Dangers of corporate governance failures

There is always a thin line between good and bad in corporate governance
"The RBI governor’s call for good corporate governance practices is a well-timed reminder."
"The RBI governor’s call for good corporate governance practices is a well-timed reminder."File

The Reserve Bank of India (RBI) Governor Shaktikanta Das has once again ignited debate on corporate governance. On Monday, while speaking at a conference for the directors on the boards of private sector banks in Mumbai, he asked the banking sector in the country to further strengthen the governance and assurance functions to identify and mitigate risks at an early stage.

Even as the RBI governor acknowledged the role played by the banks in supporting the economy and maintaining resilience along with improved financial performance in the face of several adverse shocks in recent times, he emphasized on a robust governance structure as the first and the most important requirement for ensuring the stability of a bank as well as sustainable financial performance.

He asked the directors of banks to further strengthen the governance and assurance functions (risk management, compliance and internal audit) so that the banks are able to identify and mitigate risks at an early stage.

If we look at the overall scenario in the country, we find corporate governance failures happening at frequent intervals leaving a wide range of negative effects on businesses, their stakeholders and the broader economy. In the last couple of decades we have witnessed some glittering corporates suddenly losing sheen and falling from grace.

Corporate governance failure is directly happening at the hands of the top brass of the company. Any move of the management or the board of directors of a company which ignores their legal and ethical responsibilities towards the company and its stakeholders leads to failure in corporate governance. Usually, the top authorities, while not adhering to ethical and legal standards, lead to poor decision-making and a lack of accountability. Lack of transparency in the operations of the company, displaying their authority loaded with conflict of interest, poor risk management practices and corrupt practices are some common traits leading to corporate governance failure.

This governance failure has a wide range of negative effects on the functioning of companies. Significant financial loss and reputational damage are the immediate things that happen to a company with poor corporate governance practices. In the context of wider economic impact, corporate governance failures in large corporates can result in a decline in investor confidence and a broader economic downturn becomes inevitable.

The Indian corporate world has scripted some shocking corporate governance failure stories. One of the biggest corporate governance failures in India is the Satyam Scandal of 2009. The founder of Satyam Computer Services, Ramalinga Raju, admitted to committing a massive fraud, inflating the company's profits and assets by several billion dollars. This led to the company's collapse and a major loss of investor confidence in Indian companies.

Who can forget the fall of Infrastructure Leasing & Financial Services (IL&FS) and Nirav Modi scandal in 2018? It was a major infrastructure financing and development company in India before defaulting on its debt obligations. The fall of the company was because of several irregularities and fraudulent activities within the company. The scandal led to a liquidity crisis in the Indian financial system.

Notably, the Dewan Housing Finance Limited (DHFL) scandal was the biggest corporate fraud of 2019. The investigating agencies have found it a classic case of meddling with the books inviting trouble for the company. The fraud saw the “Bandra Books” emerging on the scene. Reportedly, the supposed Bandra branch for which a parallel set of books exists, does not exist in reality. It was a completely made up entity for the corrupt business practices to thrive. According to SEBI, if the fake income in the Bandra books is taken out, DHFL has been making losses for years on end. The fraud has allowed DHFL to raise a whopping Rs. 24,000 crores through public issue of debt securities.

In 2020, failure in corporate governance saw Yes Bank failing to hold on to its reputation as one of India's largest and successful private sector banks. The bank top brass was found to have engaged in several irregularities and fraudulent activities. Its founder, Rana Kapoor, was accused of granting loans to companies in exchange for bribes. The bank was eventually rescued by the Reserve Bank of India.

Let me share an anecdote of a coffee shop. When the CCD (the coffee chain Cafe Coffee Day) announced the opening of its first outlet in Srinagar, a top economist, who was also a top functionary of the then State government, was excited. He even inaugurated the outlet and was not wasting any opportunity to present the entity as one of the modern day business success stories. His objective was to present the CCD’s successful business model to breed a culture of entrepreneurship among the local youth. He would always say why a man from Bangalore would establish a coffee shop here and why not the local youth take to such entrepreneurship.

CCD was India’s biggest coffee chain in the 2000s and its proprietor V. Siddhartha belonged to a family with a 140-year history of growing coffee beans. At one point in time CCD had more than 1750 outlets across the country. A German coffee maker had inspired V. Siddhartha to launch Cafe Coffee Day as a rival to Starbucks. It was a time when the cafe culture was catching up fast among young Indians. The success story of the CCD was getting global attention as the chain launched its IPO (Initial Public Offer) in 2015. At that time, the rumours were hot that Coca Cola was planning to invest a whopping Rs.2,500 crores into this coffee chain company.

But destiny had something else in store for the CCD. Just two years after its listing on the stock markets, things started taking ugly turn. In September 2017 the Income Tax (I-T) department conducted a series of raids at over 20 locations linked to Siddhartha. He was reportedly heavily in debt. His Coffee Day Enterprises Ltd had seen net loss widening to Rs. 67.71 crore in the fiscal year ended March 31, 2018 from Rs. 22.28 crore loss in the previous year. This despite revenues climbing to 122.32 crores. He disappeared suddenly one evening in 2019. His dead body was found 36 hours after he went missing in Mangaluru. It was apparently a case of suicide.

The CCD came under the radar of experts who found that the company was experiencing serious corporate governance issues since the inception of its success story in 2000. Ironically, the period of its success was simultaneously loaded with huge debt. It was found that the founder of the company, Siddhartha, had taken on debt in his private capacity to buy land and invest in long gestation projects. The company went out of funds required for both operations and capex.

Today, CCD is one such corporate governance failure story which saw the company falling from grace, not because its business model was faulty, but for the fact that it miserably failed to comply with corporate governance rules and not sticking to legislation. However, there is an underlying message in the fall of the company. It should serve as a constant reminder to the businesses or to those who have an appetite to become a successful entrepreneur that good corporate governance practices are the cornerstone of scripting a top business success story.

To conclude, the RBI governor’s call for good corporate governance practices is a well-timed reminder. The management and board of directors of corporates need to observe ethical practices and remain disciplined, transparent, fair and accountable for their actions. Otherwise, failure in corporate governance has the potential to wipe out the company and can have a negative impact on the overall economy of the country.

(The views are of the author & not the institution he works for)

DISCLAIMER: The views and opinions expressed in this article are the personal opinions of the author.

The facts, analysis, assumptions and perspective appearing in the article do not reflect the views of GK.

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