Some of the improvements include:

• Listed companies are required to have at least 50% of the board as independent directors. Furthermore, resolutions in company board meetings need to be ratified by at least one independent director
• Total tenure of an independent director is not allowed to exceed 2 consecutive terms (5 years per term). In fact, a special resolution from shareholders is required to allow a second term
• Independent directors are not allowed to receive stock options to maintain their independence
• India is one of first countries to legislate social responsibility for corporations. For example, companies that meet a certain size filter are required to spend at least 2% of their average net profits made during the three immediately preceding financial years on socially impactful factors
• Corporations must have at least one-woman director in the interests of diversity and thought

A common feature of emerging market companies, is a controlling shareholder, often referred to as the promoter or founder of a business. This is particularly prevalent in India where promoters own approximately 45% of the equity of publicly listed companies.   A deep understanding of the ownership structure, Board composition, promoter’s incentives, track record and character is crucial to determining the success of the business.

This requires specialist knowledge from those who have operated within the same market over time. Being on the ground, local experts can leverage off their experience, resources, strong relationships and networks to understand the following:

• Is there a controlling shareholder and what is their ulterior motive?
• Do their actions align with the interests of minority shareholders?
• Are there any red flags in terms of a history of mistreating minority shareholders?

Another important factor to consider, where a controlling shareholder exists, is the ability of minority shareholders to partake and influence significant decisions (e.g. the nomination process, voting thresholds for various resolutions etc.). This can be a major concern for minority shareholders in capital markets where weak minority investor protection exits. In the most recent release of the World Bank’s “Doing Business” report, India ranks 8^th in the world for protecting minority shareholders, ahead of many developed countries like the United States, Australia, Japan and across Europe. According to the report, India scores highly in terms of shareholder rights and governance, corporate transparency and conflict of interest regulations. Sometimes perception is not reality, especially for investors in developed markets who believe companies they know and understand are less likely to experience governance issues. Lack of familiarity does not necessarily equate to weak corporate governance.

The investment case for active management in emerging markets rests most heavily on the concept of market inefficiency. However, market inefficiency is not something investors should shy away from. The fact that the market is inefficient provides a ripe environment for strong value-add for active managers with local knowledge and experience. Whilst passive strategies are becoming increasingly available today given their low cost and ease of implementation, they have many important shortfalls, especially when it comes to investing in markets where there is a larger dispersion of governance practices. Passive investing means you are obliged to invest in all constituents of the index, preventing active avoidance of companies with lower governance standards.

Furthermore, given the higher levels of both risk and return potentially available from investing in emerging markets, investors who can identify companies undergoing a significant rate of advancement in corporate governance standards can find themselves in a sweet spot. These companies tend to re-rate quicker as the market acknowledges their advancement.

The chart below, assuming other influences are held constant, illustrates this “sweet spot” where the rate of advancement of a company’s corporate governance can have the most significant impact on its stock price.