Corporate Governance Checklist

We always hear from market commentators that such and such company has good corporate governance. Here we will understand what we actually mean by that and how we gauze companies by making a small corporate governance checklist.

Meaning:

Corporate governance refers to the set of rules, practices, and processes by which a company is directed and controlled. Good corporate governance is important for investors because it can help ensure that a company is well-managed and that its assets are protected.

The Indian corporate governance framework focuses on the protection of minority shareholders; accountability of the board of directors and management of the company; timely reporting and adequate disclosures to shareholders and corporate social responsibility.

Here are some key items to consider when evaluating the corporate governance of a company you are thinking of investing in:-

Board of directors:

The board of directors is responsible for overseeing the management of a company and making decisions on its behalf. Look for a board that is diverse, independent, and has a good mix of industry experience and expertise. Reading the annual report is a good way of getting this information.

Capital Allocation:

Company management needs to be prudent in the allocation of capital so that the required returns of its investors are earned by them. Profitable companies misallocating capital in loss-making ventures is a negative for investors.

A loss-making company like PayTm is trying to buy back its shares when it just came up with an IPO a few months ago raising a question about its capital allocation policy. To ensure a capital allocation policy that benefits the shareholders, one should look at the financial parameters like trends in ROE(Return on Equity) & ROIIC (Return on incremental invested capital).

Executive compensation:

Executive compensation should be reasonable and aligned with the interests of shareholders. Revenue-based commission to Promoters is a common way of paying high remuneration. This is visible in companies with high promoter holding. High executive remuneration ensures only the top-level management is earning disproportionately at the expense of minority shareholders. Investors should look for a company that has a clear and transparent compensation policy that is approved by the board of directors.

Audit committee:

The audit committee is responsible for overseeing the financial reporting process and ensuring the accuracy and integrity of a company’s financial statements. The audit Committee is basically an internal watchdog to oversee the ethical management of the company. A good audit committee will involve the majority of members being independent and non-Executive. Investors should look for a company that has an audit committee that is independent and has expertise in business or finance.

Disclosure and transparency:

Good corporate governance requires disclosure and transparency. Look for a company that provides regular and comprehensive disclosure of its financial and non-financial information which will include key matrices to understand business such as same-store sales, Like for Like growth rate, revenue per employee, etc.

Risk management:

Good corporate governance also involves effective risk management. Look for a company that has a robust risk management system in place and that is able to identify, assess, and manage risks in a timely and effective manner.

A company that has exports as a significant percentage of their revenue or a significant percentage of their business coming from small geographies is exposed to such specific risks. It is important to understand what the management is doing to manage this in event of a mishap.

Overall, good corporate governance is important for investors because it can help protect their investment and ensure that a company is well-managed and well-positioned for long-term success. Basic homework prior to making investment decisions will help us in avoiding bad investments.

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