Corporate governance can be defined as the system of internal controls and procedures by which individual companies are managed. It basically provides a framework for any company for dos and don’ts. It defines rights, roles and responsibilities of every individual in the organization.
These frameworks, however, could differ among countries and jurisdiction. The big picture is to consider the interest of all the stakeholders while running an organization.
Necessity of Corporate Governance
Weak corporate governance is found to be the most common reason behind any company failure. A lack of proper oversight by the board of directors, inadequate protection for the minority shareholders and incentives at companies which promote risk taking are some of the key drivers for company’s management to neglect corporate governance.
Poor corporate governance practices have resulted in several high-profile scandals and corporate bankruptcies over the past several decades. One of the examples of such poor corporate governance currently in the market is DHFL.
Dewan Housing Finance Ltd (DHFL) Scam
Investigative portal Cobrapost alleged a Rs 31,000-crore scam by the promoters of non-banking finance company Dewan Housing Finance Ltd DHFL, using bank loans, which it claimed routed through shell companies and passed on to the promoters. This money was then used to acquire assets overseas, including property, shares and a cricket team in Sri Lanka.
Details about the DHFL Scam (Source: Cobrapost)
• Created dozens of shell entities, largely with a nominal capital of Rs. 1 lakh, divided them into small groups of two–four companies, with a lot of them having the same/similar addresses and having the same set of initial directors, and on many occasions having the same group of auditors to mask the financial details
• Disbursed huge loans to these shell companies mostly without any security and/or collateral, and the proceeds appear to have been used for creation of private assets both offshore and in India
• Disbursed loans amounting to thousands of crores to these shell companies in the name of secured loans against slum development projects without any due diligence or checking of collateral or maintaining adequate debt–equity ratio
• Disbursed loans in a single tranche, rather than following the established norm of disbursal in stages against progress of the project works
• Ensured that most of the shell companies hid the name of the lender DHFL, the terms of loan and terms of repayment in their financial statements to be submitted as required by the law
• Advanced monies to several companies (run from the same address) in Gujarat and Karnataka around state elections
Given donations in crores to the Bharatiya Janta Party (BJP)
• Been involved in illegal insider trading, and violation of Securities and Exchange Board of India (SEBI) takeover regulations, amounting to approximately Rs. 1,000 crore
• Created offshore assets of approximately Rs 4,000 crore
• Bought Wayamba, a Sri Lanka Premier League cricket team, by using loan money dubiously advanced by DHFL.
Scale of Fraud
To just gauge the scale of fraud, DHFL’s net worth is Rs 8,795 crore with cash in hand of Rs. 2468.14 crore. It has, however, taken loans from banks and financial institutions to the tune of Rs 96,880 crore, including Rs. 31,312 crore in the form of non-convertible debentures, Rs. 36,963 crore from banks, Rs. 2,965 crore from external commercial borrowings, Rs. 2,848 crore from the National Housing Board (NHB), Rs. 9,225 crore in public deposits and Rs. 13,567 crore from other sources. Out of this sum, the company has disbursed Rs. 84,982 crores in loans and advances to other entities. According to the annual report, DHFL has secured loans from at least 36 banks.
Consequences of Poor Corporate Governance Fundamentally DHFL was a good company, but due to management’s fraud and their poor corporate governance, there are huge losses not only to the public sector banks, such as State Bank of India and Bank of Baroda, with an exposure of over Rs. 11,000 crore and Rs. 4,000 crore, respectively, but also to the foreign banks, debenture holders, and to all the shareholders of DHFL. Also it will lead the entire capital market into utter shock and severe liquidity crunch, especially after what happens with IL&FS.
Since there were also huge amounts of tax evasion by DHFL, the government is also at loss. The stock price of DHFL has fallen by more than 80% in last 6 months leading to the fall of market Capitalisation from Rs. 19,695 crore to Rs. 3,635 crore in the same period.
If such scams are not identified, resolved and persons responsible punished, will damage India’s prestige on the world stage. Investors and institutions will fear to invest in India.
More examples of Poor Corporate Governance
Recently there have been more such corporate governance issues. We can take again a very recent example of Zee and Essel group chairman Subhash Chandra who acknowledged that he had committed mistakes and apologized to banks, non-banking finance companies, and mutual funds as he had not lived up to their expectations.
Subhash Chandra is the promoter of Zee Entertainment which is a profitable, high margin operating and a fast-growing mass media company. To boost the company growth further, the promoter started pledging Zee’s shares and took the loan to invest in various subsidiaries so as to generate more income sources apart from their core business. They invested zee’s money in various road projects, power projects, solar projects, etc. which are not at all related to the company’s core business. The same thing they have done with DishTV, which is already a debt-laden company. The promoters have pledged the companies share, invested it in non-core activities and now they are neither able to generate returns nor they are able to roll over the loans. The Essel group has to meet interest or principal obligations on borrowings against pledged shares till Sept. 30 otherwise, as per SEBI regulations, rating agencies will downgrade the Essel Group’s debt instrument. That would force mutual funds to write down the value of the investment and would set off another crisis for them after IL&FS. Shareholders have also taken the hit as the share price of both the DishTV and Zee Entertainment has fallen by approx 44% and 25% respectively in last one month.
Just because of the poor decision by the promoters, all the other stakeholders had to suffer and this is why good corporate governance is a very important aspect for all the stakeholders.
Shivam Daga,
MBA-FA(2018-20)
