Withthe abovebackground, wecanlookat theconcept of corporategovernance.First, wewilldiscuss corporate governance in general terms and will then consider how it is being implemented in India.
Corporate governance refers to the processes, and the related organisational structures, by which organisations are directed, controlled and held to account. It “involves a set of relationships between an organisation’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the organisation are set, and the means of attaining those objectives and monitoring performance are determined”. It can also be viewed as the laws, rules, regulations, systems, principles, and processes which regulate companies.
Corporate governance is also intimately connected with the following:
¤ Bringing the interests of shareholders and investors to the forefront
¤ Linking the company’s governance mechanisms to society’s conception of corporate accountability
¤ Commitment to values, ethical business conduct and strictly observing the distinction between personal and corporate funds
¤ Promoting fairness, transparency and accountability in company policies
¤ Observing principles of corporate social responsibility (CSR).
Corporate governance can help companies financially in the following ways:
¤ Improving corporateperformance
¤ Attracting financial and human resources
¤ Tapping international financial markets
¤ Managing risks
¤ Avoiding corporate failure.
Ideas of corporate governance emerged in late 1980’s and early 1990’s. In this regard, the National Commission on Fraudulent Financial Reporting (Treadway Commission) in the United States, and the Committee on the Financial Aspects of Corporate Governance (Cadbury Committee) in the United Kingdom did pioneering work. OECD Principles of Corporate Governance came out in April 2004.
The ‘Cadbury Committee’ was set up in May 1991 with a view to overcome the huge problems of scams and failures in the corporate sector worldwide in the late 1980s and the early 1990s. Cadbury Committee based its recommendations on three principles: transparency, integrity and accountability. Openness (transparency) of companies in disclosing of information, within the limits set by their competitive position, is “the basis for the confidence which needs to exist between business and all those who have a stake in its success”.
Integrity was defined as meaning “both straightforward dealing and completeness”. The Report statedthat financialreportingshouldbe “honest and...shouldpresent a balancedpictureofthestate of the company’s affairs”. As regards accountability, Cadbury committee held: “Boards of directors are accountable to their shareholders and both have to play their part in making accountability effective”, the former through the quality of information they provide and the latter through a willingness to exercise their responsibilities.
The Committee formulated a Code of Best Practice in four parts for compliance by the boards of all the listed companies.
(i) Board of Directors: The board should meet regularly, retain full and effective control over the company and monitor the executive management. There should be division of responsibilities so that no one individual has unfettered powers of decision. Where the chairman is also the chief executive, there should be a strong and independent member on the board. All directors should have access to the company secretary, who is responsible to the Board for ensuring that proper procedures are followed and that applicable rules and regulations are complied with.
(ii) Non-Executive Directors: The non-executive directors should bring an independent judgement to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct. The majority of non-executive directors should be independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgment, apart from their fees and shareholding. There should be full and clear disclosure of total emoluments of directors paid in any form.
(iii) Financial Reporting and Controls: The board should present a balanced and understandable assessment of the company’s position. The financial reporting should give a true and fairpicture.
(iv) Dealing with the Rights and Responsibilities of Shareholders: The shareholders, as owners of the company, elect the directors to run the business on their behalf and hold them accountable for its progress. They appoint the auditors to provide an external check on the direc- tors’ financial statements. The Committee’s report particularly emphasises that the board should fairly and accurately report company’s progress to shareholders. Institutional investors/shareholders should make greater use of their voting rights and take positive interest in the board’s functioning. Both shareholders and boards of directors should consider how to strengthen the accountability of board of directors to shareholders.
The annual audit is one of the cornerstones of corporate governance. It provides an external and objective check on the way in which the financial statements have been prepared and presented by the directors of the company. The Cadbury Committee recommended that a professional and objective relationship between the board of directors and auditors should be maintained, so as to provide to all a true and fair view of company’s financial statements. Auditors’ role is to design audit in such a mannerthat it provides a reasonable assurance that the financial statements are free of material misstatements. Secondly, every listed company should form an audit committee which gives the auditors direct access to the non-executive members of the board. The Committee further recommended regular rotation of audit partners to prevent unhealthy relationship between auditors and the management. It also recommended disclosure of payments to the auditors for non-audit services to the company.
Corporate governance in developed economies was also seen from the perspective of risk management. Thecollapse of Lehmanbrothers,the hugelosseswhich banks sufferedandinstances of reckless risk trading by mangers in search of profits and bonuses made it necessary for boards to ensure better risk management. The Turnbull committee provided guidance to companies in UK in this matter. In September2011, Financial Reporting Council, UK examined this question further. Its main conclusions on how boards should handle risk are listed below.
¤ The Board should determine the company’s approach to risk covering, risk identification, oversight of risk management, and crisis management.
¤ Boards have to concentrate on those risks capable of undermining the strategy or long-term viability of the company or of damaging its reputation.
¤ Shareholders should be given meaningful reports on risk through an integrated account of the company’s business model, strategy, key risks and mitigation.
¤ Good corporate culture is essential to good risk management.
¤ The board should link up risk management and internal audit functions.
¤ Transparency and clear lines of accountability through the organisation are essential for
effective risk management.
¤ The Board should spell out its appetite or tolerance for key individual risks.
¤ The exact dividing lines between the Audit Committee and the Board and between the Audit and Risk Committees need to be defined.
Evolution of Corporate Governance in India
Policies on corporate governance in India followed a path similar to one taken in the West. The emphasis in Indian policies can be said to be more on protecting small shareholders, preventing frauds and malpractices and promoting corporate social responsibility. The components of corporate governance are embodied in the recently passed Companies Act. Many of the individual elements of corporate governance which figured earlier in separate regulations and voluntary codes have now become part of the Companies Act.
Now, we will consider the various steps which culminated in the passing of the Companies Act. Ministry of Corporate Affairs and SEBI took the lead in advancing corporate governance. The main stages are outlined below.
1. Confederation of Indian Industries (CII) set up a task force in 1995 under the chairmanship of the well-known industrialist Rahul Bajaj. In 1998, the CII released the code “Desirable Corporate Governance”.
2. SEBI set up a Commission under Kumarmanlagam Birla. The commission covered three main points: protection of investor interest, promotion of transparency and creating standards of disclosure of information on international regulatory patterns.
3. In 1999, the Companies Act was amended to introduce provisions for nomination facilities to shareholders, share buybacks and for formation of investor education and protection fund.
4. Naresh Chandra Committee was set up in 2002. It discussed matters such as the statuary auditor-company relationship, rotation of statutory audit firms/partners, procedure for appointment of auditors and determination of audit fees, and true and fair statement of financial affairs of companies.
5. SEBI appointed Narayana Murthy Committee in 2002. Its report: (a) made mandatory recommendations regarding responsibilities of audit committee; (b) suggested ways of improving qualityof financial disclosure;and(c) proposedthat boardsshould assessbusiness risksand report them in the company’s annual reports.
6. SEBI took a major step towards strengthening corporate governance by incorporating various conditions in Clause 49 of the Listing Agreement to the Indian stock exchange. It became
effective from 31 December 2005. It covered items such as Board Independence, Audit Committees, Disclosure and certification of accounts by CEO/CFO.
7. The Ministry of Corporate Affairs issued Voluntary Guidelines on Corporate Governance in December 2009.