India’s Best Governed Companies List Has Three New Entrants

WATCH | Fineprint: Takeaways from India Inc.'s governance scorecard.

Cipla Ltd., Dr. Reddy’s Laboratories Ltd. and Tata Power Company Ltd. have made it to the top 10 on the Indian Corporate Governance Scorecard for the first time as India Inc. looks to improve governance standards.

Hindustan Unilever Ltd., Housing Development Finance Corporation Ltd., Infosys Ltd. continued to be among the best governed companies.

Overall, the governance standards of BSE 100 companies, aggregating to 72 percent of the total market capitalisation, have seen an incremental increase, according to a report titled ‘Stability Despite Headwinds’, put together by proxy advisory firm Institutional Investor Advisory Services India Ltd., BSE and International Finance Corporation. The report assessed companies on various parameters, including board effectiveness, conflict of interest, stakeholder engagement, audit quality and executive remuneration.

The institutionalisation of governance practices has led to greater stability of scores for the larger listed companies. In the BSE 100, institutionally owned and widely held companies have better governance scores. In comparison, public sector undertakings continue to fare poorly, the report said.

“The median score for PSUs continues to remain ‘FAIR’ due to inadequate independent representation on the board and lack of transparency on critical issues like related party transactions, board evaluation and stakeholder management policies.”

Well-governed companies — those with a score of 60 or more — at a portfolio level, report a better price performance compared to other not-so-well governed companies, the report said.

Further, IPO companies—50 firms analysed in the report that were listed between April 2015 and March 2017—have not been able to hold ground. The median scores for IPO companies declined to 54 from 55 last year, the report said.

Here are the various governance themes that companies have been assessed on:

Board Effectiveness

It’s critical to have non-promoter directors with domain expertise on the board as this allows the board to challenge the assumptions made by the management in taking decisions. And while most companies have disclosed their board evaluation process, they are hesitant to disclose the outcome of this exercise, the report said.

• Only 41 of the BSE 100 companies, and 13 of the 50 IPO companies have sufficient breadth of skills, including an information technology expert.
• Only eight of the BSE 100 companies provided some form of board improvement plan.
• Just eight of the BSE 100 companies, and three of the 50 IPO companies had detailed disclosures on succession planning in their annual reports.
• There is a marked improvement in board meeting attendance for both the BSE 100 and IPO companies.

Conflict Of Interest

The report said there existed a lacuna in how companies have framed their policies regarding conflict of interest. For a large number of companies, this policy only extends to the board and senior management but not to all employees. The conflict of interest policy must outline the possible areas of conflict faced by employees and have a process for capturing and disclosing such conflicts, the report explained.

• Just 49 percent companies in the BSE 100, and 14 of the 50 IPO companies have a robust conflict of interest policy covering all employees.
• 44 percent of the BSE 100 companies have robust policies explicitly mentioning that interested directors will abstain from discussing and voting on related party transactions.

Stakeholder Engagement

Acceptance of anonymous complaints, without a fear of retaliation, was a key parameter to gauge companies on this principle. While advocating that companies must provide for a robust whistleblower mechanism, the report also pointed out increased instances of misuse. In leaking anonymous whistleblower letters to media, some companies have been subjected to a trial-by-media, which has resulted in investor panic and a sharp deterioration in stock price, the report said.

• 34 of the BSE 100 companies had a comprehensive whistle-blower mechanism that allowed all stakeholders, including suppliers, to report issues—and these mechanisms accepted anonymous complaints.
• For IPO companies, this is an area of development.

Audit Quality

Recent audit failures have had material economic implications for the country. The ‘Big Four’ audit firms are facing regulatory scrutiny for separate issues, and the RBI has even banned an audit firm from bank audits.  ICAI’s Quality Review Board, which is responsible for the review of audit quality, has reviewed just 580 audit engagements over six years between 2012 and 2018, of which it found only 39 percent to be of generally accepted standards. The results are reflective of what the market experience is- less than half the audits are of acceptable quality, the report said.

• In IPO companies, severe issues were reported by the auditors in some of the companies. As a result, the number of companies in which auditors have raised concerns on the financial statements has increased to 32 percent from 24 percent in 2018.
• However, the number of companies in which auditors have raised concerns on the financial statements has reduced in BSE 100 companies from 35 percent in 2018 to 25 percent this year.
• While the number of companies with audit comments has reduced, there remains a lingering doubt on the quality of audit being conducted.

Executive Remuneration

Remuneration in Indian corporates has outpaced revenue and profit growth in the past. While the Indian Corporate Governance Scorecard rewards companies where the structure of executive remuneration comprises two-thirds variable pay, Indian companies average at 50 percent variable pay. Add to that, performance metrics used to determine variable pay are rarely disclosed, the report said, adding the numbers this year are heartening.

• In 55 of the BSE 100 companies, the CEO compensation was in line with both revenue and profitability over three years—an increase from 42 companies in 2018.
• The theme of aligning executive pay to performance continues for IPO companies.