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Institutional Investors and Corporate Governance

Volume 14, Number 1 Article by Jinesh Panchali March, 2002

Institutional Investors and Corporate Governance :

The challenge of promoting enterprise and accountability is common to all markets. What degree of freedom is right for corporate boards and how to make them accountable is a major concern in the realm of corporate governance. Even where market forces are expected to take care of the utilisation of available resources, there has to be a system which ensures that owners of these resources are made accountable for their use in the larger interests of the economy.

The proportion of funds invested in shares by institutional investors has been growing steadily in India, as in most countries. On the other hand, a comparison of the Indian model of corporate governance with those of other countries reveals that it is quite fragile and vulnerable. It does not adequately protect the rights of individual shareholders, and leaves them exposed to the vagaries of the market as well as the moral hazard emanating from large-shareholder (or promoter) managed public corporations. In this scenario, it is clear that the onus of ensuring good governance lies with institutional investors, who are in a strong position to intervene and influence corporate policy should the need arise. Research indicates that such activism can not only ensure good governance, but also improve shareholder wealth. Jinesh Panchali examines the rationale for institutional investors? activism in general and in the Indian capital market in particular, discusses empirical evidences and chalks out the scope and modes of activism. These include interventions in the public and private domain, which may be friendly political processes or hostile overtures - the latter being usually adopted as a last resort. Factors influencing institutional investors? activism are discussed, including the free rider problem, conflict of interests and the agency problem. The existing framework, and the experience in the Indian market are also described, and recent initiatives in the field are critically examined. Finally, an alternate approach for evolving suitable a framework for institutional investors? activism in Indian capital markets is suggested.

Reprint No 02104