Lesson from Bhushan Steel: Don't trust the numbers, look at corporate governance

The last 15 days have been very eventful for Syndicate Bank, Bhushan Steel and Prakash Industries. When news of the arrest of Sudhir Kumar Jain, CMD of Syndicate Bank, came out in the press, there was panic not just in the banking sector but also in these two companies. After all, Syndicate Bank is a lender to these two companies. While the investigation is on with respect to the bribery and other malpractices , what went unnoticed in this entire episode is the loss to the shareholders of all the three companies, especiallysmall shareholders.

The share price of Bhushan Steel has fallen more than 55 percent, eroding more than half the value. Though the fall has not been as severe as Bhushan Steel in case of the two other companies, there is definitely a loss arising out of the news.

This fall in the stock prices of these companies is not driven by what the market defines as the fundamentals of the stock, but is purely due to the absence of corporate governance. It is being said that Bhushan Steel, in spite of borrowing 40,000 crores, has not defaulted on payments till now. Though some signs of distress have emerged in the recent past, they are not alarming and are applicable to many other companies thatare facing issues because of the prevailing economic scenario.

Whether there will be recovery in the future or not is debatable, but there is a very important lesson for investors from this episode: Corporate governance practices in a company is much more important than the numbers in financial statements. A company may sound very healthy as per the balance sheet, P&L and cash flow statements but may be weak in terms of corporate governance practices. If this happens to be the case, the value of shares may get eroded at the drop of a hat.

The other lesson from this incident is that shareholders can’t believe in companies based on the two-three page glossy corporate governance report that every company publishes in its annual report and claims to follow.

The small shareholders have limited access to the information about the company. The independence of the board of directors of companies remains as elusive as ever. The investigation in the case of Syndicate Bank, and also in the context of most of the PSU banks, shows critical decision-making remains a one-man show, thereby undermining the role of the independent directors. Corporate fairness, transparency and accountability are difficult to fathom for small shareholders.

Any shareholder, purely driven by the financial performance of a company, may end up getting trapped and find the value of his shares eroding instantly, as in the case of Bhushan Steel. Is there a mechanism by which small shareholders will be able to identify those incidents which cause share values to fall in this manner? The answer, unfortunately, is no.

In spite of measures taken by SEBI in the past and also a series of measures proposed to be implemented from 1 October, 2014 to strengthen corporate governance practices, the fact remains that small shareholders still cannot trust two core pillars of corporate governance i.e. transparency and independence.

So what is the way out? Avoid these companies for investments and trust only large established players. Or at least those who have an unblemished record till now. For a small shareholder, the biggest threat is investing in a medium size or small company which has very little to offer in the context of corporate governance.