This article has been written by Garima Gunjan, from ILS Law College, Pune. The article talks about the emergence of Corporate Governance in the US and the UK and its three models. Also, tries to highlight how the current picture of Corporate Governance took shape in India and the related legislations.
Table of Contents
Corporate governance is a set of business factors that consists of processes, rules, and practises through which the authorities run the system. It is an important part of the daily administration of the companies through which companies function successfully. Like any other policy, corporate governance defines the professional relationship between those who run the company collectively, such as stakeholders, directors’ board, management, and shareholders. Companies review their corporate governance policies timely and enforce them accordingly. This system is implemented to regulate the responsibilities and rights of the company employees. It helps to ensure that an organization functions transparently, which is in the interest of company employees. The corporate bigwigs implement corporate governance policies so that the employees come together to work and build professional stability, integrity which results in growth and financial success for the companies.
In this era of technology and liberalization, where there are business upgrades at a large scale daily, enterprises need to implement a corporate governance model. It also strengthens employees’ bonds and integrity, which improves professionalism and makes the organization inclusive. Suppose a company decides to implement corporate governance in its system. In that case, employees can successfully deliver results for long terms, the price of its share remains healthy, mismanagement and corruption issues get minimized, its investors gain strong confidence seeing employees’ performance rise, and its brand value gets better in the market.
Corporate governance: The picture painted till now
The corporate world has seen numerous companies getting dissolved in the last few decades owing to scandalous reasons. It happened mainly as top authorities didn’t follow any business ethics, chose to show higher current profits, didn’t allow auditors to curb improper policies, allowed greed to prosper, sacrificed long-term profits, among others. As such incidents kept increasing, federal agencies of many countries (especially in the US) that acted as market regulators started introducing rules to keep such incidents under control.
In the United States
‘Corporate Governance’ is a term that started trending in the United States (U.S.) for the first time in the early 70s. The authorities felt its need when many big enterprises of that era started going bankrupt and had to shut down. Those who managed these companies were criticized as they managed their respective company affairs passively.
The issue especially caught attention when, in 1974, when in the U.S., the Securities and Exchange Commission (S.E.C.) started interrogating three directors of a company called Penn Central with a diversified portfolio for misconduct accusations. The S.E.C. found out that senior officials were aware of bribes being paid and corporate records were being falsified. The S.E.C. reported a similar scenario with several other bigwigs that had closed down abruptly. The agency solved several such cases by doing board-level changes, creating audit committees, and appointing outside directors.
In 1976, the S.E.C. amended the listing requirements of the New York Stock Exchange by mentioning that every company is required to maintain an audit committee consisting of qualified independent directors. These key reforms were labelled as S.E.C. ‘s control over corporate governance and management. This was the beginning of corporate governance, which started for the first time in the U.S. and underwent several changes in the last few decades.
In 2002, the U.S.A. came up with the Sarbanes-Oxley Act. In the past, the country had witnessed scandals such as WorldCom and Enron, where external auditors and directors shared a close relationship, due to which they ignored corporate malpractices. And these companies collapsed. The 2002 Act established New York Stock Exchange (NYSE) listing requirements and reforms in the corporate management sector. It talked about C.F.O. (Chief Financial Officer) and C.E.O. (Chief Executive Officer) accurate responsibilities, preparedness of annual reports, made external auditors more independent and increased their powers, the appointment of financial experts in audit committees, and establishment of a regulatory committee for auditors.
In the United Kingdom
The United Kingdom (UK) saw the emergence of corporate governance in the 1990s. The first such reform was the Financial Reporting Council (that regulates UK Accounting Standards) along with the London Stock Exchange established a committee regarding the financial aspects of corporate governance. Around the same time, many UK companies had shut down owing to a lack of accountability in the management by top executives. Also, a decline in competitiveness owing to recession added to its woes.
In 1992, the Cadbury Committee established the code of conduct regarding the London Stock Exchange’s rule for a listing of the companies which all companies in the UK had to comply with. This committee became popular across the globe. Many countries adopted it as a model code for developing corporate governance roles at their places. Our own India’s Kumar Mangalam Birla Committee was based on the findings of this Cadbury Committee.
In 1995, the Greenbury Committee investigated the remuneration packages of directors and disclosed them in their annual reports. The Combined Code of 1998 consists of recommendations for investors and companies by advising compliance, review of company operations annually, and keeping shareholders informed. In 2003, Smith Report emphasized audit committees’ importance.
In 1999, the Organization of Economic Cooperation and Development (OECD) came up with its principles on corporate governance, which was prepared in consultation with World Bank, member countries, and other private sector organizations. It talked about the protection of the shareholder’s rights, timely disclosures to be done to promote transparency, and the roles of the board of directors.
Again in 1999, Basel Committee guidelines were launched that talked about establishing corporate governance in banking institutions across the globe. It talked about internal checks, the role of internal and external auditors, compensation for directors, and the compliance role of senior management.
Corporate governance models
Corporate governance enforces ways into finance and structure institutions so that they can make the right decisions. Since its emergence in the US in the early 1970s, three prominent models have been established that other countries follow. These are:
1. Anglo-American Model (AAM)
Modelled on the free economy theory, the core value of AAM lies in the market forces’ free inter-play, which in turn decides capital prices and who gets to run companies. Entities based on this model operate to maximize their shareholders’ wealth, who, in turn, decide who is eligible to run such a company. The rate of return earned by the investors decides the efficiency of the Board of Directors (BoD). AAM is based on the triangular relationships between managers, shareholders, and BoD.
In this model, company investors provide the bulk capital. As long as their interests are being served, the shareholders remain uninvolved, due to which there is no interference in directors’ elections. As executive directors are allowed to appoint their own nominees as executive directors, they in turn have failed to keep a check over the conduct of those appointed executive directors. Due to this, several companies have seen governance-related problems.
2. Japanese Model (JM)
It follows the Keiretsu system where related and associated companies have inter- locked directorates and shareholdings. Companies based in Japan, such as Toyota, Mitsubishi, Sumitomo, etc., are based on this system. A group can have diversified portfolios, some operating in the same industries and others in different ones. Banks are responsible for providing capital to such companies via equity and debts. Under the JM, many times, even the banks become part of the group that is responsible for gathering funds.
The banks that provide funds to the companies have a prominent role in appointing BoDs of such companies, and it affects decision- making process. The focus is to appoint experienced professionals as companies’ non-executive directors to maintain transparency.
3. German Model (GM)
It is quite similar to the JM, where both public and private sector banks are involved in the management of German companies. Such companies have nominees from such banks who are involved in the corporate governance policies and take care of investors’ and shareholders’ interests.
The German BoD consists of two tiers of the system. The upper tier consists of non-executive supervisory boards that are represented by company investors. The lower tier has management boards that consist of executive directors. No member is allowed to serve both tiers. The upper-tier summons the lower one for meetings. Companies are allowed to have higher debt to equity levels.
The traits of corporate governance and their evolution over the time frame
Indian corporate entities followed British era rules for the management of companies. It focused on managing organization models as business institutions entered into a contract with other entities to manage the latter. Due to the absence of regulations, there was a misuse of financial resources.
In the early 80s and 90s, as world institutions looked forward to establishing branches in India, the need for good corporate administration arose. In 1996, the Chamber of Indian Industries (CII) proposed a corporate administration code where it talked about how the corporate governance framework would take care of practises and methods required while running the company management. With an aim to develop code for companies, investors’ concerns, transparency in businesses, disclosure of information by entities, the code tried to introduce clarity in the Indian corporate sector.
The Kumar Mangalam Birla Committee on corporate governance suggested that listed companies should disclose their annual reports separately, provide full information to shareholders, and secure the rights of investors.
Clause 49 of the SEBI Act, which came into force in 2000, talks about the functions and constitution of audit committee boards. This clause was amended again in 2004 based on the Murthy Report recommendation where points related to shareholder disclosure, corporate disclosure, audit board, and Indian companies’ disclosure standards. Owing to lack of preparedness, this 2004 change was finally implemented in 2006.
India has seen a rise in corporate frauds and mismanagement in the business field in the last few years. In early 2009, the Indian corporate was left shocked when the Satyam scam was out after evidence revealed its Board had failed to prevent large-scale financial fraud. Soon, the National Association of Software and Services Companies (NASSCOM) and CII came with their own set of corporate governance reforms, where their main focus was company ethics.
There are several regulations that provide frameworks for corporate governance in India. These frameworks are based on international rules for the same. Few of such regulators are Standard Listing Agreement of Stock Exchanges, The Companies Acts (CA) 2013, SEBI (Securities and Exchange Board of India) Guidelines, Accounting Standards that ICAI (Institute of Company Secretaries of India), and Secretarial Standards that ICSI (Institute of Company Secretaries of India) issues.
The provisions of the Companies Act, 2013 provide the corporate governance framework for both listed and unlisted companies. It talks about the composition of the Board of Directors, women directors, resident directors, independent directors, the audit committee of listed and public companies, internal audits, nomination, and remuneration committee of different types of committees, and corporate social responsibility policies.
The SEBI Code of corporate governance talks about the composition of the board of directors, audit committee (its constitution and tasks), remuneration of directors, the role of shareholders and administration, compliance, corporate governance report.
Future of corporate governance
As more companies are adopting corporate governance models, they are witnessing diversity in every section. Instead of insiders, private entities are allowing outsider professionals with ample experience in their BoD team. Board agendas are now being decided to keep in mind the needs of stakeholders. Interaction between different levels of management now needs governance of high quality.
Network governance will see a rise where there shall be the distribution of power within different degrees, all participants shall have equitable ownership, and each governing authority shall hold power.
Corporate governance is a policy under which companies function in an ethical and transparent manner. This code was established after several entities went down due to unethical practices by top company authorities, and shareholders lost all their money. With several legal regulators placing their corporate governance policies, they keep a tab on functions of BoDs, company auditors, shareholders, and investors and protect their rights. Corporate Governance has played a key role in running companies transparently.
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