Independent,not free

A poisonous mix of accounting opaqueness,regulatory laxity and judicial indolence is a major roadblock to smooth development...

Written by Arindam Banik | Published: April 15, 2009 1:33:51 am

A poisonous mix of accounting opaqueness,regulatory laxity and judicial indolence is a major roadblock to smooth development of the capital market in emerging countries — particularly when these invite greater participation from foreign investors. The Satyam scandal brought into focus the importance of good corporate governance among publicly held companies in the Indian context. The irony is that while the Satyam story went public in January 2009,the company had regularly been winning accolades and awards for the quality of its corporate governance; even as late as September 2008,Satyam won the coveted Golden Peacock Global Award for Excellence in Corporate Governance for 2008.

This is not an India-specific story. In fact,the history of capitalism is replete with such headline-making scandals. Take Enron for example,the energy company that has become a byword for corporate fraud. It had 22,000 employees and claimed revenue of nearly $100 bn the year before its 2001 collapse. The group had a complex accounting structure,under which huge debts were hidden behind fraudulent off-balance sheet partnerships. Its top executives were found guilty of insider trading and lying to investors. Ken Lay,its disgraced chairman,died before he could be sentenced.

Then there’s Bernard Madoff. His swindle took in as much as $65 billion over two decades before the 2008 market meltdown. According to a statement that he read out in court,he would tell prospective investors that their money would be invested in shares of common stock options and other securities of large well-known corporations. In reality,they were deposited in a bank account at Chase Manhattan. Money was withdrawn from the bank whenever clients asked for redemptions.

For many,the above scandals affirm Adam Smith’s 1776 warning: “The directors of [joint stock companies,however,being managers rather of other people’s money than of their own,it cannot be well expected that they should watch over it with the same anxious vigilance [as owners… Negligence and profusion,therefore,must always prevail,more or less,in the management of the affairs of such a company.”

Recognising this fundamental wisdom,various regulatory agencies advised companies to have independent members on their boards. SEBI has made it mandatory for publicly listed companies to have some minimum number of independent directors. This had two broad objectives: one,effective corporate governance,and two,enhanced investor confidence. It is worth remembering,as we consider reforms in a post-Satyam world,that Satyam’s independent directors were among the most respected and renowned in India.

The lesson to take away is that while it might help the cause of good corporate governance to have a large number of independent directors on their board,the episode highlighted the inherent weakness of independent directors in terms of delivery. In most cases,they are appointed by the promoters and so are not strictly independent; they might well acquiesce to the promoters’ agenda without unduly worrying about its impact on company performance. There are reasons to remain worried about the rationale of independent directors’ long-term appointments. Arguably,they may not be able to independently act when taking an unbiased decision,thus only supporting the coloured decision. Sometimes financial incentives are too strong for them to remain silent spectators of the board. It is also observed that in most cases independent directors are retirees; eventually they are guided by their own economic rationale.

Poor corporate governance may not always be tantamount to fraud. Lesser forms involving a hierarchy of reasons such as the lack of transparency,acting in other than the company’s interest or of minority shareholders,may also lead to appropriation and theft. While the final deterrence against fraud may be quick and exemplary punishment,other mechanisms do have a role in incentivising better corporate governance. At present,there are no such incentives — at least as perceived by the promoters. This can be seen from the fate of corporate governance ratings initiated by Indian rating agencies. First undertaken by Crisil and then by ICRA and CARE,corporate governance ratings have not emerged exactly as hot favourite of Indian companies. Of the 4700 listed firms,the trio have rated around 50; only 19 have disclosed their ratings to the public.

This isn’t going to help investor confidence; naturally,there are calls for effective regulation from governments. Given the increased strain that the current financial crisis has placed on corporate structures a variety of regulatory regimes need to be examined and tried out. Satyam’s troubled road to recovery should teach us that lesson.

This piece was co-written by Pradip K. Bhaumik. The writers are at the International Management Institute,New Delhi

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