Munnalal started a business from scratch, and ended up as substantial owner of a midsized engineering company. The position of technical director in the company fell vacant when its incumbent resigned to take up another assignment. To the surprise of the board, Munnalal proposed that his young son Kishorilal should be madethetechnical director.Onedirectoropenlyexpressed hisopposition to the proposal and doubted Kishorilal’s credentials. Munnalal replied that his son has studied engineering in Remote Westbrook Technical University. In reply to the member’s question, he added that Remote Westbrook Technical University is an accredited University in New Mexico. Kishorilal, he added also took training in some workshops near Detroit. When there was further opposition, he pleaded that his health was poor and that he would like someone from his family to take reins if he were to become too ill. Kishorilal, he added, would be elected a member on the strength of his shareholding.
Assume that you have been the Secretary of the company for many years and have the ears of Munnalal. What would be your advice to Munnalal?
1. You would advise Munnalal that such opposition from Independent Directors is routine in corporate life. Munnalal should not change his position.
2. Your advice would be that Kishorilal should start at the shop floor and then gradually take up higher responsibility.
3. Company should appoint an elderly technocrat with management experience who is nearing retirement and he should be appointed with specific mission to groom Kishorilal.
4. You should stay away because in family matters people do not pay heed to reason.
1. As a Secretary you are required to act in interest of the company. Keeping Munnalal happy may be important for your career advancement, but obviously ignoring the opinion of Independent Director as routine is not a sensible approach. Independent Directors are required precisely for such purpose of balancing interest of the promoter and the interest of other shareholders who are not controlling the affairs of the company. Secretary needs to pay heed to valuable opinion of Independent Directors(s). Clearly, Kishorilal does not have the requisite experience and even education to start from that level of management. That precisely is the issue here.
2. Munnalal would want to see tangible result in a time frame because he may not be keeping good health and is anxious to have a successor from family. This option is somewhat vague as Kishorilal may take long time to move up the ladder. This option does not meet with the demand of the situation.
3. This is the right option. When the company brings in an executive with sound experience and maturity, its current operations will not suffer. Since the incumbent is near retirement he would not try to extend his career horizon but instead sincerely groom Kishorilal. In about two years, it should be possible to groom Kishorilal. After that Kishorilal may take over substantial responsibility. If the incumbent still wants to continue for some more time he may be given some advisory position wherefrom also he can support Kishorilal. This is the pragmatic course of action.
4. No doubt Munnalal is personally concerned about this issue. However, the matter affects the whole company. Since Munnalal has controlling interest in the company and he is not keeping good health, the succession anxiety is understandable. In that situation good advice surely has value. If the Secretary shies away from tendering that advice, he would be failing in his duty. He isnostrangereithertothecompany ortoMunnalal. Hecannotaffordtoremaina mutespectator.
4. Committees of the Board of Directors
Every listed company and some other specified companies have to constitute an audit committee. Audit committee shall have not less than three independent directors; at least two of them should be able to understand financial statements like balance sheets, profit and loss accounts, cash flow
statements and statements of changes in equity. The chairperson should have this ability. The terms of referenceor jurisdiction of an auditcommitteeshallincludeall mattersrelating to finance,accounts, commercial transactions, investments and audit.
The audit committee shall have power to investigate into all these matters. The auditors and key managerial personnel have a right to be heard in the meetings of audit committee. Where Board does not accept any recommendation of the audit committee, it has to be disclosed.
The Act provides a vigilance mechanism so that directors and employees can report their genuine concerns or apprehensions about things happening in the company. Any person who uses such mechanism shall have direct access to chairperson of the audit committee. This is a kind of whistleblower provision.
5. Nomination and Remuneration Committee, Stakeholders Relationship Committee
The Act has made provision for a Nomination and Remuneration Committee and a Stakeholders Relationship Committee. The Nomination and Remuneration Committee will identify persons who are qualified to become directors and who may be appointed in senior management. The Board of Directors of a company which consists of more than one thousand shareholders, debenture- holders, deposit-holders and any other security holders at any time during a financial year will have to constitute a Stakeholders Relationship Committee.
Related party transactions are those in which board directors or their immediate family members have a personal financial interest. They place them in conflict of interest situations. Their gain may depend on company’s loss. It is a cardinal principle that they should keep a safe distance from such transactions. Or they have to deal with them ‘at arm’s length’.
The Companies Act includes safeguards in this matter. No company can enter into any contract or arrangement with a related party without consent of board of directors given by a resolution. If the transaction exceeds certain limit, it needs the prior approval of the company in general meeting by a special resolution. Any member who is interested in the transaction can vote on such special resolution. However, no approval is needed if the transaction is on an arm’s length price i.e. at full market price. The Board has to disclose every related partytransaction in its report to shareholders. The company has to maintain a register showing the contracts and arrangements in which directors are interested.
Every listed company and or specified company has to attach to its Board’s report to shareholders a secretarial audit report given by a company secretary in practice. The task of a company secretary who heads its secretariat is to ensurethat the company dulycomplieswith all thelegal requirements as specified in the Companies Act and other relevant laws. The secretarial auditor will audit the working of the company’s law division whose task it is to ensure that the company conforms to all the applicable rules and regulations. Secretarial auditor will report on (a) whether the company has complied with the Companies Act and other laws applicable to it and (b) whether the company’s law division or secretariat is maintaining the proper professional standards.
The Companies Act has introduced the concept of class action for the first time in India. Class action is different from legal action which individual litigants take. An individual litigant or a group fights a case on its own behalf. For example, suppose that twenty farmers suffer losses when industrial effluents flow into their fields. One of the farmers files a case in a court and gets compensation. This is an individual legal action. The judgement will not apply to other farmers, though they belong to the class or group who suffered loss. However, there is a provision in countries such as USA for filing class action suits. In such suits, the judgement will apply to all similarly placed persons even if they do not join the suit.
The Companies Act has introduced a similar provision. Where members, depositors or any class of them are of the opinion that affairs of company are being conducted in a manner prejudicial to the interest of company, its members or depositors, they may file an application before tribunal. The class action can also cover the auditors.
9. Corporate Social Responsibility (CSR)
(i) If a company (a) has a net worth of rupees five hundred crore or more, or (b) turnover of rupees one thousand crore or more, or (c) a net profit of rupees five crore or more in a financial year, then it has to constitute a Corporate Social Responsibility Committee of the Board. The committee should have three or more directors, with at least one independent director. The Board’s report to share holders should disclose the composition of the Corporate Social Responsibility Committee.
(ii) The Corporate Social Responsibility Committee has to perform the following functions: (a) Formulate and recommend to the Board, a Corporate Social Responsibility Policy for taking up the activities specified in the Companies Act. (b) Recommend the amount of expenditure to be incurred on the CSR and (c) monitor the Corporate Social Responsibility Policy of the company
(iii) The company’s board has to approve, after considering the CSR committee’s recommendations, the Corporate Social Responsibility Policy. The policy has to be included in its report to shareholders and also has to be placed on the company’s website. The board has to ensure the implementation of the activities included in its CSR policy.
(iv) A company to which CSR applies has to spend on it every financial year, at least two per cent of the average net profits made during the three immediately preceding financial years. The company shall give preference in its CSR policy to the local area where it operates. If the company is unable to spend the CSR money, it should explain the reasons in its report to share holders.
(v) CSR can cover programmes for:
(a) eradicating extreme hunger and poverty;
(b) promotion of education;
(c) promoting gender equality and empowering women;
(d) reducing child mortality and improving maternal health;
(e) combating human immunodeficiency virus, acquired immune deficiency syndrome, malaria and other diseases;
(f) ensuring environmental sustainability;
(g) employment enhancing vocational skills;
(h) social business projects;
(i) contribution to PM’s National Relief Fund or fund set up by the Central Government or the State Governments for socio-economic development and relief and funds for helping vulnerable groups.
To sum up, the new Companies Act includes various aspects of good corporate governance such as independent directors on boards; enhanced disclosure norms; enhanced accountability of management; stricter enforcement; audit accountability; protection for minority shareholders; investor protection and activism; and CSR.
UNGC: A Modern Cornerstone of Corporate Governance
Recognizing that solutions to the most fundamental challenges facing society require extraordinary collaboration, the UN entered the corporate sustainability realm in 2000 with the Secretary-General’s launch of the United Nations Global Compact (UNGC).
The UNGC is a United Nation’s initiative to encourage businesses worldwide to adopt sustainable and socially responsible policies, and to report on their implementation. The UN Global Compact is a principle-based framework for businesses, covering ten principles in the areas of human rights, labour, the environment and anti-corruption. Under the Global Compact, companies are encouraged to work along with UN agencies, labour groups and civil society.
The UNGC is the world’s largest corporate citizenship initiative with 10000 corporate participants and other stakeholders over 130 countries with two objectives: “Mainstream the ten principles in business activities around the world” and “Catalyse actions in support of broader UN goals, such as the Millennium Development Goals (MDGs).”
The precursor to the launch of UNGC was in an announcement of the UN Secretary-General Kofi Annan in an address to the World Economic Forum on January 31, 1999, and UNGC was officially launched at UN Headquarters in New York on July 26, 2000.
The Global Compact Office is supported by seven UN agencies: the United Nations Framework Convention on Climate Change; the United Nations High Commissioner for Human Rights; the United Nations Environment Programme; the International Labour Organization; the United Nations Development Programme; the UnitedNations Industrial Development Organization;and the United Nations Office on Drugs and Crime.
The UN Global Compact is a call to companies everywhere to:
1. Voluntarily align their operations and strategies with ten universally accepted principles in theareas of humanrights,labour, environment andanti-corruption and
2. Take actions in support of UN goals, including the Millennium Development Goals.
By doing so, business can help ensure that markets advance in ways that benefit economies and societies everywhere. Endorsed by chief executives, the UN Global Compact is a leadership platform for the development, implementation, and disclosure of responsible corporate policies andpractices.
The initiative brings companies together with key stakeholder groups including: Government, civil society, labour, investors, educators and the United Nations.The Global Compact asks companies to embrace, support and enact, within their sphere of influence, a set of core values in the areas of human rights, labour standards, the environment and anti-corruption. The Ten Principles enjoy universal consensus and are derived from the Universal Declaration of Human Rights, the International Labour Organization’s Declaration on Fundamental Principles and Rights at Work, the Rio Declaration on Environment and Development, and the United Nations Convention against Corruption.
Businesses should
Principle 1: support and respect the protection of internationally proclaimed human rights; and
Principle 2: make sure that they are not complicit in human rights abuses.
Businesses should
Principle 3: uphold the freedom of association and the effective recognition of the right to collective bargaining;
Principle 4: eliminate all forms of forced and compulsory labour;
Principle 5: ensure effective abolition of child labour; and
Principle 6: eliminate discrimination in respect of employment and occupation.
Businesses should
Principle 7: support a precautionary approach to environmental challenges;
Principle 8: undertake initiatives to promote greater environmental responsibility; and
Principle 9: encourage the development and diffusion of environmentally friendly technologies.
Businesses should
Principle 10: work against corruption in all its forms, including extortion and bribery.