Pharma Governance Maladies and Corporate Leadership

On September 26, 2017, two media headlines related to the Indian pharma industry, possibly made many wonder – Are these some of the key reasons prompting the Government to enforce stringent and costly regulations in this sector?

Above revelations came close on the heel of a series of alleged fraudulent, collusive and even criminal behavior of many domestic pharma players, by several overseas regulators, including the US-FDA. Besides international media, similar reports often featured in the national business dailies too. Most of these allegations are related to pharma marketing practices, and drug quality related concerns. In that sense, the core issues of following two news items are no different, and were reported as follows:

  • “The income tax (IT) investigation wing claims to have unearthed a nexus between a leading pharmaceutical company and doctors, and evidence showing payments running into Crores to the latter for prescribing the company’s medicines.”
  • Reaching out to Niti Aayog, Indian drug industry lobby groups, “mainly objected to three proposals in the draft policy floated last month: one drug one brand, curbing retailer margins, and mandatory bioavailability and bioequivalence (BA/BE) test for all drugs approved by state regulators and also future renewals.”

Out of these, the objection to mandatory BA/BE tests appears more intriguing to me – for two reasons. First, the news report doesn’t mention the participation of any global pharma company or their lobby groups in this meeting. If true, it would possibly mean, the pharma MNC players operating in India aren’t unduly worried about BA/BE requirements, which are mandatory in other countries of the world, primarily to ensure high generic drug quality standards.

The second one being, when the Indian pharma industry is so vocal on ‘poor quality’ of generic drugs sans brand names, apparently to protect branded generics, why is its lobby groups opposing mandatory BA/BE tests – so critical to address the quality issue. Opposing these tests, citing some ‘reason’, appears absurd. Resolving safety concerns on ‘Unbranded’ generics is nonnegotiable – for patients’ health and safety.

The major incident that snowballed:

It reminds me of the major US-FDA related quality issue involving Ranbaxy of India that eventually snowballed, attracting global media attention. This incident was well covered by Indian Press and Television, as well. As one such business daily reported, the much talked about whistleblower Dinesh Thakur, reportedly claimed that his boss in Ranbaxy made a detailed presentation of the alleged widespread manufacturing lapses and fudging of data in the company first to “a closed-door board of directors meeting in Thailand” in September 2004, and then to its science committee on December 21, 2004. Be that as it may, Ranbaxy subsequently pleaded guilty to several charges by the US-FDA, based on Dinesh Thakur’s testimony, and paid a hefty fine of US$ 550 million. It is worth noting, although Ranbaxy had an immaculate Board of Directors at that time, including distinguished and eminent personalities as the Independent Directors, the company used to be run by the promoters, or in other words, the key shareholders of the company. It may be coincidental that the majority of such incidences reported from India, either related to dubious pharma marketing practices or drug quality standard, may find a curious link with the promoter or the key shareholder driven domestic pharma companies.

The purpose of this article is not to assign blame to anyone, or any organization, but to have an intimate look at the governance process of most of such companies, which is systemic in nature. It may be worth pondering thereafter, whether one can learn the way forward from the credible research reports, available on this important subject.

The doctrine of ‘Maximizing Shareholder Value’:

In many corporate training sessions, especially for the senior management, including pharma industry in India, the above well-known doctrine is emphasized and reemphasized – again and again. It postulates, the ‘corporate managers should make maximizing shareholder value their goal – and that boards should ensure that they do.’

Indian pharma companies predominately being the promoter or the key shareholder driven corporations, choosing ‘maximizing shareholder value’ as the primary corporate mission, I reckon, is not too uncommon, either.

The basic premises of the theory:

The details of this theory were articulated in the 1976 Journal of Financial Economics article “Theory of the Firm,” by Michael Jensen and William Meckling. The concept was further deliberated in the article titled “The Error at the Heart of Corporate Leadership” by Joseph L. Bower and Lynn S. Paine, published in the May-June 2017 issue of Harvard Business Review, and its basic premises were summarized as follows:

  • Shareholders own the corporation and are “principals” with the original authority to manage the corporation’s business and affairs.
  • The corporation’s shareholders delegate decision-making authority to the managers and are thus “agents” of the shareholders.
  • As agents of the shareholders, managers are obliged to conduct the corporation’s business in accordance with shareholders’ desires.
  • Shareholders want the business to be conducted in a way that maximizes their own economic returns. (The assumption that shareholders are unanimous in this objective is implicit throughout the article.)

A flawed corporate governance model?

Bower and Paine in their above paper lucidly analyze a number of serious flaws in the basic premises of ‘maximizing shareholder value’ model. For example, they indicate that the ultimate responsibility and accountability for good corporate governance, or lack of it, lies squarely with the concerned senior management and the Board of Directors of the company and none else – not even with its large shareholders.

Moreover, the authors caution that this theory’s doctrine of alignment spreads moral hazard throughout a company and narrows management’s field of vision.

Putting it in the context of Indian pharma industry, I reckon, such risks increase alarmingly, when promoters take all management and Governance decisions, with the senior management, including the Board of Directors doing no more than endorsing those, knowingly or unknowingly, just as what happened in case of Ranbaxy, mentioned above.

Providing a more realistic foundation for corporate governance:

Against this backdrop, and accepting the following ground realities, there evolves a critical need to have a more realistic foundation for corporate governance and shareholder engagement, as the above HBR article deliberates:

  • Corporations are complex organizations whose effective functioning depend on talented leaders and managers.
  • Corporations can prosper over the long term only if they’re able to learn, adapt, and regularly transform themselves.
  • Corporations perform many functions in society – such as providing investment opportunities and generating wealth, producing goods and services, creating employment, developing technologies, paying taxes, and making several other significant contributions to the communities in which they operate.
  • Corporations may have differing objectives and strategies in this regard – such as, what the purpose of a corporation ought to be from a societal perspective may not be quite the same as what its promoters or key shareholders believe those to be.
  • Corporations must create value for multiple constituencies – such as, companies succeed only if customers want their products, employees want to work for them, suppliers want them as partners, shareholders want to buy their stock, and communities want their presence. In contrast, the ‘creating more shareholder value’ theory’s implied decision prompts that managers should always maximize value for shareholders – oversimplifies this challenge and leads eventually to systematic underinvestment in other important relationships.
  • Corporations must have ethical standards to guide interactions with all their constituencies, including shareholders and society at large – going beyond forbearance from fraud and collusion, is essential for earning the trust companies need to function effectively over time. ‘Creating more shareholder value’ theory’s ambivalence regarding corporate ethics can set companies up for destructive and even criminal behavior -which generates a need for the costly regulations that agency theory proponents are quick to decry.

All the above eight points, especially the last one, as many consider, are so relevant for the Indian pharma industry, probably more in the promoter-driven ones, as these constitute the bulk of it. It is equally important to understand that corporations are embedded not just in a network of financial systems, but also in a political and socioeconomic matrix, whose health is vital to their sustainability. Thus, changing from ‘‘creation of more shareholder value-centered governance’ to a ‘company-centered governance’ would be more meaningful in today’s paradigm.

The merits of ‘company-centered governance’:

As the Harvard article says, following are some of the merits of changing to a ‘company-centered governance’ from ‘creating more shareholder value-centered governance:’

  • More board-level attention to succession planning and leadership development
  • More board time devoted to strategies for the company’s continuing growth and renewal
  • More attention to risk analysis and political and environmental uncertainty
  • A strategic (rather than narrowly financial) approach to resource allocation
  • A stronger focus on investments in new capabilities and innovation
  • More-conservative use of leverage as a cushion against market volatility
  • Concern with corporate citizenship and ethical issues that goes beyond legal compliance

Conclusion:

Almost all domestic pharma companies in India are currently family run, mostly by the first or second-generation entrepreneurs, with well-defined and clearly established ownership pattern.

The glorious history of the family run Indian pharma business has started facing a more challenging future, especially in addressing the types of maladies, as epitomized in the above two recent media reports. With the ongoing process of ‘creating more shareholder value’ driven governance – almost totally scripted by the promoter or the key shareholders at the helm, the task ahead remains formidable. Additionally, the reports on Ranbaxy whistleblower’s narrative, prompted many to wonder the role of Independent Directors on the Board of strong promoter driven Indian pharma companies, besides others.

In this scenario, particularly to address the Governance related maladies effectively, a highly competent corporate leadership professionals should be empowered to steer the Indian pharma organizations, in general, from ‘creation of more shareholder value centric governance’ to a well-crafted ‘company centric governance’ process, in a well-calibrated manner and sooner.

By: Tapan J. Ray 

Disclaimer: The views/opinions expressed in this article are entirely my own, written in my individual and personal capacity. I do not represent any other person or organization for this opinion.

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