For corporate India, closer scrutiny of financial numbers comes at a cost

In a recent survey conducted by international law firm Baker McKenzie involving 100 Indian C-suite executives, compliance and regulatory scrutiny were identified as the biggest macroeconomic challenge facing Indian business. These were also seen as the area of greatest cost increase over the next two years by business leaders.
 
While questions are being raised in investor circles over trustworthiness of corporate India’s balance sheet numbers, the recent instances of slip-ups on the governance front -- such as siphoning off funds to related parties, conflict of interest situations of promoters/key managerial person, disclosure levels on promoter holdings, pledging of promoter shares -- have not helped matters.
 
“Governance failures or audit deficiencies drive greater due diligence across the board for all companies, even those with good governance practices, and make deal completion longer and more cumbersome,” says Pallavi Gopinath Aney, principal, Baker McKenzie Wong & Leow.
 
Amarjit Chopra, former president of ICAI, the audit services regulator, agrees that integrity of Indian corporate promoters and the board members has become a matter of grave concern for foreign investors. “When your own banks are feeling shy of lending to Indian corporates, how do you expect foreign investors to enhance their stake and take the risk?” he asks.
 
Many financial experts and corporate lawyers are pained by the increasing instances coming to light where promoters under the garb of related party transactions and multi-layered corporate structures indulge in syphoning off funds and money laundering. Experts say window dressing of financial numbers is a common practice adopted by companies to improve the overall financial outlook and profitability of a company.
 
“Unfortunately, such practices have been witnessed not just in promoter-driven small private companies but also in public-listed entities with large market shares,” says V Lakshmikumaran, managing partner, Lakshmikumaran & Sridharan.
 
While regulators like the Securities and Exchange Board of India (Sebi) and the Ministry of Corporate Affairs have upped the ante on the compliance front over the last three-four years, most companies just about manage to “comply” with various rules and regulations and tick the right boxes, say experts.
 
“In many cases, promoters continue to effectively run their companies on a day-to-day basis, giving rise to a trust deficit around safeguarding the interests of other stakeholders in the company,” says Neeraj Gupta, partner -risk assurance services, PwC India.

 
Experts point out that divorce of ownership from management is yet to become a way of life in corporate India. In many cases, the effectiveness of the board is impeded by the members being hesitant to speak up and give feedback, whether to executive management or to their peers, says Gupta.
 
Auditors, independent directors and regulators have been at the receiving end of criticism for their respective roles or inadequate response to a situation that has been in the making over the last two-three years. “India Inc needs to go beyond the mandatory regulatory requirements to make investors comfortable and the balance sheet more trustworthy,” says Dinesh Kanabar, CEO, Dhruva Advisors.
 
The way forward, feel many experts, is independent directors, auditors, institutional investors and regulators enhance scrutiny of companies.  According to Shriram Subramanian, founder-managing director, InGovern Research Services, there is a need for greater diligence by boards of companies and auditors. “They owe a fiduciary responsibility to shareholders and hence, should be more transparent and fair to minority shareholders,” he adds.
 
Agrees Shailesh Haribhakti, chairman, Baker Tilly DHC: “Auditors are the first level of regulators and need to spruce up audit quality.” Haribhakti is in the process of setting up Centre for Improving Audit Quality, a not-for-profit company for training auditors, senior finance professionals, among others. 
 

The challenge, feel experts, is to make auditors and independent directors “truly independent”. Chopra suggests a change in the way independent directors and auditors are appointed to a company. A Sebi or Ministry of Corporate Affairs mandated panel for auditors and independent directors could be looked into, he says.
 
Sudhir Soni, national director and partner, assurance services, SR Batliboi & Co, feels the use of technology can enable auditors to test larger populations, as against the current sampling approach or reliance on controls.
 
Experts say to improve governance at the board level, there is a need for a pool of adequately qualified, trained independent directors who are provided adequate insight into the operations of the company.

To overcome regulatory oversight, experts agree that there is a need to strengthen resources made available to regulators for them to be more effective. Soni suggests that the regulatory focus should be on public interest entities. “Multiplicity of regulation needs to be avoided,” he adds.

Why companies are in the dock
 
The growing scrutiny of India Inc’s financial statements is a result of a combination of factors. These include:
 

• Growing level of non-performing assets in the banking sector is making  it difficult to borrow funds or pay back existing obligations
• Investors are wary of instances of window dressing of financial figures and adoption of  creative accounting practices by some promoters and management
• Recent instances of corporate frauds do not inspire confidence
• Corporate governance lapses
• Auditors not asking enough difficult questions 
• Regulatory oversight