The Hindu Business Line : A report card that doesn't impress

IN THEORY corporate governance came as a fashion to soon become a fad and now a passion. It however appears that in India the approach which the Government has taken to instil good governance practices is either to follow the practices adopted by developed countries in this regard or as a knee-jerk reaction to any scam.

New regulations are being introduced at regular intervals based on the recommendations of high-powered committees. Some of these new regulations on governance issues have been fiercely opposed by industry and the authorities succumbing to pressures have either withdrawn or modified several contentious clauses of the new regulations.

The revised clause 49 of the Listing agreement with stock exchanges, which was based the Narayana Murthy Committee recommendations, is an example of watering down several key recommendations of the committee.

In early 2004, a corporate governance country assessment for India was carried out as part of the joint World Bank-IMF programme of Report on the Observance of Standards and Codes. The objective was to benchmark the observance of corporate governance by India against the OECD principles of corporate governance.

The OECD principles of corporate governance which were originally framed in 1999 were revised in early 2004 and are considered as benchmark on corporate governance by the World Bank.

The report of the World Bank team on assessment of corporate governance practices in India is based on interviews with a cross-section of corporates, market participants, government departments, SEBI, stock exchanges, lawyers, analysts, accountants, auditors, and so on.

The report has been cleared for publication by the Government though that does not mean that the Government agrees with or endorses the findings of the report.

The report assesses India's compliance with each of the OECD principles of corporate governance.

The compliance level has been classified into five categories, namely, observed, largely observed, partially observed, materially not observed and not observed. Out of 23 principles, Indian corporates have been found to be observing 10, six were `largely observed', another six `partially observed' and one item was `materially not observed'.

The only item where the assessment team had found Indian corporate `materially not observing' concerns facilitating all shareholders, including institutional shareholders, to exercise their voting rights.

The principles call for institutional shareholders to disclose their voting policy and also to disclose when they act in a fiduciary capacity how they manage material conflicts of interest that may affect exercise of their key ownership rights.

The Table presents the areas where the assessment team had found Indian corporates to be only `partially observant' of the OECD principles:

The report has made several policy recommendations if a principle is less than fully observed. Some of the important policy recommendations are as follows:

Sanctions and enforcement: The existing provisions on sanctions in the Companies Act are considered inadequate, particularly the magnitude of fines. Stock exchanges, at present, do not have power to impose fines. Sanctions and enforcements should be credible deterrents for the corporates to carry out their business practices within the applicable laws and regulations. It should be such as to ensure that business practices are aligned with the legal and regulatory framework, in particular with regard to related party transactions and insider trading.

The current regulatory framework places the responsibility of oversight of listed companies partly with the Department of Company Affairs (DCA), SEBI and the stock exchanges.

This fragmented structure gives rise to regulatory arbitrage and weakens enforcement. Keeping in view the enormous size of our equity market there is a need to thoroughly review this three-tiered supervision system and clearly demarcate the responsibility of each regulator.

On a priority basis, the directors should upgrade their knowledge and skill. If boards are not expected to simply `rubber stamping' the decisions of management or promoters they must have a clear understanding of what is expected from them. They should know their duties of care and loyalty to the company and all shareholders. They should know their changing responsibilities and should be familiar with the changes in this regard arising from changes in laws and regulations.

A key missing ingredient is a strong focus on professionalism of directors. Director training institutes can play a key capacity building role and expand the pool of competent candidates.

Institutional investors acting in a fiduciary capacity should be encouraged to form a comprehensive corporate governance policy, including voting and board representation.

Before examining the Indian corporate scene, it would be relevant to mull over the following:

In India, like most countries, corporates are run like CEO's personal fiefdom.

CEOs do not generally care for welfare of all stakeholders but do care for the interest of the principal shareholders only.

Majority of directors are unaware that they are agents of shareholders and that they hold a position of trust and faith.

Participation of a non-executive director in meetings, whether of the board or its committees, is inversely proportional to the health of bottom line — better the bottom line lesser the participation.

Most directors of companies do not consider it necessary to update themselves on changes in laws and regulations or the business model of the company of which they are directors and which affect their duties and responsibilities as directors.

So long as the performance of the company is satisfactory, which is judged by the health of bottom-line, refusal to approve or object to any proposal of management is considered bad manners.

Non-executive directors do not consider them as watchdog of shareholders.

Board rooms are invariably filled up with `yes' men who do not raise relevant questions and assent to all proposals put up by the management.

A person is invited to become a non-executive director only if he/she enjoys the patronage of the chairman/CEO through old school connection or social circuit or golf club.

Except during a crisis even nominee directors play a passive role at meetings.

General rule for the domestic corporate sector is that what you preach on corporate governance need not necessarily be practised in the company you manage.

Same non-participating directors can become extremely vocal and inquisitive and raise uncomfortable questions the moment performance of the company becomes unsatisfactory.

Is it right that non-executive directorships are considered more as a symbol of social status and connections than as a position of responsibility?

One wonders whether these augur well for good corporate governance.

Let us take another real-life situation. Is it right that at the end of a month, quarter, half-year or a full year the CEO and CFO discuss between themselves how much profit should be shown? When business in a particular period has been good, which may not be repeated in the forthcoming periods, is there a tendency to hold back a part of the profit to be shown in the subsequent periods?

Is profit supposed to be a derived figure being the resultant figure arrived at after deducting costs from revenues or is it determined first and other figures fit in to support the already determined profit figure?

Several years ago such practice, which is not too uncommon in India, would have been dubbed as financial engineering and the accountant would have been showered with accolade for his/her wisdom. But can one do this now?

Attention is drawn to the Auditing and Assurance Standard 4 (Revised) on auditor's responsibility to consider fraud and error in an audit of financial statements. AAS 4 in no uncertain terms has specified that fraudulent financial reporting involves intentional misstatements or omissions of amounts or disclosures in financial statements to deceive financial statement users.

In sum, no amount of regulation can guarantee improvement of corporate governance in our country. This is basically a matter of attitude and approach.

As an essentially top-down process responsibility of CEO in this regard is paramount. If the CEO believes wholeheartedly in improving corporate governance he can drive the same effectively throughout the organisation. After all, corporate governance is nothing but the system by which corporates are directed, controlled and operated. If therefore the governance improves, overall corporate performance is bound to improve.

(The author is Vice-President and Secretary, Tata Tea Ltd.)

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