As the stock market rises and the general sentiment burgeons, there is a rush to collect monies from the liquidity overhang at the moment. With more than Rs 15,000 crore being raised from initial public offerings and around Rs 21,500 crore from the qualified institutional placement route, the scene is buzzing.
However, at the same time, some developments are likely to challenge the manner in which business is conducted. For one, there is a need for transparency and disclosures and finally sound governance. In fact, the need has turned into a demand.
First of all, there will have to be a switch over to the International Financial Reporting System (IFRS). It would require the management to align the accounting and reporting norms in line with international practices. It is to be implemented by 2011. However, closer home, the Securities and Exchange Board of India?s (Sebi) Committee on Disclosures and Accounting Standards or SCODA has come out with a discussion paper on several factors to make disclosures more transparent and investor friendly.
Its primary recommendations include having listed firms to declare their balance sheet details on a half-yearly basis, the rotation of statutory auditors and the reduction of the time-frame for declaring annual results. The recommendations even provide for the chief financial officer (CFO) to be appointed after several deliberations with the audit committee.
Recently, Sebi chairman CB Bhave mentioned at an event that the regulator will also be looking closely at companies that do not disclose information to independent research agencies. A Crisil report also stated that of the
3,500 actively traded companies only 150 have been covered by research outfits. Hence, the need for transparency and disclosures is bound to rise.
Cost vs benefits
As the requirement for more frequent and extra information rises, so would be the cost of compliance. And, it?s likely to have an impact as well. After the implementation of the Sarbanes Oxley Act in 2002 in the US, which required stringent disclosure requirements, the cost of compliance went up substantially and many companies wanted to migrate their listing overseas to London and other places that had less stringent norms.
?There is no need to fear an exodus in India because the norms are already rather easy and there are not many places to go. Yes, there could be a chance to delist. But then the advantages of listing far outweigh that of delisting and there would only be a few who would want to take this route,? says a CFO with a leading Indian group.
However, the fact remains that the cost of compliance is set to rise. If the SCODA recommendations pass through, then companies will have to present their balance sheet on a half-yearly basis. This would require beefing up the current accounting processes and practices and require a substantial investment of resources in addition to monetary resources.
Prabal Banerji, CFO with the Hinduja Group, says, ?The more we do, the better it is in this field. The cost is just minuscule and moreover, it would be a one time effort that will lead to benefits over the long-run.?
Agreeing with him, Mandar Gupte, CFO with a leading multinational in India, says, ?Yes, the cost of compliance would definitely rise. There are no two thoughts about it. However, the benefits of complying with these far outweigh the trouble involved.? He mentions that the standardisation of accounts across nations would be one definite benefit as group companies in different countries would be able to consolidate their accounts faster.
Also, key functions like MIS and analytics will also be standardised across international operations.
Those without global operations and domestic presence would also have an advantage in the long-run. A latest study by Standard & Poor?s mentions that better governed firms are rewarded with higher market valuations.
Another four-year study, from 2005 till 2008, of nearly 300 companies listed on the National Stock Exchange (NSE) found evidence of a positive and significant relationship between corporate governance practices and company performance.
The study evaluated companies against 127 parameters covering various facets of corporate governance, including shareholder capital, shareholder rights, financial and operational information, board and management information and remuneration, corruption, leadership and business ethics.
Alka Banerjee, vice-president, Standard & Poor?s Index Services, says, ?While there is an ongoing debate on the appropriate management and control structures for bringing about greater transparency in the functioning of a company, these findings demonstrate that good corporate governance enhances a company?s access to capital, contributes towards its financial performance, and also encourages long-term sustainability.?
She adds, ?Better governed firms not only command a higher market valuation, they are less leveraged, have higher interest coverage ratios, provide a higher return on net worth and capital employed, and their profit margins are also relatively more stable.?
Interestingly, the NSE study also found that the price to earnings ratio (P/E) and yield ? the return earned by the shareholders by way of dividend ? are also relatively higher for better governed firms.
Hinduja?s Banerji, ?Moreover, better disclosure, transparency and governance norms would enable companies to raise various types of resources from overseas. The confidence that the disclosures are up to mark reduces the cost of borrowing and also makes a variety of sources available.?
The implementation
?This is the right time to implement these disclosure norms as the market conditions are improving and the mood is optimistic. Last time, during the liquidity crunch and the market meltdown, we had seen several companies, even the blue-chip ones, resorting to window dressing,? says another CFO, not wanting to be named.
Here there are varied views on the implementation of the IFRS and the newer disclosure norms. While the first view advocates taking an attitudinal leap and gearing up for making more disclosures, the other view is for turning a blind eye to the developments and waiting to see how things pan out.
And, yet there are corporates struggling to get an action plan ready for implementation because new norms could throw existing practices awry. For successful implementation, Banerji recommends, two teams should be created. One team would be dedicated to existing compliance and the other team would focus on new implementation. And, these teams need to work in tandem to see there is no friction and day to day operations are not hampered.
Hinduja?s Banerji adds, ?It?s a change management issue and this way change and existing operations can be managed and as the implementation team comes up with the integration plan, along with the compliance team, all practices can dovetail into one.?
Viren H Mehta, director, Ernst & Young India, says that there are at least three things that separate companies that are likely to be successful in implementing IFRS projects from those that aren?t so successful.
He says that the first step is to carry out a comprehensive diagnosis to identify activities to cover the gaps identified therefrom. After this preliminary work is done, robust project management would be required to provide focus to disparate activities, and then automating various data gathering and reporting processes would complement the whole process. ?These critical success factors are equally applicable for companies going for IPOs as well,? adds Mehta.
Gupte adds another aspect to the change management issue associated with the increased demand on transparency and disclosures. ?People and stakeholders need to be educated thoroughly in these processes and also with a view to tell them how they would be impacted,? he says.
There would be vendors, suppliers and clients who would be used to a certain way of reporting and collections and payments. When the system changes, they should not be caught on the wrong foot and there should not be any friction that could be potentially disruptive to operations.
Besides, there could be small matters like methods of revenue recognition. When changed, these could impact the payment schedules ? to vendors and even employees.
For example, the variable pay of several sales people is based on revenues. Changes in the revenue recognition system would therefore impact the variable salaries. Involving the human resources department at an early stage and educating them on the process and the likely HR impact is also a practice that some of the large companies are putting in place. Many of them have an implant on the implementation team as well. Some companies are thinking of starting a help desk where counsellors would explain implications of the new norms and these desks would be made available for a few days a week during designated periods.
There are several ideas that are bound to come-up as organisations open up to the idea of implementing global practices and also provide transparency and disclosure. The opportunities outweigh the challenges.