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Public Sector Undertakings (PSUs) Dive into Compliance and Governance Challenges

Introduction

A disconcerting truth is highlighted in a recent report by Institutional Investor Advisory Services: Public Sector Undertakings (PSUs) exhibit a substantial decline in compliance with corporate governance standards when compared to their private counterparts. An analysis of the BSE 100 companies revealed that while 93 were compliant with regulatory requirements for board independence as of December 2023, the seven non-compliant entities were exclusively PSUs, including a bank.


Despite efforts to address governance deficiencies, Public Sector Undertakings (PSUs) continue to exhibit weak board structures and struggle to meet minimum regulatory standards for corporate governance. This long-standing issue has drawn concerns for several years, yet regulatory enforcement over PSUs remains inadequate. Notably, the government has carved out exceptions for PSUs in regulatory requirements, further exacerbating compliance challenges within this sector.


Regulatory norms stipulate that listed companies must ensure at least half of their board comprises independent directors if the Chairperson is an executive director or represents the promoter group. For other firms, the minimum requirement stands at 33 per cent. Despite incremental improvements in compliance among BSE100 companies, PSUs still lag in meeting these mandated standards, reflecting ongoing governance challenges within the sector.

Exploring the intricate landscape of compliance and governance hurdles faced by Public Sector Undertakings (PSUs) in today's dynamic business environment

Role of PSUs in India's Economy

Public Sector Undertakings (PSUs) have played a pivotal role in shaping India's economic landscape. Majority-owned by the Union or State Governments, PSUs were initially established to drive industrial and regional development, particularly in sectors where private sector involvement might be limited. Furthermore, they have served to prevent monopolies in key sectors and have been significant contributors to employment generation. Given their substantial impact, ensuring proper governance of PSUs is of paramount importance.


Evolution of Governance in PSUs

Historically, PSUs were predominantly owned and controlled by the Government, with decisions regarding board appointments, key personnel, and policies vested in governmental authorities. While the listing of PSUs has diluted the government's ownership stake, it remains influential in shaping the day-to-day operations of these enterprises. However, this centralised decision-making has faced criticism over time. 


Enhancing Corporate Governance in PSUs

To strengthen corporate governance practices within PSUs, it is imperative for the Government to acknowledge its role as a majority owner rather than a sole owner. This entails recognising the distinction between ownership and management functions, with the Government primarily performing the former. By delineating clear boundaries between ownership and management, PSUs can operate with greater autonomy and accountability, fostering a culture of transparency and efficiency in their operations.


Embracing Accountability and Autonomy

Furthermore, empowering PSUs with greater autonomy while holding them accountable for their performance is essential for fostering a conducive environment for corporate governance. Encouraging professional management practices and ensuring the appointment of qualified and independent directors to PSU boards can further enhance governance standards. By promoting a culture of accountability and autonomy within PSUs, the Government can facilitate their growth and contribution to India's economic development while safeguarding the interests of all stakeholders.


Corporate Governance Challenges in PSUs

PSUs, integral to India's economic development, encounter unique governance challenges due to government ownership. These challenges include issues with board appointments, lack of independence, skills mismatches, delays in appointing independent directors and compliance burdens, among others.


Appointment and Independence of Directors

One of the critical issues in PSUs revolves around the appointment of directors by the government, leading to questions about the independence of the board. With all directors appointed by the government, the true autonomy of the board is often compromised, raising concerns about impartial decision-making and oversight. The process of director appointment in PSUs is often driven by government directives rather than a genuine assessment of required skill sets. 


Compliance Challenges and Regulatory Ambiguity

PSUs face a plethora of regulatory requirements from various authorities, including the Companies Act 2013, SEBI regulations, and Department of Public Enterprises guidelines. However, navigating these regulations alongside oversight from bodies like the Comptroller & Auditor General of India (CAG) and Central Vigilance Commission (CVC) poses significant compliance burdens. Ambiguity in interpretation and inconsistency in provisions further compound these challenges.


Evidenced Deficiencies


Progress and Challenges in Corporate Governance

Amidst these governance challenges, there have been notable strides in corporate governance among other firms, accompanied by heightened transparency. The Institutional Investor Advisory Services (IiAS) highlighted in its Corporate Governance Score report that this year's performance among BSE100 index constituents marks the best since assessments began in 2016. With 64 companies scoring in the 'Good' and 'Leadership' categories, it indicates an overall positive trajectory in corporate governance across corporate India.


Root Causes of Disparity in Governance

The divergence in governance standards between Public Sector Undertakings (PSUs) and private firms can be attributed to several key factors. Primarily, the regulatory framework surrounding PSUs is notably more lenient compared to that governing private enterprises. This leniency is further exacerbated by exemptions granted by the government from specific corporate governance regulations. As a consequence, PSUs often grapple with weak board structures and encounter difficulties in adhering to even the most fundamental regulatory standards. These challenges undermine the core principles of independent oversight and accountability within PSUs, setting them apart from their private sector counterparts.


Absence of Market-Driven Pressure

Unlike private companies, which operate under constant pressure from market forces and shareholder interests to perform efficiently and adopt best practices, PSUs function without such external pressures. This lack of urgency in the PSU sector exacerbates governance challenges, creating a cycle of non-compliance and inefficiency. Without the market-driven impetus for improvement, PSUs often struggle to prioritise governance reforms and may fall behind in adopting industry best practices.


Challenging Investor Perceptions

Historically, investors have approached companies controlled by private promoters with caution, wary of potential governance issues. However, the governance challenges within Indian PSUs challenge this perception. Instances such as those involving the Power Trading Corporation and its subsidiary PTC India Financial Services highlight how state backing and institutional holdings do not guarantee effective governance. These instances, coupled with controversies such as mass resignations of independent directors and regulatory penalties, underscore the urgent need for reform within PSUs to restore investor confidence and credibility.


Call for Reform

The prevalence of governance challenges within PSUs necessitates comprehensive reform efforts. Addressing regulatory loopholes, strengthening board structures and enhancing transparency and accountability mechanisms are critical steps towards improving governance standards within PSUs. Moreover, fostering a culture of ethical leadership and decision-making at all levels is essential for instilling long-term governance resilience within these entities.


Economic Imperatives

The imperative to address governance challenges within PSUs extends beyond mere corporate performance enhancement; it is integral to fortifying economic resilience and nurturing sustainable growth. Given the pivotal roles PSUs play in vital sectors such as energy, banking and infrastructure, bolstering governance frameworks within these entities is indispensable for optimising resource allocation, fostering transparency and cultivating a culture of accountability. Such measures are essential for ensuring the efficient functioning of PSUs and their contribution to national economic development.


Global Alignment and Investor Confidence

Moreover, enhancing governance standards within PSUs aligns with global best practices and serves to enhance their appeal as investment destinations. Foreign investors, increasingly emphasising governance standards as key indicators of long-term viability, are more inclined to invest in entities that adhere to international norms. By upholding robust governance standards, PSUs can position themselves as dependable investment options, thereby bolstering India's economic integration with global markets and attracting foreign capital inflows. This, in turn, contributes to the overall attractiveness and competitiveness of the Indian economy on the global stage.


The Great Board Refresh 2024

Looking forward to the forthcoming board refresh set to commence from April 2024, Institutional Investor Advisory Services (IiAS) has drawn attention to a notable observation: as of December 2023, 39 companies had independent directors on their boards with tenured positions. As the grandfathering of previous board tenures for independent directors concludes for most companies, there are anticipated risks associated with this transition. A key concern raised by the report is the potential for business groups to reshuffle independent directors across various group companies, a practice that could undermine the intended purpose of regulatory frameworks.


The report underscores the significance of observing how Indian companies navigate this impending board refresh. It poses an intriguing question: Will companies genuinely embrace the imperative to refresh their boards or opt to maintain the existing status quo? This highlights the evolving dynamics of corporate governance in India and the inherent challenges that companies encounter as they strive to maintain compliance while adapting to regulatory changes.


Conclusion

In conclusion, understanding the root causes of the governance disparity between PSUs and private firms is crucial for implementing effective reform measures. By addressing regulatory shortcomings, fostering a culture of accountability and prioritising governance reforms, PSUs can bridge the governance gap and align themselves more closely with global best practices. Ultimately, these efforts will not only enhance the credibility and performance of PSUs but also strengthen investor confidence and contribute to sustainable economic growth.


Our Directors’ Institute- World Council of Directors can help you accelerate your board journey by training you on your roles and responsibilities to be carried out in an efficient manner helping you to make a significant contribution to the board and raise corporate governance standards within the organization.



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