UNIT V

Corporate governance in developing and transition economies The third quarter of the 20th Century witnessed innumerable corporate failures, triggered by frauds and scams worldwide. The reasons for such failures went far beyond just corporate misgovernance. Company managements with the connivance of board members and auditors conspired to defraud their stakeholders, both internal and external. The problems of misgovernance were deep-rooted and did not emanate only from the dichotomy between ownership and management. Lack of transparency and disclosures and inequitable treatment of shareholders, window dressing, fudging of accounts and funnelling of corporate funds into private channels were all becoming too common. These developments created a popular stir and the collective conscience of the world Problems Faced by Developing and Transition Economies Many developing, emerging and transition economies lack or are just now in the process of developing the most basic market institutions. Hence, corporate governance in these societies involves a much wider range of issues. Economic growth in these countries has turned out to be lower than expected. Privatisation does not seem to have brought about the anticipated improvements in corporate efficiency. The state and para-state institutions such as privatisation funds remain the largest shareholders of companies. Internal owners dominate in many companies, while the external owners do not have enough voting power to control the companies and thereby to ensure for themselves appropriate returns. Defining Corporate Governance In its narrowest sense, corporate governance can be viewed as a set of arrangements internal to the corporation that define the relationship between the owners and managers of the corporation. Corporate governance &is the relationship among various participants in determining the direction and performance of corporations. The primary participants are (1) the shareholders, (2) the management and (3) the board of directors.

In its narrowest sense, corporate governance can be viewed as a set of arrangements internal to the corporation that define the relationship between the owners and managers of the corporation. Corporate governance &is the relationship among various participants in determining the direction and performance of corporations. The primary participants are the shareholders, the management and the board of directors. Corporate Governance Models The countries with developed economies apply two different systems of corporate governance the group-based system and the market-based one or as they are often referred to as the insider and outsider systems. Insider System In concentrated ownership structures, ownership and/or control is concentrated in the hands of a small number of individuals, families, managers, directors, holding companies, banks and/or other non-financial corporations. Most countries, especially those governed by civil law, have concentrated ownership structures. Insiders exercise control over companies in several ways: own the majority of the company shares and voting rights; own some shares, but enjoy the majority of the voting rights. Companies that are controlled by insiders enjoy certain advantages. Insiders have the power and the incentives to monitor management closely thereby minimising the potential for mismanagement and fraud. Moreover, because of their significant ownership and control rights, insiders tend to keep their investment in a firm for longer periods. As a result, insiders tend to support decisions that will enhance a firms long-term performance as opposed to decisions designed to maximise short-term gains. The Institutional Framework for Effective Corporate Governance As we have seen earlier, developing countries and transition economies lack the required framework to put in place best corporate governance practices. The following are the desiderata for such a framework:

1. Property rights: It is essential that property rights, laws and regulations establish simple and straightforward standards to specify clearly who owns what and how these rights can be combined or exchanged (for example, through commercial transactions), and standards for recording required information (such as the legal owners of property, has the property been used as loan collateral, etc.) in a timely and cost-efficient manner into an integrated, publicly accessible data base. Investors will be extremely reluctant to provide capital to firms without legally stipulated and enforced property rights. Corporate Governance Challenges in Developing, Emerging and Transition Economies Establishing any one of institutions enumerated above is a necessary and challenging undertaking without which democratic markets and corporate governance cannot take root. Success requires that the private and public sectors work together to establish the necessary legal and regulatory framework and a climate of trust through ethical behaviour. While the set of institutions described above is designed to be comprehensive, each region is in a different stage of establishing a democratic, market-based framework and a corporate governance system. Hence, each nation has its own particular set of challenges. Current Corporate Governance Settings in Transition Economies In emerging economies, the term corporate governance is new, yet it has caught on rapidly. A set of formal legal frameworks, often modeled after the Anglo-American system, frequently exists. Nearly all firms have shareholders, boards, and professional managers, which are the components of modem corporate governance. However, the similarities in governance between emerging and developed economies are often more in form than in substance. The countries in transition are facing the problem of corporate governance in a specific way. Their corporate sector consists of instant corporations formed as a result of mass privatisation, without the simultaneous development of legal and institutional structures necessary to operate in a competitive market economy. Under the circumstances of diffuse ownership, it enables insiders to strip assets and leave little value for minority shareholders.

The question is whether it is possible to reproduce all at once from the institutions of developed market economies in transition economies. The standard institutional portfolio has evolved gradually in different circumstances. Merely transplanting these institutions is not possible because there are new conditions and many cultural differences. On the other hand, to develop entirely new institutions would be an unpredictable adventure. The transition economies cannot afford the luxury of searching for third system between socialism and capitalism. Instead, they have to find a way to accept the existing institutional portfolio and to make it work in the specific cultural, historical and economic environment.

The Emergence of Corporate Governance Issues in India

The Stock Exchange of London appointed, as discussed earlier, the famous Cadbury Committee which submitted its report in 1992 that included the Code of Best Practices to be practised by listed companies. Sir Cadbury Report was implemented by the London Stock Exchange as part of its Listing Agreement with its member companies. The Cadbury Report is generally considered to be the foundation stone of corporate governance. In India, the real history of corporate governance dates back to the year 1992, following efforts made in many countries of the world to put in place a system suggested by the Cadbury Committee. The Confederation of Indian Industry framed a voluntary code of corporate governance for listed companies in 1998. This was followed by the recommendations of the Kumar Mangalam Birla Committee set up in 1999 by SEBI culminating in the introduction of Clause 49 of the standard Listing Agreement to be complied with all the listed companies in stipulated phases. The Kumar Mangalam Birla Committee divided its recommendations into mandatory and non-mandatory.

Corporate Governance in IndiaA Performance Appraisal

It is over a decade that the concept of corporate governance has become a passion with industry analysts in India. It has long passed the stage of being a fashion statement which was the case in early 1990s, as its ideals having been propagated as the be-all and end-all of all corporate endeavour in the aftermath of economic liberalisation in the country on one hand, and the then newly published Cadbury Report, on the other. All these got irretrievably intermixed to give the concept an aura and a halo. Now, after more than a decade down the line and with a lot of studies and in-depth research having been done by several committees, a reality check and analysis throw up a lot of somewhat unpalatable home truths.

The Future of Corporate Governance in India

Although India has a long way to go to be ranked among the best in the world in corporate governance, the driver is exactly right. A large number of CEOs now realise that their companies need financial and human capital in order to grow to scales necessary to survive international competition. They also understand that such capital will not be available in a non-transparent corporate regime that is bereft of international quality of disclosures and accountability. It is precisely this realisation which is driving the corporate governance movement in India and which, has greater chances of delivering substance rather than ticking mandated governance checklists. It is important to note that there are still some lacunae in different aspects of corporate governance: India still has poor bankruptcy laws and procedures (legal and procedural; barriers to good corporate governance); Indian accounting standards still do not mandate consolidationalthough this is slated to change; Indian stock markets are still inefficiently run, and do have adequate depth or width to give shareholders greater comfort. The Indian bond market is in its infancy. Past experience on governance issues in the country has shown that none of the corporate governance principles can be cast in stone and laid to rest forever. There is an ongoing need for constant review and course corrections that would keep the country in the pink of health in terms of its corporate excellence. By a judicious mix of legislation, regulation, and suasion, this task needs to be constantly addressed. With growing maturity and competitive compulsions, it should be possible to gradually reduce legislative interventions and increase regulatory compliance with, and self-induced adherence to, the best practices in this field. Till then, however, legislation and regulation to ensure at least certain minimum standard is inevitable.