The US financial markets are in the throes of their biggest clean-up since the crash of 1929. A series of recent scandals reveal that the very core of the US financial system had decayed in the breakneck pursuit of the Mammon in the 1990s. The spectacular collapse of Enron, Global Crossing and investigations into Computer Associates, Xerox and half a dozen global biggies for inflating performance figures; Merrill Lynch’s settlement after its analysts were caught plugging crappy companies and obscene CEO salaries are symptomatic. These sordid cases have exposed the incestuous relationships between companies, bankers, research analysts and auditors under the cover of disclosure norms and corporate governance codes.
The problem is that the US way of doing business was not restricted to that country. They preached it to the world. Paul Krugman in his The New York Times column quotes Lawrence Summers (then Deputy secretary of the Treasury) 1998 speech saying: I would suggest to you that the single most important innovation shaping (America’s) capital market was the idea of generally accepted accounting principles. Summers, he says advised Asian economies, then in the middle of a disastrous financial crisis, to emulate American-style “transparency and disclosure.” Today, the claims lie in shreds and so-called disclosures that have turned out to be an elaborate cover for the collusive greed of companies and their fat-fee earning auditors, lawyers, consultants and investment bankers.
Meanwhile, Indian business houses and their bankers have lobbied to import several US practices into India and they come with the added bonus of a regulatory system that is slow, susceptible to pressures and reluctant to punish. Now that US regulators are letting in the harsh glare of sunlight to disinfect several pernicious practices, we too should effect a quick course correction. Fortunately, our slowness to adopt change makes our task that much easier. Let us examine a few areas that need change.
The claim by certain Indian companies and institutions that their accounts are more transparent and superior because they are cast according to US Gaap has to be questioned. The adoption of book-building as the best way to place Initial Public Offerings also needs re-examination. When investors charged that book-building allows for price manipulation and was unfair to the small guy, they were largely ignored. But maybe the small investors voice will probably be heard with a little more respect in the coming days. This is especially important in decision-making process itself. Investor groups allege that multi-disciplinary committees set up by financial regulators end up lobbying the case of the corporate sector. US investigations have revealed how true this is; after all, lawyers, chartered accountants and investment bankers who are separately represented in such committees are ranged on the side of corporate houses that pay their fees. The policy-making process needs to ensure that adequate weight is given to the investors voices in order to balance the lop-sided representation. Stock options and high CEO compensation are a matter of concern in both countries.
Krugman, author Michael Lewis and the legendary Warren Buffet have all zeroed in on obscene CEO compensations as the root of collusive practices, which created hugely, padded corporate profits. Krugman says that anything less than 20 per cent profit growth was considered a failure in the late 1990s and yet in 2000, CEOs paid themselves 458 times as much as ordinary workers even though profits hadn’t really increased. At the recent Annual General Meeting of Berkshire Hathaway, investment guru Warren Buffet, denounced the greed of CEOs and said that he had dumped their holding in one company after he saw what the CEO was paid.
Michel Lewis, who analysed Buffet’s concern, came up with Michael Eisner of Disney and Sandy Weill of Citigroup as the CEOs who are most likely to have offended Buffet with their avaricious compensation. CEO compensation is causing serious concern in India too. While in the US, most companies are professionally managed, CEO compensations, however unjustified, at least depended on performance. It is another matter that these numbers were carefully doctored with the help of friendly auditors. In India, family run companies are awarding themselves hefty salaries by manipulating shareholder meetings without even bothering about performance or the share price. This is especially true in the manufacturing sector where profits and stock prices have both plummeted in recent times. Yet, CEO salaries have soared to the point where they amount to a back door dividend to promoters, which ignores other investors.
Leading the Indian pack is Reliance Industries. Dhirubhai Ambani whose salary tops Rs 8.85 crore in 2001-01 followed by Mukesh and Anil Ambani with Rs 7.13 crore each. This adds a whopping Rs 23.11 crore, even after the company takes care of most major expenses including the corporate jets which ferry them to glitzy parties thrown by close political buddies. The two Munjals of Hero Honda took home Rs eight crore, but nobody is complaining yet because the company is doing well. The chairman of low profile Cadila group takes home Rs 3.81 crore, which is more than what several top companies pay their head honchos. His son Pankaj Patel pockets another Rs 3.91 crore and between them, they corner over 11 per cent of the company’s net profit. Hindustan lever, Dr Reddy’s, the Aditya Birla group, Infosys, ITC, Wipro and ICICI are among those whose high pay packets have attracted attention although only Dr Reddy’s is the only one really doing better year after year. The point here is that CEO compensations, which are now ratified by compensation committees are not performance based, and only allow industrialists and professional managers to reward one another through cross-directorships on company boards.
A third area where we need to train our attention is tip-spewing analysts and the business programmes that encourage them. Despite Securities and Exchange Board of India’s rule of analysts requiring to state their own market positions in relation recommendations, news channels such as NDTV rarely ask them to do so. Even CNBC, which is usually more meticulous, often forgets it. The US is debating a reform where research reports to disclose what percentage of the bank’s research reports include “buy” recommendations and what percentage recommend “sell” or “hold.” This would expose a bank that says buy all the time and almost never a sell.Indian regulators need to join the global clean up and initiate quick changes in our own systems too. -- Sucheta Dalal