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Study on the State of
Corporate Governance
in India
Gatekeepers of Corporate Governance
Securities and Exchange Board of India (SEBI)

Authors: Kshama V Kaushik
Rewa P Kamboj

Indian Institute of Management Calcutta
Indian Institute of Corporate Affairs
Thought Arbitrage Research Institute
Study on the State of Corporate Governance in India
Gatekeepers of Corporate Governance Securities Exchange Board of India

Table of Contents

Executive Summary .............................................................................................................................. 1
Literature Review .................................................................................................................................. 3
1. Introduction .............................................................................................................................. 6
2. Regulatory Framework of Securities and Exchange Board of India (SEBI)....................... 7
3. SEBI & Corporate Governance ............................................................................................. 11
4. Effectiveness of SEBI as a Gatekeeper of Corporate Governance in India ..................... 12
4.1 Study of extent of adoption of corporate governance norms by listed companies ...... 12
4.2 Study of Effect of Adoption of corporate governance norms on listed companies ...... 14

Movement of Companies toward Better Corporate Governance ................................................... 20
Data Skewness .................................................................................................................................... 21
4.3 Study of effectiveness of SEBIs overall regulatory mechanism by analysing the first
level of authority, that is, the Assessing Officer level as well as the appeals process,
that is, the Securities Appellate Tribunal (SAT) ............................................................. 24
4.4 Study the mechanism of Consent Orders and analyse its prevalence, effectiveness as a
deterrent and transparency of the system .................................................................... 31

Annexure I SEBI ............................................................................................................................... 41
Annexure II SEBI .............................................................................................................................. 42


1

Executive Summary

This section analyses the role of perhaps the most important regulator of the capital market
and the corporate world in India, the Securities Exchange Board of India (SEBI).
We begin with the evolution of SEBI as a regulator and trace its growth through various
phases. We briefly discuss the regulatory framework of SEBI and the broad contours of the
mechanism of corporate governance it has devised.
The methodology used is:
a. We have analysed data from National Stock Exchange of company-wise submissions
with respect to compliance with provisions of corporate governance code for the
quarter ended 30
th
June 2011 and found that over 70% of companies are adhering to
the corporate governance norms. However, this analysis is limited to only examine
whether companies had declared adherence to prescribed corporate governance
mechanisms and did not cover examining the quality of such mechanisms or the
benefit of such mechanisms for individual companies

b. We have analysed the effect of adoption of corporate governance norms mandated
by SEBI on 100 companies forming part of BSE 100 index over a period of seven (7)
years since they were introduced in 2005, that is, an analysis of around 800 financial
statements. We have used the established statistical tool of Tobins Quotient to
examine effectiveness of Clause 49. We have relied on financial evaluation tools
including important financial ratios to examine whether the barometer of financial
performance displays trends that indicate effectiveness of Clause 49. Finally, we co-
related these ratios to study their inter-relationships and co relationships. The
analysis indicates a causality between improvement ofcorporate governance
processes following the introduction oftt Clause 49 in India. However, we could not
create a co relation between improved corporate governance and sustained
corporate performance.

c. We have analysed SAT orders passed in case of 100 appeals and the corresponding
100 Adjudicating Officer (AO)/ SEBI orders passed to ascertain the effectiveness of
the adjudicating and appellate process. Our analysis shows that the investigation and
appeals process tends to be slow, often arbitrary, due to higher discretionary powers
and at times opaque. Often the fines are very small compared to the extent of
alleged offences and the rules of disgorgement of profits by the perpetrators rarely
followed, creating no punitive action or dis-incentivising inappropriate business
conduct. While the inherent spirit of framework is robust and in line with best
practices of bringing in timely justice and fair play, its implementation needs to be
more effective for capital markets to be buoyant and transparent.

d. We have analysed consent orders to determine the efficacy of the entire process and
found that while the system of consent orders may be effective for settling cases, it
lacks transparency and is marred with opacity in many areas. We also noticed that

2

the Adjudicating Officer is very powerful in the entire process by playing a significant
role in the issue of show cause notices, enquiry, forwarding the case for settlement
and approving authority in consent orders which calls for greater transparency and
clearer guidelines.

We conclude that SEBI has played a big role in instituting a basic standard of corporate
governance in the country, albeit only for listed companies. These measures have reduced
information asymmetry and improved market liquidity; however, how much these measures
have helped in improving corporate performancea real barometer of effectivenessis not
evident.


3

Literature Review

Gatekeepers are individuals, institutions or agencies that are interposed between investors
and managers/owners in order to play a watchdog role to reduce agency costs. If
gatekeepers are absent or do their job inefficiently then, it is reasonable to believe, there will
be fewer checks on managers/owners to behave in a manner consistent with placing
investors interests above self-interest. In other words, market efficiency will be lower which,
in turn, would raise the cost of capital.

Kraakman (1986) defines gatekeepers as parties who are in a position to prevent
misconduct by others by withholding their co-operation.
1

Scholars like Kraakman and Coffee further define gatekeepers as reputational intermediaries
who provide verification and certification services to investors. But they also acknowledge
that the role of gatekeepers as reputational intermediaries who can more easily be deterred
than the principals they serve has been developed in theory but less often examined in
practice
2
.

Gatekeepers essentially assess or vouch for corporate clients own statements or a specific
transactionif this sounds like duplication, it is; however, this duplication is necessary
because it is generally accepted that a gatekeeper has a lesser incentive to lie than the
client andregards the gatekeepers word as being more credible
3
.

Hamdani defines gatekeepers as parties who sell a product or provide a service that is
necessary for clients wishing to enter a particular market or engage in certain activities
4
.

Therefore, bankers, auditors and analysts are gatekeepers for clients wishing to enter the
capital market. Extending the argument, for clients who wish to raise money through shares,
the capital market regulator (Securities Exchange Board of India) is a major gatekeeper.
Lending to the corporate sector is one of the main planks of a commercial bank; therefore,
the banking sector regulator (Reserve Bank of India) is another gatekeeper to ensure
corporate governance through the regulatory mechanism of prudential lending norms and
monitoring use of money, among other things.

Having a network or series of gatekeepers is, however, no guarantee that corporate
wrongdoing will be detected or avoided. In a wave of corporate scandals starting from Enron,
we have seen instances of multiple gatekeeping failure in which wrongdoing went
undetected through several layers. The failure of this network of gatekeepers was a
recurring theme in business scandals. In too many instances, the gatekeepers in pursuit of

1
Gatekeepers: Anatomy of a Third-party Enforcement Strategy, Kraakman, R.H., Journal of Law,
Economics and Organisation 2, 53-104
2
The Acquiescent Gatekeeper: Reputational Intermediaries, Auditor Independence and the
Governance of Accounting, John C.Coffee, Jr., May 2001, Columbia Law and Economics Working
Paper No.191. available at SSRN:http://ssrn.com/abstract=270944
3
Understanding Enron: Its About the Gatekeepers, Stupid, John C.Coffee, Jr., Columbia Law
School, page 5
4
Gatekeeper Liability, Hamdani, Assaf, Southern California Law Review, volume 77, page 7,
available at SSRN:http://ssrn.com/abstract=466040

4

their own financial self-interest compromised the values and standards of their profession in
the recent round of corporate scandals, the first tierthe managersfailed and then the
gatekeepers failed as well.
5

In fact, some scholars believe that, theoretically at least, the services of gatekeepers can be
performed either from within or outside the corporation
6
. Of course the law mandates that
certain gatekeepers must be external to the organization such as auditors but there are other
gatekeepers like lawyers or internal auditors who may serve their function just as effectively
if they worked from within the corporation.

Accountability of a gatekeeper requires a certain quantum of liability s/he must bear. As far
as individual gatekeepers are concerned (such as auditors, lawyers, etc.), every country has
some rules to punish errant behaviour. However, there are few (if any) instances of
accountability of gatekeepers who are institutions; for instances, if SEBI or RBI fails to detect
or deter abuse of governance norms by companies or banks, the investor has little recourse
to hold them accountable. Gatekeepers liability may not always be created for the
gatekeepers own waysalthough this is also a possibilitybut for the wrongs attributed to
the corporation that could have been deterred or at least minimised by precautions taken by
gatekeepers.

Andrew Tuchs study shows that incentive problems will arise if gatekeepers are not capable
of bearing the full liability imposed on them. In other words, gatekeepers incentives to take
precautions are diluted where they are protected from full liability arising from their activities
7

A similar assertion is made by Steven Shavell in an optimal deterrence theory which
prescribes the legal rules that optimally deter socially harmful conduct and discusses the
dilution of incentives arising from a wrongdoers inability to pay for the losses it causes
8
.

A gatekeeper may even be shielded from the full effects of a liability regime by insolvency,
although it rarely occurs in practice (Arthur Anderson being a notable example). Some
categories of gatekeepers may collaborate with each other to adopt risk-shifting
arrangements; for example, comfort letters exchanged among bankers, analysts, auditors,
etc. Likewise, communications among regulators (such as between SEBI and RBI) may also
be termed as risk-shifting or risk-sharing arrangements. The objective of such an exercise
may be variedallocating liability or getting additional knowledge of the clients affairs or
information exchange.

Corporate conduct is overseen by multiple gatekeepers who act on different aspects of
business transactions. This ought to lead to an interlocking web of protection against

5
AAA&S, Report of the American Academy of Corporate Responsibility Steering Committee
6
The Devolution of the Legal Profession: A Demand Side Perspective, Ronald J.Gilson, 49 Md
L.Rev., 869, 905 (1990).
7
Multiple Gatekeepers, Andrew F.Tuch,Virginia Law Review, Vol.96, Issue 7, pp 1583-1672.
Available at SSRN:http://ssrn.com/abstract=1577405
8
Economic Analysis of Accident Law, Steven Shavell, 1
st
Harvard University Press paperback
edition 2007, 1987, page 167-68.

5

wrongdoing by all gatekeepers, calling into question the conception of the gatekeeper as a
unitary actor
9

Gatekeepers operate in an interdependent rather than independent manner and it is
important to have a certain degree of collective responsibility among all gatekeepers to
harness the total capacity to deter wrongdoing. A regime of fault-based liability coupled with
joint and several liability would be optimal for advancing the cause of optimal deterrence
10
.

9
Multiple Gatekeepers, Andrew F.Tuch, Discussion paper no.33, 3/2010, Harvard Law School,
Cambridge, MA
10
Andrew Tuch, page 86

6

Securities and Exchange Board of India
1. Introduction
At independence, India had a functioning stock market (Bombay Stock Exchange is Asias
oldest stock exchange), a flourishing trading sector, a fledgling industrial sector and a well-
developed banking sector. The concept of joint stock companies was immensely popular
since it was first introduced by the British rulers and Indian businessmen took to the
concept very well as it helped disperse risk more widely and provided better access to
funding resources.
However, the method of running these companies or corporate governance took an entirely
indigenous flavourbusinessmen hardly altered their style of working under sole-
proprietorship or partnership mode and often treated the company as their personal
property. Promoters were unwilling to give up unbridled control over the business that is
inevitable in a joint-stock company. The concept of a managing agency house (often a
partnership firm that provided specific services) where promoters would pass a resolution
appointing their family firm as the managing agent almost in perpetuity and with unfettered
powers was a neat solution.
Corporate governance, as is understood in the modern context, was an alien concept to
indigenous Indian business houses for a long time. The socialist policies followed by the
government after independence also contributed to weak governance norms that was more
evident in Indias huge public sector and nationalised banks where the governing ethos took
on a form of its own.
Faced with a fiscal crisis in 1991, the Indian Government responded by enacting a series of
reforms aimed at general economic liberalization. This opened up the Indian economy not
only in terms of business opportunities and newer funding avenues but also to fresher ideas
of governance models. To develop Indias capital markets further, the central government
established regulatory control over stock markets through the formation of the Securities
and Exchange Board of India. SEBI, which was originally established in 1988 as an
advisory body, was granted authority to regulate the securities market under the Securities
and Exchange Board of India Act of 1992 (SEBI Act). Through the passage of this Act,
Parliament established SEBI as an independent statutory authority, but required it to submit
annual reports to the legislature.

SEBI was designed to serve as a market oriented independent entity to regulate the
securities market akin to the role of the Securities and Exchange Commission (SEC) in
the United States The stated purpose of the agency is to protect the interests of investors
in securities and to promote the development of, and to regulate, the securities
market.

The first initiative at introducing corporate governance in a structured manner in India was by
the industry through its association, CII in 1998. It was a purely voluntary set of
recommended governance norms that companies could adopt and be seen as being well-
run companies. But to ensure more wide-spread adoption of corporate governance norms it
is necessary to have a certain statutory compliance value and therefore, SEBI undertook the

7

second initiative in corporate governance by introducing a code formed by a committee
under the chairmanship of a leading industrialist, Kumarmangalam Birla in 1999. The
recommendations of this committee contained new provisions in line with global
developments such as putting out a Management Discussion & Analysis report as part of the
annual report, emphasising on Board committees and advocating the role of independent
directors. These proposals were introduced by SEBI in 2000 for companies within its
jurisdictionlisted companiesby amending the Listing Agreement that companies enter
into with stock exchanges.
But SEBIs mandate extends only to companies listed on stock exchanges and a
comprehensive adoption of corporate governance norms for all companies can be brought
about in India only through the legislative route. Therefore, the third set of corporate
governance proposals was carried out by the Department of Company Affairs (now Ministry of
Corporate Affairs) based on the recommendations of the Naresh Chandra committee in
December 2002. It made recommendations in two key aspects of corporate governance:
financial and non-financial disclosures and independent auditing and board oversight of
management and also a series of recommendations regarding statutory auditors.

The fourth initiative on corporate governance in India was again carried out by SEBI based on
the recommendations of the Narayana Murthy committee which was set up to review Clause
49and suggest measures to improve corporate governance standards.

This was done in the wake of the Enron scandal in the United States in order to evaluate the
adequacy of the existing Clause 49 and to further improve existing practices in order to
enhance the transparency and integrity of Indias stock markets and ensure compliance
with corporate governance codes, in substance and not merely in form. The changes
suggested reflect global norms of corporate governance developed in Anglo Saxon countries
that have a different business environment than India.

2. Regulatory Framework of Securities and Exchange Board of India
(SEBI)

SEBI acts as a developer and regulator of the capital market in India. SEBI has delegated
powers to two exchanges (Bombay Stock Exchange, National Stock Exchange) to ensure
that their members adhere to the SEBI regulations and instructions.
The total market capitalization as on March 31, 2011 of listed companies in India at Bombay
Stock Exchange is Rs 68,39,084 crores as per SEBIs Annual Report for the year ending
March 31,2011.
Some of the roles that SEBI performs as a market regulator are:
1. To regulate the market by creating rules for functioning of various products.
2. To approve/ amend the laws of stock exchanges.
3. To inspect the books of accounts and call for periodical returns from recognized stock
exchanges.

8

4. To inspect the books of accounts of financial intermediaries and levy fees/ charges on
them.
5. To compel certain companies to list their shares in one or more stock exchanges.
6. To educate investors.
7. To prosecute and judge directly the violation of certain provisions of the companies
Act.
8. To prohibit and prevent insider trading
9. To frame rules for merger and takeover of companies.
10. To regulate issue of capital and debt in primary and secondary market.
11. To prevent unfair trade practice and market manipulation.
Thus, SEBI drafts regulations in its legislative capacity, conducts investigations and
authorizes enforcement action in its executive function, passes rulings and orders in its
judicial capacity. Though this makes it very powerful, there is an appeals process to ensure
fairness and accountability through a Securities Appellate Tribunal (SAT). SAT was formed
in 1995 to act as a forum of justice to appeal against the orders passed by SEBI Board or
the adjudicating officer (AO) appointed under SEBI Act.

The general process flow of adjudicating and appeals process is usually as below but may
vary a little in some cases:


9

Flowchart for Adjudication Proceedings

Commitment of Offence
SEBI obtaining information on the basis
of reports from stock exchanges or
otherwise
SEBI Ordering and enquiry, Enquiry
Proceedings completed, summons
may be issued for collection of
evidence, Enquiry Report submitted
to SEBI and Show Cause Notice may
be sent to the defaulter.
Appointment of Adjudicating Officer
Issue of Show Cause Notice
Submission of reply and evidence/
records/. Opportunity given for
personal hearing through legal
representation
Submission of reply and evidence/
records. In case of non-receipt of reply,
an ex-parte order may be issued
Detailed investigation and order passed
by SEBI Board/ Adjudicating Officer

10

Flowchart for Appeal Process
(At any stage an appeal can be filled with the Central Government of India)

Order Passed by SEBI Board/ AO

Appeal filed with SAT
SAT may send the case back to SEBI
for fresh order/ speedy investigation
Appeal decided in favour of
SEBI/ Appellant
Aggrieved party may approach
High Court
High Court passes an interim/
final order
Appeal can be filled in Supreme
Court

11

3. SEBI & Corporate Governance

SEBI has set out corporate governance provisions that are intended to drive in a minimum
standard of corporate governance among listed companies in India. This is issued as a part
of the Listing Agreement that each listed company signs with the stock exchange under the
title Clause 49. Clause 49 remains the most significant corporate governance reform and
established a new corporate governance regime.

Like corporate governance standards in the United States and the United Kingdom, Indias
corporate governance reforms followed a fiduciary and agency cost model. With a focus on
the agency model of corporate governance, the Clause 49 reforms included detailed rules
regarding the role and structure of the corporate board and internal controls. These
norms lay criterions for:

1. Appointment of independent directors in board.
2. Appointment, composition and Powers of Audit Committee
3. Functioning of Remuneration Committee, Investors Grievances Redressal
Committee
4. Compensation that can be paid to non-executive directors.
5. Adherence to internal control of conduct by Board of Directors and other top
executives.
6. Disclosure of Accounting Policies, Contingent Liabilities, Related Party
Transactions, IPO Proceed utilisation.
7. Certification by CEO/ CFO on adequacy of internal control system,
correctness of the reported financials.
8. Whistle Blower Policy.

A certificate of compliance on terms contained in Clause 49 is required to be signed by the
director and auditors/ company secretary of the company is to be annexed to the annual
report.

The stock exchanges are mandated to ensure compliance with the above provisions at the
time of listing of shares and through quarterly compliance reports received from listed
companies. Listed companies are also required to submit a consolidated compliance report
to SEBI within 30 days of the end of each quarter.

The Clause 49 reforms were phased in over several years, applying at first to larger
entities and eventually to smaller listed companies.

12

Eventually, compliance of corporate governance must be carried out by:

Issuer Companies
Stock Exchanges
Central Securities Depositories
Stock Brokers
Mutual Funds
Foreign Institutional Funds
Investment Banks
Depository Participants
Credit Rating Agencies
Venture Funds
Registrars and Underwriters

4. Effectiveness of SEBI as a Gatekeeper of Corporate Governance in
India

SEBI is the capital market regulator in India and has been active in recent years in its efforts
to usher in a standard form of corporate governance. This part of the study analyses
effectiveness of SEBIs role in implementing corporate governance mechanisms. This is
done in four parts:
a. Study of the extent of adoption by listed companies of SEBI corporate
governance norms.
b. Study of the effect of such adoption on the performance of companies
c. Study of effectiveness of SEBIs overall regulatory mechanism by analysing
the first level of mechanism, that is, the Assessing Officer level as well as the
appeals process, that is, the Securities Appellate Tribunal (SAT)
d. Study of the mechanism of Consent Orders and analyse its prevalence,
effectiveness as a deterrent and assess transparency of the system

4.1 Study of extent of adoption of corporate governance norms by listed companies

We have analysed data from National Stock Exchange of company-wise submissions with
respect to compliance with provisions of corporate governance code for the quarter ended
30
th
June 2011.


13

Our analysis showed that almost all companies were following corporate governance
measures:

*Cannot Comment: Data includes fields which did not have any input,
hence cannot determine if compliance is done or not.

This analysis is limited to only examine whether companies had declared adherence to
prescribed corporate governance mechanisms and did not cover examining the quality of
such mechanisms or the benefit of such mechanisms for individual companies.

A study on corporate governance in India
11
states that India has one of the best corporate
governance laws but poor implementation together which, together with socialistic policies of
the pre reform era has affected corporate governance. The legal environment plays a crucial
role in determining the nature of corporate governance in any country and encompasses two
important aspects the protection offered in the laws (de jure protection) and to what extent
the laws are enforced in real life (de facto protection).

Two indices have been used for this purpose a shareholder rights index ranging from 0
(lowest) to 6 (highest) and a rule of law index ranging 0 (lowest) to 10 (highest) to measure
the effective protection of shareholder rights. The first index captures the extent to which the
written law protected shareholders while the latter reflects to what extent the law is enforced
in reality. India has a shareholder rights index of 5, being one highest in the sample
examined of 49 countries but the rule of law index a score of 4.17 on this index ranking
41st out of 49 countries studied.

Thus it appears that Indian laws provide great protection of shareholders rights on paper
while the application and enforcement of those laws are lamentable. This difference in
protection of shareholders rights has led to completely different trajectories of financial and
economic developments in the different countries.

The study concludes that the bigger challenge in India lies in the proper implementation of
corporate governance rules at the ground level.

11
Corporate Governance in IndiaEvolution and Challenges by Rajesh Chakrabarti, College of
Management, Georgia Tech, USA
Particulars Number of companies Percentage
Complied 1044 71
Non Complied 106 7
Cannot comment* 312 21
Total 1462 100

14

4.2 Study of Effect of Adoption of corporate governance norms on listed companies

OECD Principles of Corporate Governance (2004) and various corporate governance
indexes (such as Standard & Poors Corporate Governance Index) focus on the
characteristics of corporate governance mechanisms rather than outcomes based on the
principle that effective and robust processes result in appropriate results. However, authors
like Pitabas Mohanty argue that if a company has got a governance system then it must get
reflected in certain outcome(s). (The argument is that) if the processes are in order, we must
observe certain desirable outcomes. If the outcomes are not present, then the mere
existence of a process does not amount to anything
12
.
Significant research on this area conducted by Gompers et al. (2003), Bebchuk and Cohen
(2004) and Bebchuk, Cohen and Ferrell (2009) show that firms with stronger stockholder
rights have higher Tobin Qs, their proxy for measurement of corporate value, indicating that
better-governed firms are more valuable.
Brown and Caylor in Corporate Governance and Firms performance ( 2004) create a
summary index of firm-specific governance, Gov-Score, and relate it to operating
performance, valuation, and cash payouts for 2,327 firms in USA. They show that poorly-
governed firms (i.e., those with low Gov-Scores) have lower operating performance, lower
valuations, and pay out less cash to their shareholders, while better-governed firms have
higher operating performance, higher valuations, and pay out more cash to their
shareholders.Scholars also agree that there are no formalized & generally accepted criteria
for determining if a particular system of corporate governance system works
13
.

Bain and Band (1996)
14
and Bhagat and Jefferies
15
believe that the following form the pillars
of corporate governance and have a positive relationship with the value of a firm.

Independent board of directors
Equal rights of minority shareholders
Dispersed ownership
Timely & transparent information system
Independent auditor

There are also other factors that affect the relationship between the value of a firm and
corporate governance which include a) role of judiciary, banks, government and politicians,
b) macro-economic factors such as economic growth rate, inflation, interest rates c)
intangibles such as goodwill, customer relations, supply chain and growth potential, etc.

12
Mohanty, Pitabas, Institutional Investors and Corporate Governance in India,
www.nseindia.com/content/research/Paper42.pdf, accessed on 20/1/12
13
Macy, J., Measuring the Effectiveness of Different Corporate Governance Systems: Towards a
More Scientific Approach, Journal of Applied Corporate Finance, Vol 63, No. 2, 1998
14
Bain, Neville and David Band, Winning Ways Through Corporate Governance, Macmillan
Business 1996
15
Bhagat, Sanjai and Richard H Jefferies, 2002, The Economics of Corporate Governance
Studies, MIT Press

15

In other words, the value of a firm is a combination of of the monetary value plus the social
value of the firm.
Indian corporate governance systems are drawn from the Anglo Saxon model of corporate
governance where the focus is on shareholder value maximisationshareholder value being
derived in terms of market valuation of a firm
16
.
Several studies have linked different parameters of performance to corporate governance to
assess its effectiveness. Some of these parameters include share price movements,
volatility of share prices, earnings per share, etc. Kaplan
17
and Gibson
18
suggest that
performance of a corporate governance system can be evaluated by investigating the link
between corporate performance and CEO turnover. The reasoning is that an effective
governance system requires poor performing managers to be penalised by removal.

However, Gibson also provides evidence that when the firm has a domestic private large
shareholder, the relationship between CEO turnover and corporate performance weakens in
emerging markets. This is also indicated in India, where the agency gap between owners
and managers is low , which is compounded by the fact that owners of the top 500
companies in BSE as on 30 September 2011 hold 60 % of the listed companies, creating a
strong entrenchment of management and therefore CEO turnover may not provide accurate
indications of good or bad corporate governance.

Chhaochharia and Laeven (2007)
19
have evaluated the impact of firm-level corporate
governance provisions on the valuation of firms in a large cross-section of countries. They
have distinguished between governance provisions that are set at the country-level and
those that are adopted at the firm-level and conclude that governance provisions adopted by
firms beyond those imposed by regulations and common practices among firms in the
country have a strong, positive effect on firm valuation.

Despite the costs associated with improving corporate governance at the firm level, many
firms choose to adopt governance provisions beyond what can be considered the norm in
the country, and these improvements in corporate governance have a positive effect on firm
valuation. Indian software and other companies listed overseas, especially in the USA ,
followed these principles of voluntarily imbibing greater measures of corporate governance
for the perceived value it created for their businesses.

The challenge is to find a broad yet accurate measurement indicator that factor in the effect
of corporate governance by linking two or more appropriate parameters which reflect the
performance of a company within a certain environment. Tobins Quotient is widely used by

16
Kakani, Ram Kumar, Biswatosh Saha, V.N.Reddy, Determinants of Financial Performance of
Indian Corporate Sector in the Post Liberalisation Era: An Exploratory Study, May 2006
17
Kaplan, S.N., Top Executive Rewards and Firm Performance: A Comparison of Japan and the
United States, Journal of Political Economy, Vol 102, No.3, 1994, pp 510-546), Abe (Abe, Y, Chief
Executive Turnover and Firm Performance in Japan, Journal of the Japanese and International
Economies, Vol 11, 1997, pp 2-26
18
Gibson, M.S., Is Corporate Governance Ineffective in Emerging Markets, Journal of Financial and
Quantitative Analysis, Vol 38, No.1, March 2003, pp 231-250
19
Chhaochharia, Vidhi and Luc Laeven, The Invisible Hand in Corporate Governance
http://www.luclaeven.com/papers_files/CG_Provisions.pdf, 2007

16

academicians as a proxy for firm performance when studying the relationship between firm
performance and corporate governance. Tobins Quotient or Tobins Q is a ratio devised by
Nobel Laureate James Tobin of Yale University in 1969 who hypothesised that the combined
market value of all companies on the stock market should be equal to their replacement
costs. The ratio is calculated as:
Tobins Q= Total Market Value of a Firm
Total Asset Value
(Where Total Asset Value refers to the replacement value of assets.)
If Tobins Q is equal to 1.0, the market value will be perfectly reflected by the recorded
assets of the company. If Tobins Q is greater than 1.0 then the value is greater than the
value of the companys recorded assets. The accepted view is that in such cases the market
value reflects some unmeasured or unrecorded asset of the company. This extra value is
often used as a proxy for corporate governance.
Cheung and Pruitt
20
developed and empirically tested the robustness and usefulness of the
simple formulation of Tobins q. They concluded that the co-relation of the values obtained
through q values is theoretically correct and can be safely applied. This conclusion in many
ways supports the main assertions of another prior study on Tobins q by Perfect and Wiles.It
is now widely accepted that Tobins q is an appropriate proxy for the underlying, true q,
which is an indicative measure to invest.

Clause 49 of the Listing Agreement of Indian Companies
The corporate governance mandate is contained in the revised Clause 49 issued by
Securities and Exchange Board of India effective from April 1, 2004 for listed companies.
These provisions have been in effect for a period of seven years and can reasonably be
expected to be entrenched long enough for its effect to be reflected in certain parameters.
These provisions are designed to improve the way in which companies are managed. The
main provisions of Clause 49 are:

Guidelines Impact Objective
Board of
Directors
Professionalization of directorial oversight,
transparency of board remuneration & processes
Independence of
Oversight
Audit
Committees
Improvement in quality of financial oversight and
therefore in firm performance
Risk Assurance
Subsidiary
Companies
Greater oversight of unlisted companies by
shareholders of holding company
Capital Protection
Disclosures Better control mechanisms being implemented,
better risk management processes
Financial
Transparency
CEO/CFO
certification
Greater ownership of financial affairs of the
company leading to better oversight mechanism
Accountability

20
Chung, Kee H. and Pruitt, Stephen W. , A Simple Approximation of Tobin's Q. Financial
Management, Vol. 23, No. 3, 1994. Available at SSRN: http://ssrn.com/abstract=957032

17

Methodology and Analysis

We have used Tobins Q as a proxy to analyse the effectiveness of corporate governance
practices that listed companies in India are mandated to implement.

We have analysed the movement of Tobins Q over 100 companies comprising BSE 100
index over a period of seven years from the financial year 2004-5 to 2010-11. This involved
analysis of 800 financial statements to collect financial data to examine whether introduction
of SEBIs corporate governance mechanisms has had an impact on corporate performance.

This ratio was originally intended to be calculated on the replacement value of assets.
However, it is difficult to obtain an estimate of the replacement cost of assets unless there is
a defined market for used equipment. Indian laws require assets to be recorded at historical
cost adjusted for depreciation; in certain cases mark-to-market is used but this is not the
usual case. Therefore, we have used total assets as they appear in the financial statements
of companies.

We have also analysed certain financial performance indicators of the 100 companies
comprising BSE 100 index over this period of seven years to study the link, if any, between
corporate governance mechanisms. For instance, Return on Assets (ROA) is an indicator
of how profitable a company is relative to its total assets and may be considered as a proxy
for efficiency of management in using its assets to generate earnings; in other words, ROA
may be considered as a proxy for operating performance.

Return on Equity (ROE) is an indicator of maximisation of shareholder wealth which, in
terms of the Anglo Saxon model, is the basic purpose of corporate governance. ROE is the
amount of income returned on the equity invested in the company and may be considered a
proxy for the ability of the company to maximise shareholders wealth.

Net Profit to sales is an indicator of how efficiently a company is being operated. It may be
considered as a proxy for effectiveness of certain corporate governance mechanisms that
seek to improve operational performance.

Employee Cost as a percentage of sales indicates whether certain HR processes included
in corporate governance mechanisms are effective in improving employee efficiency.

Cost of Debt indicates whether the company is being run effectively enough to bring down
the debt component and improve cost efficiencies and may be considered as a proxy for
financial efficiency.

Terms Explained:

1. Tobins Q is the ratio of market capitalisation over the total assets of the company.
Market Capitalisation has been calculated by multiplying the number of shares with the
issued capital. Total Assets are taken as per Annual Financials reduced for deferred
revenue expenditure to the extent not written off.

2. Return is Net Profit after Tax

Net Profit (after tax) = Earnings Before Interest & Taxes minus Interest minus Taxes

Earnings Before Interest & Taxes = Operating Revenue- Operating Expenses+ Non-
Operating Income.

Operating Revenue= Sales Revenue

18

Operating Expenses= Cost of Goods Sold+ Selling, General and Administrative
Expenses+ Depreciation & Amortisation+ Other Expenses

Non-Operating Income= Dividend Income+ Profits from Investments+ Gains on
account of foreign Exchange.

3. Return on Assets is the ratio of returns for a year over the average of total assets
during the years. Average Assets is the summation of opening and closing assets
divided by two.

4. Equity means Shareholders Funds ie Share Capital + Reserves and Surplus. Return
on Equity is the ratio of returns for a year over the reported equity.

5. Sales are before excise duty adjustments and in case of banks it refers to the interest
earned.

6. Total Debt includes both secured and unsecured long term debt. Cost of Debt is ratio
of interest cost over average debt. Average Debt is the summation of opening and
closing debt divided by two.

7. Price/ Earnings Ratio is the ratio of Closing market price of the shares at BSE divided
by reported Earnings per Share.

8. Mean is simple average of the data variables over sample size and period.

9. Median is the middle most value of the data variables over sample size and period.

10. Skewness is a measure of the asymmetry of the data around the average mean. If
skewness is negative, the data are spread out more to the left of the mean than to the
right. If skewness is positive, the data are spread out more to the right. The skewness
of the normal distribution (or any perfectly symmetric distribution) is zero. In case data
skewness is more than +/- 5, the mean has been substituted by the median for
analysis.

Our discussion and analysis:
The table below depicts the average Tobins Q of BSE 100 companies annually since the
introduction of SEBIs Clause 49 in April 2005.

Tobins Q
(mean)
2011 2010 2009 2008 2007 2006 2005 Trend
Market
Cap/Total
Assets
3.47 3.5 2.2 4.04 3.85 4.24 3.27 Oscillating

We observe that there was a marked increase in Tobins Q one year after corporate
governance regulations were introduced in 2005 and there has been a marked improvement
in the measure over the next 3 years, suggesting that the capital market reacted favourably

19

and rewarded companies for implementing corporate governance mechanisms. This
observation is in line with prior empirical studies done by Jain, Kim and Rezaee in 2006 ,
suggesting that SOX regulations in the USA created a buoyancy in the markets by reducing
information asymmetry due to higher levels of disclosures, which increased the market
liquidity and size.
At an average Tobins Q of over 3 for all years (except one), it indicates that markets value
companies far more than what they are worth as compared to the amount of investment
made by them.


20

Movement of Companies toward Better Corporate Governance

We analysed the movement of these 100 companies over a period of seven years to see if
assimilation of corporate governance mechanisms recommended by Clause 49 has helped
companies to move up on the index of Tobins Q. This was analysed with reference to the
mean Tobins Q ratio for each of the years to observe the migration of companies past the
mean towards a higher benchmark.
The results, as depicted in the table below, indicate that the number of companies that are
below the mean Tobins Q ratio for BSE 100 has only increased over this period. If corporate
governance mechanisms were effective, it is expected that companies would have moved
closer to the higher Tobins Q benchmark. This could also mean that the market accepts a
certain corporate governance standard as the basic after a period of time and does not
continue to reward companies beyond a certain point.
Therefore, while the number of companies below mean Tobins Q has increased over time, it
is not clear whether this is because of ineffectiveness of corporate governance mechanisms
or because the market expects such standard behaviour from everyone and does not
recognize these basic efforts.

Distribution of Companies around Mean Tobins Q
Distribution of
Companies Above &
Below Mean Tobins
Q
2011 2010 2009 2008 2007 2006 2005
Number of
Companies More
than mean
30 30 26 33 31 28 23
Number of
Companies less than
mean
70 69 71 63 59 58 59
NA
-

1

3

4

10

14

18
Total 100 100 100 100 100 100 100


21

Data Skewness

We also observed that there is great data skewness in the sample of BSE 100 with Tobins
Q ranging from less than 1 up to 25 as shown in the table below. Such a high Tobins Q
suggests that assets of those companies may be over utilised as compared to the amount of
capital invested in them. Theoretically, a high Tobins Q should encourage those companies
to invest more in capital to balance market valuations.
Tobins Q Spread Year-Wise
Tobins Q Ratio 2011 2010 2009 2008 2007 2006 2005
Not Available
-

1

3

4

10

14

18
Upto 1
39

31

41

25

27

23

27
1 to 2
13

19

27

16

12

9

18
2 to 3
16

16

9

15

14

13

13
3 to 5
13

14

10

16

10

18

9
5 to 10
11

12

8

18

20

15

10
More than 10
8

7

2

6

7

8

5
Total
100

100

100

100

100

100

100

Alternatively, this high Tobins Q indicates that there is unexplained exuberance in capital
markets regarding certain companies which puts their market capitalisation far above what
the companies are actually worth. Sectors like Capital Goods, FMCG and Transport
Equipment show a high Tobins Q above 5 up to 25 which is inexplicable. Information
Technology shows Tobins Q on an average between 2 to 5, indicating that the capital
market factors in intangibles in the IT sector that is not reflected in total assets appearing in
financial statements. Only the Finance sector shows a consistent Tobins Q between 0 and
1.
Therefore, average Tobins Q depicted in the first table needs to be read in the context of
this skewness.
Other Financial Ratios:
We have analysed data of 100 companies
21
over a period of seven years. This translates
into 800 financial statements from which we have extracted financial ratios that could
indicate effectiveness of corporate governance mechanisms. These ratios have then been
aggregated into annual figures to show the trend across BSE 100 companies and the results
are depicted in the table below:

21
Forming part of BSE 100

22

Financial Ratios Over 7 Years
Analysis: Return on Assets: The data shows an oscillating trend and appears to reflect
general macroeconomic factors as well. The effect of corporate governance mechanisms is
not very apparent.
Return on Equity: The data showed an increasing trend initially and then has declined
steadily, mirroring the recessionary trend in those years. This suggests impact of
macroeconomic factors rather than improvement in corporate governance mechanisms.
Net Profit/Sales: Although the data shows an oscillating trend, after factoring in recession,
profitability shows an improvement over the years. However, it may be premature to
conclude that this is as a result of corporate governance mechanisms.

Employee Cost/Sales: Employee costs over sales shows a rising trend over the years of
the sample period. Improving corporate governance should contribute to more efficient HR
systems which should help to bring down employee costs as a percentage of sales, which,
however, is not supported by data. Rising employee cost can also be explained by rising
inflation (which would also have an adverse effect on sales) and therefore the effect of
corporate governance on employee costs is not clear.
Cost of Debt: Other than the exceptional year of 2009, the cost of debt shows a declining
trend. This could indicate that more value is created for shareholders as cost of financing
goes down.
Corporate governance is expected to bring in efficiencies in the way a business is run
and must, in the final analysis, be reflected in the outcomes as represented by
financial numbers. Some of these efficiencies would be reflected in a lower cost of
debt, more efficient employee costs per unit of sales, besides providing better returns
on assets and to shareholders.
Ratios 2011 2010 2009 2008 2007 2006 2005 Trend
Return on
assets

12.98

13.67

13.16

15.94

15.98

14.29

13.41

Oscillating
Return on
Equity

18.59

19.28

19.17

23.08

24.77

21.53

20.75

Oscillating
Net Profit/
Sales

14.78

15.17

13.75

15.07

14.07

13.31

13.75

Oscillating
Employee cost
as %age of sales

6.10

5.88

5.52

5.78

5.19

5.52

5.61

Oscillating
Cost of Debt
6.34

6.50

8.39

6.98

6.63

5.97

7.07

Oscillating

23

Our analysis of data reveals that at an aggregate level, these financial ratios do not
provide any trend that conclusively points to the effect of better governance by itself
and may depict the influence of other macro-economic factors as well.

Correlation Coefficient
We find that these financial ratios do not independently provide conclusive proof of the effect
of corporate governance on financial performance. Therefore we examine if there is any
correlation between Tobins Q ratio (the proxy for corporate governance) and the main
profitability ratios of Return on Assets (ROA) and Return on Equity (ROE) as well as the
share prices (of corporate performance). Correlation coefficient is a measure of the strength
of linear association between two variables and will be between -1.0 and +1.0; that is, if the
co-relation is positive, there is a positive relationship between the two variables and vice
versa. The strength of the relationship is determined by the fraction beyond zero.
We have conducted a series analysis between Tobins Q and each of ROA, ROE and Share
Prices for each company in BSE 100 over seven years. We then found the correlation
coefficient for each of these companies and the result for the entire sample is:
Co-relation Co-effcient of Tob Q with ROA, ROE & Share Prices
Correlation
coefficient
Return on
Assets
(ROA)
Return on
Equity
(ROE)
Share Prices
NA
3

3

3
0 to -1
18

28

7
0 to 0.5
30

30

24
0.5 to 1
49

39

66
Total
100

100

100

We observe from this data that:
ROA: As many as seventy nine per cent (79%) of companies in our sample showed a
positive correlation between corporate governance and profitability as measured by return
on assets.
ROE: Up to sixty nine (69%) of companies in our sample showed a positive correlation
between corporate governance and increased shareholder wealth (ROE)
Share Prices: As many as ninety per cent (90%) of companies in our sample showed a
positive correlation between corporate governance and higher share prices. That is, markets
recognized improvements in corporate governance by rewarding these companies at the
stock exchange.

24

We observe that at a broad level, there appears to be a positive correlation between Tobins
Q ratio and certain profitability indicators as well as share prices. This suggests that
companies that are perceived by stakeholders to be better governed also, in fact, deliver
better returns. That is, not only do companies that rank higher on the corporate governance
actually display higher profitability but also their shares are valued higher.
However, while there may be some individual trends noticed in different years for certain
companies, these appear to be more because of sectoral and macroeconomic factors
cannot clearly be said to be because of introduction of corporate governance mechanisms
contained in Clause 49.
Perhaps the most significant result is the shifting of the mean Tobins Q over a period of
seven years which would indicate whether Clause 49 has helped companies achieve better
corporate governance. As indicated in table above this improvement of Tobins Q ratio has
not occurred, which, we believe, indicates that there are only a few companies which excel
on corporate governance parameters while the vast majority of companies (60 to 70 per
cent) have made no movement towards better corporate governance over the years, as
perceived by the capital market.
Thus, we conclude that there is no clear evidence of effectiveness of Clause 49 on
performance of companies.

4.3 Study of effectiveness of SEBIs overall regulatory mechanism by analysing the
first level of authority, that is, the Assessing Officer level as well as the appeals
process, that is, the Securities Appellate Tribunal (SAT)
We have analysed SAT orders passed in case of 100 appeals and the corresponding 100
Adjudicating Officer (AO)/ SEBI orders passed to ascertain the effectiveness of the
adjudicating and appellate process. The period of study for SAT orders is from March 1,
2010 to September 30, 2011 and the sample has been selected on a random basis within
the constraints of data availability
22
.
The objective of the analysis is to study the nature of offences, time taken by SEBI in
completion of adjudicating proceedings, nature of penalties levied, analysis of SAT orders
whether it has taken independent decisions in favour or against SEBI and reduced the
penalties for appellant ensuring law of justice, time taken to complete appeal proceedings at
SAT and finally the time taken at SEBIs end for disposal of cases.
Methodology Followed
1. SAT orders were examined on following parameters:
Date of SAT order
Name of the Appellant
Nature of Offence
Appeal decided in favour of

22
Source: (www.watchoutinvestors.com) & (www.sebi.gov.in)

25

Revised Penalty
2. The respective AO/ SEBI order were analyzed to study the entire judiciary process on
following factors:
Date of order
Date of Appointment of Adjudicating Officer
Date of Show cause Notice
Time of Offence
Original Penalty

3. A detailed analysis was carried out to ascertain:
Types of Violation covered under these orders
Type of Penalties Charged by AO/ SEBI order
Appeals decided in favour of SEBI/ Appellant
Amount/ Quantum of Penalties waived
Time lag between the date of offence and date of appointment of AO
Time lag between the date of appointment of AO and date of show cause notice
Time lag between the date of show cause notice and the date of order passed by
AO/ SEBI
Time lag between the date of order passed by AO/ SEBI and the date of SAT order
Time lag between the date of SAT order and date of offence
Time lag between the date of AO/ SEBI order and date of offence

Assumptions of the study / Limitations of the Data
1. Samples of 100 appellants with maximum of 2 appellants in one SAT order have been
considered.

2. Date of offence is the first date of violation. In cases of offence relating to
noncompliance with summons issued by SEBI, date of offence has been taken as the
date of 1st summons issued.

3. Date of appointment of adjudicating officer could not be found in case of ex-parte
orders/ investigations ordered by SEBI/ otherwise (32 such cases). We could not
ascertain the reasons why this date was not written in the orders. In 5 cases, date of
appointment of adjudicating officer is after the date of show cause notice which are
essentially show causes issued by enquiry officer, these have been taken as enquiry
cases.

4. In one case, no show cause notice has been issued, hence the date of show cause
cannot be analysed.

5. To ascertain whether the outcome of SAT order was in favour of SEBI/ Appellant,
following assumptions have been made:

Appeals decided in favour of Appellant comprise of cases where the order has

26

been completely set aside or the monetary penalty has been reduced to zero.

Appeals decided in favour of SEBI consist of cases where there is no reduction
in the penalty or the order has been withheld by Appellant. Cases withdrawn
unconditionally or cases settled thru consent order have been also clubbed
under the category of favourable to SEBI.

Appeals where the order has been withheld but the quantum or conditions or
amount of penalty has been reduced by Appellate have been taken as Relief to
Appellant. In case the order has been sent back to SEBI for further
investigation or a fresh order have been also considered as relief to Appellant.

6. In order to determine the nature of violations, data has been clubbed in the following
manner:

a) Price Manipulation comprises of the cases where promoters or directors or broker or
company has involved itself in synchronised/ circular/ cross deals to create artificial
volume and rig securities prices. It also consists of cases whereby false or misleading
corporate public announcements have been made or insider trading has been done.

b) Takeover violation comprises of the cases where the regulations relating to takeover
code i.e. Disclosures of more than 2%/5% voting rights, shareholding pattern by the
company have not been followed.

c) Investors grievances relate to the companies delays in dematerialisation of shares,
non-redress of investors grievances, huge selling in the shares with an objective to
defraud investors, delay in refund of investors funds, non-implementation of moral
code of conduct to protect investors interest.

d) Violation of code of conduct of brokers encompass the cases where the brokers
have not maintained proper books of accounts, segregation of client moneys and own
funds, fund based activities, unauthorised terminals, KYC norms non-compliance etc.

e) Non responsiveness of summons issued by SEBI includes the cases of zero
response or non-cooperation as to the quantum & timeliness of information submitted.

f) Failure to pay stock broker registration charges on a timely basis.

g) IPO manipulation includes the cases where fraudulent financing of IPOs have been
done to oversubscribe the shares and make disproportionate profits on the date of
listing or create benami shareholding. It also includes subscription to avoid under
subscription of shares.

7. This study cannot comment on final collection of the penalty amount by SEBI.


27

Observations
1. Nature of Offence
We have identified the nature of violations by categorising them as under:

In our study, most of the cases pertain to share price manipulation or IPO manipulation
(56%), Stock Broker code of conduct violations (15%), Takeover Code Violation (12%).
This reflects the state of securities market where securities price manoeuvring is rampant
either at the time of issue of shares or later through means of circular trades, synchronised
deals and cross deals.
In such fictitious transactions the beneficial ownership in the scrip does not change but
artificial volumes are created, perhaps to lure common investors. In such cases the price is
not derived by fair market mechanism but by creating an artificial buying pressure.
However more research is required to comment upon SEBIs detection and disciplinarian
role in such cases.

49
15
12
8
7
6
2
1
Nature of Offence
Share Price Manipulation Stock Broker Code of Conduct Violation
Takeover Code Violation Investors Grievances
IPO Manipulation Non Responsiveness to summons issued
Non Payment of Broker Registration Fees Listing Agreement Violation

28

2) Nature of Penalty
The amount and nature of penalties are laid down in Section 15 of SEBI Act. The penalties
in our sample are:

In 73% of the cases monetary penalty has been charged. A further analysis of the penalties
has been done in the following section on disposal of cases.

3) Disposal of Appeals

In 49% of the cases the appeal has been decided in favour of SEBI and remaining 51%
cases the appellant has given full or partial relief to appellant.
In 49 cases which have been determined in favour of SEBI, a monetary penalty of Rs 296.50
lacs have been levied.
In 51 cases where the appellant has received full or partial relief, calculation has been done
to establish the amount of penalties waived by SAT. To facilitate the waiver calculation 11
cases have been excluded for the following reasons:
73
15
3 8
1
Nature of Penalty
Monetary
Debarred from dealings in
securities market
Debarred from dealings in
securities market & Monetary
49
34
17
Disposal of Appeals in Favour of
SEBI Relief to Appellant Appellant

29

a) Impounding of money by SEBI and then ordered to refund the amount so impounded to the
appellant.

b) Cases with monetary penalty sent back to SEBI for fresh order forming part of relief to
appellant have not been considered.

c) Debarment from dealing in securities or cancellation of share broker certificate.

In remaining 40 cases the penalty has been waived by 90% bringing from Rs.997.05 lacs in
the original order to Rs 101 lacs in SAT orders.
This shows a degree of ambiguity in the basis of penalties levied by SEBI and also in
the policy of reversal later on.

4) Ageing Analysis of Cases

-
10
20
30
40
50
60
Date of offence vs Date of appointment of AO
Date of appointment of AO vs show cause notice Date
Date of AO order vs show cause notice Date
Date of AO order vs offence Date
Date of SAT order vs AO order Date
Date of SAT order vs offence Date
N
o
.

o
f

O
r
d
e
r
s

Ageing Analysis of SAT Orders and AO Orders

30

Interpretations:
i. A comparison of date of offence with date of appointment of adjudicating officer to
examine the time taken by SEBI to start punitive action in case of default: In the 68
cases where date of appointment of AO is available, in 25% cases the AO has been
appointed within a year. However in 35% of the cases it took more than 4 years for
SEBI to appoint an AO. That is, there is a delay of as long as 4 years to appoint an
AO from the time of violation. This may result in loss of evidence and increase the
investors losses.

ii. A comparison of date of appointment of AO with date of issue of Show Cause Notice
to determine the time taken by AO to initiate adjudicating proceedings against the
violator: Out of 62 cases on which data was available, in 65% cases AO has issued
show cause notice within 6 months, whereas in 32% cases it took more than 6
months to issue the same. In 4% cases the show cause notice was issued after 36
months. In certain AO/ SEBI orders we have found instances of transfer of the
adjudicating officer resulting in unwarranted delays. There is no prescribed standard
time within which the AO is required to issue a show cause notice, which leaves room
for discretion.

iii. A comparison of the date of order by AO/ SEBI with the date of Show Cause Notice
to determine the amount taken to complete the process of enquiry after the notice
has been sent to the violator: In 37% of the cases the proceedings have been
completed in one year. However in 40% cases it took more than 2 years to complete
proceedings. Such long periods carry the risk of the defaulter becoming untraceable,
destruction of circumstantial evidence and increasing investor losses.

iv. A comparison of date of order by AO/SEBI with time when the offence was
committed to determine the time taken to actually punish the violation: In 25% cases
the order is passed within 3 years whereas in 56% cases it takes more than 5 years
to pass an order.

v. A comparison of date of SAT order with the date of passing an order by AO/ SEBI to
find the time taken by SAT to complete the appellate proceedings: In 59% of the
cases SAT proceedings have been completed within 6 months. This shows efficiency
in disposal of cases by SAT.

vi. A comparison of the date of SAT order with date of offence to ascertain the time lag
between the time of non-compliance and the final indictment after first leg of appeal
process is complete: It takes more than 5 years in 64% of the cases from the time of
offence to the time of disposal of appeal at SAT with 16% in more than 9 years
bracket.
The above analysis shows that the investigation and appeals process is slow, often
arbitrary and opaque. While the process framework is good and in line with best
practices of justice and fair play, the problem lies in the implementation in routine

31

everyday cases. The entire process of enquiry, adjudication, trial, decision and appeal
must be streamlined and the reasonable time frame strictly enforced to help SEBI
perform its role as a good gatekeeper of corporate governance.

4.4 Study the mechanism of Consent Orders and analyse its prevalence,
effectiveness as a deterrent and transparency of the system
According to the SEBI guidelines of April 2007, a consent order means "an order settling
administrative or civil proceedings between the regulator and a person (Party) who may
prima facie be found to have violated securities laws. It may settle all issues or reserve an
issue or claim, but it must precisely state what issues or claims are being reserved. A
consent order may or may not include a determination that a violation has occurred."

Consent order allows compounding of offence whereby an accused pays compounding
charges in lieu of undergoing consequences of prosecution. Consent orders were introduced
with an objective of appropriate action, remedy and deterrence without resorting to litigation,
lengthy proceedings and consequent delays. Consent Orders can be passed in respect of all
types of enforcement or remedial actions including administrative proceedings and civil
actions. Any person who is notified that a proceeding may or will be initiated/instituted
against him/her, or any party to a proceeding already initiated/instituted, may, at any time,
propose in writing for settlement.

Consent orders are aimed to reduce the regulatory cost, time and effort spent on pursuing
enforcement actions. We have analyzed a few consent orders to determine the efficacy of
the entire process. This has been done in the following parts:

Analysis of consent orders over a period of two years from September 1, 2009 to
September 30, 2011.

ii) Sample Study of 100 consent orders from May 1, 2009 to September 30, 2011
covering takeover regulations.

i. Analysis of consent orders over a period of two years from September 1, 2009 to
September 30, 2011

During the period of two years beginning September 2009 a total of 379 consent
orders have been passed. (Source: www/sebi.gov.in)

ii. The consent orders have been plotted quarterly and monthly in the under mentioned
tables and graphs.


32

The data portrays a declining trend in the number of consent orders issued from as
high as 37 cases in month of September 2009 to 10 cases in September 2009. The
reason can be on account of negative media opinion on the procedures followed in
passing consent orders.

The data pertaining to two years showed multiple consent orders passed for the
same applicant. In the cases of 12 applicants, repetition ranging from 2 to 4 consent
orders has been observed. However the study cannot comment on group entities or
persons acting in concert with different names of the applicants.

SEBI consent order scheme aims to achieve litigation free alternative of achieving
justice and discipline but over enthusiasm towards this process may dissuade the
honest law abiders. This may also help the offenders to relieve themselves of severe
regulatory action by paying a paltry sum of penalty. One of the considerations for
passing consent order and compounding charges is applicants past record that is it
has not been found guilty of similar or serious violations in the past. However by
allowing multiple consent orders from the same violator may encourage tendency of
violations without any fear of law and its consequences.

0
10
20
30
40
50
60
70
80
Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11
Number of orders Quarterly
Number of orders Quarterly

33

ii) Sample Study of 100 consent orders from May 1, 2009 to September 30, 2011
covering takeover regulations.

A sample of 100 consent orders was studied for the following points:

Name of Applicant
Date of consent order
Year/ Date of offence
Amount of Penalty Imposed
Date of Application for consent order
Denial/ Admission of Guilt
23

The above parameters were analyzed on the following criteria:

1. Consent Order Date vs Application Date
A comparison has been made between the date of consent order issued by SEBI
and the date of application filed by applicant requesting settlement by way of
consent. In case of multiple applicants filing application, first date has been
considered as the date of application.

Time taken to complete the consent proceedings has been tabulated as under:

To conclude 53% of the cases are resolved within 180 days, 28% cases take 180-360
days and remaining 19% cases are resolved in more than 360 days.
Thus SEBIs objective of avoiding lengthy legal proceedings, delays in litigation fulfilled
with the help of consent orders.

2. Date of Offence is defined as the date when the said regulation was not followed as per
the text of consent order. In cases where such date is not clearly mentioned, date of

23
Source: www.takeovercode.com, www.sebi.gov.in, www.watchoutinvestors.com
2
20
31
21
7
19
0
5
10
15
20
25
30
35
0-60 days 60-120 days 120- 180 days 180- 270 days 270- 360 days More than 360 days
Number of cases
Number of cases

34

offence has been taken as middle of the year; in case year only mentioned, in case date
not available date of adjudication, in case date of adjudication is not available then date
of show cause notice sent by SEBI is taken; in case of multiple failures of continuous
nature over a period of time, an average date has been taken & in other cases the first
date taken.

In case of suo motto applications when date of offence could not be ascertained as
above, date of application has been taken as the date of offence.

Ageing of the cases on the date of passing consent order date taking into account the
date of offence has been captured as under:

From the above it can be concluded that 35% of the cases which are more than 7
years old have been settled by way of consent order, which is may be the only way to
recover dues but 24% of the cases are less than 12 months old where SEBI could
have taken the normal route of prosecution which could be a stronger deterrent than
consent order.

There are no clear guidelines which determine which type of cases may be settled
through the consent order route, leaving considerable scope for discretion.

11
13
14
2
5
7
3
10
11
24
0
5
10
15
20
25
30
less than
6 months
6 months
to 12
months
12
months
to 24
months
24
months
to 36
months
36
months
to 48
months
48
months
to 60
months
60
months
to 72
months
72
months
to 84
months
84
months
to 96
months
More
than 96
months
Number of cases
Number of cases

35

3. Penalty Levied under Consent Order
As per Section 15 of SEBI Act, Chapter V the penalty that can be levied for delay in
filling information/ return, to enter into agreement, to redress investors grievances
etc. has to be Rs 1,00,000 per day subject to maximum of Rs 100,00,000. In case of
mutual funds, stock brokers, asset management companies, additional limits have
been also specified. In case of insider trading, non- disclosure of acquisition of
shares and take overs, fraudulent and unfair trade practices penalty is 3 times the
amount of profit made out of such practice or Rs 250,000,000 whichever is higher.

Thus, theoretically at least, in the sample of 100 cases, SEBI could have levied a
minimum penalty of Rs 100 lacs and in some cases Rs 2,500 lacs also.

However the results differ substantially as is mentioned in the table:

In 58% of the cases penalty levied is less than Rs 3 lacs. This points to the revenue
loss to SEBI and weaker monetary deterrent for regulatory lapses.

As per Section 15J of SEBI Act, the adjudicating officer while determining the
quantum of penalty should consider amount of disproportionate gain/ unfair
advantage accruing to defaultee, amount of loss caused to investor group and the
repetitive nature of default.
Compounding of offences has been allowed under the SEBI Circular of Consent
Order in lieu of prosecution. However an attempt to determine the basis of the
penalties levied as part of the study has remained inconclusive.

We have mapped the amount of penalty levied and the ageing of the case and the
results are:
13
9
36
15 15
6
3
2
1
0
5
10
15
20
25
30
35
40
less than
equal to
Rs 50,000
Rs 50,000
to Rs 1lac
Rs 1 lac to
Rs 3 lacs
Rs 3 lac to
Rs 5 lacs
Rs 5 lacs
to Rs 8
lacs
Rs 8 lacs
to Rs 12
lacs
Rs 12 lacs
to Rs 20
lacs
Rs 20 lacs
to Rs 50
lacs
> Rs 50
lacs
Number of cases
Number of cases

36

No Conclusive correlation can be drawn between the ageing of the case and the
amount of penalty levied.

It is difficult to determine whether SEBI has truly taken into account the magnitude of
the default and loss to common investors while passing the consent orders. The
results of the study shows subjectivity in the amount of penalty recovered.

4) Admission/ Denial of Guilt

As per the SEBI circular on consent orders, Consent orders can be passed either a)
admitting guilt or b) without admitting or denying guilt.

In 60% of the sample consent order cases, settlement has been reached with the
applicant without admitting or denying guilt which is specifically mentioned in the
Consent Order. However, in remaining 40% of the cases do not mention the words
neither admission nor denial of guilt or similar words to indicate this and therefore
has been assumed here to be the applicants admission of guilt.

-
5
10
15
20
25
30
35
40
less
than
equal
to Rs
50,000
Rs
50,000
to Rs
1lac
Rs 1
lac to
Rs 3
lacs
Rs 3
lac to
Rs 5
lacs
Rs 5
lacs to
Rs 8
lacs
Rs 8
lacs to
Rs 12
lacs
Rs 12
lacs to
Rs 20
lacs
Rs 20
lacs to
Rs 50
lacs
> Rs 50
lacs
> 8 years
7 to 8 years
6 to 7 years
5 to 6 years
4 to 5 years
3 to 4 years
2 to 3 years
1 to 2 years
< 1 year
Amount in Rupees Lacs
N
o
.

o
f

O
r
d
e
r
s

Penalty Compared with Ageing of the Case

37

However, no correlation can be derived between the amount of penalty levied and
denial/ admission of guilt on the above assumption.

40
60
Number of cases
Admission
Neither admission nor
denial
-
5
10
15
20
25
30
35
40
less
than
equal to
Rs
50,000
Rs
50,000
to Rs
1lac
Rs 1 lac
to Rs 3
lacs
Rs 3 lac
to Rs 5
lacs
Rs 5 lacs
to Rs 8
lacs
Rs 8 lacs
to Rs 12
lacs
Rs 12
lacs to
Rs 20
lacs
Rs 20
lacs to
Rs 50
lacs
> Rs 50
lacs
Neither admission nor denial Admission cases
Penality Compared with Admission or
Denial of Guilt
N
o
.

o
f

O
r
d
e
r
s
Amount in Rupees Lacs

38

5) Suo Motto

In 13 out of sample 100 cases the applicant has suo motto filled for settlement
through consent before initiation of the adjudication proceedings by SEBI. In 3 out of
these 13 suo motto cases the settlement is without admission or denial of guilt
pointing towards opacity of the entire process.

In other 87 cases the consent application has been filled during the adjudication
proceedings.

The system of consent orders may be effective for settling cases but it lacks
transparency and is marred with opacity in terms of

The amount of penalties to be levied.
Non acceptance of new cases on the parameter of time of default.
Compounding of offences
Time limit for reaching settlement
Criterion for accepting applications in case of repeat offenders

We also noticed that the Adjudicating Officer is very powerful in the entire
process by playing a significant role in the issue of showcause notices,
enquiry, forwarding the case for settlement and approving authority in consent
orders which calls for greater transparency and clearer guidelines.

We conclude that SEBI has played a big role in instituting a basic standard of
corporate governance in the country, albeit only for listed companies. However,
research shows that if one sector of an economy displays certain behaviour, there is
a spill-off effect on other sectors as well and thus, corporate governance norms in
listed companies may reasonably be expected to influence adoption of such practices
in unlisted companies and other businesses too.
The study could not find any conclusive evidence that adopting corporate governance
norms as mandated by SEBI has any improvement on corporate performance as
measured by accepted standards of Return on Assets or Return on Equity. While
profitability per se as well as share prices have shown a consistent upward trend,
there is no clear evidence that this is because of improved corporate governance
alone and not a mix of macro economic factors.
G Sabarinathan
24
conducts a review of the SEBIs performance on areas such as
disclosures, corporate governance etc. Overall, the analysis in Sabarinathan (2010)
indicates that SEBI has led the effort in improving standards of corporate governance
in India in companies that are already listed and are about to be listed. It is hard to
say whether that is the result of poor legal preparation on the part of SEBI or the
leniency of the appellate systems towards the trade.

24
SEBIs Regulation of the Indian Securities Market: A Critical Review of the Major
Developments, G. Sabarinathan

39

Similarly, SEBIs record in enforcing the canons of corporate governance has not
been impressive. The reason for the same may partly be the regulatory arbitrage that
has been noted earlier due to the joint responsibility for oversight of companies
between the MCA and SEBI. For reasons that are understandable, the two agencies
approach regulatory oversight somewhat differently and are endowed with different
organizational and legal capacities in the enforcement of their regulatory remit. The
Indian corporate sector took advantage of this arbitrage when it successfully pushed
back the initial, more demanding set of recommendations of the Committee headed
Mr Narayana Murthy.
Black and Khanna (2007) have tried to estimate the impact of compliance with
Clause 49 on the market valuation of companies in India. It concludes that faster
growing firms gained more than other firms, consistent with firms that need external
equity capital benefiting more from governance rules. Cross-listed firms gained more
than other firms, suggesting that local regulation can sometimes complement, rather
than substitute for, the benefits of cross-listing.
The positive reaction of large Indian firms contrasts with the mixed reaction to the
Sarbanes- Oxley Act (which is similar to Clause 49 in important respects), suggesting
that the value of mandatory governance rules may depend on a countrys prior
institutional environment
25
.
Although SEBI is a young institution it has been fairly successful in fulfilling its
mandate as the capital market regulator, ensuring deepening of markets and
increasing participation of investors. However the enforcement process tends to be
somewhat arbitrary and rather opaque and leaves scope for discretion in the hands
of officials. The system of enforcement is also slow as these statistics show: As per
Annual Report of SEBI for 2010-2011, Page 110- Page 112, there are 3,493 pending
cases as on March 31, 2011. On analysis of these cases we find that as many as
32% of the pending cases have an ageing of 6 or more than 6 years while 28% of the
cases have been pending for 3 to 5 years (Annexure I). During the year 2010-11 a
total of 1801 cases have been disposed off by SEBI; out of these, 9% of the cases
pertain to 2004-2005 or years before almost more than 6 years old, 41% of the
disposed cases are 3-5 years old. Only 18% of the cases pertain to 2010-2011.
(Annexure II).
The enforcement system needs to be made more transparent to ensure greater
confidence in capital markets. While the inherent spirit of framework is robust and in
line with best practices of bringing timely justice and fair play, the problem lies in the
implementation which needs to be more effective for capital markets to be buoyant
and transparent.

25
Khanna, Vikramaditya S. and Black, Bernard S., Can Corporate Governance Reforms
Increase Firms Market Values? Evidence from India, Journal of Empirical Legal Studies, Vol
4, 2007: ECGI-Finance Working Paper no. 159/2007; University of Michigan Law &
Economics, Olin Working Paper No.07-002. http://ssrn.com/abstract=914440)

40

ANNEXURES


41

Annexure I SEBI

As per Annual Report of SEBI for 2010-2011, Page 110- Page 112, there are 3,493 pending
cases as on March 31, 2011. The details of the cases are as follows:

Year
Cases
U/sec 11,
11B & 11D
Enquiry
Proceedings
Adjudicating
Proceedings
Prosecution
Proceedings
Summary
Proceedings
Total
cases
Percentage
of cases
1995-96 0 0 0 7 0 7 0.20
1996-97 0 0 0 4 0 4 0.11
1997-98 2 0 0 5 0 7 0.20
1998-99 0 0 8 9 0 17 0.49
1999-2000 0 2 0 23 0 25 0.72
2000-01 29 1 4 24 0 58 1.66
2001-02 1 0 2 81 0 84 2.40
2002-03 48 6 11 193 0 258 7.39
2003-04 80 14 13 381 19 507 14.51
2004-05 66 0 13 61 0 140 4.01
2005-06 0 0 42 24 62 128 3.66
2006-07 63 33 134 23 0 253 7.24
2007-08 119 53 371 39 0 582 16.66
2008-09 0 13 120 29 0 162 4.64
2009-10 277 17 301 30 0 625 17.89
2010-11 316 16 287 17 0 636 18.21
Total 1001 155 1306 950 81 3493 100

42

Annexure II SEBI

During the year 2010-11 a total of 1801 cases have been disposed off by SEBI. The details
of the cases are as follows:

Year Cases
U/sec
11, 11B
& 11D
Enquiry
Proceedings
Adjudicating
Proceedings
Prosecution
Proceedings
Summary
Proceedings
Total
cases
Percentage
of cases
1995-96 0 0 0 0 0 0 0.00
1996-97 0 0 0 0 0 0 0.00
1997-98 0 0 0 0 0 0 0.00
1998-99 0 0 0 0 0 0 0.00
1999-2000 3 0 0 0 0 3 0.17
2000-01 3 0 0 2 0 5 0.28
2001-02 0 0 1 2 0 3 0.17
2002-03 7 14 5 15 0 41 2.28
2003-04 33 14 3 3 4 57 3.16
2004-05 19 10 23 0 0 52 2.89
2005-06 18 13 56 0 90 177 9.83
2006-07 54 27 106 0 0 187 10.38
2007-08 61 14 295 0 0 370 20.54
2008-09 23 3 255 0 0 281 15.60
2009-10 69 5 229 0 0 303 16.82
2010-11 30 8 284 0 0 322 17.88
Total 320 108 1257 22 94 1801 100

43

Indian Institute of Management Calcutta
Indian Institute of Corporate Affairs
Thought Arbitrage Research Institute

Sebi

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