The Hindu Business Line : The baggage of opaqueness

MAJOR accounting frauds such as Enron, WorldCom, Dynergy, Adelphia, and so on, have attracted considerable debate on transparency, disclosure and corporate governance. These are now widely discussed by regulatory agencies, institutional investors and governments as a way to improve the image of the corporate sector.

For instance, McKinsey & Co., in its global survey on corporate governance, found that investors worldwide were willing to pay as high as a 20 per cent premium over the market price for investments in companies with good governance structure. Studies by the OECD and the Asian Development Bank have also reported major initiatives taken by several countries, including emerging markets, to attract internal and external funds for development. India is no exception to this worldwide move, with several policy initiatives being taken.

While these initiatives have certainly improved the performance of Indian companies on transparency, disclosure and corporate governance in the past few years, the gaps are still large. SEBI and the DCA have constituted new committees to review the level of corporate governance initiatives.

The Companies Bill had raised tremendous expectations in bringing far-reaching changes in the corporate governance structure. However, following its withdrawal, there are reports that suggest that the N. R. Narayana Murthy Committee (constituted by SEBI) would also dilute some of its requirements on corporate governance initiatives. The captains of industry are also arguing for abolition of quarterly reporting of financial results. These would be a major setback in improving corporate governance.

It will be interesting to note where India stands on transparency and disclosure (T&D) vis-à-vis the developed and emerging markets. A study by Standard & Poor (S&P) reports that countries such as the US and the UK scored 70 against a total of 98, whereas many emerging markets were far below this level. The S&P study, based on the annual reports of the year 2000, ranked 19 emerging markets. India was ranked sixth with an average transparency and disclosure score of 40. Countries such as South Africa (55), Korea (45), Malaysia (45), China (44) and Hungary (43) were ahead of India on this score. However, owing to the initiatives during the past three years, India's disclosure level has improved considerably and is on a par with developed nations.

For instance, based on a sample of annual reports of Nifty companies, the average disclosure score of Indian companies is found to be around 70, and the 2002-03 score is higher than that of many developed markets in 2000.

In other words, the disclosure initiatives of the last three years have improved India's image in the global market. The S&P scoring had been done on the basis of: i) financial transparency and information disclosure, ii) ownership structure and investors' relations; and iii) board and management structure and process.

Indian firms' performance has gone up significantly with respect to the first two categories, thanks to the initiatives of SEBI and the ICAI. However, the level of compliance with regard to the third requires improvement. Though the corporate governance code was introduced in 2002 and extended to all listed companies in 2003, the number of items included in this section is far below that of S&P's benchmark requirement.

Of the 35 items considered by S&P under the governance structure, Indian regulation does not require some 13 items for disclosure. Rather than bringing out new policies that would require Indian companies to improve the governance structure, the Government and SEBI are moving in the opposite direction.

Agencies such as S&P command substantial reputation among global investors and any deterioration in T&D rating of Indian companies will doubtless affect the image of Indian companies and their valuation in the global market. It will also have a bearing on flow of funds, and any reverse flow at this juncture will affect the stock market and investors.

It is also found that the S&P score and FII holdings are positively correlated across the different disclosure categories for the Nifty companies. This clearly reveals the level of importance that global investors give on transparency and disclosure while investing money. These initiatives are critical since FII investments in many good companies are hitting the ceiling, and, to avoid retracement of such investment, it is imperative the standards on mid-size companies are improved.

In addition to improving the score by including more items, the next major effort should be on the quality of transparency, disclosure and governance. Justice King pointed out that the financial reports should present a comprehensive and objective assessment of the activities of the company so that shareowners and relevant stakeholders with a legitimate interest in the company's affairs can obtain a full, fair and honest account of its performance (King Code 2002). There is a long way to go to make this possible. For instance, though segment reporting is mandatory and the accounting standard prescribes the same quite elaborately and with clarity, many companies still inform the shareholders that they are in a single segment. Comparing the performance of Tata Motors, Ashok Leyland and Mahindra and Mahindra is a case in point. If Tata Motors claims that it is in a single business, which includes HCV, LCV and passenger cars, it will be difficult to make such a comparison. Similarly, how can one compare Bajaj Auto with Hero Honda if the former claims that it is in a single business segment.

It is common knowledge that the market or customers for commercial vehicles and cars is independent, with the risks being different. The companies themselves, in their management discussion and analysis part of their annual reports, discuss the different market environments. However, when it comes to segment reporting, they take the stand of single business segment. If this argument is acceptable, then companies such as L&T and Hindustan Lever will stop providing segment reports, claiming that they are in the manufacturing and FMCG sectors respectively.

The ICAI can only facilitate by drafting good accounting standards. The compliance of these depends on the spirit and desire for adopting good corporate governance. Thus, in order to be world class, the efforts at improving transparency, disclosure and governance structures should be forward-looking.

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