<b>Amit Tandon:</b> What gets measured can be improved

Quantifying governance practices through development of scorecards is a step in the right direction

One of the more famous expressions in the US Supreme Court is of Justice Potter Stewart, who, in his characterisation of pornography, wrote, “I know it when I see it”, to describe his threshold test for obscenity. One can say something similar about governance. Investors know which is a well governed company — they certainly know the badly governed ones. 

Probe them regarding a wider set of companies and most will give an impressionistic answer — “A” is better governed than “B”, which is better governed than “C” — but falter to say that “C” is better governed than “A”. Experience shows that identifying governance “levels” at the extremes may be easy, but ranking a large set is not, unless you can score each company’s governance.

Recently, IFC Washington, the BSE Limited and Institutional Investor Advisory Services (where I work) have been involved with doing just this — quantifying governance practices through the development of governance scorecards. 

Anne Molyneux, a board member of ICGN, a governance network, defines scorecards as a quantitative tool to assess the level or standard of corporate governance in an individual company, usually in the form of a questionnaire. Governance scorecards are extensively used in a few countries including Germany and closer home, across six Asean countries.

A governance scorecard will have uses for all market participants: Companies use it to hold a mirror to their corporate governance practices. They can measure themselves to set a baseline score, which will help them benchmark themselves on the scale and across peers. But the biggest gain for companies is to keep scoring themselves periodically. Governance practices do not have an “immediate fix”: It is a journey and having a compass in the form of a governance scorecard will help companies navigate the myriad requirements of its many stakeholders.

As part of their investment decision, equity investors are already scoring companies on their governance quality, whether implicitly or explicitly. A scorecard gives them a uniform measure across the portfolios, schemes and competition. They can look at an individual company or take a portfolio approach, an example being the FTSE4Good Index Series, designed to measure the performance of companies demonstrating strong environmental, social and governance (ESG) practices. 

Combining ratings with governance scorecards, if properly used, is a powerful tool in the hands of lenders. This addresses the issue not just of the ability to pay but of willingness as well. And finally, regulators. They use scorecards to complement surveillance and measure market-wide governance levels. In Asean countries, these are used to provide a common benchmark across the region. In fact, sector-specific scorecards are popular, with Singapore, the Netherlands, Italy and five others developing governance scorecards for banks, following the financial crisis.

But for a scorecard to be used and accepted by market participants, it must be relevant to market conditions and existing governance practices. Keeping this in mind, the scorecard uses the G20/OECD principles of corporate governance as a framework        (detailed in an earlier column, “Putting principles into practice”, February 19, 2016), but has also been suitably modified for Indian corporate practices. 

RATE THE FIRM: A governance scorecard will have uses for all market participants. Companies use it to hold a mirror to their corporate governance practices. 

Companies are expected to answer an aggregate of 70 questions across four categories for 140 points, which are then normalised to 100. The questionnaire and scoring are in a self-help format. For example, “Does the board have gender diversity?” Companies score nil for no women on the board, one mark for a women director on the board, but can get two for having independent women directors. The idea is to nudge companies to walk that extra mile. Answers need to be backed by public disclosures. It is not enough for a company to say it has a succession policy; some evidence needs to be present in the public domain.

It is early to comment on how robust the questionnaire is. However, looking at the S&P BSE Sensex companies, they seem to fall along a curve, with seven per cent in leadership roles, 43 per cent classified as good, 33 per cent as fair and the remainder 17 per cent anchoring the list. Detractors could argue that just seven per cent in the leadership role — that too of S&P BSE Sensex companies — is a harsh standard. But analysis shows that in individual categories, companies have scored over 80 per cent — it is just that companies don’t score uniformly well across all categories. 

To paraphrase Peter Drucker, “what gets measured can be improved” and improve governance standards we must.

The author is founder and managing director, Institutional Investor Advisory Service India Limited. Twitter: @amittandon_in