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Corporate Governance: The Unknown Growth Driver

Corporate Governance: The Unknown Growth Driver

Insolvency and Bankruptcy Code (IBC), which now holds almost $20 Bn in debt, has increased questions around asset quality

Since 2016, Indian Corporate Governance Scorecard, developed by BSE Limited, IFC and others

Companies such as Cipla, HDFC and Infosys are in the leadership category

As India aspires to achieve a 6-7% GDP growth amidst a slowing global economy, there is an imperative need for stronger corporate governance. Corporate Governance can ensure a strong financial system in the economy with sustainable development, reduced market vulnerability to financial crisis and better market trust and confidence with fewer incidents of financial frauds.

More efficient monitoring and transparent internal and external audit systems are important for effective corporate governance, however, corporate financial records are oftentimes misrepresented or manipulated.

Well-known valuation professor Aswath Damodaran once made an interesting observation that the modern financial statement filing reports, run at over 300 pages for many global companies. The disclosures section itself is often a data dump that makes it difficult to assess the real picture when it comes to either valuation or corporate governance assessments.

The Urgency Around Corporate Governance

In India, the loan defaults in companies and the setting up of Insolvency and Bankruptcy Code (IBC), which now holds almost USD 20 bn in debt, has increased questions around asset quality. Amidst this are the economic growth concerns that are now sounding a much-needed wake-up call to look at corporate governance more seriously than just as a passing side-note.

Tracking Corporate Governance

Since 2016, Indian Corporate Governance Scorecard, developed by BSE Limited, International Finance Corporation (IFC) & Institutional Investor Advisory Services India Limited (IiAS), has looked at best practices and standards in corporate governance, for Indian listed entities and identified 4 levels of corporate governance: basic, fair, good and leadership and scored 150 companies across this scorecard.

Corporate Governance: The Unknown Growth Driver

Companies such as Cipla, HDFC and Infosys are in the leadership category, while other companies like Marico, Dr Reddy’s and Tata Motors are in a good category.

Breaking it down further, they look at the following parameters:

  • Rights and equitable treatment of shareholders: This looks at related party transactions, conflicts of interest, investor grievance policies and quality of shareholder meetings
  • Role of stakeholders in corporate governance: Supplier management, employee welfare, investor engagement, whistle-blower policy, business responsibility initiatives
  • Disclosures and transparency: Ownership structure, company filings, financials, audit integrity, risk management, dividend pay-out and policies
  • Responsibilities of the board: Board and committee composition, training for directors, board evaluation, director remuneration, succession planning

Every factor is looked at independently, ensuring that companies which have a high score, need to address different factors of corporate governance and not excel only in one area.

The median score distribution shows a higher score for MNCs and widely held companies. Taking the idea further, they also looked at the difference between the BSE 100 companies and recent IPOs.

Their analysis of 50 recent IPOs also showed interesting trends. Most of the post-IPO companies were in the fair category with just 3 companies – ICICI Pru Life, Narayana Health and Syngene International in the good category, 10 in the basic category and none were featured in the leadership category.

Two key concerns extracted from the analysis that are often overlooked are:

Board Composition: While discussions on gender diversity have been a key theme across sectors, the other critical aspect is of skill diversity which can bring in a better quality of discussions.

Corporate Governance: The Unknown Growth Driver

Quality Of Financial Statements: Recent audit failures have raised questions about the fairness of financial information. The issues were more acute for the IPO stage companies.

Corporate Governance: The Unknown Growth Driver

While the scorecard gives some sense of the governance status for the listed BSE 100 companies and a benchmark status for IPO companies, firms cannot wait till they reach this stage to bring in corporate governance measures.

The governance factors need to be addressed much earlier, when companies are in the start-up stage. Unfortunately, there are no clear benchmarks for the companies in that stage.

There is no index that can help compare the start-up governance readiness and the issues get highlighted at a later stage. By that time, for some companies, it might be a little too late to fix some fundamental governance issues.

In the absence of other benchmarks and control systems, early investors often play an important role in ensuring that the start-ups they invest in, do not chase growth at the cost of good governance and transparency. Some of the key factors involve a diverse board, with women directors and validated financial statements. These are the key requirements for evaluation, even when the investment is for early stage companies.

Learnings In Corporate Governance

Corporate governance is a critical success factor for a company’s success and it is never too early to start investing in it. Investors have to be serious about how the investee firms develop their focus on corporate governance and that it forms an important part of due diligence and investment decision. The following are the three most critical findings across Caspian’s investees:

  • Companies with the below-average score on governance indicators are twice likely to default or delay repayments
  • Companies with above-average score on governance indicators are three times more likely to raise funds
  • Through subsequent loan cycles, companies are likely to improve their governance scores.

An early investment into corporate governance can give rich dividends, not just for the investee companies, but for all startups, who are serious about responsible growth.

Note: The views and opinions expressed are solely those of the author and does not necessarily reflect the views held by Inc42, its creators or employees. Inc42 is not responsible for the accuracy of any of the information supplied by guest bloggers.