional shareholder activism
must be self-generated, although a trend in India towards such
activism appears to be developing steadily.

Despite these regulatory reforms, one significant area of concern

continues to be the lack of adequate information available with
shareholders in order to enable them to exercise their considered
vote. While the Companies Act does contain elaborate provisions as to
the notice to be given to shareholders to convene meetings, both in
terms of the time period and information to be provided,

the

disclosure and transparency standards followed in practice continue to

be below par. While there has been a gradual increase in the amount
and quality of information disseminated to shareholders to elicit their

17

franchise, it is arguably inadequate. The lack of availability of quality

information strikes at the heart of shareholder indifference in the
exercise of voting rights. Intermediaries such as proxy advisors and
governance analysts can bridge the informational disparity to some
extent. While such intermediaries played a negligible role, if at all, in
Indian corporate governance in the past, they have revolutionized the
governance sphere in the last two years. In the next Part, I consider the
impact of these intermediaries on shareholder activism in India.
5.

Corporate Governance Intermediaries

Globally, governance intermediaries such as proxy advisors play a

significant role in influencing corporate decision-making. Proxy
advisory

firms

analyze

corporate

proposals

and

make

recommendations to their clients, who are primarily institutional

investors, on the manner in which they should exercise their votes.
The firms also put out public recommendations, which can be utilized
by retail shareholders for whom it is uneconomical to specifically turn
to proxy advisors. The proxy advisory industry is rather well
established internationally, and it is actively involved in corporate
governance in jurisdictions such as the US. For example, the industry
leader, Institutional Shareholder Services (ISS) controls about 61% of
the market, and is a force to reckon with, as its recommendations are
capable of swinging the votes at shareholders meetings and altering
the outcome of the decision taken.

18

A.

Proxy Advisors in India: Their Influence

Since 2010, the proxy advisory industry has blossomed in India as well.
Within a span of two years, three proxy advisory firms have been
established in India, and they have already published hundreds of
recommendations regarding corporate proposals pertaining to
various listed companies in India. Their recommendations cover
companies proposals relating to the appointment of directors
(especially independent directors), the appointment of auditors,
and major corporate transactions such as mergers and takeovers.
Where there are governance concerns, the recommendations of proxy
advisors have been against the management proposals. For example,
these firms have recommended against appointment of independent
directors who have served companies for a long period of time,
although there is yet no maximum tenure mandatorily prescribed for
independent directors. They have raised similar concerns with respect
to auditor appointments. They have also registered opposition in the
case of mergers and corporate restructurings where there is a
likelihood value to the public shareholders might be eroded.

No longer can managements and controlling shareholders ignore

the influence of minority shareholders (both institutional and retail).
The recommendations of the proxy advisory firms have the effect of

19

shedding greater light on corporate proposals, and of galvanizing

minority shareholders to overcome collective action problems and
shareholder apathy and to participate more effectively in corporate
decision-making. The fledgling nature of the proxy advisory industry in
India and the absence of systematic empirical evidence might not yet
indicate whether there has been greater exercise of minority franchise
in Indian listed companies, but the fact that the recommendations are
discussed in the public domain in a transparent manner (such as
through the financial press) is expected to operate as a set of checks
and balances against managements and controlling shareholders from
initiating proposals that might not pass muster from a governance
standpoint.

Another positive effect of the proxy advisory industry is its ability to

constantly enhance governance standards. Although listed companies
in India are required to comply with the standards of corporate
governance set out by law, the close monitoring by proxy advisory
firms will motivate companies to elevate their standards of
governance. It is expected that the industry will also help instill global
best standards and practices among Indian companies.

Proxy advisory firms also benefit institutional investors in other

ways. For example, it

is no longer necessary for institutional

investors to spend efforts and costs on research, as they can simply

20

outsource these functions to external firms. The investors and their

managements can train their resources on investment analysis and
decisions, and minimize their focus on governance decisions in their
investee companies. Moreover, managers of institutional shareholders
tend to discharge their responsibilities to their own investors by relying
upon external independent advice on voting and governance matters.

While the emergence of the proxy advisory industry represents a

whole new chapter in Indian corporate governance as it generates the
much need activism among public shareholders, it is necessary to
caution against some possible concerns that have been witnessed in
other jurisdictions. It is much too early to determine their impact in
India yet, but lessons from experiences in those jurisdictions would
play a role in better moderating the functioning of the industry in India
so as to take full advantage of its benefits by addressing any ill-effects
along the way.

B.

Concerns and Possible Mitigating Factors

At a conceptual level, there are different lines of concerns raised

regarding the operation of proxy advisory firms. These concerns

21

have emanated globally in the industry, and are not specific to India,
where the experience with the industry is fairly new. First, proxy
advisory firms may suffer from conflicts of interest, either actual
or potential, that may impinge upon the independence and
impartiality of their recommendations. Proxy advisory firms comprise
both for-profit entities that must raise revenues to carry on their
business, and some non-profit entities. While for-profit entities
mainly charge their customers (being institutional investors) a fee for
the advisory services rendered, some firms also seek other income by
offering consultancy services. Often, such services, which are in the
nature of governance consultancies, are provided to listed companies.
This raises conflict concerns, as the independence of recommendations
put out in respect of such companies is not beyond doubt. It is not
known if such conflicts have manifested in the Indian context yet, but
it is useful to take cognizance of international practices that have
emanated.

Second, there are concerns regarding the policies followed by the

proxy advisory firms while conducting their research and issuing
recommendations. One of the criticisms is that the governance
methodologies and metrics developed and utilized are too general and
do not pay sufficient attention to the specificities involved in each
company. For example, there could be a tendency to adopt a check-

22

the-box or one-size-fits-all approach, without delving into the

circumstances that operate in each company or with respect to
different proposals. Excessive standardization of recommendations will
have

the

effect

of substantially diluting

their

value,

and

obliterating the contributions that proxy advisory firms can make

towards better corporate governance.

Third, the functioning of proxy advisory firms can be subjected to more

optimal monitoring with a robust legal regime that clearly delineates
the legal responsibility and liability of proxy advisory firms for the
advice they provide. Currently, such a regime does not exist in India.
At most, firms may be responsible contractually for the advice they
provide to institutional investors with whom they have a contractual
relationship. Responsibility for a wider audience in the form of
retail investors for public recommendations is even remote. The
absence of such a regime for responsibility could potentially threaten
the full utilization of the proxy advisory industry as an effective
corporate governance intermediary.

At a broad level, some of the concerns raised may be addressed either

by market forces or by governmental regulation. A market-based
approach would rely on a number of high quality players in the
industry to enhance standards through competitiveness. This would
necessitate the presence of a larger number of players in the

23

industry as opposed to the current oligopoly situation witnessed in the

market, both in India and globally. The shortcoming of relying purely
on a market-based approach is evident from other sectors in the
corporate governance field, such as credit rating agencies and large
accounting firms, where a limited number of large players dominate the
industry.

On the other hand, proxy advisory firms are subject to virtually no

governmental regulation. Since the lack of a legal regime governing the
industry would exacerbate the issues such as conflicts of interest and
the inadequacies in transparency standards, leading economies
around the world are actively considering reform efforts to rein in
proxy advisors. Proposals for regulating the proxy advisory industry
are under active consideration in Europe, the United States and
Canada.

In India, proxy advisory firms do not fall within any specific

regulatory oversight mechanism. Given the industrys nascence, SEBI,
which may have the closest domain relationship with such firms, has
not yet taken any steps to regulate it. At the same time, there have
been calls for SEBI to initiate steps to regulate the industry and lay
down standards of service to be provided by proxy advisory firms.
This would require the establishment of a registration mechanism for
such firms, which would ensure that only those firms with basic

24

qualifications and competence levels will be permitted to carry on the

business, thereby instituting high entry-barriers. This would help
maintain high quality standards in the industry. Such a registration
mechanism would also help SEBI monitor the actions of the firms, and
also to impose sanctions in the event of non-compliance with services
standards. This would be similar to the regulation of credit rating
agencies, whereby SEBI has been effective in maintaining standards
within the Indian industry, although the industry at the wider global
level had come under some criticism due to its role in the sub-prime
crisis.

C.

Other Informational Intermediaries

Apart from proxy advisory firms, other types of intermediaries are

beginning to cast their spell on Indian corporate governance. The year
2012 has witnessed several analysts publishing reports regarding
various Indian leading companies on matters that range from
accounting practices to governance standards to the role of controlling
shareholders.

By highlighting

issues regarding governance

of

companies, which extends beyond the traditional confines of financial

analysis, these intermediaries are imposing considerable pressure on
managements and controlling shareholders to re-examine their own
governance standards and practices. This will lend itself to greater

25

transparency, as the availability of more information and deeper

analysis will enable investors to take a more informed view of their
investments.

However, this phenomenon is very recent, and its impact on overall

governance standards is yet unknown. In any event, certain recent
reports issued by analysts have been surrounded by their own share of
controversies. Not only have these reports been strongly refuted by
companies and their managements, in one case a criminal complaint
was even filed by the company concerned against the analyst firm
and the individuals who authored the report. For these reasons, a
more detailed consideration of the impact of these analyst firms as
informational intermediaries on Indian corporate governance must
await another day.

6.

Feasibility of Interactive/Combative Strategies

After having considered the measures adopted by the regulators and

the industry to enhance shareholder participation, it is now
appropriate to explore the trends and strategies that activist investors
may adopt by directly interacting with their investee companies in
India and, if those result in failure, by undertaking more severe
measures such as bringing about a change in control of the companies

26

or even litigating against the companies, their directors and

management.

A.

Interactive Strategy

Some types of investors, such as private equity funds, venture capital

funds and even hedge funds engage in relationship investing, which
involves a long-term relationship between the investors and the
company. In this arrangement, investors are in close contact with
management and they also tend to provide strategic advice to
management that is beneficial not only to the company but also
indirectly preserves (or even enhances) value to the investors in the
stock they hold. While it is likely that such interactive efforts are being
undertaken in the Indian context too, whereby institutional investors
influence corporate governance in companies, their effect is hard to
measure. As such interaction takes place in confidence, trends cannot
be discerned due to the absence of publicly available information.

While interactions between investors and companies are useful in

corporate governance, there are some limitations to this approach in
India. First, companies are under no legal obligation to engage with
investors. Their obligations extend to providing information as
required by company law and securities regulation, which is uniform
for all investors. Specific investors are entitled to seek further

27

information regarding certain matters, such as inspection of the

register and index of members and debenture-holders and minutes of
shareholders meetings. Other details such as additional financial
information and even minutes of board meetings need not be provided
to individual investors. Second, companies could find themselves in
violation of the law if they selectively provide sensitive information to
specific investors. Under the SEBI (Prohibition of Insider Trading)
Regulations, 1992, insiders such as directors and managerial personnel
are not permitted to communicate or counsel or procure directly
or indirectly any unpublished price sensitive information to any
person While the regulations on insider trading do not prohibit
discussions with institutional investors, several constraints are imposed
on the conduct of such discussions. Listed companies are required to
maintain and adhere to a code on corporate disclosure practices.
Under such a code, listed companies can provide only publicly
available information to institutional investors or analysts.
specific

information

provided

to

such

investors

must

Any
be

simultaneously made public. The regulations impose other checks

and balances to ensure that discussions with institutional investors do
not provide them with an advantage unavailable to other investors in
the market.

28

While interaction between investors and companies is possible, the

significant constraints imposed on that process might limit its
effectiveness as a tool to influence governance in Indian companies.

B.

Change of Control Strategy

Where mere interaction with management is found to be inadequate

or ineffective, it is common for activist investors to advance to the
next stage of confronting management with efforts to displace them. In
several jurisdictions, it is not unusual for investors in such cases to
initiate proxy wars and control fights to

replace incumbent

managers with new ones who may be amenable to the views of

the activist investors regarding the business and strategy for
the company. Often, activist investors have indeed succeeded in
replacing managements that have resisted their efforts.

However, in India, it is unlikely that such efforts towards change

in control are likely to succeed. Most public listed companies in India
continue to have controlling shareholders (or promoters), barring a
handful that has diffused shareholding. Given that the controlled
company structure is predominant in the Indian corporate landscape,
any attempt by activist investors to seek control of Indian companies
would encounter

significant obstacles. The concept

of hostile

takeovers, which is the common form of control seeking mechanism,

29

is almost non-existent in India with only a few such having been

attempted and even fewer having succeeded.

For these reasons, it is necessary to remain pessimistic about the

utility of hostile takeovers and proxy fights as weapons in the arsenal of
activist investors in Indian companies. While they may be effective in
other jurisdictions with diffused shareholding, the viability of such
mechanisms in controlled companies that are omnipresent in India
remains doubtful. The situation might likely change in the future with
the growth of retail investment and reduction in controlled
shareholder blocks because listed companies are now required to have
at least a minimum of 25% public shareholding (which is reduced to
10% in the case of government companies).

C.

Litigation Strategy

Internationally, activist investors have also resorted to litigation in

extreme cases where boards and managements of companies have
acted in a manner that investors believe has caused loss either to the
companies or their shareholders. On occasions, they have even
succeeded. Whether such a litigation strategy would be effective in
achieving the activist investors goals of enhancing corporate
governance and shareholder value in Indian companies is a widely

30

open question. However, as this report details further, the outlook is

bleak.

Shareholder suits form a useful method of enforcing corporate law

and

governance

norms

through

private

mechanisms.

The

advantage of this method is that the enforcement can be controlled

by an affected shareholder rather than to rely upon public
enforcement that is controlled by the state. Under corporate law,
shareholder may bring principally two types of actions. The first is a
derivative action, whereby a shareholder may sue on behalf of the
company in respect of a loss caused to the company. The classic
instance where derivative action is an effective shareholder remedy
is when the directors or officers of a company have breached their
duties to their company, but the board decides not to initiate legal
action against them. In such a case, the derivative action enables the
shareholder to bring a suit on behalf of the company against the
offending party. If the suit is successful, the company will enjoy the
remedies. For instance, any recoveries under the suit will inure to the
benefit of the company rather than the shareholders. The second type
is a direct action. Here, the shareholder brings a suit against the
company, its board, management or other shareholders for the breach
of a duty owed to the shareholder. In such case, the shareholder can
bring a suit for its own benefit and the remedies would inure to the
benefit of the shareholder, who may enjoy it directly. For instance, any

31

recovery or benefit under a direct shareholder suit will accrue to the

shareholder, and generally not to the company.

Company law in India provides shareholders with the options of

bringing both a derivative suit and a direct suit if their interests are
adversely affected and a cause of action arises under law. However,
these remedies are arguably not fully effective. The remainder of this
section deals briefly with each of these types of actions and why they
may or may not be viable options to activist shareholders.

7.

Evaluating the Impact of Shareholder Activism

After considering the trends regarding shareholder activism that

are emanating from India, and assessing the possibilities and
limitations within the Indian context, it is necessary to evaluate the
effectiveness of such activism as a measure of enhancing corporate
governance, both generally as well as in the specific context of India.

A.

Distilling the Evidence

The present study finds palpable anecdotal evidence that indicates a

greater role on the part of activist shareholders in India since 2011
than that witnessed in the past. This is due to the efforts of the

32

corporate regulators to enhance shareholder participation in corporate

decision-making through various measures such as e-voting, emeetings and the imposition of a stewardship role on institutional
investors such as mutual funds. Apart from being nudged by the
regulators, certain activist investors themselves have taken on the
mantle of influencing corporate governance in companies in which
they have invested. The emergence of a strong set of informational
intermediaries in the form of proxy advisories signals a new era in
shareholder activism in India. Although it is too early to determine the
impact of these measures on Indian corporate governance, it is
reasonable to expect the momentum towards shareholder activism
and (away from passivity) to continue in the near future.

While some general trends in India can be gleaned from anecdotal

evidence, there is little track record to build any empirical evidence
yet. Although there are empirical studies carried out in other markets,
they

remain

equivocal

about

the

positive

impact

of

shareholder activism on corporate governance. A number of reasons

have been offered, that range from the methodological to the
substantive. At the outset, there are difficulties in measuring the
effectiveness of shareholder activism. For instance, there is often no
public evidence of the interactive efforts of shareholders to influence
corporate governance in investee companies. Moreover, there are
difficulties in establishing the causal link between activism and better

33

corporate governance. Even when measurable, the results have not

been convincing, as the impact appears to be quite feeble. As Gillan
and Starks note:

The evidence provided by empirical studies of the effects of

shareholder activism is mixed. While some studies have found positive
short-term market reactions to announcements of certain kinds of
activism, there is little evidence of improvement in the long-term
operating or stock-market performance of the targeted companies.

On the other hand, it has been argued that the significant costs
generated by shareholder activism cannot justify the limited benefits it
confers.

Concerns have also been expressed about the possible negative impact
of some forms of activism, such as the type pursued by hedge funds.
The natural assumption is that any value created by activist
shareholders is equally enjoyable by the other passive investors, which
arises due to the overall enhancement of governance standards in the
company. But, that assumption is not necessarily valid in all
circumstances. Activist investors may likely pursue agendas not
shared by and often in conflict with those of passive investors.
Moreover, institutional investors are subject to inherent conflicts of
interest. Although they may hold shares for the benefit of their own

34

investors (such as unit-holders in a mutual fund), it is the managers

who exercise voting rights in the investee companies. There is a risk
that the activist approach may be beneficial to the managers, but not
necessarily in the interests of the ultimate investors or unit-holders in
the institution. While there is yet no evidence of such a distinct
conflict that has emanated in India, the importance of its adverse effect
on shareholder activism cannot be ignored.

While the anecdotal evidence indicates the strong emergence of

shareholder activism in India, the empirical evidence regarding its
impact on corporate governance in other markets is mixed. Given this
situation, the benefits of shareholder activism as a measure to boost
corporate governance in India must be accepted with some caution.

B.

Effect on Controlled Companies

While evaluating the impact of shareholder activism, regard must be

had to the ownership structure of companies. Activism may have a
different effect on companies with controlling shareholders as opposed
to those without. For example, in companies without controlling
shareholders, the influence of activist shareholders and increased
voting by shareholders may have a direct bearing on the
outcome of proposals made by management. On the other hand,

35

where controlling shareholders are dominant, it is unlikely that efforts

on the part of the regulators to promote shareholder voting or activist
stances adopted by certain institutional shareholders will have the
same effect as in companies with diffused shareholding. As Bebchuk
and Hamdani note:

In [ companies with controlling shareholders] , the rules governing

voting procedures are likely to be inconsequential.

Controllers-

unaffected by the collective action and free-rider problems that

discourage action by dispersed shareholders-will exercise their voting
power

even

without

rules

to

facilitate

shareholder

voting.

Furthermore, as long as a controller has enough votes to determine

voting outcomes, even rules that facilitate voting by minority
shareholders will not enable them to pass resolutions not favored
by the controller.

In insider economies such as India, due to the influence of controlling

shareholders, activist investors would not find it easy to alter the
outcome of decisions made at shareholders meetings. This may in turn
reduce the incentives of activist investors to adopt stances that
operate to act as a check on management. As a corollary, controlling
shareholders are less likely to be deterred by the actions of activist
shareholders.

36

In a study that is specific to India, Geis has conceptually and

empirically demonstrated that while independent blockholding by
institutional investors is generally useful in theory, it is unlikely to
have any impact on corporate governance in India due to the current
ownership

structure

of Indian

companies

with

concentrated

shareholding.

Hence, if there is some ambivalence regarding the effectiveness of

shareholder activism generally, then its positive effect on controlled
companies that populate the Indian corporate setting is only likely to
be minimal.

In concluding this section, we find that while shareholder activism does

influence corporate governance in several ways, not the least by
publicizing governance failures and drawing attention to specific issues
that may be of relevance to the investing community, we are far
from finding any empirical correlation between shareholder activism
and corporate governance. If that link is not clear in developed
markets such as the US with companies that have diffused
shareholding, we must accept shareholder activism in insider
economies like India that have controlled companies with some
amount of caution. While it would be rash to argue against activism,
its impact must not be overstated.

37

8.

Conclusion

This report traces the evolution of shareholder activism in India.

Hitherto non-existent, the phenomenon has been ushered into Indian
corporate governance within a span of the last two years. It has been
facilitated through regulatory reforms that enable greater participation
of shareholders in corporate decision-making. More than that, a
market environment for activist investors and corporate governance
intermediaries has rapidly taken shape in India. The proliferation of
proxy

advisory

firms

issuing

recommendations

in respect of

hundreds of Indian listed companies, and high-profile examples of

institutional investors such as hedge funds confronting Indian
managements is emblematic of the trend.

However, the corporate structure and legal system in India offer

considerable resistance that prevents full utilization of the benefits
of shareholder activism. The existence of controlling shareholders in
most Indian companies cushions the impact of activist investors. The
legal system is not conducive to shareholder litigation, which is a tool
utilized by activist investors in other jurisdictions, often successfully. At
an overall level, there is also some pessimism about the impact of
shareholder activism on the long-term performance of companies and
shareholder value.

38

In building upon the present study, future efforts may be undertaken

on two fronts. First, there is a need for greater empirical research on
the impact of shareholder activism in India, which would help better
understand its desirability and effect in the Indian context. Second,
more efforts must be taken to enhance the power of minority
shareholders who are compelled to act in the shadow of controlling
shareholders. These include measures such as cumulative voting for
appointment of independent directors, prohibition on controller
shareholder voting in case of interested party transactions, and the
like. If such an enabling regime were created, it would provide the
necessary incentives to activist shareholders to bring about overall
enhancement of corporate governance norms in the listed companies
in which they have invested, and also generally raise governance
standards within the country.

39