Analysis of Indian Corporate Financial Reporting

Submitted in partial fulfillment of the requirements of

Independent Project (Term 4)

By

Anandh Sundar (PGP 10032)

Miheer Desai (PGP 10195)

on

10th

September 2011

Guide

Prof. Sobhesh Kumar Agarwalla

2

Abstract

Do India‟s premier companies go that extra mile to disclose relevant information to investors?

One would certainly expect so, given the high institutional holding in these stocks. To test

this hypothesis, we ranked 62 companies on 10 non accounting parameters, to assess the

quality, quantity and user friendliness of their non financial reporting. The results are

tabulated in the exhibits, and while Infosys (predictably) seized the first spot, the other

companies threw up some surprises.

From FY 2011-12, companies can save on printing/postage costs by sending annual

reports/other communications electronically, and can now devote more resources to making

the online version of the report more comprehensive and informative. In that light, this report

should be useful. The criteria, along with their explanation and assigned weights, are

tabulated as an exhibit for use in future research.

Key Words: - Indian corporate financial reporting, „financial reporting ranking‟, „disclosure

quality‟, ‟disclosure scores‟, ‟qualitative financial reporting‟

3

Contents

Introduction ............................................................................................................................................ 5

Reporting Requirements under Law ....................................................................................................... 6

INCORPORATION LAW .................................................................................................................. 6

REGULATORY EDICTS .................................................................................................................. 6

ACCOUNTING STANDARDS ......................................................................................................... 6

Selection of Companies........................................................................................................................... 7

Literature Review .................................................................................................................................... 8

Methodology ........................................................................................................................................... 9

Discussion of Criteria ............................................................................................................................ 10

NON-MANDATORY CRITERIA ................................................................................................... 11

Data Analysis (10%) ....................................................................................................................... 11

Aesthetics and Lucidity (5%) ......................................................................................................... 11

MANDATORY CRITERIA ............................................................................................................. 11

Helping investors understand the business (10%) ........................................................................ 11

Industry specific disclosures (10%) ............................................................................................... 12

Performance Drivers (15%) ........................................................................................................... 12

Comparative analysis (10%) .......................................................................................................... 13

Risk Analysis (10%) ........................................................................................................................ 13

Risk Impact (5%) ............................................................................................................................ 13

Management and Directors’ Information (5%) ............................................................................. 14

Corporate Citizenship .................................................................................................................... 14

Information on third party assessors (5%) .................................................................................... 14

Additional information to investors (10%) ................................................................................... 14

Discussion on Ranks .............................................................................................................................. 15

SECTOR SPECIFIC INFERENCES ................................................................................................ 16

Limitations and Further Study .............................................................................................................. 19

Best Practices ........................................................................................................................................ 20

4

List of Exhibits

Exhibit 1: Grades of evaluation criteria ................................................................................................ 22

Exhibit 2: Criteria-wise scores of company reports .............................................................................. 24

Exhibit 3: Exceptional historical data by Tata Steel .............................................................................. 25

Exhibit 4: Many PSUs present in two languages .................................................................................. 26

Exhibit 5: HDFC Bank fails to highlight section headings ................................................................... 27

Exhibit 6: Innovative business description by Tata Steel ..................................................................... 27

Exhibit 7: Ackruti explaines changing strategies .................................................................................. 28

Exhibit 8: Airtel explains M&A rationale for both sides ...................................................................... 28

Exhibit 9: PNB makes a vacuous and possibly misleading claim ........................................................ 29

Exhibit 10: Glenmark explains how exogenous factors determine its strategy .................................... 29

Exhibit 11: GAIL discloses methodology of the award ........................................................................ 30

Exhibit 12: GAIL mentions no threats/risks in the relevant section ..................................................... 30

Exhibit 13: DCM Shriram gives capex and revenue splits ................................................................... 31

Exhibit 14: LIC Housing Finance breaks up its loan portfolio ............................................................. 31

Exhibit 15: Colgate Palmolive (FMCG) gives due importance to advertizing spends ......................... 32

Exhibit 16: Infosys takes performance driver reporting to the next level ............................................. 32

Exhibit 17: GAIL does a good comparative analysis vis-a-vis the market ........................................... 33

Exhibit 18: Elegant and comprehensive risk analysis by TCS ............................................................. 33

Exhibit 19: Cairn (India) clarifies contingent liabilities ....................................................................... 34

Exhibit 20: Infosys management remuneration .................................................................................... 34

Exhibit 21: Serious analysis of CSR activities by Sterlite .................................................................... 35

Exhibit 22:TCS relates CSR activities with core competencies ........................................................... 35

Exhibit 23: Tata Steel makes analyst reports available ......................................................................... 37

Exhibit 24: Sun Pharma presents additional information in one view ................................................. 39

Exhibit 25: Final ranking of company reports ...................................................................................... 39

Exhibit 26: Sector-wise scores of company reports .............................................................................. 39

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Introduction

Indian managements are world famous for their “jugaad” - which fortunately has not

extended to their financial reporting. While the world has been repeatedly racked by crises

exacerbated by poor accounting (1987 S&L crisis, 2000 dot com bubble or 2008 subprime

mortgages meltdown), India has just seen a single case (Satyam). Indian finance

professionals are respected globally, so at first blush, the temptation is to laud them for this as

another example of „India Shining‟ etc. Still, mere compliance with the letter of the law does

not imply achieving excellence (or even fair disclosure of accounts). This report highlights

several examples of the same.

Still, there is little reason to gloat over this. This may be due to the lack of investigative

reporting/academic research on this subject, and if studies are conducted in greater depth, the

results may be different. In the last quarter of 2011, India‟s leading lender took a blood bath

of provisioning against teaser loans. This u-turn (earlier its CEO supported by the Board of

Directors refused to provide for this) coinciding with the change in CEO/MD, invited

criticism from all and sundry including ICAI, RBI and analysts. This may seem a trivial

accounting malaise, but the rot is deeper. When the going gets tough, the weak cook the

books. Companies have stopped conference calls post 2009, made disclosures more

infrequent etc, in response to worse industry conditions. This is true especially for the

midcaps.

In this light, we decided to study whether Indian companies „walk the talk‟ when it comes to

optional/ voluntary disclosures, which are standard in other developed markets. There is

enough literature in the form of committee reports/listing agreement voluntary sections etc.

Analysts, in our view, would be more than happy to suggest improvements in a company‟s

reporting practices, if the company asks them. Hence, given that Nifty companies are India‟s

most tracked companies with an expected sizeable analyst following, they should have been

pace setters. And hence this study was conducted.

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Reporting Requirements under Law

Indian law on financial disclosures can be categorized under 3 parts

INCORPORATION LAW

Most Indian companies are incorporated under the Companies Act 1956. Schedule VI of the

Companies Act 1956 and other provisions of the companies act apply to most Nifty

companies. Special entities like LLPs, banks are incorporated under other Acts like LLP Act,

Banking Regulations Act.

REGULATORY EDICTS

Regulators like SEBI (for listed companies), IRDA and RBI prescribe certain additional

disclosures via listing agreement and circulars respectively. These disclosures are not

necessarily investor focussed (as are accounting standards), but directed towards other

constituencies as well. For example, many of the RBI directed bank disclosures are aimed at

customers, to allow them to assess the quality and safety of their bank.

ACCOUNTING STANDARDS

They generally apply to most legal entities irrespective of form, industry and activity. While

most of these disclosures relate to financial items, some allow for non financial analysis such

as segment disclosure, quantitative disclosures, risk management etc. Now, legal/regulatory

edicts often dictate the presentation format leaving little to the imagination. While accounting

standards related disclosures merely outline the basic principles, leaving most other choices

to the reporting entities. That is why we defined the base score 1(of 3) as mere compliance

with legal/regulatory edicts, 2 for good presentation and 3 for innovative disclosure.

The mandatory non accounting disclosures are

1. MD&A where management gives its take on the company‟s performance v/s earlier

year, and gives the industry SWOT analysis too, as per Section 217 of the Companies

Act 1956.

2. Quantitative information(production/sales/energy consumption) is to be disclosed as

per Schedule VI of the Companies Act 1956

3. Listing agreement mandates that the company layout its risk perception/ management

policy in brief. There are several other „recommendatory‟ disclosures that are rarely

adhered to.

7

Selection of Companies

We aimed at analyzing the reporting of all 50 S&P CNX Nifty(viz „Nifty‟) companies, which

constitute around 53% of India‟s market cap (NSE website). In our view, these companies

influence a lot of investing decisions, both individually and collectively (index futures,

economic barometers etc). Given the large extent of public scrutiny, they were expected to set

the lead in disclosure practices.

Some of the companies were not included either because their 2011 reports were not out at

the time of freezing the list, or because their sector had already been adequately represented.

Quite a few PSU blue chips came in this list. Given their tendency to stick to the letter of the

law and avoid any additional disclosures, our rankings would be penalized them heavily, thus

dragging them to the bottom of the list. In our view, the Nifty companies we excluded did not

carry any educational/informative value. The final cut of 62 companies is, in our view,

representative of India Inc's sectoral representation. Further rankings could add to or detract

from this number. The list below reconciles the company selection to the Nifty companies

list. Note that FY10 annual reports were analyzed for 9 companies- HCL Technology,

RCOM, Tata Communications, Idea Cellular, Hindalco, Sun Pharma, and Reliance Capital

8

Literature Review

We could not find any prior publicly available academic research on this topic. While a

private website (Reportwatch) publishes its annual report on annual reports to rank 500

global annual reports, it does not transparently reveal its criteria weights, which in our view

are essential for a better understanding of the rankings.

While India‟s professional institutes ICAI & ICSI confer awards on companies for best

corporate financial reporting/corporate governance, they have more of an accounting

fidelity/legal compliance mindset, and do not follow a remotely similar objective.

We searched SSRN, Google Scholar and Science Direct using multiple keywords such as

„financial reporting ranking‟, „disclosure quality‟, „disclosure scores‟, „qualitative financial

reporting‟ etc. We observed several examples of research which had touched upon some of

our criteria but none that was as comprehensive as this study was. We list them below

1. In their landmark study on „An Empirical Analysis of the Quality of Corporate

Financial Disclosure‟, Singhvi and Desai examined variables like assets size (A),

number of stock-holders (N), listing status (L), CPA firms (C), rate of return (R) and

earnings margin (E), and hypothesized a conceptual relationship between the index of

quality of disclosure (I) and the above-mentioned variables to be of the following

order: (I) = f (A, N, L, C, R, E). While these factors identified all ring true to us,

we were not able to do the detailed statistical analysis appropriate for a study of

this nature.

2. In their study on study on „Relationship Between Annual Report Readability and

Corporate Financial Performance‟, Baker and Khare claimed that more profitable

companies are more verbose in their letters to stock holders than those with

lower profitably. An intuitively appealing finding, which even we found to be

largely true (it is a different matter that that verboseness was mostly fluff!).

3. Beattie, McInnes and Stella Fearnley published a methodology for analyzing and

evaluating narratives in annual reports: a comprehensive descriptive profile and

metrics for disclosure quality attributes. This proved useful to shape our thinking.

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Methodology

We considered only reports/presentations/transcripts prepared for Indian shareholders. This

was done to avoid penalizing companies with no ADRs/GDRs, which therefore need not file

20-Fs with the SEC. The 20F document being much more exhaustive in disclosure

practices/norms, it would have rewarded companies for statutory(as per foreign norms)

disclosures.

Our scoring pattern tried to follow this approach on all parameters

1. Merely meeting statutory/listing agreement compliances would merit 1 point

2. Good presentation/some slight extra innovation would merit 2 points

3. Exceptional disclosure practice on par with global best practices, would merit a 3

points

4. Not meeting even the minimum criteria would result in 0 points

We could have merely evaluated one document (the annual report) and its usual constituents.

However, the reality is that investors rely on the website for additional information, as well as

non statutory documents like investor relations PPT, conference call transcripts, sustainability

report etc. Ignoring this information would have penalized those companies which take pains

to customize their report/website and show creativity (in presentation not in accounting!). We

thought that thinking from investors‟ perspective would instead lead to much more

appropriate evaluation criteria, and therefore the criteria goes beyond just the annual report,

and is truly representative of „financial reporting‟.

The three grades in each criterion are explained in Exhibit 1.

10

Discussion of Criteria

While the scoring explained in Exhibit 1 is self explanatory, the rationale behind the weights

are not. Incorporating the post presentation feedback, we polled 25 IIMA PGP2 students with

an investing background, and 5 analysts, requesting them to assign 100pts to the below

criteria, with an option to state another criteria(which nobody did). The results threw up

interesting insights that compared to other MBA students; we gave more importance to data

analysis/additional information while giving less importance to risk and third party reports.

Analysts (not surprisingly) did not desire general information (industry/business) and

preferred to do their own data analysis. But they did want more performance drivers,

comparative analysis and risk disclosure from the companies.

Criteria Used for Evaluation Weights

by us

MBA

Student

Analyst

Industry Specific Disclosures 10 10.9 11.0

Helping investors understand underlying business 10 12.8 7.3

Performance drivers(past, current and predictive data) 15 14.7 21.7

Comparative Analysis(with own budget/competition) 10 11.1 14.0

Risk Analysis 10 11.3 9.0

Risk Impact(quantifies potential impact of risk factors) 5 8.0 5.7

Management/Directors information 5 5.4 7.7

Corporate Citizenship 5 3.1 5.0

Information on third party assessors(analyst reports,

ratings etc)

5 8.7 4.3

Additional Information available to investors(transcripts,

PPTs etc)

10 2.6 5.7

Data Analysis (quantity of information, use of graphs and

table)

10 6.0 7.3

General Aesthetics and lucidity (ease to read) 5 5.4 1.3

We discuss the philosophy behind each criterion and extract certain extreme examples below

for demonstrating good and bad performance.

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NON-MANDATORY CRITERIA

Data Analysis (10%)

Whatever the company may wax eloquent, investors know that long term financial data

remain the ultimate measure of the company‟s performance and quality. The more the

number of years for which data is presented, the less the possibility of accounting gimmicks

and earnings manipulation. Longer term data also show the performance of companies

through economic/ sectoral cycles revealing, in the words of Warren Buffett, who was

swimming naked. As seen in criteria-wise scores in Exhibit 2, 90% of the companies

analyzed have revealed performance for 5 or more years.

In this regard, the reporting of Tata Steel has been extraordinary. They have disclosed

production, financial, dividend and ratio data for the last 55 years, starting FY 1956-57. A

snapshot of segmented production data is seen in Exhibit 3. In today‟s world where real

performance can be easily hidden under the garb of financial statements, such disclosures

engender a lot of confidence in the company.

Aesthetics and Lucidity (5%)

While this criterion may seem trivial, the overall design of the report plays a positive role to

the extent it makes reading easier and a negative role to the extent it makes reading tougher.

An overwhelming majority of PSUs include both languages (English and Hindi) side by side

or page by page in the same annual report (Exhibit 4). This is desirable given the objective of

financial inclusion.

While HDFC Bank report starts off well, a few pages later the aesthetic quotient drops so low

that even titles (e.g. “Retail Banking” in Exhibit 5) are not highlighted and are not

distinguishable from rest of the text on first glance. Clearly such reporting exacts unnecessary

incremental effort from the reader and is penalized in the criterion score to that extent.

However, the bad eggs are few in number, with 95% of companies scoring 2 or 3.

MANDATORY CRITERIA

Helping investors understand the business (10%)

For a new (potential) investor, this is perhaps the most important section of the annual report.

Companies tend to explain about their business across different sections like letters from

management, Directors‟ Report and Management Discussion and Analysis. In general

12

companies have performed well under this criterion, with as high as 85% scoring the highest

grade i.e. 3. There is no dearth of examples of good under this criterion. On the one hand

there are companies that show abundant creativity so that the readers may gain valuable

insights in the underlying business, as seen in Exhibit 6.

Realty and telecom companies had a series of bad years post the subprime crisis and 2G

auction fallouts. Yet Ackruti and Bharti Airtel have presented data to give investors a

strategic insight into their business. In Exhibit 7, Ackruti reassures investors of its strategic

sense over the years. In Exhibit 8, Bharti Airtel displays a rare sensitivity by stating the

seller‟s rationale in M&A, something quite uncommon in hubris driven M&A atmosphere of

today.

One instance of bad reporting under this criterion is seen in Exhibit 9. This statement is either

meaningless or misleading until the company specifies the parameter for which it ranks No. 1

(revenue, profit, balance sheet size, NIM, CASA, etc.)

Industry specific disclosures (10%)

Because there is nothing sadder than buying a good company at a high price, it is important to

know the state of the industry/ sector in which the company operates. This is mainly

explained in the management letters and Management Discussion and Analysis (MD&A). As

in other criteria, reports which identify trends and provide forecasts are rated higher. The

MD&A section often tends to be verbose. However, as shown in Exhibit 10, some companies

like Glenmark use innovative means of presentation that capture industry trends in an

excellent manner.

Most companies simply list the awards won leaving investors clueless about the stature and

methodology of the award(s). GAIL (India) Ltd. departs from this practice, much to our

delight. In Exhibit 11, the reader can possibly infer that since GAIL is the monopoly gas

utility in India and hence has high revenues, assets and profits by definition, it may not be

any great achievement that GAIL has won the award.

In their bid to fit in with conventional reporting templates, companies may miss the spirit of

reporting. This is starkly exemplified in Exhibit 12, where GAIL gives a prominent title to a

section in the report but mentions absolutely no threats or risks in the text.

Performance Drivers (15%)

One can liken the performance drivers to the technical specifications of an automobile.

Skilfully chosen advertising words and pictures can sway the mind of the buyer, but the

technical specifications will tell them the truth of the matter. Performance drivers like sales

13

mix by product/service, geography, R&D progress, employee productivity etc. help the

investor predict the real performance of the company independent of what the management

says.

As seen in Exhibit 13, DCM Shriram takes investors through the logical process from capital

expenditure to revenue generated in each segment of business in the concise form of a pie

chart. Such charts directly help the investor to evaluate the capex efficiency.

Many times, KPIs are industry-specific. LIC Housing finance breaks down its portfolio really

well allowing investors to get a sense of the impact if interest rates or credit risk change

drastically (Exhibit 14). Colgate Palmolive captures advertising spending, a key variable for

FMCG companies, perhaps to drive home that the company is not cutting back on strategic

(here advertising) spending to inflate profits in the short term (Exhibit 15). In the true spirit of

cost accounting, Infosys goes a step ahead to directly attribute contribution of various factors

like volume, price, mix and FX to revenue growth (Exhibit 16).

Comparative analysis (10%)

It is important for the company to explain why results have changed over the year. It is even

better if it quantifies its locus standi in the market. As seen in Exhibit 17, GAIL does a good

job in this regard with little fuss.

Risk Analysis (10%)

Investors would like to know about systematic (market) as well as unsystematic (company-

specific) factors affecting the company. Once these are understood, a natural progression is

the need to understand what the company is doing to control these risks. An excellent

example of systematic risk disclosure is Exhibit 18, where key risks, their specific impact on

TCS and (most importantly) the steps TCS is taking to mitigate them are tabulated elegantly.

Risk Impact (5%)

Contingent liabilities and off-balance sheet items can have incredible real effects on company

performance as was demonstrated by the subprime crisis. Thus, it is important to know the

maximum possible impact of these on the profits. As seen in Exhibit 2, this is one criterion

where scores of companies are distributed relatively uniformly between 3, 2 and 1.

Cairn India is locked into several disputes with Government/ONGC on oil royalties, tax

holiday under Section 80IA, service tax disputes etc. While the standard practice (which

Cairn follows) is to disclose this under contingent liabilities, most companies shy away from

quantifying their potential outgo, and instead play a game of whispers with Dalal Street. As

14

seen in Exhibit 19, Cairn India sets a good example, by quantifying its potential liability in

the event of outflows, and supporting its estimate by legal opinions and citing the case facts

in brief.

Management and Directors’ Information (5%)

Fiduciary duty of management is the cornerstone of the modern corporation. The

shareholders (principals) need to know the selection policy and procedure and remuneration

of management (agents). Interestingly, 57% of the companies surveyed scored low on this

criterion (Exhibit 2: 1 point for merely mentioning names of senior management). This goes

well with the impression of Indian companies being heavily influenced by promoters even

today.

As per the Indian Companies Act, the information of employees drawing remuneration above

Rs 5lakh/month is to be disclosed as part of the annual report. However, it is permitted to

avoid sending this information by default, and instead dispatch the information only by

request. Some companies go out of their way to provide such information in the report itself,

as seen in Exhibit 20.

Corporate Citizenship (5%)

As seen in Exhibit 21, Sterlite makes it a point to report about CSR activities in fair detail.

Even well meaning corporates are often accused of destroying investor/social value by

plunging into ill planned initiatives or not leveraging their core competencies. In this regard,

the CSR disclosure by TCS is exemplary, where it clearly distinguishes areas where it has

core competencies from mere volunteering (Exhibit 22).

Information on third party assessors (5%)

This was a very low-scoring criterion where most companies (87%) had a score of 1 or 0.

(Exhibit 2). Indian companies have not yet accepted the convention among better American

companies to disclose all sell side analysts that are following the company and their reports

on the company. Tata Steel does a great job in this regard, as seen in Exhibit 23.

Additional information to investors (10%)

Revealing additional information like analyst presentations and conference call transcripts on

the website serves to reduce the information asymmetry between institutional and retail

investors. Almost half the number of companies uploaded conference call transcripts on their

website (Exhibit 2), which is a good sign. Sun Pharma is the best performer here, as it makes

all data available on a single page, as seen in Exhibit 24.

15

Discussion on Ranks

Given that the points scored in each criterion can be {0,1,2,3} and the weight of each

criterion is {5%,10%,15%}, least count of the score is 0.05. One of the tests of any rating or

ranking system is the relative differentiation in generated scores between the bet and the

worst. The current system seems to be doing reasonably well, with the best score being 2.9

and the worst being 1.35 out of maximum 3. The 62 companies surveyed resulted in 22

distinct aggregate scores. Based on the criteria described above, the criteria-wise and

aggregate scores of each company and consequent ranks are shown in Exhibit 25.

Banks

Auto

Conglomerate

Financial Services

FMCG

Healthcare

Infra

IT-ITeS

Metals & Mining

Oil & Gas

Realty

Telecom

Aggregate

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9

Ran

ge

Mean

Mean Scores and Range for Various Sectors

16

SECTOR SPECIFIC INFERENCES

Sector-wise scores are shown in

17

Exhibit 26. The following inferences can be drawn from analysis of scores:

1. Telecom annual reports are released late maybe due to sectoral turmoil. Barring

Airtel, none of the other telcos had released their FY 2010-11 annual reports by 18th

August.

2. Underpeformers gloss over their reasons for non performance (Tata Communication)

and hence score less in comparative analysis.

3. Companies with lumpy revenues (real estate, healthcare) do not focus beyond past 5

yrs, in general. Hence they score fewer points in data analysis relative to other sectors.

4. Market leaders have more to lose (in terms of competitive advantage) by better

disclosures - or so they feel. That is why only a few market leaders/innovators

disclose well.

5. Has boilerplate killed bank’s incentive to innovate in the financial reporting? Banks

have lower overall score than expected (Exhibit 26). However, they show an upward

bias in their scores on Risk Analysis and Risk Impact because of a strict regulator in

the form of RBI, which mandates several disclosures via its annually updated master

circular on this subject. Banks also show lower variation in their aggregate scores

(difference between maximum and minimum is only 0.20), possibly because of

stringent regulation.

6. The IT industry has been in the forefront while setting standards for manpower

recruitment/training, facilities management, branding, foreign capital raising etc. No

wonder then, that their investor relations is among the best in India, if not globally.

Right from conference call transcripts, investor presentations, other conferences etc,

data is frequently updated and uploaded on the website, with focus on both individual

and institutional investors (

18

7. Exhibit 26). Admittedly, a „Golden Peacock‟ corporate governance award winner was

destroyed in the infamous Satyam scam, but otherwise the industry has acquitted itself

quite well, setting new records in transparency and responsiveness. One may argue

that this is due to their ADRs, FII investor base, etc. (who are habituated to similar

treatment in their home markets), but whatever be the reason, one must admire the

industry.

8. Healthcare being technically complex (both operationally and from investor view

point) and intangible asset heavy, one would have expected companies to put their

best foot forward and use non financial disclosures to educate investors and analysts.

However, we do not find any such industry effort (

19

9. Exhibit 26), not even in the market leaders. Even the companies which disclose well

lose themselves in the alphabet soup of poorly presented jargon. We found that

companies with ADRs/GDRs did better than those with purely domestic listings.

Indian investors are wary of new fangled healthcare companies (Biocon is the only

major unconventional listed player in this space), and maybe the poor sector

understanding/communication is a contributory factor to this state of affairs.

10. PSUs being low scorers:- The 7 PSUs we considered(GAIL, SBI, ONGC, PNB, Coal

India,LIC Housing Finance) had an average score of 2.01, which drops to 1.95

excluding the professionally managed IDFC. As the main shareholder(GOI) has

internal reporting, C&AG audits etc as information source, we suspect that public

reporting is given short shrift.

The graph below gives an idea of the scores distribution(selected companies listed on the X

Axis), which we notice is clustered near 2.2(the mean).

NUMERICAL ANALYSIS OF FOREIGN INFLUENCE AFFECTING SCORES

During the project presentation, it was suggested that companies with greater foreign

exposure(customers, suppliers, lenders, shareholders) would have better investor disclosure

records. We decided to test this hypothesis by collecting data on shareholding, exports,

imports and foreign debt. These percentages were converted into numerical scores on scale of

0-3(0%-0, 0% till 20%-1, 20% till 50%-2 and above 50%-3). These scores were then

regressed on the total score of the company. The results below indicate that where powerful

parties need information(customers, FIIs), it correlates well but not when parties with private

information hold sway(lenders, promoters, suppliers with L/C).

20

The table below analyzes the various and overall foreign influence factors.

Sl No Correlation of Score with Value Comments

1 Promoters - Shares held %

-0.21

Significantly negative as

expected because

accountability to external

shareholders reduced

2 Non-promoter Institutions -

Shares held %

0.26

Significantly positive as

expected because

accountability to external

shareholders increased

3 Non-promoter FIIs - Shares held

%

0.29

FIIs are even more activist than

domestic institutions, so this

slight extra is only expected.

4 Tot Foreign holding(%)-this

includes FII+Foreign promoters

0.05

Unexpectedly lower, because

the foreign promoter effect

significantly erodes the FII

advantage.

5 Export / Sales (%)

0.26

Foreign customers would look

to the financial stability of the

company, so this correlation is

expected as it prods the

company to disclose more

publicly.

6 Total forex earnings / Total

income (%)

0.13

This would include other

income also, so the correlation

is weaker there. Still, it

measures the overall cash

realization so somewhat

reliable ratio.

7 Raw material imports / Raw

material purchases (%)

0.02

Surprisingly, this is quite low.

Maybe, the foreign suppliers

are shielded against credit risk

by EXIM Bank/L/Cs etc and so

they may not care about the

additional disclosures

8 Foreign debt(% to total debt)

0.05

Lenders have their own sources

of information via covenant

compliance certificates etc, so

again this low correlation is not

a surprise

9 Total Foreign Dependence

(Summing points for 4+5+6+7+8).

For 0%, we give 0 points. Till 20%,

1 point; 20%-50% 2 pts, and then

3pts. Hence, max points a

company can score under foreign

dependence is 15.

0.16 The strong correlations of

export sales and foreign are

somewhat offset by lower

correlations to debt and

imports. If we change the

foreign holding to just include

FII, then the correlation

increases from 0.16 to 0.21

21

Limitations and Further Study

1. Due to time and annual report availability constraints, we were able to do just 62 annual

reports. Assuming that a full analysis/ranking takes around 1.5hr/company, a study of

even 100 companies would need 150hrs, with around 30hrs for analysis/report. A larger

group could probably do more justice to it.

2. Given more time/resources, we would have liked to do a inter temporal(‘year on year’)

analysis of improvement in reporting scores over a larger time period, compared with the

shareholding pattern changes/stock returns during that time. While this would need

significant statistical data manipulating for isolating the reporting factor from other „noise‟

factors, we think this is doable.

3. Least Count of 0.05 may have skewed the rankings. Mitigated partly by comparing notes

on some companies analyzed by both the team members.

4. We assigned weights to factors based on our judgment of what was important to

investors. Our small poll ascertained some areas of differences and a larger scale survey

may have revealed more valuable insights/factors.

5. We feel that further work can be done in the following areas

a. Ideally, this study should be conducted annually. In the post IFRS scenario (where

Indian companies have to inform more and better), companies must make their

annual reports stand out from the rest in both content and clarity, or else risk being

lost in the clutter/downgraded for more accounting risk. Hence, this study will

assume practical importance too

b. Annual reports going online due to MCA circular-scope for improving quality and

quantity of disclosure at little marginal cost

c. Regressing scores on market performance-does positive link exist?

d. Looking for causal factors- factors-shareholding pattern, size, industry etc

22

Best Practices

From the subprime crisis, banks learnt to value their retail depositors. But companies have

not learnt that lesson yet. Barring few exceptions, the additional information (beyond that

statutorily mandated to be disclosed) is selectively made available to analysts via separate

logins etc, rather than being freely disclosed to all investors. This would deter the stable retail

investor base which financial inclusion may bring to the table. Hence, efforts should be made

to have the information disclosure user friendly by:

1. Tabulating the investor base by city, and then conducting interactive workshops in cities

with certain minimum base of interested investors (say 500+). The content could be

tailored in the local language as well. No company does this at present.

2. Primers/Business FAQs should be downloadable from the website to demystify the

company. For non standard industries/sunrise industries, this is more important. Mundra

Port(one of 2 listed ports) gives FAQs about its business and plans.

3. Given the (relatively) slow and expensive internet in India, the file size should not be

unnecessarily large, and the format should not be wasteful. For instance, having 28MB

annual reports (by just scanning physical copy) is wasteful compared to uploading the

digital version of 4 to 5MB. And instead of uploading an mp3/video file of conference

call, the text version of transcript should be uploaded.

4. Segmenting investors into analysts and others is fine for the purpose of tailoring

information to their needs. But then, the information should be accessible to all

interested parties with minimum hassle like how Tata Steel has done.

5. Fundamentally oriented investors and analysts often need annual reports & conference

call transcripts for several years at a time. Like how Sun Pharma has done, have a friendly

web interface like a shopping cart, allowing investors to select and download multiple

documents in a single zip file.

6. Sadly, the reading habit is dying down especially among the generation brought up on a

diet of TV, radio and YouTube. Hence, multimedia content like site visits, presentations

and the like will keep some interest. JSW Steel sets a good example in this front.

7. Many investors still swear by Peter Lynch‟s adage of investing in what they think they

know. Hence, uploading the ad campaign videos and bringing the brands to life, would

increase their awareness and interest, given that investors may have missed the

advertisements of their own company in all the advertisement clutter out there.

23

8. When the going gets tough, the meek either stop the investor presentations, skip

conference calls or hide behind the excuse of „no comments‟, ‟no remarks on market

speculation‟ etc. But the better approach is to maintain, or even improve, the

disclosures through good times and bad. And responding comprehensively to bad news

is essential; otherwise bears will have a field day. A multinational minerals company with

operations in Western India was hit by a barrage of adverse reports about floods/illegal

mining etc, but it responded quickly by rebutting the allegations comprehensively,

ensuring that short sellers lost momentum.

And finally, when used well, the annual report can be a good marketing tool to prospective

employees, investors and clients. It is not just the Finance Department‟s responsibility, but

also that of Corporate Communications/Strategy and other teams too.

24

Exhibit 1: Grades of evaluation criteria

Para

met

er

Wei

gh

t

Gre

at

Aver

age

Min

imu

m

Exp

ecta

tion

/ R

egu

lati

on

Data Analysis (non mandatory) 10% 10yrs data/Ratios

calculations

Graphs for 5yrs 3-5yrs past

data/Ratios

General Aesthetics and lucidity

(non mandatory)

5% Excellent Average Unsatisfactory

Industry Specific Disclosures 10% Forward looking,

trend spotting and

outlook

Present situation

analysis and insights

SWOT

Analysis/plain

vanilla industry

description

Helping investors understand

underlying business

10% Clear

description/rationale

for strategy

Photos/Maps/Brands

/explained well even

without graphics

Description of key

business units OR

functional segment

(NOT geographic)

reporting AND

subsidiary accounts

extract (net assets,

P&L, %holding)

Performance drivers 15% Predictive data

(order book, % of

contracts which are

fixed price,

estimated, R&D

progress stage for

pharma)

Analytical(sales

mix, customer

breakup,

geographical

breakup of

employees/assets),

calculating 'core',

presenting proforma

metrics(EBITDA,

Operating profit,

Cash profits)

Basic (like sales in

MT, number of

employees)

Comparative Analysis 10% Performance

compared to own

budget/guidance OR

explains under/ over

performance wrt

industry

Reasonable

explanation of

change

Merely compared to

previous year

25

Para

met

er

Wei

gh

t

Gre

at

Aver

age

Min

imu

m

Exp

ecta

tion

/ R

egu

lati

on

Risk Analysis 10% Risk mitigants also

mentioned

Explains the risks in

relation to the

company

Merely mentions

economic

risks/industry

specific risks

Risk Impact 5% Sensitivity Analysis

wrt interest

rates/forex

Management

outlook/Max impact

assessment on the

contingent

liabilities/guarantees

/litigation.

Contingent

liabilities,

guarantees(performa

nce/bank), litigation

Management/Directors

information

5% For independent

directors, is the

director appointment

policy explained?

OR, is the value

added by the

respective director

outlined.

Section 217A

employee details

report in annual

report itself

Names of next level

management(next to

MD/CEO)

Corporate Citizenship 5% Sustainability Report

section in

AR/available online

Linking CSR/energy

efforts to the

company's activities

Description of CSR

Activities + energy

saving efforts(if

applicable)

Information on third party

assessors

5% Links to the equity

analyst reports-

equally for all

analysts

Names of the equity

analysts covering the

company on website

Credit Rating

mentioned in annual

report(if co has debt)

Additional Information to

investors

10% Conference Call

transcripts

Investor

presentations/

Analyst Presentation

Quarterly Results

only

26

Exhibit 2: Criteria-wise scores of company reports

Criteria Mean STDDEV Max Min 3 2 1 0

Data Analysis 2.39 0.66 3.0 1.0 48% 42% 10% 0%

General Aesthetics and

Lucidity 2.45 0.59 3.0 1.0 50% 45% 5% 0%

Industry Specific

Disclosures 2.45 0.74 3.0 0.0 58% 31% 10% 2%

Helping investors

understand the business 2.85 0.36 3.0 2.0 85% 15% 0% 0%

Performance drivers 2.42 0.62 3.0 1.0 48% 45% 6% 0%

Comparative Analysis 2.15 0.62 3.0 0.0 26% 65% 8% 2%

Risk Analysis 2.26 0.85 3.0 0.0 48% 32% 16% 3%

Risk Impact 1.85 0.81 3.0 1.0 26% 34% 40% 0%

Management/Directors

information 1.58 0.74 3.0 1.0 15% 29% 56% 0%

Corporate Citizenship 1.79 0.81 3.0 1.0 24% 31% 45% 0%

Information on third party

assessors 1.11 0.58 3.0 0.0 5% 8% 81% 6%

Additional Information to

investors 2.29 0.76 3.0 0.0 44% 45% 8% 3%

Aggregate Score 2.24 0.34 2.90 1.35 NA NA NA NA

27

Exhibit 3: Exceptional historical data by Tata Steel

28

Exhibit 4: Many PSUs present in two languages

29

Exhibit 5: HDFC Bank fails to highlight section headings

Exhibit 6: Innovative business description by Tata Steel

30

Exhibit 7: Ackruti explains changing strategies

Exhibit 8: Airtel explains M&A rationale for both sides

31

Exhibit 9: PNB makes a vacuous and possibly misleading claim

Exhibit 10: Glenmark explains how exogenous factors determine its strategy

32

Exhibit 11: GAIL discloses methodology of the award

Exhibit 12: GAIL mentions no threats/risks in the relevant section

33

Exhibit 13: DCM Shriram gives capex and revenue splits

Exhibit 14: LIC Housing Finance breaks up its loan portfolio

34

Exhibit 15: Colgate Palmolive (FMCG) gives due importance to advertising spends

Exhibit 16: Infosys takes performance driver reporting to the next level

35

Exhibit 17: GAIL does a good comparative analysis vis-a-vis the market

Exhibit 18: Elegant and comprehensive risk analysis by TCS

36

Exhibit 19: Cairn (India) clarifies contingent liabilities

Exhibit 20: Infosys management remuneration

37

Exhibit 21: Serious analysis of CSR activities by Sterlite

Exhibit 22: TCS relates CSR activities with core competencies

38

Exhibit 23: Tata Steel makes analyst reports available

Exhibit 24: Sun Pharma presents additional information in one view

39

Exhibit 25: Final ranking of company reports

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Infosys 1 228 30-Apr-11 3 3 3 3 3 3 3 3 3 3 1 3 2.90

TCS 2 164 20-May-11 3 3 3 3 3 3 3 3 1 3 1 3 2.80

L&T 3 260 19-May-11 3 3 3 3 3 3 3 2 2 3 1 2 2.70

Dabur India Ltd 4 183 15-Jun-11 3 3 3 3 3 2 3 2 2 2 1 3 2.65

Dr Reddy's 4 220 13-May-11 2 3 3 3 3 2 3 2 3 2 2 3 2.65

Cairn India 4 144 25-Jun-11 2 3 3 3 3 2 3 3 2 3 1 3 2.65

Tata Steel 7 244 25-May-11 3 3 2 3 3 2 3 2 2 3 3 2 2.60

Reliance 7 216 21-Apr-11 3 2 3 3 3 3 3 2 2 2 1 2 2.60

HUL 9 164 20-May-11 3 3 3 3 2 3 3 2 1 3 1 3 2.60

Wipro 9 212 27-Apr-11 2 3 3 3 3 2 2 3 3 3 1 3 2.60

HCL Technologies 9 146 29-Jul-10 2 2 3 3 3 2 3 3 3 2 1 3 2.60

Glenmark 12 118 10-May-11 2 3 3 3 3 2 3 3 3 2 1 2 2.55

Tata Power 13 172 19-May-11 3 3 3 3 3 2 2 2 2 2 1 3 2.55

Grasim 14 143 11-May-11 3 2 3 3 3 2 3 1 1 2 1 3 2.50

Marico 14 171 02-May-11 3 3 3 3 2 3 2 2 1 3 1 3 2.50

Tata Motors 16 155 26-May-11 3 2 3 3 2 3 2 1 2 3 1 3 2.45

ICICI Bank 16 204 28-Apr-11 3 3 2 3 2 2 3 3 3 1 1 3 2.45

DCM Shriram 16 100 06-May-11 2 2 3 3 3 2 3 2 1 2 1 3 2.45

IDFC 16 124 13-Jun-11 3 3 3 3 2 2 3 1 1 3 1 3 2.45

JSW Steel 16 124 16-May-11 2 3 3 3 3 3 2 3 2 1 1 2 2.45

Shriram Transport Finance 21 132 29-Apr-11 3 3 3 3 3 2 3 1 1 2 1 2 2.45

Punj Lyold 22 112 30-May-11 2 3 3 3 3 2 3 2 1 1 1 3 2.45

Voltas 23 128 19-May-11 3 2 3 3 2 3 2 2 1 2 1 3 2.40

Sterlite 24 188 25-Apr-11 2 3 2 3 3 2 3 3 1 3 1 2 2.40

Bharti Airtel 25 160 01-Aug-11 2 2 1 3 3 2 3 3 3 2 1 3 2.40

Ashok leyland 26 96 19-May-11 2 2 3 3 2 2 3 1 3 1 1 3 2.30

HDFC 27 152 10-May-11 3 2 3 3 2 2 3 2 1 1 2 2 2.30

Hindalco 27 160 04-Jun-10 3 2 3 3 2 2 3 3 1 2 0 2 2.30

LIC Housing Finance 29 108 28-Apr-11 2 2 3 3 3 2 3 1 2 1 1 2 2.30

Biocon 29 164 28-Apr-11 2 2 3 3 3 2 2 1 1 2 1 3 2.30

Sesa Goa 29 149 25-Apr-11 2 3 2 3 3 2 3 3 1 3 1 1 2.30

Sun Pharma 32 106 10-May-10 3 3 3 3 2 3 1 1 1 1 1 3 2.25

Axis Bank 33 176 22-Apr-11 2 3 3 3 2 2 3 3 1 1 1 2 2.25

M&M Finance 33 156 25-Apr-11 3 3 3 3 2 2 3 1 1 1 1 2 2.25

Sobha Developers 33 196 10-May-11 2 3 2 3 3 2 1 1 2 2 2 3 2.25

40

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HDFC Bank 36 156 18-Apr-11 3 2 1 3 2 2 3 3 2 1 1 3 2.25

ITC 36 176 20-May-11 3 2 2 3 2 2 2 2 3 3 1 2 2.25

Reliance Capital 36 114 30-Apr-10 3 2 2 2 3 2 3 1 1 1 1 3 2.25

Adani Enterprises 39 132 12-May-11 3 2 3 3 3 1 1 2 1 1 3 2 2.20

SBI 40 146 17-May-11 3 2 2 2 2 2 3 3 2 1 1 2 2.15

Ranbaxy 40 155 12-Mar-11 3 3 2 3 2 2 2 2 1 2 1 2 2.15

ONGC 42 256 30-May-11 3 3 3 3 2 3 1 1 2 3 1 0 2.10

Idea 42 86 06-May-10 2 2 2 3 2 3 2 1 1 1 1 3 2.10

DLF 44 194 23-Jun-11 1 3 3 3 3 2 2 1 1 1 1 2 2.10

Adani Power 45 106 09-May-11 2 2 3 3 3 1 1 2 1 3 2 1 2.05

Mundra Port 46 76 10-May-11 2 2 3 3 3 2 1 1 1 1 1 2 2.05

Ackruti City 46 123 30-May-11 2 2 3 3 2 2 2 1 1 2 1 2 2.05

HDIL 46 87 27-May-11 2 3 2 3 3 2 1 1 1 1 2 2 2.05

3i India 49 146 28-Apr-11 2 2 2 3 2 2 2 2 2 1 1 2 2.00

Coal India 50 210 12-May-11 3 1 2 3 2 3 2 1 2 1 0 1 1.95

Godrej Consumer Products 51 156 02-May-11 1 3 1 3 2 2 2 2 1 2 1 3 1.95

Asian Paints 51 140 10-May-11 3 3 2 2 2 2 2 1 1 1 1 2 1.95

Lupin 51 91 12-May-11 2 3 2 3 2 2 2 1 1 1 3 1 1.95

RCOM 51 124 15-May-10 2 2 2 2 2 2 2 2 1 1 1 3 1.95

Colgate 55 60 00-Jan-00 3 2 2 2 2 3 1 1 1 1 1 2 1.90

3M India 56 76 28-May-11 3 2 3 3 1 1 2 1 2 2 1 1 1.85

GAIL 56 240 23-May-11 1 2 1 3 3 3 0 1 2 2 1 2 1.85

Unitech 58 114 29-May-11 1 2 2 2 2 2 1 2 1 1 1 2 1.65

Bajaj Auto 59 107 18-May-11 2 3 0 3 2 3 0 1 1 1 0 2 1.60

PNB 60 111 04-May-11 2 3 1 2 1 0 3 3 2 1 0 0 1.40

Cipla 61 103 29-Jun-11 1 1 2 2 1 1 1 2 1 1 1 2 1.35

Tata Communications 61 147 31-May-10 1 2 1 2 1 1 2 1 1 1 1 2 1.35

41

Exhibit 26: Sector-wise scores of company reports

Sector Companies Mean Range

Auto 3 2.12 0.85

Banks 5 2.08 1.10

Conglomerate 5 2.29 0.65

Financial

Services 6 2.33 0.20

FMCG 6 2.26 0.75

Healthcare 7 2.17 1.30

Infra 6 2.33 0.65

IT-ITeS 5 2.58 0.90

Metals & Mining 6 2.33 0.65

Oil & Gas 4 2.30 0.80

Realty 5 2.02 0.60

Telecom 4 1.95 1.05

Aggregate 62 2.24 1.55