How government can also benefit from better corporate governance

Indian capital markets have grown tremendously, in multiple dimensions, since 1991. This year is widely regarded as the milestone year with the onset of a liberal and capital-attractive economy.

The public capital markets were opened to foreign portfolio investors (IFPs) in 1992. This led to a significant amount of portfolio capital flows into the country and, in turn, led to an increased availability of funds for economic agents, stimulating foreign capital. foreign exchange reserves, and improved trading volumes and liquidity on the stock exchanges.

Around the same time, in the early 1990s, the mutual fund industry (CPF) opened up to the private sector. This has helped channel a significant amount of savings from the household sector to capital markets.

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However, there has been another very important impact of opening up the stock markets to REITs and MFs. Listed companies have been subjected to a higher level of scrutiny and market discipline than before.

Of course, our laws and our institutional framework have also strengthened considerably over the years. As a result of these factors, companies in general have adopted an increasingly higher level of corporate governance standards.

Of course, over time companies have gone through phases of reluctance, hesitation, acquiescence, acceptance and finally celebration of the idea of ​​good corporate governance.

At the same time, there are still great variations in the standards demonstrated by companies across various groups of promoters.

There are two key factors that could lead a company to embrace the idea of ​​a strong corporate governance framework.

The first and most commonly observed reason is the constraint due to various laws and regulations.

This leads to an attitude focused on compliance. The second factor is the company’s awareness that adopting a higher standard would, in the long run, reward management and controlling shareholders far more than the cost of adoption to them. This leads to a happier adoption of the highest standards.

I speak here consciously of the motivations of management and controlling shareholders (M&S), rather than of all stakeholders. This is because the former has key control over the practices followed by the company.

This relates, fundamentally, to the idea of ​​incentives that determine the behavior and performance of agents in real life.

M&S have traditionally often won at the expense of other stakeholders, using questionable methods in favor of the former.

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However, M&S also increasingly realize that over the longer term, stock markets reward companies with progressive corporate governance standards.

The rewards are in fact significantly higher than what M&S ​​could earn through direct benefits, using questionable methods. So M&S who have insightful minds and eyes have turned to improved corporate governance practices. We must thank, for this, the high levels of disclosure, transparency and efficiency brought to our stock markets.

Interestingly, public sector units (PSUs) are also often arrested for poor corporate governance practices. Their counterparts in the private sector are generally blamed for the greed of M&S that is at the root of their bad practices.

PSUs are more institutionally oriented and therefore should not be subject to malicious practices motivated by greed. However, the key factor in the case of PSUs is ignorance as well as the short-sighted approach taken by their controlling shareholders, ie the government of the day.

The ignorance of government officials about the trade-offs involved in the areas of corporate finance and capital markets often leads to their poor decision-making results.

There is pressure on PSUs to pay high dividends or invest in unprofitable projects, simply to meet the needs of fiscal stimulus or short-term output growth.

The government does not appreciate the long-term negative impact on the companies concerned. As an example, Coal India could have invested a lot more instead of paying dividends, and Air India should have received a lot less investment than it actually received over the years.

A recent example of confusion in decision making was seen in the case of the Indian Rail Catering and Ticketing Corporation (IRCTC). The government has decided to request a 50% share of commodity fee revenue earned by IRCTC.

In one day, he reversed his own decision. It is not known how the government arrived at its initial decision. Of course, the government maintains many relationships with the IRCTC.

He is the licensor, the client and the majority shareholder of the latter. Many government decisions regarding PSUs can have contradictory impacts on other stakeholders, or even on itself because of its multiple relationships.

The expected increase in revenues shared by IRCTC with government would have increased government revenues. Yet, due to the sharp drop in the IRCTC’s stock price, the government reportedly lost considerable wealth, which would have been far greater than the accumulated profits, over the following years, thanks to the increase in income.

The turnaround in his decision showed that he understood the negative effect of his initial announcement, but hadn’t given it much thought.

The biggest question is this. Do controlling shareholders, including government, understand how to make decisions that maximize their benefits? Do they adopt logical frameworks, or do they just follow their instincts or take simplistic approaches to making important decisions that impact all stakeholders in a business?

There are frameworks available to help M&S make optimal decisions and they should use them to their own advantage. These would also be part of a good corporate governance framework.

Without a carefully designed decision-making framework, businesses and stakeholders will often be rocked by negative outcomes, or worse yet, a possible threat to their own prosperity or existence.

(The author is Associate Professor, Finance at SPJIMR Bhavan.)

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