Tuesday, December 23, 2008

Corporate Governance and all that.....


Corporate governance is an oxymoron. Business is done with a view to acquiring power and wealth and if short cuts have to be taken, they will be. This is true not just of Indian companies, but of companies worldwide. It is all a question of degree and not one of principle.

Let us take the beginnings of any company that is family founded. If you try and go back to the beginnings of how the promoter got to build up his capital, subscribe to rights issues and keep up his lifestyle when the directors’ salaries were restricted by Companies Act to a measly sum, it will tell you stories about how companies’ wealth got diverted to promoters and professionals in power. So, do not delve too deep. You will not invest at all. In today’s context, the call you have to take as an investor is about whether the promoter will leave anything on the plate for you. In good times there is enough gravy to go around, so you will not feel the pinch as “shareholder”. It is when the bad times roll, when promoters are compelled to maintain their lifestyles that you end with the short end of the stick.

Family owned companies undertake corporate restructuring to accommodate family members. Professionally managed companies with no distinct owner, often use the company as a tool to attain personal ambitions. There is no structure that guarantees “corporate governance”.

Whether it is something as small as using the office telephone for personal use or taking commissions on purchases, there is only a question of degree of “dishonesty”. Or like making the companies buy a private aircraft for use by the top echelon at shareholder expense. It is established that corporate governance in its pure form cannot exist anywhere in the world. Sometimes, the extent of transgression can be as subtle as a banker denying a loan to a friend’s competitor or something as brazen as a set of “professionals” hi-jacking the company from its shareholders. I have often seen cases of unrelated diversifications, which have been undertaken, merely to cater to some personal fancies of the promoter.

Therefore, it is best that one accepts as a fact that corporate jiggerypokery is a way of life and every one is snow white, unless caught with his hand in the cookie jar.

Practices such as quarterly earnings and stock options have contributed a lot for encouraging corporate dishonesty,. Pressure to deliver quarterly results makes the management sacrifice longer term interests. Stock options are a very deceptive form of stealing from the shareholders, whatever is the legal position. In good times, the stock options always get exercised and in bad times it does not. A lose-lose for the shareholder in either case. You have only to see the recent annual report of a media company, where the notional “cost” of stock options exceeds the operating profits! The ideal situation is that stock options must be granted before the company goes public. Having gone public, there should be no dilutions on this front. The way out would be for the company to create a separate trust which can buy from the secondary market and then grant ESOP’s out of that. This way, the costs are also truly reflected and the shareholder is not surprised.

One important fact that encourages corporate dishonesty is the total lack of punishment for white collar crimes. Apart from the delays and the lack of professional competence required to establish the crime, the penalties are too tiny. Often, the penalty is on the company and not on the directors/managers! Recently, there was an announcement that any company that makes losses for more than three years would get de-listed! Why penalize the shareholder?

Similarly, there is this whole game of “preferential offers” and issuance of warrants to promoters which the law permits but hurts the minority shareholders. A fair way to go about the preferential offers would be to resort to a ‘rights’ issue and if the minority shareholder does not take it on, then go to the private placement route. If the government is serious about Corporate Governance, then the first thing to do would be to stop this shareholder abuse.

I see seminars on corporate governance being sponsored by companies that do not practice it; I see high corporate governance ratings for companies that are extremely low on the same. Perhaps the rating agencies are being practical. So long as you are leaving something for the shareholder and the creditor, everything is hunky-dory!

In a raging bull market, fund managers and investors tend to ignore the factor of “honesty” whilst investing. Companies that they had avoided in bear markets due to management issues, become hot favourites in bull markets. The answer is simple. These managements are more interested in rigging up the share price, so now they become the desired investments for a fund manager.

World over, white collar crime is tolerated by regulators, with punishments being very mild. So, it is really a matter of “cost-benefit” analysis whilst doing a white collar crime and nothing more. One only has to go through cases like Enron and the list of entities involved includes the so called “best” names in the financial services industry. The western world also has something interesting called “compounding”. Frequently, we come across the term “xyz paid an amount to the Securities Exchange Commission, without admitting or denying guilt’. How wonderful! Or does it mean that there are some “offences” which carry a price tag in dollar terms and nothing more? No wonder, we have also adopted this in our legislation of capital markets! Or we have scores of American Companies “restating earnings”. This is but another way of saying “we lied to you”! Now there is a raging debate on whether the Sarbanes Oxley guidelines need to be diluted to bring more business to USA. This by itself shows that governance is secondary to commerce!

There is also this new fad for “independent” directors having to be appointed on the Boards of companies. Do you think that any promoter will appoint someone on the Board who he thinks will be a nuisance? Let us get real. No director can be truly independent. And if the law imposes too much burden and liability on the independent director, no one would want to be one. Business is about networking and relationships. In this space, there is no tolerance for anyone trying to act “inconvenient”. At best, an independent director can protest against “daylight” robbery. We have yet not seen any “independent” director coming out and blowing a whistle.

How do we use this in our investment philosophy? If you want to stay long term with a company, then focus on its Management quality. However, for short term speculative opportunities look for managements with a “past” and gamble on them. Maybe you will lose your shirt, but there is also a chance that you could hit the jackpot. Also, if you at all want to invest in equities, do not worry too much about this aspect. After all, the promoter also has a vested interest in the stock price. Maybe the ride quality for him and the investor are different, but the destination ought to be the same!

In the recent Satyam case, institutional shareholders have forced the management to give up its ghost. I hope that there is similar fervor when it comes to mightier companies. Maybe the legal framework will get more protective of the non-promoter shareholder. However, as the old saying goes, “Wall Street writes the rules”. It is very difficult to envisage a legislation that can hurt promoters getting cleared.

Remember, it pays to be a skeptic, so that you never get disappointed.
(Personal views, as always.)

No comments: