How and why transparency in boardrooms helps both India Inc & investors

“India is known to have an issue with corporate governance. There is currently demand from clients for governance related research as high governance stocks tend to outperform in difficult markets,” says Nick Paulson-Ellis, country head, Espirito Santo Securities.

The Canada-based Veritas Investment has put out reports slamming big and influential companies in India — from real estate giant DLF to Vijay Mallya’s UB Group, the influential Anil-Ambani led Reliance Communication to the NBFC Indiabulls. With every released report, the stock market has reacted sharply with the respective stocks getting hammered. A livid Indiabulls has now initiated criminal proceedings against Neeraj Monga, the executive vice-president of Veritas, who authored the report.



Crowd’s Swelling, and it’s Good

In the past two years, India has also seen the emergence of three proxy advisory firms. Globally, such advisory firms provide investors with qualitative research and independent opinion on corporate governance issues and boost shareholder activism.

The three are: IIAS, set up last year and founded by former Fitch Ratings head Amit Tandon and former MD of Gujarat Ambuja Anil Singhvi. The company has raised funding from BSE, Fitch and HDFC. InGovern Research has been founded by Shriram Subramanian, who was earlier with Infosys Consulting. Former Infy CFO Mohandas Pai has a stake in the company. The third is SES, founded by JN Gupta, a former executive director of Sebi.



All the three are trying to nudge and cajole institutional investors to assert themselves in key decisions being taken in the companies they track. “Our focus will be deep research, driven by long-term issues. We are not driven by quarterly results,” says Subramanian of InGovern.

Recently, the advisory firms warned shareholders to vote against resolutions seeking reappointment of auditors if they have not changed for many years. They published reports opposing merger plans of Sesa Goa-Sterlite, Escorts and Akzo Nobel India. In the past two years, InGovern has put out voting recommendations for over 500 shareholder meetings. IIAS published a report early this year informing investors of misuse of preferential issue of warrants by the Indian promoters.

A Go at Bulge-brackets

The spotlight has also been turned on promoter pay cheques that haven’t been impacted a tad despite dipping corporate performance. “There is a disproportionate difference between promoter family and professionals’ salary, even when they hold the same designations in a large number of companies in India. It needs to be addressed,” says Gupta of SES. Recently, IIAS opposed a proposed salary hike for the promoters of Sun TV Network Kalanithi Maran and his wife who together took home Rs 128.8 crore in 2010-11.



So far promoters have mostly won and pushed through their proposals, despite opposition. But these pressure groups have managed to draw attention, create a stir in the media and put the spotlight on the issues. “These are still early days but we are gaining traction,” says Tandon of IIAS.

The regulators and government bodies too are building pressure points. Market watchdog Sebi is now pushing for better accountability from both promoters and institutional investors like MFs. For example, it has mandated top 500 listed firms to offer e-voting platforms — instead of ballots — to allow shareholders to vote irrespective of their physical location. Since 2010, it is demanding that AMCs exercise their voting rights in companies they have invested in and disclose it on their websites and annual reports.

But Why Now?

Well, that’s the big question. That India has a corruption problem is not new. Many Indian promoters have had dodgy reputations and poor governance track records. Hiding behind multiple crossholdings, many have used public money for private gains for years. In fact, says Shankar Jaganathan, author of Corporate Disclosures 1553 to 2007 AD: “If you compare now to the 1990s, you realise we have made substantial progress on disclosures and transparency.”

In areas of promoter holding and consolidated financial statements which are prominently disclosed today, the 1990s look like dark ages where detectives would slog for a number of days before they could unearth the same information.

Yet, there is an overwhelming perception that lately India has been slipping — that too under full global glare. Transparency International ranks 183 countries to judge how corrupt the country’s public sector is perceived to be. In 2007, India was ranked 72, it slipped to 87 in 2010 and in 2011 to 95.

This is something that Hong Kong-based Sharmila Gopinath, research director, Asian Corporate Governance Association, too echoes: “Till two years ago we had ranked India third in our rankings of 11 Asian countries for ‘CG Watch’. In 2010, we did a white paper on corporate governance in India, after which India fell in the rankings to 7th.”

One explanation is that the world is today measuring India against a new set of benchmarks. Barely a decade back, global investors flocked to India haling its robust democracy, institutional framework, independent judiciary and free Press. “There is a growing realisation that India is long on talk and short on execution,” says a senior executive of an independent research outfit, on conditions of annonymity. They forgot that when you engage with the world and seek global capital then you have to live by the global rules.

Advantage Slowdown

Let’s not forget that this has also to do with difficult economic times. “Growth hides lots of inefficiencies. It is in bad times that the cracks begin to show,” says Rashesh Shah, chairman, Edelweiss Group. Last year (2011-12) was a bad one with poor growth and lower profits. “Also, in bad times investors become very vigilant,” he says. The bulk of this activism is bunching up in recent months because most Indian companies publish annual reports in July-September. “It is still the annual reports where you get most detailed information about Indian firms,” says Shah.

True, India has had bad economic phases in the past. But there are two important differences this time. Disclosure norms for companies have substantially gone up in the past decade giving more ammunition to aggrieved investors. Also, FII stakes in Indian firms have gone up substantially and hence they can no longer ignore and be passive.

Wrath of the FIIs

Over the past decade, thanks to the buzz around BRICs and the sizzling India story, global investors queued up to invest in India. As a result, FII investments in Indian companies have risen substantially. According to ET Intelligence Group data, in the BSE top 100 companies, between 2001 and 2012, 41 out of 100 companies have seen FII holding rise by a minimum of 10%. There are 17 companies in the list where FII holding today is more than 30%.

Many of these companies with high FII holdings have been in the news for all the wrong reasons. The list is topped by Vijay Mallya’s United Spirits where FII holding has gone up from around 8% in 2001 to almost 50% today. Real estate giant DLF has seen FII holding go up from 0% to 15.64%. Anil Agarwal’s Sesa Goa has seen FII holding go up from 0.26% to 26.19%. Unitech has seen the FII holding go up from 14.54% to 32.23%. “These FIIs are becoming vocal now. In the past 3-4 years, they haven’t made much money here,” says Anil Singhvi, founder director, IIAS, a proxy advisory firm.

Assertive FIIs are showing the way for the hitherto passive domestic FIs. For long, domestic MFs and insurance firms have remained passive investors. Now thanks to peer pressure from FIIs and a little push from Sebi, they are becoming more active. This could also be because holdings of private insurance companies and mutual funds have risen sharply over the past decade.

Shah of Edelweiss estimates MFs and private insurance firms in India today hold as high as 3% of total equity holdings in the stock market. “Earlier many domestic FIs were afraid to vote alone. That has changed. Informed clear guidance report from proxy firms too is strengthening their hands,” says Shah.

So, What’s the Bottom Line?

Will all this help? Prithvi Haldea, founder of Prime Database, who has kept track of Indian promoters and stock market for decades isn’t very optimistic. “Promoters discover new ways [to dodge the system]. Auditors and regulators are always behind, chasing the market wisdom,” he says. “Look at insider trading. The regulator has put so many layers to curb it but it still continues.

They [promoters] simply find new loop holes.” It is the same thing with the appointment of independent directors. It is the promoters who pick them. How can you have ‘independent’ director then, he asks. Some proxy firms are talking about tenures of audit firms. “Tell me when was the last time you heard a new audit firm pointing out problems with his predecessor’s report,” he asks. Companies have found ways to do things which may be legally right but ethically not.

And his prescription is simple: enforcement. The punishment should be swift and harsh. That’s the best way to send the message home. Two, make the laws simple and unambiguous. For instance, he says, an independent director must be as accountable as other directors. Three, auditors have been allowed to get away with few disclaimers. “It cannot continue. Hang them. He is the one with access to accounts and he has to do his duty,” he says. Setting up an independent regulator for auditors is critical.

Yet, We Can!

Yet there are three reasons to be optimistic. One, the mood and the discourse in India has changed. Powerful promoters, hitherto considered invincible, are no longer so, thanks to CAG, SC and RTI. Earlier, Indian stock market was sensitive to profitability. Now, ethical and governance records are also being considered.

Two, for companies, stock market performance is the biggest test. And of late, stocks with suspect governance records have been consistently underperforming. Connected stocks have fallen out of favour. For example, stocks in Ambit Capital’s P-75, an index of the most connected firms in India have underperformed over the past two years.

“For the first time in India’s history perhaps the ‘cleanliness’ of corporates has become such a critical influencer in the stock market. It is a momentous watershed for India…we are not going the Russian way towards a plutocracy,” says Saurabh Mukherjea, head of equities, Ambit Capital. While the economy has slowed down and corporates too have taken a beating, “net-net the impact is a long-term positive for the economy,” he says.

Three, the influence of assertive FIIs will only rise in India. A country that needs $1 trillion to finance its infrastructure projects will need to attract FIIs. That money will come with strings attached.

Going forward, long-term funds like pension funds etc, which run a marathon rather than a sprint with their investments will bet on Indian stocks. They will benchmark performance to not so much the quarter-on-quarter results as much as long-term issues like corporate governance etc. In India in 2008, S&P set up a S&P sustainability index where companies need to abide by a set of broad ranging non-financial disclosures to get included.

Espirito Santos too tracks companies on 30 different parameters relating to governance issues, including accounting standards, cash flows, background check on promoters, quality of boards. “In India, standards are high, enforcement is low,” Paulson-Ellis says. One of the top five MFs in India is now implementing a new investment process which will have focus on corporate governance.

“Some impact has begun to show,” says Paulson-Ellis. And all that would bring cheer not just to foreign investors, but also to the retail Indian investor looking for that extra avenue to park his money.