Friday, October 18, 2013

India Inc Performance Below Par In Corporate governance?

The story published in the Business Standard today (October 18, 2013) reports that the 'India Inc performance below par in corporate governance'. The report is based on a study by InGovern Research Services, a proxy advisory firm. The firm analysed top 100 companies that form part of the Nifty and Junior Nifty indices.

The study draws conclusions from the following facts (as mentioned in the report):

10 per cent of the companies have less than seven or more than sixteen directors;
17 per cent of directors on an average attend less than 75 per cent of board meetings;
Average number of board meetings held was seven;
The number of independent directors in 13 per cent of the companies is less than 50 per cent;
22 per cent of independent directors have served the company for more than nine years; and
36 companies have had the same auditors for more than 10 years.

Can we draw any definitive conclusion from the above facts?

The Companies Act 2013 provides that the number of directors in the Board should not exceed 15, unless approved by shareholders by a special resolution. It is difficult to establish that the optimum size of the Board is 15. Literature says that smaller the Board, better it is. Deliberations in a Board meeting is not effective if the size of the Board is large. At the same time it says that a Board that has diversity in terms of  knowledge and skills, and experience works better than a Board that lacks such diversity. We must appreciate that the same size does not fit all. The size of the Board depends on the nature of its businesses. A company that is engaged in different types of businesses should have a larger Board than the same of a company that is engaged in a single business. The size also depends on the complexity of the business. The size stipulated in the Companies Act 2013 is only indicative. That is the reason why the Act enables a company to have a larger Board with the approval of shareholders by a special resolution. It is unlikely that shareholders would bother too much about the size of the Board. Their main concern is the performance of the company. If a company consistently performs as per the market expectation, shareholders would not bother about the Board size. More likely that they will leave the decision on the size of the Board to the management.

The fact that 17 percent of directors, on an average, attend less than 75 per cent of Board meetings does not throw much light on the state of corporate governance. To me, 17 per cent is not a large number to ring warning bell about the state of corporate governance in India.

The fact that Average number of Board meetings was seven signals positive aspect of corporate governance. The Companies Act 2013 requires minimum four meetings a year. Again it cannot be said that four is the optimal number. It depends on the requirements of the company in a particular year. Too long a gap between two meetings signals poor governance as it reflects management's attitude towards the Board and lack of oversight on executive decisions.

The fact that the number of independent directors in 13 per cent of the companies is less than 50 per cent reflects non-compliance. Any kind of non-compliance with laws and regulations cannot be defended. However, the brighter side is that 87 per cent of companies complied with clause 49 of the Listing Agreement.

The fact that 22 per cent of independent directors have served the company for more than nine years does not reflect poorly on Indian corporate governance. In most Indian companies the dominant shareholder group controls the company. The controlling shareholder, who manages the company, takes the Board as the sounding board and look at board members for advises. The monitoring role of the Board is less prominent than it is in companies where shareholding is dispersed and the company is managed by professional managers. Therefore, long tenure of dependable independent directors serve Indian companies better. The Companies Act 2013 stipulates that an independent director can serve a maximum of two terms of five years each. He/she will be eligible for reappointment after cooling off period of three years. This will not change the scenario significantly. The controlling shareholder will continue to consult the retired independent director, whom he/she considers friend, philosopher and guide, outside the Board and will reappoint him in the next available opportunity.

It is not a surprise that 36 companies have the same auditors for more than ten years. It is no different from the situation prevailing in developed countries. Indian Companies Act 2013 has introduced the rotation of auditors. We should take it only as an experiment. The debate whether the rotation of auditors improves the audit quality is yet to be settled. We have to wait to see the result. However, it will be difficult to estimate the result because a number of provisions have been introduce, at the same time,  in the Companies Act 2013 to improve the audit quality and the quality of financial reporting by companies. Perhaps, we shall live with it in years to come without knowing the actual result. It will definitely increase the cost of audit and will create hardship for audit firms, particularly small firms.

I do not agree that we can conclude that Indian companies are lagging in corporate governance based on the above facts.

The same news paper (Business Standard) reports on the same day (October 18, 2013) that Indian companies have performed best among companies in emerging market economies in terms of transparency in corporate reporting based on a report by Transparency International.

The Report says that India is an exception among BRIC countries.

The Companies Act 2013 has incorporated many of the so called best corporate governance practices adopted by developed countries. This will enhance the confidence of international investors in Indian companies. It may not improve corporate governance. Measuring quality of corporate governance is always illusive. It is better to measure outcomes of corporate governance, such as, quality of financial reporting and outcome of CSR activities.

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