Exit, Voice and Loyalty: Responses to Decline In Firms, Organizations and States

Recently, while I was reading a book on corporate governance(Ownership & Control: Rethinking Corporate Governance for the Twenty-First Century  by  Margaret M.Blair ), I came across an interesting  reference to a book there, while the author was discussing the shareholder behaviours .According to Ms.Blair, Albert O.Hirschman argued in his book , Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations and States, if participants  in an enterprise  were able to exit freely , they would not be very  motivated to use voice to try to reform the enterprise, whereas, if  they were unable or constrained in their ability to exit, they would be more likely to find effective ways to use voice. The book was published in 1970. I was not sure of getting a copy. But when I searched , found that the book was available.  As I could not resist the temptation, I immediately  went ahead and purchased a copy even though it is priced high for the small book it is. But now I feel  happy, satiated and am able to explain why certain things happen in certain ways in organizations. Also, why certain organizations  do not take corrective actions  and go down the hill. And, I could use the arguments there  to explain  why independent directors on boards, even with enormous power legitimately vested  with them,  normally do not raise any voice  against even atrocious behaviours of promoters or management but meekly resign.

Take the case of an organization. An employee  may disagree with the management on many things  and may have lots of concerns about the way the organization is managed. But he may not openly raise his concerns if he is able to get another job, equally rewarding. According to Hirschman, ”The presence of the exit alternative can therefore  tend to atrophy the development of the art of voice”. But if an employee has difficulty in exiting, may be because of his age or qualifications or his nature of commitment or due to any other reasons, he will raise his voice rather than make a silent exit. And in certain types of organizations, like a family, exit option usually does not exist. Voice could be the only available option. The analogy could be easily applied to an enterprise-customer relationship.

Voice can take many forms. It can be through individual  or collective petition to the management directly or through appeal to a higher authority  with the intention of forcing a change in management , or through various types of actions and protests, including those that are meant to  mobilize public opinion.

And loyalty   is a key aspect in the battle  between exit and voice because as a result of loyalty, members may postpone their exits and also use the voice option with great determination and resourcefulness, according to Hirschman. And in the case of loyal people, the chances of voice to function effectively as a corrective mechanism if voice is backed by the threat of exit.

In most of the cases of corporate governance failures, directors, especially the independent directors(IDs), meekly resign without raising any voice. They do so because of three reasons: One, there is no loyalty factor necessitating voice, two, they can easily get another directorship elsewhere, and three raising a voice might jeopardize their possibility of directorships elsewhere. So far, to the best of knowledge, there have been only two instances of  IDs raising their voice against decisions of owners or management. One was in respect of Coal India, where the IDs raised their voices against the majority owner, the Government of India as certain decisions made by Government and to implemented by the company was harmful for the company as an entity. Another instance was in respect of DLF, which was involved in some murky land deals with Robert Wadra, the son-in-law of Ms.Sonia Gandhi, the UPA chief, where the IDs categorically denied  receiving any information on such deals and raised voice against the promoter and management.

The book gives wonderful examples how will customers react to quality problems and also many other economic and national aspects where exit, voice and loyalty are involved. A classic book which every senior manager must read.

A Step In The Right Direction By SEBI

It has been reported by ET that SEBI might consider imposing caps on the number of Independent Directorships a person can hold.(“SEBI Mulls Five-Board Cap For Independent Directors”, Reena Zachariah, 10/01/13). While in general, the cap is applicable to any director, the recommendations are going to be even more stringent in the case of CEOs of listed companies. CEOs can think of becoming Independent Director(ID) only in two other companies. There is only a handful of IDs in India who sit across  as many boards as the law permits.  While the exact number of directorships by a person  can take on is debatable even when he is not a CEO elsewhere, the multiple directorships  can set a severe limit on the time that an individual can devote to a company. Mr.Deepak Parekh was reported to be critical of the proposal on the ground that there is a paucity of good directors and many companies have not been able to fulfill the criteria laid down by SEBI and also because Ids are required to sit on the boards of subsidiary companies.

It is not surprising that Mr.Deepak Parekh, Chairman of HDFC is critical of the proposal. Deepak S.Parekh, while he was Executive Chairman of HDFC, was independent director on  12 publicly listed companies and also was on the board of a number of private and/or unlisted companies. His remuneration from these companies used to be more than Rs.1.00 Cr. ‘Professional director’    R.A.Shah( 88 years old), is still chairman at 4 companies, Vice-chairman of a company , director on seven companies and alternate director on another six companies, in addition to being Senior Partner at the solicitor firm, Crawford Bayley. The annual report of Biocon for 2011-12 where Mr.S.N.Talwar is an ID, lists 44 companies where he is either Chairman, Director or Alternate Director. Earlier the law  permitted  upto 15 directorships in public limited companies with no restrictions on directorships in private limited companies but the new Company Law 2013 has reduced number of directorships in public limited companies to 10 and across all companies to 20.

But such multiple directorships actually put lots of pressure on director time, and can lead to lack of attendance or at least dilution of their expected duties, leading to a denigration of the very institution of IDs.Estimates by Carter and Lorsch  (2004) put the time to be devoted  by any Non-Executive Director  (NED)for a company from about 80 hours(for a stable and satisfactory company situation and industry complexity  and where the board plays a watchdog role) to 320 hours (for a challenging company  situation and industry complexity where the board  plays the pilot role).Hence, any NED/ID will have to devote about 10 to 40 days to each company depending on the nature and complexity of the companies.

According to James O’Toole, Professor at University of Southern California, while commenting about Robert Townsend  wrote that Townsend(2007) “castigated dilettantish professional directors who sit on twelve boards and contribute to none.” Townsend himself had written  in 1971 on outside directorships and trusteeships for the Chief Executive, said:”Give up all those non-jobs. You can’t even run your company, dummy.”(Townsend 2007)

Mr.Parekh’s concerns that there is a paucity of good directors and many companies have not been able to fulfill the criteria laid down by SEBI must be put at the doorsteps of the companies and their boards . The Clause 49 regulations have been in place for more than  8 full years now. What have  India Inc and their boards done to train and make the availability of director candidates better during this period? In fact, a large number of aspiring director candidates have been trained by various bodies like IOD but to the best of my knowledge, very few of them have been successful in getting nominated for ID openings. The companies must try out new candidates by casting the net wide rather than restricting themselves to look at a given/very limited set of IDs who are already overloaded.