Clause and effect: the new corporate order

The debate on whether the Securities and Exchange Board of India (Sebi) would extend the deadline for listed companies to implement the revised clause 49 of the Listing Agreement is, thankfully, over. Sebi has rightly stuck to its guns. A nine-month extension of the April 1, 2005 deadline was generous enough and companies ought to have read the writing on the wall, sensing there was little room for further bargaining.

Now that January 1, 2006 has come and gone, life will be a lot different for listed companies. Sebi chairman M Damodaran had made it clear that compliance with the revised clause?which specifies strict governance norms ranging from the number of independent directors on boards to detailed certification by key company officials?is non-negotiable. However, there are some important issues to be considered in this context.

In general, the awareness of Corporate India to the benefits of good corporate governance has grown perceptibly over recent years. At several fora, corporate bosses and regulators have harped on the need to follow the principles of good governance, not just in letter but also in spirit. So my guess is that the larger listed companies would, perhaps, not have waited till the last minute to comply with what the new clause wants. And most top CEOs openly admit that any talk of a shortage of skilled independent directors (IDs) is nonsense. There are enough very good and talented people who can add value to any boardroom discussion.

There are cases where companies have requested erstwhile institutional nominees to continue on their boards as IDs, for the sheer value they bring to boardroom discussions. Whether all IDs are truly independent is, however, another matter.

The clause 49 issue is, however, not that simple when it comes to the smaller companies: the ones that are listed, but are at the bottom of the market capitalisation heap. It is these companies where compliance checks will need to be most intense.

While ensuring compliance with the Listing Agreement is naturally the job of the stock exchanges, the issue which will need to be carefully examined is whether the bourses or, indeed, Sebi, have the manpower or the wherewithal to scrutinise in detail the compliance levels for the thousands of smaller companies which form a large part of the pack of over 9,000 listed firms. Is it, perhaps, better for a separate arm of the regulator to solely focus on clause 49 compliance issues?

While regulatory officials argue that 80% of the market capitalisation would be covered if the top companies are clause 49 compliant (thereby implying that it?s safe for the investors if the top companies are following the rules), what is also important to see is whether the smaller listed companies are also toeing the line. After all, investors do put in money in the smaller companies and these cannot be allowed to get away.

Another important area is that of punishment for non-compliance. While delisting is an obvious solution whenever a company fails to comply with the Listing Agreement, the interests of investors will also have to be kept in mind. Hence, the penalties (monetary and otherwise) have to be tough and handed out swiftly in a manner that puts the fear of God in potentially errant companies and managements. Besides, stock exchanges have to be that much more vigilant in ensuring that companies are clause 49 compliant at the time of listing itself, rather than allowing them to raise public money, get listed and then attempt to police them after they have crowded the market.

The important thing is, governance cannot be a function of size. A listed company which has raised public money needs to follow good governance standards. Hence, while the revised clause 49 will be applicable only to those companies which have a paid-up capital of Rs 3 crore and recorded net worth of Rs 25 crore anytime in its history, it is worth examining whether a graded system can be made applicable to those below this threshold. These companies can be asked to follow at least some of the norms in the clause, thereby bringing in some benchmarking for even the smaller listed companies.

Ultimately, clause 49 or otherwise, Corporate India will have to wake up to the fact that high governance standards will lead to gains for the companies themselves, and for their stakeholders. More than any regulation, it is this realisation that will help Indian companies do better in the new corporate environment.