Corporate Governance Ratings / Audit A presentation by ICRA Limited 18th October, 2004
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Corporate Governance Ratings / Audit
A presentation by ICRA Limited
18th October, 2004
ICRA Limited
Governance benefits
Rating framework
The way forward
Agenda for discussion
2
ICRA Limited
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
3
What are the benefits of Corporate Governance ?
ICRA Limited
Mckinsey Investor Opinion Survey- June 2002 …. board practices are at least as important as financial performance
Source: McKinsey Investor Opinion Study4
How important is CG relative to financial numbers ?
16 1843 44
4566 61
50 4140
18 217
15
15-
20
40
60
80
100
120
EasternEurope /Africa
LatinAmercia
Asia NorthAmerica
WesternEurope
% o
f in
ves
tors
Less important Equally important More important
ICRA Limited
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 Study5
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
A similar survey carried out by ICRA among domestic fund managers
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Importance of Corporate Governance vis-à-visfinancial numbers/growth prospects
0%20%40%60%80%
Moreimportant
Asimportant
Lessimportant
Not at allimportant
Used onlyfor
eliminatingcos.
Will you pay a higher premium for good Corporate Governance ?
0%
30%
60%
90%
Usullay Yes SometimesYes
Normally No Only inexceptional
cases
Never
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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ICRA Limited
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
(%)
ICRA Limited
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
Governance benefits
Rating framework
The way forward
Agenda for discussion
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ICRA Limited
Objectively and independently evaluate the Corporate Governance practices of a company and rank it on a relative rating scale that would facilitate comparison.
Overriding emphasis is on ‘Substance’ over ‘Form’
The ICRA rating is meant to indicate 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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ICRA Limited
Ratings 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 detailed perusal of documents like Board Notes and Agenda Papers not available in the public domain
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ICRA Limited
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
ICRA Limited
Accepted ratings so far
Bank of Baroda CGR2
Infosys Technologies Limited CGR1
Wipro Limited SVG1
ITC Limited CGR2
Godrej Consumer Products Limited CGR2
Godrej Consumer Products Limited SVG2
PNB Gilts Limited CGR3+
Esab India Limited (Since Withdrawn) CGR4
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ICRA Limited
Some observations from rating experience….
Extent of involvement of Independent Directors in evaluating strategic issues vary widely Administrative , routine details are invariably sent to Board
Audit Committee seems to be effective and functional However, quality of Risk Management Systems differ greatly
Nomination and Compensation Committee role is still evolving
Rigorous and structured performance evaluation in some cases ; however linkage between performance evaluation and remuneration is tenuous
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ICRA Limited
Some observations from rating experience….
Innovative practices seen in some Boards :
Evaluation of Board members
Board Committees comprised entirely of Independent Directors
Independent Directors meeting without executive presence
Feedback from Directors on quality of Agenda Papers
By and large, companies have adhered to Indian GAAP
Disclosure practices range from ‘exemplary’ to ‘complying
with statutory minimum’
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ICRA Limited
Governance benefits
Rating framework
The way forward
Agenda for discussion
18
ICRA Limited
The basic essence , ‘Evaluating Substance over Form’ needs to be maintained while devising alternative frameworks.
Key challenge is in evaluating issues like : Board effectiveness (from outside the board room !) ‘Independence’ and ‘ competence’ of outside directors Extent of guidance provided by the board on key challenges
facing the company Focus on ethical practices
Some thoughts ….
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ICRA Limited
Unlike credit ratings, there is no ‘quantitative’ measures for peer comparison
A judgmental call, arrived at with sufficient rigour and due diligence, may ,therefore, be unavoidable in some areas
Some thoughts ….
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ICRA Limited
Thank You
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