Market fall and the issue of corporate governance

The recent market fall is not all about economic crisis. Implementation of healthy corporate governance is another factor that led to the wreck

If you think that the fall in share prices of major companies during last two months has happened only because of prevailing economic crisis in India, it is time to think again. While there is no doubt economic crisis has eroded value of many stocks, what has added fuel to the fire is the deficiency in implementation of healthy corporate governance practices by several companies. Investors have lost huge amount of money not only because of volatility but also because of non-compliance with corporate governance policies by many companies. Corporate governance practices exist only in glossy pages of annual reports of these companies and are yet to be implemented in its true spirit. Let us look at some cases to understand this.
 

Yes Bank’s share price, a darling of many analysts and investors, has fallen to around Rs280 from its all-time high of Rs547, in a span of less than three months, which means about 50% loss in the value. Share price of the Bank fell by 17% on 31 July 2013, when the corporate governance issue came to the fore. Madhu Kapur, the widow of Ashok Kapur, one of the promoters of the bank along with Rana Kapoor, raised corporate governance issues in an affidavit filed before the Bombay High Court over the rejection of her daughter Shagun Gogia’s nomination as a director.
 

Another company, Gitanjali Gems, has been in news for multiple reasons. Share price of the company has already tanked more than 90% from its all time high and nobody knows what will be the lowest level for the stock. After market regulator Securities and Exchange Board of India (SEBI) cracked down on Prime Securities, the stock price of Gitanjali Gems started tumbling. This was a case of alleged market price manipulation and lack of transparency and can be associated with deficient corporate governance practices once again.
 

Recent fall in shares of Financial Technologies and Multi Commodity Exchange Of India Ltd (MCX) are also broadly linked to corporate governance issue in which though regulator failed to take note of regulatory deficiencies, the company also did not set high standards of voluntary compliance with regulation.
 

There are many such examples in the recent times where companies have failed to follow corporate governance practice causing huge loss to the shareholders. Opto Circuits is one such example, where the share price had tumbled at the beginning of the current year after it failed to notify resignation of its company secretary on time. Once a premier stock, it has now become a penny stock. Infosys also faced issues of corporate governance when Narayan Murthy re-joined the IT company thus raising doubts on high standards set by him, though this did not cause loss to the shareholders.
 

There are many companies, which have lost more than 90% of the value over the last one year. Many of them have seen unprecedented fall in the share price because of corporate governance issue.
 

In India, companies fail to meet even the basic tenants of corporate governance. Let us look at transparency, which is one of corner stone of corporate governance.  ITC on its approach to corporate governance, mentions its approach towards transparency as, “ITC believes that transparency means explaining Company's policies and actions to those to whom it has responsibilities. Therefore, transparency must lead to maximum appropriate disclosures without jeopardising the Company's strategic interests. Internally, transparency means openness in Company's relationship with its employees, as well as the conduct of its business in a manner that will bear scrutiny. We believe transparency enhances accountability.”
 

This sounds great and ITC has been following this aspect of corporate governance. However, do all the companies follow it? ‘Conduct of business in a manner that will bear scrutiny’ evades many companies. Shareholders, especially the minor ones, have no idea about such transparency, as many companies do not find it necessary to be transparent. Minor shareholders are the ones who suffer major losses. The recent case of NDTV highlighted by Moneylife points this aspect.
 

While companies are expected to take responsibility to set exemplary standards of ethical behaviour, both within the organisation as well as in their external relationships, there are cases like the Micromax, where the mobile handset maker’s MD is caught allegedly bribing MCD officials. Other constituents of corporate governance such as, trusteeship, empowerment and accountability, continue to evade many companies.  Companies like Educomp reach a stage where salaries not paid for long time to the employees with management justifying the failure as the risk arising from prevailing market conditions thereby putting aside failure of proper corporate governance compliance.
 

A series of lapses on corporate governance front shows the risk that Indian investors are exposed to. We know that a chain is as strong as its weakest link. The deficiency on corporate governance front is working out as the weakest link in case of many Indian companies. Time has come when we should not buy stocks only on the basis of fundamental and technical analysis. Need of the hour is corporate governance analysis. Unfortunately, the data points available here are very limited.

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The private placement market is a place for amazingly high-risk and low-reward products. Sample this. India Infoline (IIFL) is touting a paper that involves placing money with a Delhi-based developer of properties called Pratibha Impex. The company will pay interest at 18%pa (per annum) with quarterly payouts in year 1 and monthly payouts in year 2. The principal is proposed to be repaid in 12 monthly instalments after completion of one year. The marketing document tells you that you get a yield of 19.4%; that is, if you were to reinvest all your receipts at 18%pa, the effective return would be 19.4%. The minimum investment size is Rs35 lakh. Many investors may fall for the high yield without realising the pitfalls.

The total amount proposed to be raised is just Rs19 crore, a fraction of the company’s size. Couldn’t it have sourced the money from somewhere else? There is no credit rating. The debentures are ‘secured’ by a piece of land at Noida. There is a corporate guarantee of the issuer as well as personal guarantees of promoters which would be hard to enforce. Since the debenture is unlisted, there would be tax-deducted at source. Remember that liquidity will be zero, so there is no exit until the end of the tenure. In all such cases, while the yield is high, risks are much higher. Lesson: stick to listed and regulated products.
 

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