Back Next to impossible to legislate culture of integrity and trust
D. Murali
IT HAS become so fashionable to talk about corporate governance that we tend to switch off whenever somebody launches on to this topic. Yet, a CA couple Kshama and Kaushik Dutta have put together a readable presentation in Corporate Governance: Myth to Reality, from LexisNexis (www.lexisnexis.co.in).
"The mixing of business and ethics has always raised complex issues," notes Naresh Chandra in his foreword. As antidote, we have regulations and reporting requirements that tend to err on the excessive side. And these get applied in "a technical, routine and bureaucratic manner", only to raise compliance cost to industry. In the US too, high cost of compliance has been a source of worry to the Securities and Exchange Commission and the PCAOB, as in their recent reports on SOX implementation.
"Enterprises, in their quest to traverse the distance between good and greatness, have to look beyond profits and market share to being socially and environmentally responsible. This sets the juggernaut of corporate governance rolling," write the authors in their preface, outlining concisely what the concept is about. If that goes above your head, try this: "The ultimate aim of a person travelling on the corporate governance highway is to have a clear conscience and a peaceful night's sleep."
Do you know that the Dutch East India Company, founded in 1602, was the world's first multinational company in which private investors participated on a large scale on a long-term basis? "Shareholders had to wait for an agonisingly long period of seven years to see any returns on their investment," informs the book. Dividend was paid in spices, not cash.
When the company turned down demands for a scrutiny of accounts, the shareholders approached the Dutch government, which promised corrective measures such as limiting directors' term to three years, and mandating that they can buy spices only from public auctions like other buyers. An inspiring anecdote, this is, in the evolution of corporate governance.
In the absence of regulations, companies that voluntarily adopt good governance expect markets to reward them, point out the Duttas. But when regulation absorbs much of the discretionary governance practices and makes it compulsory for everyone across the board, markets may factor in governance as a given. The book cites Ira Millstein of OECD that regulation should focus on attracting capital by promoting four principles — fairness, transparency, accountability and responsibility.
Unlike most accountants who refuse to take a clear stand, the authors are categorical on tricky issues. For instance, in the discussion on corporate governance ratings, as what Moody's offers, the duo declares: "Such ratings are inevitably subjective and may not add much value for stakeholders." A costly exercise, not only of money but also senior management time, you'd realise.
About a year ago, the Financial Stability Forum, an initiative of G-7 finance ministers and central bank governors revised its principles to focus on corporate governance framework. The other five principles are about rights of shareholders, disclosure, and so forth. Considering the large role of institutional investors, these principles call upon them to disclose their corporate governance policies. "The recurring theme of the revised principles is `reducing conflicts of interest'," observe the authors.
Can goodness be legislated? If that's your question, chapter 3 has the answer. "Since much of corporate governance depends on the personal integrity and ethics of the people who are delivering results, it is tricky to try and enforce good corporate behaviour from outside. It is next to impossible to legislate a culture of integrity and trust as culture has to start within companies and extend outwards." Therefore, look at rules as minimum standards of behaviour, explain the authors. "To comply with the spirit behind the rules, companies and businesses will need to exceed these minimum standards of conduct."
The CEO is not the Chief Ethics Officer yet, and so he may wonder if good governance is better business sense. In response to the query, the book lists a bunch of surveys and research that show how the answer is in the affirmative.
"Companies with better governance tend to perform better, in the sense that they have a higher return on assets and higher market valuation, which makes it easier for them to fund their operations," is a quote from a World Bank research paper.
Status quo is not an option, proclaims the book, urging directors to see themselves as agents of real owners and delineating the role of management as `delivery boys' of the owners' interests. Move from the old mantra of `trust me' to consumers' demands of `show me', is how the authors instruct companies.
On earnings management, the euphemism for "purpose intervention in the financial reporting process", the book reports an analysis of Indian companies that shows absence of any distinct correlation between earnings surprise and share price change. However, "there is an unexpected high correlation between the positive earnings surprise values and the negative share price movements," say the Duttas.
Are auditors called upon to be bloodhounds? It seems so, opine the authors. "Many of the suggested procedures in both the US and the EU regulations are forensic in nature. These involve performing substantive tests or applying methods and techniques of evidence collection, which presume the possibility of dishonesty at various levels of management." But why aren't auditors aggressively tackling the possibility of fraud? Two reasons for the apathy that the Kshama and Kaushik mention may be unpalatable to the professionals: One, passivity, or hoping that fraud will go away or remain unnoticed by regulators; and two, arrogance, in being haughty enough to think that fraud happens to other people.
It may sound evangelical to hear the book extolling the virtues of IFRS or the International Financial Reporting Standards. But the authors point out how IFRS harmonises internal and external reporting by creating a single accounting language, and putting an end to problems of interpretation across countries.
"Adopting IFRS helps to benchmark the company against its peers." But remember that switching over to IFRS may call into question the viability of some aspects of business.
Separate chapters are devoted to the board's role, the independent director, the audit committee, the lessons from corporate failures, and the future of corporate reporting.
"When corporate reports closely and honestly reflect all aspects of a company's working, it is difficult to dismiss reporting as being separate from governance," conclude the authors, highlighting the crucial role that reporting plays.
Valuable read.
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