Monday, May 01, 2006

Corporate (Mis)Governance Index

I would like to share some of the methods I use to quantify "Lack of
Corporate Governance". These simple and unorthodox methods may not
sound convincing but they work.

In 2003 I realized that most of my mistakes in past 2 years were
occurring due to inability to filter out dishonest managements. After
looking various texts I was unable to come out with anything concrete.
That year I started work on a Corporate (Mis)Governance Index.

I would admit that
1.The initial target was to create a Corporate Governance Index. After
failing on this I tried the reverse and created Corporate
(Mis)Governance Index.
2. Initially I was skeptical of any success in this project. But the
experience of last 3 years has shown that these homegrown tricks are
better than having no clue.

here is the methodology I use(Don't laugh at it till you try!!)
1. Check board composition.
variables :
a. Number of people of the same surname in the board i.e. no of
Ambani's in RIL board. With some knowledge you can also add related
surnames:). Check both absolute and percentage of total board strength
Interpretation: >3 or 16.66% means bad, >4 or >25% is too bad

b. Number of executive directors from the pervious set (point a)
Interpretation: Little fuzzy here. If the ratio is too high that means
they are paying all their uncles and nephews fat salaries. If its too
low it means they have added even 'Mataa jii' to the board.

c. Find number of non-working directors. (Mother's, sons, daughters of
main promotor who never attend a board meeting)
Criteria: people who skipped more than 1/3 of the board meetings. Give
AGM, EGMs extra weightage.
Interpretation: This is to find the how many of the family members are
there on board just for the heck of it. Sometimes it also points out
independent directors who are just pawns of promoters.

d. Total salaries + commissions + bonuses as a percentage of Net
profits (take average of last 3 year's profit because 100% jump in
profit shouldn't mean 100% hike in salaries)

e. Check the history of equity dilution. You can find this in any
financial website like IciciDirect.
Search for word preferential allotment. Can't find it use google!
Interpretation: Preferential allotment at low prices is the most
misused tool in the times of bearish markets.

f. Check history of mergers and acquisitions. If you find that there
are acquisitions of companies where promoters held 100% stake, you can
be sure that the parent company would have paid hefty price.

g. Similarly check for the divestment/ de-mergers /sellouts. Check the
price the company got out of them and who bought the assets.

h. You can also check the ratio of independant directors. In my tests
it hasn't helped in a single case(not sure why)

The data about points a -d is available on the annual reports. Don't
ignore the corporate communications that the companies send as
worthless crap. Atleast read the salary increases part!.

As for f, g, h experience helps. One reason why I never start with
high investment ina company is that it takes time to come to know
about a company. Once you hold some stake your eyes are on lookout for
news about the company and you would learn to see the instances of

Some interesting cases of high Corporate MisGovernance Index
1. Penta Media (scored on virtually every point)
2. Reliance group (scored very high on a-d)
3. Sah petroleum (small company which came out with IPO. The faily
members take 8.5% of profits home!!)

Some of the companies from LWb Special whose scrored were relatively
higher are Jindal Steel and Power & Sterlite.

The companies which scroed zero on Corporate MisGovernance Index
include HDFC, ITC, HLL, INFY. It just shows that this index is not
exhaustive enough to measure MisGovernance by professionals.

Surprisingly all PSU's scored low on Corporate MisGovernance Index.
may be that's becasue the index doesn't measure lack of
disclosures/lack of foresight etc.

1 comment:


Corporate Governance is for the birds.