Corporate Governance Assessment / Ratings A presentation by ICRA Limited 14th December , 2007
Mar 27, 2015
Corporate Governance Assessment / Ratings
A presentation by ICRA Limited
14th December , 2007
ICRA Limited
The Rating / Assessment Framework
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ICRA Limited
Objectively and independently evaluate the Corporate Governance practices of a company.
Overriding emphasis is on ‘Substance’ over ‘Form’
Underlying theme the extent to which a company adopts and follows such
practices and conventions that would provide its stakeholders an assurance on the quality of
Corporate Governance practices
What are we trying to do ?
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In case of CG Assessment , it is a detailed report meant for use by the top management of the company highlighting Strengths and weaknessesDeviations from generally accepted best practices Potential ‘red-flags’ from CG perspective
In case of CGR , a Rating on a scale of CGR1 to CGR6
The assessment is a one-time exercise not subject to the annual surveillance process
What is the deliverable ?
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Assessment Approach
Primary focus on the business processes
Strength and integrity of structures , processes, risk management and
disclosure standards from a stakeholders perspective
The measurable outcome is also evaluated
No established input-output relation, however consistently poor
performance needs to be factored in
Emphasis on substance over form , not a ‘Checkbox’ exercise
Involves perusal of documents like Board Notes and Agenda
Papers not available in the public domain
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Key Variables in the Rating Process
Ownership structure
Governance Structure and Management Processes
Board Structure and Processes
Audit Committee and Risk Management
Stakeholder Relations
Transparency & Disclosures
Financial discipline
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Feedback from Independent Directors a key part of the exercise
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Typical issues evaluated…… I
Ownership structure Is is transparent ? What is the extent of cross-holdings ?
Quality of decision making process in the company Are Governance Arrangements clearly defined and followed ? What is the nature of the planning process ?
What is the nature and quality of Board supervision? Composition of Board Boards role in overseeing strategy, projects, acquisition ? Boards role in executive compensation / succession panning?
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Quality of control systems and risk management Internal Audit function Effectiveness of Audit Committee Progress in developing holistic risk management systems Non-audit services provided by the auditors
Transparency and disclosure standards Nature and quality if analyst presentation Quality and level of detail in Annual Accounts Disclosures on transaction with ‘related-party’
Demonstrated evidence of commitment to , and focus on, ethical practices ?
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Typical issues evaluated…… II
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Executive Compensation process of setting compensation is it disproportionate compared to peers and profit growth? Does it provide large short term incentives?
Financial Discipline Accounting policies compared with GAAP ROCE earned compared to peers in various business lines Dividend policy Nature of transaction with subsidiaries / associates
Are there any instance of discrimination against minority shareholders ?
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Typical issues evaluated…… III
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Some specific areas for ICRA analysis
Boards’ role in guiding the management on key issues
facing the company
Acquisitions / Investments / Diversification
What is the rationale ?
What role did the board play?
Does the board review performance compared to projections?
Rationale for subsidiaries / associates
Are transactions on arms-length basis ?
Share movement analysis pre major announcements
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Benefits
An objective and independent assessment of a company’s
governance practices
An opportunity to benchmark a company’s practices with
the best practices in the field.
An opportunity to utilize the insights that ICRA has gained
during assessing companies for CG practices
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What have clients gained ?Some examples
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ICRA Limited
ICRAs’ observations: Unstructured, informal discussions would precede major corporate
decisions
Clients response An Executive Committee, with representation from all SBUs and
Business Heads formed
The EC meets every month to review operations as well as strategic issues . Formal minutes maintained
An ‘Acquisition Framework’ has been drawn up, which delineates steps to be taken for any M&A activity.
Illustrating benefits ……(I)
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ICRAs’ observations: Audit Committee composition and practices had scope for
improvement
Clients response Audit Committee reconstituted with only Independent Directors
Audit Committee has started the practice of meeting External and Internal Auditors without management presence
From time to time external speakers invited to brief Committee on changes in Accounting Policy , Approach to Risk Management and the like
Illustrating benefits….. (II)
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ICRA Limited
ICRAs’ observations: Control systems w.r.t “vetting of contracts” seemed to be an area
of weakness
Clients response Scope and coverage of Internal Audit was significantly enhanced
Adequacy of systems in this area became a focus area for the Audit Committee
Illustrating benefits….. (III)
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ICRA Limited
ICRAs’ observations: An analysis of BoD meetings
revealed the adjacent focus areas
Clients response Practice of dedicated strategy
session has been initiated
These sessions also provide an opportunity for external directors to “watch” senior management and identify potential
Illustrating benefits….. (IV)
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Board Focus Areas -Based on Agenda Items
8%
35%
5%6%
26%
20%
Strategy
Internal Control
Investments
Human Resources
Fin. Review
Ops. Review
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ICRA’s observations: Detailed presentations in the Board on operational issues was
‘cluttering’ Board proceedings
Succession planning an area of concern , especially given the ownership structure
Clients response Less of “Show and tell” presentations, more emphasis on seeking
guidance from Board Members on key aspects
More active Nomination Committee
Greater focus on succession planning
Illustrating benefits….. (V)
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Procedural lapses in compliance with Clause 49 highlighted
Improvement in minuting process
Greater focus on Nomination Committee issues
Laying down a policy for Non-Audit fees by SA
Other observations
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The basic essence of the exercise is ‘Evaluating Substance over Form’
Unlike credit ratings, there is no ‘quantitative’ measures for peer comparison
A judgmental call, arrived at with sufficient rigour and due diligence, is therefore the hallmark of the process
The rating / assessment offers valuable insights if used as a diagnostic tool
To conclude ….
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Financial theory is yet to establish a linkage
Research supports the proposition that ‘good governance enhances value’. Opinion based surveys
Research studies linking governance rankings / ratings with performance and value creation
CALPERs focus list
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What are the benefits of Corporate Governance ?
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ICRA survey suggests high importance of Corporate Governance for investors
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Importance of Corporate Governance vis-à-visfinancial numbers/growth prospects
0%
20%
40%
60%
80%
More
important
As
important
Less
important
Not at all
important
Used only
for
eliminating
cos.
Will you pay a higher premium for good Corporate Governance ?
0%
30%
60%
90%
Usullay Yes SometimesYes
Normally No Only inexceptional
cases
Never
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Mckinsey Investor Opinion Survey- June 2002 …. board practices are at least as important as financial performance
Source: McKinsey Investor Opinion Study22
How important is CG relative to financial numbers ?
16 1843 44
4566 61
50 41
40
18 217
15
15
-
20
40
60
80
100
120
EasternEurope /Africa
LatinAmercia
Asia NorthAmerica
WesternEurope
% o
f in
ve
sto
rs
Less important Equally important More important
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Mckinsey Investor Opinion Survey- June 2002 ----- investors would be willing to pay more for the shares of a well-governed company
Source: McKinsey Investor Opinion Study23
Premium for Governance?
78 78 76 76 73
22 22 24 24 27
0
20
40
60
80
100
120
WesternEurope
Asia NorthAmerica
LatinAmerica
EasternEurope /Africa
% i
nve
sto
rs
Yes No
ICRA Limited
Research linking governance ranking with stock performance
CLSA study The April 2003 study showed that over the past five years, high
CG stocks (ranked in the 1st quartile) outperformed the Sensex by 169%
The out-performance was at over 40% even if one excluded the Software stocks
CG and Equity Prices - A Study by Paul Gompers of Harvard Business School and others A ‘Governance Index’ was calculated for 1500 large firms during
the 1990s An investment strategy that bought firms in the decile with
strongest CG and sold firms in the decile with lowest CG would have outperformed the index by 8.5% during the period .
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ICRA Limited
Research linking governance ranking with stock performance
CG and Expected Stock Returns - A Study by Wolfganag Dorbetz , University of Basel An investment strategy that bought high-CGR firms and shorted
low CGR firms would have earned excess returns of 12% compared to the DAX 100 during 1998-2000.
Lipper-GMI Mutual Fund Report The two firms compared the performance and portfolio of 725
large-cap funds against GMI’s corporate governance ratings
Conclusion : Mutual funds that invest in companies with higher CG ratings have been rewarded with superior returns
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Research linking governance ranking with stock performance
Study by Japan Corporate Governance Research Institute. (Data from 2003 report) The Institute has developed the JCG Index , which measures
corporate governance in Japanese firmsTheir study found that high JCG Index firms achieved superior
performance , as measured by ROA, ROE, Stock Returns etc.
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Average ROE - last 5 years
0.14
4.64
1.87
0
1
2
3
4
5
low JCG index High JCG index all responding firms
(%)
Return on Common Stock- last 5 years
-9.25
-0.43
-5.71
-10
-8
-6
-4
-2
0
low JCG index High JCG index all responding firms
(%)
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Shareholders Wealth Effect of CALPERs focus list
California Public Employees Retirement Systems identifies and publishes a Focus list annually ----companies with poor Governance and financial performance
CALPERS study showed that there is a significantly positive shareholder impact from the release of CALPERs focus list over the period 1992-2001 At 95% confidence, the study found that inclusion in the focus list
results in a 5.37% additional return over a 6 month period.
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ICRA Limited
Thank You
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