Where Angels Prey

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

Wednesday, January 19, 2011

Does A Five Star Board Guarantee Good Corporate Governance in MFIs?

Ramesh S Arunachalam
Rural Finance Practitioner

A common judgment made with regard to Corporate Governance has often and repeatedly proved costly. Very often, people look at members of the board as a surrogate for good corporate governance and Micro-finance is no exception…

If you look at the credit rating reports of MFIs in the last few years and especially, those pertaining to some of India’s largest MFIs, the above is apparent…Most of these reports[i] use the presence of a five star board to claim that governance in these MFIs is very good.

Yet, as the last few months have shown, there could be serious governance and related violations in some MFIs…as espoused by the granting of a huge loan to the founder to buy shares in the MFI…to sacking of the CEO of a large MFI who had just led the company through a spectacular IPO…to turbo charging growth and tweaking performance through multiple, over and ghost lending to attract equity investment at a premium and build wealth for themselves and their shareholders and so on and so forth.

What is interesting is that all of these happened despite the concerned MFI boards having so called ‘5 star’ board members… and despite institutional representation on the boards…of these MFIs…

Therefore, using board membership as a surrogate for good Corporate Governance is fraught with danger and I hope that credit rating companies do not use this in the future…the damage created by the use of this inappropriate surrogate is already huge…as the lessons from India’s largest corporate failure suggests…Read on…

“It was the autumn of 2008 and Satyam Company Secretary G Jayaraman was beaming. For the second time in six years, India's IT outsourcer had walked away with the coveted Golden Peacock Award for excellence in corporate governance, an award instituted by the World Council for Corporate Governance.

Later that week, Vadlamani Srinivas proudly told the press that the award was 'a testament to our [Satyam's] efforts to continually innovate corporate governance best practices in the industry.' The Golden Peacock was not the first award that year. In April, a global investor relations firm MZ Consult ranked Satyam among the top five companies in the Asia-Pacific region in the financial disclosure procedures category. 'We are pleased to be recognised...

Our practices are designed to provide complete, accurate, timely information in clear formats,' said Vadlamani Srinivas. To the corporate world, Satyam's hubris was well earned. After all it had all the bells and whistles required of a well-governed modern-day company.

Sat yam's five star board of directors, as on- lookers liked to call it, had just the right number of independent directors with just the right credentials-eminent scholars and administrators.  Also, Sat yam had Price Waterhouse-one of the big four audit firms-as the statutory auditor.

All was well with Satyam's world-or so everyone thought.

Two blows dealt to the company's image within a span of one month ended Sat yam's high-prized innocence-the fateful and insane board decision taken on 16 December and then Mr Ramalinga Raju's confession of false invoicing of 7 January.

Never in the history of corporate India has a company fallen so hard and fast. And everyone, from investors to experts, attributes this to the failure of the company's corporate governance controls. In fact, all events surrounding the scam-the aborted Maytas bid, World Bank barring the company from all Bank contracts-were being linked to the way Satyam was governed.”[ii]

Therefore, if Mr Ramalinga Raju created false invoices to show better operating performance to create greater wealth for shareholders/himself and bring in more investments and use this vicious cycle of maniupulation, there appears to be a parallel in micro-finance as well, especially regarding Corporate Governance and other practices. Some MFIs seem to have used similar practices to grow inorganically - as has happened during April 2007 to March 2009 (and there is hard data available) and thereafter – and attract huge equity investment at a premium and the investors perhaps forced these MFIs to grow faster so as to recover their premium investments quickly and the cycle continued…. We all saw what this could do in terms of the following – a) multiple lending; b) over lending not commensurate with the loan absorption and debt servicing capacity of the clients; c) ghost lending; d) large focus on consumption loans; e) use of agents to turbo charge growth and several other issues…leading to what is now famously described as the 2010 AP micro-finance crisis caused by huge levels of indebtedness amongst the poor and other factors…
Satyam, had won every conceivable Corporate Goverance award and yet, it (then) blatantly violated every single CORPORATE GOVERNANCE rule. Likewise, there are also some Indian MFIs who top the global charts for the Corporate Governance awards in micro-finance while in reality, perhaps, engaging in not-so-good (NSG) and non-transparent (NT) governance and other practices – in areas such as - board practices (including meetings, minutes, sub-committees), shareholding, compensation for senior management and board members, appointment (there is so much conflict of interest) and compensation of independent directors, presentation of results and operating performance, systems and the like.
And many of these MFIs have been cited as having good governance just because they had a famous board. Therefore, having a high profile board and/or winning Corporate Governance awards, does not automatically guarantee Good Corporate Governance in MFIs. And let us be clear on that…as for a variety of reasons, board members may be not so active and/or have a disconnect with the CEO and senior management…
Therefore, the key point is that Corporate Governance has to be ensured by appropriate regulation and supervision (both on and off site) and other means including enhancing accountability of auditors and third party supervisors (like externally appointed internal auditors and/or rating agencies, without conflict of interest), incentivizing MFIs/organizations for appointment of truly independent directors (IDs) and making IDs responsible/liable for Board decisions, presentation of Operating Performance and the like
And as Dr N R Narayana Murthy stated, 'Corporate governance…is about maximizing shareholder value legally, ethically and on a sustainable basis, while ensuring fairness to every stakeholder-the company's customers, employees, investors, vendor-partners, the government of the land and the community.'

And the regulators should not give up their roles in ensuring this as self regulation has not and will not work…and I sincerely hope that SEBI and RBI (including The Malegam Committee) work together to frame (and bring into force) appropriate Corporate Governance guidelines for all NBFC MFIs including those that are listed as well as those that aspire to be listed…

Forthcoming (This Week and Thereafter):

1)      The Self Regulation Experience in Indian Micro-Finance: Critical Issues to Ponder….
2)      Is the Current Indian MFI Business Model Flawed As Dr Rangarajan Argues?
3)      What is Responsible Finance and How to Ensure it Operationally?
4)      What does the IFMR Access to Finance Study Tell Us?

Plus More…

[i] While I can quote several examples from these credit rating reports, the idea is not to embarrass anyone and so, I have refrained from quoting these reports…
[ii] Source: Corporate Governance: The Indian Way, Aanand Pandey…In The Satyam Saga

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