This article has been written by Gaurav Garg pursuing Diploma in Corporate Law & Practice: Transactions, Governance and Disputes and edited by Shashwat Kaushik.
This article has been published by Sneha Mahawar.
Table of Contents
Corporate governance is the combination of rules, processes, or laws by which enterprises are operated, regulated, or controlled. It refers to the set of policies created to direct a company on the principles of accountability, transparency, and ethical practises. There is no legislation or statute by which corporate governance is regulated; rather, there are rules, guidelines or reports by various authorities by which it is regulated or operated. Some are mandatory, some are Voluntary and some are recommendatory. An example of good corporate governance is a well-defined and enforced structure that works to benefit everyone concerned by ensuring that the enterprise adheres to accepted ethical standards, best practises, and formal laws. Alternatively, bad corporate governance is seen as poorly structured, ambiguous, and non-compliance, which damages the image or financial health of the business.
Importance of corporate governance
Corporate governance is important because it provides management accountability to shareholders and other stakeholders (both inside and outside investors). Further, it provides transparency in the basic operations of the company and integrity in financial reports generated by the company. Checks and balances through auditing committees are an integral part of good corporate governance. Open communication between the organisation and the stakeholders of the company is also necessary to boost their confidence in the company. Investor loyalty is a guarantee of the best corporate governance practises.
Evolution of corporate governance in india
Before liberalisation, the operation of the business was run on British rules. Policies and rules were amended or altered as per the desire of British employers. Later, the Companies Act of 1866 and 1956 were enacted but until 1991, there was no corporate governance. After the globalisation of the Indian industry, foreign investors park their money and it is essential that services other than their investment interest be given to them. Indian companies felt the need for corporate governance. After this, all the authorities hereinafter referred to have given their contributions, through which the rights of stakeholders (shareholders, creditors, consumers, employees, etc.) have been protected through a set of policies and measures that need to be adopted by companies for good corporate governance. Some of the benefits of adopting corporate governance are Lower cost of capital, Higher share prices, financial stability as a company gains shareholder trust, etc.
The cooperation of some of the authorities through which the concept of corporate governance has evolved:
PHASE 1 (1996–2008)
- CII (Confederation of Indian Industry) 1998,
- SEBI set up a committee (KMBC) in 1999,
- MCA (Ministry of corporate affairs) in 2000,
- NCC (Naresh Chandra Committee, 2002),
Six principles by the Organisation for Economic Co-operation and Development:
- The basis for an effective corporate governance framework.
- The right of shareholders.
- Equitable treatment of shareholders.
- The role of stakeholders in corporate governance.
- Disclosure and transparency.
- The responsibilities of the board
These principles have formed the basis for corporate governance initiatives in OECD countries and non-OECD countries. They represent the minimum standard that countries with different traditions have agreed on.
Phase 2 after 2008
In 2008, a scam happened, due to which the Indian corporate community experienced a significant shock with damaging revelations about board failure. This was also called a Satyam Scam. In its report, the CII emphasised the unique nature of the Satyam scandal, noting that Satyam is a one-off incident. In addition to the CII, the National Association of Software and Services Companies also formed a Corporate Governance and Ethics Committee, chaired by N.R. Narayana Murthy, one of the founders of Infosys and a leading figure in Indian corporate governance reforms.
Impact of COVID-19 on the stock market
At the beginning of 2020, COVID-19 caused huge destruction to the economy. As per the report of the WHO for 2020, more than 18 million people got positive and 6,90,257 died. Unprecedented fluctuations are seen in the stock market; despite best efforts, it has been difficult to predict market trends. Due to that, there is a huge impact on share returns and trade volume. The only mitigating factor left to overcome the pandemic was good governance. In March 2020, the US stock market fluctuated four times in ten days. Since its inception in 1987, that fluctuation has only ever been triggered once, in 1997.
Together with the US crash, stock markets in Europe and Asia have also plunged. The S&P 500 fell 9.5% and the Nasdaq ended 9.4% lower, while losses on the UK’s FTSE 100 wiped some £160.4bn off the market. In France and Germany, indexes cratered by more than 12%. “Markets are at a breaking point,” said Neil Wilson, chief market analyst at Markets.com. “No one knows what a total economic shutdown, however temporary, looks like.”
How should directors and in particular independent directors remain fully engaged in company matters and committed to company governance? How should the directors balance business realities?
We have never experienced such uncertainty and never faced any such type of global lockdown in the past. There was a truly unprecedented and extremely difficult challenge. COVID-19 has tested the true ability of directors across the globe, irrespective of the size or nature of the business. For any business, that was the time for taking instant decisions and building confidence in people.
The steps towards corporate governance that most directors must take to balance business realities are as follows:
- Real-time data
In such a situation, the board needs to stay connected with key management to understand the detailed internal and external data on a daily basis. At such a time, the board should support management and look for a remedy. There is no scope for hearsay information. The information should be real and trustworthy.
- Direct communication
The Board of Directors should have direct communication with all the stakeholders. It has to be simple and accurate and it should be from the right person in whom every stakeholder has trust. Such a person can be an executive director.
- Empower people
The board must work collaboratively with the management to empower them to make swift decisions. The management should be given some independence to take decisions, along with accountability and responsibility. The focus must be only on reducing process timelines without compromising corporate governance. The company must have preestablished protocols for fighting COVID-19, if they do not have any protocols, then the board associated with the managing director has to make such policies as soon as possible.
- Analysis risk factors
The Board of Directors, along with the risk analysis committee, should consider whether the impact of COVID-19 is prolonged. the feasibility of implementing these steps under different scenarios given the possibility of fewer resources being available, increased health and safety regulations, supply chain issues, availability of financing sources, customer situations, etc. All the situations have to be analysed. The additional steps that might be required are creditor liquidation, contractual defaults, and violations of licences or other compliances. These are some of the critical aspects that have to be evaluated by the board along with the management.
Steps companies can take to prepare for stakeholder activism
After taking all such measures, there might still be a situation where the shareholder is not able to understand the position of the company and think about their interests. During the pandemic, it was obvious or pre-anticipated that the shareholder may be anxious as of now. This time, the market has been very volatile; business were under stress, contracts were getting renegotiated, etc. In this situation, stakeholders were bound to ask questions.
In such a situation, the following measures are necessary to be taken:
- Direct communication with the stakeholder through general meetings or special meetings is mandatory whenever deemed necessary. Make him believe that his money is safe. Make a different committee for any query. During the pandemic, SEBI also directed the company to hold a meeting through video conferencing with their shareholders regularly.
- The company should not conceal information until it is necessary and disclose true statements to build the continuous trust of their stakeholders.
- True reports should be provided to them by the audit committee and management directly. They should also know about measures that companies should take to fight the pandemic.
Does the board have a plan in case one or more directors and key managerial personnel suffer from COVID-19? Should the company form a special committee to monitor developments?
As COVID-19 caused huge destruction, this was a very probable situation for the company under these circumstances. In this situation, the Board of Directors, along with the nomination and remuneration committee, have to play a very important role. Along with this, they should also delegate some power to special committees specially formed for the evaluation of COVID contingencies.
- They should make a succession plan in case any director or KMP suffers from COVID
- They should also make emergency protocols because if any of the KMPs or directors get positive, that would cause a huge loss to the company. Its share value tremendously goes down, and only good governance in such a situation can save it.
- They should also evaluate the performance of each member of the board or KMP. In the event of death, if any KMP or director died, then it became very difficult for the company to find a good talent in such a short period of time. The company has to pre-plan such types of contingencies and make a list of people who can replace them.
- Planning is the only way a company can save itself from such contingencies.
- The Board of Directors can also delegate such tasks to a special committee that can make sound judgements on data provided by the board and make sound policies to preserve short-term and long-term objectives. The board can also involve KMP in this special committee to speed up decision-making and information flow.
- The plans should be practical and real, not hypothetical. They should be simple and easy to perform. There must be an efficient use of business resources, and this special committee should be regularly updated according to evolving risks and needs.
During the COVID pandemic, good corporate governance played a very important role to mitigating share volatility or uncertainty. The directors get the opportunity to take decisions and learn to tackle such unprecedented situations. The dramatic corporate shift caused by the pandemic presents various unique challenges for directors. Still, it also sheds light on their ever-evolving role as leaders and decision-makers. It motivates them to work with their full efficiency and makes them ready to fight this kind of pandemic if it comes in the future. In these types of adversity and uncertainty, it’s clear that modern governance matters more than ever.
Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.
LawSikho has created a telegram group for exchanging legal knowledge, referrals, and various opportunities. You can click on this link and join: