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Oct 16, 2000
"The regulator's role is to provide to the investor all the information on the basis of which he can make an informed assessment of the risk"
Mr. Y.H. Malegam is a chartered accountant and was a member of the Kumarmagalam Birla committee on Corporate Governance. He is also the Chairman, Accounting Standards Committee, SEBI.
In an interview with equitymaster.com, Mr. Malegam spoken about the genesis of corporate governance and its impact on capital markets.
Internationally, what were the factors that led to the concept of Corporate Governance? Were the same factors responsible for driving Corporate Governance in India?
There were certain underlying imperatives, which led to the spread of the Corporate Governance movement worldwide. The most important of these are the following: -
There was a growing dissatisfaction with financial statements and their inability to predict corporate failure. This is highlighted in a speech titled the “Numbers Game” which Mr. Arthur Levitt, Chairman of the SEC made at New York University. He said that companies had failed to hold the line on good accounting practices.
“Companies operate in the grey area between legitimacy and outright fraud. A grey area is where the accounting is being perverted, where managers are cutting corners; and where earnings reflect the desires of management rather than the underlying financial performance of the company”. The general attack was on the fact that accounting standards permitted too many alternatives and companies were resorting to “creative” accounting.
There was a growing lack of confidence in the system of Board accountability. Whereas in theory, the Board directed and controlled the management and was accountable to the shareholder, the practice was totally different. The two major reasons identified were: (i) board composition and (ii) board functioning. The feeling was that in most cases there was a sort of “old boys network” insofar as board appointments were concerned.
Business Week in an article described most directors as “stars on a Christmas tree” who lent their names and added class to a board but did not have the time or the desire to make a worthwhile contribution. Similarly, there was a feeling of a power structure in the Board, which was mostly controlled by the CEO and the Board did not effectively control the management.
There was a change in shareholder composition with institutional investors forming an increasing proportion of shareholder voting strength. Thus there was gradually emerging a class of shareholders who were knowledgeable, conscious of their rights and willing to enforce them.
There was the birth of the knowledge society. As a society becomes more affluent it becomes more knowledge-based. These new knowledge-based classes of shareholders were thirsty for more information and more concerned with ethical issues.
There was the growing market sensitivity to earnings. Markets react to punish those companies whose earnings fall short of market expectations. A small drop in earnings results in a much larger reduction in market capitalisation. This impairs the ability of the company to access the capital market and increases the cost of capital.
There was an increase in legislation and civil suits which increased the personal liability of directors. Their best and perhaps only defense was the existence and satisfactory operation of a sound system of corporate governance.
There was increasing competition between developing countries for a larger share of international funds earmarked for emerging markets. Recognition that these funds would only flow to those jurisdictions, which are strongly regulated, and which had an ethical base.
What are the salient features of the Kumarmangalam committee recommendations?
The salient features of the Kumarmangalam Birla Committee report are: -
Board composition with an optional mix of executive, non-executive and independent directors.
Board operation through Committees viz. the Audit Committee, the Remuneration Committee and the Shareholders / Investors Grievance Committee.
Mandatory provisions regarding the powers and rights of the Committees.
Mandatory provisions regarding the matters which the Management is required to place before the Board.
Greater transparency through mandatory disclosures to shareholders.
Corporate Governance is a 'soft issue' how much importance does it have in the capital markets? Does it have any implication on company valuations?
Corporate Governance may not have a direct impact on company valuations but it can have the following indirect impact: -
FII's and other large investors may hesitate to invest in companies, which have poor corporate governance, and this could depress their share prices.
As a general rule, good corporate governance will result in companies being run more efficiently and thereby improve their earnings and their market capitalisation.
Your opinion on the small software companies capitalising on the buoyant market and SEBI’s move to free the IPO norms for software companies?
There are obvious limitations on the role of a regulator. After all, the investor who invests in the stock market weighs the risks with the benefits and makes his choice. The regulator's role is to provide to the investor all the information on the basis of which he can make an informed assessment of the risk and to prevent exploitation of the investor through false information.
SEBI thus far has played a key role in the development of the IPO market. What are all the other key areas that you think adequate regulations are required?
SEBI has done an admirable job. It has had to move simultaneously on several fronts and everyone is still in a learning process. In this context, until the markets reach a level of maturity, there is some amount of over-regulation, which is unavoidable.
The private placement market has been highly successful as compared to the IPO route. What are your views on this trend?
The private placement market has been highly successful but it is still a restricted market. The risk in relying only upon this market is that there can be manipulation of the market post-issue unless there are adequate safeguards.
What are the changes you would like to see in the Indian accounting standards?
Indian accounting standards are anchored on the International Accounting Standards but the process of issue of standards is still too slow. Therefore, there still exist gaps in the framework of standards, which need to be filled fast. IASC, which had a similar method for the issue of standards, has now proposed a new set-up. The board will have only two part-time members and all the rest as full time members. The Accounting Standards Committee of SEBI has recommended that 4 key standards - consolidation, reporting by segments, deferred tax accounting and related party disclosures - should be in place by 1st April 2001.
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