Scams on 2G, loan-for-bribes and other suspected accounting frauds came to light. These have underlined that investors should invest in companies with good corporate governance practices. Corporate governance goes beyond disclosures that a company makes.
Board composition:
board of a company with good corporate governance has more independent members and professionals with repute. This helps to bring diverse expertise and improvise in business decisions and strategic thinking. If you look at the board at Infosys, not only are more than half of independent professionals drawn from varied fields; the position of chairman and managing director is also held by two different persons, so that corporate power is not concentrated in one individual.
Share price volatility:
of companies with good governance are less volatile as compared to the others. Check the beta measure for Infosys or HDFC and compare it to that of companies mentioned in the 2G scam to realise the difference.
Disclosures: Companies with good governance practices are transparent in disclosing material information to its stake holders. The disclosure a company usually makes is on changes in shareholding pattern, financial results, acquisitions and other material information. It is also important that there should not be any insider trading on account of this information. Explaining what is being done is important. For instance, in the much-reported buyout of Honda from Hero Honda by the Hero Group, the price of buyout and the royalty payment to be made to Honda in future is still a secret. This has agitated some minority shareholders.
Financial results: Companies with good governance give steady financial performance. They usually have a healthy net worth and a good cash flow position. It is important to know the auditors of go through the financial results and audit report with a fine comb to look for any qualifications or observations made by the auditors. Many a time, the notes to accounts provide insight into the accounting pracwhere the income and cash figures were inflated for years.
Good investor service: Companies with good governance have shareholder wealth creation as a prime objective and provide good investor services. They survey, take feedback and suggestions. Beside providing easy access on information to shareholders. Infosys puts on its website the Many a per cent, respectively. However, Ispat and MTNL, mentioned in Table 2, have eroded shareholder wealth by 24 and 20 per cent in the three-year span.
Market valuation: Again, the companies mentioned in Table 1 have a better ratio in terms of price-to-earnings (PE) and price-to-book value (P/BV). In spite of their rich valuation, they have consistently rewarded their shareholders. Whereas, those in Table 2 have eroded investors' wealth. The above data clearly show the companies with better market perception have outperformed the market returns handsomely. They are able to get better valuation in terms of P/E ratio and P/BV ratio. Due to their financial strength, they are able to raise capital and service it at ease. The objective of any company is to generate shareholder wealth. Having transparent procedures and proper disclosure, is the need of the hour. Good governance gives good valuation and better business prospects. A good guide for investing your money.