You are on page 1of 28

Corporate Governance

Assessment / Ratings



A presentation
by ICRA Limited
14th December , 2007
ICRA Limited
The Rating / Assessment Framework
2
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 ?
3
ICRA Limited
In case of CG Assessment , it is a detailed report meant for
use by the top management of the company highlighting
Strengths and weaknesses
Deviations 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 ?
4
ICRA Limited
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

5
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
6
Feedback from I ndependent Directors a key part of the exercise
ICRA Limited
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?


7
ICRA Limited

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 ?



8
Typical issues evaluated II
ICRA Limited
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 ?


9
Typical issues evaluated III
ICRA Limited
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
10
ICRA Limited
Benefits
An objective and independent assessment of a companys
governance practices
An opportunity to benchmark a companys practices with
the best practices in the field.
An opportunity to utilize the insights that ICRA has gained
during assessing companies for CG practices
11
ICRA Limited
What have clients gained ?
Some examples
12
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)
13
ICRA Limited
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)
14
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)
15
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)
16
Board Focus Areas -Based on Agenda Items
8%
35%
5%
6%
26%
20%
Strategy
Internal Control
Investments
Human Resources
Fin. Review
Ops. Review
ICRA Limited
ICRAs 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)
17
ICRA Limited
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
18
ICRA Limited

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 .
19
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
20
What are the benefits of Corporate
Governance ?
ICRA Limited
ICRA survey suggests high importance of
Corporate Governance for investors
21
Importance of Corporate Governance vis--vis
financial 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 premiumfor good
Corporate Governance ?
0%
30%
60%
90%
Usullay Yes Sometimes
Yes
Normally No Only in
exceptional
cases
Never
ICRA Limited
Mckinsey Investor Opinion Survey- June 2002
. board practices are at least as important as financial performance
Source: McKinsey Investor Opinion Study
22
How important is CG relative to financial
numbers ?
16 18
43 44
45
66 61
50
41
40
18
21
7
15
15
-
20
40
60
80
100
120
Eastern
Europe /
Af rica
Latin
Amercia
Asia North
America
Western
Europe
%

o
f

i
n
v
e
s
t
o
r
s
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 Study
23
Premium for Governance?
78 78 76 76
73
22 22 24 24
27
0
20
40
60
80
100
120
Western
Europe
Asia North
America
Latin
America
Eastern
Europe /
Af rica
%

i
n
v
e
s
t
o
r
s
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 .


24
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 GMIs corporate governance ratings
Conclusion : Mutual funds that invest in companies with higher
CG ratings have been rewarded with superior returns
25
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 firms
Their study found that high JCG Index firms achieved superior
performance , as measured by ROA, ROE, Stock Returns etc.


26
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.
27
ICRA Limited
Thank You
28

You might also like