Sunday, October 28, 2012

SC judgement on RTI Act

The Supreme Court judgement in the Namit Sharma case involving the RTI Act has rightly caused concern in various quarters. The SC ruled that the Information Commission was "judicial tribunal" and hence all benches of the Commission must work with two members each, with one member having a judicial background and the other as an expert.

Former Chief Justice of the Delhi High Court A P Shah highlights the issues raised by the judgement of the honourable court:

First, equating the information commissions with a "judicial tribunal" is clearly erroneous. The only issue to be decided before the commission is whether information, which is already available with the autho-rities, should be disclosed or not. The commission does not therefore dispense justice (like a court), it merely deals with disclosure of information.

Second, the Act already provides certain qualifications for appointments to the post of information commissioners ("persons of eminence" and "knowledge and experience" in particular fields). However, the court has completely rewritten the provisions of the Act by insisting on qualifications that go beyond what has been prescribed by the Act, and further, by specifically laying down the requirement of two-person benches, having at least one judicial member. This is a clear case of judicial overreach where the court has virtually legislated provisions of law.

More importantly, there are important practical concerns that flow from this judgment, and which the court has unfortunately glossed over. A huge fallout by way of immediate effect of this judgment would be the cessation of the activities of all the information commissions until members with judicial background are appointed. The position of the current incumbents to the post of CICs becomes precarious as they cannot continue to work as per the SC decision. It is completely unclear whether they would resign or be removed — and if so, under what provision?

The RTI Act is one of the biggest triumphs of Indian democracy, an instrument of empowerment that does more for accountability of government than most other measures in that direction. It is, perhaps, a more valuable tool for fighting corruption than the proposed Lok Pal. It is important that nothing comes in the way of the working of this majestic Act. The government has been quick to move a review petition before the SC and one hopes that the SC will provide suitable redress. 

Friday, October 26, 2012

CEO pay and risk-taking

Aligning CEO pay with risk is one of the challenges of governance today; the failure to do so has been cited as one of the reasons for the financial crisis of 2007. How do we bring about this alignment? An article in HBR (The life cycle of CEO compensation, October, 2012) has some interesting ideas.

The article suggests that using an appropriate mix of stocks and stock options (instead of a pre-determined or set mix) might help. Options lead to an increase in prospective wealth and hence encourage risk-taking; stocks, which are current wealth, discourage risk-taking; the greater the stocks, the greater the aversion to risk because CEOs don't want to lose what they have.

It follows that CEOs will take big risks at the beginning of their careers when their option holdings are high and wealth holdings low; their appetite for risk will fall with time. If you want the firm to take risks and the CEO is at the end of his term, it would be best to expedite his departure and bring in a newcomer. If the firm is being too conservative and you want to encourage risk-taking, give lots of options to the CEO. In general, it's a good idea to set a ratio for holdings of stocks and options so that the appetite for risk is optimal.

In a post below, I pointed to research which suggests that leaders from outside are more likely to take gambles. If you want to encourage this further, give outsiders stock options; if you want a check on it, give the outsider lots of stocks.

Rajat Gupta sentence

The two year jail sentence and $5 m dollar fine imposed on Rajat Gupta will be debated for a long time. We need to be clear: the punishment is not for insider trading, although news headlines focus on the 'insider trading' case. Judge Rakoff's sentencing order makes it clear that, in the opinion of the learned judge, Gupta's offence was breach of trust. It also casts doubts on whether insider trading trading is as big an offence as it is made out to be:

The heart of Mr. Gupta’s offenses here, it bears repeating, is his egregious breach of trust. Mr. Rajaratnam’s gain, though a product of that breach, is not even part of the legal theory under which the Government here proceeded, which would have held Gupta guilty even if Rajaratnam had not made a cent. While insider trading may work a huge unfairness on innocent investors, Congress has never treated it as a fraud on investors, the Securities Exchange Commission has explicitly opposed any such legislation, and the Supreme Court has rejected any attempt to extend coverage of the securities fraud laws on such a theory........In the eye of the law, Gupta’s crime was to breach his fiduciary duty of confidentiality to Goldman Sachs; or to put it another way, Goldman Sachs, not the marketplace, was the victim of Gupta’s crimes as charged. Yet the Guidelines assess his punishment almost exclusively on the basis of how much money his accomplice gained by trading on the information.At best, this is a very rough surrogate for the harm to Goldman Sachs. 

So Goldman was the victim and it is not at all clear that it suffered any loss on account of Gupta's actions. To put it differently, Gupta's actions were not worthy of a man of his stature but they caused no harm, at any rate no great harm, to anybody. His actions pale beside various acts of skulduggery in the corporate world, such as the fiddling of accounts, payment of bribes, misuse of corporate funds for personal gain etc. And yet, in the eyes of American law, Gupta merits a two year jail term.

It does appear that the sentence is more a reflection on the harshness of the American system, which has a tendency to hand out long sentences in the name of deterrence, than on the nature of the offence that Gupta is said to be guilty of. In making this suggestion, one is not even taking into account the many contributions and accomplishments of Gupta.

Thursday, October 25, 2012

Outsiders are the best and worst leaders

One critical choice in selecting a leader is: do we opt for an insider or outsider? Gautam Mukunda, HBS professor, suggests that outsiders make the best and worst leaders- they succeed or fail dramatically. An insider can only produce modest outcomes. Either we take a risk with an outsider or we stay with an insider in the knowledge that no great outcomes are possible.

When an organisation is in dire crisis, it is relatively easy to plump for an outsider: after all, you have little to lose and a great deal to gain. But what do you do when the organisation is cruising along but wants to go the next level? We are truly stumped. It doesn't surprise me that most organisations simply prefer business as usual.

There are a couple of other options that suggest themselves to me. How about selecting an outsider in
advance and making him an insider? Then, we bring in the ability to view things differently and marry it to familiarity with the existing situation. Or, how about choosing an insider who has a reputation of being something of a contrarian, a de facto outsider?

More in my ET column.

Wednesday, October 24, 2012

Glass Steagall is not the answer to systemic risk

There has been talk everywhere of limiting the scope of banks. It is argued that the "utility" part of banking, the provision of basic banking services, must be separated from the "casino" part, which includes investment banking and proprietary trading. The mechanism proposed in the UK is the Vickers Commission proposal for ring-fencing; in the US, the preferred mechanism is the Volcker Rule. There is growing clamour in some circles for a return to the Glass-Steagall Act which would give a straight separation of investment banking from commercial banking.

I believe the focus on scope is not the way to address systemic risk. We need better risk management that addresses a whole set of issues other than scope. Here is my EPW article, How do we resolve the too-big-to-fail problem?

Foreign flows are not the key reform issue

We had a burst of reforms in September. The media gushed ecstatic about it and was quick to pronounce it a success.Why? Because, it is said, foreign inflows shot up and the rupee appreciated after its steep fall, as foreign investors responded positively to reforms.

So, here we have a fairy-tale story. There is a loss of confidence in the economy and the rupee plummets. Finance minister P Chidambaram comes galloping in. Bang! There is burst of reforms. Whoosh! Foreign capital comes flooding in. All ye, dance in joy!

Sorry to be a party-pooper but the story just doesn't wash when you take a close look at the numbers. Foreign inflows were not much larger in January and February this year, long before reforms in sight. And neither the sharp depreciation in the rupee this year nor the more recent appreciation means much because, in real terms, the rupee has largely stayed within the 5% band for the real effective exchange rate.

Once you see this, you realise that the focus on FDI in the current bout of reforms is misplaced. FDI flows have never been a cause of concern in recent years. The problem is with domestic investment. With the infrastructure sectors ridden with regulatory and policy uncertainties, private investment is unlikely to pick, so public investment must step in. This must be the focus of reforms, not FDI.

More in my last ET column, Reform focus is misplaced. I should have linked it long back but have not be able to post for a long while thanks to several pre-occupations.

Thursday, October 04, 2012

Spotting disaster-prone CEOs

Many  a famous company has gone under because of some disastrous act or decision of some CEO. Instances of this in the financial crisis are legion- RBS, Bear Stearns, Lehman Brothers. Is it possible to identify and remove CEOs headed for disaster? Lucy Kellaway, FT columnist, thinks there is. She suggests the equivalent of a test of roadworthiness for cars.

She posits that hubris is the reason for the downfall of companies and CEOs. Ergo, the challenge is to spot signs of hubris. She thinks this can be done by using a questionnaire on board members, the CEO's personal assistant and the CEO himself:

The test could be arranged around a small number of simple questions such as: how would you rate his arrogance on a score of one to five? Has it increased recently? Has he changed his mind on anything in the past year? Has he done anything even slightly dodgy? In answering these questions, spineless non-executive directors would be discouraged from fudging answers by the promise of a prison sentence should they fail to be candid. 
I'm afraid the columnist is being rather simplistic. Assuming that we can get people to answer the above questions honestly, does it provide a basis for removing a CEO? I doubt very much. First, almost anybody at  that level would be given to a certain amount of arrogance: without it, perhaps, they wouldn't be there, and they would have to be less than human if the pay and power they commanded didn't go to their heads.
Secondly, it is the same arrogance that often produces results. When it succeeds, it is called aggressiveness, drive or focus. When it fails, people give it other names: overconfidence, recklessness, hubris. That is why, there is no dearth of arrogant CEOs who don't quite end up as disasters. And there are some modest CEOs who have much to be modest about.
The answer to disastrous CEOs has to be found elsewhere: in stronger systems, processes and dispersion of power at the top. The problem is not arrogance but the job description of the CEO itself. So long as you have so much power concentrated in one person, there is always the potential for trouble. Drucker once wrote that the CEO is not a person but a team, say, a team of three persons. Companies have found it impossible to embrace this principle or any worthwhile degree of decentralisation or diffusion of power. Until that happens, fasten your seat belts. 


The SC's order on a PIL related to the CAG has not received the attention it deserves in the media. Here is a TOI report.

The petitioner contended, as many government spokesmen have in recent days, that it was not for the CAG to comment on matters of economic policy. The SC had a sharp response:

CAG is not the traditional Munimji to prepare only balance sheets. It is constitutionally mandated to examine the efficiency, effectiveness and economy of the decisions of the government in using resources. If the CAG will not do this, then who will?
This does repudiate the government contention, in the wake of the recent SC bench observations on the presidential reference, that it was not for the CAG to suggest auctions or estimate the losses incurred by not following the auction route.

How does one reconcile the SC bench ruling on the presidential reference with the SC observations on the PIL? Well, I can only attempt an answer. It is true that auction need not be the only method for the allocation of natural resources. The government need not adopt the method in every instance of sale of natural resources. However, if the government has adopted a different method, it is open to the CAG to comment on whether it was appropriate in that instance or not. And, of course, the SC has every right to examine whether any method adopted was mala fide or smacked of arbitrariness.

I have defended the allocation method adopted by government in the case of coal blocks. However, the CAG, it would appear, was within its rights to question the correctness of this approach and give its comments. As the SC has pointed out, it is for parliament to accept or reject the CAG's views. The procedure is for CAG reports to be examined by the Parliamentary Accounts Committee. The fact that CAG reports on the 2 G spectrum sale and on coal blocks have touched off a political furore and rendered the functioning of a parliament difficult cannot be reasons to ask the CAG to refrain from commenting on such matters. It is for political parties to get their acts together, observe discipline and ensure the smooth functioning of parliament.

It does seem to me that, between the two judgements, a fine balance has been struck. It is the prerogative of government to decide on matters of economic policy. Equally, it is the prerogative of the CAG to comment on the government's decisions.

Wednesday, October 03, 2012

Mafia is alive and kicking

The Mafia in Italy is alive and kicking. The Economist reports that it has extended its tentacles from its traditional base in the south to the northern region.

The fact that the ‘Ndrangheta, a crime syndicate born in the toe of the Italian boot, should be found in cahoots with local politicians in a town 60km (38 miles) from the French border is striking evidence of something that is gradually becoming clear: the mafia is no longer a southern phenomenon in Italy, but a national one.
Of the 22 local authorities disbanded last year because of alleged infiltration by organised crime, four were outside the south. What is happening along the coast near Rome is unclear. Some investigators fear a turf war may have started between local hoodlums and Camorra mobsters intent on expanding their influence.
The report mentions how the Mafia has infiltrated various local councils and at least one instance where it helped a politician get elected to the European parliament. No point in fretting about the nexus between politicians and criminals in India; like inflation, it is a global phenomenon. Think of the notorious links between politicians and criminal groups in Japan.

To take this further, it is a mistake to think of politics and crime as two distinct vocations. There are politicians in all countries (including the US) who are known to have engaged in criminality. And criminals do find it expedient to become politicians themselves. So, you have two sets of criminals: one operates within the framework of the law and the other operates outside it. Both profit by breaking the law. 

Brajesh Mishra

Former National Security Advisor Brajesh Mishra, who passed away a few days ago, has been widely mourned. The tributes cut across party lines. This is an acknowledgement of his contribution in ensuring a certain acceptability for India's going nuclear in 1998 and, more so, in using the event to b build a strategic partnership with the US.

The leak of the letter from PM Vajpayee to president Clinton saying that it was the Chinese threat that forced India to go nuclear may have been a PR disaster. However, one would imagine that this is precisely the point Mishra emphasised in private to the American side: look, we are on your side and we will help you contain China; now that we have the bomb, we can help you better. It seems to have worked.

Mishra was conferred the Padma Vibhushan by the UPA government despite the fact that he happened to be a confidante of Vajpayee, a rare instance of such honours transcending the political divide. It's a different matter that the UPA government has not been able to bring itself to confer the Bharat Ratna on Vajpayee. That may entail a political cost and, of course, it would trigger demands for a similar award for Karunanidhi, Karpoori Thakur, Kanshi Ram and others, past or present, in various political parties.