Fundamental analysisModule 7, lesson 37 of 48
Management quality and corporate governance
How to judge a company's board, independent directors, audit committee, executive pay and disclosures, and how to assess management from its track record.
In this lesson
- Explain what corporate governance is and why it matters to minority shareholders.
- Assess a board's composition, independence and committees from the annual report.
- Judge executive pay against performance.
- Assess management from its record of promises, capital decisions and disclosure.
Builds on
- Understanding a company's business modelJudging management means judging how well they run the business described in that lesson.
On this page
In simple terms
A minority shareholder owns a tiny slice of a company and has almost no say in how it is run. Corporate governance is the set of rules, structures and behaviour that protects that shareholder: it makes sure the people in control run the company in the interest of all shareholders, report honestly, and do not take more than their share.
In many Indian listed companies, a founding family or group, the promoter, owns a large stake and controls the board. That can be good, because the promoter has a lot at stake, or bad, if the promoter treats the company as their own and minority shareholders as an afterthought. Good governance is what makes the difference.
The board of directors
The board oversees management on behalf of shareholders. When reading the annual report's corporate governance section, check:
- Independence. SEBI's listing rules require listed companies to have independent directors, people with no material relationship with the company or promoter. Look at who they are: real independence and relevant experience, or long-standing friends and former employees?
- Tenure and attendance. Directors who have served for decades, or who miss many meetings, provide weaker oversight.
- Committees. The audit committee, which oversees financial reporting and auditors, and the nomination and remuneration committee, which handles appointments and pay, should be led by independent directors.
- Changes. Independent directors resigning, especially with vague reasons or mid-term, deserve attention.
Executive pay
Executive pay is disclosed in the annual report. Ask:
- Is pay linked to performance over several years, not just one?
- How does it compare with profits and with pay at similar companies?
- Do promoter family members receive large salaries or commissions in addition to their dividends?
Worked example: Two made-up companies
| Saral Consumer | Lohit Holdings | |
|---|---|---|
| Net profit | ₹500 crore | ₹60 crore |
| Pay to top executives and promoter family | ₹15 crore | ₹18 crore |
| Pay as a share of profit | 3% | 30% |
| Profit trend over five years | Rising | Falling |
At Lohit, a large share of profit goes to the people in control as pay, even as profit falls. Minority shareholders bear the cost.
Judging management from its record
Management quality is hard to judge from interviews and presentations, which are designed to impress. The record is more reliable.
- Promises against delivery. Read the MD&A and investor presentations from three to five years ago. Did management do what it said, on targets, capacity, debt and new products?
- Capital decisions. Were acquisitions, expansions and diversifications sensible, and did they earn good returns? The capital allocation lesson covers this.
- Candour. Does management discuss setbacks openly, or only good news? Annual reports that never mention a problem are a warning.
- Consistency. Are accounting policies stable, or changed whenever results are weak? Are targets quietly redefined?
- Treatment of minority shareholders. Look at related-party transactions, share issues to insiders and dividend policy.
Disclosure quality
Good governance shows in how a company communicates. Clear segment reporting, detailed notes, timely announcements to the exchanges and consistent explanations are good signs. Frequent restatements, late filings, vague notes and important news first appearing in the media rather than in exchange filings are bad ones.
Why it matters
Good businesses can still be poor investments if the people in control divert value away from minority shareholders. Poor governance is also often an early warning of worse problems: many corporate collapses and frauds were preceded by weak boards, aggressive accounting and evasive disclosure. Governance analysis protects you from risks that ratios cannot show.
Limitations
Governance structures can look good on paper while behaviour is poor, and a strong board cannot always restrain a determined controlling shareholder. Judgements about management are partly subjective. Some well-governed companies perform badly, and some poorly governed ones perform well for a time. Use governance as one input, but give red flags heavy weight.
Common mistakes
- Mistaking charisma for competence.
- Assuming independent directors are independent without checking who they are.
- Ignoring pay to promoter family members.
- Trusting presentations over the record.
Try it yourself
Choose a listed company and use its latest annual report.
- In the corporate governance report, list the board members, note which are independent, and check their attendance.
- Find the pay of the top executives and any promoter family members, and compare it with net profit.
- Read the MD&A from three years ago and list its main promises. Check which were kept.
- Write a short note on whether you would trust this management with your money, and why.
Key takeaways
- Corporate governance is the system of rules, structures and behaviour that makes sure a company is run in the interest of all its shareholders, not just those in control.
- Many Indian listed companies have a controlling promoter, so the key governance question is often whether minority shareholders are treated fairly.
- Look at the board's independence and experience, the audit committee, related-party approvals and attendance in the corporate governance report.
- Judge executive pay against long-term performance, and compare it with peers and with the company's profits.
- Judge management by its record, what it promised, what it delivered, how it allocated capital and how candidly it disclosed problems, not by its charisma.
Check your understanding
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Terms used in this lesson
- Corporate governance
- The rules, structures and behaviour that make sure a company is run in the interest of all its shareholders, not just those in control.
- Independent director
- A board member with no material relationship with the company or its controlling shareholders, meant to oversee management on behalf of all shareholders.
- Promoter
- In India, the founders or controlling shareholders of a listed company, together with their family and related entities.
- Annual report
- A company's yearly report to shareholders, containing its audited financial statements, notes, auditor's reports and management's commentary.
References
- SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (as published, with amendment notes), Securities and Exchange Board of India. SEBI's listing regulations, which set governance requirements for listed companies.
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This lesson is general education, not investment advice. Examples use made-up or clearly dated figures to explain ideas; they are not recommendations. Read the disclaimer.