In my last column, I?d dealt with the issue of how corporate governance (CG) ratings are becoming an important tool by which investors can assess the performance of corporations. These ratings are now coming of age in India, with the Securities and Exchange Board of India (Sebi) making a major case for them in the Indian market. In fact, Sebi chairman G N Bajpai is also slated to make a major presentation on governance ratings at the forthcoming International Organisation of Securities Commissions meeting in Sri Lanka later this month. In this, the concluding part of my series on CG ratings, I will discuss how detailed the CG ratings procedure is. Whether it is Fitch India or Crisil or Icra, each rating agency has its own unique methodology and execution procedures for judging the stature of a company in terms of its governance practices.
Fitch, for instance, has both governance and responsibility ratings. It believes that CG ensures that the board of directors develops, implements and explains policies that enhance shareholder value, lower the cost of capital, reduce financial, business and operational risk, and address reasonable stakeholder concerns. Governance ratings are then based on 70 detailed metrics grouped into seven main heads: governance policy and ethics, risk management, ownership structure and control, board and management organisation, board and executive compensation, investor rights and relations and financial reporting, audit and verification.
Fitch?s corporate responsibility ratings look at the key impact areas and their associated risks over a wide range of business, operational, environmental and social issues and assess how well the company?s board has responded to and is managing and reporting on those risks. The ratings also provide useful pointers for boards about what additional risks in business they need to control and report to shareholders.
Once the key issues, impacts and risks have been agreed, the agency estimates the potential investment effect of these by a process of mapping them against investment value drivers. This is done by taking into account things like the permanence of intangible values, regulatory interference, liability to legal actions, collateral reputation damage, brand value impairment and long-term access to people skills. The agency then goes through the company in detail to see how policies developed by the company are maximising opportunity and minimising risk across the key issues and impact areas. This is done through five company response areas like policy development, implementation, validation and assurance, performance, transparency and disclosure.
The execution stage involves depending on a wide range of information. At Crisil, for example, the information required would include the company?s annual and intra-year reports, the company charter or by-laws, filings with government/regulators, AGM/EGM/board meeting records, major transactions over the past three years, details of board structure and related policies, details of assistance provided to suppliers, benefits to employees, attrition rates, social projects undertaken etc. The rating agency will also depend on a series of meetings with the chief executive and wholetime directors, the finance chief, company secretary/corporate counsel, directors (particularly independent directors), shareholder relations personnel, key shareholders and creditors, company auditors, suppliers, customers and human resources personnel. From the receipt of information, the agency would take year and under annual surveillance.
Icra has an equally detailed rating process which depends on, among other things, an analysis of past annual reports, the company?s website to judge disclosure levels, going into the history of penalties levied by regulators, record of investor servicing, share issue history and dividend policy, financial policies and systems for information and control. The ownership and management structure, quality of financial reporting and the record in fulfillment of interests of the financial stakeholders are key parameters.
With CG ratings, investors will be able to identify companies with effective CG practices and even differentiate between two equally well-governed companies on the basis of value creation. The key issue is that such ratings provide an independent insight into governance practices and their sustainability and, as Crisil says, provides a benchmark support for an equity investment decision. Companies can assess their status on all these fronts and set out a road-map for improvement and also attract investors by highlighting the effectiveness of CG practices.