This document analyzes the role of the Securities and Exchange Board of India (SEBI) as the gatekeeper of corporate governance in India. It studies SEBI's regulatory framework and effectiveness in enforcing corporate governance norms for listed companies. The study finds that over 70% of listed companies comply with governance codes, but the quality of compliance is not examined. Analysis of 100 companies over 7 years indicates improved governance processes after new rules in 2005, but no clear link to sustained performance. The investigation and appeals processes are often slow, arbitrary and opaque. Consent orders lack transparency. While SEBI has improved governance for listed firms, the impact on actual corporate performance is unclear.
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Study On The State of Corporate Governance in India
This document analyzes the role of the Securities and Exchange Board of India (SEBI) as the gatekeeper of corporate governance in India. It studies SEBI's regulatory framework and effectiveness in enforcing corporate governance norms for listed companies. The study finds that over 70% of listed companies comply with governance codes, but the quality of compliance is not examined. Analysis of 100 companies over 7 years indicates improved governance processes after new rules in 2005, but no clear link to sustained performance. The investigation and appeals processes are often slow, arbitrary and opaque. Consent orders lack transparency. While SEBI has improved governance for listed firms, the impact on actual corporate performance is unclear.
This document analyzes the role of the Securities and Exchange Board of India (SEBI) as the gatekeeper of corporate governance in India. It studies SEBI's regulatory framework and effectiveness in enforcing corporate governance norms for listed companies. The study finds that over 70% of listed companies comply with governance codes, but the quality of compliance is not examined. Analysis of 100 companies over 7 years indicates improved governance processes after new rules in 2005, but no clear link to sustained performance. The investigation and appeals processes are often slow, arbitrary and opaque. Consent orders lack transparency. While SEBI has improved governance for listed firms, the impact on actual corporate performance is unclear.
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Study On The State of Corporate Governance in India
This document analyzes the role of the Securities and Exchange Board of India (SEBI) as the gatekeeper of corporate governance in India. It studies SEBI's regulatory framework and effectiveness in enforcing corporate governance norms for listed companies. The study finds that over 70% of listed companies comply with governance codes, but the quality of compliance is not examined. Analysis of 100 companies over 7 years indicates improved governance processes after new rules in 2005, but no clear link to sustained performance. The investigation and appeals processes are often slow, arbitrary and opaque. Consent orders lack transparency. While SEBI has improved governance for listed firms, the impact on actual corporate performance is unclear.
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E-mail: contactus@tari.co.
in; Phone: +91 11 41022447; +91 11 41022448;
Address: Thought Arbitrage Research Institute; C-25, Qutab Institutional Area, New Delhi 110016
Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities and Exchange Board of India (SEBI)
Authors: Kshama V Kaushik Rewa P Kamboj
Indian Institute of Management Calcutta Indian Institute of Corporate Affairs Thought Arbitrage Research Institute Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
Table of Contents
Executive Summary .............................................................................................................................. 1 Literature Review .................................................................................................................................. 3 1. Introduction .............................................................................................................................. 6 2. Regulatory Framework of Securities and Exchange Board of India (SEBI)....................... 7 3. SEBI & Corporate Governance ............................................................................................. 11 4. Effectiveness of SEBI as a Gatekeeper of Corporate Governance in India ..................... 12 4.1 Study of extent of adoption of corporate governance norms by listed companies ...... 12 4.2 Study of Effect of Adoption of corporate governance norms on listed companies ...... 14
Movement of Companies toward Better Corporate Governance ................................................... 20 Data Skewness .................................................................................................................................... 21 4.3 Study of effectiveness of SEBIs overall regulatory mechanism by analysing the first level of authority, that is, the Assessing Officer level as well as the appeals process, that is, the Securities Appellate Tribunal (SAT) ............................................................. 24 4.4 Study the mechanism of Consent Orders and analyse its prevalence, effectiveness as a deterrent and transparency of the system .................................................................... 31
Annexure I SEBI ............................................................................................................................... 41 Annexure II SEBI .............................................................................................................................. 42
Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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Executive Summary
This section analyses the role of perhaps the most important regulator of the capital market and the corporate world in India, the Securities Exchange Board of India (SEBI). We begin with the evolution of SEBI as a regulator and trace its growth through various phases. We briefly discuss the regulatory framework of SEBI and the broad contours of the mechanism of corporate governance it has devised. The methodology used is: a. We have analysed data from National Stock Exchange of company-wise submissions with respect to compliance with provisions of corporate governance code for the quarter ended 30 th June 2011 and found that over 70% of companies are adhering to the corporate governance norms. However, this analysis is limited to only examine whether companies had declared adherence to prescribed corporate governance mechanisms and did not cover examining the quality of such mechanisms or the benefit of such mechanisms for individual companies
b. We have analysed the effect of adoption of corporate governance norms mandated by SEBI on 100 companies forming part of BSE 100 index over a period of seven (7) years since they were introduced in 2005, that is, an analysis of around 800 financial statements. We have used the established statistical tool of Tobins Quotient to examine effectiveness of Clause 49. We have relied on financial evaluation tools including important financial ratios to examine whether the barometer of financial performance displays trends that indicate effectiveness of Clause 49. Finally, we co- related these ratios to study their inter-relationships and co relationships. The analysis indicates a causality between improvement ofcorporate governance processes following the introduction oftt Clause 49 in India. However, we could not create a co relation between improved corporate governance and sustained corporate performance.
c. We have analysed SAT orders passed in case of 100 appeals and the corresponding 100 Adjudicating Officer (AO)/ SEBI orders passed to ascertain the effectiveness of the adjudicating and appellate process. Our analysis shows that the investigation and appeals process tends to be slow, often arbitrary, due to higher discretionary powers and at times opaque. Often the fines are very small compared to the extent of alleged offences and the rules of disgorgement of profits by the perpetrators rarely followed, creating no punitive action or dis-incentivising inappropriate business conduct. While the inherent spirit of framework is robust and in line with best practices of bringing in timely justice and fair play, its implementation needs to be more effective for capital markets to be buoyant and transparent.
d. We have analysed consent orders to determine the efficacy of the entire process and found that while the system of consent orders may be effective for settling cases, it lacks transparency and is marred with opacity in many areas. We also noticed that Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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the Adjudicating Officer is very powerful in the entire process by playing a significant role in the issue of show cause notices, enquiry, forwarding the case for settlement and approving authority in consent orders which calls for greater transparency and clearer guidelines.
We conclude that SEBI has played a big role in instituting a basic standard of corporate governance in the country, albeit only for listed companies. These measures have reduced information asymmetry and improved market liquidity; however, how much these measures have helped in improving corporate performancea real barometer of effectivenessis not evident.
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Literature Review
Gatekeepers are individuals, institutions or agencies that are interposed between investors and managers/owners in order to play a watchdog role to reduce agency costs. If gatekeepers are absent or do their job inefficiently then, it is reasonable to believe, there will be fewer checks on managers/owners to behave in a manner consistent with placing investors interests above self-interest. In other words, market efficiency will be lower which, in turn, would raise the cost of capital.
Kraakman (1986) defines gatekeepers as parties who are in a position to prevent misconduct by others by withholding their co-operation. 1
Scholars like Kraakman and Coffee further define gatekeepers as reputational intermediaries who provide verification and certification services to investors. But they also acknowledge that the role of gatekeepers as reputational intermediaries who can more easily be deterred than the principals they serve has been developed in theory but less often examined in practice 2 .
Gatekeepers essentially assess or vouch for corporate clients own statements or a specific transactionif this sounds like duplication, it is; however, this duplication is necessary because it is generally accepted that a gatekeeper has a lesser incentive to lie than the client andregards the gatekeepers word as being more credible 3 .
Hamdani defines gatekeepers as parties who sell a product or provide a service that is necessary for clients wishing to enter a particular market or engage in certain activities 4 .
Therefore, bankers, auditors and analysts are gatekeepers for clients wishing to enter the capital market. Extending the argument, for clients who wish to raise money through shares, the capital market regulator (Securities Exchange Board of India) is a major gatekeeper. Lending to the corporate sector is one of the main planks of a commercial bank; therefore, the banking sector regulator (Reserve Bank of India) is another gatekeeper to ensure corporate governance through the regulatory mechanism of prudential lending norms and monitoring use of money, among other things.
Having a network or series of gatekeepers is, however, no guarantee that corporate wrongdoing will be detected or avoided. In a wave of corporate scandals starting from Enron, we have seen instances of multiple gatekeeping failure in which wrongdoing went undetected through several layers. The failure of this network of gatekeepers was a recurring theme in business scandals. In too many instances, the gatekeepers in pursuit of
1 Gatekeepers: Anatomy of a Third-party Enforcement Strategy, Kraakman, R.H., Journal of Law, Economics and Organisation 2, 53-104 2 The Acquiescent Gatekeeper: Reputational Intermediaries, Auditor Independence and the Governance of Accounting, John C.Coffee, Jr., May 2001, Columbia Law and Economics Working Paper No.191. available at SSRN:http://ssrn.com/abstract=270944 3 Understanding Enron: Its About the Gatekeepers, Stupid, John C.Coffee, Jr., Columbia Law School, page 5 4 Gatekeeper Liability, Hamdani, Assaf, Southern California Law Review, volume 77, page 7, available at SSRN:http://ssrn.com/abstract=466040 Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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their own financial self-interest compromised the values and standards of their profession in the recent round of corporate scandals, the first tierthe managersfailed and then the gatekeepers failed as well. 5
In fact, some scholars believe that, theoretically at least, the services of gatekeepers can be performed either from within or outside the corporation 6 . Of course the law mandates that certain gatekeepers must be external to the organization such as auditors but there are other gatekeepers like lawyers or internal auditors who may serve their function just as effectively if they worked from within the corporation.
Accountability of a gatekeeper requires a certain quantum of liability s/he must bear. As far as individual gatekeepers are concerned (such as auditors, lawyers, etc.), every country has some rules to punish errant behaviour. However, there are few (if any) instances of accountability of gatekeepers who are institutions; for instances, if SEBI or RBI fails to detect or deter abuse of governance norms by companies or banks, the investor has little recourse to hold them accountable. Gatekeepers liability may not always be created for the gatekeepers own waysalthough this is also a possibilitybut for the wrongs attributed to the corporation that could have been deterred or at least minimised by precautions taken by gatekeepers.
Andrew Tuchs study shows that incentive problems will arise if gatekeepers are not capable of bearing the full liability imposed on them. In other words, gatekeepers incentives to take precautions are diluted where they are protected from full liability arising from their activities 7
A similar assertion is made by Steven Shavell in an optimal deterrence theory which prescribes the legal rules that optimally deter socially harmful conduct and discusses the dilution of incentives arising from a wrongdoers inability to pay for the losses it causes 8 .
A gatekeeper may even be shielded from the full effects of a liability regime by insolvency, although it rarely occurs in practice (Arthur Anderson being a notable example). Some categories of gatekeepers may collaborate with each other to adopt risk-shifting arrangements; for example, comfort letters exchanged among bankers, analysts, auditors, etc. Likewise, communications among regulators (such as between SEBI and RBI) may also be termed as risk-shifting or risk-sharing arrangements. The objective of such an exercise may be variedallocating liability or getting additional knowledge of the clients affairs or information exchange.
Corporate conduct is overseen by multiple gatekeepers who act on different aspects of business transactions. This ought to lead to an interlocking web of protection against
5 AAA&S, Report of the American Academy of Corporate Responsibility Steering Committee 6 The Devolution of the Legal Profession: A Demand Side Perspective, Ronald J.Gilson, 49 Md L.Rev., 869, 905 (1990). 7 Multiple Gatekeepers, Andrew F.Tuch,Virginia Law Review, Vol.96, Issue 7, pp 1583-1672. Available at SSRN:http://ssrn.com/abstract=1577405 8 Economic Analysis of Accident Law, Steven Shavell, 1 st Harvard University Press paperback edition 2007, 1987, page 167-68. Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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wrongdoing by all gatekeepers, calling into question the conception of the gatekeeper as a unitary actor 9
Gatekeepers operate in an interdependent rather than independent manner and it is important to have a certain degree of collective responsibility among all gatekeepers to harness the total capacity to deter wrongdoing. A regime of fault-based liability coupled with joint and several liability would be optimal for advancing the cause of optimal deterrence 10 .
9 Multiple Gatekeepers, Andrew F.Tuch, Discussion paper no.33, 3/2010, Harvard Law School, Cambridge, MA 10 Andrew Tuch, page 86 Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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Securities and Exchange Board of India 1. Introduction At independence, India had a functioning stock market (Bombay Stock Exchange is Asias oldest stock exchange), a flourishing trading sector, a fledgling industrial sector and a well- developed banking sector. The concept of joint stock companies was immensely popular since it was first introduced by the British rulers and Indian businessmen took to the concept very well as it helped disperse risk more widely and provided better access to funding resources. However, the method of running these companies or corporate governance took an entirely indigenous flavourbusinessmen hardly altered their style of working under sole- proprietorship or partnership mode and often treated the company as their personal property. Promoters were unwilling to give up unbridled control over the business that is inevitable in a joint-stock company. The concept of a managing agency house (often a partnership firm that provided specific services) where promoters would pass a resolution appointing their family firm as the managing agent almost in perpetuity and with unfettered powers was a neat solution. Corporate governance, as is understood in the modern context, was an alien concept to indigenous Indian business houses for a long time. The socialist policies followed by the government after independence also contributed to weak governance norms that was more evident in Indias huge public sector and nationalised banks where the governing ethos took on a form of its own. Faced with a fiscal crisis in 1991, the Indian Government responded by enacting a series of reforms aimed at general economic liberalization. This opened up the Indian economy not only in terms of business opportunities and newer funding avenues but also to fresher ideas of governance models. To develop Indias capital markets further, the central government established regulatory control over stock markets through the formation of the Securities and Exchange Board of India. SEBI, which was originally established in 1988 as an advisory body, was granted authority to regulate the securities market under the Securities and Exchange Board of India Act of 1992 (SEBI Act). Through the passage of this Act, Parliament established SEBI as an independent statutory authority, but required it to submit annual reports to the legislature.
SEBI was designed to serve as a market oriented independent entity to regulate the securities market akin to the role of the Securities and Exchange Commission (SEC) in the United States The stated purpose of the agency is to protect the interests of investors in securities and to promote the development of, and to regulate, the securities market.
The first initiative at introducing corporate governance in a structured manner in India was by the industry through its association, CII in 1998. It was a purely voluntary set of recommended governance norms that companies could adopt and be seen as being well- run companies. But to ensure more wide-spread adoption of corporate governance norms it is necessary to have a certain statutory compliance value and therefore, SEBI undertook the Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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second initiative in corporate governance by introducing a code formed by a committee under the chairmanship of a leading industrialist, Kumarmangalam Birla in 1999. The recommendations of this committee contained new provisions in line with global developments such as putting out a Management Discussion & Analysis report as part of the annual report, emphasising on Board committees and advocating the role of independent directors. These proposals were introduced by SEBI in 2000 for companies within its jurisdictionlisted companiesby amending the Listing Agreement that companies enter into with stock exchanges. But SEBIs mandate extends only to companies listed on stock exchanges and a comprehensive adoption of corporate governance norms for all companies can be brought about in India only through the legislative route. Therefore, the third set of corporate governance proposals was carried out by the Department of Company Affairs (now Ministry of Corporate Affairs) based on the recommendations of the Naresh Chandra committee in December 2002. It made recommendations in two key aspects of corporate governance: financial and non-financial disclosures and independent auditing and board oversight of management and also a series of recommendations regarding statutory auditors.
The fourth initiative on corporate governance in India was again carried out by SEBI based on the recommendations of the Narayana Murthy committee which was set up to review Clause 49and suggest measures to improve corporate governance standards.
This was done in the wake of the Enron scandal in the United States in order to evaluate the adequacy of the existing Clause 49 and to further improve existing practices in order to enhance the transparency and integrity of Indias stock markets and ensure compliance with corporate governance codes, in substance and not merely in form. The changes suggested reflect global norms of corporate governance developed in Anglo Saxon countries that have a different business environment than India.
2. Regulatory Framework of Securities and Exchange Board of India (SEBI)
SEBI acts as a developer and regulator of the capital market in India. SEBI has delegated powers to two exchanges (Bombay Stock Exchange, National Stock Exchange) to ensure that their members adhere to the SEBI regulations and instructions. The total market capitalization as on March 31, 2011 of listed companies in India at Bombay Stock Exchange is Rs 68,39,084 crores as per SEBIs Annual Report for the year ending March 31,2011. Some of the roles that SEBI performs as a market regulator are: 1. To regulate the market by creating rules for functioning of various products. 2. To approve/ amend the laws of stock exchanges. 3. To inspect the books of accounts and call for periodical returns from recognized stock exchanges. Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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4. To inspect the books of accounts of financial intermediaries and levy fees/ charges on them. 5. To compel certain companies to list their shares in one or more stock exchanges. 6. To educate investors. 7. To prosecute and judge directly the violation of certain provisions of the companies Act. 8. To prohibit and prevent insider trading 9. To frame rules for merger and takeover of companies. 10. To regulate issue of capital and debt in primary and secondary market. 11. To prevent unfair trade practice and market manipulation. Thus, SEBI drafts regulations in its legislative capacity, conducts investigations and authorizes enforcement action in its executive function, passes rulings and orders in its judicial capacity. Though this makes it very powerful, there is an appeals process to ensure fairness and accountability through a Securities Appellate Tribunal (SAT). SAT was formed in 1995 to act as a forum of justice to appeal against the orders passed by SEBI Board or the adjudicating officer (AO) appointed under SEBI Act.
The general process flow of adjudicating and appeals process is usually as below but may vary a little in some cases:
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Flowchart for Adjudication Proceedings
Commitment of Offence SEBI obtaining information on the basis of reports from stock exchanges or otherwise SEBI Ordering and enquiry, Enquiry Proceedings completed, summons may be issued for collection of evidence, Enquiry Report submitted to SEBI and Show Cause Notice may be sent to the defaulter. Appointment of Adjudicating Officer Issue of Show Cause Notice Submission of reply and evidence/ records/. Opportunity given for personal hearing through legal representation Submission of reply and evidence/ records. In case of non-receipt of reply, an ex-parte order may be issued Detailed investigation and order passed by SEBI Board/ Adjudicating Officer Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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Flowchart for Appeal Process (At any stage an appeal can be filled with the Central Government of India)
Order Passed by SEBI Board/ AO
Appeal filed with SAT SAT may send the case back to SEBI for fresh order/ speedy investigation Appeal decided in favour of SEBI/ Appellant Aggrieved party may approach High Court High Court passes an interim/ final order Appeal can be filled in Supreme Court Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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3. SEBI & Corporate Governance
SEBI has set out corporate governance provisions that are intended to drive in a minimum standard of corporate governance among listed companies in India. This is issued as a part of the Listing Agreement that each listed company signs with the stock exchange under the title Clause 49. Clause 49 remains the most significant corporate governance reform and established a new corporate governance regime.
Like corporate governance standards in the United States and the United Kingdom, Indias corporate governance reforms followed a fiduciary and agency cost model. With a focus on the agency model of corporate governance, the Clause 49 reforms included detailed rules regarding the role and structure of the corporate board and internal controls. These norms lay criterions for:
1. Appointment of independent directors in board. 2. Appointment, composition and Powers of Audit Committee 3. Functioning of Remuneration Committee, Investors Grievances Redressal Committee 4. Compensation that can be paid to non-executive directors. 5. Adherence to internal control of conduct by Board of Directors and other top executives. 6. Disclosure of Accounting Policies, Contingent Liabilities, Related Party Transactions, IPO Proceed utilisation. 7. Certification by CEO/ CFO on adequacy of internal control system, correctness of the reported financials. 8. Whistle Blower Policy.
A certificate of compliance on terms contained in Clause 49 is required to be signed by the director and auditors/ company secretary of the company is to be annexed to the annual report.
The stock exchanges are mandated to ensure compliance with the above provisions at the time of listing of shares and through quarterly compliance reports received from listed companies. Listed companies are also required to submit a consolidated compliance report to SEBI within 30 days of the end of each quarter.
The Clause 49 reforms were phased in over several years, applying at first to larger entities and eventually to smaller listed companies. Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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Eventually, compliance of corporate governance must be carried out by:
4. Effectiveness of SEBI as a Gatekeeper of Corporate Governance in India
SEBI is the capital market regulator in India and has been active in recent years in its efforts to usher in a standard form of corporate governance. This part of the study analyses effectiveness of SEBIs role in implementing corporate governance mechanisms. This is done in four parts: a. Study of the extent of adoption by listed companies of SEBI corporate governance norms. b. Study of the effect of such adoption on the performance of companies c. Study of effectiveness of SEBIs overall regulatory mechanism by analysing the first level of mechanism, that is, the Assessing Officer level as well as the appeals process, that is, the Securities Appellate Tribunal (SAT) d. Study of the mechanism of Consent Orders and analyse its prevalence, effectiveness as a deterrent and assess transparency of the system
4.1 Study of extent of adoption of corporate governance norms by listed companies
We have analysed data from National Stock Exchange of company-wise submissions with respect to compliance with provisions of corporate governance code for the quarter ended 30 th June 2011.
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Our analysis showed that almost all companies were following corporate governance measures:
*Cannot Comment: Data includes fields which did not have any input, hence cannot determine if compliance is done or not.
This analysis is limited to only examine whether companies had declared adherence to prescribed corporate governance mechanisms and did not cover examining the quality of such mechanisms or the benefit of such mechanisms for individual companies.
A study on corporate governance in India 11 states that India has one of the best corporate governance laws but poor implementation together which, together with socialistic policies of the pre reform era has affected corporate governance. The legal environment plays a crucial role in determining the nature of corporate governance in any country and encompasses two important aspects the protection offered in the laws (de jure protection) and to what extent the laws are enforced in real life (de facto protection).
Two indices have been used for this purpose a shareholder rights index ranging from 0 (lowest) to 6 (highest) and a rule of law index ranging 0 (lowest) to 10 (highest) to measure the effective protection of shareholder rights. The first index captures the extent to which the written law protected shareholders while the latter reflects to what extent the law is enforced in reality. India has a shareholder rights index of 5, being one highest in the sample examined of 49 countries but the rule of law index a score of 4.17 on this index ranking 41st out of 49 countries studied.
Thus it appears that Indian laws provide great protection of shareholders rights on paper while the application and enforcement of those laws are lamentable. This difference in protection of shareholders rights has led to completely different trajectories of financial and economic developments in the different countries.
The study concludes that the bigger challenge in India lies in the proper implementation of corporate governance rules at the ground level.
11 Corporate Governance in IndiaEvolution and Challenges by Rajesh Chakrabarti, College of Management, Georgia Tech, USA Particulars Number of companies Percentage Complied 1044 71 Non Complied 106 7 Cannot comment* 312 21 Total 1462 100 Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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4.2 Study of Effect of Adoption of corporate governance norms on listed companies
OECD Principles of Corporate Governance (2004) and various corporate governance indexes (such as Standard & Poors Corporate Governance Index) focus on the characteristics of corporate governance mechanisms rather than outcomes based on the principle that effective and robust processes result in appropriate results. However, authors like Pitabas Mohanty argue that if a company has got a governance system then it must get reflected in certain outcome(s). (The argument is that) if the processes are in order, we must observe certain desirable outcomes. If the outcomes are not present, then the mere existence of a process does not amount to anything 12 . Significant research on this area conducted by Gompers et al. (2003), Bebchuk and Cohen (2004) and Bebchuk, Cohen and Ferrell (2009) show that firms with stronger stockholder rights have higher Tobin Qs, their proxy for measurement of corporate value, indicating that better-governed firms are more valuable. Brown and Caylor in Corporate Governance and Firms performance ( 2004) create a summary index of firm-specific governance, Gov-Score, and relate it to operating performance, valuation, and cash payouts for 2,327 firms in USA. They show that poorly- governed firms (i.e., those with low Gov-Scores) have lower operating performance, lower valuations, and pay out less cash to their shareholders, while better-governed firms have higher operating performance, higher valuations, and pay out more cash to their shareholders.Scholars also agree that there are no formalized & generally accepted criteria for determining if a particular system of corporate governance system works 13 .
Bain and Band (1996) 14 and Bhagat and Jefferies 15 believe that the following form the pillars of corporate governance and have a positive relationship with the value of a firm.
Independent board of directors Equal rights of minority shareholders Dispersed ownership Timely & transparent information system Independent auditor
There are also other factors that affect the relationship between the value of a firm and corporate governance which include a) role of judiciary, banks, government and politicians, b) macro-economic factors such as economic growth rate, inflation, interest rates c) intangibles such as goodwill, customer relations, supply chain and growth potential, etc.
12 Mohanty, Pitabas, Institutional Investors and Corporate Governance in India, www.nseindia.com/content/research/Paper42.pdf, accessed on 20/1/12 13 Macy, J., Measuring the Effectiveness of Different Corporate Governance Systems: Towards a More Scientific Approach, Journal of Applied Corporate Finance, Vol 63, No. 2, 1998 14 Bain, Neville and David Band, Winning Ways Through Corporate Governance, Macmillan Business 1996 15 Bhagat, Sanjai and Richard H Jefferies, 2002, The Economics of Corporate Governance Studies, MIT Press Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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In other words, the value of a firm is a combination of of the monetary value plus the social value of the firm. Indian corporate governance systems are drawn from the Anglo Saxon model of corporate governance where the focus is on shareholder value maximisationshareholder value being derived in terms of market valuation of a firm 16 . Several studies have linked different parameters of performance to corporate governance to assess its effectiveness. Some of these parameters include share price movements, volatility of share prices, earnings per share, etc. Kaplan 17 and Gibson 18 suggest that performance of a corporate governance system can be evaluated by investigating the link between corporate performance and CEO turnover. The reasoning is that an effective governance system requires poor performing managers to be penalised by removal.
However, Gibson also provides evidence that when the firm has a domestic private large shareholder, the relationship between CEO turnover and corporate performance weakens in emerging markets. This is also indicated in India, where the agency gap between owners and managers is low , which is compounded by the fact that owners of the top 500 companies in BSE as on 30 September 2011 hold 60 % of the listed companies, creating a strong entrenchment of management and therefore CEO turnover may not provide accurate indications of good or bad corporate governance.
Chhaochharia and Laeven (2007) 19 have evaluated the impact of firm-level corporate governance provisions on the valuation of firms in a large cross-section of countries. They have distinguished between governance provisions that are set at the country-level and those that are adopted at the firm-level and conclude that governance provisions adopted by firms beyond those imposed by regulations and common practices among firms in the country have a strong, positive effect on firm valuation.
Despite the costs associated with improving corporate governance at the firm level, many firms choose to adopt governance provisions beyond what can be considered the norm in the country, and these improvements in corporate governance have a positive effect on firm valuation. Indian software and other companies listed overseas, especially in the USA , followed these principles of voluntarily imbibing greater measures of corporate governance for the perceived value it created for their businesses.
The challenge is to find a broad yet accurate measurement indicator that factor in the effect of corporate governance by linking two or more appropriate parameters which reflect the performance of a company within a certain environment. Tobins Quotient is widely used by
16 Kakani, Ram Kumar, Biswatosh Saha, V.N.Reddy, Determinants of Financial Performance of Indian Corporate Sector in the Post Liberalisation Era: An Exploratory Study, May 2006 17 Kaplan, S.N., Top Executive Rewards and Firm Performance: A Comparison of Japan and the United States, Journal of Political Economy, Vol 102, No.3, 1994, pp 510-546), Abe (Abe, Y, Chief Executive Turnover and Firm Performance in Japan, Journal of the Japanese and International Economies, Vol 11, 1997, pp 2-26 18 Gibson, M.S., Is Corporate Governance Ineffective in Emerging Markets, Journal of Financial and Quantitative Analysis, Vol 38, No.1, March 2003, pp 231-250 19 Chhaochharia, Vidhi and Luc Laeven, The Invisible Hand in Corporate Governance http://www.luclaeven.com/papers_files/CG_Provisions.pdf, 2007 Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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academicians as a proxy for firm performance when studying the relationship between firm performance and corporate governance. Tobins Quotient or Tobins Q is a ratio devised by Nobel Laureate James Tobin of Yale University in 1969 who hypothesised that the combined market value of all companies on the stock market should be equal to their replacement costs. The ratio is calculated as: Tobins Q= Total Market Value of a Firm Total Asset Value (Where Total Asset Value refers to the replacement value of assets.) If Tobins Q is equal to 1.0, the market value will be perfectly reflected by the recorded assets of the company. If Tobins Q is greater than 1.0 then the value is greater than the value of the companys recorded assets. The accepted view is that in such cases the market value reflects some unmeasured or unrecorded asset of the company. This extra value is often used as a proxy for corporate governance. Cheung and Pruitt 20 developed and empirically tested the robustness and usefulness of the simple formulation of Tobins q. They concluded that the co-relation of the values obtained through q values is theoretically correct and can be safely applied. This conclusion in many ways supports the main assertions of another prior study on Tobins q by Perfect and Wiles.It is now widely accepted that Tobins q is an appropriate proxy for the underlying, true q, which is an indicative measure to invest.
Clause 49 of the Listing Agreement of Indian Companies The corporate governance mandate is contained in the revised Clause 49 issued by Securities and Exchange Board of India effective from April 1, 2004 for listed companies. These provisions have been in effect for a period of seven years and can reasonably be expected to be entrenched long enough for its effect to be reflected in certain parameters. These provisions are designed to improve the way in which companies are managed. The main provisions of Clause 49 are:
Guidelines Impact Objective Board of Directors Professionalization of directorial oversight, transparency of board remuneration & processes Independence of Oversight Audit Committees Improvement in quality of financial oversight and therefore in firm performance Risk Assurance Subsidiary Companies Greater oversight of unlisted companies by shareholders of holding company Capital Protection Disclosures Better control mechanisms being implemented, better risk management processes Financial Transparency CEO/CFO certification Greater ownership of financial affairs of the company leading to better oversight mechanism Accountability
20 Chung, Kee H. and Pruitt, Stephen W. , A Simple Approximation of Tobin's Q. Financial Management, Vol. 23, No. 3, 1994. Available at SSRN: http://ssrn.com/abstract=957032 Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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Methodology and Analysis
We have used Tobins Q as a proxy to analyse the effectiveness of corporate governance practices that listed companies in India are mandated to implement.
We have analysed the movement of Tobins Q over 100 companies comprising BSE 100 index over a period of seven years from the financial year 2004-5 to 2010-11. This involved analysis of 800 financial statements to collect financial data to examine whether introduction of SEBIs corporate governance mechanisms has had an impact on corporate performance.
This ratio was originally intended to be calculated on the replacement value of assets. However, it is difficult to obtain an estimate of the replacement cost of assets unless there is a defined market for used equipment. Indian laws require assets to be recorded at historical cost adjusted for depreciation; in certain cases mark-to-market is used but this is not the usual case. Therefore, we have used total assets as they appear in the financial statements of companies.
We have also analysed certain financial performance indicators of the 100 companies comprising BSE 100 index over this period of seven years to study the link, if any, between corporate governance mechanisms. For instance, Return on Assets (ROA) is an indicator of how profitable a company is relative to its total assets and may be considered as a proxy for efficiency of management in using its assets to generate earnings; in other words, ROA may be considered as a proxy for operating performance.
Return on Equity (ROE) is an indicator of maximisation of shareholder wealth which, in terms of the Anglo Saxon model, is the basic purpose of corporate governance. ROE is the amount of income returned on the equity invested in the company and may be considered a proxy for the ability of the company to maximise shareholders wealth.
Net Profit to sales is an indicator of how efficiently a company is being operated. It may be considered as a proxy for effectiveness of certain corporate governance mechanisms that seek to improve operational performance.
Employee Cost as a percentage of sales indicates whether certain HR processes included in corporate governance mechanisms are effective in improving employee efficiency.
Cost of Debt indicates whether the company is being run effectively enough to bring down the debt component and improve cost efficiencies and may be considered as a proxy for financial efficiency.
Terms Explained:
1. Tobins Q is the ratio of market capitalisation over the total assets of the company. Market Capitalisation has been calculated by multiplying the number of shares with the issued capital. Total Assets are taken as per Annual Financials reduced for deferred revenue expenditure to the extent not written off.
2. Return is Net Profit after Tax
Net Profit (after tax) = Earnings Before Interest & Taxes minus Interest minus Taxes
Operating Revenue= Sales Revenue Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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Operating Expenses= Cost of Goods Sold+ Selling, General and Administrative Expenses+ Depreciation & Amortisation+ Other Expenses
Non-Operating Income= Dividend Income+ Profits from Investments+ Gains on account of foreign Exchange.
3. Return on Assets is the ratio of returns for a year over the average of total assets during the years. Average Assets is the summation of opening and closing assets divided by two.
4. Equity means Shareholders Funds ie Share Capital + Reserves and Surplus. Return on Equity is the ratio of returns for a year over the reported equity.
5. Sales are before excise duty adjustments and in case of banks it refers to the interest earned.
6. Total Debt includes both secured and unsecured long term debt. Cost of Debt is ratio of interest cost over average debt. Average Debt is the summation of opening and closing debt divided by two.
7. Price/ Earnings Ratio is the ratio of Closing market price of the shares at BSE divided by reported Earnings per Share.
8. Mean is simple average of the data variables over sample size and period.
9. Median is the middle most value of the data variables over sample size and period.
10. Skewness is a measure of the asymmetry of the data around the average mean. If skewness is negative, the data are spread out more to the left of the mean than to the right. If skewness is positive, the data are spread out more to the right. The skewness of the normal distribution (or any perfectly symmetric distribution) is zero. In case data skewness is more than +/- 5, the mean has been substituted by the median for analysis.
Our discussion and analysis: The table below depicts the average Tobins Q of BSE 100 companies annually since the introduction of SEBIs Clause 49 in April 2005.
We observe that there was a marked increase in Tobins Q one year after corporate governance regulations were introduced in 2005 and there has been a marked improvement in the measure over the next 3 years, suggesting that the capital market reacted favourably Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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and rewarded companies for implementing corporate governance mechanisms. This observation is in line with prior empirical studies done by Jain, Kim and Rezaee in 2006 , suggesting that SOX regulations in the USA created a buoyancy in the markets by reducing information asymmetry due to higher levels of disclosures, which increased the market liquidity and size. At an average Tobins Q of over 3 for all years (except one), it indicates that markets value companies far more than what they are worth as compared to the amount of investment made by them.
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Movement of Companies toward Better Corporate Governance
We analysed the movement of these 100 companies over a period of seven years to see if assimilation of corporate governance mechanisms recommended by Clause 49 has helped companies to move up on the index of Tobins Q. This was analysed with reference to the mean Tobins Q ratio for each of the years to observe the migration of companies past the mean towards a higher benchmark. The results, as depicted in the table below, indicate that the number of companies that are below the mean Tobins Q ratio for BSE 100 has only increased over this period. If corporate governance mechanisms were effective, it is expected that companies would have moved closer to the higher Tobins Q benchmark. This could also mean that the market accepts a certain corporate governance standard as the basic after a period of time and does not continue to reward companies beyond a certain point. Therefore, while the number of companies below mean Tobins Q has increased over time, it is not clear whether this is because of ineffectiveness of corporate governance mechanisms or because the market expects such standard behaviour from everyone and does not recognize these basic efforts.
Distribution of Companies around Mean Tobins Q Distribution of Companies Above & Below Mean Tobins Q 2011 2010 2009 2008 2007 2006 2005 Number of Companies More than mean 30 30 26 33 31 28 23 Number of Companies less than mean 70 69 71 63 59 58 59 NA -
1
3
4
10
14
18 Total 100 100 100 100 100 100 100
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Data Skewness
We also observed that there is great data skewness in the sample of BSE 100 with Tobins Q ranging from less than 1 up to 25 as shown in the table below. Such a high Tobins Q suggests that assets of those companies may be over utilised as compared to the amount of capital invested in them. Theoretically, a high Tobins Q should encourage those companies to invest more in capital to balance market valuations. Tobins Q Spread Year-Wise Tobins Q Ratio 2011 2010 2009 2008 2007 2006 2005 Not Available -
1
3
4
10
14
18 Upto 1 39
31
41
25
27
23
27 1 to 2 13
19
27
16
12
9
18 2 to 3 16
16
9
15
14
13
13 3 to 5 13
14
10
16
10
18
9 5 to 10 11
12
8
18
20
15
10 More than 10 8
7
2
6
7
8
5 Total 100
100
100
100
100
100
100
Alternatively, this high Tobins Q indicates that there is unexplained exuberance in capital markets regarding certain companies which puts their market capitalisation far above what the companies are actually worth. Sectors like Capital Goods, FMCG and Transport Equipment show a high Tobins Q above 5 up to 25 which is inexplicable. Information Technology shows Tobins Q on an average between 2 to 5, indicating that the capital market factors in intangibles in the IT sector that is not reflected in total assets appearing in financial statements. Only the Finance sector shows a consistent Tobins Q between 0 and 1. Therefore, average Tobins Q depicted in the first table needs to be read in the context of this skewness. Other Financial Ratios: We have analysed data of 100 companies 21 over a period of seven years. This translates into 800 financial statements from which we have extracted financial ratios that could indicate effectiveness of corporate governance mechanisms. These ratios have then been aggregated into annual figures to show the trend across BSE 100 companies and the results are depicted in the table below:
21 Forming part of BSE 100 Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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Financial Ratios Over 7 Years Analysis: Return on Assets: The data shows an oscillating trend and appears to reflect general macroeconomic factors as well. The effect of corporate governance mechanisms is not very apparent. Return on Equity: The data showed an increasing trend initially and then has declined steadily, mirroring the recessionary trend in those years. This suggests impact of macroeconomic factors rather than improvement in corporate governance mechanisms. Net Profit/Sales: Although the data shows an oscillating trend, after factoring in recession, profitability shows an improvement over the years. However, it may be premature to conclude that this is as a result of corporate governance mechanisms.
Employee Cost/Sales: Employee costs over sales shows a rising trend over the years of the sample period. Improving corporate governance should contribute to more efficient HR systems which should help to bring down employee costs as a percentage of sales, which, however, is not supported by data. Rising employee cost can also be explained by rising inflation (which would also have an adverse effect on sales) and therefore the effect of corporate governance on employee costs is not clear. Cost of Debt: Other than the exceptional year of 2009, the cost of debt shows a declining trend. This could indicate that more value is created for shareholders as cost of financing goes down. Corporate governance is expected to bring in efficiencies in the way a business is run and must, in the final analysis, be reflected in the outcomes as represented by financial numbers. Some of these efficiencies would be reflected in a lower cost of debt, more efficient employee costs per unit of sales, besides providing better returns on assets and to shareholders. Ratios 2011 2010 2009 2008 2007 2006 2005 Trend Return on assets
12.98
13.67
13.16
15.94
15.98
14.29
13.41
Oscillating Return on Equity
18.59
19.28
19.17
23.08
24.77
21.53
20.75
Oscillating Net Profit/ Sales
14.78
15.17
13.75
15.07
14.07
13.31
13.75
Oscillating Employee cost as %age of sales
6.10
5.88
5.52
5.78
5.19
5.52
5.61
Oscillating Cost of Debt 6.34
6.50
8.39
6.98
6.63
5.97
7.07
Oscillating Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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Our analysis of data reveals that at an aggregate level, these financial ratios do not provide any trend that conclusively points to the effect of better governance by itself and may depict the influence of other macro-economic factors as well.
Correlation Coefficient We find that these financial ratios do not independently provide conclusive proof of the effect of corporate governance on financial performance. Therefore we examine if there is any correlation between Tobins Q ratio (the proxy for corporate governance) and the main profitability ratios of Return on Assets (ROA) and Return on Equity (ROE) as well as the share prices (of corporate performance). Correlation coefficient is a measure of the strength of linear association between two variables and will be between -1.0 and +1.0; that is, if the co-relation is positive, there is a positive relationship between the two variables and vice versa. The strength of the relationship is determined by the fraction beyond zero. We have conducted a series analysis between Tobins Q and each of ROA, ROE and Share Prices for each company in BSE 100 over seven years. We then found the correlation coefficient for each of these companies and the result for the entire sample is: Co-relation Co-effcient of Tob Q with ROA, ROE & Share Prices Correlation coefficient Return on Assets (ROA) Return on Equity (ROE) Share Prices NA 3
3
3 0 to -1 18
28
7 0 to 0.5 30
30
24 0.5 to 1 49
39
66 Total 100
100
100
We observe from this data that: ROA: As many as seventy nine per cent (79%) of companies in our sample showed a positive correlation between corporate governance and profitability as measured by return on assets. ROE: Up to sixty nine (69%) of companies in our sample showed a positive correlation between corporate governance and increased shareholder wealth (ROE) Share Prices: As many as ninety per cent (90%) of companies in our sample showed a positive correlation between corporate governance and higher share prices. That is, markets recognized improvements in corporate governance by rewarding these companies at the stock exchange. Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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We observe that at a broad level, there appears to be a positive correlation between Tobins Q ratio and certain profitability indicators as well as share prices. This suggests that companies that are perceived by stakeholders to be better governed also, in fact, deliver better returns. That is, not only do companies that rank higher on the corporate governance actually display higher profitability but also their shares are valued higher. However, while there may be some individual trends noticed in different years for certain companies, these appear to be more because of sectoral and macroeconomic factors cannot clearly be said to be because of introduction of corporate governance mechanisms contained in Clause 49. Perhaps the most significant result is the shifting of the mean Tobins Q over a period of seven years which would indicate whether Clause 49 has helped companies achieve better corporate governance. As indicated in table above this improvement of Tobins Q ratio has not occurred, which, we believe, indicates that there are only a few companies which excel on corporate governance parameters while the vast majority of companies (60 to 70 per cent) have made no movement towards better corporate governance over the years, as perceived by the capital market. Thus, we conclude that there is no clear evidence of effectiveness of Clause 49 on performance of companies.
4.3 Study of effectiveness of SEBIs overall regulatory mechanism by analysing the first level of authority, that is, the Assessing Officer level as well as the appeals process, that is, the Securities Appellate Tribunal (SAT) We have analysed SAT orders passed in case of 100 appeals and the corresponding 100 Adjudicating Officer (AO)/ SEBI orders passed to ascertain the effectiveness of the adjudicating and appellate process. The period of study for SAT orders is from March 1, 2010 to September 30, 2011 and the sample has been selected on a random basis within the constraints of data availability 22 . The objective of the analysis is to study the nature of offences, time taken by SEBI in completion of adjudicating proceedings, nature of penalties levied, analysis of SAT orders whether it has taken independent decisions in favour or against SEBI and reduced the penalties for appellant ensuring law of justice, time taken to complete appeal proceedings at SAT and finally the time taken at SEBIs end for disposal of cases. Methodology Followed 1. SAT orders were examined on following parameters: Date of SAT order Name of the Appellant Nature of Offence Appeal decided in favour of
22 Source: (www.watchoutinvestors.com) & (www.sebi.gov.in) Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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Revised Penalty 2. The respective AO/ SEBI order were analyzed to study the entire judiciary process on following factors: Date of order Date of Appointment of Adjudicating Officer Date of Show cause Notice Time of Offence Original Penalty
3. A detailed analysis was carried out to ascertain: Types of Violation covered under these orders Type of Penalties Charged by AO/ SEBI order Appeals decided in favour of SEBI/ Appellant Amount/ Quantum of Penalties waived Time lag between the date of offence and date of appointment of AO Time lag between the date of appointment of AO and date of show cause notice Time lag between the date of show cause notice and the date of order passed by AO/ SEBI Time lag between the date of order passed by AO/ SEBI and the date of SAT order Time lag between the date of SAT order and date of offence Time lag between the date of AO/ SEBI order and date of offence
Assumptions of the study / Limitations of the Data 1. Samples of 100 appellants with maximum of 2 appellants in one SAT order have been considered.
2. Date of offence is the first date of violation. In cases of offence relating to noncompliance with summons issued by SEBI, date of offence has been taken as the date of 1st summons issued.
3. Date of appointment of adjudicating officer could not be found in case of ex-parte orders/ investigations ordered by SEBI/ otherwise (32 such cases). We could not ascertain the reasons why this date was not written in the orders. In 5 cases, date of appointment of adjudicating officer is after the date of show cause notice which are essentially show causes issued by enquiry officer, these have been taken as enquiry cases.
4. In one case, no show cause notice has been issued, hence the date of show cause cannot be analysed.
5. To ascertain whether the outcome of SAT order was in favour of SEBI/ Appellant, following assumptions have been made:
Appeals decided in favour of Appellant comprise of cases where the order has Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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been completely set aside or the monetary penalty has been reduced to zero.
Appeals decided in favour of SEBI consist of cases where there is no reduction in the penalty or the order has been withheld by Appellant. Cases withdrawn unconditionally or cases settled thru consent order have been also clubbed under the category of favourable to SEBI.
Appeals where the order has been withheld but the quantum or conditions or amount of penalty has been reduced by Appellate have been taken as Relief to Appellant. In case the order has been sent back to SEBI for further investigation or a fresh order have been also considered as relief to Appellant.
6. In order to determine the nature of violations, data has been clubbed in the following manner:
a) Price Manipulation comprises of the cases where promoters or directors or broker or company has involved itself in synchronised/ circular/ cross deals to create artificial volume and rig securities prices. It also consists of cases whereby false or misleading corporate public announcements have been made or insider trading has been done.
b) Takeover violation comprises of the cases where the regulations relating to takeover code i.e. Disclosures of more than 2%/5% voting rights, shareholding pattern by the company have not been followed.
c) Investors grievances relate to the companies delays in dematerialisation of shares, non-redress of investors grievances, huge selling in the shares with an objective to defraud investors, delay in refund of investors funds, non-implementation of moral code of conduct to protect investors interest.
d) Violation of code of conduct of brokers encompass the cases where the brokers have not maintained proper books of accounts, segregation of client moneys and own funds, fund based activities, unauthorised terminals, KYC norms non-compliance etc.
e) Non responsiveness of summons issued by SEBI includes the cases of zero response or non-cooperation as to the quantum & timeliness of information submitted.
f) Failure to pay stock broker registration charges on a timely basis.
g) IPO manipulation includes the cases where fraudulent financing of IPOs have been done to oversubscribe the shares and make disproportionate profits on the date of listing or create benami shareholding. It also includes subscription to avoid under subscription of shares.
7. This study cannot comment on final collection of the penalty amount by SEBI.
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Observations 1. Nature of Offence We have identified the nature of violations by categorising them as under:
In our study, most of the cases pertain to share price manipulation or IPO manipulation (56%), Stock Broker code of conduct violations (15%), Takeover Code Violation (12%). This reflects the state of securities market where securities price manoeuvring is rampant either at the time of issue of shares or later through means of circular trades, synchronised deals and cross deals. In such fictitious transactions the beneficial ownership in the scrip does not change but artificial volumes are created, perhaps to lure common investors. In such cases the price is not derived by fair market mechanism but by creating an artificial buying pressure. However more research is required to comment upon SEBIs detection and disciplinarian role in such cases.
49 15 12 8 7 6 2 1 Nature of Offence Share Price Manipulation Stock Broker Code of Conduct Violation Takeover Code Violation Investors Grievances IPO Manipulation Non Responsiveness to summons issued Non Payment of Broker Registration Fees Listing Agreement Violation Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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2) Nature of Penalty The amount and nature of penalties are laid down in Section 15 of SEBI Act. The penalties in our sample are:
In 73% of the cases monetary penalty has been charged. A further analysis of the penalties has been done in the following section on disposal of cases.
3) Disposal of Appeals
In 49% of the cases the appeal has been decided in favour of SEBI and remaining 51% cases the appellant has given full or partial relief to appellant. In 49 cases which have been determined in favour of SEBI, a monetary penalty of Rs 296.50 lacs have been levied. In 51 cases where the appellant has received full or partial relief, calculation has been done to establish the amount of penalties waived by SAT. To facilitate the waiver calculation 11 cases have been excluded for the following reasons: 73 15 3 8 1 Nature of Penalty Monetary Debarred from dealings in securities market Debarred from dealings in securities market & Monetary 49 34 17 Disposal of Appeals in Favour of SEBI Relief to Appellant Appellant Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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a) Impounding of money by SEBI and then ordered to refund the amount so impounded to the appellant.
b) Cases with monetary penalty sent back to SEBI for fresh order forming part of relief to appellant have not been considered.
c) Debarment from dealing in securities or cancellation of share broker certificate.
In remaining 40 cases the penalty has been waived by 90% bringing from Rs.997.05 lacs in the original order to Rs 101 lacs in SAT orders. This shows a degree of ambiguity in the basis of penalties levied by SEBI and also in the policy of reversal later on.
4) Ageing Analysis of Cases
- 10 20 30 40 50 60 Date of offence vs Date of appointment of AO Date of appointment of AO vs show cause notice Date Date of AO order vs show cause notice Date Date of AO order vs offence Date Date of SAT order vs AO order Date Date of SAT order vs offence Date N o .
o f
O r d e r s
Ageing Analysis of SAT Orders and AO Orders Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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Interpretations: i. A comparison of date of offence with date of appointment of adjudicating officer to examine the time taken by SEBI to start punitive action in case of default: In the 68 cases where date of appointment of AO is available, in 25% cases the AO has been appointed within a year. However in 35% of the cases it took more than 4 years for SEBI to appoint an AO. That is, there is a delay of as long as 4 years to appoint an AO from the time of violation. This may result in loss of evidence and increase the investors losses.
ii. A comparison of date of appointment of AO with date of issue of Show Cause Notice to determine the time taken by AO to initiate adjudicating proceedings against the violator: Out of 62 cases on which data was available, in 65% cases AO has issued show cause notice within 6 months, whereas in 32% cases it took more than 6 months to issue the same. In 4% cases the show cause notice was issued after 36 months. In certain AO/ SEBI orders we have found instances of transfer of the adjudicating officer resulting in unwarranted delays. There is no prescribed standard time within which the AO is required to issue a show cause notice, which leaves room for discretion.
iii. A comparison of the date of order by AO/ SEBI with the date of Show Cause Notice to determine the amount taken to complete the process of enquiry after the notice has been sent to the violator: In 37% of the cases the proceedings have been completed in one year. However in 40% cases it took more than 2 years to complete proceedings. Such long periods carry the risk of the defaulter becoming untraceable, destruction of circumstantial evidence and increasing investor losses.
iv. A comparison of date of order by AO/SEBI with time when the offence was committed to determine the time taken to actually punish the violation: In 25% cases the order is passed within 3 years whereas in 56% cases it takes more than 5 years to pass an order.
v. A comparison of date of SAT order with the date of passing an order by AO/ SEBI to find the time taken by SAT to complete the appellate proceedings: In 59% of the cases SAT proceedings have been completed within 6 months. This shows efficiency in disposal of cases by SAT.
vi. A comparison of the date of SAT order with date of offence to ascertain the time lag between the time of non-compliance and the final indictment after first leg of appeal process is complete: It takes more than 5 years in 64% of the cases from the time of offence to the time of disposal of appeal at SAT with 16% in more than 9 years bracket. The above analysis shows that the investigation and appeals process is slow, often arbitrary and opaque. While the process framework is good and in line with best practices of justice and fair play, the problem lies in the implementation in routine Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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everyday cases. The entire process of enquiry, adjudication, trial, decision and appeal must be streamlined and the reasonable time frame strictly enforced to help SEBI perform its role as a good gatekeeper of corporate governance.
4.4 Study the mechanism of Consent Orders and analyse its prevalence, effectiveness as a deterrent and transparency of the system According to the SEBI guidelines of April 2007, a consent order means "an order settling administrative or civil proceedings between the regulator and a person (Party) who may prima facie be found to have violated securities laws. It may settle all issues or reserve an issue or claim, but it must precisely state what issues or claims are being reserved. A consent order may or may not include a determination that a violation has occurred."
Consent order allows compounding of offence whereby an accused pays compounding charges in lieu of undergoing consequences of prosecution. Consent orders were introduced with an objective of appropriate action, remedy and deterrence without resorting to litigation, lengthy proceedings and consequent delays. Consent Orders can be passed in respect of all types of enforcement or remedial actions including administrative proceedings and civil actions. Any person who is notified that a proceeding may or will be initiated/instituted against him/her, or any party to a proceeding already initiated/instituted, may, at any time, propose in writing for settlement.
Consent orders are aimed to reduce the regulatory cost, time and effort spent on pursuing enforcement actions. We have analyzed a few consent orders to determine the efficacy of the entire process. This has been done in the following parts:
Analysis of consent orders over a period of two years from September 1, 2009 to September 30, 2011.
ii) Sample Study of 100 consent orders from May 1, 2009 to September 30, 2011 covering takeover regulations.
i. Analysis of consent orders over a period of two years from September 1, 2009 to September 30, 2011
During the period of two years beginning September 2009 a total of 379 consent orders have been passed. (Source: www/sebi.gov.in)
ii. The consent orders have been plotted quarterly and monthly in the under mentioned tables and graphs.
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The data portrays a declining trend in the number of consent orders issued from as high as 37 cases in month of September 2009 to 10 cases in September 2009. The reason can be on account of negative media opinion on the procedures followed in passing consent orders.
The data pertaining to two years showed multiple consent orders passed for the same applicant. In the cases of 12 applicants, repetition ranging from 2 to 4 consent orders has been observed. However the study cannot comment on group entities or persons acting in concert with different names of the applicants.
SEBI consent order scheme aims to achieve litigation free alternative of achieving justice and discipline but over enthusiasm towards this process may dissuade the honest law abiders. This may also help the offenders to relieve themselves of severe regulatory action by paying a paltry sum of penalty. One of the considerations for passing consent order and compounding charges is applicants past record that is it has not been found guilty of similar or serious violations in the past. However by allowing multiple consent orders from the same violator may encourage tendency of violations without any fear of law and its consequences.
0 10 20 30 40 50 60 70 80 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Number of orders Quarterly Number of orders Quarterly Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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ii) Sample Study of 100 consent orders from May 1, 2009 to September 30, 2011 covering takeover regulations.
A sample of 100 consent orders was studied for the following points:
Name of Applicant Date of consent order Year/ Date of offence Amount of Penalty Imposed Date of Application for consent order Denial/ Admission of Guilt 23
The above parameters were analyzed on the following criteria:
1. Consent Order Date vs Application Date A comparison has been made between the date of consent order issued by SEBI and the date of application filed by applicant requesting settlement by way of consent. In case of multiple applicants filing application, first date has been considered as the date of application.
Time taken to complete the consent proceedings has been tabulated as under:
To conclude 53% of the cases are resolved within 180 days, 28% cases take 180-360 days and remaining 19% cases are resolved in more than 360 days. Thus SEBIs objective of avoiding lengthy legal proceedings, delays in litigation fulfilled with the help of consent orders.
2. Date of Offence is defined as the date when the said regulation was not followed as per the text of consent order. In cases where such date is not clearly mentioned, date of
23 Source: www.takeovercode.com, www.sebi.gov.in, www.watchoutinvestors.com 2 20 31 21 7 19 0 5 10 15 20 25 30 35 0-60 days 60-120 days 120- 180 days 180- 270 days 270- 360 days More than 360 days Number of cases Number of cases Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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offence has been taken as middle of the year; in case year only mentioned, in case date not available date of adjudication, in case date of adjudication is not available then date of show cause notice sent by SEBI is taken; in case of multiple failures of continuous nature over a period of time, an average date has been taken & in other cases the first date taken.
In case of suo motto applications when date of offence could not be ascertained as above, date of application has been taken as the date of offence.
Ageing of the cases on the date of passing consent order date taking into account the date of offence has been captured as under:
From the above it can be concluded that 35% of the cases which are more than 7 years old have been settled by way of consent order, which is may be the only way to recover dues but 24% of the cases are less than 12 months old where SEBI could have taken the normal route of prosecution which could be a stronger deterrent than consent order.
There are no clear guidelines which determine which type of cases may be settled through the consent order route, leaving considerable scope for discretion.
11 13 14 2 5 7 3 10 11 24 0 5 10 15 20 25 30 less than 6 months 6 months to 12 months 12 months to 24 months 24 months to 36 months 36 months to 48 months 48 months to 60 months 60 months to 72 months 72 months to 84 months 84 months to 96 months More than 96 months Number of cases Number of cases Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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3. Penalty Levied under Consent Order As per Section 15 of SEBI Act, Chapter V the penalty that can be levied for delay in filling information/ return, to enter into agreement, to redress investors grievances etc. has to be Rs 1,00,000 per day subject to maximum of Rs 100,00,000. In case of mutual funds, stock brokers, asset management companies, additional limits have been also specified. In case of insider trading, non- disclosure of acquisition of shares and take overs, fraudulent and unfair trade practices penalty is 3 times the amount of profit made out of such practice or Rs 250,000,000 whichever is higher.
Thus, theoretically at least, in the sample of 100 cases, SEBI could have levied a minimum penalty of Rs 100 lacs and in some cases Rs 2,500 lacs also.
However the results differ substantially as is mentioned in the table:
In 58% of the cases penalty levied is less than Rs 3 lacs. This points to the revenue loss to SEBI and weaker monetary deterrent for regulatory lapses.
As per Section 15J of SEBI Act, the adjudicating officer while determining the quantum of penalty should consider amount of disproportionate gain/ unfair advantage accruing to defaultee, amount of loss caused to investor group and the repetitive nature of default. Compounding of offences has been allowed under the SEBI Circular of Consent Order in lieu of prosecution. However an attempt to determine the basis of the penalties levied as part of the study has remained inconclusive.
We have mapped the amount of penalty levied and the ageing of the case and the results are: 13 9 36 15 15 6 3 2 1 0 5 10 15 20 25 30 35 40 less than equal to Rs 50,000 Rs 50,000 to Rs 1lac Rs 1 lac to Rs 3 lacs Rs 3 lac to Rs 5 lacs Rs 5 lacs to Rs 8 lacs Rs 8 lacs to Rs 12 lacs Rs 12 lacs to Rs 20 lacs Rs 20 lacs to Rs 50 lacs > Rs 50 lacs Number of cases Number of cases Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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No Conclusive correlation can be drawn between the ageing of the case and the amount of penalty levied.
It is difficult to determine whether SEBI has truly taken into account the magnitude of the default and loss to common investors while passing the consent orders. The results of the study shows subjectivity in the amount of penalty recovered.
4) Admission/ Denial of Guilt
As per the SEBI circular on consent orders, Consent orders can be passed either a) admitting guilt or b) without admitting or denying guilt.
In 60% of the sample consent order cases, settlement has been reached with the applicant without admitting or denying guilt which is specifically mentioned in the Consent Order. However, in remaining 40% of the cases do not mention the words neither admission nor denial of guilt or similar words to indicate this and therefore has been assumed here to be the applicants admission of guilt.
- 5 10 15 20 25 30 35 40 less than equal to Rs 50,000 Rs 50,000 to Rs 1lac Rs 1 lac to Rs 3 lacs Rs 3 lac to Rs 5 lacs Rs 5 lacs to Rs 8 lacs Rs 8 lacs to Rs 12 lacs Rs 12 lacs to Rs 20 lacs Rs 20 lacs to Rs 50 lacs > Rs 50 lacs > 8 years 7 to 8 years 6 to 7 years 5 to 6 years 4 to 5 years 3 to 4 years 2 to 3 years 1 to 2 years < 1 year Amount in Rupees Lacs N o .
o f
O r d e r s
Penalty Compared with Ageing of the Case Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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However, no correlation can be derived between the amount of penalty levied and denial/ admission of guilt on the above assumption.
40 60 Number of cases Admission Neither admission nor denial - 5 10 15 20 25 30 35 40 less than equal to Rs 50,000 Rs 50,000 to Rs 1lac Rs 1 lac to Rs 3 lacs Rs 3 lac to Rs 5 lacs Rs 5 lacs to Rs 8 lacs Rs 8 lacs to Rs 12 lacs Rs 12 lacs to Rs 20 lacs Rs 20 lacs to Rs 50 lacs > Rs 50 lacs Neither admission nor denial Admission cases Penality Compared with Admission or Denial of Guilt N o .
o f
O r d e r s Amount in Rupees Lacs Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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5) Suo Motto
In 13 out of sample 100 cases the applicant has suo motto filled for settlement through consent before initiation of the adjudication proceedings by SEBI. In 3 out of these 13 suo motto cases the settlement is without admission or denial of guilt pointing towards opacity of the entire process.
In other 87 cases the consent application has been filled during the adjudication proceedings.
The system of consent orders may be effective for settling cases but it lacks transparency and is marred with opacity in terms of
The amount of penalties to be levied. Non acceptance of new cases on the parameter of time of default. Compounding of offences Time limit for reaching settlement Criterion for accepting applications in case of repeat offenders
We also noticed that the Adjudicating Officer is very powerful in the entire process by playing a significant role in the issue of showcause notices, enquiry, forwarding the case for settlement and approving authority in consent orders which calls for greater transparency and clearer guidelines.
We conclude that SEBI has played a big role in instituting a basic standard of corporate governance in the country, albeit only for listed companies. However, research shows that if one sector of an economy displays certain behaviour, there is a spill-off effect on other sectors as well and thus, corporate governance norms in listed companies may reasonably be expected to influence adoption of such practices in unlisted companies and other businesses too. The study could not find any conclusive evidence that adopting corporate governance norms as mandated by SEBI has any improvement on corporate performance as measured by accepted standards of Return on Assets or Return on Equity. While profitability per se as well as share prices have shown a consistent upward trend, there is no clear evidence that this is because of improved corporate governance alone and not a mix of macro economic factors. G Sabarinathan 24 conducts a review of the SEBIs performance on areas such as disclosures, corporate governance etc. Overall, the analysis in Sabarinathan (2010) indicates that SEBI has led the effort in improving standards of corporate governance in India in companies that are already listed and are about to be listed. It is hard to say whether that is the result of poor legal preparation on the part of SEBI or the leniency of the appellate systems towards the trade.
24 SEBIs Regulation of the Indian Securities Market: A Critical Review of the Major Developments, G. Sabarinathan Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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Similarly, SEBIs record in enforcing the canons of corporate governance has not been impressive. The reason for the same may partly be the regulatory arbitrage that has been noted earlier due to the joint responsibility for oversight of companies between the MCA and SEBI. For reasons that are understandable, the two agencies approach regulatory oversight somewhat differently and are endowed with different organizational and legal capacities in the enforcement of their regulatory remit. The Indian corporate sector took advantage of this arbitrage when it successfully pushed back the initial, more demanding set of recommendations of the Committee headed Mr Narayana Murthy. Black and Khanna (2007) have tried to estimate the impact of compliance with Clause 49 on the market valuation of companies in India. It concludes that faster growing firms gained more than other firms, consistent with firms that need external equity capital benefiting more from governance rules. Cross-listed firms gained more than other firms, suggesting that local regulation can sometimes complement, rather than substitute for, the benefits of cross-listing. The positive reaction of large Indian firms contrasts with the mixed reaction to the Sarbanes- Oxley Act (which is similar to Clause 49 in important respects), suggesting that the value of mandatory governance rules may depend on a countrys prior institutional environment 25 . Although SEBI is a young institution it has been fairly successful in fulfilling its mandate as the capital market regulator, ensuring deepening of markets and increasing participation of investors. However the enforcement process tends to be somewhat arbitrary and rather opaque and leaves scope for discretion in the hands of officials. The system of enforcement is also slow as these statistics show: As per Annual Report of SEBI for 2010-2011, Page 110- Page 112, there are 3,493 pending cases as on March 31, 2011. On analysis of these cases we find that as many as 32% of the pending cases have an ageing of 6 or more than 6 years while 28% of the cases have been pending for 3 to 5 years (Annexure I). During the year 2010-11 a total of 1801 cases have been disposed off by SEBI; out of these, 9% of the cases pertain to 2004-2005 or years before almost more than 6 years old, 41% of the disposed cases are 3-5 years old. Only 18% of the cases pertain to 2010-2011. (Annexure II). The enforcement system needs to be made more transparent to ensure greater confidence in capital markets. While the inherent spirit of framework is robust and in line with best practices of bringing timely justice and fair play, the problem lies in the implementation which needs to be more effective for capital markets to be buoyant and transparent.
25 Khanna, Vikramaditya S. and Black, Bernard S., Can Corporate Governance Reforms Increase Firms Market Values? Evidence from India, Journal of Empirical Legal Studies, Vol 4, 2007: ECGI-Finance Working Paper no. 159/2007; University of Michigan Law & Economics, Olin Working Paper No.07-002. http://ssrn.com/abstract=914440) Study on the State of Corporate Governance in India Gatekeepers of Corporate Governance Securities Exchange Board of India
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ANNEXURES
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Annexure I SEBI
As per Annual Report of SEBI for 2010-2011, Page 110- Page 112, there are 3,493 pending cases as on March 31, 2011. The details of the cases are as follows: