Securities & Exchange Board of India is planning to come up with a Corporate Governance Rating Index. The proposal is still at a conceptual stage. The objective is to gauge the level of corporate governance in a company. According to Shri G. N. Bajpai the index will be based on three principles:

• Level of wealth creation by a corporate
• Quality of wealth management
• Sharing of wealth with all stakeholders

The purpose is to bring back the small investors to the markets and restore their confidence. The corporate governance ratings index will be the second attempt by the capital market regulator to raise the level of governance in listed companies. It had earlier constituted a committee for the purpose under the chairmanship of Shri Kumar Mangalam Birla and based on the recommendations, an amendment to the listing agreement was made by incorporating Clause 49.

Go to top

Department of Company Affairs (DCA) in collaboration with the Institute of Company Secretaries of India (ICSI) has decided to set up "Investor's Clinics" all over the country at strategic locations. Stock market scams and endless fly-by-night operators have not only confused the small investor class, but they have lost piles of money in the process. According to Dr. S. P. Narang, Secretary of the ICSI, the clinics are being set up to help investors access balance sheets and understand matters such as dematerialization of securities, stock margins, settlement norms etc. The clinics are expected to form a significant part of the investor education exercise that the government wants to pursue very seriously. According to DCA officials, "Investor confidence is very crucial to capital market revival. Although the institutional investors and high net worth individuals are the ones with money, the 'feel good factor' among the general public and the revival of their confidence in the capital market are very important.

The government has also mandated the ICSI for undertaking investor awareness programmes all over the country. In view of the current depressed market conditions, these investor awareness programmes to be conducted through the ICSI's network of regional offices and chapters will enable the small investors to make judicious investment decisions.

Go to top

The SEBI appointed panel to review the takeover code headed by Justice P. N. Bhagwati has suggested several significant changes in the Takeover Code in its recently submitted report. The suggested changes include:

a) Allowing banks and financial institutions to fund takeovers,
b) Disallowing the original bidders from withdrawing after a competitive bid comes in,
c) Allowing acquirers to offer shares of third listed company in the open offer,
d) Tightening of disclosure norms at 5 per cent, 10 per cent and 14 per cent,
e) Acquirers holding over 15 % to disclose sale and purchase at every 2 % level f) Acquirers to give an undertaking that no asset stripping will take place No creeping acquisition to be allowed beyond 75 per cent holding.

The SEBI Board is expected to take a view on the report shortly.

Go to top

According to Shri G. N. Bajpai, Chairman, Securities & Exchange Board of India poor governance by domestic companies has eroded investor's confidence. Speaking at seminar on "Capital Markets" organised by the Federation of Indian Chambers of Commerce & Industry (FICCI) in Mumbai, he called for better compliance and management practices for improving corporate governance. He also observed that governance practices were sketchily observed by many corporates and should be enforced more forcefully.

Go to top

The Department of Company Affairs is finally taking action on a section of companies that did not avail of the Company Law Settlement Scheme (2000) to file their annual returns, balance sheets and other documents with the registrar of companies (ROC). The DCA has decided to slap stiff graded late fee fine on about 100 foreign companies that have sought condonation of continuous non-filing of documents for up to over 10 years. Foreign companies that did not avail of the amnesty scheme, will now face penalties under section 611 of the Companies Act, 1956. The filing fees for the foreign companies have also been increased five fold to Rs. 5000. DCA feels that the stiff penalties will act as a deterrent to such lapses.

The DCA is planning to amend the Companies Act, 1956 to enable companies to hold their board meetings through electronics means like video and telephone conferencing and take advantage of information technology. However, it has been decided that some subjects of importance should be transacted only through meetings in person. The new provisions will be regulated by promulgation of certain rules, which can be modified in accordance with the experience gained, from time to time.

Go to top

Associated Chambers of Commerce and Industry (ASSOCHAM) has outlined an eight-point strategy to improve corporate governance standards in India at a recently held seminar on "Corporate Governance Best Practices" in Mumbai. The Seminar was addressed by Shri G. N. Bajpai, Chairman, SEBI and Shri Adi Godrej, noted industrialist. Other speakers were Shri Shailesh Haribhakti, CEO of the Haribhakti Group and Shri R. V. Shahi, Chairman & Managing Director, BSES Ltd.

The chamber has stated that adherence to best practices in corporate governance and strict vigil by the regulator as also the professionals will make the investment climate conducive to investors. It is also felt that the violation of the listing agreement should be made punishable. ASSOCHAM has also pointed out that the professional codes of conduct of various professional involved with the listed companies, namely company secretaries and chartered accountants should be made stringent so as to deal effectively with malafide acts and negligence on part of such professionals.

Go to top

In a move aimed at removing misconceptions about the degree of auditors' responsibility in the certification of financial statements, the auditors' reports of companies would henceforth explicitly mention, "the financial statements are the responsibility of the company's management".

The opening paragraph of an auditors' report, in the case of companies registered under the Companies Act, would now state that the auditor's responsibility is only to express an opinion on these financial statements and that the opinion is based on an audit carried out by the chartered accountants.

These modifications to the format of an auditors' report to the shareholders of a company have now been made and issued by the Central Council of the Institute of Chartered Accountants of India (ICAI).

"These changes are applicable with immediate effect and auditors' reports of companies would have to comply with the new format. By explicitly mentioning such statements, we are only clarifying our role to the user of a financial statement", an ICAI council member said.

Every auditor giving a report to the shareholders of a company would also be required to include a 'scope paragraph', describing the nature of audit carried out by them on the financial statements.

"We conducted our audit in accordance with auditing standards generally accepted in India. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.

An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. It also includes assessing the accounting principles used and significant estimates made by the management as well as evaluating the overall financial statement presentation.

"We believe that our audit provides a reasonable basis to our opinion", says a new paragraph in the revised format of audit report released by ICAI.

This paragraph would now necessarily from part of every auditors' report to the shareholders of a company.

Further, the last paragraph of an auditors' report on "true and fair view" has also been modified. "The modified format now requires the affirmation of the true and fair view to be given in conformity with the accounting principles generally accepted in India", an ICAI council member said.

(Source: Business Line)

Go to top

A) The Department of Company Affairs (DCA) has planned to set up a Centre for Corporate Excellence to ensure better corporate governance. A token Rs. 1 crore has been earmarked for the proposed centre during 2002-03. The proposed centre would have three broad functions, such as, research and studies, education, promotion and development and accreditation and awards with respect to matters with a bearing on corporate governance and excellence.

B) The Standing Conference on Public Enterprises, SCOPE, is setting up a Centre of Excellence for Corporate Governance in Public Enterprises.

Go to top

The Government has set up, at the Ministry level, an advisory panel comprising senior representatives of both industry and trade, professional institutions such as ICAI, ICWAI and the Institute of Company Secretaries of India (ICSI), and eminent business personalities, to advise the Department of Company Affairs (DCA), on various aspects of company law, and related matter.

Addressing a workshop on The Companies (Amendment) Bill, 2001, jointly organised by The Bengal Chamber of Commerce & Industry and ICSI here, Mr. Vinod Dhall, Secretary, DCA, Government of India, said the objective was to create an effective platform for discussions, professionally, between DCA and the industry.

The panel, after periodic interactions, will advise DCA on what further needs to be done on the company law front, so that the Indian corporate sector can achieve that much needed paradigm shift by setting up a benchmark for global standards.

He clarified that since the DCA was not used to the Rule-making process, power has to be invoked to issue Rules, and for this, the necessary inputs have to be there.

Describing the voluminous Companies Act, 1956 as a kind of a Bible, compared to the SEBI Act, which was more like a book, and quite amenable to rule-making, he said company law too, like everything else, has to adapt to changes taking place globally.

Unveiling the vision for the Indian corporate sector, he said there was need to create a proper framework of corporate governance, enabling companies to stay in line and also contribute more for benefit of all stakeholders.

Advocating an arm's length relationship between regulatory bodies and the corporate sector, he advised companies to upgrade standards of governance, so that balance sheets made more sense.

Pointing out that the new accounting standard was a good thing to have happened, he said the newly set up National Accounting Standards Advisory committee, a separate statutory body, would be working independently of the ICAI.

In the context of growing importance of corporate governance, Mr. Dhall submitted that the role of an audit committee has to be re-defined. Describing such committees in companies as the first watchdog, after which only the statutory auditors come in to play, he said these committees had a major role to play in the finalization of accounts.

Commenting on the issue of technical scrutiny of accounts by Registrar of Companies (ROC), he sought industry's comments on whether there was need to institute a "random enquiry" to establish that the company accounts present a true and fair view.

Describing the small penalties prescribed by the Companies Act on erring companies as a kind of joke, he said these needed to be revised drastically, especially in an environment where non-compliance of laws has become the order of the day. "Where there is a law, there has to be compliance, and in a cost-effective manner".

On the position with regard to the Companies Amendment Bill, which was placed in Parliament in August last year, he said the Bill was now before a select Parliamentary Committee.

(Source: Business Line)

Go to top

Of the 37 listed PSUs, seven companies did not comply fully with SEBI's corporate governance norms in 2000-01, the Comptroller and Auditor General of India (CAG) said in a report. The violation is in respect of Independent Directors. The seven companies which have been pulled up for not complying with SEBI's listing norms include BHEL, IBP, Chennai Petroleum, Rashtriya Chemicals and Fertilizers and Chemicals Travancore Ltd and Kochi Refineries, the CAG said in its report tabled in Parliament.

Go to top

The Company Affairs Secretary, Mr. Vinod Dhall, has said that the officials of the Department of Company Affairs had been asked to trace the promoters of 79 vanishing companies across the country with the help of the State Governments where necessary.

Go to top

Concerned over publicly-listed MNC companies going private, the Securities and Exchange Board of India (SEBI) has decided to set up a committee to suggest tighter norms to discourage companies seeking to delist from domestic bourses.

It is expected that SEBI would tighten norms and make it difficult for MNCs to go private by buying back public shareholding and converting themselves into 100 per cent subsidiaries of the parent company.

Over 50 companies have announced their intention to delist in the recent past. These include the likes of Cadbury, Wartsila Diesel, Reckitt Benckiser, Philips, ITW Signode, Otis Elevators and Cabot.

The exit of these companies have already had an adverse impact on market capitalization, liquidity as well as volumes in the exchanges, market analysts said.

According to some market estimates, there are nearly 95 companies which have foreign promoters holding in excess of 51 per cent. Many of these are actively considering the delisting option, thereby converting their Indian ventures into fully owned subsidiaries.

Various reasons have been cited for MNCs hiking their stake and going private. One is that it is the international practice among MNCs to keep their foreign subsidiaries private. In India these companies were coerced to go public by the government in the 1970's. They are now going private as there are no restrictions or obligation to remain listed on the domestic bourses.

Another reason is that since listing norms on the exchanges have been tightened; MNCs are finding it both difficult and expensive to adhere to the compliance requirements.

(Source: The Economic Times)

Go to top

Rishi Chopra, ETIG Writes in ET: Welcome to the land of the unknown. You may have heard of the 'A' category or 'B' category stocks listed on the Bombay Stock Exchange (BSE) but did you know there are also companies classified as 'unknown'? These comprise stocks whose registered address is not known to the exchange.

The last count on April 2, 2002 showed that the exchange had 683 companies having no definite address. The BSE has suspended trading in all these scripts.

Interestingly, of the 683 unknown companies, as many as 144 companies had Mumbai as their last known address followed by New Delhi with 101 and Ahmedabad with 60 companies. A company is referred to as unknown when communication from the BSE is returned unanswered as the company has relocated and hasn't bothered informing the exchange. These companies have not complied with listing requirement such as paying listing fees.

Some of the somewhat familiar companies in the list include Hamco Mining & Smelting, Beta Napthol, MS Shoes, Blue Blends Petro, Garware Nylons, Pittie Cements and so on. Even pal Peugeot, the failed joint venture between Premier Automobile and Peugeot of France, figures in the list with its last known address as Parliament Street in Delhi. MS Shoes, which figured in a major scandal a few years back, is of course the best known of the lot.

The list is dominated by various finance and securities companies based in Mumbai, Ahmedabad and Delhi. These include the like of Atash Securities, Oceanic Investments and Forward Securities last seen at Nariman Point in Mumbai, Credential Finance with its last known address at Malad, Netwest Finance at, Fort, Mumbai and KCS Financial Services last seen at Lajpat Nagar at New Delhi.

The exchange sends all its correspondence such as bills for listing fees, copies of amendment to listing agreement, investor's complaints and so on to the companies at its registered officer address available with it. However, the correspondence in respect of these kind of companies are returned undelivered by the postal authorities for reasons such as 'not known', shifted' and so on. As a result, these end up facing suspension for failing to meet listing norms.

A number of textile (23) and steel firms too figure in the list. There are also around 22 pharma concerns and some 25-export firms. Some of the software firms include Pertech Computers (Delhi), Proline Software (Delhi) and Exel Software (Chandigarh). There is even a TCL Technologies last based in Thane, Mumbai.

Besides being unknown, these companies have also been made a part of the Z group since they have fulfilled three of the seven criteria of non-compliance for shifting a company to the Z group.

Go to top

A two-day seminar on 'Corporate Governance' was held at Kuala Lumpur, during the first week of April 2002, where issue such as corporate transparency models, duties of directors, protection and voting rights of institutions and small investors were discussed.

Experts felt that western standards on corporate governance may not work in East Asia, but they could provide a starting point for governments trying to restore confidence of the foreign investors. An Australian expert felt that homegrown rules may take very long and borrowing some to start the ball rolling was better that having none. Nara Srinivasan, a professor at Edith Cowan University ranked Australia as the regional leader with the highest disclosure standards, where the call for greater transparency began in the mid 1980s.

Like many Asian peers, Malayasian firms are mostly family owned or state controlled, with shareholding concentrated in the hands of a few. Foreign portfolio investors have pulled out as much as $ 3 billion from Malaysia since mid - 2000. Megat Najmuddin, President of the Malayasian Institute of Corporate Governance (MICG) called on the government to act fast, firmly and decisively to prevent further backsliding.

Go to top

Wall Street Journal Reports: "Asian firms with the best corporate governance standards outperformed domestic equity market benchmarks by an average of 14.4 percentage points in 2001, a report by CLSA Emerging Markets said on Monday.

The report, which covered 25 emerging markets across the globe, found in nine out of the 10 Asian countries it covered the top quartile firms ranked by corporate governance outperformed.

In each of the five years to 2001, the top quartile out performance for Asia averaged 147 percentage points, led by India with 615 percentage points of out performance.

Sharp improvements in corporate governance standards in South Korea, Malaysia and China boosted equity returns in these Asian markets in 2001, the report said. The investment analytics firm released on Monday a report entitled "Make me holy…but not yet", that found a high correlation between corporate governance and share price performance in Asia. It confirmed an observation made in a similar study in 2001, which sparked controversy and an outcry from firms that fared badly against CLSA's measure of corporate governance. CLSA considers 57 issues in seven categories and said the situation had improved significantly in the past year. But it was the improvement made in corporate governance (CG), and not the absolute degree of governance itself, that mattered most for stock performance in markets outside the top quartile. "There is evidence that below the top-CG quartile, it is not the absolute level of CG but whether CG is seen as improving or declining which has a bigger role in determining stock-price performance", the CLSA report said.

(Source: Financial Express)

Go to top

Corporate governance has evolved over the past century to more effectively promote the allocation of the nation's savings to its most productive uses. And, generally speaking, the resulting structure of business incentives, reporting, and accountability has served us well.

• A stray governance: And yet, our most recent experiences with the bankruptcy of Enron and, preceding that, several lesser such incidents suggest that the governance of our corporations has strayed from our perceptions of how it is supposed to work. By law, shareholders own our corporations and, ideally, corporate managers should be working on behalf of shareholders to allocate business resources to their optimum use.
  
  But as our economy has grown, and our business units have sufficient stakes to individually influence the choice of boards of directors or chief executive officers. The vast majority of corporate share ownership is for investment, not to achieve operating control of a company.
  
  
• CEO, the key: Thus, it has increasingly fallen to corporate officers, especially the chief executive officer, to guide the business, hopefully in what he or she perceives to be in the best interests of shareholders. Indeed, the boards of directors appointed by shareholders are in the overwhelming majority of cases chosen from the slate proposed by the CEO.
  
  The CEO sets the business strategy of the organisation and strongly influences the choice of the accounting practices that measure the ongoing degree of success or failure of that strategy. Outside auditors are generally chosen by the CEO or by an audit committee of CEO -chosen directors. Shareholders usually perfunctorily affirm such choices.
  
  To be sure, a CEO can maintain control over corporate governance only so long as companies are not demonstrably in difficulty. When companies do run into trouble, the carte blanche granted CEOs by shareholders is withdrawn. Existing shareholders, or successful hostile bidders for the corporation, usually then displace the board of directors and the CEO. Such changes in corporate leadership have been relatively rare but, more often than not, have contributed to a more effective allocation of corporate capital.
  
  
• Incentives work: For the most part, despite providing limited incentives for board members to safeguard shareholder interest, this paradigm has worked well. We are fortunate, for financial markets have had no realistic alternative other than to depend on the chief executive officer to ensure an objective evaluation of the prospects of the corporation.
  
  Apart from a relatively few large institutional investors, not many existing or potential shareholders have the research shareholders have the research capability to analyse corporate reports and thus to judge the investment value of a corporation. This vitally important service has become dominated by firms in the business of underwriting or selling securities.
  
  
• Optimistic analysts: But, as we can see from recent history, long-term earnings forecasts of brokerage-based securities analysts, on average, have been persistently overly optimistic. Three to five year earnings forecasts for each of the S&P 500 corporations, compiled from projections of securities analysts by I/B/E/S, averaged almost 12 per cent per year between 1985 and 2001. Actual earnings growth over that period averaged about 7 per cent.
  
  Perhaps the last 16 years, for which systematic data have been available, are an historical aberration.
  
  But the persistence of the bias year after year suggests that it more likely results, at least in part, from the proclivity of firms that sell securities to retain and promote analysts with an optimistic inclination.
  
  Moreover, the bias apparently has been especially large when the brokerage firm issuing the forecast also serves as an underwriter for the company's securities.
  
  I suspect that with the underlying database publicly available, it is just a matter of time before the ex-post results of analysts' recommendations are compiled and published on a regular basis.
  
  I venture to say that with such transparency, the current upward bias of analysts' earnings projections would diminish rather rapidly, because investment firms are well aware that security analysis without credibility bas no market value.
  
  
• When PEs, where insignificant: Prior to the past several decades, earnings forecasts were not nearly so important a factor in assessing the value of the corporations. In fact, I do not recall price-to-earnings ratios as a prominent statistic in the 1950s. Instead, investors tended to value stocks on the basis of their dividend yields.
  
  Since the early 1980s, however, corporations increasingly have been paying out cash to shareholders in the form of share repurchases rather than dividends. The marginal individual tax rate on dividends, with rare exceptions, has always been higher than the marginal tax rate on capital gains that repurchases create by raising per share earning through share reduction. But, until the early 1980s, share repurchases were frowned upon by the Securities and Exchange Commission, and companies that repurchased shares took the risk of being investigated for price manipulation.
  
  
• Buybacks bite dividends: In 1982, the SEC gave companies a safe harbour to conduct share repurchases without risk of investigation. This action prompted a marked shift toward repurchases in lieu of dividends to avail shareholders of a lower tax rate on their cash receipts.
  
  More recently, a desire to manage shareholder dilution from the rising incidence of employee stock options has also spurred repurchases.
  
  As a consequence, dividend payout ratios, which in decades past averaged about 55 per cent, have in recent years fallen on average to about 35 per cent.
  
  But because share prices have risen so much more than earnings in recent years, dividend yields - the ratio of dividends per share to a company's share price - have fallen appreciably more than the payout ratio.
  
  
• Elevated uncertainty: Earnings uncertainty has been particularly elevated in recent years. The process of capital reallocation has not only increased the long-term earnings growth potential of the economy as a whole, but has widened as well the degree of uncertainly for individual firms.
  
  Not surprisingly then, with the longer-term outlook increasingly amorphous, the level and recent growth of short-term earnings have taken on especial significance in stock price evaluation, with quarterly earnings report subject to anticipation, rumor, and 'spin'.
  
  Such tactics, presumably, attempt to induce investors to extrapolate short-term trends into a favourable long-term view that would raise the current stock price.
  
  CEO s, under increasing pressure from the investment community to meet short-term elevated expectations, in too many instances have been drawn to accounting devices whose sole purpose is arguably to obscure potential adverse results. Outside auditors, on several well-publicised occasions, have sanctioned such devices, allegedly for fear of losing valued corporate clients.
  
  This situation is a far cry from earlier decades when, if my recollection serves me correctly, firms competed on the basis of which one had the most conservative set of books. Short-term stock price values then seemed less of a focus than maintaining unquestioned credit worthiness.
  
  Value for corporate reputation: A change in behaviour, however, may already be in train. The sharp decline in stock and bond prices following Enron's collapse has chastened many of the uncritical practitioners of questionable accounting. Corporate reputation is fortunately re-emerging out of the ashes of the Enron debacle as a significant economic value. Markets are evidently beginning to put a price-earnings premium on reported earnings that appear free of spin. Likewise, perceptions of the reliability of firms' financial statements are increasingly reflected in yield spreads on corporate bonds.
  
  Corporate governance has doubtless already improved as a result of this greater market discipline in the wake of recent events.
  
  Limit on regulation: But the Congress is clearly signaling that more needs to be done. I hope that any legislative and regulatory initiatives will move to further realign current practice with the de jure governance model that served us well in generations past. Most success in that direction would seem to come primarily from changes in incentives for corporate officers.
  
  We have to be careful, however, not to look to a significant expansion of regulation as the solution to current problems, especially as price-earnings ratios increasingly reflect the market's perception of the quality of accounting. Regulation has, over the years, proven only partially successful in dissuading individuals from playing with the rules of accounting.
  
  Overdue changes: Some changes, however, appear overdue. In principle, stock option grants, properly constructed, can be highly effective in aligning corporate officers' incentives with those of shareholders.
  
  Regrettably, the current accounting for options has created some perverse effects on the quality of corporate disclosures. This has, arguably, further complicated the evaluation of earnings and diminished the effectiveness of published income statements in supporting good corporate governance.
  
  The failure to include the vale of most stock option grants as employee compensation and, hence, to subtract them from pretax profits, has increased reported earnings and presumably stock prices. This would be the case even if offsets for expired, unexercised options were made. The Financial Accounting Standards Board proposed to require expensing in the early to middle 1990s but abandoned the proposal in the face of significant political pressure.
  
  Misused stock options: The Federal Reserve staff estimates that the substitution of un-expensed option grants for cash compensation added about 2.5 percentage points to reported annual growth in earnings of our larger corporations between 1995 and 2000. Many argue that this distortion to reported earnings growth contributed to a misallocation of capital investment, especially in high-tech firms.
  
  Some have argued that the Black-Scholes option pricing, the prevailing means of estimating option expense, is approximate. But so is a good deal of all other earnings estimation, as I indicated earlier. Moreover, every corporation does report an implicit estimate of option expense on its income statement. That number for most, of course, is zero. Are option grants truly without any value?
  
  Critics of option expensing have also argued that expensing will make raising capital more difficult. But expensing is only a book-keeping transaction. Nothing real is changed in the actual operations or cash flow of the corporation. If investors are dissuaded by lower reported earnings as a result of expensing. It means only that they were less informed than they should have been. Capital employed on the basis of misinformation is likely to be capital misused.
  
  Critics of expensing also argue that the availability of options enables corporations to attract more-productive employees. That may well be true. But option expensing in no way precludes the issuance of options. To be sure, lower reported earnings as a result of expensing could temper stock price increases and thereby exacerbate the effects of share dilution. That, presumably, could inhibit option issuance. But again, that inhibition would be appropriate because it would reflect the correction of misinformation.

  Dubious independence
  
  In a further endeavour to align boards of directors with shareholders, rather than management, considerable attention has been placed on filling board seats with so-called independent directors. However, in my experience, few directors in modern times have seen their interests as separate from those of the CEO, who effectively appointed them and, presumably, could remove them from future slates of directors submitted to shareholders.
  
  I do not deny that laws could be passed to force selection of slates of directors who are patently independent of CEO influence and thereby significantly diminish the role of the CEO. I suspect, however, that such an initiative, while ensuring independent directors, would create competing power centres within a corporation, and thus dilute coherent control and impair effective governance.
  
  Character, the key: I should like to emphasizes that a market economy requires a structure of formal rules - a law of contracts, bankruptcy statutes, a code of shareholder rights - to name but a few. In virtually all transactions, whether with customers or with colleagues, we rely on the word of those with whom we do business. If we could not do so, goods and services could not be exchanged efficiently.
  
  Companies run by people with high ethical standards arguably do not need detailed rules to act in the long-run interests of shareholders and, presumably, themselves.
  
  But, regrettably, beings come as we are- some with enviable standards, but other who continually seek to cut corners. Yet there can be only one set of rules for corporate governance, and it must apply to all.

Go to top

Majority of the Stock Options issued during the boom days are all "underwater" i.e. below the exercise price (also called the Strike Price). Some are even below the face value of the stock. This is a devastating carnage of the illusions and dreams of reaching Infosys levels of wealth.

For the company, the main choices at this "wet stage" are whether to (a) re-price the stocks en block or selectively, (b) issue additional stocks at the current low levels to off-set the loss in some measure, or (c) cancel all outstanding options and abandon stock option schemes as a bad dream, never to be entertained in future. The first two in particular have corporate governance implications.

Repricing involves reducing the price in respect of the outstanding options from the level at which they were offered, to the current market price or even lower. Some companies like NIIT have done this.

On re-pricing, the company realizes lesser amount for the options/shares than originally estimated. The guidelines in India have not clarified the accounting impact of such re-pricing. In the case of USA, the Federal Accounting Standards Board has issued guidelines according to which any such concession will be treated as an employee cost and an expense in the books of the company.

Even if the company were not to be bothered about the accounting implications, as it is flush with money, there are two critical points that need to be answered.

By re-pricing, the company will be creating an impression and expectation amongst the employees that there will be a perpetual safety net against falling prices and that there will never be a downside risk. This agitates against the very foundation of stock options, which require that employees take the risk of the market variations as they rake in potential benefits. If the company also has a scheme of Stock Appreciation Rights, the concerned employees may expect the same beneficial treatment, which will result in a "freebie" or the culture of a "deferred wage".

The second critical point in repricing relates to corporate governance. If the markets went down, do companies compensate other shareholders or holders of convertible debentures? Obviously not. It is in this context that the institutional investors in the West have been decidedly against re-pricing of stock options. They feel that re-pricing side steps the original objectives and brings in a culture of "heads-I-win, tails you lose", as the Director of Centre for Financial Research and Analysis in the USA remarked. Of course, the HR community and the senior management plead that employees are a different lot of shareholding stakeholders - that any cost of repricing can be recovered by the "retention effect" it creates. That the cost of recruiting against potential leavers could be more than the cost of repricing and that the move is in the interests of the rest of the shareholders. This is rather a weak argument though, based on assertions than research.

Within the choice of repricing companies have a sub-choice of selective re-pricing. Selective re-pricing pre-supposes that some employees deserve to be compensated by re-pricing while others do not. For instance, senior management is expected to be bearing the responsibility for the financial results and the market response. Their reward should be substantially contingent on market performance of the company's stock. Consequently, the argument is that they should not be given any benefit of re-pricing.

In the case of other employees, the assumption is that stock options are sometimes a proxy to cash compensation in part or full. If such is the case, the company would have records of the assumptions made on the potential benefits due to the stock options and as to how much has been set off against a regular compensation package. Some argue that these employees deserve the benefit of repricing of the outstanding options to the extent of the estimated loss in compensation.

Microsoft avoided the terrible mess of re-pricing by giving new/additional options at the current market price to compensate for the assumed loss due to the underwater options. In such cases, it is assumed that the flow of benefit in future due to the rising market prices will offset the notional or actual losses incurred by the employee, on account of the earlier stock options for which the exercise price was relatively high. If the assumption fails, the company will be expected to intervene again with a fresh tranche at even lower prices, with greater impact on the accounts and noises from the other shareholders.

Protestations from other shareholders could be expected due to the apprehended impact of additional stock options on the over all shareholder value. Other shareholders tend to believe that fresh offers will dilute the market and thus reduce the potential value of their shares.

Institutional activists believe that senior management can induce arguments and even artificial conditions by which they can benefit from fresh issues at low prices. They fear that this will become a perpetual cycle to suit sectional financial interests defeating the foundations of the stock option policy. For this reason, senior management is often excluded from the compensatory additional issue of options.

These reactions to the "bust" conditions appear to mask an inherent problem in the assumptions that is becoming increasingly apparent. Stock options are considered an efficient method of compensating employees on the basis of the returns to the investors. Thus, if the market pushes the stock prices either way, it should get reflected in the employee's compensation. However, there is an increasing feeling that this indeed is a weak linkage as the stock price movements appears to be less driven by managerial performance or non-performance than a combination of secular, seasonal, cyclical and sectoral trends. A McKinsey report suggests that the total returns to shareholders appear to be determined by market and sectoral movements to the extent of 40% of the returns. Thus, managers` compensation through stock options will appear to be rewards or penalties for events beyond their substantive influence.

Further complications have been noticed in recent periods. For instance, consistent performance of companies does not appear to be rewarded by the market sentiments as much as the difference between the market expectations and actual performance! Commensurately, even if the actual performance were high, there could be a dip in the market prices if it does not meet the expectations of the research analysts who are the opinion makers. Similarly, managers in some badly performing companies may get the benefit of short spikes unrelated to actual efforts at improving the company's financial performance. For example, a set of good Board decisions or senior management appointments or a potential takeover may push up the market prices giving wealth to undeserving managers!

Considering the carnage, the horns of dilemmas in compensating for the under water options and the complexities showing the weak linkage between manager performance and stock price movements, companies should be tempted to cancel all stock option schemes as a bad dream. However, these difficulties do not indicate the futility of stock options as a compensation and performance management devise. They actually point to the need for greater sophistication and modeling by which the variations are neutralized so as to capture the linkage between performance and the returns to the shareholders.

Shareholders have not yet lost their faith in the stock options for employees. For want of any other better model they would want these to work - for three reasons. (a) it is the most potent way of linking the perspectives of employees with the shareholder value even if the correlation is admittedly moderate. (b) it continues to be effective in creating a stake for the senior managers than the salary can possibly offer (c) it is a compensation, which does not imply cash flow for the company and supports the variability in pay (d) it continues to give hope that even after reckoning the possible adverse effects on the financial statements and of market dilution, the net effect will be positive for all the shareholders.

Go to top

1. The Companies Act, 1956 defines a public sector company as one in which government holds 51% or more equity. Indian Public Enterprises are diverse in terms of their ownership pattern, legal status, business they are in, their size, and spread. There are departmental enterprises like railways, cooperative enterprises, statutory corporations, joint stock companies listed on the stock exchanges and others in which the extent of ownership varies from 51% to 100%. Since the advent of economic liberalization in 1991 PSEs have also witnessed wide ranging changes in the external environment and internal needs and processes. Many of the policy initiatives taken by the government since 1991 have somewhat altered the complexion of relationship between the CPSEs and government. These initiatives and the market forces have exerted pressures on the CPSEs and brought into focus governance issues. However, these changes in the environment and internal pressures did not result in any changes at the Board level until government announced special packages for Navratna and Miniratna companies who were to exercise additional powers subject to the approval by their reconstituted Boards.
   
   
2. Issue of guidelines by Securities and Exchange Board of India (SEBI) for compliance on issues of corporate governance brought to centre stage the need for discussion, debate and compliance. According to the guidelines all listed companies, whether private or public sector, must comply with the mandatory requirements to improve corporate governance. The new requirements included changes in the composition of Boards, appointment of Board Committees, better reporting and disclosures. Therefore, Boards of most of the listed companies had to be reconstituted with the induction of part time Non-Official Directors. However, it has to be mentioned that a good number of CPSEs were not listed and thus did not receive any attention. But the debate on the subject in the industry circles, particularly on the Cadbury Committee Report, has generally created some awareness among enterprises. The Cadbury Code addressed the prominent concerns arising out of corporate failures.
   
   
3. Notwithstanding the guidelines of SEBI, the political and bureaucratic grip on the CPSEs remained unchanged and the corporate governance issues remained fuzzy and diffused. The SEBI guidelines looked at the issues purely from shareholder/small investor's point of view and did nothing much towards independence of the Boards.
   
   
4. The complex relationship of the CPSE Boards vis-à-vis the government agencies, departments can be explained in the diagram below.
   
   
   
   
   
   
5. The Standing Conference of Public Enterprises (SCOPE), New Delhi, had recognized in 1996, the need to examine the corporate governance issues relevant to the public sector enterprises. It was recognized that the codes, which were referred to (Cadbury Committee's recommendations and that of Confederation of Indian Industry's) at that time, were most appropriate to the private sector and that the infirmities in the public enterprise governance needed specific examination and attention. An attempt was made to address the special conditions of the central public sector enterprises, which are also publicly listed and traded on the stock exchanges. Thus, on SCOPE's request Yaga Consulting prepared a report in October 1997 titled "Corporate Governance and the Public Sector Undertaking".
   
   
6. The report thus prepared was widely circulated among industry leaders, government secretaries and others. In the meanwhile, government had also appointed the Kumaramangalam Birla Committee on the subject. This committee, of course, had a typical private enterprise perspective. While there are many issues common to private and public sector governance but there are specific and special issues so far as public sector enterprises are concerned. Therefore, the SCOPE felt the need for a review of the paper prepared earlier in order to develop first principles to improve the corporate governance. Following principles are drawn from that paper.
   
   BOARD STRUCTURE
   
   
7. The Boards of CPSEs generally consist of full-time functional Directors, nominees of administrative ministry, non-official part-time Directors and at times special worker representatives. However, it is not uncommon to find vacancies unfilled for long periods, as a result, only the functional Directors and ministry representatives are found running the enterprises. Full time Directors are selected and appointed following a lengthy procedure. The Public Enterprises Selection Board selects and recommends. The recommendations are not necessarily accepted by the administrative ministry and the appointments committee of the cabinet. All appointments are subject to clearance by the Central Vigilance Commission.
   
   
8. In most cases of CPSEs the positions of chairpersons and the Chief Executives are combined. This is not generally so in SLPEs. By a specific decision of the government, members of Parliament are barred from appointments to the Boards of CPSEs. Government guidelines lay down that fulltime functional Directors should not exceed 50% of the total strength, and government nominee Directors should not exceed one sixth of the actual strength and in no case exceed two. Violations of these guidelines by the administrative ministries are not uncommon. The non-official part-time Directors should be at least one third of the Board and the responsibility for these appointments lies with the PESB, DPE, and the administrative ministry. The compensation for the full-time Directors is as per the scheduled classification of the company and the guidelines issued by the DPE from time to time.
   
   CONTROL STRUCTURE
   
   
9. As mentioned earlier, the courts have held that public sector enterprises are part of State and thus bestowed special privileges and rights on the employees. The PSEs also figure frequently in Parliament debates and its Committees. PSEs are also burdened with numerous social responsibilities.
   
   
10. The Department of Public Enterprises (DPE) issues guidelines on Board appointments, lays down service conditions, and issues, instructions on wages and salaries.
    
    
11. The Central Vigilance Commissioner (CVC) issues guidelines on conduct, disciplinary cases, investigations and the like. Norms fixed for the conduct of government employees are almost, ipso facto, made applicable to the public sector employees also. The central Public Sector Undertakings are also subject to a special additional audit by the Comptroller and Auditor General (CAG). This audit is rarely able to appreciate the demands of market forces and the commercial decisions taken by the enterprise. The Central Bureau of Investigation (CBI), an autonomous policing organisation of the Government, assumes jurisdiction over the employees and the Directors as they are treated as "public servants". The investment proposals and the new projects of the PSEs have to go through a maze of clearances from the ministers and the planning commission.
    
    
12. Though several of the public sector enterprises have part of the equity in the hands of general public and the employees, Boards continue to be Ministry dominated and controlled. In practice, government nominated Directors carry briefs on the agenda before attending Board meetings. Several Boards do not have full complement of Directors and several positions of Chief Executives remain unfilled for long periods awaiting several clearances. The Governments nominee directors exercise disproportionate authority, in and outside the board meetings which seriously affects transparency. Chief Executives and Directors are generally treated as subordinate in stature to the bureaucrats in the ministry. The salaries, and even, foreign travel of Directors need recommendation or approval from the Ministry. Capital expenditure beyond certain limits, long-term purchase agreements, joint ventures and technology agreements need clearance by the Ministry. Shareholders' meetings are treated routinely and taken for granted.
    
    
13. The controls from the external environment have eroded the capability of the Boards of public sector enterprises to be independent, to provide leadership and to enhance shareholder value. The expectations of employees and general public from the Boards also appear to be modest. The Department of Public Enterprises (DPE) has conceived the functions of the Boards as mostly relating to Production Management, Materials Management, Financial Management, Construction Management and General Management. The illustrative checklist provided by the Department of Public Enterprises (DPE) recommends several managerial functions for the Boards and makes little reference to Governance and strategic aspects.
    
    THE WAY FORWARD
    
    
14. Independence of the Board and its transparency and accountability are among the central features and one can argue, prerequisites for good Corporate Governance. The challenge is to create the broad framework for good governance followed by internal practices that would nurture and foster good Corporate Governance. In the case of private sector firms, the zone of discretion to improve Corporate Governance lies primarily in the hands of shareholders and Board meetings and management action. In the case of public enterprises, the control system is mostly vested in to the specially created mechanisms, which are outside the three common fields of shareholder meetings, Board meetings and management action.
    
    
15. The guidelines issued, by the Securities and Exchange Board of India (SEBI), by amending the listing agreements, do provide the broad framework for reforming the internal conditions of Governance, such as the Board structure, ensuring shareholder rights, constitution of committees, reporting and disclosures. The important need now is to improve the macro-conditions for good Corporate Governance in public enterprises. The following steps may be considered for this reform process.

• The Government of India, through the Department of Public Enterprises (DPE), may bring out a policy paper detailing its approach to "State as an owner", budgetary support, subsidies and price regulations so that there is greater role clarity, transparency and accountability.
  
  
• A new role may ensue for the Department of Public Enterprises (DPE) which would be that of a support function to the Government and administrative ministries breaking away from one of controlling, coordinating and exercising authority over the public sector enterprises. It would also mean that the DPE reorients itself as a "service provider" to the administrative ministries and not as a controller of public enterprises. Its accountability should be on the basis of the value added as a service provider to the Administrative Ministries or to the Public Sector Undertakings at their specific request.
  
  
• Presently, the Comptroller and Auditor General (CAG) is vested with the authority to advise Public Sector Undertakings on the appointment of auditors, issue directions, prepare special reports, affirm or comment upon or supplement the audit reports that may have been considered and accepted by the Board. There have been two popular complaints against this process. Firstly, that it delays the annual shareholder meetings and secondly, that a further check is an affront to the certified external auditors. The additional oversight by the Comptroller Auditor General (CAG) in respect of public enterprises may be removed by amending the law suitably. Even within the existing legal framework it should be possible to modify the approach to audit and its frequency. The special provision/dispensation available to "Government Companies" under the Companies Act and other special Acts must be removed.
  
  
• There is a Memorandum of Understanding system, currently in practice to resolve the principal - agent issues between the Administrative Ministry and the public enterprises. This Memorandum Of Understanding (MOU) is considered by many as a failed experiment but continues to be a live control mechanism without any known benefit. As the ownership gets dispersed, the legitimacy of a Memorandum Of Understanding (MOU) becomes questionable. Such an agreement with the majority shareholder, outside the Board and the shareholder meetings, may also erode the quality of governance. It may be advisable to scrap the Memorandum Of Understanding (MOU) system.
  
  
• Currently, employees of the public enterprises are covered by Article 12 of the Constitution, which bestows writ jurisdiction on the employees as they are treated as "public servants" and their service conditions are deemed law. This right, which is not available to employees of enterprises in which government holding is lower than 51% of the shares, erodes the authority and flexibility needed for effective Corporate Governance. This condition discriminates public enterprises from their counterparts in the private sector though both may be widely held and publicly listed. Hence, suitable amendments to the Constitution and the Companies Act called for.
  
  
• Similarly, the jurisdiction of the Central Bureau of Investigation (CBI) and the Central Vigilance Commissioner (CVC) over the Public Sector Undertakings needs to be withdrawn. Vigilance and security mechanisms need to be internalized and integrated towards achieving corporate goals.
  
  
• The Public Enterprises Selection Board (PESB) which processes the selection of both functional and Independent Directors may also need to change its current supremacy over the Board and the shareholders meetings, in the matter of Board appointments. The Administrative Ministry and the Appointments Committee of the Cabinet have a stranglehold, over and above the Public Enterprises Selection Board (PESB), in the appointment of Directors and Chief Executives. This erodes the quality of Boards on the one hand, due to several inherent political dynamics and, on the other, due to the delay in appointments. It is necessary to let the Boards be appointed through the nominations committee of the Board and through debates and voting in the shareholder meetings.
  
  
• Concurrent with the above, it is necessary to restrain the Members of Parliament from raising questions over specific public enterprises in the Parliament. Discussions in Parliament on operational matters appear to give political leaders an undue leverage for interference both in Governance and the management. To curtail this, the Parliament may adopt a convention of taking up issues in the Committee on Public Undertakings or any other such committee that may review the Government's policy and related issues.

Reference:

CACG Guidelines Monitoring of State Owned Enterprises In India, New Zealand and Australia. Best Practice Guide No.3- February 2001; Yaga Consulting Pvt. Ltd. India.

Go to top