Enlightened companies always endeavour to improve corporate governance because they believe, and rightly so, that better corporate governance leads to better enterprise performance. They can use corporate governance (CG) scorecard as a tool to assess corporate governance practices of a company. It emerged in Germany in the year 2000 as state-owned companies were privatised and blue chip companies experienced serious failure. The scorecard emerged as a guide to investors and analysts in making investment decisions.
Both ICRA and CRISIL introduced CG rating in mid-2000. However, it has not achieved much success. There could be many reasons for the lack of enthusiasm in CG rating. First, it is difficult for an external agency to assess the quality of CG primarily based on records. Second, the market does not have much trust on CG rating because it is voluntary and there is no regulator to ensure independence. Moreover, due to short-termism, the market is interested in short-term enterprise performance and not on corporate governance per se. Although CG rating and CG scorecard are similar, CG scorecard does not suffer from the shortcomings of the CG rating. It is a low cost tool, which is prepared for internal use by the board of directors and top executives to periodically review the quality of corporate governance.
The first step in developing the CG scorecard is to assign weight, in the scale of 1 to 10, to each component of CG to signify its importance in the CG mechanism. For example, weights may be assigned to the following components: efficiency and effectiveness of the functioning of the board of directors, the level of transparency and accountability, mechanism to protect the interest of non-controlling shareholders, effectiveness of the risk management and internal control systems, internal control process to ensure compliance with laws and regulations, engagement with stakeholders and CSR. The next step is to break down each component into different elements. Weight, on the scale of 1 to 10, to be assigned to each element to signify its importance. Score, on a scale of 1 to 10, is to be awarded against each element based on the assessment of performance against that element. Suppose that for an element weight assigned is eight and score awarded is seven. The maximum weighted score that the element can earn is 80 and the weighted score earned is 56. The maximum weighted score and actual weighted score of all the elements should be added. The score (percentage) for the component is calculated by dividing weighted score earned by the maximum weighted score. For example, if the total maximum weighted score for a component is 2,000 and total weighted score earned is 1,400, the percentage score for the component is 70 percent. The next step is to prepare a summary sheet, which will show weight assigned to each component, percentage score of each component, the maximum weighted score (percentage) that a component can earn and actual weighted score earned by each component. From these numbers the overall CG score (percentage) can be calculated. Ideally, this whole exercise should be carried out at a retreat involving directors and members of the top management. Managers, who are identified as change leaders, may also be invited to provide inputs.
The process of preparing the scorecard helps the company to assess the ‘reach’ and quality of its own corporate governance and to identify opportunities for improvement. It also raises the awareness about good CG practices. The process should be carried out periodically, may be once in every two years.
The CG scorecard should be prepared based on the existing code and the global best practices. However, it should be tailor-made for the company. Some well accepted practices might not be relevant to the company. We may take an example. It is now well accepted that the board should formally evaluate its own performance and performance of committees and individual independent directors.
This is very important to improve the effectiveness of the oversight function of the board. But this may not be relevant for a public sector enterprise. The government appoints independent directors for a term of three years. It may not be inclined to remove any of the independent directors based on the report card prepared by the board.
More From This Section
Therefore, evaluation of individual directors will not serve any purpose. On the other hand, it might have a dysfunctional effect on the functioning of the board. Therefore, it might be appropriate for the board of a PSE to evaluate its own performance only.
The government or any other agency may develop a template for the CG scorecard, which may be used by a company as a starting point to develop a scorecard for its own use.
Asish K Bhattacharyya E-mail: asish.bhattacharyya@gmail.com Affiliation: Chairman, Riverside Management Academy