When non-compliance is self-defeating

Written by YRK Reddy | Updated: Jan 6 2007, 05:30am hrs
In a recent conference of international institutional investors, many leading investors expressed concerns over the low road being taken in India on meeting corporate governance standards. They were commenting on the impending proposals to dilute the standards, the extent of compliance and quality of enforcementand were clearly worried.

This newspaper (FE, January 3) has reported that nearly 57% of BSE companies are yet to comply with Clause 49 of the listing agreement issued by the Securities & Exchange Board of India (Sebi), requiring the induction of independent board members. Clause 49 is no Sarbanes Oxley. It doesnt cost millions of dollars for compliance, nor impose tortuous obligations. It does not check whether the compliance is in spirit or in form, and yet, there is such inexplicable reluctance.

The Report on Standards and Codes (ROSC) programme, initiated by the World Bank, examined Indias corporate governance in 2004. It concluded that stricter enforcement by regulators and stock exchanges is a key challenge. Another key challenge is the need to resolve the scope for regulatory arbitrage between the stock exchange regulator and the ministry of company affairs.

We have entered a new zone of regulatory arbitrage in the light of enforcement of Clause 49. There are two signals noticeable from the various statements of officials. One is that the Sebi directive must be enforced by the stock exchanges, as they are frontline regulators. The other is a perceptible preference for comply or explain over comply or else. Many advanced countries believe in the former approach. It tends to succeed if the reputation agents (media, research analysts, auditors, rating agencies and so on) and institutional investors are active and challenging, and the markets for control operate well. But if the institutional arrangements are not yet in good shape, would it not be prudent to apply a degree of compulsion It could prod the standardisation of the code of behaviours that constitute a culture. This needs to be resolved quickly, and if the stock exchanges are expected to be frontline regulators, they must be held accountable for the quality of their enforcement.

Clause 49 is no Sarbanes-Oxley. It doesnt cost millions of dollars for compliance, nor impose tortuous obligations
Those companies which are reluctant to improve their compliance and corporate governance standards need not take comfort from similar failures in other developing countries. A shortsighted approach to corporate governance standards may actually reconfigure the investment quality in the companies` stock as also on the cost of debt. The reason is simple. Short-term investors are not bothered about corporate governance standards as much as the promise of profit in the near term, depending on cycles, fluctuations and sentiments. Such quality of investment brings its own risks.

On the other hand, the long-term capitalthe patient capital, that isgoes in search of high corporate governance standards. This is because long-term players clearly believe that corporate governance standards bring about greater sustainability for the company and its assets; that a good and independent board of directors can add value to risk mitigation as well as qualitatively superior strategic options; that transparency and disclosures associated with corporate governance ensure that the chances of tunneling and self-dealing would be much lower. Consequently, such players tend to invest only in companies and countries that score high on corporate governance. Such closely observant investors have even turned their assessment of corporate governance into a regular part of their project appraisal and due diligence processes.

Companies that are cynical in their approach to corporate governance, therefore, end up shooting themselves in the foot by creating conditions for adverse selection implicit in the above. There may be good lessons corporate India can draw from our history and experience with the adoption of quality standards through the 1970s and 1980s. Those companies that saw the advantages of quality certifications, assurances and associated structures and cultures, are the ones that have gained and sustained their competitiveness. The cynical lost out and still had to embrace quality as a survival measure.

It is time that corporate India and the stock exchanges saw the big picture and developed a consensus to assure the world that a progressive India has no patience left for cynical laggards.