CORPORATE GOVERNANCE IN INDIA: CONCEPT, COURSE OF ACTION AND COMPLIANCE

CORPORATE GOVERNANCE IN INDIA: CONCEPT, COURSE OF ACTION AND COMPLIANCE Mr. Pradeep Kumar Gupta Associate Lecturer, L M Thapar School of Management, Patiala

ISSN – 163 Year: February 2009

Volume 3, Issue 1/4

Abstract: While corporate governance may not state the economic prospects of developing countries, it certainly takes part in shaping them. Good corporate governance is vital because of its role in attracting investors to invest both in the domestic and in the international capital markets. Investors primarily consider two variables before making investment decisions in the companies – the rate of return on invested capital and the risk associated with the investment. Good corporate governance practices reduce this risk by ensuring transparency, accountability, and enforceability in the capital marketplace. As a result, the investors expect the Board and the Management in the companies to act in their best interests at all times so as to earn a risk adjusted rate of return that is higher than the cost of capital. Practices that the Board of Directors of a listed entity follows to fulfill the expectations of all stakeholders (i. e. Shareholders, employees, creditors, customers, government, regulatory authorities and society at large) is called corporate governance practices. While sound corporate governance practices ensure a company’s long-term success, weak practices often lead to serious problems. Key Words:

Corporate, Good, Governance, Board, Management, Director, Stakeholder, Practices, Framework

INTRODUCTION

(1) Companies pool capital from a large investor base both in the domestic and in the international capital markets. (2) In this context, investment is ultimately an act of faith in the ability of a company’s management. In order to manage the affairs of a company and to act in the best interests of all at all times, there must be a system whereby the directors are entrusted with responsibilities and duties in relation to the direction of the company affairs. (3) Corporate governance is a system of making Management accountable towards the stakeholders for effective management of the companies. (4) Corporate governance is also concerned with the morals, ethics, values, parameters, conduct and behaviour of the company and its management. (5) The

underlying principles of corporate governance revolve around three basic interrelated segments. These are:  

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Integrity and Fairness Transparency and Disclosures Accountability and Responsibility

(6) According to the Confederation of Indian Industry (CII), corporate governance deals with laws, procedures, practices and implicit rules that determine the ability of the company to make managerial decisions visà-vis its claimants – in particular, its shareholders, creditors, customers, the State and employees. (7) Corporate governance mainly consists of two elements i.e., A long-term relationship, which has to deal with checks and balances, incentives of managers and communications 1

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between Management and investors. The second element is a transactional relationship involving matters relating to disclosure and authority. In other words, 'good corporate governance' is simply 'good business'. (8) Practices that the Board of Directors of a listed entity follows to fulfill the expectations of all stakeholders (i. e. Shareholders, employees, creditors, customers, government, regulatory authorities and society at large) is called corporate governance practices. NEED, IMPORTANCE AND OBJECTIVES OF CORPORATE GOVERNANCE

In order to overcome the under noted serious concerns within the business community, there is a need to introduce a system of corporate governance that will ensure the transparency, integrity and accountability of Management including non-executive directors. (9) Concentration of greater financial power and authority in a lesser number of individuals, Violations of foreign exchange rules and regulations, Large scale diversion of funds to associate companies and risky ventures, Unfocussed business decisions leading to losses, Preferential allotment of shares to promoters at low prices, Exploited the weaknesses in the Accounting Standards to inflate profits and understate liabilities, Frequent changes in Board structures, •

(10) In an open financial market, investors choose from a variety of investment vehicles. The existence of a corporate governance system is likely a part of this decision-making process. In such a scenario, companies that are more open and transparent, and thus well governed, are more likely to raise capital successfully because investors will have the information and confidence necessary for them to lend funds directly to such companies. Moreover, well-governed companies likely will obtain capital more cheaply than companies that have poor corporate governance practices because investors will require a smaller “risk premium” for investing in well-governed companies. Thus, in an efficient capital market, investors will invest in companies with better corporate governance frameworks because of the lower risks and the likelihood of higher returns. Good corporate governance practices also enable Management to allocate resources more efficiently, which increases the likelihood that investors will obtain a higher rate of return on their investment. (11) Moreover, Good corporate governance practices ensure:

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Adequate disclosures and effective decision making to achieve corporate objectives; Transparency in business transactions; Statutory and legal compliances; Protection of shareholder interests; Commitment to values and ethical conduct of business. Long-term survival of the companies.

(12) Corporate governance in a developing





that have good corporate governance structures consistently outperform developing countries with poor corporate governance structures. Moreover, corporate governance can play a role in reducing corruption, and decreased corruption significantly enhances a country’s development prospects. Ultimately, the concept of corporate governance is not just one of those imported western luxuries; it is a vital consideration to be enforced successfully. (13) The aim of "Good Corporate Governance" Governance" is to ensure commitment of the board in managing the company in a transparent manner for maximizing longterm value of the company for its shareholders and all other partners. It integrates all the participants involved in a process, which is economic, and at the same time social. (14) The fundamental objective of corporate governance is to enhance shareholders' value and protect the interests of other stakeholders by improving the corporate performance and accountability. Hence it harmonizes the need for a company to strike a balance at all times between the need to enhance shareholders' wealth whilst not in any way being detrimental to the interests of the other stakeholders in the company. Further, its objective is to generate an environment of trust and confidence amongst those having competing and conflicting interests. (15) There is a global consensus about the objective of ‘good’ corporate governance: maximizing long term shareholder value. Since shareholders are residual claimants, this objective follows from a premise that, in well performing capital market, whatever

TESTS OF GOVERNANCE

CORPORATE

(16) Broadly, the test of corporate governance should cover the following aspects: Whether the funds of the company have been deployed for pursuing the main objects of the company as enshrined in the Memorandum? Whether the funds acquired from financial institutions and the capital market have been utilized for the purpose for which they were intended? Whether the company has the core competence to effectively manage its diversifications? Whether there has been proper diversion of funds by way of loans and advances or investments to subsidiary? Whether the provisions of the Companies Act, the Foreign Exchange Management Act, the Factories Act and other statutes are complied with in letter and in spirit? Whether the practices adopted by the company and its Management towards its shareholders, customers, suppliers, employees and the society at large are ethical and fair? Whether the directors are provided with the information on the working of the company and whether the institutional and non-executive directors play an active role in the functioning of the companies? Whether the internal controls in place are effective? Whether there is transparent financial reporting and audit practices and the accounting practices adopted by the company •

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CONSTITUENTS OF CORPORATE GOVERNANCE

(17) The three key constituents of corporate governance are the Board of Directors or Board, the Shareholders and the Management. These can further be detailed as:

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Role and Powers of Board Composition of Board Legislation Code of Conduct Board Independence Board Skills Role and Powers of Shareholders Board Appointments

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Board Meetings Board Induction and Training Monitoring the Board Performance Management Skills and Environment Business and Community Obligations Audit Committee Financial and Operational Reporting Risk Management

FRAMEWORK OF CORPORATE GOVERNANCE (Refer Annexure) (A) Organizational Framework: The organizational framework for corporate governance initiatives in India consists of the Ministry of Corporate Affairs (MCA), the Confederation of Indian Industry (CII) and the Securities and Exchange Board of India (SEBI).

(18) In 1998, the Confederation of Indian Industry (CII), "India's premier business association," unveiled India's first code of corporate governance. However, since the Code's adoption was voluntary, few firms embraced it. Soon after, SEBI appointed the Kumar Mangalam Birla Committee to fashion a code of corporate governance. In 2000, SEBI accepted the recommendations of the Kumar Mangalam Birla Committee and introduced Clause 49 into the Listing Agreement of Stock Exchanges. Clause 49 outlines requirements vis-a-vis corporate governance in exchange-traded companies. In 2003, SEBI instituted the N.R. Narayan

latest revisions to Clause 49 became law on January 1, 2006 (SEBI, vide circular th SEBI/CFD/DIL/CG/1/2006/13/1 dated 13 January, 2006). The main provisions of Clause 49 as inserted vide SEBI F.No. SMDRP/Policy Cir 10/2000 dated 21.02.2000 in the Listing Agreement of Stock Exchange are: I. Board of Directors; II. Audit Committee; III. Remuneration of Directors; IV. Board Procedure; V. Management; VI. Shareholders; VII. Report on Corporate Governance; and VIII. Compliance Certification Certification (19) The Ministry of Corporate Affairs (MCA) had appointed a Naresh Chandra Committee on Corporate Audit and Governance in 2002 in order to examine various corporate governance issues. It made





(20) The Ministry of Corporate Affairs (MCA) had also set up a National Foundation for Corporate Governance (NFCG) in association with the CII, ICAI and ICSI as a not-for-profit trust to provide a platform to deliberate on issues relating to good corporate governance, to sensitize corporate leaders on the importance of good corporate governance practices as well as to facilitate exchange of experiences and ideas amongst corporate leaders, policy makers, regulators, law enforcing agencies and nongovernment organizations. The foundation has been set up with the mission to: 1. Foster a culture for promoting good governance, voluntary compliance and facilitate effective participation of different stakeholders; 2. Create a framework of best practices, structure, processes and ethics; and 3. Make significant difference to Indian corporate sector by raising the standard of corporate governance in India towards achieving stability and growth.

amended, from time to time, to bring more transparency and accountability in the provisions of corporate governance. That is, corporate laws have been simplified so that they are amenable to clear interpretation and provide a framework that would facilitate faster economic growth. The Companies Act, 1956 is the central legislation in India that empowers the Central Government to regulate the formation, financing, functioning and winding up of companies. The Companies Act, 1956 has elaborate provisions relating to the Governance of Companies, which deals with management and administration of companies. It contains special provisions with respect to the accounts and audit, directors remuneration, other financial and non-financial disclosures, corporate democracy, prevention of mismanagement, etc. The main two Sections of this Act related to the corporate governance are Section 292A and Section 211. •

(B) Legal Framework: (21) An effective legal framework is indispensable for the proper and sustained growth of the company. In rapidly changing national and global business environment, it has become necessary that regulation of corporate entities is in tune with the emerging economic trends, encourage good corporate governance and enable protection of the interests of the investors and other stakeholders. The Legal framework for corporate governance consists of the Company Laws and the SEBI Laws. Company Laws: The Ministry of Corporate Affairs (MCA) is the main authority for regulating and promoting efficient, transparent and accountable form of corporate governance in the Indian corporate

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Section 292A: (22) The concept of Corporate Governance receives statutory recognition, with the insertion of Section 292A in the Companies Act, 1956 with an amendment made to it through the Companies (Amendment) Act 2000. The New Section 292A made it obligatory upon a public company having a paid-up capital of Rs. 5 crores or more to have an audit committee comprising at least three directors as members. Two-thirds of the total number shall be nonexecutive directors. Section 211: (23) As per this Section, every Profit and loss account and Balance sheet of the company shall comply with the





are required to report whether the Accounting Standards have been complied with or not. The Securities Exchange Board of India (SEBI) has added a new clause in the Listing Agreement to provide that listed enterprises shall compulsory comply with all the Accounting Standards issued by ICAI from time to time. (24) The Companies Bill 2004 has been introduced to provide the comprehensive review of the company law. It contained important provisions relating to corporate governance, like, independence of auditors, relationship of auditors with the management of company, independent directors with a view to improve the corporate governance practices in the corporate sector. It is subjected to greater flexibility and self-regulation by companies, better financial and non-financial disclosures, more efficient enforcement of law, etc. This amendment to the Companies Act 1956 mainly focused on reforming the audit process and the board of directors. It mainly aimed at :- (i) laying down the process of appointment and qualification of auditors, (ii) prohibiting non-audit services by the auditors; (iii) prescribing compulsory rotation, at least of the Audit Partner; (iv) requiring certification of annual audited accounts by both CEO and CFO; etc. For reforming the boards, the bill included that remuneration of non-executive directors can be fixed only by shareholders and must be disclosed. A limit on the amount which can be paid would also be laid down. It is also envisaged that the directors should be imparted suitable training. However, among others, an independent director should not have substantial pecuniary interest in the company’s shares. SEBI

Laws:

practices in the country and further improve these practices. It is implementing and maintaining the standards of corporate governance through the use of its legal and regulatory framework, namely, The Securities Contracts (Regulation) Act, 1956, Securities and Exchange Board of India Act, 1992 and the Depositories Act, 1996. REASONS FOR CORPORATE GOVERNANCE FAILURES

(26) If the Board is in awe of the family executive, it makes it difficult for the Board sometimes to ask tough questions or at other times the right questions at the right time in order to serve the interests of the shareholders better. As a result truly independent directors are rarely found in Indian companies. (27) Serving on multiple boards is problematic because doing so can overburden directors, thus hampering their performance, and increase the potential for directors to experience conflicts of interest between the various corporations they serve. (28) It is admitted that contribution of the independent directors is limited because the average time spent in Board meetings by these directors is barely 14 to 16 hours in a year. In some cases, it has been found that no proper training and orientation regarding the awareness of rights, responsibilities, duties and liabilities of the directors is provided to an individual before appointing him/her as a director in the Board. (29) Also there is unseen but the active participation of political class. (30) The directors on the board are largely reliant on information from the







their exercise of due diligence. Excessive reliance on information from the management is symptomatic of the ownership or control of companies in India by business families, and that poses a particular challenge for corporate governance in India.

constitute a panel of auditors to review the financial statement of all BSE Sensex and NSE Nifty companies. Also there is no statutory compliance for the companies to obtain a report on Corporate Governance Rating by the Credit Rating Agencies in India.

(31) The greatest drawback of financial disclosures in India is the absence of detailed reporting on related party transactions. In addition, poor quality of consolidated accounting and segment reporting leads to misrepresentation of the true picture of a business group.

REQUIREMENTS TO STRENGTHEN CORPORATE GOVERNANCE

(32) Although India's investor-protection laws are sophisticated, litigants must wait a long time before receiving a judgment. (33) Delays in the delivery of verdicts, high costs of litigation and the lengthy judicial appointment process in courts make the legal enforcement mechanism ineffective. (34) According to the OECD, “the credibility and utility of a corporate governance framework rest on its enforceability.” (35) In India, the two audit-related issues which are commonly recognized are that of auditor independence (which is a problem worldwide) because of the large if segmented market in accounting services, and the perceived powerlessness of auditors in the face of corporate pressure. In many

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To promote or to increase awareness among entrepreneurs adoption of good corporate governance practices, which are the integral element for doing and managing business. To ensure the quality of audit that is at the root of effective corporate governance by making the Auditor accountable for the disclosure of financial information. To make the Board of Directors as well as the CEOs and CFOs accountable for the discharge of their duties with the proper use of their rights within the powers. To form an appropriate system in order to check the Directors independence in the board and to monitor the work of Audit firms. To pay special attention in the quality and effectiveness of the legal, administrative and regulatory framework. To increase the shareholder activism





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each regulatory Authority for the enforcement of Clause 49 of the Listing Agreement, thereby improving India’s corporate governance enforcement mechanism (40). To resolve the conflict between the dominant shareholders and the minority shareholders by improving the rights of minority shareholders. To make a statutory compliance for the listed companies to compulsorily obtain a report on Corporate Governance Rating (CGR) from a Credit Rating Agency in India.

FUTURE PROSPECTS CORPORATE GOVERNANCE

enforcing tax reforms coupled with deregulation and competition; etc. but we cannot eliminate the possibility of frauds and scams as seen in the recent Satyam case. (43) Scams are an integral part of corporate history. They come to light only when the going gets rough. Only when the tide goes out we see all those swimming naked. Such scams are an opportunity for self-renewal; neither self-denial nor blame game. The frequency and scale of such scams has been far more in the West than in India. We need to take such types of scams as an opportunity in future for overhauling the system of corporate governance in India.

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To highlight the frauds and irregularities in the corporate sector (41) the issues of governance, accountability and transparency in the affairs of the company, as well as about the rights of shareholders and role of Board of Directors have never been as prominent as it is today. With the integration of Indian economy with global markets, industrialists and corporations in the country are being increasingly asked to adopt better and transparent corporate practices. The degree to which corporations observe basic principles of good corporate governance is an increasingly important factor for taking key investment decisions. If companies are to reap the full benefits of

CONCLUSION

(44) Good corporate governance may not be the engine of economic growth, but it is essential for the proper functioning of the engine. (45) The investors both National and International would be loyal to invest in the Indian companies if they follow all the standards of corporate governance practices. (46) Further, to nurture and strengthen this loyalty, our companies need to give clear-cut signal that the words “your company” have real meaning. That requires well functioning Board, greater disclosure, better management practices, and a more open, interactive and dynamic corporate governance environment. Quite simply, share holders’ and creditors’ support are





is in promoting and maintaining integrity, transparency and accountability in the management of the company as well as in manifestation of the values, principles and policies of a corporation. In order to make an honest and objective assessment on corporate governance practices we do need more laws but better enforcement because

the effectiveness and the utility of good corporate governance practices rest on its enforceability. Ultimately, good corporate governance practices in India will be shaped by our administrative and regulatory authorities like SEBI, MCA, etc. by implementing transparent and effective corporate governance laws.

Annexure FRAMEWORK OF CORPORATE GOVERNANCE Corporate Governance Framework

Organizational Framework

Ministry of Corporate affairs (MCA)

SEBI*

Legal Framework

Confederation of Indian Industry (CII) Recommendations (1997-98)

Company Laws

Companies Act, 1956

Section 292A (Setting up an Audit Committee)

SEBI Laws

Companies Bill, 2004

Section 211 (Statutory Compliance of Accounting Standards)





1. India_MurthyCTee_Febo3, Report of the SEBI Committee on Corporate Governance, Feb 08, 2003. 2. India_MurthyCTee_Febo3, Report of the SEBI Committee on Corporate Governance, Feb 08, 2003. nd 3. Ravi M. Kishore, Taxmann’s Advanced Accounting, 2 edition 2007. nd 4. Ravi M. Kishore, Taxmann’s Advanced Accounting, 2 edition 2007. 5. www.business.gov.in/corporate_governance 6. Desirable Code for Corporate Governance recommended by the Confederation of Indian Industry (CII), www.ciionline.org nd 7. Ravi M. Kishore, Taxmann’s Advanced Accounting, 2 edition 2007. 8. FAQs on corporate governance, National Stock Exchange of India Ltd., www.nseindia.com nd 9. Ravi M. Kishore, Taxmann’s Advanced Accounting, 2 edition 2007. st 10. Bhat & Varun, publication of Iowa Law Review, University of Iowa dated 1 May, 2007. 11. www.business.gov.in/corporate_governance st 12. Bhat & Varun, publication of Iowa Law Review, University of Iowa dated 1 May, 2007. 13. www.business.gov.in/corporate_governance 14. www.business.gov.in/corporate_governance 15. Desirable Code for Corporate Governance recommended by the Confederation of Indian Industry (CII), www.ciionline.org nd 16. Ravi M. Kishore, Taxmann’s Advanced Accounting, 2 edition 2007. 17. www.business.gov.in/corporate_governance st 18. Bhat & Varun, publication of Iowa Law Review, University of Iowa dated 1 May, 2007. 19. www.business.gov.in/corporate_governance 20. www.business.gov.in/corporate_governance 21. www.business.gov.in/corporate_governance nd 22. Ravi M. Kishore, Taxmann’s Advanced Accounting, 2 edition 2007. nd 23. Ravi M. Kishore, Taxmann’s Advanced Accounting, 2 edition 2007. 24. www.business.gov.in/corporate_governance 25. www.business.gov.in/corporate_governance





34. OECD: ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT, DEVELOPMENT, WHITE PAPER ON CORPORATE GOVERNANCE GOVERNANCE IN ASIA 5 (2003), http://www.oecd.org/dataoecd 35. D. Murali, Excerpts from the interview with Ms. Lalita Som, Author ‘Stock market capitalization and corporate Governance’, www.oup.com 36. D. Murali, Excerpts from the interview with Ms. Lalita Som, Author ‘Stock market capitalization and corporate Governance’, www.oup.com st 37. Bhat & Varun, publication of Iowa Law Review, University of Iowa dated 1 May, 2007. st 38. Bhat & Varun, publication of Iowa Law Review, University of Iowa dated 1 May, 2007. st 39. Bhat & Varun, publication of Iowa Law Review, University of Iowa dated 1 May, 2007. st 40. Bhat & Varun, publication of Iowa Law Review, University of Iowa dated 1 May, 2007. 41. www.business.gov.in/corporate_governance 42. www.business.gov.in/corporate_governance 43. Press Release published on IndiaPRwire.com by IndiaPRwire Pvt. Ltd. dtd. 19-01-09. st 44. Bhat & Varun, publication of Iowa Law Review, University of Iowa dated 1 May, 2007. 45. Desirable Code for Corporate Governance recommended by the Confederation of Indian Industry (CII), www.ciionline.org www.ciion line.org 46. Desirable Code for Corporate Governance recommended by the Confederation of Indian Industry (CII), www.ciionline.org 47. www.business.gov.in/corporate_governance Bibliography www.business.gov.in/corporate_governance st Bhat & Varun, publication of Iowa Law Review, University of Iowa dated 1 May, 2007. Desirable Code for Corporate Governance recommended by the Confederation of Indian Industry (CII), www.ciionline.org www.ciionline.org Press Release published on IndiaPRwire.com by IndiaPRwire Pvt. Ltd. dtd. 19-01-09. D. Murali, Excerpts from the interview with Ms. Lalita Som, Author ‘Stock market • •

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CORPORATE GOVERNANCE IN INDIA: CONCEPT, COURSE OF ACTION AND COMPLIANCE

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