Putting the house in order

0
494

The global financial crisis will expose cracks in India’s corporate governance standards, argues Jamie Allen of the Asian Corporate Governance Association

India’s corporate governance standards, like those in many other Asian markets, have improved significantly over the last decade.

The country’s desire to become more competitive internationally was a major catalyst for corporate governance reform at the policy level, even before the Asian financial crisis of 1997. Stock market scandals in India in the early 90s were another driving force, as was the UK’s Cadbury report, an early code of practice for corporate governance published in 1992 that inspired reform in India.

Jamie Allen
Jamie Allen

Initiatives to improve internal controls have been encouraging. However, India, like much of Asia, still has much progress to make. In particular, the concept of the independent director requires immediate redress. Individuals who aren’t particularly independent are often appointed as independent directors in India. The same criticism applies to many other countries, but due to the pervasiveness of family concentrated ownership in India, the autonomy of audit, remuneration, nomination and other standard board committees is often questionable. State-owned companies subject to government control are similarly perceived to lack effective governance.

The standards of corporate governance exhibited by family controlled corporations are diverse. Companies like the Mahindra Group appear to be genuinely well governed. But in many other companies, transactions are being undertaken in the interests of the family, sometimes at the expense of public shareholders.

Shareholder voting systems urgently require reappraisal. Generally in Asia, votes are counted by a show of hands. Regardless of whether an investor holds 10 shares or a million shares, he is awarded the same vote. In companies with international share ownership, this voting system is fundamentally flawed. The most serious omission is the fact that votes from cross-border investors are often not counted.

There are only three markets in Asia – China, Hong Kong and Thailand – that properly count shareholder votes. India could gain a significant advantage by joining their ranks.

While private equity investors have the freedom to investigate a company’s internal controls to protect their investments, public investors must rely primarily on published information. In many instances, company details can be extremely limited so investors have to use alternative information such as financial reports, management structures and director compensation to guide their decisions.

Financial and non-financial reporting can be used to determine whether a company has addressed its weaknesses along with its successes. World class companies like Infosys are a great example in India. They disclose bad news, which a lot of companies don’t do. Disclosures of executive and director compensation in relation to company profitability are another consideration and an area where further transparency is necessary.

Regulators should be more proactive in engaging companies and organizing training, such as director training, to encourage adherence to best practices.

Regulatory bodies such as the Securities & Exchange Board of India and the Ministry of Corporate Affairs, which enforces and implements the Companies Act, have been generally effective. The government, however, has been somewhat ambivalent in granting regulators the necessary authority to allow vigorous enforcement.

There’s a very important role for lawyers in this whole process, especially in IPOs, where bringing companies to market with good corporate governance is crucial. Equally, in M&A transactions lawyers can advise on how to put better governance structures in place, in addition to providing assistance on compliance with changing rules and regulations, the implementation of best practices and meeting market expectations.

But if law firms are to play such a crucial role in driving up the standards of corporate governance in India, they must lead by example. It is for this reason that I’m delighted to see so many Indian law firms participating in India Business Law Journal’s billing rates report (see page 43). Such a commitment to openness and transparency in billing practices is an important first step that will ultimately benefit the participating firms and their corporate clients.

When markets are flourishing, there aren’t many visible consequences of poor corporate governance. Indeed, investors often don’t put a large premium on the concept. But in the current climate and over the next few years, profitability is likely to decline, economies might contract, investors may become excessively cautious and corporate governance cracks will start to appear.

India would be wise to put its house in order now.

Jamie Allen is the founding secretary general of the Asian Corporate Governance Association (ACGA). Prior to the establishment of ACGA in mid-1999, he ran a consulting firm that conducted customized economic research on finance-related topics, including corporate governance, for blue chip clients in Asia.