India Ratings points to India Inc massaging results
Financial analysts like to look at key financials like EBITDA or PAT, but a study by India Ratings for the Serious Fraud Investigation Office (SFIO) points out, using statistical analysis, that for several BSE 500 companies, the results are likely to have been massaged. India Ratings, a groupcompany of ratings firm Fitch, analysed data for 421 large corporates for a 12-year period from FY02 to FY13. In other words, the key lesson appears to be that analysts would do well to look at metrics that cannot be massaged like cash in the bank. For banksespecially, the lesson to be learnt is that if the cash numbers look at variance with other metrics, it would be a good idea to get a more detailed forensic study done—indeed, even the stock market regulator would do well to get detailed forensics done on a random basis for the BSE 500 firms. Interestingly, the highest proportion of massaging of numbers takes place in downturn years—FY09 and FY13—in the study. Selling and distribution expenses, bad debts, provisioning and write-downs are, the study points out, the areas where the bulk of mischief occurs—these are areas where management discretion is the highest.
The results of the study are intuitive, and fortunately for us, the stock marketregulator also seems to be basing its policies keeping this in mind. So, for instance,India Ratings points out that the greatest discrepancy in variables is to be found incompanies where the promoter shareholding is greater than 50%—it is not as ifIndian promoters are worse than foreign ones. Perhaps that is why the markets regulator has put in place where at least a fourth of the company’s stock must be held by the public. While Sebi can do little about this, India Ratings found thatcompanies with higher level of institutional shareholdings tend to have better numbers, probably due to the fact that large institutions are expected to go through earnings data with a fine toothcomb. While companies with higher levels of debt have better numbers for the same reason of additional scrutiny by another pair of professionals, there is a temptation for highly-leveraged firms to massage the data in order to avoid breaching critical covenants based on financials. Fortunately, given the arguments being made in favour of hiring global auditors in place of home-grown ones, the study finds no meaningful difference in the quality of earnings. It may be interesting for banks to do a study on their bad and stressed assets to see if there is a correlation with the India Ratings’ study—chances are the correlation will be high