Hetal Dalal
Discerning investors intuitively understand the value of good corporate governance. It results in an optimal balance in the agenda of management, promoters, and other stakeholders in everyday operations, and in taking material decisions. More importantly, good corporate governance generates trust, and predictability of behaviour (or, at least, no serious surprises), which provides significant comfort to investors.
But governance standards are difficult to measure. Most investors know which companies are well-governed, or at the very least, they are sure about the companies that are not well-governed. Several investors can even rank (broadly) companies or groups in terms of their corporate governance standards.
International Finance Corporation (IFC, a member of the World Bank Group), BSE Ltd, and Institutional Investors Advisory Services Ltd (IiAS, where I work), jointly developed a framework for the assessment of corporate governance standards—the Indian Corporate Governance Scorecard. Based on the G20/OECD Principles of Corporate Governance, this is a set of 70 questions, the assessment of which is based on publicly available information. The final scores are clubbed into four categories—leadership (score of 70 and above), good (score between 60 and 70), fair (score between 50 and 60) and basic (score of 50 or less).
While one can argue that publicly available information is not sufficient to assess governance standard, this is the only information that investors have access to. A good performance on the scorecard does not mean the company carries no governance risk—only that the probability of event risk on corporate governance is relatively low.
For three years, listed companies have been assessed on the scorecard—in 2016, BSE Sensex companies (S&P BSE Sensex then) were evaluated, in 2017 the BSE 100 (S&P BSE 100 then) and this year, BSE 100 index constituents and 50 companies that were listed on the BSE between April 2015 and March 2017 were evaluated. The three-year assessment shows some interesting results.
First, companies with generally good corporate governance standards have only improved over the years. The highest score was 79 in 2018 assessment against 73 in the previous assessment, and there were five companies in the leadership category, against three last year. But overall median scores declined for both BSE Sensex and BSE 100 companies, driven by the banking sector that has undergone a difficult time, and public sector enterprises that have had slower progress on governance.
Second, investors have a strong role to play in the governance framework. The median score of IPO companies was less than that of the BSE 100 companies. For that matter, the median scores of BSE 100 companies excluding BSE Sensex companies were lower than the median score of BSE Sensex companies. A dominant reason for the median score trailing the size is the institutionalisation of shareholders and the active engagement of investors. IPO companies may have institutional shareholders, but their engagement with investors is still nascent. With the passage of time, IPO companies are compelled to align their policies to what investors expect as well as those of their better-governed peers.
Third, an evaluation of BSE Sensex companies that scored well (score of 60+) on the Indian Corporate Governance Scorecard in 2016 shows that over the following two years (till 2018), the stock prices of these companies grew faster than those index companies that scored lower. The same result was seen in the assessment of the BSE 100 companies over a one-year period—the price performance of companies that scored well (a score of 60+) was stronger than the remaining companies of the index. And the difference in the median returns is material.
The assessment clearly concludes that governance matters, for both long-term passive investors and short-term funds. The 2017 assessment of BSE 100 companies on the Indian Corporate Governance Scorecard shows a correlation between governance scores and stock beta—essentially well-governed companies are likely to show lesser volatility in price performance. Therefore, the imperative for investors to engage in the governance agenda is clear.
The experience over the past 12-18 months shows that investor engagement has reached a new high for Indian companies. Institutional investors are voicing their opinion, either through pushbacks (example – Jubilant Foodworks’ recant of its decision to pay a royalty to promoters in less than 12 hours) or by voting their shares and defeating resolutions. Mutual funds, individually and sometimes through the Association of Mutual Funds in India (AMFI), are taking a position on issues and voting their shares.
Insurance companies, under the diktat of the Insurance Regulatory and Development Authority, are voting their shares as well and are getting ready to have a structured engagement process with companies. The pension regulator, too, has asked its funds to vote and develop a stewardship code.
At the same time, the Kotak Committee recommended that the Securities and Exchange Board of India, being the dominant capital markets regulator, must create broad principles of engagement and a standard stewardship code for all asset managers. While one could argue that there needs to be better cohesiveness in the approach, the overarching philosophy of all regulators is the same–that increased engagement by investors with their investee companies will create long term value.
Hetal Dalal works at Institutional Investor Advisory Services India Limited (IiAS). Twitter: @hetal_dalal
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