Enforce corporate governance

Written by YRK Reddy | Updated: Sep 15 2007, 06:08am hrs
SEBI must be complimented for baring its teeth against a few prominent companies that have not complied with corporate governance norms. A sizeable number of listed companies remain resistant. Regulators worldwide face a dilemma in choosing to wield a cane against such errant companies or opting for continued forbearance. Arguments are made both ways.

First, isnt comply or explain the popular approach in many other countries Such an approach suits some market economies where there exist robust institutions that provide the requisite checks and balances and command discipline amongst firms. The UK, Australia, New Zealand and Canada are notable examples. In several emerging markets, however, entrenched interests are dominant enough to provide scope for expropriation and reallocation of value addition in favour of the main shareholder. In addition, the culture promotes a relationship-based approach to governance at the cost of rules and standards.

Ownership concentrations, their involvement in management and the business culture in India favour such a system. It is therefore difficult to instill the discipline needed for the sort of adherence to principles that would encourage voluntary disclosures.

Some regulators may be worried whether a rule-based approach and strict enforcement will crowd out potential listings. The Sarbanes-Oxley Act in the US has been cited as the single biggest reason for the flight of companies from New York to London and elsewhere. In India, the requirements are very modest. The only reason for continued non-compliance appears to be cynicism and the absence of a demonstrated deterrent.

Second, will it not be better to let stock exchanges discipline their members Reliance on self-regulatory mechanisms instead of direct regulation has always been a difficult policy choiceas it should not be so loose as to result in errant behaviour, nor so strict as to snuff out entrepreneurship. Stock exchanges, as self-regulating bodies, would have been the ideal conduits to ensure compliance, but in most countries where stock exchanges are part of a thriving oligopolistic system, the attitude is why fix what aint broke

Third, wouldnt companies worry about their reputation risk sooner more than later Many hope that corporations will not want to risk their reputation and hence would comply to escape any shameful penalties that could impose long-lasting direct and indirect costs. As it turns out, companies which source finance from quality investors and compete in international markets have performed well on reporting and disclosure standards. But most other companies seem to believe that the relationship-based approach to various stakeholders will somehow compensate the potential loss of reputation, and that one can purchase or repurchase reputationeven if, as someone said, it ends up like lipstick on a chimpanzee.

Fourth, is corporate governance a serious enough matter to punish non-compliance Non-compliance with corporate governance standards is not the same class as a stock market scandal. It does not cause market volatility that burns a hole in peoples pockets. It is, rather, a slow burning issue, and the smoke should indicate potential risks or needless adventurism. The transaction costs tend to be trivial. Yet, if the company (whether in the public sector or private) is not complying, it suggests that either the dominant shareholder has no respect for rules, or it sees corporate governance as a threat to conducive conditions for expropriation. Non-compliance is the smoke before the fireit has triggered systemic risk even in India.

There is yet another reason why the regulator must not merely bare its teeth but bite hard: the broken window syndrome. Sociologists note that if someone breaks a window and you ignore it, the next would be vandalism, robbery or squatting. Non-compliance with the minimal standardsin letter, if not spiritis that broken window.