The fight for corporate governance in India
Poor standards are a major grievance of domestic and foreign investors
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Over the past few years, trust in political and business institutions in India has seen a sharp decline as a series of corruption scandals rocked both sets of institutions. The crisis of confidence may seem to be a daunting challenge for regulatory agencies but it can also turn into an opportunity for reform for those wise enough to seize it.
The recent moves of India’s capital market watchdog, Securities and Exchange Board of India (Sebi) to improve corporate governance norms of listed companies must therefore be seen as a welcome step in the direction of reform. But much still remains to be done. Following the recently amended companies law that put the spotlight on corporate governance issues, Sebi’s latest directives can help raise the bar on corporate governance in India if the regulator, in league with stock exchanges, follows up on its tough words with punitive action on erring firms.
Speaking at an event recently, Sebi chairman U.K. Sinha pointed out that nearly one-fifth of listed companies in India do not even comply with basic shareholding reporting norms set by the regulator. He expressed disappointment at the quality of filings companies make, and stressed the need for exchanges to hire more people to monitor whether companies are complying with the letter and spirit of listing agreements. Two days later, Sebi came up with detailed guidelines for stock exchanges to ensure compliance with disclosure norms. Sebi directed exchanges to follow up on companies at every stage of key corporate developments, after receiving such information from other sources or even take suo moto steps.
Poor corporate governance standards in India have been a major grievance of domestic and foreign investors alike for long. India’s national stock exchanges and Sebi have come under fire repeatedly from investor associations for not taking action against companies that failed to honour listing agreements. The International Monetary Fund is the latest complainant and has highlighted the lack of compliance with listing obligations as a key weakness in its recent financial sector assessment report on India.
One lesson from the financial crisis that struck the world five years ago was that opaqueness in financial markets can sow the seeds of systemic risks in an economy. In India, weak corporate governance standards have adversely affected price discovery and have played a key role in the exodus of retail investors from stock markets, limiting the depth and liquidity of these markets. Markets have been trapped in a vicious cycle: disincentives for small investors limit their participation that, in turn, limits the constituency for genuine reforms.
The lack of stringent disclosure norms and the absence of strong punitive action have loaded the die in favour of insiders and against minority shareholders. Loose reporting norms have promoted an investing cult that relies heavily on insider information rather than one based on analysis of public filings. Extreme volatility in stock prices prior to major corporate announcements, and opaqueness during mergers and takeovers has become routine. Even routine analysis of quarterly earnings is often handicapped by the leeway offered to companies to smoothen their earnings. Institutional investors often have to hire forensic accountants to gauge the “true earnings” of firms in any particular quarter; which adds to their costs of investing in India.
Breaking this cycle tends to benefit both investors and honest entrepreneurs. Empirical evidence from emerging markets including India shows that a major regulatory move on corporate governance norms is followed by a sharp appreciation in the stock premia of large well-governed companies. Superior corporate governance standards help investors separate the wheat from the chaff, limiting mis-pricing of capital.
Although over the past 25 years, Sebi has had major successes in acting against errant market intermediaries, its record against errant promoters has been extremely weak. In the mid-2000s, under the chairmanship of M. Damodaran, Sebi did initiate similar moves to raise the bar on corporate governance in India. But resistance from corporations, a turf war with the ministry of company affairs and interference from the Union government ensured that Sebi’s autonomy was undermined and the initiative petered out.
The signs are more promising this time. More companies now tend to tap capital markets abroad for funds and manage to benefit from higher corporate governance standards. A small but growing class of activist shareholders has emerged in India, which will add heft to the fight for greater corporate transparency. The ministry of company affairs has come a long way in the path towards greater corporate governance, if the provisions of the recent companies’ law are to be taken seriously.
It is now Sebi’s turn to up the ante on corporate governance once again. The benefits to Indian markets may not accrue immediately but the long-term benefits of financial stability make it well worth the fight.
What are the reasons for the lack of strong corporate governance in India? Tell us at email@example.com
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