labels: industry - general, investment - general, governance , union budget 2003
Wake up call for India Inc news
Uday Chatterjee
01 April 2003

Mumbai: Despite welcome sops offered to India’s capital markets in this year’s budget, the bourses have not responded in a gung-ho fashion as expected and the investor, particularly the small investor, is still avoiding the capital market.

Apart from the ongoing US-led Iraq war, the main reason for the low investor interest is the doubt in his mind whether companies are following good corporate governance (GCG) practices.

The lack of GCG practices leaves the investor in an uncertain frame of mind about a company’s promoters and management. The investor has now realised that the main reason for the spectacular fall of once-deified companies like Enron and many others was basically that they did not follow GCG practices.

GCG practices essentially mean good management. Such practices are not just for the benefit of shareholders but other stakeholders of a company — like the company’s creditors, vendors, employees and, last but not the least, customers, whose stake, though intangible, is of vital importance.

To illustrate, not having GCG codes and practices would mean that the shareholder is told that the company is making profits while actually it may be making losses. The company’s bankers are assured that their monies are not being diverted while in actuality they may be have been siphoned out.

The vendor, often a small-scale unit in India, is unsure that payments will be made on time. The plant manager of the company is made to make false certifications that the mineral water manufactured in his plant is according to laid-down standards. Lastly, the customer is led to believe that the mineral water he is consuming is according to standards while actually it is not.

Taking the initiative to improve GCG codes and practices, the Securities and Exchange Board of India (SEBI) set up a committee in November 2002 headed by Infosys chief mentor N R Narayanamurthy to review the implementation of existing GCG codes by listed companies and to recommend changes to improve practices.

The committee submitted its report to SEBI in mid-March 2003 and the report has been posted on SEBI’s website () for comments from the general public and financial intermediaries, which have to be submitted before 16 April 2003.

The major recommendations of the committee are:

  • Companies should lay down a code of conduct for all board members and the senior management of the company.
  • In the case of listed companies, the audit committee of the company should review financial statements and draft audit reports, including quarterly and half-yearly management discussion and analysis of financial conditions and results of operations.
  • The audit committee also has to review reports related to compliance with laws and risk management, management letters of internal control issued by statutory internal auditors and records of related third-party transactions.
  • All members of the audit committee should be “financially literate” and at least one member should have accounting or related financial management expertise.
  • Companies should move towards a regime of unqualified statements; this recommendation is not mandatory, though.
  • Companies raising money through a public issue should disclose to the audit committee the uses and application of funds by major category on a quarterly basis. In addition, the company shall prepare a statement of funds utilised for purposes other than those stated in the offer document on an annual basis, which is to be certified by independent auditors of the company.
  • The practice of appointing nominee directors by financial institutions should be discontinued. But if an institution wishes to appoint a director on the board of the company, it should be approved by the company’s shareholders. Such directors shall not be considered as independent directors.
  • An institutional director, thus appointed, shall have the same responsibilities and shall be subject to the same liabilities as any other director.
  • The government’s nominee on public sector companies shall be elected with the approval of shareholders and should be subjected to same responsibilities and liabilities as any other director.
  • Any director will not have any material or pecuniary relationships or transactions with the company, its promoters or its senior management, except for receiving remuneration as a director.
  • The committee has said that it is in favour of ratings on GCG by agencies like Crisil and ICRA. It has suggested that companies should be rated on parameters of wealth generation, maintenance and sharing as well as on GCG. But the rating has not been mandatory as the ratings process is still in a development phase.

These recommendations are clearly designed to ensure that companies set exemplary goals for themselves and adhere to their goals. A regular review of operational performance ensures that companies stick to their management objectives of profitability and growth. A review of financial performance ensures that the money is spent for the purposes for which they are meant and financial malpractices, if any, are detected at an early stage for which corrective action can be taken.

The most significant recommendation is regarding the composition of the board of directors. This will ensure that directors are independent and will function keeping the overall interest of only the company into account. The change in responsibilities and liabilities of nominee directors will also ensure that there is no conflict of interest between the institution they are representing and the company.

These recommendations on GCG are largely meant to protect the interests of shareholders and increase shareholder value. The investor will be comfortable investing in a company that follows recommended codes and practices. This will go a long way in bringing the small investor to the capital market, which it is shunning at the moment.

SEBI is awaiting recommendations from the general public and financial intermediaries after which it will study them and pass its ruling on the subject. Passing of the order could take some time, as there are some dissenting voices, especially with regard to the role of nominee directors.

Companies, however, would do well to start implementing the other recommendations of the committee without waiting for SEBI’s order as that would improve their internal efficiencies; it is not that only when ordered by the regulator that certain practices have to be implemented.

Companies like Infosys and Wipro have been implementing GCG much before certain practices became mandatory and the success achieved by these companies, their shareholders and other stakeholders are there for all to see and emulate.

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Wake up call for India Inc