What gets measured can be improved: A Corporate Governance Scorecard for India

IiAS has worked with IFC Washington and the BSE to develop a Corporate Governance Scorecard for India. A scorecard is aquantitative tool to assess the level or standard of corporate governance in an individual company, usually in the form of a questionnaire.

One of the more famous expressions in the US Supreme Court is of Justice Potter Stewart who in his characterization of pornography wrote, “I know it when I see it,” to describe his threshold test for obscenity.

One can say something similar about governance. Investors know which is a well governed company (- they certainly know the badly governed one’s). Probe them regarding a wider set of companies and most will give an impressionist answer saying ‘A’ is better governed than ‘B’ which is better governed than ‘C’ but falter to say ‘C’ is better governed than ‘A.’ Experience shows that identifying governance ‘levels’ at the extremes may be easy, but ranking a large set is not, unless you can score each company’s governance.

Recently IFC Washington, the BSE Limited, and Institutional Investor Advisory Services – where I work, have been involved with doing just this: quantifying governance practices through the development of governance scorecards.

Anne Molyneux a board member of ICGN, a network of institutional investors focused on corporate governance, defines scorecards as a quantitative tool to assess the level or standard of corporate governance in an individual company, usually in the form of a questionnaire. Governance scorecards are extensively used in a few countries including Germany and closer home across six ASEAN countries.

A governance scorecard will have uses for all market participants: Companies use it to hold a mirror to their corporate governance practices. They can measure themselves to set a baseline score, which will help them benchmark themselves on the scale and across peers. But the biggest gain for companies is to keep scoring themselves periodically. Governance practices do not have an ‘immediate fix’ - it is a journey, and having a compass in the form of a governance scorecard will help companies navigate through the myriad requirements of its many stakeholders.

As part of their investment decision, equity investors are already scoring companies on their governance quality – whether implicitly or explicitly. A scorecard gives them a uniform measure across the portfolios, schemes and competition. They can look at an individual company or take a portfolio approach an example being the FTSE4Good Index Series which is designed to measure the performance of companies demonstrating strong Environmental, Social and Governance (ESG) practices.

Combining ratings with governance scorecards if properly used is a very powerful tool in the hands of lenders. This addresses the issue not just of the ability to pay,

but willingness as well. And finally, regulators. They use scorecards to complement surveillance and measure market-wide governance levels. In ASEAN countries, these are used to provide a common benchmark across the region. In fact, sector specific scorecards are popular – with Singapore, Netherland, Italy and five others developing governance scorecards for banks following the financial crisis.

But, for a scorecard to be used and accepted by market participants, it must be relevant to market conditions and existing governance practices. Keeping this in mind, the scorecard uses the G20/OECD principles of corporate governance as a framework (- detailed in an Institutional EYE http://www.iiasadvisory.com/single-post/2016/02/19/OECD-Principles-Are-there-more-regulatory-changes-ahead) – but has also been suitably modified for Indian corporate practices.

Companies are expected to answer an aggregate of 70 questions under the four categories for 140 points, which are then normalized to 100. The questionnaire and scoring is in a self-help format. Example “Does the board have gender diversity?” Companies score nil for no women on the board, one mark for a women director on the board, but can get two for having independent women directors. The idea is to nudge companies to walk that extra mile. Answers need to be backed by public disclosures. It is not enough for a company to say it has a succession policy. Some evidence needs to be present in the public domain.

It is early to comment on how robust the questionnaire is. However, looking at the S&P BSE SENSEX companies, they seem to fall along a curve, with 7% a leadership role, 43% classified as good, 33% as fair and the remainder 17% anchoring the list. Detractors could argue that just 7% in the leadership role – that too of S&P BSE SENSEX companies – is a harsh standard. But analysis shows that in individual categories, companies have scored over 80% - it is just that companies don’t score uniformly well across all categories.

Peter Drucker can be paraphrased to having said ‘what gets measured can be improved’ and improve governance standards in India we must.

For more information on the scorecard : paste the following link on to your browser: http://www.iiasadvisory.com/governance-scorecard

A modified version of this Institutional EYE appeared in Business Standard on 13 January 2017. Link or paste the following link on your browser:

http://www.business-standard.com/article/opinion/amit-tandon-what-gets-measured-can-be-improved-117011201458_1.html

For a PDF version, click here