Good governance practices will enliven M&A culture

By Shardul Thacker, Mulla & Mulla & Craigie Blunt & Caroe

Astringent regulatory approach requires a framework of strong financial disclosure norms, aimed at ensuring transparency and accountability. Such an approach promotes self-governance by enabling participants in the system to discharge their rights and duties efficaciously, and makes a third-party monitoring mechanism more effective.

The object of corporate governance (CG) norms is to protect the interests of stakeholders by making companies accountable to them. This is achieved by vesting the stakeholders with rights as against the company and statutorily imposing duties on it.

Shardul Thacker Partner Mulla & Mulla & Craigie Blunt & Caroe
Shardul Thacker
Mulla & Mulla & Craigie Blunt & Caroe

Clause 49 of the listing agreement with stock exchanges deals with CG issues – the composition of boards of directors and audit committees, qualifications of members of these groups, and financial disclosures by listed companies. It also recommends the formulation of an internal code of conduct.

Clause 49 was introduced by the Securities and Exchange Board of India (SEBI) in 2000 and was subsequently amended in 2006 and 2008. The Companies Bill, 2011, seeks to harmonize company law with SEBI’s CG provisions, reducing controls and approvals by the central government, while ensuring that the directors function strictly in accordance with the compliance framework. Under the bill, the main areas of focus remain the same, i.e. defining “independent directors”, strengthening of the role of audit committees, and improving the quality of financial disclosures, which is the essence of CG.

It is generally agreed that good and clean governance does not stem merely from statutory compliance. Loopholes exist in every law so mere adherence on paper and not in principle will continue to give rise to lapses, e.g. Satyam (2009), which had received the Golden Peacock Global Award for Excellence in CG in 2008. Nevertheless, information furnished to stakeholders and regulators under statutory financial disclosure norms remains significant, as this information is in the public domain and is accessible to all market participants, which enhances competition and M&A prospects.

Due diligence

The due diligence process that a buyer company undertakes is crucial to an M&A decision, especially in terms of the time and cost incurred to complete all procedural compliances. Foreign M&A practitioners often complain that though Indian companies appear to have sophisticated business practices, they have less developed compliance, financial reporting and CG processes in place, and where these loopholes are plugged by statutory regulations, regulatory and legal compliance is poor.

Among private Indian companies – often managed by families and owning a host of subsidiary companies or otherwise having a range of related entities – matters may be complicated by concentrated and complex ownership patterns. The nexus between “promoters” and the political class breeds widespread corruption which might make, for example, a US acquirer open to charges of Foreign Corrupt Practices Act violations.

As a result of such issues, due diligence pertaining to M&A contracts places a significant burden on a potential buyer. For example, contracts for loans, leases, etc., entered into with related parties could be tools to keep the books in shape but would be detrimental to the interests of the buyer.

The Indian regulatory framework provides an answer to such concerns. Clause 49(II) of the listing agreement provides that the auditing committee is an uninfluenced body that files a report in a standardized format and justifies any departure from what has been prescribed. The Companies Act, 1956, sections 294 to 302, deal with related-party transactions. The corresponding provisions under the new bill are clauses 184, 186, 188 189 and 193.

Section 301 of the act provides that a company must maintain a register of contracts with parties in which directors are interested. Accounting standard 18, issued by the Institute of Chartered Accountants of India, also defines the term “related party transaction”. Along with clause 49(VI) of the listing agreement, which provides for disclosure of contingent liabilities, this brings transparency into the system and makes buy-side diligence less burdensome in M&A deals.

Non-compliance with corporate governance practices can hamper a seller company’s successful and efficient exit strategy. Compliance with prevalent CG practices may save it from incurring legal and other costs to rectify compliance records later.

A CG survey published by the Federation of Indian Chambers of Commerce and Industry in collaboration with Grant Thornton (2010-11) shows that a majority of firms continue to believe that good CG practices help to enhance a firm’s external evaluation, improve investor perceptions and thus reduce the cost of capital. However, the survey also found that most companies only partly complied with the SEBI rules.

A World Bank report in 2004 found that India observed most of the principles under the OECD’s corporate governance codes. In spite of having a sound regulatory structure in place, implementation and enforcement failures continue to undermine corporate governance practices in India.

Shardul Thacker is a partner at Mulla & Mulla & Craigie Blunt & Caroe in Mumbai.


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