When shareholders don't buy the numbers

Last month, the resolution to approve the accounts of a direct-to-home service provider was defeated for third time. Regulations need to provide direction regarding the way forward in such instances

Indian regulations give limited discretion to the board for decision-making. This is seen from the list of items on which shareholders are expected to vote — from director appointments, to raising money, to allowing companies to send documents to shareholders using a courier. How does this translate into practice? Once a resolution is placed before shareholders, apart from a few voicing their dissent, it is usually approved, with the execution left to the discretion of company management.

What if a resolution is not approved? If independent directors do not find support, they do not join the board. If an executive director fails to get shareholder support, they are expected to move on — but usually companies approach shareholders again. If an executive director’s salary is not approved, companies either revise the salary or go back to shareholders with more clarity. If a merger does not pass muster, companies can call off the transaction, modify the terms of the deal or return to investors with additional details. But when accounts are not approved, one wades into uncharted territory, as regulations are silent.

The accounts are prepared by the company management, audited by statutory auditors, signed by its board members and the auditors before they are finally presented to the shareholders for approval. Once rejected, seeking shareholder approval for the same set of financial accounts for a second time serves a limited purpose. The recent examples of a direct-to-home service provider, where the accounts were presented in three different meetings, and an airline, where accounts were presented twice, are both proof. Doing the same thing, over and over again, but expecting different outcomes serves no purpose. Companies need to address investor concerns, which may possibly mean having to restate the accounts, before approaching the shareholders again for approval.

Let us take the example of a company having large receivables that the management believes are recoverable and the auditors do not. The auditors decide to qualify the accounts. At this stage, one approach where auditors have given a qualified opinion is for the board to respond to the qualifications by explaining its stance in the director’s report.

The management may agree that the recoverable needs to be written off. They can make changes citing conditions that existed but could not be recognised, or quantified, at the time of preparing the accounts. Or conditions that did not exist at the time of filing the financial results and only surfaced later.

It will be for the shareholders to decide how convincing the management’s argument is. Once presented to the shareholders, if they decide not to approve the financial statements, what next?

If the accounts are qualified, the management can write-down the receivables, make the appropriate adjustments and re-present the accounts to shareholders. If there is new material information, that too can serve as a trigger to restate the accounts.

It may be appropriate to mention that in the US accounts carrying audit qualifications cannot be presented to shareholders, or filed with the regulators. The company and the auditors are expected to resolve all issues and differences at the time of finalising the audit.

There are other twists. The shareholders may vote against the approval of accounts even if these are unqualified — bankers find it to be the more prudent way forward. It can be the other way around, when shareholders approve qualified accounts. Recently, in the case of a power-utility controlled non-bank finance company most investors argued that they voted for the accounts because they believed that it would have jeopardised their receiving a dividend. Although the resolution to payout dividend is a separate one, needing separate approval, in a somewhat pure sense, dividends can be paid provided the accounts are approved. But this payout can always be treated as an interim dividend, so investors might be overthinking it.

The Companies Act has half the solution; it says that where the accounts are not adopted by the shareholders, they should still be filed with the registrar who should take them on record as “provisional” till the adopted accounts are filed. This suggests making the regulatory filings, stating that the financial statements have been audited and approved by the board, but not adopted by the shareholders. Sai Venkateshwaran, partner assurance, KPMG, is of the opinion that “where the accounts are not adopted, a definite and binding process to have these provisional accounts adopted needs to be spelt out, so that it’s not a permanent impasse.”

Having the accounts adopted is important as one year’s accounts are the base for the subsequent year. The closing balances for one year are the opening balances for the next. “Ensuring the accuracy of a prior period is vital. The entire edifice risks collapsing if the opening balance is being disputed or there is uncertainty around it,” Mr Sai argues.

Getting the shareholders to sign-off on the financial statements is crucial for a company’s continuing operations. These are the basis on which bankers lend, suppliers extend credit, distributors agree to carry the product and investors buy equity. Having the process and regulatory framework in place to deal with contingencies when accounts are not approved is imperative.

The writer works for Institutional Investor Advisory Services India Limited. The views are personal. @AmitTandon_in