Mumbai: Head of Indian equities at the UK-based investment bank Noble Group, Saurabh Mukherjea, said in an exclusive interview that one in five of the BSE 500 companies on the Bombay Stock Exchange has accounting problems, largely because basic checks on a promoter are either weak or have conflicts of interest. This, he says, could lead to a crisis of confidence for foreign institutional investors, or FIIs. Edited excerpts:
How deep is the problem of creative accounting and corporate governance among listed Indian firms?
Basic checks: Saurabh Mukherjea of Noble Group.
We face corporate governance issues in one in two companies that we cover. One in five companies in the BSE 500 raises accounting issues. In past four months, we have met 50 listed firms but so far covered 16 because of such issues. Essentially, two in every three firms are not worth covering on account of corporate governance and accounting issues.
Can you name some of the firms that you have found most aggressive in fudging accounts?
We cannot reveal names due to legal issues. However, accounting issues are present across the whole spectrum of listed companies from the Nifty 50 (of the National Stock Exchange)?to?small-cap stocks.
Which sectors are most prone to creative accounting?
If we had to point to a couple of sectors where accounting issues crop up the most, it would have to be real estate and infrastructure.
How do they do this?
Our biggest concerns in these two sectors are value of land banks and treatment of valuation of work in progress. These two aspects drive the valuation of listed entities the most.
How are Indian firms reacting?
Adverse findings are usually greeted with threats of reputational damage, accompanied by a request to block the report.
How do you deal with it?
We generally follow two methods. First, whatever we reveal in the public domain is attributable to analysis of publicly available data and secondly, we tend to be more candid in closed-door conversations with investors.
What’s your advice to FIIs on investment in India?
Indian equities are almost unprecedentedly cheap. In fact, the only time when Indian equities were available at more attractive valuations was spring 2003, a quarter which presaged the beginning of the five-year bull market. However, successful investment in India entails using primary data checks on a promoter’s ethics, forensic accounting checks on the accounts and some basic charting work to see if a stock has been subject to promoter manipulation in the past. For those who are willing to do the homework, there are good companies available at attractive valuations.
What is the biggest concern at this point?
In a modern capital market there are three basic checks on a promoter’s power—auditors, independent directors and regulators. In India, each of these three is either conflicted or enfeebled by political interference. As a result, there are very few restraints on promoters and that worries investors, particularly FIIs. If we cannot reform our market on each of these fronts, FII confidence will be hard to regain.
What’s the scale of FIIs’ concerns on corporate governance after the Satyam debacle?
We advise around a third of the significant FIIs operating in India—around 40. Of these, around a third have called us up post-Satyam to have their portfolios vetted for accounting issues. I believe other advisers to FIIs are also seeing a similar volume of incoming calls.
How can we tackle creative accounting practices?
The capital market regulator needs to make independent directors more independent; prohibit auditors from doing consultancy work for the firms they audit; and make quarterly reports mandatory on a consolidated basis with cash flow statements and balance sheets.