It is high time the regulator cracked the whip.
Two weeks ago, the Securities and Exchange Board of India (Sebi) sent notices to 20 companies because of their failure to meet corporate governance requirements.
And Sebi chairman M. Damodaran said in New York last week: “We want to make examples of big companies.”
That’s a worthwhile principle to follow. India has impressive corporate governance norms on paper, to help protect investors from managers and promoters who work against their interests. It is often believed that the best of the Indian corporate world has mended its ways, and the really serious episodes of misgovernance are to be found in the smaller companies. That’s not the real story, however.
Academic research has shown that Indian corporate governance levels have improved over the past few years because of two sets of factors. First, the official committees headed by Kumar Mangalam Birla and N.R. Narayana Murthy have together put out an impressive rule book on corporate governance, and the new Clause 49 of the listing agreement between companies and the stock exchanges is on a par with the best in the world. Second, the global competition for capital and talent has forced companies to mend their ways, Clause 49 or no Clause 49.
Yet, despite the recent progress, India’s corporate governance standards leave much to be desired. A recent research paper by Rajesh Chakrabarti of the Indian School of Business, William Megginson of the University of Oklahoma and Pradeep Yadav of the University of Oklahoma notes: “While on paper the country’s legal system provides some of the best investor protection in the world, the reality is different with slow, overburdened courts and widespread corruption. Consequently, ownership remains highly concentrated and family business groups continue to be the dominant business model. There is significant pyramiding and tunnelling among Indian business groups and, notwithstanding copious reporting requirements, widespread earnings management.” (Pyramiding and tunnelling help promoters of capture cash flows that should have gone into the pockets of investors).
Sebi’s action against 20 large companies (whose names it has not been revealed) is welcome because it recognizes the fact that some of the biggest misdemeanours are within well-known companies. Hanging a few big cats is not a bad idea.
Yet, there are two additional issues. First, assuming that Sebi does eventually punish these companies, what will the exact nature of the punishment be? Some newspaper reports suggest that the market regulator will impose fines on the companies, which in effect is a fine on shareholders. A better idea would be to accept the principle of personal responsibility and impose personal fines on individual directors who are paid to protect shareholder interests.
The second niggling issue is the role of institutional investors. Globally, it is large investors who keep company managements on their toes. Shouldn’t those who have large stakes in these companies have blown the whistle before Sebi did?
In India, investor activism of this sort has been rare. And soaring share prices are one more reason for institutional investors to turn a blind eye to mismanagement.
India is different from China and the rest of Asia in one important way. Our strength is not a visionary government but high-quality companies. We need to build on this entrepreneurial strength, which is nurtured by a vibrant equity culture. High standards of corporate governance are a must if India’s growth surge is to be sustained. Else, there is a danger that we’ll go the way to Indonesia or South Korea, where poor corporate governance and crony capitalism helped push these countries into the crisis of 1997.
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