Have they become the new risk factor for stock prices?

Back in 2009, the big risk for stock markets came from companies where promoters had pledged a chunk of their shares. We saw stocks like Orchid Pharma and GTL tanking when financers started selling pledged shares.
SEBI made it mandatory to disclose pledged shares and the problem was resolved. Now the big risk is the decision by statutory auditors to resign. Why is it becoming such a price sensitive issue?

Vakrangee and Manpasand

What is common between the stocks of Manpasand Beverages and Vakrangee Software? Both the stocks tanked sharply after their auditors resigned under slightly dubious circumstances. In case of Vakrangee and Manpasand, the auditors had problems with the level of transparency and disclosure practices of the company. In fact, the company had refused to divulge critical information to the auditors which had led to the auditors resigning from their positions. This problem of auditors resigning has become the single most price sensitive issue. In fact, there were fears that the stock of Edelweiss could also come under pressure after its auditors (Price Waterhouse) resigned and had to be replaced by S R Batliboi. However, better sense prevailed in the markets in this case. The bigger question is why are auditors so keen to put in their papers and what does it mean for companies at large. There are two basic things to understand here.

Pressure from regulators

For too long, auditors were the blue-eyed boys of Indian regulation. Despite playing a very critical and central role in the accounting and audit of Indian companies, auditors had little by way of accountability to the market regulator. They were still regulated by the ICAI, a statutory body in its own right. It is only after repeated cases of auditor negligence that SEBI has made auditors directly responsible for the quality of accounting and the quality of audit. That puts a lot more onus and pressure on these statutory auditors.

Better safe than sorry

Considering the level of opacity in Indian accounting practices, Indian auditors are finding it easier to give up their clients rather than risk a ticking-off by the market regulator. That explains why auditors are willing to sign out and lose the business at the slightest sign of opacity or weak governance. This is more so in case of mid cap and small cap companies where the levels of transparency and corporate governance are much lower. To be fair, you really cannot blame the auditors for that. Putting too much onus on auditors is inviting such knee-jerk reaction which can at times be unfair to genuinely good companies. A better way would be to have a well-crafted process for dealing with such auditor discomfort. It will suit the auditors and the investors too! ©