Where Angels Prey

Where Angels Prey is a novel by Ramesh S Arunachalam. Please refer to www.whereangelsprey.com for more information

Wednesday, October 20, 2010

Corporate Governance in Indian MFIs: Critical Issues

Mr Ramalinga Raju, who created false invoices to show better operating performance to create greater wealth for himself/shareholders and bring in more investments, was a trend setter in Corporate (Mis) governance. There appears to be a parallel in micro-finance as well, especially regarding Corporate Governance practices.
Satyam, had won every conceivable Corporate Goverance award and yet, it (then) blatantly violated every single CORPORATE GOVERNANCE rule. Likewise, there are also several Indian MFIs who top the global charts for the Corporate Governance awards in micro-finance while in reality, perhaps, practicing not-so-good (NSG) and non-transparent (NT) governance – in areas such as - board practices (including meetings and minutes drafting), shareholding, compensation for senior management and board members, appointment (there is so much of conflict of interest) and compensation of independent directors, presentation of results and operating performance, systems and the like.
My Observations: Some of the largest and biggest Indian MFIs have a poor track record in Corporate Governance:
1.    Related Party Transactions: MFIs have provided huge loans to founder directors to enable them to buy shares in the same MFI (that the founders promoted in the first place)
2.    Whimsical Management Style: MFIs have suddenly terminated services of their senior management including CEOs, without any explanation and/or apparent reason. A live example is currently available…
3.    Black-Box Type Operations: MFI boards function like a black box and are very difficult to understand. MFI boards often use procedures and make decisions, in a non-transparent manner that may not necessarily be in the best interest of the MFI and/or its (minority) shareholders. The examples given in points 1 and 2 should suffice and there are numerous other examples
4.    Family/Friends as Board Members: Many MFI boards consist of members who are either friends and/or family of the founder and/or chief functionaries including CEOs. There are boards in MFIs where the father and/or the mother and/or the son and/or daughter and/or their spouses and/or their uncles are active members – prompting a friend to say that MFIs are Common Wealth of the families concerned. Sometimes, board members become more permanent than the furniture in the board room (as former SEBI chairman, Mr Damodaran said in a similar Indian context)
5.    Functioning of Independent Directors: Independent directors in Indian MFIs lack accountability and true independence in their functioning. Some of them are even compensated by way of stock options and the like – instruments that compromise their independent functioning. As noted in point 4 above, when independent directors owe their appointments to the promoter/CEO, then, it is very unlikely that they would be anything different than nodders (as Mr Damodaran has said in a similar context)
6.    Functioning of Nominee Directors: Strangely, even directors nominated by institutional investors are quite and sometimes, they do not even write a dissent note, when the board norms and procedures are violated. The current procedures adopted by institutional investors, to ensure the accountability (and effective functioning) of their nominee directors, also appears very weak. Examples 1 and 2 are a case in point and there are several such incidents available
7.    Compensation Practices: Irrational compensation of senior management, founder/other directors – much similar to that observed in financial services companies during the sub-prime and global financial crisis is observable today in Indian micro-finance. Adhoc bonuses, pay raises (followed by sudden termination), the grant of shares when options have been sanctioned, the non-transparent pricing of options, provision of loans to enable board members to buy own company shares are some of the key issues in Indian micro-finance
The key lesson for me is:
Having a high profile board and/or winning Corporate Governance awards, does not an automatically guarantee Good Corporate Governance in MFIs. 
It has to be ensured by:  
a) appropriate regulation and supervision (both on and off site)
b) using other means including enhancing accountability of auditors and third party supervisors (like externally appointed internal auditors and/or rating agencies), who are capable of challenging the MFI and its board, if and when required
c) incentivizing MFIs/organizations for appointment of truly independent directors (IDs) and making IDs responsible/liable for Board decisions, presentation of Operating Performance (results) and the like. In fact, board members must spend quality time at the MFI and should also become familiar with operations through discussions and field visists, and
d) penalising institutional investors who appoint and forget about the working of their nominee directors. The accountability of nominee directors to their (parent) investors must be enhanced

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