February 2004
ICRA CORPORATE GOVERNANCE SURVEY
Contacts:
Introduction
Kolkata
It is by now well recognised that sound Corporate Governance is one of the pre-requisites for attracting capital, both at the national and corporate levels. In the words of the Task Force on Corporate Governance established by the Organisation for Economic Co-operation and Development (OEDC), “the degree to which corporations observe basic principles of corporate governance is an increasingly important factor for investment decisions”. Globally, investor opinion surveys conducted by McKinsey & Company have confirmed that “Corporate Governance remains a great concern for institutional investors”, with an overwhelming majority of them being willing to pay a premium for companies demonstrating consistent adherence to high governance standards.
Anjan Deb Ghosh General Manager ICRA Rating Services (91) 33 22408839
[email protected] Mumbai Subrata Ray Assistant General Manager ICRA Rating Services (91) 22 24331046
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How much importance do institutional investors and large brokerage houses in India attach to Corporate Governance? What, in the opinion of these investors, are the characteristics of good Corporate Governance? To get an answer to these and other related queries, ICRA carried out a survey of 35 leading institutional investors and large brokerage houses during the period October-December 2003. This is the first such survey that has been carried out which is focussed exclusively on the Indian institutional investors and brokerage houses.
Key Findings The key findings of the ICRA survey are as follows:
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Corporate Governance is very important in the Indian context and the current focus on it is well justified. Over 90% of the respondents considered Corporate Governance “very important” in the Indian scenario. A similarly overwhelming majority felt that contrary to the view sometimes echoed in the corporate sector, the current emphasis on Corporate Governance is desirable and will play a major role in making the capital markets a safer place for investors.
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“Integrity of accounting statements”, and “stress on ethical behaviour” are the key objectives of good Corporate Governance from the investors’ viewpoint.
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“Insider trading”, “selective leak of price sensitive information”, and “ dubious accounting practices ” are the biggest concerns from the Corporate Governance perspective.
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ICRA Corporate Governance Survey
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It is not possible to differentiate Corporate Governance practices on the basis of ownership, that is whether an entity is a multinational corporation, or a public sector undertaking, or a bank, and so on. More than 60% of the respondents held this view.
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Corporate Governance is as important as other quantifiable factors, such as likely growth in earnings, from the point of view of investment decisions. Close to 85% of the respondents felt this way. However, a significant 40% also admitted to having invested in companies with questionable Corporate Governance practices in the past, if the ‘story’ was really appealing.
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The primary reason for investors focusing on Corporate Governance while taking investment decisions is the perceived integrity of accounting statements. The facts that well governed corporate entities are less likely to indulge in malpractice and more likely to protect the interests of minority shareholders are some of the other contributory reasons.
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A large majority of investors in India is willing to pay a premium for companies with good Corporate Governance practices. Over 95% of the respondents stated that they would be willing to pay a premium for companies with good Corporate Governance practices. However, nearly 60% of the respondents were not in a position to quantify the premium.
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Many investors believe that there is a linkage between good Corporate Governance and good long-run corporate performance. Close to 40% of the respondents felt that the linkage is strong while nearly 50% felt the linkage is moderate. Only a very small percentage of the respondents felt that there is no linkage.
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Characteristics of Corporate Governance 1.
The key objectives of good Corporate Governance, as identified by the respondents to the ICRA Survey, are: Maintaining integrity of accounting statements Ensuring ethical behaviour Protecting minority shareholder rights Other objectives identified were ensuring legal compliance, maximising shareholder value and following sound risk management practices
K ey O b jectives M a in ta in in g in te g rity o f a /c s ta te m e n ts E n s u rin g e th ic a l b e h a v io u r P ro te c tin g m in o rity s h a re h o ld e rs rig h ts E n s u rin g le g a lc o m p lia n c e M a x im is in g s h a re h o ld e r v a lu e F o llo w in g s o u n d ris k m g m t.p ra c tic e s 0
1
2
3
4
5
6
Scale: 6 for maximum importance; 1 for minimum importance 2.
The principal characteristics of good Corporate Governance, as identified by respondents to the ICRA Survey, are: High level of transparency and disclosures Integrity of accounts Appropriate governance structure Surprisingly, the presence of a strong and independent Board of Directors, which has been the focus of Corporate Governance reforms in most countries, ranked fourth in the order of importance. Moreover, many investors did not derive additional comfort from the presence of multiple Board committees.
Characteristics of good CG High level of transparency & disclosures Integrity of accounts Appropriate governance structure Strong & independent Board of Directors Care for minority shareholders Active Board Committees
0
1
2
3
4
5
6
Scale: 6 for maximum importance; 1 for minimum importance 3.
The biggest concerns from the point of view of Corporate Governance, as identified by the respondents to the ICRA Survey, are: Insider trading and selective leak of price sensitive information Dubious accounting practices Unethical practices Inadequate concern for minority shareholders.
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Excessive promoter control on management, unrelated diversification, and overarching CEOs were also cited as concerns but ranked lower in the order of seriousness.
C o rp o rate G o vern an ce C o n cern s In s id e r tra d in g , s e le c tiv e le a ks D u b io u s a c c o u n tin g p ra c tic e s U n e th ic a lp ra c tic e s In a d e q u a te c o n c e rn fo r m in o rity s a h re h o ld e rs E x c e s s iv e p ro m o te r c o n tro lo n m g m t. U n re la te d d iv e rs ific a tio n O v e ra rc h in g a n d c e le b rity C E O s 0
1
2
3
4
5
6
7
Scale: 6 for maximum importance; 1 for minimum importance 4.
The key requirements for a high level of transparency & disclosures, as identified by the respondents to the ICRA Survey, are: Speedy dissemination of price sensitive information Presentation of all relevant details in Annual Accounts High quality of Management Discussion and Analysis (MDA).
R eq u irem en ts o f T ran sp aren cy & D isclo su res S p e ed y d is se m ina tion o f p rice s e ns itiv e in fo . R e lev an t de ta ils in A nn u alA c co u nts H ig h qu ality M D A R e s po n sive n es s to inv e sto r qu erie s Q u ality of an a ly s t m e e t, A G M d isc lo s ure s 0
0 .5
1
1 .5
2
2 .5
3
3 .5
4
4 .5
Scale: 6 for maximum importance; 1 for minimum importance The respondents to the ICRA Survey also felt that segmental reporting is very important for ensuring a high level of transparency and disclosure. Im p o rta n c e o f S e g m e n ta lR e p o rtin g 100% 80% 60% 40% 20% 0% V e ry im p o rta n t
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M o d e ra te ly im p o rta n t
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N o t im p o rta n t
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ICRA Corporate Governance Survey
The most desirable characteristic of the Board of Directors, according to respondents to the ICRA Survey, is Presence of skilled and effective Independent Directors In other words, simple numerical majority did not seem to provide much comfort. Investors also did not find a combined position of Chairman and Managing Director to be very greatly negative. Also, opinion was divided on the effectiveness of the Audit Committee to prevent fraud. A u d it C o m m itte e s Effe ctive n e s s in p re ve n tin g frau d
D esirab le C h aracteristics o f B o D S kille d , effe ctiv e Ind ep en de nt D ire ctors
60% 50% 40% 30% 20% 10% 0%
M ajority In de pe nd en t D irec to rs
S ep ara te M D a nd C h airm an
0
0.5
1
1.5
2
2.5
G reatly effective
3
S om ew hat effective
Ineffective
Scale: 3 for maximum importance; 1 for minimum importance 6.
Unlike the view prevailing in certain corporate circles, respondents to the ICRA Survey did not feel India is going overboard on Corporate Governance. An overwhelming majority felt the emphasis is warranted and will help in making the Indian capital markets a safer place for investors. Is In d ia g o in g o ve rb o ard o n C o rp o rate G o ve rn an ce ?
W ill th e e m p h as is o n C o rp o rate G o ve rn an ce in cre as e in ve s to rs faith in C ap ital M ark e ts ?
100% 80%
80% 60% 40% 20% 0%
60% 40% 20% 0%
To so m e extent
Y es
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No
C annot say
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To a larg e exten t
N ot at all
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Corporate Governance and Investment Decisions •
Corporate Governance practices are at least as important as other quantitative numbers from the point of view of investment decision-making. Close to 85% of the respondents felt this way. Importance of Corporate Governance vis-à-vis financial numbers/growth prospects 80% 60% 40% 20% 0% More important
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As important
Less important
Not at all important
Used only for eliminating cos.
Even as the importance of Corporate Governance is well appreciated, there have been instances when investments have been made in companies not displaying high quality of Corporate Governance practices if the growth prospects and financial numbers appeared attractive. Close to 40% of the respondents to the ICRA Survey admitted to having invested in companies with questionable Corporate Governance practices, in case the growth and earnings prospects appeared attractive.
Have you invested in companies with questionable Corporate Governance practices? 80% 60% 40% 20% 0% Yes, very often
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Sometimes
Very rarely
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Never
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ICRA Corporate Governance Survey
The primary reason why investors look at Corporate Governance practices is because they feel confident about the integrity of accounting numbers. The other contributory reasons are lower possibility of frauds and higher likelihood of minority shareholder interest being protected in entities with good Corporate Governance practices.
Why is Corporate Governance im portant for investment decisions?
Integrity of Accounting Numbers
Less possibility of frauds Interests of minority shareholders w ill be protected Superior management skills 0
0.5
1
1.5
2
2.5
3
3.5
4
Scale: 4 for maximum importance; 1 for minimum importance •
While most investors are willing to pay a premium for well-governed companies, most are also unable to quantify the level of premium. While over 95% of the respondents to the ICRA Survey stated that they would be prepared to pay a premium for well-governed companies, most did not quantify the premium amount.
W ill you pay a hig her pre m ium for good C orporate G overnance ?
Type of prem ium for C orporate G overnance ? 60%
90% 60% 30% 30% 0% U sullay Y es S om etim es N orm ally N o O nly in Y es exceptional cases
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N ever
0% >20%
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10-20%
< 10%
D ifficult to quantify
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ICRA Corporate Governance Survey
Many investors believe that there is a linkage between good Corporate Governance and good long-run corporate performance. Close to 40% of the respondents felt that the linkage is strong while nearly 50% felt it is moderate. Only a very small percentage of respondents felt there is no linkage.
Linkage between Corporate Performance and Corporate Governance? 60% 40% 20% 0% Strong linkage
Moderate Linkage
Only in some cases
No linkage
Conclusions The first-ever survey of fund managers, brokers and institutional investors in India on the relevance and importance of Corporate Governance broadly mirrors the findings of global surveys on the issues by McKinsey & Company. However, while Corporate Governance has emerged as a potent factor influencing investment decision-making, most Indian fund managers and brokers find it difficult to specify the level of premium that adherence to good Corporate Governance practices earn for companies. Not surprisingly, capital market participants are concerned primarily about the integrity of accounting statements and quality of transparency and disclosures and feel that selective leak of price sensitive information and dubious accounting practices have been the biggest concerns from the Corporate Governance perspective.
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