A well-balanced board of directors, proactive shareholders and swift action against malpractices could restore market confidence.
More skeletons tumble out in bear markets than during bull phases and Satyam Computer in India and the collapse of investment banks in the US are cases in point. Satyamgate laid bare the complete lack of accountability in the company and prompted questions on corporate governance practices of the country’s 6,000-odd listed entities. Corporate governance, which is the system that helps firms control and direct operations, is in the spotlight as key parts of the governance framework such as audit and finance functions have failed to check the promoter-driven agendas. The Smart Investor spoke to fund managers, CIOs and research heads to gauge the status of corporate governance practices prevailing in India, what could be done to improve the same and how all this will impact investors.
Role of the board
Among the many shortcomings of the Satyam episode has been the role of independent directors who were supposed to safeguard the interests of all stakeholders. While the three committees (See: Corporate Governance Committees) have explicitly mentioned the role, independence, remuneration and responsibilities of independent directors, the same has not translated into becoming an adequate check on managerial excesses. Says Andrew Holland, CEO, equities, Ambit Capital, “Independent directors should also (in addition to the management) be held accountable for board decisions and audit-related compliance practices.”
While there have been suggestions for a selection committee to choose independent directors, mandatory training, performance assessments, limit on directorships and compulsory attendance of Board meetings, two key areas relating to CEO/Board chair segregation and number of independent directors could be the right steps forward. Says Neville Dumasia, head, Governance, Risk and Compliance, KPMG, “The concept of CEO and Board chair separation is well accepted in Europe, and American companies are steadily moving in that direction. This would bring a better balance in the boardroom.” The second issue of a majority of independent directors (number currently varies from a third to a half), which is the case with companies in NYSE and Nasdaq, could prove tricky as Indian boards are promoter-dominated. Regulations could however, change all that. “In fact, in a number of European and American companies the only sitting executive on the Board is the CEO,” says Dumasia.
Role of auditors
Though a lion’s share of the focus in the Satyam episode was on the role of the independent directors, experts believe the role of auditors is now in spotlight. Asks a fund manager, “Auditors are not changed for ages together. Why can’t we have a system similar to the one adopted by PSU banks where auditors have to be changed every three years?” Holland, however, believes that instead of changing auditors annually, one could look at changing audit heads of the same firm.
A fallout of the Satyam case is the issue of delays involved in enforcement of Indian corporate laws. The need is to enforce corporate laws in a transparent, swift and uniform fashion. “Accountability and action against fraud/negligence are major concerns,” believes N K Jain, secretary and CEO, Institute of Company Secretaries of India. “Professionals (auditors) should be made accountable and consequences (punishment) should follow if there are any deficiencies and slip-ups,” he adds.
| CORPORATE GOVERNANCE COMMITTEES |
| 2000 Kumar Mangalam Birla |
| > Composition of Board of Directors |
| > Need for an independent audit committee |
| > Defined who an independent director is.Board to meet every quarter |
| > Share key information with shareholders |
| 2002 Naresh Chandra |
| > CEO, CFO certification of financial statements |
| > Disclosure of contingent liabilities & risks |
| > Independent director will not have apecuniary relationship with company which might hamper his judgement |
| > Statutory limit on sitting fee to independent directors |
| 2003 Narayana Murthy |
| > Strengthen responsibility of audit committees |
| > Improve quality of financial disclosures |
| > Utilisation of IPO funds |
| > Disclose business risks in annual reports |
| > Whistleblower policy |
| These mandatory requirements have been incorporated in the Clause 49 of the listing agreement |
Minority shareholders
Experts believe that it is the institutional investors who have the tools, bandwidth and clout to extract information and play an activist role (as had happened in Satyam’s case) in ensuring that managements don’t go off-track. If institutional investors act collectively, they can demand the required changes at companies they have invested in.
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Says Anup Bagchi, executive director, ICICI Securities, “While independent directors can certainly play an important role in ensuring better risk management, demand for good governance by institutional shareholders is the best driver towards higher governance standards.” Establishing minority shareholders’ groups can also be a positive step. Individual shareholders through these groups can communicate with institutional shareholders for taking up their concerns with the company’s management.
While retail investors cannot bring about many changes to a corporate agenda, they can take precautions before making investments. (See: Beyond Corporate Governance Compliance, a checklist. Says Shailesh Haribhakti, executive chairman and managing partner, Haribhakti & Co, “The criteria of consistent track record, transparency in dealings with stakeholders, disclosure of all relevant information and accountability at levels of the organisation should help in making the investment decision.”
While it might be difficult for retail investors to get hold of information on all aspects of the organisation they will be well served to keep an eye out for notes to the accounts. Says Holland, “Notes to the accounts are a useful source of information and reading them gives an idea of the exceptions or practices that the auditor has chosen to single out.”
While our survey shows that experts believe that retail investors are indifferent about corporate governance, the Satyam episode will probably highlight the need to weigh this aspect. A KPMG study on companies listed in the UK and US indicated that markets tend to give a lower valuation to companies with perceived corporate governance problems. Experts point out that in India companies such as HDFC and BHEL tend to get a better valuation than their peers as do professionally-run companies like HUL, ITC and Infosys not just due to their performance, but also due to their adherence to corporate governance norms.
What is next
Our survey and feedback from various experts indicates that a majority of BSE Sensex companies are perceived to be above average in terms of corporate governance practices. While some, such as Jain, also believe that corporate governance norms must be redefined in light of the Satyam episode.
While the corporate governance framework in the country is seen at par with other developed markets, the same has to be implemented in ‘letter as well as spirit’. Additionally, shareholders should ensure that the composition of Board of Directors is a balanced mix of independent directors and management appointees. This would help keep a check on the internal processes of the company. With shareholder activism on the rise, the proactive role of institutional investors will also make the company management more accountable.
While things have improved substantially over the last five years, experts believe that more needs to be done, which will further improve disclosure levels and make managements accountable. At the retail shareholder level, one could look at a company’s past track record (including significant events that reflect management excesses), qualitative and quantitative disclosures (vis-a-vis peers) and consistency in delivering on promises. Experts believe that more rigorous vetting is needed when small and medium companies are considered for investment.
| BEYOND CORPORATE GOVERNANCE COMPLIANCE – A CHECKLIST |
| AN INDEPENDENT BOARD Members of the board, especially independent and institutional members are not just yes men, but put forth their views and ensure that interests of all stakeholders (minority shareholders) are protected |
| PERFORMANCE Impeccable track record of steady performance and return ratios. Investors should keep an eye on the various accounting jugglery methods that a company may resort to |
| TRANSPARENCY Complete disclosure of events that will have an impact on the company’s operations and are in investor interest. The company must have a “when in doubt, disclose” attitude. Also, how much of operational-cum-financial information a company reveals periodically vis-à-vis its peers |
| SHAREHOLDER-FRIENDLY Prudent use of cash, have a consistent record of rewarding shareholders |
| ACCOUNTABILITY External audit functions must be unbiased and accountable, firms must set a high standards for adhering to accounting principles |
For now, the key concern for investors, says a fund manager is, “I will be worried if no action is taken against the culprits. While our compliance norms are the best in the world, we fail miserably on prosecution whereas in markets such as the US, action is swift and the penalties severe.”