Company Law - “Shareholders Democracy: Its importance and effectiveness.”

INTRODUCTION

"The highest measure of democracy is neither the 'extent of freedom' nor the 'extent of equality', but rather the highest measure of participation ". A. d. Benoist

Organized Industry and organized labor have, in modern democratic society, become giant and powerful social forces. To this great-organized corporate power in modern industrial democracy must be added other forces that differ in importance from country to country. In United States the charitable foundations, a by-product of corporate growth, exercises an increasing influence of its own. In a number of European Countries, on the other hand such as Great Britain, Germany or in the Scandinavian States, the consumer co-operatives, and organizations which have grown from small non-profit making co-operative ventures into powerful movements. In India such consumer movements did not gained much recognition so the legislative framework remain supreme in the area of check and balance on the Corporations. One of the institutions in the Corporate Setup is that of the Shareholders. Indeed this is the only institution which is theoretically empowered to influence and even frame corporate decisions. managers of their company. The first control mechanism lies in the voting rights that are normally attached to ordinary shares. An ordinary share usually confers on its holders the right to cast one vote on all matters put to the vote at the shareholders meeting.

There are two main ways in which shareholders can exert control over the Thus, in a company which has a conventional capital structure, every ordinary shareholder has the right to have a say in the corporate decision making process by virtue of his shareholding. This control mechanism is some times referred to as control in the form of 'voice'. The second form of control is based on the market forces, where there is an active market in a company's shares, its shareholder from time to time express their dissatisfaction by selling their shares.

Herein we are concerned with the 'voice' aspect of the corporate control process. This process is basically an attribute of democracy which has been imported in the corporate set up so as to confer upon the shareholders some rights and control instruments. In the modern shareholding culture we find that the democratic control mechanisms that have been provided to the shareholders are actually being used through proxies. Our law gives such a cushion to the busy shareholders to get them represented in a meeting through proxies. Now this mechanism has become predominant and is being used so often that the real objective of this so called 'voice, as control mechanism is loosing its importance and effectiveness.

DEMOCRACY AS IT IS UNDERSTOOD

Democracy is a term derived from two Greek words, 'demos' and 'cratia'. 'Demos' means the people and 'cratia' means power. In short, it means the power of the people . However as Finer observes, "Democracy has come to mean so many different things, some very hostile to each other, that the word needs careful analysis if misunderstanding and idle controversies are to be avoided, and if possible, quite legitimate differences of connotation, and its very varied institutional arrangements are to be revealed" .

In order to make any institution democratic it has to follow certain sacrosanct Principles and the reason being that the new democracies are inherently fragile. Once a new system of government has been designed, agreed to and implemented, the priority is to consolidate it.

 Some of the vital principles of ‘Democracy' are:

1. Transparency: Transparency refers to openness of the government

system. The process of governing needs to be both visible and understandable to

the population. As such, it will reassure them that it is trustworthy, and encourage

their support and co-operation, rather than risking their alienation .

Accountability: Accountability refers to the answerability of government

to the law and to the people - an essential ingredient of a new democracy. As long as the government remains, in real terms, answerable to the population, a self-sustaining regulatory process is set in motion .

3. Participation: When people feel a part of the system, they take a share of responsibility for it and play a role in making it work. At a basic level, the electoral process symbolizes such participation. Voting is a fundamental part of being involved in governance by having a real say in the choice of government. But participation must exist between elections too.

An analogy can be drawn from a comparison between political governance set up and the corporate setup, the power relationship between the shareholders and the corporation vis a vie citizens and state. The flow of power and responsibility in both the systems could be compared to understand the concept after all both the setups have a natural entity (shareholders and citizens) and legal entity (company and state). If we take the democratic setup then we see a body of people who are elected by masses and are called peoples representatives. They make laws and policies for governance of the state. They are accountable to the people at least when they go to seek fresh mandate. Similarly in the corporate setup we see shareholders who could be compared to citizens of the state, and the directors as their elected representatives. These directors are entrusted with a responsibility of conducting the business of the organization and the overall governance of it. They are responsible to the shareholders and in the annual general meeting they have to face the people who had elected them. A company is also a form of government which is governed by the Board of directors (as per the concept of Corporate Governance) and the shareholders the voters who take part in the election process and elects the board of directors. It is an internal mechanism of a company to govern itself but this also follows the principles of democracy for its efficient running, allowing a say of every Shareholder and to create a check and balance system.

SHAREHOLDERS DEMOCRACY

Like in any other Institutional Framework or system of governance in the Corporations also a system of democracy exits which follows the same principles but with a less vigor. The directors in a corporations are accountable to the shareholders whereas the shareholders are required to participate in the decision making process in order to create a 'check and balance' approach and their should be transparency in all the actions of the corporation whether they are taken by company or by the shareholders. Shareholders Democracy which is part of corporate democracy means that a company is under the control of its shareholders. In this every shareholders has equal opportunity to elect and constitute a board of directors to manage and conduct the affairs of the company. They act under as agents and trustees for the company in a fiduciary capacity. As such, their meaningful participation at company meetings is an imperative .

In the present paper we are more concerned with the Principles behind the Participation of the Shareholder in the working of the corporation. When shareholders invest in a corporation, the interest represented by their shares typically includes some right (albeit a contingent right) to receive a return on their investment, and a right to vote .

PARTICIPATION AND ROLE OF PROXY SYSTEM

The large topic of shareholder participation in corporate governance exists in an often overlooked procedural context that of disclosure and information flow. Informed participation is as important as participation per se. Furthermore, the distinction between passive participation in a simple ratification mode and active participation in the agenda-setting sense is an essential aspect of the overall topic of shareholder participation in corporate governance . One way by which the participation of the shareholders in the affairs of the company increased was by way of proxies. It is important that at least from a corporate democracy standpoint, there ought not be any obstacles to shareholder participation in corporate governance in the proxy process While it can certainly be argued that greater shareholder participation in corporate governance is necessary to provide an appropriate check on directoral abuses , this is only one of several possible arguments in favor of permitting large shareholders a greater role in the corporate decision making process . Increased shareholder participation in corporate governance could also produce a second potential benefit i.e. better decision making. Some directors have made some astonishingly poor decisions, at least from the economic perspective , over objections by shareholders.

ARGUMENTS IN DEFENSE OF PROXIES

A member may vote either in person or by proxy . Articles may allow voting by proxy even by show of hands . A proxy is entitled to vote at a meeting or in a resolution. The instrument of proxy encourages the participation of a member indirectly and also strengthens the democratic pattern of the modern corporations. The Companies (Amendment) Act, 2000 has, among others, laid down the law relating to passing of general meeting resolutions by postal ballot . This is a unique provision in as much as that never before in the history of Indian corporate laws share holders have been given a right to vote in respect of the business of a corporate without actually attending its general meeting. The need for such right arises as corporate in numerous cases hold their general meetings in far flung areas of the Country where they have their registered offices, with the result that a vast majority of shareholders residing all over India do not find it convenient to travel to such remote places and attend such meetings. One really can not fault the corporate as they hold their general meetings as per law {section 166 of the Companies Act 1956} which provides that the annual general meetings {AGMs} shall have to be held at the registered office or at some other place within the city/town/village in which the registered office is situated. However there is no restriction in holding extra ordinary general meeting in any other place but corporate usually prefer to hold such meetings where they have been holding their AGMs. Be as it may, the net result is that a miniscule number of shareholders are really able to attend the general meetings and exercise their voting rights. Thus, where a resolution has been passed by the shareholders of a company at a general meeting which has been attended by say, hardly 1% of the total number of shareholders holding say 3% of the voting power, it cannot be said that the shareholders' democracy has been implemented in true spirit although there is no violation of law . To over come the aforesaid situation that has been in existence for decades in India, the introduction of the concept of postal ballot in the statute books, is really welcome. It provides for true shareholders' democracy. Pertinently, by way of good corporate governance, the listing agreement has also provided for companies passing resolutions through postal ballot, albeit the same is discretionary on the part of the companies. This is understandable, as the provisions of the Companies Act, in this regard, had not yet come into force at that time. Further there have been continues efforts to promote corporate democracy in the Indian scenario. The Companies Amendment Bill, 2003 has been introduced in the Rajya Sabha on May 7, 2003. It includes, inter alia holding of meetings on Sundays, this can be called as step further in enhancing the participation of shareholders in the functioning of the government as it becomes easy for the shareholders to be present on this rather than on any other working day. But however this cannot be called a sufficient step to make a secured and dependable form of democracy. It would have been better if clauses providing for more attendance and authorizing the proxy holders to speak and vote on show of hands at such meetings, are also made part of such meeting .

In India the Justice Sachar Committee in 1978 recommended that:

1. The proxy holders should be allowed to speak at general meetings

2. Every proxy holder should entitle to vote on show of hands.

3. Two-way proxy from affording members an opportunity of voting for or against a

resolution should be sent along with notice of general meetings to every

shareholders entitled to attend and vote at the meeting.

But till date the amendments on these are awaited. The simple reason behind proxies can be that, it is not convenient for members to attend every time when the meeting is called but we may very interested in the happening of the events in the meeting and wanted to play an active role then he may empower and appoint any other person to attend and vote on his behalf. This method enables the participation of the members indirectly. Recently on April 14, 2003 SEC chairman William Donaldson proclaimed "time has come for a thorough review of the proxy rules and regulations to ensure that they are serving the best interests of today's investors and fostering sound corporate governance and transparent business practices." To that end, the Securities & Exchange Commission announced that it has asked its Division of Corporate Finance to examine current proxy regulations with a view to improving corporate democracy .

ARGUMENTS AGAINST PROXY SYSTEM

The proxy system no doubt has many favorable arguments but like any other system this is also not free from critiques. It has been argued that this form of Corporate democracy may have existed at common law, for in many cases both ownership and control of the early corporation resided in a few individuals but this postulated presence of this form of corporate governance, however, was disproved by Berle and Means in their classic studies on the separation of ownership from control in large corporations . Berle and Means found that because ownership in large companies was so widespread, no one shareholder could amass even a significant minority interest. Thus, the vote of each individual shareholder counted for little or nothing. Furthermore, Berle and Means observed that "where ownership was sufficiently sub-divided, the management could become a self-perpetuating body even though its share in the company's ownership is negligible." Management therefore, and not the 'shareholder-owner,' controls the modern corporation.

Managerial control necessarily diminishes opportunities for meaningful participation by shareholders in corporate governance and in the corporate electoral process23.

• First, shareholders receive limited information on those corporate policies and

practices that are not submitted to them for their vote.

• Second, they have only limited access to corporate proxy machinery.

• Finally, the only potential recourse for most investors is a state law right to

nominate directors from the floor at shareholder meetings. This right remains

more theoretical than real, however, for the shareholder proxies are received and

the votes are cast even before the meetings have begun.

Then can it be said that there is no real participation of shareholders and it is only the major shareholders who are the players in the field and rest of the small investors are just watching all the happenings like a the spectators. If we have to imbibe the principles of democracy in our corporate culture then it is necessary that every eligible member should make active efforts to participate in the decision making process of the company whereas the state should take responsibility to make laws which facilitates this process. It is well accepted that in large companies it is not possible to involve every shareholder in the decision-making process but through the instrument of proxy this can also be achieved. By strengthening the instrument of proxy it is possible to come over the hurdles, defeat the lacunas of proxies and reverting back the title of ownership to the shareholders. This system would also improve check and balance system in the organization, which would result in greater efficiency of the management and will reduce the incidence of frauds and misrepresentation.

CONCLUSION

'Democracy is not something you believe in or a place to hang your hat, but it's something you do. You participate. If you stop doing it, democracy crumbles'.

Abbie Hoffman

A company can also be understood as a form of government which is governed by the directors, and the shareholders are the voters who take part in the election process and elect the board of directors who can be equated with the Parliament or senate of any country. It is an internal mechanism of a company to govern itself but this also follows the principles of democracy for its efficient running, allowing a say of every member and to create a check and balance system. One of the ways to participate in this democratic process is by way of proxies where the member is unable to come and the meeting. But like as it has been stated earlier that there are arguments in both favor and against proxies. But if we have to imbibe the principles of democracy in our corporate culture then it is necessary that every eligible member should make active efforts to participate in the decision making process of the company whereas the state should take responsibility to make laws which facilitates this process. By strengthening the instrument of proxy it is possible to come over the hurdles, defeat the lacunas of proxies and revert back the title of ownership to the shareholders. This system would also improve check and balance system in the organization, which would result in greater efficiency of the management and will reduce the incidence of frauds and misrepresentation. This information level of the proxies need to be increased as if this group or category of people are participating in the most vital aspect of democracy, then they need to be properly informed in order to take correct decisions.