Corporate GovernanceInvestor Expectations & Benefits
A presentation
by ICRA Limited
15th December, 2005
Agenda for discussion
What are investors looking for ?
Do investors reward good Governance ?
ICRA’s Rating/ Assessment framework
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ICRA Limited
Characteristics of good CG - Findings from
an ICRA investor survey..I
Characteristics of good CG
High level of transparency & disclosures
Integrity of accounts
Appropriate governance structure
Strong & independent Board of Directors
Care for minority shareholders
Active Board Committees
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ICRA Limited
Corporate governance concerns - Findings
from an ICRA investor survey..II
Corporate Governance Concerns
Insider trading, selective leaks
Dubious accounting practices
Unethical practices
Inadequate concern for minority sahreholders
Excessive promoter control on mgmt.
Unrelated diversification
Overarching and celebrity CEOs
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ICRA Limited
Overall, investors are looking for an
assurance that..
 Entrepreneurial activities are underpinned by a proper
system of checks and balances
 The management communicates, transparently and honestly,
with investors
 Controlling shareholders are not in a position to take
advantage of minority shareholders
“Shareholders have only the governance
mechanism to formally assert their rights”
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ICRA Limited
Typical CG issues from Enron and
Parmalat …..a comparison
Issue
Fallibility of Auditors
Independence of Board
Enron
Parmalat
Failed to identify actual debt level Failed to detect false bank balances
Independent Directors beholden to Independent directors were family
management
members & friends of promoters
Accounting jugglery
Asset sales shown as revenues,
debt levels hidden
Complex structure
Created a web of subsidiaries and Created a web of subsidiary and
associates
associates
Losses in various operations hidden,
other loss making businesses funded
CFO and his wife created many of Apparent connection between legal
counsel and associates
Related party transactions the subsidiaries
Source : CLSA Report --Parmalat Smokescreen
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ICRA Limited
Typical CG issues in the Indian context
 Free cash flows being used to fund a ‘group’s investment
plans in unrelated area
 Loans and advances to a maze of subsidiaries and
associates
 Mandated takeovers, M&A, dividend payouts etc. Limited
or no board autonomy to debate and decide
 Preferential allotments to promoters and promoter groups
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ICRA Limited
In ICRA’s opinion, the key elements of
Corporate Governance are
 Ownership transparency
 Strong , Independent Board of Directors
 ‘Watchdog’ for all stakeholders
 Accounting integrity , independent ‘Auditors’
 Transparency and disclosures
 Appropriate compensation philosophy
 A transparent and fair decision making process
 No back seat driving
 The freedom must be exercised within a framework of
accountability
 Focus on ethical practices
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ICRA Limited
Agenda for discussion
What are investors looking for ?
Do investors reward good Governance ?
ICRA’s Rating/ Assessment framework
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ICRA Limited
What are the benefits of Corporate
Governance ?
 Financial theory is yet to establish a linkage
 Research supports the proposition that ‘good governance
enhances value’.
 Opinion based surveys
• McKinsey Investor Opinion Survey
 Research studies linking governance rankings / ratings with
performance and value creation
 CALPERs focus list
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ICRA Limited
Governance ranking research
 CG and Equity Prices - A Study by Paul Goompers of
Harvard Business School and others
 A ‘Governance Index’ was calculated for 1500 large firms during
the 1990s
 An investment strattegy that bought firms in the lst decile
(strongest CG) and sold firms in the 10th decile (lowest CG) would
have outperformed the index by 8.5% during the period .
 CG and Expected Stock Returns - A Study by Wolfganag
Dorbetz , University of Basel
 An investment strategy that bought high-CGR firms and shorted
low CGR firms would have earned excess returns of 12%
compared to the DAX 100 during 1998-2000.
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ICRA Limited
Governance ranking research …..II
 Study by Japan Corporate Governance Research Institute.
(Data from 2003 report)
The Institute has developed the JCG Index , which measures
corporate governance in Japanese firms
Their study found that high JCG Index firms achieved superior
performance , as measured by ROA, ROE, Stock Returns etc.
Return on Common Stocklast 5 years
Average ROE - last 5 years
4.64
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0
-2
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1.87
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0.14
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low JCG index
High -0.43
JCG index
all responding firms
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-6
-5.71
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low JCG index
(%)
(%)
4
High JCG index
all responding firms
-10
-9.25
ICRA Limited
Shareholders Wealth Effect of CALPERs
focus list
 California Public Employees Retirement Systems
identifies and publishes a Focus list annually ---companies with poor Governance and financial
performance
 CalLPERs study showed that there is a significantly
positive shareholder impact from the release of CalLPERs
focus list
 1997 update showed that CalPERS focus list companies
outperformed by 23% in 5 years after focus listing
compared to 89% under-performance in previous 5 years
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ICRA Limited
Agenda for discussion
What are investors looking for ?
Do investors reward good Governance ?
ICRA’s Rating/ Assessment framework
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ICRA Limited
Ratings / Assessment Approach
 Primary focus on the business processes
 Strength and integrity of structures , processes, risk management
and disclosure standards from a stakeholders perspective
 The measurable outcome is also evaluated
 No established input-output relation, however consistently poor
performance needs to be factored in
 Emphasis on substance over form , not a ‘Checkbox’
exercise
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ICRA Limited
Key Variables in the Assessment Process
 Ownership transparency
 Risk Governance
 Board Structure and Processes
 Audit and Control
 Transparency & Disclosures
 Financial discipline
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ICRA Limited
Accepted ratings so far
 Bank of Baroda
 Andhra Bank
 Infosys Technologies Limited
 Wipro Limited
 ITC Limited
 Godrej Consumer Products Limited
 3i Infotech Limited
 PNB Gilts Limited
Excludes several CG Assessments which are not
in public domain ……..
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ICRA Limited
Thank You
Contacts:
shivakumar@icraindia.com
aghosh@icraindia.com
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ICRA Limited