In this blog post, Disha Mohanty, a student pursuing her LL.B (5th year) from National Law University, Odisha and a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the need for corporate governance in an enterprise.
With a myriad of businesses that are operating in today’s economy, the necessity to institute a relevant model of corporate governance is of utmost importance concerning enterprises. While there isn’t a concrete definition which defines the term corporate governance, the closest definition can be said to have been given by Catherwood which states- “Corporate governance means that company manages its business in a manner that is accountable and responsible to the shareholders. In a wider interpretation, corporate governance includes company’s accountability to shareholders and other stakeholders such as employees, suppliers, customers and local community.” In other terms, the idea behind corporate governance is to ensure the carrying out of good practices so as to protect the rights and interest of all the concerned stakeholders at large, without any misuse of the power a company may acquire having attained a profitable status.
Modes of Corporate Governance
One may take into account, two essential modes of corporate governance which have been developed- external mode of corporate governance, which is inclusive of the sanctions issued by various components of the Ministry of Corporate Affairs and the Registrar of Companies, which could be enforced by means of regulations and sanctions, and internal corporate governance, which is developed by a company, i.e., stakeholders such as shareholders, directors and officers, in order to ensure the adherence of the laws and the avoidance of problematic issues such as violations of law, mismanagement in the interest of the requisite shareholders, corporate sabotage, etc., so as to safely secure the shareholder’s interests.
While the level of flexibility concerning listed and unlisted companies, which further concerns private and public companies will consequently differ concerning the degree of responsibility, the need to follow corporate governance is the same for all the parties involved which would otherwise lead to substantial losses, as can be seen in cases such as Satyam. Corporate governance is a necessity that has to be maintained at all levels of company, regardless of factors such as size of the company or the capital it has acquired, non-compliance will have a negative impact which can be hard to recover from, hence protection of the rights of the parties such as the shareholders, the outside parties who choose to enter into business, the employees, and ultimately the public at large, is a must.
With regard to especially private companies, which seek to enforce corporate governance, they often seek to resort to mechanisms such as investment agreements- which can consist of shareholder’s agreements and share purchase agreements, which serve to provide limited protection.
External Instruments of Corporate Governance
In addition to the external corporate governance instruments such as SEBI Regulations (Listed Companies) or through Companies Act, and its subsequent rules, regulations and Government of India Circulars, companies must invest their resource to develop an internal mechanism for following the practices of good corporate governances. The cost of corporate governance must be further taken into account, which is based on the degree of regulation with listed public companies bearing the brunt of being the most heavily regulated, while private companies have acquired the mantle of being the least regulated and permitting maximum flexibility in this regard.
One may note that the Memorandum of Association and the Articles of Association which is usually made in semblance with Table F, undergo considerable change concerning the rights of the investor, and with subsequent funding the structure of corporate governance will also evolve, eventually require the AOA to address the increasing number of rights and liabilities that the parties concerned will have to undertake.
While enterprises with a considerable capital and resources at their disposal can accommodate the requirement of the corporate governance framework, due importance must be given to the implications it may construe for a small and medium enterprises sector which can bring up the problems of credit constraint and to a certain extent incompetence on a managerial level.
Laws pertaining to Corporate Governance
Concerning India, especially as far as public enterprises are concerned one may refer to the Clause 49 of the Listing Agreement with the Stock Exchanges which is deemed to be the standard clause for corporate governance, In addition to the Guidelines on Corporate Governance for Central Public Sector Enterprises (CPSEs) issued by the Department of Public Enterprise (DPE).With regard to Multinational Companies, on the other hand, are governed by the Organization for Economic Cooperation and Development(OECD) Guidelines.
With reference to accounting standards, one may further refer to the accounting standards provided by Institute of Chartered Accountants of India in concurrence with the law stipulated in Section 129 and Section 133 of the Companies Act 2013. Furthermore, one may also refer to the secretarial standards which have been issued by the Institute of Company Secretaries of India such as SS-1 and SS-2 in keeping with Section 118(10) of the Companies Act, which is applicable to all companies except One Person Companies, which essentially raises an important point that with the growing differences with the corporate structuring of the company, the ‘one approach fits all’ stance cannot be adopted in situation like these.
Need for Corporate Governance
The necessity for efficient corporate governance is strengthened by the fact that it maintains the stability of the financial market by maintaining a competitive environment which further spurs on financial growth and increased improvement in the accountability system which results in risk mitigation substantially , and clarity in the decision making process followed by the company, leading to compliance with the legal requirements and hence not being party to litigation which can be financially straining for the company to quite an extent.
Transparency with regard to the corporate governance practices will increase the stakeholder’s faith in the company, and in the long run, will benefit the company itself as increased faith in the functioning of the company will lead to increased access to capital and shall lead to economic stability. A code of conduct will display the company’s commitment to maintaining an ethical stance which is crucial to maintaining a good image in the market. In order to do this it needs to take into account the concerns and suggestions of all the parties concerned and hence the Companies Act 2013 has mandated four committees that must be constituted for a prescribed class of companies, such as the Audit Committee, the Nomination, and Remuneration Committee, the Stakeholders Relationship Committee, and the Corporate Social Responsibility Committee.
Further with regard to the Board of Directors, the responsibility and subsequently, the accountability has increased manifold. In addition to the mandatory requirement of at least one-third of the board comprising of independent directors, and in order to address the sex ratio differences, it is mandatory to have a female director on board.
With regard to case laws on the topic, the Satyam case has garnered a reputation for itself as one of the biggest failures with regard to corporate governance compliance and has been sufficiently elaborated upon, in addition to the cases such as the Reebok India and United Spirits misgovernance case. However, the author would like to analyze the case of N. Narayan v Adjudicating Officer of SEBI.
As per the facts of the case, the appellant was a promoter-cum-director of PSTL, which was listed on BSE and NSE and was involved in a variety of entertainment industry businesses. Investigation by SEBI revealed the glaring irregularities that the company in question had committed with regard to the accounts maintained, and had hence displayed inflated profits and revenues in the statement issued, which fraudulently mislead the public at large to invest in the shares of the company, and hence violating a series of SEBI notifications and subsequently as per procedure on detection of the discrepancies, a due penalty was imposed as per section 15HA of the SEBI Act.
As per investigation, despite the Appellant’s claim of being the HR director and hence only taking the auditor’s statement as the word of law, there were sufficient violations made by the directors, including the appellant, and hence an order was passed restraining the Appellant and other Directors for a period of two years and three years respectively from buying, selling or dealing in securities in any manner whatsoever or accessing the securities market directly or indirectly and from being Director of any listed company.
The discrepancies in the accounting followed by procedural non-compliance, resulting in deviance from the norms of good corporate governance, led to the company being held accountable for violating provisions pertaining to prohibition of manipulative and deceptive practices, insider trading, fraudulent & unfair trade practices, in addition to the actions taken by the directors not being in keeping with the responsibility they have been bestowed with and resulting in market abuse of the securities market and most importantly violating the terms of disclosure and transparency, because of which the Appellant was rightfully from restrained in any involvement with the securities market for the stipulated period and duly penalized.
Corporate governance practices are necessary to ensure the smooth functioning of the market and are aimed to benefit all the stakeholders concerned, especially with regard to transparency, which will increase an investor’s faith. Hence, it is necessary for enterprises, in general, to ensure that they institute good corporate governance and maintain the same, as a failure on the same account will result in the company having to bear the brunt for misgovernance substantially.
 , AIR 2013 SC 3191