Experiences with Pluralist Stakeholder Model in India: For Whom Should a Company be Run?

– Surbhi Soni*

This article seeks to trace the emergence and operation of a stakeholder model of corporate governance in India, that is sourced in directors’ fiduciary duties, Corporate Social Responsibility [‘CSR’], and the agency of Independent Directors [‘IDs’] in the Companies Act of 2013 [‘Act’]. It examines the shortcomings of Section 166(2) of the Act, gaps in enforcement of CSR, and the lack of effective participation by IDs. It concludes that reimagining corporate governance is imperative to secure the goal of stakeholder governance, and suggests reinventing companies’ growth indicators, mandating disclosure requirements, appointing CSR Experts and Labour Directors, and calls for a more conscientious participation by IDs.

Models of Corporate Governance

The expression ‘fiduciary duty’ entails that one acts in the best interests of another. A director always owes her fiduciary duties to a company.[1] Thus, the subject of inquiry essentially becomes, how are the best interests of a company served, or for whose benefit should a company be run. There are two major theories of corporate governance. In 1970, the Chicago School economist, Professor Milton Friedman postulated the ‘Friedman doctrine’, announcing that the social responsibility of a company is to maximize the wealth of its owners, i.e., shareholders. Thus, ethical or moral choices regarding the expenditures of a company, are not the directors’ prerogative, but instead choices within the domain of shareholder democracy. This is known as the shareholder primacy model. Contrarily, the stakeholder interests model, originally propounded by Ian Mitroff and Edward Freeman, recognizes that with corporate rights, come social responsibilities. It envisages the role of directors and the company such that, it accommodates the competing interests of various stakeholder groups; for example, its creditors, employees, sensitivity towards the environment, and the society at large. They are also known as “non-shareholder constituencies” of a company.[2]

Bridging the gap between these two approaches of corporate governance is difficult, and company laws of most jurisdictions can be grouped into either the shareholder or the stakeholder model.[3] In the U.S.A., U.K., and Australia, corporations follow the shareholder primacy model of corporate governance.[4] Despite its socialist tendencies in the first few decades since independence, corporate governance in India also overwhelmingly espoused the shareholder model till the enactment of the Act in 2013. This was due to the heavy influence of colonial laws which primarily sought to attract and retain capital in businesses.[5] Further, the lack of codification of the duties of directors and the absence of clear domestic precedents resulted in a heavy reliance on common law, which, as noted earlier, accorded primacy to shareholders.

Fiduciary Duties, CSR, and IDs to Protect Non-Shareholder Constituencies

Duties of a director, including fiduciary duties, were codified in India for the first time in the Act in 2013. The Act incorporated the stakeholder model, sourced primarily in Section 166(2), which reads, “A director shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of the environment as a whole.” Thus, India adopted a pluralist approach towards stakeholders, alive to the age of ESG – environmental, social, and governance factors.

Section 166(2) of the Act is free from any explicit or implicit hierarchy in the interests of various stakeholders. This is unlike the approach in the U.K., which also recognizes the interests on non-shareholder constituencies. U.K.’s enlightened shareholder value [‘ESV’] model does not consider different stakeholders’ interests as distinct obligations of the company.[6] Instead, the ESV model envisions the interests of the non-shareholder constituencies as a sub-set of the dynamic interests of shareholders themselves. Hence, long term consequences of corporate decisions, interests of employees, and business relationships with corporate partners (such as suppliers, investors, etc.),[7] are all means to further shareholders’ interests. Stakeholders’ interests are, thus, subservient to shareholders’ interests.[8]

There are two further aspects of the Act that incline Indian corporate governance to a stakeholder model. First, the Act lists the roles and functions of IDs. This was absent from the hitherto applicable Clause 49 of the Listing Agreement, which only provided for the appointment of IDs in listed companies. Schedule IV of the present Act contains a code for IDs, and requires them to safeguard and balance the diverse and often competing interests of all stakeholders. Secondly, the Act enforces the concept of CSR. All ‘large companies’, whether public or private, are required to set aside a minimum of 2% of their average net profit of the three preceding financial years to be spent on certain socially desirable activities provided in Schedule VII of the Act. These activities include preventing extreme hunger or poverty and promoting education.

However, despite the formalistic adoption of a pluralist stakeholder model in India, it is well recognized that Section 166(2) of the Act is not doing “what it says”,[9] and the impacts of a stakeholder-oriented corporate governance model are conspicuous by their absence in the society. The following sections of this article probe into the statutory scheme to analyse the lack of enforcement of such a model. First, the drawbacks of Section 166(2) of the Act are analysed. Thereafter, the role of IDs, and the functioning of CSR are explored.

Section 166(2) – Accountability and Subjectivity

The first major reason for the failure of the stakeholder model in India is the lack of accountability. The Act grants no effective right of enforcement to the stakeholders whose interests may have been vitiated by the directors or the company.[10] This is primarily because of three reasons: first, two of the three non-shareholder constituencies identified in Section 166(2), ‘community’ and ‘environment’, are extremely vague,[11] and no enforceable right of action can be conceptualized for these stakeholders. In fact, corporates snappily retort that under a stakeholder model, the accountability will shift to the loudest and most passionate political activists.

Second, unlike shareholders and creditors who are empowered to proceed in the name of the company against the directors, no such right of derivative action, or class action suits,[12] is available to the other stakeholders, that is, the employees or the community. It is noteworthy, that in March 2017, the Uttarakhand High Court pronounced the rivers Ganga and Yamuna as legal persons, and designated inter alia, the Advocate General of the State of Uttarakhand as their custodian, who could sue on their behalf. This right was subsequently expanded to the environment broadly, including air, glaciers, grasslands, etc. However, these orders had left many questions about enforcement of such a right unanswered. Subsequently, in July 2017, these orders were stayed by the Supreme Court of India. Therefore, at present, ‘environment’ in India does not have a ‘right to sue’ for it protection.

Finally, concentrated corporate ownerships, a marked trend in Indian corporate ownership, contribute to the culture of lack of accountability. Concentrated ownerships reduce ‘agency costs’, that is, the costs of aligning the interests of the shareholders with those of the Board of Directors [‘Board’].[13] In such cases, the Board is more likely to defer to the interests of the shareholders. Thus, corporate landscapes with widespread concentrated ownerships are less likely to protect stakeholders, unless shareholders take an active interest in doing so. In fact, even minority shareholders are vulnerable to opportunism by dominant shareholders in such jurisdictions.[14] Therefore, statutory shortcomings and structural patterns contribute to the absence of accountability in carrying out fiduciary duties.

The second major drawback of Section 166(2) is that it does not provide a rule of priority in which directors must consider stakeholder interests, especially when competing interests come in conflict. Thus, prioritization among competing stakeholder interests is left to the discretion of directors. Additionally, the directors exercise subjectivity in estimating and evaluating what is best for the company, and in turn, for the company’s stakeholders themselves. In such a scenario, ideally, adherence to the stakeholder model would encompass determining priority of a given stakeholder group based on the peculiarity of each transaction. For example, in a transaction of issuing additional equity, interests of existing shareholders must have a prominent bearing upon the corporate decision.[15] Similarly, when deciding on standard employment terms, directors should prioritize dignity and well-being of the employees (including paying a living wage, ensuring work-life balance, and a safe workplace environment) over cost minimization (as provided in the National Voluntary ESG Guidelines of Business 2018). However, it is seen that, in practice, directors seek to prioritize groups that are most closely aligned to their own interests, and often attempt to further their professional ambitions.[16] For example, promoter directors often prioritize the interests of controlling shareholders, while nominee directors are required to protect the interests of their nominator entities on priority. Thus, owing to a lack of priority in Section 166(2), stakeholder benefactors whose interests do not cater to the interests of directors’ aides, are seldom accommodated in a company’s decisions.

Dichotomized Experiences with IDs

IDs are vested with the specific responsibility of safeguarding the interests of all stakeholders. They are individuals who have no pecuniary or material relationship with the company (Section 149(6)). Arguably, one of the most important roles envisaged for them, is to balance conflicting interests between different stakeholders (Schedule IV, paragraph II(6)). Reinier Kraakman, et al, postulate that the strategy of involving such persons is that, in the absence of high-powered incentives (monetary incentives) to indulge in opportunism, such persons will respond to low-powered incentives, such as conscience, pride, and reputation.[17] However, in Indian corporate governance, first, IDs are not entirely free from high-powered incentives since their degree of independence is questionable; and second, low-powered incentives, while difficult to measure, seem to manifest in extremes, and standalone, fail to serve their purpose.

Independence of directors, inter alia, depends on ‘actual remoteness of insiders from the appointment process’.[18] However, under Schedule IV of the Act, IDs are selected by the Board, and their appointment is confirmed at a meeting of the shareholders. Their re-appointment is subject to a performance evaluation, undertaken by the Board itself. Thus, their appointment and reappointment procedure raises doubts as to their independence.

The Indian experience with low-powered incentives (of pride and conscience) is evidenced in two contrasting trends. The first of these is that, as part of a peculiar cultural trend in corporations, IDs do not perceive themselves as ‘watchdogs’ of corporate decisions, and seldom interfere with matters of corporate governance.[19] Second, and at the opposite end of the spectrum, is the statistic of record-high number of IDs resigning from their positions before term, evidently dispassionate about re-appointment. It is easy to read between the lines. Indian corporate governance, in the context of IDs, is dichotomized – where on the one hand, IDs work hand in glove with other directors, and on the other hand, feel powerless and over-regulated in the performance of their duties. Thus, the concept of IDs, whose incentives are divorced from the monetary returns of a company, is futile, as long as their independence, regulation, and authority are not better protected. Consequently, their involvement on the Board and on CSR Committees, is an insufficient safeguard (for better corporate governance) and a myopic policy decision, since IDs may either actively choose not to dissent, or will have little incentive to do so.

Corporate Social Responsibility – An Easy Way Out

The final instrument to realize a stakeholder model in the Act is CSR. The rationale behind making CSR mandatory was to engage companies as ‘partners’ in social development of the country. However, as identified by the High Level Committee formed by the Ministry of Corporate Affairs on CSR, in its recent Report [‘CSR Report’], CSR regime is in dire need of an overhaul. Limited applicability of CSR obligations to only business entities under the Act, underreporting and restricted information disclosures, and most importantly, misuse of CSR for either creation of capital assets for the company, or merely disbursing them to implementing agencies, are some common patterns that require legislative intervention.[20] Additionally, large companies can escape liability, even if they do not contribute towards CSR, by rendering an explanation for it in the Board’s Report. The standard that an explanation is required to meet in order to exempt the company from liability is not clarified anywhere.[21]

Finally, CSR Committees, that recommend and monitor the expenditure on CSR, are required to include at least one ID. From the previous section, it is apparent that this is an inadequate safeguard to ensure accountability and objectivity in the functioning of CSR Committees.[22]


The Companies Act, 2013 lays the foundation for a stakeholder approach to corporate governance in India through the instrument of fiduciary duties. However, upon examining the provisions of the Act, Section 166(2) appears to be a sequestered island of idealism in the corporate governance regime in India. The Act must adapt its textual pluralist approach to an enforceable pluralist approach. Towards that end, the Act must modify the incentives to directors in their performance of fiduciary duties. Growth indicators of a company’s internal performance must include assessing furtherance of stakeholder interests. Additionally, public-domain disclosure requirements addressing fulfilment of responsibilities under Section 166(2) will help improve accountability, while also revealing the patterns of prioritization of stakeholders that directors resort to, in corporate decision-making.

Further, while the CSR Report made several important recommendations, most importantly, to prevent misuse and misallocation of CSR funds, the CSR expenditure must be brought within the statutory financial audit of the company, by incorporating it within Schedule III of the Act. This will make the process of CSR more transparent. Additionally, the Act must mandate engagement of CSR Experts by the CSR committees. While the Report does not provide any eligibility criteria for such experts, parallel legislations, such as the to-be Schedule VIII of the Arbitration and Conciliation (Amendment) Act 2019, can provide some insight. The aforementioned Schedule lists criteria for ‘Qualifications and Experience of Arbitrators’. With criteria for technical expertise akin to this Schedule, qualified with requirements of integrity and goodwill, such a body of experts may well take shape and positively impact the CSR regime. The involvement of such an expert body is also hoped to raise the threshold for explaining default in CSR by Indian companies.

Furthermore, corporate governance in India must enhance representation of non-shareholder constituencies. Spearheading the way, the co-determination model of corporate law in Germany, inter alia, mandates that one-half of the representatives of supervisory boards of all companies (that employ more than 2000 German-origin workers; one-third, in the case of companies with 500 employees), to be elected by the work force.[23] Further, the group of ‘Labour Directors’ must internally represent the diversity in the workforce. Thus, the labour directors must include a blue-collar worker, a white-collar worker, and a labour-union representative.[24] The fact that companies with strong co-determination models in Germany have been found to be very stable in steering through economic and financial crises – less number of lay-offs, less probability of share buybacks, and quick recoveries – is a testimony to the success of the model. In a limited sense, the co-determination model is also enforced in the European Union [‘EU’] as a whole, through the European Works Council Directive. It mandates multinational companies (with more than 1000 employees and at least 150 employees each in two or more EU Member States) to divulge information to, and engage in consultation with, the employees. Indian legislators must provide for effecting such a co-determination model in India by securing employees’ representation on the Board through Labour Directors, using appropriate thresholds.

Finally, as mishaps in the times of the Covid-19 pandemic have shown (in Vishakhapatnam, Tamil Nadu, and Chhattisgarh), it is high time that Indian companies undergo stricter environmental compliances. As the notional representatives for the environment, and the community at large on corporate boards, IDs must conscientiously participate in corporate governance to protect the rights of these constituencies. Towards that, inclusion of CSR Experts and Labour Directors is also likely to positively effect participation by IDs.

Thus, in conclusion, reinventing the company’s growth indicators, mandating disclosures on fulfilment of responsibility towards stakeholders, involvement of CSR Experts, inclusion of Labour Directors, and a meaningful representation of the environment and community by IDs will serve to enhance the enforceability of a pluralist stakeholder model of corporate governance and reign in accountability for fiduciary duties of directors. Going forward, they will herald an era where companies will be run for sustainability – their own, and of the society.

* Surbhi Soni is a third year student at the National Law School of India University, Bangalore.

[1] Mihir Naniwadekar, Umakanth Varottil, ‘The Stakeholder Approach Towards Directors’ Duties Under Indian Company Law: A Comparative Analysis’ (2016) NUS – Centre for Law & Business, Working Paper No. 16/03, 1 < http://law.nus.edu.sg/wps/pdfs/006_2016_Umakanth.pdf> accessed April 22, 2020.

[2] Reinier Kraakman, The Anatomy of Corporate Law (OUP 3rd edn, 2017) 79.

[3] Afra Afsharipour, ‘Redefining Corporate Purpose (India): An International Perspective’ (2017) Seattle University law Review 40(2), 465- 497.

[4] Shelley Marshall, Ian Ramsey, ‘Stakeholders and Directors’ Duties: Law, Theory and Evidence’ (2012) UNSW Law Journal 35(1), 294.

[5] Umakanth Varottil, ‘The Evolution of Corporate Law in Post-Colonial India: From Transplant to Autochthony’ (2016) American University International Law Review 31(2), 253.

[6] Richard Williams, ‘Enlightened Shareholder Value in UK’s Company Law’ (2012) UNSW Law Journal 35(1), 360.

[7] Companies Act 2006, s. 172; see Naniwadekar, Varottil, supra note i, 2.

[8] Gautam Sundaresh, ‘In Whose Interests Should a Company be Run? Fiduciary Duties of Directors During Corporate Failure in India: Looking to the West for Answers’ (2019) Michigan Business and Entrepreneur Law Review 8(2), 317.

[9] id, 340.

[10] Naniwadekar, Varottil, supra note i,  19.

[11] Sundaresh, supra note vii, 338.

[12] See Companies Act 2006, s. 245, which entitles only the members and depositors (after qualifying the numerical thresholds under s. 245(3)) to bring a class action for running the company in a manner prejudicial to the interests of the company or her members or depositors; thus ‘class action’, as technically defined in Act is limited in its scope.

[13] See Kraakman, supra note ii, 30.

[14] Like most jurisdictions, the Act protects the interests of minority shareholders by entitling them to bring a claim of oppression under Companies Act, s. 241. Further, voting requirements for special resolutions under Companies Act, s 114(2) seek to protect large blocks of minority shareholders. See also Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeover) Regulations, 2011 available at https://www.sebi.gov.in/legal/regulations/apr-2017/sebi-substantial-acquisition-of-shares-and-takeovers-regulations-2011-last-amended-on-march-6-2017-_34693.html.

[15] Umakanth Varottil, ‘The (Negligible) Role of Shareholders in Corporate Insolvency’ IndiaCorpLaw available at <https://indiacorplaw.in/2017/10/negligible-role-shareholders-corporate-insolvency.html> last accessed April 13, 2020; Also see Insolvency and Bankruptcy Code, 2016 (India).  

[16] Kraakman, supra note ii, 29: “Agents [directors] have an incentive to act opportunistically” because they have more information about the quotidian functioning and transactions of a company.

[17] Kraakman, supra note ii, 35.

[18] Kraakman, supra note ii, 66.

[19] Rajesh Chakrabarti, ‘Audit Quality and board Independence’ (2018) 30 National Law School of India Review 1, 54.

[20] Ministry of Corporate Affairs, ‘Report of the High Level Committee on Corporate Social Responsibility 2018’, (2019, New Delhi) 57-87.

[21] id, 97: The High Level Committee on Corporate Social Responsibility, 2015 remarked that the standard of ‘comply or explain’ was sufficient; the 2019 Report makes no remarks on the same.

[22] See Securities and Exchange Board of India, ‘Report of the Committee on Corporate Governance’ (2017) available at https://www.sebi.gov.in/reports/reports/oct-2017/report-of-the-committee-on-corporate-governance_36177.html.

[23] Thomas Meyer, ‘Workers’ Participation in Management in the Federal Republic of Germany: Structure, Considerations, Experience’ (1990) Indian Journal of Industrial Relations 25(4), 376; The enactment is called the German Limited Liabilities Companies Act, available at https://www.gesetze-im-internet.de/englisch_gmbhg/englisch_gmbhg.html.

[24] id.