governance

In this article, Anith Johnson, pursuing a Diploma in Companies Act, Corporate Governance and SEBI Regulations from LawSikho.com and Shagun Bahl discuss the provision of Corporate Governance under the Companies Act, 2013.

Emergence of Corporate Governance in India

Corporate Governance is the new golden term coined in the corporate sector in the late 1990’s by the Industry Association On Confederation of Indian Institute which was the first initiative in India as a voluntary measure to be adopted by Indian companies. It has outlined a series of voluntary recommendations to integrate best-in-class practices of corporate governance in listed companies which touches the four cornerstones of fairness, transparency, accountability and responsibility in managing the affairs of the company. The second major initiative was taken by Security Exchange of India (SEBI) as Clause 49 of the Listing Agreement. The third key initiative to effectively introduce Corporate Governance was taken by Naresh Chandra Committee and Narayana Murthy Committee who previewed Corporate Governance model working in companies from the viewpoint of shareholders, investors and other stakeholders of the company. Corporate governance guidelines both mandated and voluntary have evolved since 1998, due to the sincere efforts of several committees appointed by the Ministry of Corporate Affairs (MCA) and the SEBI. The real change in the corporate sector could be felt with the introduction of 2009 Mandatory Corporate Governance Voluntary Guidelines which has to be comply by companies listed on stock exchange by Clause 49 of Listing Agreement including mandatory codes to be followed by companies pertaining to board of directors, audit committees and various disclosures with respect to related party transactions, whistleblower policies etc. The final assent to Corporate Governance practices in the effective management of the company can be seen as introduction to new significant provisions introduced in the Companies Act, 2013 in form of independent directors, women directors on the board, corporate social responsibility and mandatory compliance of Secretarial Standards issued by Institute of Company Secretaries of India as per Section 118 of Companies Act, 2013.

Corporate Governance – Meaning and Definitions

Corporate Governance is a multi-faceted subject and difficult to comprehend in a concise definition. The main theme of corporate governance is to integrate sound management policies in the corporate framework in such a manner to bring economic efficiency in the organization in order to achieve twin goals of profit maximization and shareholder welfare. Few comprehensive definition on Corporate Governance are discussed below.

Institute of Company Secretaries of India

“Corporate Governance is the application of best Management Practices, Compliance of Laws in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stakeholders.”

Standard and Poor

“Corporate Governance is the way a company is organized and managed to ensure that all financial stakeholders receive a fair share of the company’s earnings and assets.”

Mathiesen [2002]

“Corporate governance is a field in economics that investigates how to secure/motivate efficient management of corporations by the use of incentive mechanisms, such as contracts, organizational designs and legislation. This is often limited to the question of improving financial performance, for example, how the corporate owners can secure/motivate that the corporate managers will deliver a competitive rate of return” – www.encycogov.com,

The Cadbury Committee U.K, defined corporate governance as follows

“It is a system by which companies are directed & controlled”.

Need of Corporate governance

The collapse of international giants like Eronf, Worlcom, Tyco, AOL and financial scams like Satyam have been big eye-openers in the corporate arena to make realise the company’s management, ownership and stakeholders the emergent need to comply with Corporate Governance principles in order to prevent themselves from paying huge corporate criminal liabilities in the future. These huge corporate giants paid the cost for lack of good corporate governance practices and corrupt policies adopted by management of these companies and their financial consulting firms

The significance of good corporate governance solutions has widened because of the increasing conflict between ownership and management disciplines, the non-compliance of financial reporting by auditors which inflicts heavy losses on investors and lack of fair and transparent culture in the company which shook’s investor trust in the financial viability of the company and its ethical standards.

Good Corporate Governance – Corporate solutions

Good corporate governance is embedded to the very existence of a sound company. It is important for the following reasons:

  1. Corporate governance lays down the foundation of a properly structured Board and strives to a healthy balance between management and ownership which is capable of taking independent decisions for creating long-term trust between the company and external stakeholders of the company.
  2. It strengthens strategic thinking at the top management by taking independent directors on the board who bring intellectual experience to the company and unbiased approach to deal with matters related to companies welfare.
  3. It instils transparent and fair practices in the board management which results in financial transparency and integrity of the audit reports.
  4. It sets the benchmark for the company’s management to comply with laws in true letter and spirit while adhering to ethical standards of the company for bringing out effective management solutions in order to discharge its responsibility for smooth functioning of the company.
  5. It instils loyalty among investors as their interest is looked after in the best manner by a company who adopts good management practices.

Scope of Corporate Governance

Corporate governance instils ethical standards in the company. It creates space for open dialogue by incorporating transparency and fair play in strategic operations of the corporate management. The significance of corporate governance lies in:

  1. Accountability of Management to shareholders and other stakeholders.
  2. Transparency in basic operations of the company and integrity in financial reports produced by the company.
  3. Component Board comprising of Executive and Independent Directors.
  4. Checks & balances is an integral part of good corporate governance.
  5. Adherence to the rules of company in law and spirit.
  6. Code of responsibility for Directors and Employees of the company.
  7. Open Dialogue between management and stakeholders of the company.
  8. Investor Loyalty is a guarantor of good corporate governance practices.

A Component board comprising of experienced professionals and active directorship who brings rich experience and intellectual vision on the board resulting in a greater economic efficiency of the company and enjoys the indispensable trust of the shareholders and key stakeholders of the company and they turn into trusted market players in the corporate sector enjoying everlasting market repute.

Key market players involved in corporate governance

The Corporate management decisions have an impact on various people and entities associated with the company who are collectively known as stakeholders which include shareholders, directors, creditors, employees, suppliers, government agencies and society at large. But there are only key stakeholders like shareholders, directors, officers who are active participants in corporate governance process and other stakeholders who themselves are not involved in corporate governance practices but rather are recipients of benefits derived from companies having good corporate governance practices.

Core Principles of Corporate Governance

  • Transparency

The stakeholders should be informed about the company’s activities, financial statements, and the organization’s performance and also at the same time it is very important to give accurate and precise information to the shareholders.  Poor transparency reduces the ability to raise more capital as the investors will be unaware of vital information. It also leads to less trust among the investors as a company that is financially stable and doing well will not have anything to hide. Moreover, companies that are doing well will like to make the financial statements public to promote themselves. Transparency in financial reporting increases the confidence of the shareholders will help them. The policies must be formulated in a manner which ensures transparency. 

Transparency should also be maintained between directors and employees. The directors should be easily accessible by the employees and directors should be open to ideas of the management and employees. This makes employees more committed to the vision of the company. Lack of transparency will always lead to confusion and it will hinder the productivity of the management and employees.

  • Accountability 

To achieve the goals and objectives of the company, people should be held accountable at all levels. Employees should be accountable to the management, management should be accountable to the board of directors and the board of directors should be accountable to investors and shareholders. Employees, management staff and directors will learn from the mistakes if they are made accountable and it leads to better utilization of the available resources. In this way the organization will grow faster as the scope for mistakes will reduced considerably. It is the duty of directors to encourage accountability in the organization.

  • Responsibility 

The directors of the company are primarily responsible to the shareholders, employees and the whole society. The directors of the company should work in the best interests of the company and its employees. It is the duty of the directors to determine the responsibility of the management and employees. Also, management and employees should be held accountable to make sure that responsibilities are carried out properly. Shareholders want directors to be responsible to their needs and maximize the value of the firm. 

  • Fairness

Fairness principle not only enhances corporate value but it also leads to efficiency in resource allocation. All shareholders and investors should receive equal treatment by the company and the directors should try to prevent conflict of interests. It is very important to ensure fairness in transactions which are entered by the company. For e.g. a company should not enter into related party transactions without getting the approval of the shareholder. Effective communication mechanisms should be adopted by the company to make sure policies and financial statements are informed to the shareholders.

  • Shareholder Engagement

Shareholders should not be kept in the dark and must be informed of the financial position and organizational objectives. Minority and majority shareholders should be treated equally. All transactions must be avoided which might lead to conflicts with the shareholders.

  • Leadership

Board of directors is the brain of any company and it is under their leadership and guidance that any company expands and prospers. The directors should be committed to fulfilling the vision and mission of the company which is mentioned the constitution documents. Leadership also includes motivating the employees so that they reach the maximum potential. It also includes effective decision making and capitalize on opportunities to benefit the firm. Poor leadership by the board can create problems for the company and which may eventually end in bankruptcy or shutting down.

The Key Participants are as following

Shareholders

The shareholders are the principal owners of the company who provide capital to the company in lieu of return received by them in form of dividends on the earnings of the company. The individual shareholders participate in corporate governance procedures by exercising their voting rights on the key decisions of the company in in the interest of all stakeholders. The other institutional shareholders of the company like, insurance companies, trusts, investment banks, etc. who have greater shareholding than other shareholders actively have a greater role in monitoring corporate governance activities of the company as they are interested in market viability of the company in form of large market shares.

Directors

The Board of Directors are key constitute players for formulating and implementing corporate governance practices in the heart of the company machinery by making key decisions pertaining to setting long term corporate strategy of the company, sharing high responsibility to run the company on good governance structure, bringing effective board leadership to tackle the company’s operations at all levels and monitoring its performance in a fair and transparent manner.

Officers and key managerial personnel

Key Managerial Personnel (KMP) and other officers of the company who serve the top – management level under the Companies Act, 2013 includes the Chief Executive Officer, Managing Director or Manager; Whole Time Director; Company Secretary.
The Key Managerial Personnel would advise the Boards to achieve the corporate goals and by adhering to Good Corporate Governance practices. KMP would also have to report to the Sectoral Regulators for the non-compliances made by the company.

The new law bestows upon KMP’s a significant role to run the company’s operations in such a manner by adhering to laws in true letter and spirit in order to spell out the will of directors and other stakeholders effectively and efficiently in achieving company’s twin objective of profit maximization and maximization of wealth.

Role of Corporate Governance in banks

Bank and Financial Institutions are the backbones of the economic and financial system of any country. Banks are the richest source of economic wealth of the company any nation’s progress report is depicted through healthy and sound functioning of the banking system of the country.

To strengthen the banking practices in India, RBI plays a leading role in formulating and implementing corporate governance norms for banking regime in India sector. Banking structure is the lifeblood of an economy to survive in this globalized scenario.

  • The chapter on Corporate Governance in Banks in India elaborately discusses the role of RBI in regulating good corporate governance practices in banking sector in India.

Paper on – IIBF

“The RBI move to strengthen Corporate Governance led to seminal changes in the bank administration. The sustained profitability, lower level of non-performing assets, improved return on assets etc are some of the laud indicators of the sustaining policy of operating sound banking system. Moreover, the movement of share prices in the market, increased appetite of investors to look at banks for investment in bank centric equity market further speaks of broad market opinion of bank’s performance and reflection of market confidence. The corporate governance framework in banks has been strengthened through regulation, supervision and by maintaining constant interaction with the management. They cover identification of responsibilities of the Boards of banks, disclosure and transparency in published accounts, and shareholder and stakeholder rights and controls. The rating on management (M) which has been introduced as part of the CAMELS (Capital, Asset Quality, Management, Earnings, Liabilities and Systems) supervisory process takes into account the working of the board and its committees including the Audit committee, effectiveness of the management in ensuring regulatory compliance and adequacy of control exercised by the head/controlling offices. This model has been further modified to include risk based supervision. The new evolution is intended to manage influx of a range of financial risks entering the market with their nuances.”

Role of proxy advisory firms in Corporate Governance

Proxy advisory firms is a very nascent terminology introduced in the corporate world which are basically independent research centers that evaluate the performance of corporate matters such as mergers, acquisitions, top appointments and CEO pay, on which shareholders are expected to vote on in AGMs, EGMs so that an informed decision can be taken by the shareholders about the corporate policies undertaken by these companies in order to increase their shareholding value.These firms engage in comprehensive analysis of the major activities of the company and submit detailed reports in order to guide the shareholders to take decisions which turn out to be beneficial to shareholders in the long run for safeguarding their interest with the company.

Proxy advisory firms charge fees from institutional investors and provide independent advisory services and voting recommendations to the shareholders and other institutional investors.

India has home grown proxy advisory firms such as Institutional Investor Advisory Services (IiAS), InGovern and Stakeholder Empowerment Services (SES) which provide more analytical, sophisticated and structured report to shareholding units leading to a change in the governance structure of the company.

Role of corporate governance in Family Business

The history of Indian Corporate giants includes names like Tatas, Birlas, and now presently Reliance who all are listed public Indian companies enjoying biggest market share in the country are family promoted and managed companies. Nearly a third of the Sensex companies can be said to be family promoted, controlled and managed. Research and experience show that family ownership and control brings positive approach to the family business and its constituent shareholders. However it is also true and has been seen in many family owned business in India and abroad that these businesses also brings with itself magnitude of problems delineating ownership from family management and sometimes destroying the whole businesses where power play and conflicts take the first place and fair play and transparency in takes a back seat in family owned businesses.

Corporate governance is the measuring rod which measures the long-term success of the company and keeps peace in the family.

Corporate governance regulates the family and business levels of the company and brings good solutions to family ownership challenges and often results in the long-term success of the family business and maintains peace and harmony in the controlling family and maintaining fair balance between family ownership and outside management control.

As published in https://www.oecd.org/daf/ca/corporategovernanceprinciples/43654301.pdf

Governance Solutions to Family Business Challenges- This section looks at various governance solutions to the challenges unique to family-owned businesses, and covers a variety of topics:

  • Distinguishing governance solutions in different ownership stages of the family business
  • Family governance institutions
  • Family governance documents of Specific solutions to some family governance challenges
  • Succession planning in family-owned

The main motivations for seeking improvements in their governance policies and practices:

  • To institutionalize and perpetuate the business model.
  • To provide the means to implement the defined strategic plan.
  • To add value for shareholders.
  • To enhance the potential for attracting debt financing, resources and shareholders
  • To improve the company’s image abroad, facilitating globalization and reaching a base of foreign investors

Key features of corporate governance in Companies Act, 2013

There has been a sea change in companies Act, 2013 which has waved its way from principle of corporate governance practices as the new key change in the act. The Companies Act, 2013 has taken a foot forward from SEBI’s Clause 49 of listing agreement by introducing provisions in the companies act 2013 which promotes corporate governorship code in such a manner that it will no longer be restricted to only listed public companies but also unlisted public companies. Companies Act, 2013 lays greater emphasis on corporate governance as it clearly provides the rules and regulations for the same. Some of the provisions of the Companies Act, 2013 are discussed below:

  • Board of Directors

Board of directors is the decision making body of any company. It is the duty of the board to comply with all legal rules and regulations. So it is very important that a company constitutes a board of directors as per the provisions of Companies Act, 2103.

Composition of Board- Section 149 of the Companies Act, 2013 provides for appointment of minimum three directors in a public company and two directors in a private company. A board can have a maximum of fifteen directors but can appoint more directors subject to special approval. 

Women Director- It is mandatory to appoint a women director in the following classes of company:

  • Listed company;
  • Public unlisted company having paid-up share capital of one hundred crore rupees or more, or having a turnover of 300 crore or more.

Resident Director- Section 149(3) mandates that every company will have one director who has stayed in India for a period of not less than 182 days.

Independent Director- Independent directors are impartial and bring expertise to the board. They play an important role in resolving conflicts among shareholders and the company. Section 149(6) provides for the qualifications for appointing an independent director in a public company. As per Companies Act, 2013 public listed company shall have at least one-third of directors as independent directors and public unlisted company will have two directors if they meet the following criteria:

  • Public companies having a share capital of 10 crore or more;
  • Public companies having a turnover of 100 crore or more;
  • Public companies having outstanding loans, debentures and deposits of more than 50 crores.

According to section 134 of Companies Act, 2013 the director has to give a detailed financial report which includes the director’s responsibility statement. This provision has been enacted to make directors accountable for their actions.

  • Stakeholder Relationship Committee

As per section 178(6) of Companies Act, 2013 if a company has more than one thousand shareholders, debenture-holders, deposit-holders or any other security holders in a financial year then it is mandatory to constitute a stakeholder relationship committee. The main of the committee is to resolve the conflicts between the shareholders and the board of directors and address their grievances. The chairperson of the board shall be a non-executive director.

  • Audit Committee

The Audit Committee looks after the financial reports and disclosures of a company. It is one of the most important components of a corporate governance structure. Under section 177 of Companies Act, 2013 the following class of companies are required to constitute audit committee and they are as follows:

  • Listed company
  • Public company having a share capital of more than 10 crores;
  • Public company having a turnover of Rs. 100 crores;
  • Public companies having deposits, outstanding loans or debentures more than 50 crores.

An audit committee will consist of a minimum of 3 directors and independent directors will form the majority. Section 177(4) provides duties of the audit committee and it has to act in accordance with the same.

Internal Audit

Companies Act, 2013 has mandated the internal audit for certain classes of companies as specified under Section 138 of the Companies Act, 2013.

Serious Fraud Investigation Offence (SFIO)

Section 211 (1) of the Companies Act, 2013 shall establish an office called the Serious Fraud Investigation office to investigate fraud relating to Company. The powers are given to SFIO under the act as mentioned that he can investigate into the affairs of the company or on receipt of report of Registrar or inspector or in the public interest or request from any Department of Central Government or State Government.

  • Nomination and Remuneration Committee

The nomination and remuneration committee decides the selection criteria for the key managerial personnel (KMP) and determines the remuneration of the KMP’s and directors. Section 178 of Companies Act, 2013 mandates the constitution of committee for the following class of companies:

  • Listed company;
  • Public company having a share capital of more than Rs. 10 crores;
  • Public company having a turnover of Rs. 100 crores;
  • Public company having deposits, outstanding loans or debentures more than Rs.50 crores.

The nomination and remuneration committee will consist of a minimum of 3 directors and independent directors will form the majority. 

  • Corporate Social Responsibility

The concept of CSR rests on the good corporate citizenship where corporate contributions to the societal growth as a part of their corporate responsibility for utilizing the resources of the society for their productive use.

Ministry of Corporate Affairs http://www.mca.gov.in/ has recently notified Section 135 and Schedule VII of the Companies Act as well as the provisions of (CRS Rules) which has come into effect from 1 April 2014.

Applicability

Section 135 of the Companies Act provides the threshold limit for applicability of the CSR to a Company:

  1. Net worth of the company to be Rs 500 crore or more;
  2. Turnover of the company to be Rs 1000 crore or more;
  3. Net profit of the company to be Rs 5 crore or more.

Further, as per the CSR Rules, the provisions of CSR are not only applicable to Indian companies but also applicable to branch offices of a foreign company in India.

CSR Committee and Policy

Every company as prescribed in Section 135 http://www.mca.gov.in/SearchableActs/Section135.htm of the Act and Company (Corporate Responsibility) Rules, 2014 http://www.mca.gov.in/Ministry/pdf/CompaniesActNotification22014.pdf within the threshold limit requires spending of at least 2% of its average net profit for the immediately preceding 3 financial years on CSR activities.

Further, the company will be required to constitute a committee (CSR Committee) of the Board of Directors (Board) consisting of 3 or more directors.

The CSR Committee shall formulate and recommend to the Board, a policy which shall indicate the activities to be undertaken (CSR Policy); recommend the amount of expenditure to be incurred on the activities referred and monitor the CSR Policy of the company. The Board shall take into account the recommendations made by the CSR Committee and approve the CSR Policy of the company.

The new CSR regime is based on “Comply or explain” approach to stringently push big corporate giants to take initiative towards their duty to contribute towards their CSR activities. Companies failing to do so would be required to explain why they have not included such information, in the annual report as under Section 92 of the Companies Act, 2013 as part of “comply or explain” approach for large companies.

  • Related Party Transactions

A business transaction with relatives of Directors or KMP is considered as Related Party Transactions. It is very important to scrutinize transactions with related parties. Related party transactions are not banned in India and it can be entered by a company. There are certain conditions which need to be fulfilled before entering into a related party transaction as per Section 188 of Companies Act, 2013.

  • Class Action Suits

Class action suits allow a group of aggrieved people with the same grievance to file a collective suit against the company. It allows the minority shareholders to file a suit against the company and its management in the National Company Law tribunal (NCLT). Section 245 of Companies Act, 2013 allows suit to be initiated against its directors, management, auditors and any other person who is responsible for fraudulent, unlawful or wrongful act.

Why do Companies need good Corporate Governance?

Every company should have an ethical corporate governance code as it reduces the risk of fraudulent activities by the top management. Good corporate governance structure enables accountability in the organization and also makes sure that directors, management and employees do not indulge in fraudulent and unlawful activities. The company is responsible for the welfare of the shareholders, management and employees and it is very important to protect their rights. A transparent and ethical corporate governance structure will enhance investor’s trust. It will also have an internal control framework which helps in mitigating future risks. Poor corporate governance can always lead to conflict among the shareholders which can always tarnish a company’s image. Tarnished image of the company may also lead to dissatisfied and frustrated employees. 

Companies Act, 2013 gives a lot of importance to ethical corporate structure by penalizing the officer in default if they do not comply with the same. A director or a KMP can be held liable for unlawful or illegal activities committed by him. It is the duty of the board of directors to have a good corporate governance practice in its company. Independent directors also play a vital role in having effective corporate governance by helping the company formulate policies and representing the shareholders’ grievances.

Conclusion

The Companies Act, 2013 empowers independent directors with proper checks and balances so that such extensive powers are not exercised in an unauthorized manner but in a rational and accountable way. The changes are a step forward in the right direction to smoothly run the management and affairs of the companies in the interest of stakeholders. These are all welcome changes in the globalised corporate world of today and they will strengthen the core corporate machinery by instilling strong corporate governance norms in a company leading to economic efficiency and higher ethical standards which will always inspire the company’s management to work in the direction to uphold its goals of maximization of wealth of stakeholders backed with good corporate repute.

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