INVESTOR PROTECTION AND CORPORATE GOVERNANCE: THE NEED FOR SHAREHOLDER ACTIVISM
CHAPTER I: INTRODUCTION
Corporate Governance entails conducting the affairs of the companies in such a manner that the corporate entity is accountable and fairness would be assured to all the stakeholders. It may be defined as a set of systems, processes and principles which ensure that a company is governed in the best interest of all stakeholders. The elements of good corporate governance include maintenance of transparency, accountability, disclosures, compliance with the legal framework, shareholder‟s value, etc. The legal and regulatory framework of corporate governance should aim at protection of investors. Since maintenance of transparency in dealings of the company is the most important facet of corporate governance in India, the same shall be ensured in order to provide a mechanism for protection of the investors. The need to protect the investors arises because the companies indulge in unfair trade practices and corporate frauds. When such corporate frauds are committed, the investors are the class of stake holders who are most adversely affected. The companies shall also consider that in case they go beyond the corporate governance norms, the confidence of the shareholders in the company would be instilled; which is indirectly beneficial for the company. Hence, the corporate governance mechanism shall be viewed as a mode by which the companies can gain the confidence of the shareholders. The need for making adequate disclosures rises ri ses because only adequate disclosures enable the shareholders in taking an informed decision. Also, the Companies Act, 2013 has for the first time included various aspects relating to corporate governance. This would further ensure that the companies follow good corporate governance practices. Investor Protection is the most significant facet of corporate governance. However, it is neglected. In the wake of various corporate scams and accounting scandals, insider trading, non-disclosure by companies, vanishing companies and other such practices of corporate; the relevance of investor protection has increased. On account of such corporate frauds, the investors are the segment of the stakeholders who are most gravely affected. Hence, the framework of Corporate Governance in India should aim at protection of the investors. Shareholder Activism is a modern trend which triggers the corporates to follow good corporate governance practices and ensure investor protection. The Securities and Exchange Board of India plays a pivotal role in protecting the investors in India. The Kumar Mangalam Birla Committee recommendations led to introduction of Clause 49 in the Listing Agreement which is the bedrock of Corporate Governance in India. A mandatory requirement under Clause 49 of the Listing Agreement is formulation of the Investor‟s Grievance Committee, which shall entertain the complaints of the investors and ensure that such grievances are redressed. Later the Narayana Murthy Committee made Corporate Governance Dissertation
Page 1
INVESTOR PROTECTION AND CORPORATE GOVERNANCE: THE NEED FOR SHAREHOLDER ACTIVISM recommendations to enhance investor protection by improving the disclosure requirements and widening the roles of the directors in Corporate Governance. However, there seems to be a vacuum in the requirement of the unlisted companies to follow corporate governance practices. The Corporate Governance Voluntary Guidelines, 2009 can be followed by the unlisted companies, while since the guidelines are not mandatory, the purpose remains unserved. Corporate Governance plays a significant role in investor protection. The researcher seeks to analyse whether good corporate practices have the potential of safeguarding the investors. The researcher would trace the evolution of corporate governance in India and the changing face of investor protection. In the past, India has witnessed various corporate frauds, which reflect loopholes in the current framework of the corporate governance. The researcher would analyse whether good corporate governance practices have the potential to curb corporate frauds and thereby lead to protection of investors. The researcher would also throw some light on the corporate governance govern ance provisions in India under the Companies Bill, 2012. Clause 49 of the Listing Agreement is the basis of corporate governance framework in India and it focuses majorly on the aspect of disclosure by the Company. Apart from the Clause 49 of the Listing Agreement, the Companies Act, 1956 and various regulations of the SEBI reflect the importance of disclosures to the shareholders. The researcher shall examine the relation between corporate governance and investor protection. The manner in which Clause 49 of the Listing Agreement furthers corporate governance in India shall be highlighted. The Corporate Governance Voluntary Guidelines, 2009 provides a set of disclosures that shall be made to the shareholders. The researcher would analyze the role that these guidelines would play in protecting the interests of the investors. Investor protection may be seen as a manifestation of good Corporate Governance. If the company concerned makes the adequate disclosures to the Shareholders and ensures that the investor‟s interest is protected, it would imply that the Company follows good governance practices encompassing investor protection. The Satyam Fiasco displayed that a company‟s inadequate corporate governance framework may defeat the interests of the investors. The Reebok Fraud Case brought the issue of the requirement of adequate corporate governance measures in the unlisted companies. The unlisted companies do not have any mandate to follow corporate governance practices and this may defy the interests of the investors. The researcher would scrutinize the Reebok Fraud case and the Satyam Fiasco in order to analyze the failure of corporate governance mechanisms. In unlisted companies, the shareholders have various rights such as proceeding against the company for oppression or mismanagement and proceeding towards winding up of the company, while they do not have any statutory right to mandate the company to make disclosures to them as required under the Corporate Governance mechanism. Thus, the Corporate Governance Dissertation
Page 2
INVESTOR PROTECTION AND CORPORATE GOVERNANCE: THE NEED FOR SHAREHOLDER ACTIVISM inadequacy of the rights to the shareholders in unlisted companies shall be addressed only by formulating a legal framework in order to provide that the corporate governance shall be mandatorily followed by the unlisted companies. The issue of rights of minority shareholders shall also be examined with respect to the corporate governance mechanism in India. The Companies Act, 2013 has provided for class action suits and thus has taken a leap in protecting the interests of minority shareholders. The role of institutional investors in mandating mand ating the company to follow corporate governance practices has come to the fore in recent past. The institutional investors can play a significant role in influencing the company to follow good corporate governance practices. The concept of shareholder activism is also a significant issue in terms of corporate governance practices. Shareholder Activism entails that the shareholders shall take a proactive role in formulating a dialogue with the management of the company on a regular basis. The reforms in India which highlighted the aspect of shareholder activism have also been discussed. Corporate Governance in India is based on the maintenance of transparency in the company and the same leads to the protection of investors. The researcher would also bring out the need of shareholder activism in India in terms of corporate governance. The essence of the research shall be examining the adequacy of the legal and regulatory framework in India with regard to corporate governance in protecting the interest of the investors.
Corporate Governance Dissertation
Page 3
INVESTOR PROTECTION AND CORPORATE GOVERNANCE: THE NEED FOR SHAREHOLDER ACTIVISM
CHAPTER II LEGAL AND REGULATORY FRAMEWORK OF CORPORATE GOVERNANCE IN INDIA CORPORATE GOVERNANCE
Corporations receive huge pool of capital from an investor base in domestic as well as international markets. Investment by the shareholders may thus be termed as an act reflecting faith of the investors in the ability of the management. The investors expect the management to act as trustees of the investment and earn a higher rate of return as compared to the cost of capital. Hence, the investors expect the management to adopt good corporate governance practices and act in the best interests of the investors. The Narayana Murthy Committee defined Corporate Governance as the acceptance by the corporation's management of the inalienable rights of the shareholders as the owners of the corporate entity and the role of the management as trustees of the investment of the shareholders. Hence, corporate governance is about conducting the business in an ethical manner, commitment towards values and drawing a distinction between personal and corporate funds in the management of a company.1 Corporate Governance may be defined in terms of bringing the interests of the investors and managers into line and ensuring that the corporate entity functions in the best interests of the investors.2 It deals with the interrelationship of the internal governance of the corporation and corporate accountability towards the society.3 It lays down the procedures and processes in accordance with which a corporate entity may be directed and controlled. The structure of corporate corporat e governance defines the distribution of rights right s and responsibilities of the managers, stakeholders, shareholders and other participants and specifies the rules and procedure of decision making.4 Promotion of corporate fairness, accountability and transparency is the aim of corporate governance.5 In simple terms Corporate Governance can be defined as a set of laws, rules, regulations, systems, principles, process by which a company is governed. 6 1
Consultative Paper on Review of Corporate Governance Norms in India, available at http://www.sebi.gov.in/cms/sebi_data/attachdocs/1357290354602.pdf 2 Colin Mayer, Corporate Governance, Competition, and Performance, Journal of Law and Society Volume 24, Issue 1, March 1997 available at http://onlinelibrary.wiley.com/doi/10.1111/1467-6478.00041 3 Simon Deakin, Alan Hughes, Comparative Corporate Governance: An Interdisciplinary Agenda, Journal of Law and Society Volume 24, Issue 1, March 1997, available at http://heinonline.org/HOL/Page?handle=hein.journals/jlsocty24&div=2&g_sent=1&collection=journals 4 ibid 5 World Bank, Managing Development - The Governance Dimension, 1991, Washington available at http://wwwwds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2006/03/07/000090341_200 60307104630/Rendered/PDF/34899.pdf
Corporate Governance Dissertation
Page 4
INVESTOR PROTECTION AND CORPORATE GOVERNANCE: THE NEED FOR SHAREHOLDER ACTIVISM The need for corporate governance lies in the fact that every corporation should be fair and transparent in its dealings. Maintenance of transparency and an ethical conduct is essential for attracting and retaining capital investment from the stakeholders.7 EVOLUTION OF CORPORATE GOVERNANCE IN INDIA
The Securities Secu rities and Exchange Board of India Indi a (SEBI) had set up a Committee C ommittee in 2000 under the Chairmanship of Kumar Mangalam Birla to promote and raise standards of corporate governance. The Kumar Mangalam Birla Report was was the first formal and comprehensive comprehen sive attempt to evolve a Code of Corporate Governance, considering the governance in Indian companies, as well as the state of capital markets at that time. The recommendations of the report led to the inclusion of Clause 49 in the Listing Agreement in the year 2000. These recommendations had the aim of improving the standards of corporate governance in India and were classified as mandatory and non-mandatory recommendations. These recommendations were made applicable to listed companies with paid up capital of Rs 3 crores and above or companies having a networth of Rs. 25 crores at any time. The responsibility of brining the recommendations into force lied with the Board of Directors of the Company 8. According to the report, the Board should have an optimum combination Executive and Non-Executive Directors and not less than 50 per cent of the Board should comprise of Non-Executive Directors. In case of the Chairman is a Non-Executive Director, one-third of the Board should compose of non-executive directors. The companies shall conduct Board Meetings at least four times in a year and a time gap of four months should exist between two meetings. A director should not be the member of more than 10 Committees or act as a Chairman of more than 10 Committees..9 The Report also recommended that the Companies shall set up an Audit Committee. The Report discussed the composition of the Committee, other aspects such as quorum, frequency of meeting, powers of audit committee and functions of the Committee. The Committee was to be composed of atleast three members, all being non-executive directors, and atleast one director shall have knowledge in finance and accounting. Also, the Committee shall be headed by an independent director. The functions of the audit committee include oversight of the company‟s financial reporting process and the disclosure of its financial information in order to ensure that the financial statements are credible and 6
Prabhash Dalei, Paridhi Tulsyan and Shikhar Maravi, Corporate Governance in India: A Legal A nalysis, nalysis , International Conference on Humanities, Economics and Geography (ICHEG'2012) March 17-18, 2012 Bangkok, available at http://psrcentre.org/images/extraimages/312018.pdf 7 ibid 8 Prabhash Dalei, Paridhi Tulsyan and Shikhar Maravi, Corporate Governance in India: A legal Analysis, available at http://psrcentre.org/images/extraimages/312018.pdf at http://psrcentre.org/images/extraimages/312018.pdf 9 Santosh Pande and Kshama V Kaushik, Study on the State of Corporate Governance in India , http://www.iica.in/images/Evolution_of_Corporate_Governance_in_India.pdf
Corporate Governance Dissertation
Page 5
INVESTOR PROTECTION AND CORPORATE GOVERNANCE: THE NEED FOR SHAREHOLDER ACTIVISM accurate. The committee can also recommend on aspects such as appointment and removal of external auditor, fixation of audit fee and approval for payment for any other services. The committee can also review the annual financial statements before submitting to the Board. The Remuneration R emuneration Committee C ommittee was another body which the Report recommended to be set up by the Company. This was a non-mandatory recommendation. The Committee was assigned the task of determining the remuneration of the non-executive director and the Annual Report shall make disclosures about the remuneration paid to the Directors. The Report also recommended that the Company should set up a Shareholder‟s Grievance Committee to redress the issues of the shareholders10. The Report also made recommendations pertaining to Disclosures. The details on noncompliances with regard to capital market related issues in the past three years and the penalties imposed shall be disclosed. Also, half-yearly report shall be sent to the shareholders and quarterly report shall be sent to the institutional investors. Various details which are vital for awareness of the shareholders shall be disclosed in the Annual Report. Auditor‟s certificate on Corporate Governance shall also be annexed with the Annual Report. Companies shall also disclose the consolidated accounts of their subsidiary companies in which they hold atleast 51 per cent or more capital. Shareholders should use the General Meetings as a platform to ensure that the affairs of the company are being conducted in the best interests of the investors11. The Half-yearly declaration of financial performance including the summary of important events in the past six months shall be disclosed to the shareholders. The Report also threw light on the role institutional investors in corporate governance. It was recommended that the institutional shareholders shall take active interests in composition of the Board; they shall be vigilant and maintain systematic and regular contact with the management to examine the performance and quality of management and also to ensure that the voting intentions are translated into practice12. In May 2000, the Department of Company Affairs formed a broad based study group under the Chairmanship of Dr. PL Sanjeev Reddy. The group was given the task of examining ways to operationalise the concept of corporate excellence on a sustainable basis so as to sharpen India‟s Global competitive edge and to further develop corporate culture in the country. In November 2000, a Task Force on Corporate Excellence 13 set up by the group came out with a report comprising of various recommendations for raising governance 10
ibid Report of the Kumar Mangalam Birla Committee on Corporate Governance, available at http://www.sebi.gov.in/commreport/corpgov.html 12 ibid 13 Report on Corporate Excellence on A Sustained Basis to Sharpen India’s Global Competitive Edge and to Further Develop Corporate Culture in the Country, available at http://www.acga-asia.org/public/files/IndiaReddyreport2000.doc. 11
Corporate Governance Dissertation
Page 6
INVESTOR PROTECTION AND CORPORATE GOVERNANCE: THE NEED FOR SHAREHOLDER ACTIVISM standards among all companies in India. It also suggested the setting up of a Centre for Corporate Excellence. One of the recommendations of the report was that there shall be higher delineation of independence criteria and the probability of conflict of interest shall be minimized. The commitment and accountability of the Directors shall be ensured by fewer and more focused board and committee membership. There shall be a meaningful and transparent accounting and reporting by disclosing various details in order to ensure informed participation by shareholders. Introduction of formal recognition of Corporate Social Responsibility was also recommended in the report.14 It was also recommended that there shall be a clear demarcation between policy making and oversight responsibilities. The Task Force on Corporate Excellence recommended that there shall be highest standards of corporate governance that shall be followed by the companies. The Naresh Chandra Committee was established in 2002. It is believed that the Committee was established by the Indian Government in response to the Enron debacle in 2000, various scams in the US involving the fall of various corporates like Xerox, WorldCom etc and the subsequent enactment of the Sarbanes Oxley Act, which is regarded as a stringent legislation. The Naresh Chandra Committee made various recommendations in line with international best practices15. The recommendations stipulated that the audit assignments should be carried out in a transparent manner and thus there should not be any financial interest of the auditor in the company nor should the auditor and company have any personal relationship. Various aspects such as appointment of auditor, auditor‟s disclosure of qualifications and of contingent liabilities, auditor‟s annual certification of independence etc were discussed in the report; the focus of o f which was to ensure ensu re that the process of auditing is transparent. The report also recommended the setting up of Independent Quality Review Board, appointment of an independent director, the percentage of independent directors in the Board, minimum board size of listed companies etc. 16 The aspect of disclosure of duration of board meetings, additional disclosure to directors, and appointment of independent director on the audit committee was also emphasized. Remuneration to the independent directors, exemption of independent directors from certain liabilities, training of independent directors were amongst some other recommendations. In 2002, SEBI analyzed the statistics of compliance with the clause 49 of Listing Agreement by the listed companies and realized that there was a need to look beyond the mere systems and procedures if corporate governance was to be made effective in protecting the interests of the investors. Hence, SEBI constituted a Committee under the chairmanship of NR Narayana Murthy. The Narayana Murthy Committee was assigned the task of reviewing the implementation of corporate governance code by listed companies and for issue of revised
14
ibid http://finmin.nic.in/reports/chandra.pdf 16 ibid 15
Corporate Governance Dissertation
Page 7
INVESTOR PROTECTION AND CORPORATE GOVERNANCE: THE NEED FOR SHAREHOLDER ACTIVISM clause 49 based on its recommendations. Clause 49 of the Listing Agreement forms the bedrock of corporate governance in India. OECD PRINCIPLES ON CORPORATE GOVERNANCE
In its endeavors to improve the governance practices, the Organization for Economic Cooperation and Development (OECD) had published its principles of corporate governance in 2002. The OECD principles on corporate governance are considered as a benchmark by policy makers, stakeholders, investors and corporations round the globe. These principles have advanced corporate governance agenda and act as guidelines for member and nonmember countries with respect to legislative and regulatory framework on corporate governance17. Following is an overview of the OECD principles on corporate governance: Principle I of I of the OECD Principles on Corporate Governance stipulates that the basis of an effective corporate governance framework shall be ensured. The framework should lead to promotion of transparent and efficient markets. It should be consistent with the rule of law and shall articulate the division of responsibilities amongst the supervisory, regulatory and enforcement authorities. Principle II of II of the OECD Principles on Corporate Governance provides that the rights of the shareholders should be protected and exercise of shareholder‟s rights should be facilitated. Principle III lays down that there should be equitable treatment of the shareholders and the shareholders should be given an opportunity to redress their grievances in terms of violation of shareholder's rights. Principle IV stipulates that the role of the stakeholders in corporate governance shall be recognized and co-operation between the stakeholders and corporations shall be encouraged. Principle V provides a mandate to the corporate entities to maintain disclosure and transparency. Timely and accurate disclosure shall be made with respect to governance of the company, financial position of the entity, performance of the corporate entity and particulars of ownership. Principle VI enumerates the responsibilities of the Board and accountability to the shareholders. The Board should ensure strategic guidance of the company, the Board shall ensure effective monitoring of the management and the Board shall remain accountable to the company and shareholders.
17
Consultative Paper on Review of Corporate Governance Norms in India, available at http://www.sebi.gov.in/cms/sebi_data/attachdocs/1357290354602.pdf
Corporate Governance Dissertation
Page 8
INVESTOR PROTECTION AND CORPORATE GOVERNANCE: THE NEED FOR SHAREHOLDER ACTIVISM It may be observed that the Indian Corporate Governance Framework is in compliance with the Corporate Governance principles of OECD. LEGISLATIVE FRAMEWORK OF CORPORATE GOVERNANCE IN INDIA
The Listing Agreement Clause 19 of the Listing Agreement provides that a prior intimation shall be made to the Stock Exchange about the conducting the meeting in which the proposal for buy back of securities or declaration regarding rights issue shall be made. Under clause 20 of the Listing Agreement, the Board shall disclose matters such as a s payment of dividend, di vidend, total turnover of the company, declaration regarding buyback of securities within 15 minutes of closure of the Board meeting. According to Clause 22 of the Listing Agreement, the particulars regarding increase of share capital by issue of bonus shares, reissue of forfeited shares, alteration of share capital and any such matter shall be disclosed to the stock exchange within 15 minutes of the closure of the Board Meeting. Clause 29 provides that any decision relating to change in nature of the business shall be disclosed to the stock exchange. Clause 30 of the Listing Agreement provides that the Board shall disclose issues relating to change in the director, auditor or secretary of a company to the Stock Exchange promptly. Clause 31 of the Listing Agreement provides that various documents such as the proceedings of the Annual or Extraordinary General meetings.18 Clause 32 provides that the Company shall circulate the Balance sheet, Profit and Loss Account, and Director‟s report to each shareholder. Clause 36 of the Listing Agreement provides that the Company shall keep the Exchange informed about strike, lockout and closure of accounts. Clause 41 of the Listing Agreement provides that the Company shall submit the quarterly and financial reports within 45 days from the end of each quarter.19 SEBI appointed the Committee on Corporate Governance under the Chairmanship of Kumar Mangalam Birla, to enhance the corporate governance standards in India. The objectives of establishing the Committee were to propose amendments to the Listing agreement, to draft a code containing the corporate governance international best practices and suggest safeguards against the insider trading practices. The Committee recognized that the major aspects of Corporate Governance include Transparency, Accountability and Equal Treatment of all stakeholders. The disclosure requirements under Clause 49 of the Listing Agreement include mandatory and non mandatory requirements. The mandatory and non mandatory disclosure requirements facilitate transparency in conduct of affairs of the management. Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009
18 19
http://www.sebi.gov.in/cms/sebi_data/pdffiles/21168_t.pdf ibid
Corporate Governance Dissertation
Page 9
