Everyone, from business and government leaders to financial experts to the common man, is speculating what the 2016 Budget has in store. The expectations from this budget are no different from last year but people are now anxious and want the government to walk the talk. The market is rooting for additional tax exemptions, incremental spending in the infrastructure sector and specific steps to kick-start domestic investment which remains stubbornly stagnant.
However, what is concerning is that none of the discussions focus enough on the poor governance standards inside a large number of Indian companies, which is a key underlying cause of several crises unfolding in corporate India, including rising fraud, the astonishing level of wilful defaults of Indian borrowers and the related staggering level of non-performing assets (NPAs) of Indian banks. Regulators, investors and lenders,who continue to apply traditional risk management tools and believe that they can conduct business-as-usual in India, are sticking their heads in the proverbial sand.
The new Companies Act (the “Act”), which was introduced in 2013, places significant emphasis on governance through the board and board processes. Our experience on-the-ground suggests that many Indian companies are following the tenets of the Act much more in letter than in spirit. The spirit of the Act is to constitute boards where directors are engaged and expected to consistently ask difficult questions to the management. In contrast, we find this practice to be prevalent only in a handful of companies. One reason is that the requirement in the Act to have both independent and women directors applies only to listed companies and specified classes of public companies. Amongst this category, a number of companies have appointed friends or family to fulfil the criteria outlined by the Act which puts into question the true independence of such directors. On the other hand, there are numerous private companies who do not have to follow these requirements, but who are wilful defaulters of banks or have defrauded their equity investors. Experience suggests that in these companies, the loss to investors and lenders can be greatly attributed to the lack of good corporate governance practices such as fairness, accountability, responsibility and transparency. In fact, a number of top private equity investors in India will now tell you that picking companies with good governance standards is one of the key factors to investing successfully in India.
Among other stakeholders, external auditors are a crucial element of good governance as they are responsible for providing independent evaluations of the performance of companies and investors and lenders rely on them before they make decisions. And yet, several investors and lenders in India have suffered from the lack of good quality financial information as evidenced by the numerous accounting scandals and investment disputes in India. Despite that, no external auditors or, for that matter, other advisors have been held accountable. The Act has introduced several measures to improve the independence and quality of auditing standards such as mandatory rotation of external auditors, although the effectiveness of these measures remains to be seen.
While new policy initiatives, which may be announced during the 2016 Budget, may provide respite temporarily, improving the long-term investment environment in India requires the government and regulators to put improving corporate governance firmly on its agenda.
The author is Managing Director and Head of South Asia, Kroll
