This article is written by Monesh Mehndiratta, a law student at Graphic Era Hill University, Dehradun. The article explains meaning, scope, and features of corporate governance. It further deals with theories of corporate governance and its situation in India.
It has been published by Rachit Garg.
Have you ever wondered what would happen if there was no authority to control and regulate the use of electricity or water? If this is the case, it would lead to a situation where no electricity or water would be left and the human race would have to suffer. Similarly, what would happen if there was no government in a country that could regulate the behaviour of citizens and they were free to act according to their wishes? This would result in chaos and suffering, and there would be no systematic planning, leading to a situation where the unity of the country would collapse due to the hassle. This is why smooth governance is necessary to regulate the functioning of any system.
Governance is defined as the set of rules and regulations, policies and strategies that are useful to regulate the behaviour of a system, an authority or a large number of people. When this governance is applied to a company or corporate field, it is called corporate governance. When in a country, there is a need for a democratic government for the smooth functioning of all the systems in the country and to regulate the conduct of its citizens. Similarly, in a company, there is a need for a committee or authority that could regulate the company’s management affairs and the conduct of all its members. Usually, this responsibility is given to the board of directors of a company, but even their conduct is regulated by some kind of legislation to ensure that they do not misuse or use their power and authority arbitrarily.
Meaning of corporate governance
Corporate governance is the set of rules and regulations that regulate the conduct of members in the corporate sector or any company. Usually, the responsibility for regulating the conduct of the members is given to the board of directors of a particular company, but even their roles and conduct are regulated by legislation. Shareholders have to fulfil the duty of appointing a board of directors, and in this way, they contribute to corporate governance. This governance also defines how a member must continue his term in the company, how external and internal affairs are to be conducted, and what the procedure is for different meetings of the board, like general meetings, annual meetings, etc.
Over a decade, due to advancements in technology and market practices, there has been an increase in the number of companies and the complexities of their work. Now, they not only have to focus on customers and products but also ensure good managerial personnel and shareholders in order to build their reputation and set a mark. This can only be achieved if their strategies and plans are executed well within the timeframe according to a proper framework with no unlawful activities, and all of this falls under the ambit of good corporate governance.
We are all aware that a company has its own separate legal entity and it can sue and be sued in its name, own assets and properties, appoint employees, enter into contracts, and have a seal of its own. This also means that its activities are separate from the activities of its members, and so it is necessary to govern its conduct in order to avoid unlawful practices and liabilities arising therefrom. The Financial Reporting Council of the London Stock Exchange in 1991 formed the Cadbury Committee to look into the matter of corporate governance. According to this committee, corporate governance means a system or technique by which a company can be directed and controlled in regulating its affairs and operations.
The Organisation of Economic Cooperation and Development (OECD) formed corporate practices that were accepted internationally as corporate governance standards in 1999. It has its main office in Paris, and 29 members are part of this organisation. The standards of corporate governance also had principles formulated by the Cadbury Committee. Some of these are:
- Responsibilities of the board of directors,
- Equitable treatment of all the shareholders.
- Accountability and transparency,
- Disclosure of information related to accounts,
- Importance of auditors, other directors and corporate social responsibility, etc.
Origin and evolution of corporate governance
United States of America
The origin of corporate governance can be traced back to the 1970s in the United States of America. But the initial idea of regulating the affairs of companies was developed in the year 1929, after the stock market crash, because of which a lot of companies went bankrupt and the economy collapsed. In order to prevent further damage, the U.S. Congress passed two acts. These are the Securities Act of 1933 and the Securities Exchange Act of 1934. Both the legislations provided governance for the transaction of securities of a company. The Act of 1934 also led to the establishment of the Securities Exchange Commission(SEC). The Commission also suggested enacting certain legislation for the smooth functioning and development of companies and ventures.
With the advancement of knowledge, another issue was faced by various companies. The main authorities, or the owners of the company, were insensitive to the problems faced by stockholders, or the shareholders of the company. They were concerned only about their own profit rather than the dividends and stocks. This further made the SEC realise the need for proper governance in order to manage the internal affairs of companies. The term “corporate governance” was added for the first time in the official journal of the federal government called the Federal Register in 1976. The commission worked with the New York Stock Exchange and directed the companies to form an audit committee having independent directors as their members.
The Stock Exchange Commission, along with the New York Stock Exchange, started working primarily on the advancement and implementation of corporate governance in every company. For this, they even conducted conferences where the role of shareholders in appointing the directors of a company was discussed. The chairman of the subcommittee of the judiciary’s committee on citizens’ and shareholders’ rights and remedies in 1978 created an advisory committee on corporate governance. The committee consisted of representatives from industries, consumers, shareholders, etc. The committee stressed the need for improvements in corporate governance for a better future and the economy of the nation.
Further, a committee of the American Bar Association issued a guidebook that suggested and recommended having representation of some directors outside the company on the board and that executive directors must be excluded from audit committees. The American Law Institute started working on the project of corporate governance and published its principles on corporate governance after its approval in 1994. In the later years, a lot of papers were written and conferences were held to discuss and debate the importance of corporate governance.
During the 1990s, the issue of corporate governance grabbed attention in the United Kingdom, where the executives of companies were engaged in unfair practices as a result of which problems arose. The London Stock Exchange and the Financial Reporting Council established a committee to work on the financial aspects of corporate governance in 1991. This committee was also known as the Cadbury Committee.
The Cadbury Committee gave its report and suggested principles like accountability and responsibility of directors, equitable distribution of shares with the shareholders, disclosure of information, etc., and made a code that was added to the London Stock Exchange list for companies. The principle of corporate governance was further adopted and implemented in the European Union after its impact and success in the USA and UK. It took nearly 25 years for the recognition of corporate governance to spread worldwide.
Scope of corporate governance
Corporate governance not only deals with the conduct of members of a company and the regulation of its affairs; it also deals with the interaction of the members among themselves and with the company and the public at large. It also provides that the relationship between the members of the company must be healthy so that they can work towards gaining the trust of the customers and the public. This will also help them to achieve progress in their performance.
It also provides regulations to make an effective decision and work towards its implementation. The board of directors, appointed by the shareholders, has been given the full responsibility of making decisions on all important matters after the required discussion and consultation with the members of the company, and so it is necessary for them to act according to the set principles and rules of corporate governance.
The scope of corporate governance is much wider as it includes various forms of development. These are:
Corporate governance ensures transparency and trustworthy relationships among the members and the public at large. When a company is able to gain the faith and trust of people, it is able to attract customers due to its reliability and accountability. This helps with the financial growth and development of the company.
Sustainable growth and social responsibility
Corporate governance helps in the sustainable growth of the company as it ensures the proper utilisation of resources without any misuse or wastage. This further ensures the social responsibility that every company has towards the environment and society. It promotes fairness in different market practices, which further encourages the investor to invest in a company, thus increasing employment and the generation of income.
Expansion of business
With the help of effective business strategies and governance, a company can expand its business and trade not only in its own country but also in international markets. The increasing demands of the customers depend on the conduct and affairs of the company. How a business deals with failure and complaints is important for customers in order to build healthy relationships with the management of the company. If people are satisfied with the service of the company, it will surely help in expanding the market.
Transparency and accountability
The kind of governance opted for by a company reveals whether it is accountable and promotes transparency. If proper governance is followed, then there are fewer chances of mismanagement, which further increases the efficiency of the members and the company. Corporate governance ensures that there is transparency in the procedure for the appointment of directors, executives, and other managerial personnel in a company. Accountable management will promote fair and impartial decisions and provide suitable legal remedies to the aggrieved, if any.
Thus, corporate governance and its regulation of the company are necessary to achieve growth and development in the market.
Objectives of corporate governance
Corporate governance serves the following objectives:
- It lays down a strong basis for the management and control of a company.
- Provides a structure for the board and its members. A board must have skilled, qualified, and experienced directors who can adhere to their commitment and roles.
- Establish a practice of ethical and fair decision-making.
- Promotes integrity.
- Proper disclosure of information within a stipulated time.
- Another important objective is to protect the rights of shareholders and stakeholders.
- Identifies and mitigates the risks and factors responsible for risk.
- Encourage efficiency in the functioning and dealings of the company.
- Promote long-term growth.
- Ensure fair remuneration.
- Reduce frauds, scams and unnecessary litigations.
Features of corporate governance
The following are the features of corporate governance:
Qualified board of directors
According to Section 149 of the Companies Act, 2013, every public company in India must have a minimum of 3 directors, while a private company must have a minimum of 2 directors. However, they can have a maximum of 15 members. Thus, it is necessary for a company to appoint a board of directors that is capable of fulfilling all the regulations and performing all the duties with proper diligence.
Defined roles and responsibilities
To carry out the affairs of a company properly, it is necessary that people in the management of a company, like the board of directors, secretary, chief executives, and others, have their own separate roles and responsibilities that must be defined in the Articles of Association, so that if anyone acts beyond their set powers, they are made liable for their illegal acts. The various subcommittees and meetings in a company ensure this. This is another important feature of corporate governance that helps in creating a hierarchy in companies where the roles and responsibilities of every member are defined.
It promotes integrity in the dealings and affairs of the company when all the policies and strategies are carried out properly and implemented effectively.
Corporate governance helps in mitigating the risk, which is possible if there is no governance in the company. It helps in identifying potential risks like financial, operational, legal, etc.
Accountability and transparency
Corporate governance and its legislation promote accountability and transparency in the affairs of the company and the conduct of its management. The result of corporate governance is that the board of directors is answerable to the members and shareholders of a company. The rules, regulations, and provisions make sure that if any of the managerial personnel does an illegal or unlawful act, he is made liable for the same. The absence of proper governance and systems in a company leads to fraud and scams, which also degrades the position of the company in the market.
With the help of governance and rules and regulations, the board of directors and management are bound to adhere to their commitment and fulfil their responsibilities, which is another important feature of corporate governance.
Corporate governance and its principles like accountability, transparency, fairness, etc., are used in every company around the world in order to ensure the smooth functioning and proper management of their business affairs. Every company has its own managerial personnel who are responsible for carrying out the affairs on a daily basis without any chaos or interruption by an outsider. Their conduct and powers are restricted and regulated by various pieces of legislation under the category of corporate governance. These ensure that no one in authority in a company uses their power arbitrarily.
Another important feature of corporate governance is that it provides a systematic approach and procedure for the governance and management of a company. Different models have different approaches and procedures. For example, the Anglo-American model is designed in a way that the board of directors and shareholders go hand in hand while the supervisory board and management board have authority to control under the Continental Model.
Protects the rights and interests of shareholders
It is one of the prime duties of the board of directors to protect the rights and interests of the shareholders and other stakeholders. It is their duty to ensure that all the shareholders receive their shares on time and that no one is deprived of the rights given to them. This can only be achieved if the directors appointed to the board of directors are responsible, fair, and qualified so that they adhere to all the rules and regulations of governance and legislation.
Importance of corporate governance
- The importance of the government lies in the fact that it helps in the growth and development of any venture by dealing with problems like proper financial assistance, structure, market strategies, etc. It ensures the smooth running of all the departments in a company, which further reduces the chances of chaos and confusion.
- It mitigates risk and reduces the chances of fraud, scams, and other illegal activities. If a company works on ethical principles and is governed properly, then its members become efficient and responsible in their work.
- The ultimate purpose of corporate governance is to protect the interests of the shareholders and build healthy relationships with them. This further increases the number of shareholders and their valuation, which serves as a boon for the company.
- It builds trust in the minds of the public regarding a particular company and so maintains its reputation even if the company is facing a crisis.
- It improves the efficiency of the company and its services.
- Proper corporate governance and surveillance of audits, accounts, and financial data can help in attracting several big investors by boosting their confidence in a company, which further increases capital investment.
- Corporate governance is important at times of mergers, acquisitions, and reconstruction. It helps a business or company decide which is a better deal to crack and differentiates the hoax company from others.
- It ensures that a company also makes strategies and plans for effective corporate social responsibility and welfare.
- If the norms and principles of corporate governance are followed in a company, it increases its global market and boosts economic development.
- It cultivates ethical standards and practices in the management and dealings of the company.
Principles of corporate governance
Every company or business can have their own principles, but they have to adhere to some basic principles of corporate governance that apply to every business or company. These are:
The management and board of directors are accountable for the working and functioning of a company’s assets, its financial conditions, investments and capital, audits, litigations, liabilities, etc. They must be answerable to the shareholders in order to build trust and healthy relations with them.
Another principle of corporate governance is that the board of directors and other managerial personnel must disclose information related to risks, finance, capital, loans, audits, and other issues to the shareholders and anyone having any kind of interest in the company. In this way, there must be transparency in the work.
The board of directors is under an obligation to act in a manner which is suitable for the affairs and benefit of the company. They must be responsible and sensible enough to make wise decisions on all corporate matters.
Fairness, or non-bias, is one of the most important principles of corporate governance. Everyone, whether they be employees, members, shareholders, workers or directors, must be treated equally and fairly.
Management of risk
Another important principle of corporate governance is that it must be used to identify and manage the risks beforehand rather than waiting for them to strike and affect the smooth functioning of a company.
Models of corporate governance
The following are the different models of corporate governance:
This type of model is also known as the Anglo-Saxon Model. There are different types of models in the Anglo-American model. Some of them are the stewardship model, the political model, etc., but the shareholder model is the most important. The shareholder model is based on the fact that shareholders are given equal importance as the board of directors and must have a say and the right to vote on all important matters and decisions. The model acknowledges the fact that shareholders are the major source of capital in a company and must be allowed to leave if they are not satisfied with the environment or functioning of a company.
The shareholder model demands that the board of directors must consist of independent members, as well as that the chairman of the board of directors and Chief Executive Officer (CEO) must be different people to avoid arbitrary use of powers. This model is successful only when there is harmony among the board of directors, shareholders, and management of the company. Many different U.S. authorities support this kind of model.
The governance in this model takes place at 3 levels:
- Shareholders are responsible for the election and appointment of directors and enjoy interest on their shares from the profits of companies.
- Directors who form a board of directors and carry executive work and take major decisions keeping in mind the benefit of shareholders.
- Managers who deal with administration.
The various legislations on corporate governance have limited the rights of shareholders and they are not allowed to take major decisions in a company. For this purpose, they elect a board of directors to work on their behalf. This model is usually followed in countries like America, Australia, Canada, India, the UK, and other Anglo-Saxon countries. These countries have seen the emergence of financial markets and restrictions on banking over shares held by shareholders in a company.
However, this model is influenced by external market capital by way of acquisitions, mergers, and control over trade and securities. The institutions regulating corporate governance form policies and strategies that are designed to deal with any issue that lies against corporate governance in a company. The board of directors, who are independent, is required to monitor the growth, control management and improve the structure of the organisation in such a system.
This model is based on a two-tier system of management. There are two kinds of boards in this model, and these are the management board and the supervisory board. Both boards are separate and distinct from each other. The supervisory board consists of shareholders and debenture holders, while the management board consists of executives and other managerial personnel. There is a concentration of capital in this model, and shareholders are required to work in the management and control of companies because of their common interest, and can interfere in the internal management of a company.
This model is highly supported by influential people and a country’s government because companies following this model of governance are expected to align and adhere to the objectives of the government. This type of model is mostly followed in Italy, Germany, etc.
Corporations in Italy have witnessed two types of governance. These are Catholic corporatism and Fascist corporatism. The Catholic corporatism was introduced in 1898 and remained in force till the 20th century, while the other corporatism was developed in 1920–40, and the principles are given in the Charter of Labour of 1927. The governance in Germany, on the other hand, depends on the various interest groups that aim to coordinate the affairs and management of the companies. In Germany, most of the financial help is given by the banks to the companies, so they also have the right to make and control their decisions. Under this model, both the boards are required to manage, monitor, and control the internal affairs of the company.
This model comprises major shareholders, often called ‘keiretsu’ (people who might have invested their money in common companies or have friendly relations with them), management, and the government. Small and independent shareholders are given no importance or value. The board in this model is made up of executives or insiders, and keiretsu has the power to remove a director from the board if they are not satisfied with his/her work. These people also make sure that there is governance in the functioning and working of a company. Government policies and strategies can easily affect companies following this type of model, as the government is one of the key players of the company in such a model. This type of model is only used in Japan.
The governance in this type of model is dependent on two relationships:
- Relationships between shareholders and unions, customers, suppliers, etc.
- Relationship between administrators and stockholders.
This also means that the affairs and management of a company should never be affected by such relationships. This model is based on internal control, and there is no influence from capital and markets, but the onus lies with the strategic shareholders. Since the government in Japan can interfere in corporate policies, the Ministry of Finance controls, supervises, and manages the internal affairs of a company and its relationships with its partners.
The aim of corporate governance can be easily achieved in Japan due to the structure of shareholders in a company. The only gap left to be filled is corporate transparency. The companies were founded by families, and they continue to govern their management. The banks in this model do not play a role in the management and governance of a company. Their only work is to provide financial assistance and debt.
Theories of corporate governance
There are different theories related to governance in a company. All these are discussed below:
This theory specifically deals with the relationship of shareholders with the directors. According to this theory, shareholders provide funds and capital to a company and so have a right to appoint the board of directors to take decisions on all important matters of the company. It is possible to gather a large number of shareholders every time to discuss company matters. So, to deal with such situations, they appoint a board of directors who makes decisions on their behalf, keeping in mind their interests. The theory provides that members and employees must be accountable for their work and must be punished when they do wrong, while a reward is given if they act properly and according to the set norms and principles. This way, their conduct can be regulated.
This theory is based on the relationship between principal and agent and assumes that the agent will not work for its maximum benefit at the cost of others’ interests. Managers, directors, and chief executive officers are termed as agents. One of the major issues with this theory is that the agent who is given the responsibility to manage the affairs of a company may start abusing their power and authority to gain personal benefits. They may provide misleading or false and fabricated information or manipulate the accounts for this purpose. Apart from this, they are also given the authority to make major decisions in the company and decide who will regulate or keep a check on their powers and authorities.
In order to avoid such problems and tackle the issue, an audit committee must be formed, the procedure of appointment of directors must be laid down, and a company secretariat must be appointed along with internal auditors. Apart from this, the shareholders and stockholders can suggest adopting certain principles and ethics to manage the internal behaviour and conduct of the executives of a company.
This theory compares the executives and managerial personnel of a company with a steward who is expected to work hard and maximise the profits gained from a project. This will also benefit the shareholders, as their return will be maximised. Shareholders are only concerned with the profits and success of the company while the executives have to work in the front to gain profits and benefits.
The theory assumes that the managers have no pecuniary interest or objective, and so they must be appointed to generate more wealth and profit. This theory is in contravention of agency theory, and what the manager says is deemed to be correct and final. But the question is who will ensure that the benefits of shareholders have been taken into consideration while making any decision. For this reason, there is a need to have internal auditors, audit committees, and other executive officers.
This theory states that the board of directors must take into consideration the interests of all the stakeholders, like employees, vendors, manufacturers, business partners, and other people associated with a company, while making a decision. The interests of all the stakeholders are equally important and must be valued.
This theory considers stakeholders and shareholders as the owners of a company who have a responsibility to manage its affairs and control the management. But in actual practice, shareholders are only concerned about their shares and dividends. Another argument of this theory is that the government, political bodies, trade unions,etc. also have the authority to manage the affairs of a company but, the theory fails to take into consideration that a company is formed by a group of people and not by the government so there must be no excess control or interference of government.
Resource dependency theory
This theory deals with the resources required by a company to fulfil its targets and dealings. The board of directors has the responsibility of providing necessary resources like skills, human resources, capital, information, technology, etc. to the company with the help of their links and relations. They act as links between external and internal environments. If all the resources were provided well within time, it would help in increasing the efficiency and performance of a company. Directors also provide suppliers, vendors, policymakers, and other necessary requirements to a company and can be classified into 4 different categories. These are insiders, experts, specialists, and influential people in the community for promotion.
This theory was developed by Jeffry Pfeffer (an American business theorist) and Gerald R. Salancik (American organisational theorist). The theory has an impact on the structure of a company, the appointment of members of the board, strategies related to production and marketing, the structure of contracts and other strategies of a company. According to this theory, if the appointment of employees is done outside of the company, it will have an effect on the behaviour of already employed people in the company.
Transaction cost theory
According to this theory, every contract made by a company has a value attached to it. This cost is also associated with the third or external party with whom the contract is made. This cost is known as the “transaction cost.” If the transaction cost of using a market or the cost of a contract is higher, then it is undertaken by a company.
This theory tries to explain the aim behind the formation of a company and the reason for the expansion of business. According to this theory, the aim is to minimise the transaction costs of the environment and bureaucratic costs within it. Another argument is that when the external transaction cost is higher than the internal bureaucratic cost, it will affect the growth of a company as the cost of its affairs will be cheaper than usual. The growth of a company can only be achieved if it uses cheaper resources to fulfil its operations rather than costly resources that will result in the failure of operations and obligations.
This theory states that there must be an approach to developing the support of shareholders by way of a vote. All the profits and benefits gained by a company are also determined and affected by policies and strategies of the government that favour the growth of a company and the expansion of the market.
Corporate governance in India
With the growth of technological advancements and inventions, there has been a tremendous increase in the number of products and companies in the market. At the same time, the country was witnessing a large number of scams and frauds. Some of them are Satyam Computers, Kingfisher Airlines fraud, ILFS fraud, PNB fraud, etc. As a result, there was a need to regulate the conduct of companies and their management to avoid such scams and frauds and to make the authorities of a company accountable and responsible.
Origin and evolution
The origin and evolution of corporate governance in India can be divided into two phases. These are:
- Phase one (1996-2008)
- Second phase (after 2009)
Phase one (1996-2008)
This phase is the starting phase of corporate governance in India. During this phase, the Ministry of Corporate Affairs and the Securities and Exchange Board of India worked together to bring much needed principles of corporate governance. The aim was to form audit committees and appoint independent directors and supervisors for the internal management of a company.
The Confederation of Indian Industries (CII) in 1996 took a great step and an initiative to draft a code that provides for transparency in the affairs, security of investors’ interests, implementation of international standards on disclosure of information, and builds confidence and trust among people. Mr. Kumar Mangalam Birla, the then chairman of SEBI, was told to form a committee that concerned corporate governance. The committee, in its recommendations, mandated the companies to submit annual reports and reports on corporate governance in order to help the shareholders know where the company stands in the implementation of corporate governance. It also realised the importance of the audit committee and provided the structure for its constitution and functions.
In 2001, a Standing Committee on International Financial Standards and Codes was formed to compare the situation of corporate governance in India with the international standards and suggest measures to improve it. Further, a consultative group of bank directors and various financial institutions were asked by the Reserve Bank of India in April 2001 to submit a report on the supervision of boards, audit committees, transparency, disclosure of information, etc. and suggest measures to effectively incorporate corporate governance and enhance the role of the board of directors. Another report was submitted by SEBI in 2003 on the issues of risk management, independent directors, compensation, etc. As a result of this report, major changes related to audit committees, board of directors, disclosure of information to shareholders, etc. were brought in the Indian Companies.
Phase two (after 2009)
The Satyam Computers Scandal is still counted as one of the biggest scams in the country. It was exposed in 2009 and made the government think again over the issue of corporate governance. This scandal imposed a direct question on the accountability of mechanisms and principles that were implemented to prevent such activities.
The CII gave its report on the issue of the scandal and termed it a “one-off incident.” The report claimed that the rest of the corporate sector is working smoothly, free from such activities. Apart from this, the National Association of Software and Services Companies (NASSCOM) and the Chamber of Commerce of IT-BPO formed a Committee on Corporate Governance and Ethics in this regard to avoid such activities in the future. This committee is headed by Mr. N.R. Narayana Murthy.
Need for corporate governance in India
- In a company, there are different members, and each person has his or her own attitude and way of perceiving things. The management is supposed to work according to their needs and problems faced by them so that they can satisfy all the shareholders and employees. This is only possible if there is a system that regulates and controls the behaviour and conduct of all the members.
- With an increase in the number of companies over the years, there has been an increase in the demand for investment, which is another challenge faced by a company. Only a healthy working environment and trustworthy affairs and dealings could muster the support of any investor. Thus, in order to build trust, one has to follow certain principles and guidelines and adhere to proper management and governance.
- Apart from professional dealings, a company has to fulfil other responsibilities as well. According to modern norms and principles, a company has to make sure that it does not violate any law, hurt the religious sentiments of people, avoid any kind of pollution that could damage the environment, and fulfil social responsibility as well. This is possible with corporate governance.
- Companies doing their trade and business in international markets and countries are expected to follow a certain code of conduct to regulate their management at such a high level and attract more foreign investment.
Framework of corporate governance in India
Companies Act, 2013
The Act provides provisions related to the functioning of a company and the procedure of its registration, the commencement of business and winding up. It also mentions the qualifications and powers of the board of directors and other managerial personnel like independent directors, executives, promoters, shareholders, debenture holders, etc. It covers provisions related to different types of meetings and procedures for mergers, acquisitions, and reconstruction of a company.
Securities and Exchange Board of India
SEBI provides guidelines for the issues that have not been covered in the Companies Act of 2013 and also serves the purpose of the Exchange Board. Every company has to register itself with SEBI and follow its guidelines whenever necessary.
SEBI’s consultative paper
In its consultative paper on ‘Review of Corporate Governance Norms in India’, the SEBI listed the principles of corporate governance given by the OECD and made certain proposals. The principles given by the OECD are as follows:
- Ensure an effective framework for corporate governance.
- Protection and facilitation of shareholders’ rights and other key ownership functions. ‘
- Equitable treatment of shareholders.
- Recognition of the role of stakeholders.
- Disclosure and transparency in the management of company affairs.
- Management and accountability to shareholders are the responsibilities of the board.
The following are the proposals made by SEBI in its paper:
- Appointment of independent directors
The paper suggested that the procedure for the appointment of independent directors must be revised in order to provide transparency. Generally, they are elected by a majority of shareholders, which also means that they might end up serving those majority shareholders and leave the interests of minority shareholders. This will defeat the sole purpose of appointing independent shareholders. It also stressed the fact that some countries, like Italy, have the option of the appointment of independent directors by minority shareholders. All the independent directors must be given formal letters of appointment as per the guidelines of the Ministry of Corporate Affairs.
The suggestions also included:
- Training for independent directors.
- Nominee directors are treated as independent directors.
- Minimum and maximum age.
- Maximum tenure.
- They must disclose the reasons for resigning.
- There must be clarity on the liabilities of these directors.
- Their performance must be evaluated.
- There must be a head independent director.
- They must have their own separate meetings as well.
- Cumulative voting
Another suggestion with respect to the appointment of independent directors was the cumulative or proportionate voting that exists in the Philippines and China. This will serve as an alternative to direct appointment and foster corporate governance. In this type of voting, the shareholders will have multiple options and decide whether to cast their vote for a single person, divide it between two candidates, or whichever way they want to split it.
- Separate position of chairman and managing director
Another important suggestion was to separate the positions of chairman and managing director. Otherwise, it will lead to an accumulation of powers of the management in the hands of one person, who may even abuse it, thinking that there is no check on him. This is a common practice in countries like the US, UK, France, etc.
- Diversity in the board
This will result in a board that is heterogeneous rather than homogeneous. There will be more ideas and perspectives, which will help to make effective decisions. The suggestion stated that even women must be included on the board in order to achieve gender diversity.
- Risk management
It was suggested to ask the board to prepare guidelines and procedures to identify and minimise the risk and consider such principles in order to avoid any kind of risk. Risk management is also recognised as one of the principles of corporate governance. One step could be the appointment of a Chief Risk Officer or Manager and the formation of a risk management committee.
- Other proposals
The other proposals include:
- Report by the internal auditor.
- Rotation of audit partners.
- Whistle blower mechanism (mechanism where the employees could express their problems and concerns and which safeguards them) must be implemented.
- Formation of a remuneration committee.
- Remuneration policies must be disclosed.
- Formation of a stakeholders’ relationship committee.
- Provision for e-voting must be added.
- Prohibition of affirmative rights for investors.
- Managerial remuneration must be approved by disinterested shareholders.
- Fiduciary relationship of shareholders.
- Enforcement in the private sector must be strengthened.
- Awareness for better participation.
- Norms against non-compliance with corporate governance must be enforced.
- Every company must include a section on corporate governance in their audit reports.
These are issued by the Institute of Chartered Accountants of India, which is an autonomous body that deals with issues related to accounts and finance. It provides standards for how to deal with accounts and what information must be disclosed. The provision of financial statements is also covered under Section 129 of the Companies Act, 2013.
These standards deal with various kinds of meetings, like annual general meetings, board meetings, shareholders’ meetings, etc. given in the Companies Act and the procedure to be followed in each. These are issued by the Institute of Company Secretaries in India. It also provides details regarding who will preside at the meeting, when the meeting will be conducted, how to maintain its records, procedure to be followed in a meeting, etc.
Voluntary guidelines on corporate governance
The Ministry of Corporate Affairs has given guidelines on corporate governance in 2009. These are:
- The formal letter of appointment to the directors must include:
- Fiduciary duties,
- Code of business ethics,
- List of actions,
- The offices of the chairman and chief executive officer must be separate.
- There must be a nomination committee to nominate suitable candidates for independent directors.
- The guidelines also provide a number of companies in which a director can work as a non-executive or independent director. The number is restricted to seven companies.
- The tenure of independent directors must be 6 years.
- They must have the freedom to meet the company’s management personnel.
- The guidelines also provided for a remuneration policy, a remuneration committee, and a structure of compensation for non-executive directors.
- Listed the responsibilities of the board as:
- Risk management,
- Training of directors,
- Quality decision-making,
- Evaluation of the performance of the board, and
- Ensure compliance with procedures and laws.
- It provided the constitution and powers of the audit committee.
- Procedure for appointment of auditors and certification of independence.
- Introduced the institution of the whistle blow mechanism.
Benefits of corporate governance
Corporate governance helps in the systematic functioning of a company and its affairs at the national and international levels. The following are the benefits of corporate governance:
- It helps in proper leadership where the interests of the shareholders and debenture holders are protected in a company.
- It promotes healthy relationships between the company and its members and among its members.
- It helps in establishing a profitable national and international market and, thus, helps in the expansion of a healthy market.
- It ensures long-term financial security, which further leads to growth and development, and as a result, more investors are attracted to invest in the company.
- It reduces the chances of risks and challenges.
- It improves the efficiency of the members of the company and, hence, the company.
- It reduces instances of litigation and chaos among competitors.
- The assets and resources of a company can be managed and utilised properly with the help of corporate governance.
Challenges of corporate governance
Profits and losses, issues and challenges, are the two faces of the same coin. If corporate governance has benefits, then it also has to face some issues and challenges with the growth and expansion of industries and companies. The aim is to achieve good governance, but there are a lot of challenges along the way. These are:
Getting wise and responsible people on the board of directors
Appointing the right people to the board of directors is still a challenge. The Companies Act, 2013 does not specifically provide any qualifications for the board of directors, which is a loophole as a result of which many people appoint their family members to the board of directors. The board must be such that it can make wise and honest decisions that will benefit the growth of the company and not indulge in any unlawful activity.
In 2017, SEBI released a guidance note on board evaluation that provides criteria for evaluating the performance of boards in a company. According to the note, the evaluation must be made public to achieve the desired results.
In order to take full advantage of corporate governance, it is necessary that the directors are independent and not be subject to any kind of influence or manipulation by an insider or any person outside the company. The Companies Act, 2013 provides the provision for the appointment of independent directors, but it is hardly used and, if used, such directors rarely exercise their powers and authority. There is no specific definition of an independent director to date.
Accountability to stakeholders is another issue faced by corporate governance. Whether the directors are accountable or not is a big question. Due to the lower number of general meetings where all shareholders and stakeholders are present, the accountability of directors is questionable. Another issue is the executive compensation and remuneration that are given to the key executives. The remuneration committee does not take the approval of shareholders while deciding the remuneration, which is another challenge to accountability. If the shareholders are investing their money, then they have a right to know where it is used.
Management of risk and data protection
One of the important features of corporate governance is that it helps in identifying the risks so that they can be managed appropriately. But is this fulfilled? Are the policies adopted by a company to manage risk able to do so? All these have to be addressed before it’s too late.
Another issue is the protection of sensitive data and information about the company. The increase in the number of cyber crimes is a threat to sensitive data and information. A company has to ensure that the details of its members and other data are not exposed to potential use, which can be misused by a hacker easily, and thus must frame policies for the same.
Frauds and scams
Frauds and scams are another challenge to corporate governance. If proper corporate governance is implemented in a company, there are fewer chances of fraud and scams. When any incidence of fraud or scam is reported, it puts a direct question on the effectiveness of corporate governance and mechanism enforced for its implementation. Scams and frauds like Satyam computers, Ricoh scam, ICICI bank scam, Vijay Mallya or Kingfisher scam, etc. have been a threat to corporate governance in our country and there was a need to reform and improve the mechanism and implementation of corporate governance in order to avoid such incidents in the future.
Corporate governances are the rules and regulations that control and regulate the working and functioning of a company. It has various benefits and objectives that are mentioned above. Apart from these advantages, it is facing a lot of challenges and issues in the current scenario. One of its important tasks is to reduce fraud and scams, but with the advancement of time, new crimes are emerging day by day. A company might have policies to deal with traditional crimes but not with cybercrimes or white-collar crimes. These challenges must be addressed quickly to avoid misuse of data and other such crimes.
Frequently Asked Questions (FAQs)
What is an Audit Committee?
According to Section 177 of the Companies Act, 2013, every company that has a paid-up capital of Rs. 5 crore must have an audit committee that consists of a minimum of three directors. It is the duty of the committee to discuss internal systems of control with the auditors periodically and review half-yearly and annual financial statements of the company. It must make recommendations to the board regarding the management of finance in a company that will be binding.
What are the duties of a director?
According to Section 166 of the Act, the directors have the following duties:
- Duty to care about the performance of a company.
- Duty to attend meetings.
- Duty not to delegate powers.
- Duty to disclose interest. (Section 184)
- Duty not to assign his office to anyone.
Who is included in the key managerial personnel of a company?
According to Section 203 of the Act, every company must have the following managerial personnel:
- The managing director or chief executive officer. In their absence the whole time director,
- The company secretary, and
- chief financial officer.
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