This article is written by Sristi Nimodia.
The term ‘Corporate Governance’ has seen an upsurge in the 21st century. Owing to the increase in the governance activities and constant debates on the powers and duties of the board of directors, the Companies Act has undergone evolution. Not only has it made the directors accountable and more responsible but has also increased the efficiency of the corporation by building a more trustworthy relationship amongst the Board of Directors, investors and the shareholders.
Suppose, A, an investor, invests some money in B, a corporation. While doing so he not only invests but also places his trust over those who are responsible for the management of the corporation. The concept of ‘Corporate Governance’ helps built such trust and increases transparency. In recent times, Corporate Governance is considered to be a voluntary ethical code.
The following article explains the concept of Corporate Governance and its principles. It further talks in details about the board of directors and the changes brought in Companies Act, 2013. The later part of the article focuses on Independent Directors and their role in achieving good corporate governance. Independence in true sense is the most important factor required to achieve the goal behind the whole concept of Corporate Governance.
Table of Contents
‘Corporate Governance’ is the system through which the activities of the corporation are directed and controlled. Corporation is an artificial entity with the Board of Directors acting as the brain of the corporation and is responsible for its governance. The role of appointing the board of directors is done by the shareholders.
The concept of Corporate Governance determines the relationships among the Board of directors and other participants of Corporation and their role in the direction and the performance. It makes sure that the managers don’t default in giving back investors their money. In simple words, it is the way by which the investors get the assurance of getting back the money invested by them.
As defined by the ICSI, ‘Corporate Governance’ altogether a combination of the best management practices and law in true spirit and adherence, which leads to sustainable development by aiding both in wealth management and discharge of the social responsibility. It is considered to be the best way to improve the relationships between the participants of the corporation mainly, the shareholders and the Board of Directors. In order to create a long lasting and a trustworthy relationship between the investors and the company, a set of rules and regulations has been laid out. Moreover, the whole concept of ‘Corporate Governance’ has improved company’s operational performance and has also increased the overall return.
Principle of corporate governance
Corporate Governance gives an assurance to the investors of the creditability and responsibility of the money invested by them in the Corporation. As we know, the Board of director is the brain of the corporation and is responsible for its management, hence they can be regarded as the key runners of the corporation. They are the decision makers and the fate of those involved with the corporation lies on their shoulder. Undoubtedly, such a huge responsibility calls for integrity and ethical behaviour.
The concept of ‘Corporate Governance’ ensures sustainability, transparency and accountability. This adds value to the business and further increases reinvestment, thereby increasing the business activity.
Board of directors
As per Section 2(13) of the Companies Act, 2013, any person who occupies the position of director is said to be a director. Further, Section 2(34) of the said act states that director is appointed by the board of the company. Hence as per Section 2(59), it can be said that a director is an officer of the company. He is a member of the governing body of the company and is responsible for the functioning of the company. The directors are in a fiduciary relationship both with the company and the shareholders, hence they need to act keeping in mind the best interest of both the company and the shareholders. That being said, it can be laid out that the composition of the board plays a major role in the function of the company.
The board of directors consist of both executive (responsible for day-to-day affairs of the company) and non-executive directors (have nothing to do with the day-to-day activities of the company). The executive directors consist of Whole-Time, Part-Time and Managing Directors, whereas the non-executive directors consist of Nominee, Independent and other directors.
The concept of ‘Corporate Governance’ has been laid emphasis on the independence of the board of Directors. The main aim behind the concept of Corporate Governance is to protect the interest of the shareholders and in such a scenario it is very important to have an independent director. Such a director needs to be independent of the day-to-day managerial activities and have a non-pecuniary relationship with the company.
With increased emphasis on Corporate Governance, the role of Independent director came into limelight. The Companies Act, 1956 did not talk about the concept of Independent Directors nor any provision existed in the act which mandated the appointment of such a director. Hence the Companies Act, 2013 introduced entirely new provisions on Independent Directors, including their role, powers and duties, and their responsibility in Corporate Governance.
As per Section 2(47) of the Companies Act, 2013, Independent Director is the one as defined in Section 149(6) of the said Act. According to the referred section, an Independent director is a non-executive director other than a nominee director, who values integrity and possesses the required expertise, in the opinion of the board. Further the said person should not be or be related to the promotor of the company or any of its subsidiary, holding or associate company. Moreover, he or any of his relatives should not have any pecuniary relationship with the company or hold any managerial position in the company.
That being said, it can be drawn that, a director is someone who possess values, skills, knowledge and experience in matters related to the company be it finance, law, or any other.
Need for independent director
Corporate governance has been brought forth with an aim to bring in transparency and create a balance between the needs of both the investors and the board of directors. It helps to ensure the benefit of all the participants of the corporation. Various corporate scams have brought the focus on corporate governance, a need which was not seen earlier. Hence in the light of this, it was felt that the process of selecting the directors should be transparent. Thereby in order to establish strong corporate governance and to ensure that the board is involved in rational decision making, the need for Independent Director arose.
Role of independent directors
When it comes to Corporate Governance, Independent Directors play an important role in its development. They are mainly centred with the checking and controlling of the malpractices that is being practiced. They regulate the decisions made by the Board of Directors. The Independent Directors help to build a trustworthy environment by exercising vigilance and supervisory functions. Further they keep a check on the decisions made, by acting both as an advisor and an invigilator. Independent Directors play a major role in corporate governance by acting as the strategic advisors, performers and even judgement makers. If the Independent Directors execute their role efficiently major corporate issues could be solves.
As a strategic advisor, the independent directors take part in the decision making. They act on behalf of the board and can be held individually liable for their actions. They look for the best interest of the company and hence monitor the decisions that would affect the performance of the company. With an aim protect the interest of the shareholders and other investors, the Independent Directors act a guardian. They even act as a mentor for their full-time colleagues and play an important role in succession planning.
An Independent Director, as already mentioned is a non-executive director and hence are free from the management’s command. They can therefore bring in independent judgements in matters concerning the corporation. They can question the management when required and can take steps towards the protection of interest of the shareholders. They act as a connecting link between the Board of directors and the Shareholders. Further, the Independent directors play a major role in safeguarding the interest of both the majority and minority shareholders. They ensure that the transactions of the company are beneficial to all and take due care in ensuring that no undue advantage is taken by those who are in charge of the company’s management.
Derivative action suits
As the term itself says, derivative actions are those actions which taken by the shareholders against the management of the company. When the Directors or the managers of the company do not act in the best interest of the company, the shareholders have the right to sue them. In cases, where any third party is involved, the share holders can sue them too. Again, in case of class action suits, the shareholders of the company can collectively sue the company or its directors or mangers. The concept of Derivative Suits was identified in Nirad Amilal Mehta v. Genelec Limited and Others. When the shareholders feel that the directors have not acted in good faith or their actions have resulted in the wastage of the company’s resources, the shareholders can question the decisions of the directors through the concept of derivative actions.
Corporate governance and directors
The Board of Directors being the heart and the soul of the corporation are accountable and play a major role in achieving good corporate governance. With the increasing issues in corporation in the late 1980’s, the need for an external director was felt. The need for someone who would participate without any bias was brought forth. If the board of directors is of the right mix, with correct ratio of executive and non-executive directors, with Independent directors being Independent in true sense, then the whole idea of good corporate governance can be achieved.
In todays times, the promotors and the majority shareholders have an upper hand in the appointment of the Independent shareholders. Such a thing compromises with the whole idea of Good Corporate Governance. If such a thing continues the whole idea of having a good mix of executive and non-executive directors will never be achieved. The reason behind having an independent director is to have someone with creditability and the expertise. The Independent Directors play the role of improving the creditability of the Corporation, the standard of governance and the company’s risk management system. The Independent Directors are meant to be unbiased and check the decisions taken by the management. In simple words, the Independent Directors can be regarded as the trustees when it comes to that of Good Corporate Governance. They bring in accountability to the working of the Corporation by controlling and monitoring its activities. Good Corporate Governance is concerned with fairness of the corporation and to see the benefit of the shareholders. And it can be achieved only with integrity and accountability. This in turn builds in long lasting relationships and increases return.
Conclusion and suggestions
Looking at the above discussion, it would be safe to conclude by stating that, the Independent Directors play an important role in safeguarding the interest of the shareholders. They serve an impartial role and aid in judgement making. They play a very important role in achieving Good Corporate Governance. For example, the audit committee comprising of the Independent directors help not only understand the financial health of the company but also take unbiased investment decision. At the end of the day, transparency, integrity, openness, experience, competence, expertise and most importantly independence, are the key to Good Corporate Governance.
The Companies Act,2013 through its various provisions have focussed on the role of Independent Directors, which is a welcome step towards achieving the goal of corporate governance. It is not only the Independent Directors but all the directors whether executive or non-executive, who play a combined role in achieving the goal of Corporate Governance. It is when the board functions efficiently, the gap between the investors and the Company’s Management decreases leading to better returns and long-term relationships.
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