Tuesday, March 9, 2010

Voluntary Nature of Corporate Governance Norms

For the last ten years, corporate governance norms in India have been a mandatory requirement for large listed companies, through Clause 49 of the listing agreement. However, in the recent round of reforms, the Ministry of Corporate Affairs has deviated from that path to set out voluntary guidelines for corporate governance (discussed earlier here). Even though these guidelines come in the wake of the Satyam episode, there seems to have been a conscious departure from the mandatory approach adopted by way of Sarbanes-Oxley Act in the U.S. in the aftermath of Enron and other scandals. The present step is more akin to the “comply or explain” approach followed by the Combined Code of Corporate Governance in the U.K.

A paper titled Corporate Governance in the UK: Is the Comply or Explain Approach Working? observes as follows:

We find that the Code fostered compliance, especially in the areas not covered by its forerunner, the Cadbury Code. In an encouraging sign, more than half of the non financial constituents of the FTSE350 were fully compliant with all provisions of the Code at the end of 2004. In addition, we found that on average less than 10% of all firms were not compliant with a given single provision.

However the picture is not so rosy when analyzing those firms that did not comply with the provisions of the Combined Code. We find that the firms that did not comply with the Code often did a very poor job of providing explanations. Even worse, in almost one in five cases, firms did not provide any explanations for their non-compliances at all. Further, even when an explanation is provided, most of the time it fails to identify specific circumstances that could justify such a deviation from the rule. Companies that do not comply tend to stick with the same (poor) explanation until they directly jump to compliance. Once compliant, either a company remains compliant or if it stops complying, does not provide convincing explanations as to why this is the case.
It is too early to judge whether similar results will emerge in India. The Voluntary Guidelines are quite recent and will have to be worked for sometime before they can be empirically verified.

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