Governance 101
This is going to be a lengthy & excruciating read so brace yourselves. We understand that these theoretical lessons are like the History classes at school & it is nothing but natural to lose interest. We will try to keep the module as engaging as possible but do us a favor and grab a cuppa of coffee just in case.
Keep in mind, the devil lies in the details and you must be adept in spotting areas of trouble in the company.
The Need for Corporate Governance standards:
- Accountability- Investor relations are a crucial part of good corporate governance. Investors directly/indirectly assign the management the responsibility to generate returns on their investment. The term accountability simply means that actions have consequences. When Corporate Governance incorporates the principle of accountability, shareholders know that performance will be measured. Good performance will be rewarded & poor performance might be penalized. More importantly, misconduct & manipulation will not be tolerated. The principle of accountability & transparency goes hand in hand.
- Enhanced Investor Trust- Investors love it when companies are transparent in their dealings. A survey by the consulting firm Mckinsey & Co. states that institutional investors are willing to pay up to 40% premium for companies that demonstrate superior corporate governance practices. For instance, FMCG Firms like Hindustan Unilever & Nestle India command much higher multiples than Emami or Bajaj Consumer. Another example can be that of Public Sector Enterprises. These stocks have consistently underperformed the broader markets and trade at a hefty discount to their book values.
- Corporate performance- Quality decision making enhances the long term prosperity of the company. This ought to be linked with improved corporate performance- either in terms of stock price or improved metrics.
- Combating corruption- It is natural for corruption to bloom where a lot of money is involved. Governance structures need to be crystal clear with proper whistleblower mechanisms in place. Management tone at the top influences the risk culture to a large extent. The recommendations of the Risk Management Unit must be taken seriously and dealt with an iron hand. An organization with proper disclosure practices, transparency in accounting & auditing processes would certainly fade out the menace of corruption. It would reduce the risk of crises & scandals.
- Easy finance from institutions- It is quite obvious that companies with excellent governance standards will have access to a large pool of cheap capital. The interest component is a huge expense for companies operating in capital intensive sectors. The cost of funds directly affects the viability of several projects. Also, In the case of banks, the cost of financing is important as it has a direct bearing on the Net Interest Margins (Interest on lending- Cost of borrowing). A bank with poor corporate governance standards will have a higher cost of capital. It might lose out to competition owing to high lending rates.
