Why stock market rewards wealth creators with robust corporate governance

May 01, 2019 11:40 AM

The inherent nature of the market is architected on the philosophy of allocating resources to greater wealth creators.

The BSE Sensex can be tracked for specific months before and after the elections to ascertain any such patterns. (Representational image)Good corporate governance is rewarded by what is known as ‘governance premium’ and deficit leads to serious discounting of the profits.
  • By CA Shailesh Haribhakti

In the last few years, some prominent and successful business groups of yester years have landed on the doorstep of disintegration. It appears as if these empires were erected on a plinth of quicksand and the burden of borrowing became too heavy. Many of these groups have not been under the scanner of non compliance of the legislative and regulatory framework; it would appear that governance was duly observed, albeit in “form” and “letter”, but not in substance.

A cursory glance at their annual reports reveals that the leadership, as well as the Board of Directors was full of talent, experience and expertise from different streams. In the past, the same set of managers / boards have evoked and received awards for performance, which probably encouraged them to expand and diversify. The intentions of the Executive Management, as well as the Board, may have been honourable, the goals lofty, commitment to succeed vivid and an urge to wholesomely contribute to the success and glory of the firm as well as the group deeply shared.

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One wonders why and how some of the groups in similar lines of business and diversification were able to successfully navigate the rough weathers of the macro as well as micro environment and that the groups under pain could not. Obviously, it calls for a deeper analysis of the balance sheets as well as the functioning of these companies to understand what pushed these organisations on to the journey of decline.

Whereas some part of the lament of the market punishing the firms and their group disproportionately may be justified, it is well to remember that liberal markets by nature are intolerant of mistakes and breathless in punishment. This inherent nature of the market is architected on the philosophy of allocating resources to greater wealth creators. In economics, this is known as ‘market disciplining’. There are a number of corporate governance studies, which validate that good corporate governance is rewarded by what is known as ‘governance premium’ and deficit leads to serious discounting of the profits. Refer. Newell, Roberto, and Gregory Wilson. (2002). ‘A Premium for Good Governance’., The McKinsey Quarterly (3).

Apparently, the focus of Corporate Governance in India in quite a few cases has been more in the form of diligent compliance with all the rules, regulations, guidance and directions including building diversity in the Boardroom rather than on the substance of governance, and optimal ‘wealth creation’. Somewhere along the line, the prime purpose of the existence of a Joint Stock Company to ‘optimally create and manage wealth and efficaciously sharing it with all the stakeholders,’ even while religiously complying with the ground rules, seems to have been forgotten.

The role of the Executive Management and the Board is not clearly delineated and the Board often end up replicating the role of the management leading to sub-optimal outcomes. The Executive Management is charged with the management of the business and Board with the management of the enterprise. Business management is managing the health of the business as of the day, and enterprise management is ‘nursing the enterprise for the future’, even in the face of possible challenges that might emerge in its journey of sustainability.

The board has its role clearly cut out in two loops (a) performance loop and (b) strategy loop. In the performance loop, the Board is expected to appraise the performance of the management in the light of predetermined objectives, utilisation of allocated resources and the economic value add. In the strategy loop, the board provides vision and the strategic direction for the management so that sustainability and success is ensured during the forward journey. Unfortunately, however, quite a few boards do not render the roles well, and eventually, endanger the future of the enterprise. In fact, some of the boards do not appraise even the economic value/market value add in the quarter, half year or the year, particularly in the context of the allocated resources and the market environment. Often the board engages in patiently listening to the reading of PowerPoint presentations and has perfunctory discussion.

This happens mainly because the deeper analysis of the financials and various options for dealing with challenges, opportunities and allocation of resources is not circulated beforehand. Consequently, an incisive, reflective and participative discussion is replaced by a peripheral dialogue, where CEO & CFO answer a few queries from one or two Board members.

In an era when technology can enable anything, it should be easy for firms to utilise technology which can pre produce analysis, which may not be brought out in the presentation. Delay in circulation or inadequacies of analysis may at best be due to paucity of time and at worst reluctance of the CEO & CFO to present the same before the Board. This can easily be circulated much in advance with the aid of technology solution now available so that Directors attend the Board meeting after having studied, applied their mind and being ready with alternate thoughts for a very well orchestrated, meaningful, participative and diversified discussion.

It appears some of the organisations under trouble, may have pursued new lines of businesses without adequate analysis of the impact of that line of business on the future balance sheet of the company, even though the impact that eventually landed, could have been easily foreseen. In cases where deeper, wider and varied debate in the boardroom is held, the decline could have been possibly averted. The alternative choices to pursue or not to pursue could have been informed by simulation of the balance sheet much in advance of the emergence of challenges and commitments and obligations could have been managed better.

The engagement of the board has to be qualitative with much deeper data availability, analytics and reflections, and a sharper focus on the Board’s strategic role with appropriate allocation of time may help in optimal value creation and sustainability over a period of time.

(CA Shailesh Haribhakti is the Vice-Chairman at Intuit Consulting. Views expressed are author’s own)

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