The recent crash of corporate governance at the hands of Satyam, a company of repute in information technology, has opened the Pandora’s box full of doubts and concerns regarding corporate governance and ethical standards of the Indian corporate world. The committee on corporate governance appointed by Sebi had recommend high standards for independent directors and audit committee members, who are expected not only to play a watchdog role on a continuous basis but also to go on evaluating the quality of financial performance and quality of accounts, transparency of disclosures, monitoring of the same without compromising their integrity, etc.
The questions, which have been raised are what role were independent directors playing in the process of the functioning of Satyam and how far was the audit committee effective in the transparent disclosures of financials of the company? Whether independent directors and members of the audit committee are nominated on merit as recommended by the regulator? Do these directors possess strong teeth to bite the unethical deeds of executives and promoters? I do not believe the regulator or a corporate entity has any answer for these questions in the absence of proper investigations.
The Sebi has taken up an investigation of several Sensex companies. However, there are more than 60,000 companies listed on the stock exchanges. Will it be possible to have a fair idea of the status of the total corporate sector in terms of their financial disclosures by studying a few companies? An important gap in the whole process of corporate governance has been the weakness in accountability of the board through disclosures, which have become very crucial today in the current environment when a multitude of creative accounting practices involving inevitably ambiguities and many alternative methods of reporting the financial effects of transactions used largely and routinely by the promoters to mislead rather than inform the shareholders and the public. In this regard I may repeat that the composition of the board and the monitoring role of independent directors should be the corner stone of Sebi’s regulatory check.
The Sebi report on corporate governance had expected that board members would be homogenous in terms of expertise, functions and affiliations. It is common knowledge that boards are homogenous only in one respect and that is that they work as a gang and not as a caretaker or trustee of the companies and shareholders. There is a need for creating and promoting the culture of good corporate citizenship.
As far as the quality of the expertise of independent directors is concerned, there are a few of them who can be considered as experts on the profit and loss account, balance sheet, other financial disclosures and regulatory compliances. They do not understand the significance and impact of various heads of income and expenditure given in the profit and loss account and implications of variation in components of the balance sheet.
For instance; high growth shown in fixed assets should reflect an increase in manufacturing capacity of the company, and a corresponding increase in production and sales. If investment has gone to real estate and financial assets, the profit and loss account should reflect an increase in income from dividend, rent, interest, etc, which is not a good sign for any manufacturing unit or unit providing information technology services. Moreover, expenditures relating to employees should increase in relation to operating income, sales and output. The board members generally do not examine these aspects. This is one example, there can be many. One can also find out the quality of assets, their productivity and diversion of funds from their targeted use. Unfortunately, even the audit committee does not look at such information with the angle of corporate governance. The quality and structure of capital expenditure warrant a close examination by the board as well as an audit committee. This situation warrants a merit-based constitution of the board of the companies, in particular, the selection of independent directors.
The independent directors of course should be given at least 3 to 5 year’s mandatory continuity on the board. Once they are sure of their existence on the board without fear of being removed, they can bite the mad dog of the company and can report to the stock exchanges, Sebi and Company Affairs Department by filing a quarterly report on the functioning of the company. This report should be highly confidential, wherein; the independent directors should record good and bad practices prevailing in the company. The independent directors should have a competency and the authority to seek internal information in the matter of appointment, dismissal, payment to auditors, etc.
In case they are not satisfied with the integrity of auditors, the independent directors should have veto power in the board to block the appointment of auditors. The experience is that independent directors are found on the weak pitch and fail to strike when necessary because of their appointment made by the chairman and various compensations due to them sanctioned by the executives of the company.
As such, non-executive independent directors are not independent of the company, which they supervise and monitor. They broadly fail to look after the shareholder’s interest.
A general experience of independent directors is that reporting of legal compliance to board members is just mentioned in the agenda of the meeting and the actual papers are not submitted, except one small action taken report. On many occasions, the agenda, as a formality, is placed before the board and it is completely approved with the support of the executive directors and promoter’s nominee directors. This is a very helpless and humiliating situation for independent directors to accept such approval without raising any descent. As a matter of fact, without a regulator’s mandatory guarantee of directors independence from the executives, board and chairman, and without direct incentives to act in shareholder interest, combining of management and monitoring responsibilities that independent directors have to undertake, violate the most basic principles of separation of decision rights. It is quite obvious that combining of crafting of the policies with supervision of implementation of these policies by independent directors along with monitoring functions, restricts significantly the effectiveness in performing the monitoring role.
The inconsistency observed in these functions and absence of any mechanism through which non-executive independent directors can be held accountable to shareholders in respect of their monitoring, are now failing to strengthen the confidence of shareholders in the capabilities and effectiveness of the board of a company. The audit committee is the next most important ingredient of the corporate governance after independent directors. This committee, besides looking after the draft audit report, has to examine and evaluate the financial statements and relevance of various expenditures incurred by the company, along with the quality of approval and the status of the approving authority. This committee however confines only to audit part of the report. The management discussion and their SWAT analysis of financial weakness and strength, procedures, code of conduct, ethical standard, compliance of mandatory laws and protection of all stake holders from the point of view of mis-management of resources, has to be checked and scrutinised.
The auditors have to see whether the board minutes cover the approval of expenditures and uses of funds as well as borrowing by the company and timely repayment to the lenders.
Moreover, tax liabilities to the government and claim of other stake holders have to be captured in the report. It happens on a number of occasions that the chairman and the executive directors take important oral decisions without getting approval by the board and then put it up to the board later on. Such deeds become fate accompli for board members and they have to approve for regularising such functions of the company. The expenditures of executives in terms of recreation, transport, official tours and transfer of funds in the name of charity have to be scrutinised. The lending to subsidiaries and related parties should not be allowed without the approval of the board and independent expert committee.
The management letters, letters relating to internal weaknesses issued by internal auditors should be examined. If the company cannot rectify deficiencies, financial and others, the audit committee should report to the regulator and Company Affairs Department of the Government of India. They should also file these reports with the exchange on which the companies are listed. The regulatory body and exchange should use these reports within 15 days and send the warning to the company for delisting and further punishment.
-The author is a former economic advisor, Sebi
