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Institutional EYE

Commentary on Corporate Governance Issues

Good corporate governance practices create long term value

A recent study by IFC, BSE, and IiAS shows that companies with good corporate governance standards created better shareholder wealth. Further, the study concluded that investors have a strong role to play in framing a company’s corporate governance policies and practices.

Discerning investors intuitively understand the value of good corporate governance. It results in an optimal balance in the agendas of management, promoters, and other stakeholders in everyday operations, and in taking material decisions. More importantly, good corporate governance generates trust, and predictability of behaviour (or, at least, no serious surprises), which provides significant comfort to investors.

But governance standards are difficult to measure. Most investors know which companies are well-governed, or at the very least, they are sure about the companies that are not well-governed. Several investors can even rank (broadly) companies or groups in terms of their corporate governance standards.

International Finance Corporation (IFC, a member of the World Bank Group), BSE Limited, and Institutional Investors Advisory Services India Limited (IiAS), jointly developed a framework for assessment of corporate governance standards – the Indian Corporate Governance Scorecard. Based on the G20/OECD Principles of Corporate Governance, this is a set of 70 questions, the assessment of which is based on publicly available information. The final scores are clubbed into four categories – Leadership (score of 70 and above), Good (score between 60 and 69), Fair (score between 50 and 59) and Basic (score of less than 50).

While one can argue that publicly available information is not sufficient to assess real governance standards, this is the only information that investors have access to. A good performance on the scorecard does not mean the company carries no governance risk – only that the probability of an event risk on corporate governance is relatively low.

For three years, listed companies have been assessed on the scorecard – in 2016, BSE SENSEX companies (S&P BSE SENSEX then) were evaluated, in 2017 the BSE 100 (S&P BSE 100 then) and this year, BSE 100 index constituents and 50 companies that listed on BSE between April 2015 and March 2017 (IPO companies) were evaluated. The three-year assessment shows some interesting results.

First, companies with generally good corporate governance standards have only improved over the years. The highest score was 76 in the 2018 assessment against 73 in the previous assessment, and there were 5 companies in the Leadership category, against 3 last year. But overall median scores declined for both BSE SENSEX and BSE 100 companies driven by the banking sector that has undergone a difficult 18-month period, and public-sector enterprises that have had slower progress on the governance agenda.

Second, investors have a strong role to play in the governance framework of companies. The median score of IPO companies was less than that of the BSE 100 companies. For that matter, the median scores of BSE 100 companies excluding BSE SENSEX companies was lower than the median score of BSE SENSEX companies. A dominant reason for the median score trailing size is the institutionalization of shareholders and the active engagement of investors. IPO companies may have institutional shareholders, but their engagement with investors is still nascent. With the passage of time, IPO companies will be compelled to align their policies to what investors expect as well as those of their better-governed peers. The market brings its own discipline.

Third, an evaluation of BSE SENSEX companies that scored well (score of 60 and above) on the Indian Corporate Governance Scorecard in 2016 shows that over the following two years (till 2018), the stock prices of these companies grew faster than those index companies that scored lower. The same result was seen in the assessment of the BSE 100 companies over a one-year period – the price performance of companies that scored well (a score of 60 and above) was stronger than the remaining companies of the index. And the difference in the median returns is material.

The assessment clearly concludes that governance matters, for both long-term passive investors and short-term funds. While the price performance assessment short term, the 2017 assessment of BSE 100 companies on the Indian Corporate Governance Scorecard shows a correlation between governance scores and stock beta – essentially well-governed companies are likely to show lesser volatility in price performance. Therefore, the imperative for investors to engage on the governance agenda is clear.

The experience over the past 12-18 months shows that investor engagement has reached a new high for Indian companies. Institutional investors are voicing their opinion either through push-backs (example – Jubilant Foodworks’ recant of its decision to pay royalty to promoters in less than 12 hours), or by voting their shares and defeating resolutions. Mutual funds, individually and sometimes through AMFI, are taking a position on issues and voting their shares. Insurance companies, under the diktat of the Insurance Regulatory and Development Authority, are voting their shares too and are getting ready to have a structured engagement process with companies. The pension regulator too has asked its funds to vote and develop a stewardship code. At the same time,the Kotak Committee recommended that SEBI, being the dominant capital markets regulator, must create broad principles of engagement and create a standard stewardship code for all asset managers. While one could argue that there needs to be better cohesiveness in the approach, the overarching philosophy of all regulators is the same – that increased engagement by investors with their investee companies will create long term value.

A modified version of this article was published on on 20 February 2019. The article can be accessed here

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