This article is written by Chandana Pradeep, from the School of Law, University of Petroleum and Energy Studies, Dehradun. This article analyses the concept of corporate governance as well as what contributes to the ineffectiveness of corporate governance.

Introduction

Corporate Governance refers to the way a corporation is governed. It is the technique by which companies are directed and managed. It means carrying the business as per the stakeholders’ desires. It is actually conducted by the board of Directors and the concerned committees for the company’s stakeholder’s benefit. It is all about balancing individual and societal goals, as well as, economic and social goals.

India has been open since 1991, for private liberalisation and ever since that companies have been emerging, there has been a downfall of many countries too. The way to handle these downfalls is to ensure that there is good corporate governance that exists in the companies so as to avoid frauds etc.

Corporate governance is very broad in nature and is a method in which companies are being managed and directed hence, making their importance even more.

Importance of Corporate Governance

Corporate governance is needed in any company or organization as it is a method of showing how accountable the company is, seeing from the many examples of how companies failed that there is a dire need for corporate governance. Corporate governance is needed for the following reasons.

1. Change in the structure of ownership

Mutual funds or large financial institutions hold a large part of ownership in companies, and they make sure that corporate governance is needed in these companies for efficient functioning. Methods that corporate governance is ensured by the companies are through consumer-friendly policies, transparent methods, etc.

2. Social Responsibility

There has been an increase in the need for social responsibility and there has been a lot of importance to the same. To ensure the rights of the employees, shareholders, or any of the building blocks of the company by the board of directors, corporate governance is an essential feature.

3. Scams

Over the years, there have been a lot of scams that have been taking place, and corporate governance is needed to ensure that scams or financial irregularities do not take place.

4. Global Trade

Globalization has been literally taking over the world and for that entering foreign markets and trade with foreign traders are necessary and without corporate governance, it would not be possible.

5. Made mandatory by SEBI

The Security Exchange Board of India has made corporate governance mandatory in nature for certain companies so that stakeholders, as well as shareholders, can have their interests protected.

Benefits of Corporate Governance

Corporate governance has a different benefit to different people and sectors of the economy such as:

Shareholders

• Corporate governance can help the management of the company to fulfill objectives that are in the interest of the shareholders as well as the company.
• Corporate governance ensures better security on their investment.
• Corporate governance ensures that before any major change the shareholders are informed.

Benefits for National Economy

• A study shows that more than 84% of the global institutional investors are willing to pay a premium for the shares of a well-governed company over one considered poorly governed but with a comparable financial record.
• Companies having good corporate governance increases the value of companies which affects the national economy in the long run.

Acquisition and mergers

• There are a large number of acquisitions and mergers happening, and it is very important that the rights of all the parties involved are protected and corporate governance ensures this.

How to measure the effectiveness of corporate governance

Good corporate governance is needed in today’s world. The essence of good corporate governance is ensuring trustworthy relations between the corporation and its stakeholders. Therefore, good governance involves a lot more than compliance. Good corporate governance is a culture and a climate of Consistency, Responsibility, Accountability, Fairness, Transparency, and Effectiveness that is Deployed throughout the organization (the ‘CRAFTED’ principles of governance).

The Board of the company is the most important factor in making the company have good corporate governance. The decisions that they take have a huge impact on the future of the company, examples include decisions of being too risk-prone, on matters related to fraud, etc all affect the corporate governance of a company.

The quality of the decisions that are made by the Board of the company, affects the company as well as the economy of the country. Therefore, it is very necessary to keep on improving the methods of how corporate governance can be measured.

There are so many shortcomings in the present method that is used to evaluate corporate governance such as only basic demographic things are looked into now, not more important things such as the level of experience that members of the Board have, for evaluation criteria such as customer satisfaction or employee satisfaction has to also be taken into account not just the quality of the decision, because as much as the quality of the decision matters, the satisfaction of the people working in the company also matter on an equal footing.

Instead of focusing on the business outcomes, the company should focus on how to obtain these results.

Ineffectiveness of corporate governance

There are many reasons why corporate governance has been failing and these are because corporate governance is still not being taken as a serious need in the corporate industry. Some of the reasons why corporate governance is ineffective are:

The Board of Directors are not that effective

The board of directors and the decisions that they take affect the company as well as the national economy. The Board should not contain inefficient individuals who do not have sufficient expertise in the area, as the decision they take and the quality of the decisions that they take affect how good or bad the corporate governance of the company is, the goal for every company is to have rights protected for those people who are involved in the company.

Complex Process

Complex processes are needed so as to ensure that all the processes that take place in the company are cannot be misused, but on the other side, if there are complications even in the most intricate processes, it will be difficult to solve, and if one process has faults in it, within no time all the other processes that take place in the company also start to have faults.

Communication is poor

Poor communication is a factor for the ineffectiveness of corporate governance, as while the decisions are being made by the Board of the company, there is no communication to all the employees of the company, effective communication is a must for corporate governance to be effective.

“The most frequent challenge corporations face is finding out about things too late—whether it’s the data breach, product quality failures, or ethical issues,” says Simon Barker.

Not foreseeing Risks

Lot of people in companies are completely blind to the possibility of risks and think that if they ignore the risks that arise it will eventually go away which is not true, as a risk that is not taken care of at the right time, will only worsen with time.

Improper culture followed in the company

This is a reason why corporate governance is not proper. The culture that is followed in the company has a lot of influence upon the decisions that are taken in the company, the only focus for most countries are for profits only, but that should not be the case, corporate governance is said to be good when the rights and interests are protected of the parties affected.

Incapable of handling new technologies

When the Board handling the company cannot adapt to the developing technology, the corporate governance will not be efficient. Corporate governance requires people to be adaptable to new technology as this will benefit the company as well as the people in the company.

Capital of company is insufficient

Companies having insufficient capital cannot have a proper corporate governance as it will be very difficult to maintain the working of the company.

Economically unstable

Instability in the economy is also a reason for no proper functioning of corporate governance. This is a factor that every company is prone to as the economic stability is not under anybody’s control.

Failures of Corporate Governance

Enron Scandal

This scandal took place in 2001 in October, it is viewed as one of the largest scandals in America at that time. Enron Corporation had everything in place for good corporate governance to take effect, but they never addressed the same. 

The reason why the company faced bankruptcy occurred due to an audit failure. There was a violation of a code that took place, but the Board of directors paid no attention to the same, where the Chief Financial Officer of the company was allowed to be in the Special-purpose Entities, and the auditors did not even check the same. The prices of the corporation fell in the market and the company filed for bankruptcy. This event caused a lot of change in the American laws were laws were introduced which would make financial reporting laws much more stringent and for that The Sarbanes-Oxley Act came into effect which made it mandatory for all companies to follow.

Case of Satyam

Satyam companies began facing issues starting from the year 2008, the chairman of the company announced a new move, that he was bidding on a huge amount for two companies and claimed that this was for the benefit of the investors, and hence the board of directors which consisted mostly of the chairman’s family promoted the idea.

The new decision was reversed within a day, as the market prices started dropping and this was a result of the poor corporate governance that was being followed. A lot of independent directors also started to resign due to this problem, and there was a further decrease in the market price of the company.

Finally the chairman, B.Ramalinga Raju confessed that he had committed a fraud and that it was kept hidden from all the employees, auditors among others for a long time. When the government came to know of this, new laws were developed to handle the fraud that took place in the country. The Companies Act, 2013 came into effect which addressed all these issues.

Cafe Coffee Day Case

The owner of Cafe Coffee Day v. Siddhartha  was one of the primary establishments in India. There were a lot of talks about coca-cola companies investing in cafe coffee day. But in 2019, to all of our surprise, it was revealed that they had sold off their assets for rupees 2700 Crore to another company and that cafe coffee day was facing a loss.

Conclusion

Corporate governance is a big aspect of how companies work, and a lack of good corporate governance leads to the downfall of companies that even have the biggest turnovers. There are a lot of regulatory bodies and laws that are being made so as to tackle this, all these laws are made in a place with the main motive of protecting the rights and interests of the involved parties.

To ensure that there is no ineffectiveness of corporate governance, then, the investors should be made confident in the companies, before investing so as to ensure that their investment would be profitable to them and not the opposite. For effective corporate governance, the companies are to follow a process that is transparent and there is no hidden agenda and the investors are not affected by it adversely.

References

1. https://www.sciencedirect.com/science/article/abs/pii/S037842660800215X
2. https://www.financialdirector.co.uk/2019/03/29/10-reasons-for-corporate-failure/
3. https://studycafe.in/2018/12/corporate-governance.html
4. https://thestudentlawyer.com/2020/03/21/ineffectiveness-of-corporate-governance-the-convenient-shortcomings-of-modern-regulation-of-business-organisations/#:~:text=The%20passivity%20of%20shareholders%20is%20the%20central%20issue%20of%20corporate%20governance%20ineffectiveness.&text=Dispersed%20ownership%20means%20that%20no,greater%20involvement%20in%20its%20management.
5. https://www.managementstudyguide.com/corporate-governance.htm
6. https://knowledge.insead.edu/leadership-organisations/measuring-the-effectiveness-of-corporate-governance-1149
7. https://blog.v-comply.com/corporategovernancefailure/
8. https://www.acc.com/resource-library/top-ten-issues-corporate-governance-practices-india
9. https://taxguru.in/company-law/fall-giants-corporate-governance-failures.html
10. https://www.businessmanagementideas.com/company-management/corporate-governance-company-management/corporate-governance/21145

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