Many Indian companies — with a few exceptions — are owned or controlled by business families. This poses a special challenge for corporate governance. According to Wharton management professors Jitendra Singh and Michael Useem, a crucial issue is the approach that the family member who heads the company takes towards independent directors. In well-managed companies, independent directors are viewed as partners of management and as outside guardians whose job is to make sure that management stays focused on delivering shareholder value. Other companies, however, might consider independent directors to be a burden that has to be borne mainly to satisfy regulatory rules for compliance.

In this second half of a two-part discussion on corporate governance in India, Singh and Useem — who, with their colleague Harbir Singh, are leading an Executive Education program on corporate governance in India — discuss these issues and more with India Knowledge at Wharton. (The first part of the discussion focused on Clause 49, a new regulation that requires Indian firms to increase the number of independent directors.) An edited version of the transcript follows.

Knowledge at Wharton: With a few exceptions, many Indian firms are owned or controlled by business families. What special challenge does this present for corporate governance?

Singh: This is a very important question. To my mind, a key issue really is: What is the approach by this key family executive to thinking about independent directors — whether it is the chairman or the CEO, or the CEO and chairman combined? How exactly does the leadership view independent directors? Are independent directors seen as an asset to the company, so that even if they come in and ask tough questions, it is recognized that this will only benefit the firm in the long run? Or are they seen as a burden to be tolerated primarily for compliance reasons?

Depending on the way you think about independent directors, you are going to take a somewhat different approach toward what goes on inside the boardroom. These questions relate to the softer, cultural side, which is very, very hard to regulate. This, in fact, is in the realm of role modeling and leadership by the chairperson of the board. The question is: How open are you to genuine input? Clearly, if someone is going to agree with you all the time, for that simple reason there’s not that much you’re going to learn from that person. But if there’s someone who expresses different opinions, how is that viewed? The response to such explicit dissent in the boardroom sets the tone for the board dynamics. That is the crucial issue: What is the nature of the board dynamics? And what kind of a role model is the chairman of the board?

This is an issue where some family companies — and there are some very professionally run family firms as well in India — as a general rule need to do some work in terms of changing the mindset. Independent directors are meant to serve the company’s shareholders. They are not antagonists; they are not there to upset the apple cart. It will take some time for some family executives to learn to appreciate the value that independent directors bring.

Useem: Historically boards of directors were often seen not as a hostile force but as outsiders — almost watchdogs — looking over management, and sometimes mistakenly trying to second-guess management. They were there to monitor management and to ensure that management stayed focused on returning value to investors. But my own research and that of others in the last couple of years confirms almost exactly what Jitendra was alluding to. While the board is there to monitor, and it has the legal responsibility to protect investors’ holdings, at many well-governed companies now the board is there really as a partner of top management. Top management has ideas for acquisitions, for setting up operations offshore and maybe even changing personnel. What better group to have at your elbow than non-executive directors who run their own enterprises, who think about these issues all the time themselves? In that sense, family and non-family controlled firms wisely look upon the board as a partner.

For that partnership to be strong, you want the best independent thinkers on the board. So the quick summary is: Whether a firm is family or non-family controlled, getting great outside thinkers on the board provides you, if you are the chief executive, with a fabulous, informal group to turn to for immediate guidance and advice. They know the firm as well as you do. What better people to have working with you and not looking over your shoulder?

Singh: I would add another footnote before we move on. It’s important to get really first-rate directors, but there is an important responsibility that comes to the chairman of the board. And that is, you have to model behavior in a manner where dissenting opinions are welcomed. I have been occasionally in boardrooms where on paper the independent directors have all the right credentials, and yet the group dynamic I such that even before making a comment, everyone looks at the chairman to see if he is smiling or frowning. You can bet that in that boardroom independence has already been lost. It’s a really subtle thing that has to be managed by the chairman.

Knowledge at Wharton: Even before Clause 49 came along, people like Rahul Bajaj or Kumar Mangalam Birla were working with organizations like Sebi (Securities and Exchange Board of India) or the Confederation of Indian Industry to create corporate governance codes. Have these made any difference to governance in Indian companies, or have these reports just been sitting on shelves, gathering dust?

Singh: You are right; we have seen a plethora of reports. When Mike and Harbir and I went to India last year for the first offering of our corporate governance program, we had the opportunity to see some of these reports. What is interesting is, while in matters of detail there may be some differences between them — one report might say at least one-third of the directors ought to be independent, and another says the number ought to be at least 50% — these are matters of degree.

What was interesting is that a series of reports, over almost the last decade or longer, have been urging greater transparency, participation [and] independent outside directors on the board, and these are changes in the right direction. The actual change in behavior is the next level after that, and it will take time. But on regulatory efforts — the normative side of corporate governance in India — Sebi has done a very, very good job. We had the occasion to spend time with [M.] Damodaran, the chairman of Sebi — a very fine thinker who emphasizes the right values. While you will hear arguments every now and then from corporations against specific aspects of a particular issue like Clause 49, or any particular regulatory approach, no one is arguing against the need for better governance. This takes us back to the point Mike made earlier — that the links to financial inflows into India are so strong that there is no way to get away from it.

Useem: In almost every major country where there is an active private enterprise system, over the last five or 10 years the equivalent of the CII and the equivalent of Rahul Bajaj and others have stepped forward in Australia, U.K., Canada, New Zealand, Japan and so on, to put forward a set of guidelines that are often then turned into legislative provisions or regulations. Clause 49 and Sarbanes Oxley are great examples of each. If you take a step back from that and ask yourself what’s going on, it is a partnership between the public sector — those who run Sebi, or over here, the SEC (Securities and Exchange Commission) and the NYSE (New York Stock Exchange) as a semi-private, semi-public institution — and those who run companies.

Thus, these provisions that become Clause 49 or Sarbanes Oxley are almost always a product of not a hostile force coming down from Congress or Parliament, but they are products tangibly of what people who do this for a living — either as a regulator or as a corporate executive — say will make a difference in the affirmative sense. One data footnote to support this is a study of what happened to companies in Indonesia, Malaysia, Thailand and Taiwan during the crisis of 1997, when the Thai baht crashed by 50%. The study of those four countries reveals that the companies that recovered the fastest had adopted — prior to the crisis — world standards of good governance.

It’s a way of saying that what Sebi and the SEC have done is intended to help the companies help themselves, when sometimes company executives don’t quite see what should be done. There has been some resistance to these acts, but longer term, unequivocally, the research and experience pretty much say the same thing: these provisions are good. Finally, getting back to schooling, the art of being a good director is not necessarily completely natural. For those coming onto a board — even those who have been on a board for a while — take an opportunity to think with other directors and those who are experts in good governance: What is required in a given context, whether China or India or the U.S.? It’s a good idea for these directors’ schools to be up and running.

Singh: I would add a quick footnote to that. I have found in my experience as a director that you can be most effective sometimes by putting aside your executive hat so that you are not really the key decision maker, although you can be. You almost have to hold your own thinking in abeyance. I have found some of the most effective directors I have seen just ask the right questions and then sit back and let the management shape the discourse. The idea is to help management make the best possible decision, using the input in the boardroom. This calls for somewhat different skills. I agree with Michael’s point about directors’ schools.

Knowledge at Wharton: You both mentioned China briefly. How does corporate governance in India compare with corporate governance in China? After all, Chinese companies are also attracting capital internationally. What similarities and what differences do you see in corporate governance standards in the two countries?

Useem: China is ahead of the slope compared to India in terms of foreign direct investment and equity investment, although some may argue that in terms of equity investing, India may be a better and safer choice than China. The jury is out on that for a while. China has its own traditions as India does.

It’s a mistake if we look blindly to any other operation, any other company, or any other country for ideas on what ought to be done in our company or our country. This is true in the same sense that General Motors looks to Toyota to see how Toyota runs itself, but it shouldn’t blindly adopt the Toyota lean manufacturing system. And thus, as India looks to China and the U.S. and Japan for guidance on corporate governance, it should look to see what probably does work, but make certain that these ideas are brought back into the Indian context. They should be molded, adapted and used in a way which makes sense in that context.

In China, the government is a controlling partner in many companies. Often before a CEO is appointed even in a publicly held company, the top people will check with a minister in government to see what is appropriate in terms of that succession. Indian companies, of course, do not face this situation. This is one argument why for international investors India may be a safer choice.

We’ll leave that as an open question but the main parallel I should sum up with is this: In China, there is the same kind of discussion going on among company executives and directors as we have in India and in the U.S. In all three countries — China, India and America — there is an active search to find out what are some of the better five or six key practices for boards to be strategic, to function as a partner, and at the same time protect outside investors. In that sense, India and China are on a parallel track. And both countries are looking over their shoulders at one another, not to mention the U.S., to try to find the right formulation for equity investing and good governance in their countries.

Singh: This comparison of India and China is a very interesting one. My summary assessment will be that both countries are headed in — as Mike said — parallel directions and may end up looking similar. But they are starting from very different places. In India, even in the years between 1947 and 1991 before the economy started opening up, the Indian economy was always 50% in the private sector, and as such, notions of governance were not entirely foreign to the Indian private sector.

China, between 1949 and the mid-1970s, which is the early part of the Chinese economy opening up, was a relatively closed economy. It was very much a version of a state-centered socialism economy being run along very different lines than that in India. As a result of this different institutional history, even the best Chinese firms that you see today that are going public — in fact, many in New York or Hong Kong or elsewhere — they will have different levels of participation by different levels of state agencies. Sometimes it will be the federal government, and other times it will be the provincial government, or the municipal city government, or other state institutions. The Chinese context is considerably more complex on that front.

While there have been state-owned companies in India that have also gone public, their numbers have been much smaller compared to China. As such the Chinese context is different, and somewhat more complex in terms of state participation. The Indian private sector has been much more receptive, because there was already a tradition of governance, although they’ve had to ramp up their practices as well.

We have a notion in management of past dependence: Where you can go next depends on where you have been in the past. This is also true of corporate governance. Nevertheless, both countries, given the huge level of foreign investment inflows, are feeling the same kinds of pressures from the global financial community. It’s an open question pretty much as Mike hinted, as to who will get where in the future. But I think they are both going in the same direction, and feeling the same pressures.