ICRA

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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ICRA Limited

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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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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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%

StrategyInternal ControlInvestmentsHuman ResourcesFin. ReviewOps. 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%

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

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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 inv

esto

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

% in

vest

ors

Yes No

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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

(%)

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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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Thank You

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