Equity investments: Need to check corporate governance norms

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Published: October 8, 2019 12:40:16 AM

Indices such as BSE’s CG Scorecard are helpful for small investors who find it difficult to comprehend and gauge corporate governance practices of firms whose shares they want to purchase.

There is sufficient empirical evidence across the globe that poor corporate governance process impacts share prices negatively.

Investors in the equity market have had a rough ride for the last couple of months owing to economic slowdown, global market impact, earnings downgrade, etc. Apart from the above, negative impact was caused by the lack of good corporate governance practices in many of the listed firms. A vast majority of the investors are not aware of this issue of corporate governance emerging because of the economic slowdown. There is sufficient empirical evidence across the globe that poor corporate governance process impacts share prices negatively.

Let us discuss in detail, how to pay attention to this aspect while selecting shares.

What is corporate governance

There are multiple ways of defining corporate governance. From the investor’s point of view, it is basically how a company manages its relationships, especially how a company’s management, its board and its shareholders deal with each other and external relationships, with the ultimate goal of reducing conflicts of interests and acting in the best interests of stakeholders such as shareholders, customers, suppliers, banks, government, society, etc. The board of directors is responsible and accountable for creating a framework that best suits the business conduct with its stated objectives.

How to identify well-governed companies?

This is an interesting question for many investors.One should look at the following aspects which are generally available for any listed company. Disclosure practices, executive compensation decisions and details, dividend policies, disclosure of related party transactions, procedure for reconciling conflict of interest between company, members in the board and shareholders.

Apart from the above, investors should check corporate governance principles on treatment of all shareholders equally and fairly; legal, contractual and social obligations to non-shareholders such as employees, vendors and society; number of complaints received from shareholders in a year and how many of them were addressed and how many are still pending and reasons for the same; number of independent, non-executive and women directors in the board and their proportion to the total board size, frequency of board meetings, attendance in the board meeting by various directors, etc. Also check whether the company has stated a code of conduct for board members and executives and disclosed it to relevant stakeholders.

Refer the corporate governance index

Another easy way to look around is the corporate governance scorecard of exchanges. For instance, BSE, in an initiative for the public good, has collaborated with the International Finance Corporation (IFC) Washington, a member of the World Bank Group, for developing a ‘CG Scorecard’ for Indian corporates. This will help companies to benchmark themselves on their corporate governance status as well as provide investors a standardised measure of the corporate governance status of any company. Apart from BSE, many other credit rating agencies such as CRISIL and ICRA also have their own corporate governance indices. Such indices are helpful for small investors who find it difficult to comprehend and gauge corporate governance practices of the firms.

Investors can use the above reference list and index to assess the corporate governance practices of firms. In addition to the above, pay attention for the presence of many large volume related party transactions, inter-corporate loans, especially loans to their own subsidiaries who have poor financials and performance, etc.

To conclude, many investors do not pay attention to corporate governance practices while selecting the shares. Remember, good corporate governance practice is essential for sustainable equity returns.

(The writer is a professor of finance & accounting, IIM Tiruchirappalli)

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