Question Paper Investment Banking & Financial ServicesII (262): January 2006

Section D : Case Study (50 Marks)

This section consists of questions with serial number 1 - 5. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.

Case Study Read the case carefully and answer the following questions:
1. Appraise the various alternatives available to Discovery Engineering Systems. (20 marks) < Answer > 2. Represent your appraisal in the form of a decision tree with explanatory notes. (6 marks) < Answer >

3.
4.

Discuss the various lease related risks that HP Financial Services would need to bear.
(8 marks) < Answer > How mature is IT leasing in India and what are the emerging trends in IT leasing in India? (8 marks) < Answer >

5.

What competition does IT leasing companies face from banks that also offer leasing options?

(8 marks) < Answer > Discovery Engineering Systems (P) Limited is a Noida based venture capital funded manufacturing company in the Small and Medium Enterprise (SME) sector. The company is having a very good track record for the past 3 years With an outstanding growth rate Having its own sprawly premises in Nodia Having enough working capital and provisions for contingency.

Discovery Engineering has quality management, aggressive in nature. The management team comprises of professionals having extensive knowledge and related experience both in India and abroad. Goal of the company is to work on untested projects and develop new products and hence get the pioneering advantage of earning higher than normal returns. For achieving its goal the management is also planning to develop strong marketing, sales and distribution network in India and abroad. For achieving its goals and increasing its productivity, Discovery Engineering wants to use some high cost Computer Numerical Control (CNC) machines costing Rs.200 lakhs for complete automation of all its services. This automation would help the company to achieve 100% capacity utilization from the current 80% level. Given the uncertainties associated with the CNC machine market, the Vice President (Technical) believes that the useful life of the CNC machines is a stochastic (random) variable with the following probability distribution: Useful Life (in years) Probability 3.0 0.4 4.0 0.2 5.0 0.2 6.0 0.2

After reviewing the above probability distribution, the Vice President (Finance) is not very keen on purchasing the equipment. He believes that taking the equipment on lease, preferably under a flexible arrangement will

make more commercial sense. HP Financial Services is leasing company with offerings ranging from leasing of CNC machines to various automation equipments. Under this segment the company has provided CNC machines and automation equipment to approximately 750 customers. HP has also started IT equipment leasing, which includes hardware, software and other services for HP customers. Their financial service portfolio includes operating and finance leases, variety of acquisition strategies for multi-vendor/ multi-technology solutions, utility structures and lifecycle asset management. There is also a range of re-marketing services to maximize value of older equipment, add-ons and upgrades for corporate accounts and financing for printing and imaging services. In India they have approximately 100 customers. HP Financial Services leverage their relationship to reach the different verticals that their customers target, which includes telecom companies, banking, finance, manufacturing and the government sector. Their offerings can cut across any vertical. The financial and telecom segments are emerging in nature and have a very huge growth potential, therefore HP has included these in its portfolio to increase the volume of business. HP Financial Services have come up with two lease proposals for Discovery Engineering Systems. Proposal I : A finance lease under which the lessee will have to pay a rental of Rs.350/Rs.1000 a year for a non-cancelable period of five years. After 5 years, the lease can be renewed for another three years on a yearly basis at a rental of Rs.15/Rs.1000 per year. The lease rentals are payable annually in arrears. Proposal II: This involves a Back-to Back Short-Term Lease arrangement. Under this arrangement two short term leases, each for a duration of three years will be structured. The lease rentals payable annually in arrears for the first short-term lease will be as follows: Year 1 2 3 Lease Rental (Rs. in lakhs) 45 45 45

On expiry of the lease period, the lease can be renewed for another three years on the basis of the prevailing lease rate for the equipment of that vintage. The following information is provided by the VP Finance of Discovery Engineering Systems: The capital costs of similar high technology CNC machines have been escalating at the rate of 15% over the last 3 years 3 years The ratio of cost of used CNC machine to cost of new CNC machine is expected to be 0.20 after The net realizable value of the CNC machines by the end of year 4 will be negligible The lease rentals for the second lease term should be projected assuming a pre-tax return of 25%

The cash flow projections reveal that the investment in the new CNC machines will result in an incremental EBDIT of Rs.75 lakh in year 1, Rs.90 lakh in year 2 and Rs.105 p.a. in years 3 to 6 The tax relevant rate of depreciation is 25% Marginal rate of tax (including surcharge) is 35% Post tax required rate of return is 13% p.a. Incremental cost of debt is 16% p.a.

END OF SECTION D

Section E : Caselets (50 Marks)

This section consists of questions with serial number 6 - 11. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1
Read the caselet carefully and answer the following questions: 6. In recent times Individual Credit Rating is taking pace. Explain how the lenders are benefited through Individual Credit Rating and also state the disadvantages associated with it. (9 marks) < Answer > 7. What kind of credit information does the credit information bureau store and what happens lender provides the incorrect information to the bureau? when the

(8 marks) < Answer > As the number of companies borrowing directly from the capital market increases, and as the industrial environment becomes more and more competitive and demanding, investors find that the borrowers net worth or the name are no longer sufficient to ensure successful raising of funds from the market. In such a scenario to enable the investor to take informed decision, credit rating has emerged as one of the most critical factor in choosing. Offering this service is a Credit Rating Agency, which provides an impartial and objective opinion on the credit quality of debt obligations of different companies and assists investors, individuals and institutions in making investment decision. This was the discussion requirement of credit rating for companies but now a days credit rating of the individual is also taking pace. With liberalization in full swing, loans for cars and white goods are freely available at the right price for Indias 200 million strong middle class. Today there is no stigma attached to the loan for acquisition of goods for status. The consumer finance market is on boom and with it, the need to rate or assess an individual in order to avoid the risk of default, is all the more necessary. The presence of so many consumer finance companies like Country Wide, is an indication of growing need for consumer finance and with it the individual rating. In developed financial markets, there are specialized financial institutions that maintain records of credit histories of individuals and business entities. Lenders mostly banks and credit card companies, usually setup these institutions, called credit information bureaus. Whenever an individual seeks a loan from a bank or finance company, the lender before extending the loan checks his credit profile with the bureau to find out whether the borrower has defaulted with any other lender and whether he is capable of settling the loan. The question which arises in every ones mind is that why there was no credit information bureau in India until now. Until now, if any borrower failed to repay his loan to the bank in time, the bank could not share his loan details with anyone else. Laws relating to banking secrecy prevented a lender from sharing information pertaining to their customer with any third party. The only time information of a default would come in public domain was when the bank filed a suit for recovery of the loan. The bureau largely provides information on retail borrowers. This information is available to banks that contribute information in respect of their own borrowers. Lenders are provided a credit information report based on which they can take an informed decision on whether to lend or not.

Caselet 2
Read the caselet carefully and answer the following questions: 8. What according to you are the possible costs the SSI units are expected to bear, if they dont opt for factoring? (8 marks) < Answer > Explain the difference between credit insurance and factoring. (8 marks) < Answer >

9.

There are many ways to generate cash flow. However, not all may be right for you. If your

business is smaller one or you are new, you may not qualify for a traditional working capital loan. Or you may need cash flow support above and beyond such a loan. In such circumstance one attractive alternative you have is to hire a factor. A factor is a company that purchases receivables, giving your business an advance payment up front. It is a mode of financing that can help free businesses from the cash-flow squeeze caused by slow-paying customers. Companies in the services industry are particularly well-suited to factoring as a financing tool. Smaller companies requires cash frequently while a large client or customer takes long time to pay the dues. These imbalances the financial position of the company. In such situation factoring comes to rescue the companies. Similar problems are faced by the SSI units. They have been facing constrains in their operations on account of inadequacy caused by delays in receiving payments for their supplies. A large number of SSI units are managed by their promoters and/or persons with technical orientation who are unable to pay continuous attention to the areas of debt collection, accounting and working capital management. By and large, such units do not have an organizational set up for recovery of dues from the buyers. The potential demand for factoring services from SSI sector is estimated to be sizable; it would take some time before this demand could crystallize. In this connection, it is considered that the question of reservation of a specific percentage of total business of factoring organizations for SSI sector, to give an initial boost to factoring for this sector. In its view this may not be desirable, especially in the initial stages as it could endanger the factoring organizations commercial viability. Moreover, as factoring develops, such reservation may not be necessary at all. Some experts are of the view that factoring for SSI units could prove to be mutually beneficial to both factors and SSI units and factor should make every effort to orient their strategy to crystallize the potential demand from this sector. Caselet 3 Read the caselet carefully and answer the following questions:
10. What does Clause 49 of listing agreement state with respect to appointment of independent directors? Explain the rationale of SEBI behind appointment of independent directors in the company. (9 marks) < Answer > 11. Clause 49 may be a headache to the listed companies but it is a big opportunity for headhunter to make money. Explain. (8 marks) < Answer >

Clause 49 is comparable to Sarbanes-Oxley Act in US and the EU-VIII in Europe. It alters the qualification of the independent directors (IDs) in the board, besides making the CEOs and CFOs fully accountable for the financial statements that they certify. The new clause has brought in the much-needed clarity and has done away with ambiguity. In its present form, Clause 49 puts in black and white as to who qualifies for the role of an independent director and who does not. Some of the important qualifiers are Any person holding more than 2% stake in the company has been debarred from acting as an independent director. Supplier, service provider, customers cannot act as an independent director.

 Independent directors should not be related to promoters or management at the board level or at one level below the board. He should not have been an employee of the firm in the immediately preceding three financial years. He has not been, for the last three years, and should not be, a partner of the current legal and consulting firms, which is associated with the firm. India has over 6,500 listed firms, which are required to fulfill the Clause 49. SEBI has set a deadline of December 31 this year for listed companies to implement this clause. This has created a good opportunities for the recruiting agencies. In the given time available companies should identify and appoint required number of IDs. With the stringent policies in place searching for a right candidate is definitely a difficult task. The CEOs and CFOs should be properly geared up so that the pressure of certifying the statements do not hamper their day to day functioning. Proper policies and guidelines will have to be framed in accordance with Clause 49, so that there is no confusion regarding functionality, authority and accountability of different offices within the firm. This new requirement of Clause 49, will thrust more responsibility on the CEOs and CFOs of the company. This step taken by SEBI is in the right direction. This clause will make it necessary for the CEOs/CFOs to disclose proper information in the financial system. This will definitely bring some relief to the investors. This clause also increases the frequency of audit committee meetings to a minimum of four times a year with a maximum gap of four months between any two meetings, form the original three meetings a year with a maximum gap of six months between two meetings. According to experts increased frequency of meetings will lead to better governance.
END OF SECTION E END OF QUESTION PAPER

Suggested Answers Investment Banking & Financial ServicesII (262): January 2006
Section D : Case Study 1. We have to evaluate the NPVs of the following three alternatives: Purchase Finance Lease Back to Back Short-term Lease We shall define N as the random variable presenting the useful life of the asset. Alternative (A): Purchase the Equipment The net present value of this option will be as follows: NPV (P) = P.V. [EBDIT (1-T)] + P.V. (Tax Shield on Depreciation) + P.V. (Salvage Value) Initial Investment. The present value of EBDIT (1-T) depends upon the value of N. For N = 3, P.V. [EBDIT (1-T)] @ K=13% = [75(1-0.35)*0.8550] + [90(1-0.35)*0.7831] + [105(1 0.35)*0.6930] = Rs. 134.78 Lakh For N = 4, P.V. [EBDIT (1-T)] @ K=13% = Rs. 176.64 Lakh For N = 5, P.V. [EBDIT (1-T)] @ K=13% = Rs. 213.68 Lakh For N = 6, P.V. [EBDIT (1-T)] @ K=13% = Rs. 246.46 Lakh P.V. Tax Shield on Depreciation @ K=13% and N=3 is equal to [(50*0.8850) + (37.50*0.7831) + (28.13*0.6930)] * 0.35 = Rs. 32.59Lakh Since the salvage value of the equipment is insignificant beyond the third year, we will assume that it will be retained and the full Depreciation Tax shelter available under the Income Tax act will be claimed. Salvage value of the equipment after three years = 200(1.15) 3 * 0.2 = Rs. 60.84 Lakh P.V. of the salvage value realizable after three years = (60.84*0.6930) = Rs. 42.16 Lakh Net salvage value at the end of years four, five and six is taken to be insignificant. For different values of N, the values of NPV (P) will be as follows:

Initial Investment NPV (P) N P.V. [EBDIT P.V. Tax Shield P.V. (1-T)] (Net salvage value) on Dep. 3 134.78 32.59 42.16 200 9.53 4 176.64 37.12 0 200 13.76 5 213.68 40.13 0 200 53.81 6 246.46 42.13 0 200 88.59 Expected NPV (P) = (9.53*0.4) + (13.76*0.2) + (53.81*0.2) + (88.59*0.2) = Rs.35.04 lakh. Alternative (B): Finance Lease NPV (FL) = P.V. [EBDIT (1-T)] - P.V. (Lease Rental) + P.V. (Tax Shield on Lease Rental) - P.V. (Tax Shield on Depreciation) - P.V. (Interest tax shield on displaced debt) P.V. of lease rentals during the primary period at K=16% = (200*0.350) PVIFA (16,5) = Rs.229.20 Lakh P.V. of lease rentals during the secondary period = (200*0.015) PVIF (16,6) = Rs.1.23 Lakh P.V. of Tax Shield on Lease Rental during the primary period = (200*0.350*0.35) * PVIFA (13,5) = Rs.85.99 Lakh P.V. of Tax Shield on Lease Rental during the secondary period = (200*0.015*0.35) * PVIF (13,6) = Rs.0.50 Lakh P.V. of Interest tax shield on displaced debt = [(36.67*0.8850) + (31.34*0.7831) + (25.15*0.6930) + (17.98*0.6133) +(9.65*0.5428)]* 0.35 = 123.14 * 0.35 = Rs.43.09 Lakh P.V. Tax Shield on Depreciation @ K=13% and N=3 is equal to [(50*0.8850) + (37.50*0.7831) + (28.13*0.6930)] * 0.35 = Rs. 32.59 Lakh Since the salvage value of the equipment is insignificant beyond the third year, we will assume that it will be retained and the full Depreciation Tax shelter available under the Income Tax act will be claimed. Amortization Schedule for Debt Displaced Year Amount o/s Rate of Interest Capital Debt Service at the beginning Interest Content Component Charge 1 229.20 0.16 36.67 33.33 70

2 3 4 5

195.87 157.21 112.36 60.34

0.16 0.16 0.16 0.16

31.34 25.15 17.98 9.65

38.66 44.85 52.02 60.34

70 70 70 69.99

For different values of N, the values of NPV (FL) will be as follows: N P.V. [EBDIT P.V. P.V. (Tax P.V. P.V. NPV (Lease Shield on (Interest tax (Depreciation (FL) (1-T)] Rental) Lease shield on Tax Shield Rental) displaced forgone) debt) 3 134.78 229.20 80.22 43.09 32.59 -89.88 4 176.64 229.20 80.22 43.09 37.12 -73.19 5 213.68 229.20 80.22 43.09 40.13 -39.16 6 246.46 230.43 80.65 43.09 42.13 11.46 Expected NPV (FL) = (-89.88*0.4) + (-73.19*0.2) + (-39.16*0.2) + (11.46*0.2) = Rs. -53.13 lakh. Alternative (C): Back-to-Back Short-term Lease (BBSTL) NPV (BBSTL) = P.V. [EBDIT (1-T) - P.V. (Lease Rentals)] + P.V. (Tax Shield on Lease Rental) We have not considered the interest tax shield and depreciation tax shields on the displaced debt in the computation of NPV (BBSTL). This is because of the fact that the back-to-back short-term lease is not a finance lease. We have treated the lease rentals payable over the lease term like any other operating cash outflow and valued this out flow at the marginal cost of capital. P.V. (Lease Rentals payable during the initial lease period) = 45 * PVIFA (13,3) = 106.25 P.V. (Tax Shield on Lease Rentals payable during the initial lease period) = 106.25 * 0.35 = 54.99 The equated annual lease rental (L2) payable during the second lease term can be obtained from the equation: L2 * PVIFA (25,3) = 60.84 1.952* L2 = 60.84 therefore, L2 = Rs.31.16 lakh (approx) The discount rate of 25% represents the rate of return required by the lessor. The value of Rs.31.16 lakh is the estimated market price of the used equipment after three years and has been derived from the assumption made by the finance manager. P.V. (Lease Rental payable during the second lease period)

N 3 4 5 6

= 31.16 * PVIFA(13,3) * PVIF(13,3) = Rs.51 lakh P.V. (Tax Shield on Lease Rental payable during the second lease period) = 51 * 0.35 = Rs.17.85 lakh For different values of N, the values of NPV (BBSTL) will be as follows: P.V. [EBDIT (1P.V. (Lease P.V. (Tax Shield on Lease NPV T)] Rental) Rental) (BBSTL) 134.78 106.25 37.18 65.71 176.64 157.25 55.03 74.42 213.68 157.25 55.03 111.46 246.46 157.25 55.03 144.24 Expected NPV (BBSTL) = (65.71*0.4) + (74.42*0.2) + (111.46*0.2) + (144.24*0.2) = Rs. 92.30 lakh The expected net present values of the three alternatives are as follows: Alternatives Expected NPV (Rs. in lakh) Purchase +35.04 Finance Lease 53.13 Back-to-Back Short-Term lease + 92.30 The NPV of the Back-to-Back Short-Term lease is substantially higher than the NPVs of the Purchase and Finance Lease. Therefore, the company is advised to go for Back-toBack Short-Term lease plan. < TOP >

2.
Pay offs EL = 3 p = 0.4 Purchase EL = 4 p = 0.2 C1 + 35.04 EL = 5 p = 0.2 EL = 6 p = 0.2 EL = 3 p = 0.4 EL = 4 p = 0.2 D1 Opt. for FL C2 - 53.13 EL = 5 p = 0.2 EL = 6 p = 0.2 EL = 3 p = 0.4 EL = 4 p = 0.2 Opt. for BBSTL C3 +92.30 EL = 5 p = 0.2 EL = 6 p = 0.2 9.53 13.76 53.81 88.59 -89.88 - 73.19 - 39.16 11.46 65.71 74.42 111.46 144.24

Explanatory Notes:

1. 2. 3. 4. 5.

D1 denotes the first decision node. C1, C2 and C3 denote the chance forks. EL stands for Economics Life in years. p stands for the probability associated with a given economic life. The pay offs are denominated in lakh of rupees. < TOP >

3.

The total risk of a lease portfolio consists of the following types of risks: Default risk: The risk of not receiving the lease rentals on schedule. The default risk can arise on account of certain economy wide factors like unanticipated cost push inflation which affects the financial performance of almost all lessees or on account of industry/company specific factors which affect only a few lease accounts in the portfolio3. Residual value risk: The possibility of a decline in the estimated residual value of the equipment. This risk is particularly relevant in operating leases of hi-tech equipments and is caused by factors like technological obsolescence and uncertainty with regard to the product market life of the equipment. Interest rate risk: The interest rate risk refers to the changes in the market rate of interest, which adversely affects the cost of funds to the lessor. Purchasing power risk: This refers to the reduction in the value of lease rentals in real terms caused by unanticipated inflation. This risk is particularly relevant for real estate leases or leases with a long duration. Political risk: The political risk refers to the changes in the governmental policies in general, and the fiscal policy in particular, which have significant implications for the economic viability of lease investments. An example is the withdrawal of the investment allowance scheme, which as we noted earlier has a favorable implication for the economies of leasing. Currency and Crossborder risk: These risks are relevant only for cross-border lease transactions. The currency risk refers to the fluctuations in the exchange rate of the rupee vis--vis the currency in which the lease payments are structured. The cross-border risk refers to the unfavorable changes in the political and economic environment of the country where the lessee is located. < TOP > The total leasing industry itself is very large, of which IT leasing forms a part. The IT industry slowdown has positively impacted IT leasing, as companies generally tend to go for leasing and financing options now. Though leasing has been three for a long time, the market in India is not that mature for leasing IT equipment. This is because of tax law amendment that have been affected over a period of time and also the way a typical company looks at IT as different kind of capital investment as compared to investments in an aircraft or a truck. Today banks in India are looking at extending IT solutions to all their branches and there is also a lot of activity happening on the government front. These facts assisted by mindset change are

4.

leading to a shift from buying to leasing of IT assets. In fact, India has been outlined as a high focus and growth engine for the company in the future. Utility services and pay-per-use is an emerging trend in IT leasing. The offering allows customers to buy computing power on a pay-per-use basis. Metered billing capability allows paying for actual usage. The service provider tracks usage, bills customers and collects the billing. < TOP > 5. IT leasing companies face tough competition from banks in this regard because they have the ability to access funds at lower rates. They can also finance everything without restricting themselves to IT, which gives them the ability to handle different kinds of portfolios. So, they might be able to take more risks in certain cases than we would ever do. But the advantage It leasing companies bring is that we are dedicated only towards IT leasing and they understand the IT business better than anyone else. IT leasing companies understand when technology is to be refreshed (replacing older equipment) and offer end-of-term solutions, under which they take responsibility for replacing and the customer is not paying for it. The IT leasing companies offer residual value, which banks are not providing. They take up residual value of risk involved, typically ranging from 10 to 25 percent of total contract. This gives the IT leasing companies a definite edge over banks. There are also other value adds like an asset management offering, which allows for Web-enable tracking and management, helping the customer understand where the equipment is, details of the equipment, how much is paid for it and other such information.
< TOP >

Section E: Caselets Caselet 1 6. Advantages of Individual Credit Rating 1. One of the main problems associated with consumer finance is that of bad debts. More than 20 percent of the sales become bad debts due to customer default. Unlike automobile finance, the recoveries for consumer durables are possible only after prolonged civil suits. Besides, dealers are unwilling to take any financial risk on the clients they recommend. In such a situation, the credit rating of individuals provides scope to minimize risk of default. This can, in turn, provide buoyancy to consumer finance companies. 2. Determining the willingness and ability of the borrower to pay can be assessed properly. 3. Getting durables or any other products on loans/ installments becomes easy to borrowers, especially the middle class families. 4. Rating of individuals by an outside agency, like ONICRA would be less expensive than employing a team of personnel by banks to get each credit appraisal. Today, a finance company is engaged in a variety of activities and one of them is consumer finance. By utilizing the services of independent and specialized credit rating

agencies, finance firms can concentrate on other areas of business activities and maximize their returns. Disadvantages of Individual Credit Rating 1. It is not clear how the entire process will evolve. Unlike corporate ratings, which are directly sought by a corporate before a public issue of debt, individuals cannot approach ONICRA directly to obtain a rating. Also, it is relatively easy to rate corporates owing to the availability of audited balance sheets, market data about suppliers and customers, the industry scenario and the quality of management. Individual credit rating requires a different approach. 2. The crucial issue in India is how much information individuals will voluntarily disclose. The Indian laws do not allow access to information needed for accurate rating. Obtaining information even from government authorities such as the tax department will be difficult. < TOP > 7. The credit information bureau has information on loans advanced by member banking companies, financial institutions, non-banking financial companies, housing finance companies and credit card companies. In India there is no provision for a borrower to acquire his own credit information from the bureau. In some countries it is possible for a borrower to obtain his own credit report to ascertain whether a borrower has fed the bureau with incorrect information. The only way that a borrower can correct inaccuracies in his own credit report are by approaching the lender who had fed the information in the first place. < TOP > Caselet 2 8. The high cost associated if the firm does not go for factoring are as follows:

Devaluation of your money due to inflation while waiting for payment. Inability to take advantage of net and volume discounts and other purchasing opportunities. Worsened customer relations due to collection efforts and phone calls. Inability to expand. Cash flow planning and control skewed due to uncertainty of payment dates. Inability to increase inventory. Bad debt losses. Continuous cost of ongoing credit and collection efforts. Continuous cost of accounts receivable maintenance. Inability to implement marketing and sales plans. Lowered financial statement and bank balances. Loss of working capital. Restrictions on action due to credit line and other borrowing limits.

Cost of executive and staff time fixed on non-income producing activities. < TOP >

9.

In countries where credit insurance is in popular in use, a firm can insure its receivables against credit risk. While the insurance company does not help in the collection of receivables, it settles the claims arising on account of insured accounts which have turned delinquent.( An account is considered to be delinquent not only if the customer actually becomes insolvent, but also if an account has reached a particular in being overdue.). Thereafter it takes over the delinquent account and makes vigorous efforts to collect. To ensure the insured does not throw caution to the winds by adopting liberal credit standard, the insurance company specifies the maximum amount it will cover for account with a particular credit rating. Where as the factor is a financial intermediary which pays for the debts as and when they are collected. Usually factors makes part payment immediately after the debts are purchased thereby provides immediate liquidity to the client. For rendering the services for collection and maintenance of sales ledger, the factor charges commission. < TOP > Caselet 3

10. Clause 49 of the listing agreement states that all listed entities with executive chairman to have at least 50 per cent of independent directors in the board. SEBI has set a deadline of December 31 this year for listed companies to increase the number of independent directors as per the revised clause 59 of the listing agreement, which also says that companies with non-executive chairman can have at least one-third of the board as independent directors. The companies require the independent directors to have the basic knowledge of the duties to be performed in the public company. The firms should also cooperate with the independent directors so that they can discharge their duties properly. The motive of SEBI behind this clause is very clear. Independent directors are one of the most important pillars of good board governance, and by extension it will lead to good corporate governance. Having the director who does not have the linear relations management, company, etc., is not the end reason. What is desirable is that he strives through his actions for the maximization of shareholders wealth, bringing corporate democracy and ensuring maximum transparency and disclosures by corporate houses. This reaffirms the shareholders faith, trust and confidence in accepting him as an independent director of the company. < TOP > 11. Clause 49 may be a pain to the listed companies but it is a big opportunity for headhunter to make money. The new guidelines by the market regulator have opened a huge new market for the headhunters. India has over 6,500 listed firms and on an average each should have a minimum of 3-4 independent directors. Under the new guidelines, past practices of appointing the company lawyer or the auditor on the board are not allowed any more. This has again narrowed the choice for the companies.

Leading search firms are use to charge very high for an independent director depending on the size of the company and its expectations from the prospective director. Lesser known agencies however charge one-third of the first-year remuneration of the director for recruiting them. Since the time SEBI made it mandatory for listed companies to fill half the board with independent directors (Clause 49 of the listing agreement) with strict deadlines, headhunters are setting up new teams to search around for potential independent directors (IDs). The new practice is expected to be a cash machine for headhunters < TOP > < TOP OF THE DOCUMENT >