Vote on accounts - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
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16 FEBRUARY 2009

More is not necessarily better. And, while the moral brigade may be unhappy about this, revealing more - though less often - may be the best solution for giving investors the true picture of financial statements and accounts of Indian companies.
Or, for that matter, any company in the world.

In the 1980’s companies listed on the Indian stock exchanges declared their financial statements annually. Monthly data on cement sales, steel production, or automobile production was sourced from industry associations that maintained such data. Research analysts and fund managers - and there were very few of us - had to go and meet dealers and stockists to get a sense of trends on production and sales.

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In our desire to ape the west, we moved to a 6-monthly reporting statement and then, eventually, we moved to the Wall Street phenomenon of quarterly results. The rationale being that more information would result in a better armed investment community which would then lead to better investment decisions and, hence, a more efficient allocation of capital.

Less frequent reporting
But this rush for baring it all every quarter may have led to a sacrifice of quality at the altar of quantity. Most research analysts and fund managers now wait to be spoon-fed by company management. We avidly take notes and then sputter out the garbage we hear from many managements as gospel truth on our own letter heads. Fiction gets certain "factness" to it.

The other distortion - mostly in the US - led to this focus of rewarding useless CEOs for work they did on a quarterly basis. Decisions were allowed to be taken that inflated the near-term profit of companies - and made many companies go bust in the long term. Maybe AIG, Bear Stearns, Citibank and Lehman Brothers would still be in "business" if their boards - and the regulators - were more focused on the long-term consequences of business decisions on their financial reporting.

Maybe a Global Trust, Satyam, Enron and WorldCom would not have occurred if companies reported results only two times a year. A six-monthly, partially audited interim result and an annual fully audited result. This "time gap" in reporting would give the auditors, lawyers, and members of the boards a lot more time to scrutinise the data before they signed off on the "true" representation of a company’s business and financial position.

And some tougher questions
But the frequency of declaring more accurate reported numbers is only one aspect of the search for a better solution. We all hear a lot about corporate governance. And we all know that much of it is jargon being thrown at us to impress us.

Satyam - and the failure of the financial giants globally - have shown us that frauds can (and do) occur and boards have failed in their role as an agency of internal oversight. Regulators have failed in their role to create rules within a framework that protects investors.

This is because the present framework assumes that we are angels working in a factory of sin. Maybe we are all sinners working in a factory of sin.

The existing definition of "corporate governance" and "minority protection" in the Indian context fails to address the true environment in which companies operate. Many Indian companies are engaged in some act of corruption and pay bribes. Once you have allowed this immoral culture to dominate, what stops the management in control from rewarding themselves more than they deserve? Taking a personal bribe, if you will - and justifying it for some "higher" cause. CEOs are, after all, gifts of god bestowed upon mankind. And the founder-shareholder-CEO is the lord of all gods.

There are a few key areas where minority protection and corporate governance needs to be addressed more openly and honestly:

  1. Does the company bribe to win contracts and favours? And then does it bribe again to retain those favours and silence the critics?
  2. Would management refuse to pay a bribe and risk losing a contract or would the management pay the bribe to ensure it won the contract?
  3. Does the management of the company award contracts to entities owned by family members (or lend these "interested" entities money) - and are these contracts awarded at fair terms?
  4. Does the company have a whistle-blower policy: can any employee send a complaint that directly reaches the board members?

Table 1: Data reported in the interim six month period
  For Sept 30, 2009 For Sept 30, 2008 For Sept 30, 2007 For March 31, 2009
P & L data        
Net Sales        
EBITDA        
Interest        
Depreciation        
Profit before Tax        
Tax        
Net Profit        
Production Data        
Number of cars sold        
Number of employees        
Balance sheet data        
Total Assets        
Cash in Bank        
Investments        
Gross Fixed Assets        
Depreciation        
Net Fixed Assets        
Compliance Data        
Whistle Blower complaints received        
Bribes paid to government entities        
Bribes paid to non-government entities        
Will pay a bribe to win a contract?        
Contracts given to related concerns        
Contracts received from related concerns        
Loans and guarantees given to related concerns        
Loans and guarantees received from related concerns        

For a country that boasts of a lot of gods, we seem happy to live with - and invest in - a lot of demons. And these demons wear green chaddies. While converting the colour of greed to pink - the colour of love - may be a Herculean task, let’s make a start by forcing companies to air their true colours by asking some blunt questions. Then, if we still choose to invest in these companies, the regulator does not have to waste time protecting us. Instead, the regulators can then move on with the true task of improving the playing field, not guaranteeing the result.

Note: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt Ltd and Quantum Asset Management Company Pvt Ltd.. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited.


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