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S. Venkitaramanan

THE SERIOUS concern of the US Administration about business and investor protection is shown by the fact that the President, Mr George Bush, took time off from his global preoccupations to issue a 10-point corporate governance plan. This is significant. The US Administration attaches great importance to the consequences of the Enron crisis and the need to restore investor confidence. It would be too much to expect a similar response by India's chief executive to a similar corporate crisis. No wonder our capital market is somnolent.

Mr Bush's Ten Commandments primarily concern the need to improve corporate governance. They insist on better and timely information to investors, besides holding company executives more closely responsible for their actions and reinforcing the independence of the audit system. The package also reinforces the powers of the Securities and Exchange Commission (SEC) in particular over auditors. It ensures that investors have timely access to the information necessary to judge a company's performance, condition and risk. Chief Executive Officers (CEOs) should personally vouch for the accuracy of their companies' public financial disclosures. Those who abuse their executive positions risk being disqualified by the SEC from holding corporate roles.

The President's plan includes the reasonable requirement that executives should disclose personal share transactions in their company's stock. A more important prescription is that auditors of the companies should not carry out other services, such as consultancy, if the service compromises the independence of the audit. This falls short of the more salutary prescription, which suggested that auditors should be debarred from offering consultancy services. The President's list also includes the setting up of a regulatory board to ensure that the accountancy profession is held to the highest possible standards. The SEC will reinforce its supervision of the Financial Accounting Standards Board and enforce standards that "reflect economic reality rather than technical requirements".

The general drift of the President's proposal is more to enforce CEOs' responsibility for the integrity of their financial reports than to require them to manage their businesses better. Guilty CEOs will be prevented from holding other corporate jobs. The SEC will also be made responsible for reinforcing its supervision of the Financial Accounting Standards Boards.

Until recently, that is, before Enron, the American CEOs were considered to be the acme of perfection. American CEOs, represented by people like legendary Jack Welch of GE, became the role models for many professionals. However, the fall of Enron and the flawed behaviour of its executives saw an end to the myth of the superhuman chief executive. Now, it looks as if the atmosphere has changed. There is almost a return to "mob lynching" of the once much admired managerial class.

That the President of the most powerful country should find time to concentrate on questions, such as the ones covered in his ten-point programme, speaks volumes for the priority the US Administration assigns to preserving the trust of its capital market in the integrity and behaviour of its Chief Executives. It is, however, doubtful whether the President's response in the form of tightening of control by the SEC over auditors and reinforcing strict regulations regarding CEOs will help to turn the tide. The failure of Enron was not so much due to the weaknesses of audit per se as the over-ambitious megalomaniac business plans aided by its political networking and the behaviour of executives assisted by the lenders and encouraged by rating agencies. Surely, Enron had a strong board, which included independent directors. Its Audit Committee comprised some of the best-known names in the accountancy profession. All this did not prevent the fall of Enron.

The Presidential package trusts in the efficacy of the already overburdened SEC to prevent what is basically a management failure. Audit even by the best of firms comes in only after the fact. By then, the errors of strategy and investment have already happened. The independent directors are guided very much by what the management chooses to place before the board. The details of business strategy and the investment alternatives considered by the management can never be fully understood by part-time directors who have neither the time nor access to full information and do not have the technical competence and knowledge to understand the full implications of the proposals. At most board meetings, the management comes in with a fully prepared brief. Independent directors seldom have either the time or the information to contradict managements. Controlling the auditors will only ensure that the financial information is presented in as accurate a fashion as possible. But that does not contribute to improving the management style or restricting the risk appetite of the managers.

Mr Bush's wish list seems skewed in favour of more controls over the accounting profession rather than in encouraging quality of management. Perhaps, it would have been more appropriate to lay down tougher standards for lending institutions and rating agencies which should assess more carefully the business prospects of the entities to which they lend or which they rate.

Incidentally, and importantly, Mr Bush's Ten Commandments question the ruling ideology of the free market per se being an efficient instrument for ensuring the best financial outcomes. The President's interventions imply that the `market' is subject to a variety of possible evasions and loopholes.

What is of relevance to the Indian situation is that the Securities Exchange Board of India may be tempted to copy Mr Bush's instructions. Care is required to ensure that SEBI's over-extended organisation does not take on too much additional responsibility of not only monitoring the behaviour of chief executives but also the accounting profession. These are best left to the current regulators and rating agencies.

After all, regulation cannot cure the flaws in management unless CEOs themselves change. To expect a regulator, such as SEBI or the SEC, to judge the conduct of the CEOs will be fair only insofar as it applies to the breach of rules on personal involvement in abuse of financial information or of falsification of transactions. The powers Mr Bush has chosen to confer on the SEC on banning flawed CEOs in their functions from holding further office is peremptory and will give rise to avoidable and protracted litigation as to who and what went wrong.

American observers themselves feel that board positions, which have already become less sought after, are bound to be even more difficult to fill in the context of the new regulations. The legal consequences of holding a director's position can be quite awkward. In this context, it is pertinent to mention that even in India, already the membership of the Audit Committee exposes an individual to considerable risk. While directors have necessarily to be responsible for their actions or inactions, the limitations imposed on part-time directors make it all the more incumbent on regulators to be careful before setting impossible targets before them.

We have also to recognise that directions on corporate governance should not do violence to the concept of leadership. Corporate governance does require a compromise between the dispersed authority of a leader and focussed responsibility. The members of the board are collectively responsible. But, ultimately when the chips are down, it is the chief executive as leader, who takes the punishment or the credit, as the case may be. Above all, Mr Bush should know this. After all, he is a chief executive of the most powerful enterprise in the world — the United States of America. While the checks and balances in the American political system do help to restrain the President from outrageous behaviour, the qualities of leadership and performance depend entirely on what the President himself can and does.

Leaders have to take risks, and checks and balances can do little to produce genuine leadership. But to overburden the initiative and managements by enterprising bureaucratic regulators is to ignore the real challenge of management, which is to manage the wayward fortunes of business, fashion the future and take reasonable risks. The Enron syndrome should not lead to regulatory overkill. The caution is all the more necessary in the Indian situation where regulation is only too willing to assume additional responsibility and looks at corporate leadership as an adversarial entity.

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