Industry and business
Corporate Governance is essentially all about how corporations are directed, managed, controlled and held accountable to their shareholders. In India, the question of Corporate Governance has come up mainly in the wake of economic liberalization and de-regularization of industry and business. The objective of any corporate governance system is to simultaneously improve corporate performance and accountability as a means of attracting financial and human resources on the best possible terms and of preventing corporate failure.
With the rapid pace of globalization many companies have been forced to tap international financial markets and consequently to face greater competition than before. Both policymakers and business managers have become increasingly aware of the importance of improved standards of Corporate Governance. DEFINITION OF CORPORATE GOVERNANCE Corporate Governance could be defined as ways of bringing the interests of investors and managers into line and ensuring that firms are run for the benefit of investors.
Corporate governance is the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. Corporate Governance consists of procedures and processes according to which an organization is directed and controlled. The Corporate Governance structure specifies
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In simple terms Corporate Governance can be defined as a set of laws, rules, regulations, systems, principles, process by which a company is governed. NEED FOR CORPORATE GOVERNANCE IN INDIA: A corporation is a congregation of various stakeholders, namely customers, employees, investors, vendor partners, government and society. In this changed scenario an Indian corporation, as also a corporation elsewhere should be fair and transparent to its stakeholders in all its transactions.
This has become imperative in today’s globalized business world where corporations need to access global pools of capital, need to attract and retain the best human capital from various parts of the world, need to partner with vendors on mega collaborations and need to live in harmony with the community. Unless a corporation embraces and demonstrates ethical conduct, it will not be able to succeed. Corporations need to recognize that their growth requires the cooperation of all the stakeholders; and such cooperation is enhanced by the corporations adhering to the best Corporate Governance practices.
In this regard, the management needs to act as trustees of the shareholders at large and prevent asymmetry of benefits between various sections of shareholders, especially between the owner-managers and the rest of the shareholders. EVOLUTION OF CORPORATE GOVERNANCE FRAMEWORK IN INDIA: Liberalization and its associated developments, i. e. de-regulation, privatization and extensive financial liberalization, have made effective Corporate Governance very crucial. Cases of frauds, malpractices can render capital market reforms desultory.
Independent and effective corporate governance reforms are, therefore, necessary in order to restore the credibility of capital market and to facilitate the flow of investment finance of firms. There are various reforms which were channeled through a number of different paths with both the Security and Exchange Board of India (SEBI) and the Ministry of Corporate Affairs, Government of India (MCA) playing important roles. Pre-liberalization: During the initial years Indian organizations were bound by colonial rules and most of the rules and regulations catered to the whims and fancies of the British Employers.
The companies act was introduced in the year 1866 and was gradually revised in 1882, 1913 and 1932. Indian Partnership act was introduced for the first time in 1932. The various agendas which were on its focus were managing agency model to corporate affair as individuals / business firms entered into legal contract with joint stock companies. It was characterized by abuse / misuse of responsibilities by managing agent due to dispersed ownership. The issues of profit generation and control were dilapidated leading to various conflicts.
The period of 1950s and 1960s was a period of setting up of industrial activities and cost plus regime. The genesis was the demand for very many products for which the Government administered Fair Prices. This was the time when the Tariff Commission and the Bureau of Industrial Costs and Prices were set up by the Govt. 1951 – India‘s development Regulation Act 1956 Companies Act came into existence. Development and Banking institutions came into existence. The period between 70’s to mid-eighties was an era of Cost, Volume and Profit analysis, as an integral part of the Cost Accounting function.
Post Liberalization: After liberalization, India has been keenly looked upon by the organizations/ companies worldwide for the purpose of creating new markets. Progressive firms in India have made an attempt to put the systems of good corporate governance in place. There have been number of discussions and events leading to the development of Corporate Governance. The basic minimal code for corporate governance was proposed by the Chamber of Indian Industries (CII), 1998. The guiding definition proposed by CII, ?
Corporate Governance deals with laws, procedures, practices and implicit rules that determines a company‘s ability to take managerial decisions in particular its shareholders, creditors, customers, the state and the employees. The First Phase of India’s Corporate Governance Reforms: 1996-2008 India‘s corporate governance reform efforts were initiated by corporate industry groups, many of which were instrumental in advocating for and drafting corporate governance guidelines.
Following vigorous advocacy by industry groups, SEBI proceeded to adopt considerable corporate governance reforms. The first phase of India‘s corporate governance reforms were aimed at making boards and audit committees more independent, powerful and focused monitors of management? as well as aiding shareholders, including institutional and foreign investors, in monitoring management. These reform efforts were channeled through a number of different paths with both SEBI and the MCA playing important roles. 1998 – Confederation of Indian Industry (CII)
In 1996, CII took a special initiative on corporate governance the first institutional initiative in Indian Industry. The objective was to develop and promote a code for companies be in private sector, public sectors, Banks or financial Institutions, all of which are corporate entities. The completed final draft of this code came out in April 1998. 1999- Report of the Committee (Kumar Manglam Birla) on Corporate Governance SEBI, appointed Kumar Manglam Birla as chairman to give a comprehensive view of the issues related to insider trading to protect the rights of various stakeholders.
The recommendations are expected to be enforced on the listed companies for initial and continuing disclosures in a phased manner within specified dates, through the listing agreement. The companies will also be required to disclose separately in their annual reports, a report on corporate governance delineating the steps they have taken to comply with the recommendations of the committee. These will enable shareholders to know, where the companies, in which they have invested, stand with respect to specific initiatives taken to ensure robust corporate governance.
November 2000- Report of the task force on Corporate Excellence through Governance: Department of company affairs, prepared a report on achieving corporate excellence through governance. Depending upon the size and capabilities of the companies as well the requirements of the market place, the task force recommended phased implementations of the essential measures. 2000 – Enactment of Clause 49 Shortly after introduction of the CII Code, SEBI appointed the Committee on Corporate Governance (the Birla Committee). In 1999, the Birla Committee submitted a report to SEBI to promote and raise the standard of Corporate
Governance? for listed companies. The Birla Committee‘s recommendations were primarily focused on two fundamental goals improving the function and structure of company boards and increasing disclosure to shareholders. With respect to company boards, the committee made specific recommendations regarding board representation and independence that have persisted to date in the committee also recognized the importance of audit committees and made many specific recommendations regarding the function and constitution of board audit committees.
The Birla Committee also made several recommendations regarding disclosure and transparency issues, in particular with respect to information provided to shareholders. March 2001 – RBI – Report of the advisory group on Corporate Governance: Standing Committee on International Financial Standards and Code The governance mechanism differs in each country and is shaped by its political, economic, and social history as also by its legal framework. With keen interest shown by organizations like World Bank, Asian Development Bank etc, OECD developed a set of principles which are internationally recognized to serve as good benchmarks.
April 2001 – RBI – Report of the consultative Group of Directors of Banks/Financial Institutions The Consultative group of directors of banks and financial institutions was set up by reserve bank to review the supervisory role of boards of banks and financial institutions and to obtain feedback on the functioning of the boards compliance, transparency, disclosures, audit committees etc and make recommendations for making the role of board of directors more effective with a view to minimizing risks and over exposure.
Following the best international practices as recommended by Basel Committee on Banking Supervision, the committee recommended a review of the existing framework governing the constitution of the boards of banks and financial institutions. December 2002 –Report of the committee (Naresh Chandra) on Corporate Audit and Governance Committee The department of company affairs (DCA) under the ministry of finance and company affairs appointed a committee under the chairmanship of Naresh Chandra to examine various corporate governance issues.
February 2003 (N. R. Narayan Murthy) – SEBI report on Corporate Governance The Securities and Exchange Board of India (SEBI), in its effort to improve the governance standards constituted a committee to study the role of independent directors, related parties, risk management, directorship and director compensation, codes of conduct and financial disclosures. The committee based its recommendations on various parameters like fairness, accountability, transparency, ease of implementation, verifiability and enforceability.
July, 2003 (Naresh Chandra Committee II) Report of the committee on regulation of private companies and partnerships The companies act, 1956 had its base in environment encompassing the license and permit raj in India. The act has undergone amendments more than two dozen occasions, keeping in view the various changes in the business environment. As large number of private sector companies was coming into picture there was a need to revisit the law again. In order to build upon this framework, government constituted a committee in January, 2003 to ensure a scientific and rational regulatory environment.
The main focus of this report was on, a) The Companies Act; 1956 b) The Indian Partnership Act, 1932. The Second Phase of Reform: Corporate Governance after Satyam India‘s corporate community experienced a significant shock in January 2009 with damaging revelations about board failure and colossal fraud in the financials of Satyam. The Satyam scandal also served as a catalyst for the Indian government to rethink the corporate governance, disclosure, accountability and enforcement mechanisms in place.
As described below, Indian regulators and industry groups have advocated for a number of corporate governance reforms to address some of the concerns raised by the Satyam scandal. Industry response shortly after news of the scandal broke; the CII began examining the corporate governance issues arising out of the Satyam scandal. Other industry groups also formed corporate governance and ethics committees to study the impact and lessons of the scandal. The overwhelming majority of corporate India is well run, well regulated and does business in a sound and legal manner. A. COMMITTEE ON CORPORATE GOVERNANCE
There are various committees formed with a view to reforming the Corporate Governance in India since 1990s. Some of the recommendations of these committees are highlighted below. Confederation of Indian Industries (CII) set up a task force in 1995 under Rahul Bajaj, a reputed industrialist. In 1998, the CII released the code called “Desirable Corporate Governance”. It looked into various aspects of Corporate Governance and was first to criticize nominee directors and suggested dilution of government stake in companies. SEBI had set up a Commission under Kumarmanlagam Birla.
This committee covered issues relating to protection of investor interest, promotion of transparency, building international standards in terms of disclosure of information. The Department of Companies Affairs (DCA) modified the Companies Act, 1956. It undertakes periodic review and brings about amendments in the Companies Act, 1956. In 1999, the Act introduced the provision relating to nomination facilities for shareholders and share buybacks and for formation of Investor education and protection fund. The Department of Corporate Affairs constituted Naresh Chandra Committee in 2002.
The committee talks extensively about the statuary auditor-company relationship, rotation of statutory audit firms/partners, procedure for appointment of auditors and determination of audit fees, true and fair statement of financial affairs of companies. SEBI appointed Narayan Murthy Committee in 2002. Its report mainly focuses on and makes mandatory recommendations regarding responsibilities of audit committee, quality of financial disclosure, requiring boards to assess and disclose business risks in the company’s annual reports. B. CLAUSE 49 OF THE LISTING AGREEMENT
After liberalization serious efforts have been made towards overhauling the system with SEBI formulating the Clause 49 of the Listing Agreements dealing with corporate governance. Clause 49 of the Listing Agreement to the Indian stock exchange comes into effect from 31 December 2005. It has been formulated for the improvement of corporate governance in all listed companies. Clause 49 of Listing Agreements, as currently in effect, includes the following key requirements: Board Independence: Boards of directors of listed companies must have a minimum number of independent directors.
Where the Chairman is an executive or a promoter or related to a promoter or a senior official, then at least one-half the board should comprise independent directors. In other cases, independent directors should constitute at least one-third of the board size. Disclosure: Listed companies must periodically make various disclosures regarding financial and other matters to ensure transparency. Audit Committees: Listed companies must have audit committees of the board with a minimum of three directors, two-thirds of whom must be independent.
In addition, the roles and responsibilities of the audit committee are to be specified in detail. CEO/CFO certification of internal controls: The CEO and CFO of listed companies must, (a) Certify that the financial statements are fair and (b) accept responsibility for internal controls. Annual Reports: Annual reports of listed companies must carry status reports about compliance with corporate governance norms. VOLUNTARY GUIDELINES ISSUED BY MINISTRY OF CORPORATE AFFAIRS: Voluntary Guidelines on Corporate Governance were issued by the Ministry of Corporate Affairs in December 2009. Few guidelines are worth mentioning.
1. Board of Directors Appointment of Directors Companies should issue formal letters of appointment to Non-Executive Directors (NEDs) and Independent Directors as is done by them while appointing employees and Executive Directors. Such a formal letter should form a part of the disclosure to shareholders at the time of the ratification of his/her appointment or re-appointment to the Board. The offices of chairman of the board and chief executive officer should be separate. The companies may have a Nomination Committee comprised of a majority of Independent Directors, including its Chairman.
A separate section in the Annual Report should outline the guidelines being followed by the Nomination Committee and the role and work done by it during the year under consideration. Independent Directors and NEDs should hold no more than seven directorships. 2. Independent Directors The Board should put in place a policy for specifying positive attributes of Independent Directors such as integrity, experience and expertise, foresight, managerial qualities and ability to read and understand financial statements. Disclosure about such policy should be made by the Board in its report to the shareholders.
Such a policy may be subject to approval by shareholders. All Independent Directors should provide a detailed Certificate of Independence at the time of their appointment, and thereafter annually. Independent Directors should be restricted to six- year terms. They must leave for three years before serving another term, and they may not serve more than three tenures for a company. Independent Directors should have the ability to meet with managers and should have access to information. Remuneration of Directors NEDs should be paid either a fixed fee or a percentage of profits.
Whichever payment method is elected should apply to all NEDs. NEDs paid with stock-options should hold onto those options for three years after leaving the board. Independent Directors should not be paid with stock options or profit-based commission. The Remuneration Committee should have at least three members with the majority of NEDs, and at least one Independent Director. Their decisions should be made available in the Annual Report. Duties of the Board The Board should provide training for the directors. The Board should enable quality decision-making by giving the members timely access to information.
The Board should put in systems of risk management and review them every six months. The Board should review its own performance annually and state its methods in its Annual Report. The Board should put in a system to ensure compliance with the law, which should be reviewed annually. All agenda items should be assessed for its impact on minority shareholders. Audit Committee of Board The Audit Committee should be composed of at least three members, with Independent Directors in the majority and an Independent Director as the chairperson.
The Audit Committee is responsible for reviewing the integrity of financial statements, the company’s internal financial controls, internal audit function and risk management systems. The Audit Committee should also monitor and approve all Transactions. Auditors The Audit Committee should be consulted on the selection of auditors. The committee must be supplied with relevant information about the auditing firm. Every auditor should provide a certificate stating his/her/its arm’s length relationship with the client company.
The audit partner should be rotated every three years; the firm should be rotated every five years. Audit partners should have a cooling off period of three years before they work with the client company again; the firm should have a cooling off period of five years. The Committee may appoint an internal auditor. Institution of a Mechanism for Whistle blowing The companies should ensure the institution of a mechanism for employees to report concerns about unethical behavior, actual or suspected fraud, or violation of the company’s code of conduct or ethical policy.
The companies should also provide for adequate safeguards against victimization of employees who avail of the mechanism, and also allow direct access to the Audit Committee Chairperson in exceptional cases. Amendments in Companies Act The Companies Bill 2009 is expected to be brought before Indian Parliament for consideration in the forthcoming Budget session. The provisions of the Companies Bill is related to eligibility, power and function of Auditor and Audit Committee, appointment and qualification of Directors, Independent Directors, meeting of the board and its power. CONCLUSION
Since the late 1990s, significant efforts have been made by the Indian Parliament, as well as by Indian corporations, to overhaul Indian Corporate Governance. The current Corporate Governance regime in Indian straddles both voluntary and mandatory requirements like Voluntary Guidelines by Ministry of Corporate Affairs. And for listed companies, the vast majority of Clause 49 of the listing agreements requirements is mandatory. The voluntary guideline on Corporate Governance by Ministry of Corporate Governance is a benchmark for the Corporate Governance practices in the Indian corporations, and hopefully the corporate world will make the best use of it.
Efforts are also being made by the legislature to amend the Companies Act 1956. As a result, amendments relating to Corporate Governance are expected to be brought before Parliament in The Companies Bill 2009. India has one of the best Corporate Governance legal regimes but poor implementation together with socialistic policies of the pre-reform era has affected corporate governance. REFERENCES: http://www. sebi. gov. in http://www. mca. gov. in/Ministry/latestnews http://www. conventuslaw. com/legal-framework-governing-corporate-governance-in-india