Professional Documents
Culture Documents
Corporate governance refers to the accountability of the Board of Directors to all stakeholders
of the corporation i.e. shareholders, employees, suppliers, customers and society in general;
towards giving the corporation a fair, efficient and transparent administration.
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.
Corporate Governance is the interaction between various participants (shareholders, board of
directors, and company’s management) in shaping corporation’s performance and the way it is
proceeding towards. The relationship between the owners and the managers in an organization
must be healthy and there should be no conflict between the two. The owners must see that
individual’s actual performance is according to the standard performance. These dimensions
of corporate governance should not be overlooked.
Corporate Governance deals with the manner the providers of finance guarantee themselves of
getting a fair return on their investment. Corporate Governance clearly distinguishes between
the owners and the managers. The managers are the deciding authority.
Corporate Governance deals with determining ways to take effective strategic decisions. It
gives ultimate authority and complete responsibility to the Board of Directors. In today’s
market- oriented economy, the need for corporate governance arises. Also, efficiency as well
as globalization are significant factors urging corporate governance. Corporate Governance is
essential to develop added value to the stakeholders.
Corporate Governance ensures transparency which ensures strong and balanced economic
development. This also ensures that the interests of all shareholders (majority as well as
minority shareholders) are safeguarded. It ensures that all shareholders fully exercise their
rights and that the organization fully recognizes their rights.
Corporate Governance has a broad scope. It includes both social and institutional aspects.
Corporate Governance encourages a trustworthy, moral, as well as ethical environment.
“The present paper aims at reviewing the various developments in Corporate Governance in
India. The emergence of new technologies in the era of globalisation and liberalisation entirely
changed the nature of business transactions. By the evolution of business life cycles business
transactions became very complex and managing risk became a challenging task for the
organisations. Concerns about corporate governance in India were, however, largely triggered
by Harshad Mehta stock market scam of 1992 followed by incidents of companies allotting
preferential shares to their promoters at deeply discounted prices and the recent scam of
sathyam. Good corporate governance became a key word to handle accounting scandals and to
mitigate growing concern about the quality of financial statements. In short Corporate
Governance is about promoting corporate fairness, transparency and accountability.”
Corporate Governance is essentially all about how corporations are directed, managed,
controlled and held accountable to their shareholders. In India, the question of Corporate
Governance has come up mainly in the wake of economic liberalization and de-regularization
of industry and business. With the rapid pace of globalization many companies have been
forced to tap international financial markets and consequently to face greater competition than
before. Both policymakers and business managers have become increasingly aware of the
importance of improved standards of Corporate Governance. India has one of the best corporate
governance laws but poor implementation together with socialistic policies of the pre-reform
era has affected corporate governance. Concentrated ownership of shares, pyramiding and
tunneling of funds among group companies mark the Indian corporate landscape.
Board Skills: in order to be able to undertake its functions effectively, the board
must possess the necessary blend of qualities, skills, knowledge and experience so
as to make quality contribution. It includes operational or technical expertise,
financial skills, legal skills as well as knowledge of government and regulatory
requirements.
Board Appointments: to ensure that the most competent people are appointed in
the board, the board positions must be filled through the process of extensive
search. A well-defined and open procedure must be in place for reappointments as well as for
appointment of new directors.
Board Meetings: are the forums for board decision making. These meetings enable
directors to discharge their responsibilities. The effectiveness of board meetings is
dependent on carefully planned agendas and providing relevant papers and
materials to directors sufficiently prior to board meetings.
While the CII code was well received by corporate sector and some progressive companies
also adopted it, it was felt that under Indian conditions a statutory rather than a voluntary code
would be more meaningful. Consequently the second major initiative was undertaken by the
Securities and Exchange Board of India (SEBI) which set up a committee under the
chairmanship of Kumar Mangalam Birla in 1999 with the objective of promoting and raising
of standards of good corporate governance. In early 2000 the SEBI Board accepted and ratified
the key recommendations of this committee and these were incorporated into Clause – 49 of
the Listing Agreement of the Stock Exchanges.
In May 2000, the Department of Corporate Affairs (DCA) formed a broad based study group
under the chairmanship of Dr. P.L. Sanjeev Reddy, Secretary of DCA. The group was given
the ambitious task of examining ways to “operationalise the concept of corporate excellence
on a sustained basis” so as to “sharpen India’s global competitive edge and to further develop
corporate culture in the country”. In November 2000 the Task Force on Corporate Excellence
set up by the group produced a report containing a range of recommendations for raising
governance standards among all companies in India.
A committee was appointed by Ministry of Finance and Company Affairs in August 2002
under the chairmanship of Naresh Chandra to examine and recommend inter alia amendments
to the law involving the auditor-client relationships and the role of independent directors. The
committee made recommendations in two key aspects of corporate governance: financial and
non-financial disclosures: and independent auditing and board oversight of management.
The SEBI constituted a committee under the chairmanship of Narayana Murthy for reviewing
implementation of the corporate governance code by listed companies and issue of revised
clause 49. Some of the major recommendations of the committee primarily related to audit
committees, audit reports, independent directors, related party transactions, risk management,
directorships and director compensation, codes of conduct and financial disclosures.
The Companies Act 1956 was enacted on the recommendations of the Bhaba Committee set
up in 1950 with the object to consolidate the existing corporate laws and to provide a new basis
for corporate operation in independent India. With enactment of this legislation in 1956 the
Companies Act 1913 was repealed. The need for streamlining this Act was felt from time to
time as the corporate sector grew in pace with the Indian economy and as many as 24
amendments have taken place since 1956. The major amendments to the Act were made
through Companies (Amendment) Act 1998 after considering the recommendations of Sachar
Committee followed by further amendments in 1999, 2000, 2002 and finally in 2003 through
the Companies (Amendment) Bill 2003 pursuant to the report of R.D. Joshi Committee. After
a hesitant beginning in 1980, India took up its economic reforms programme in 1990s and a
need was felt for a comprehensive review of the Companies Act 1956. The Government
therefore took a fresh initiative in this regard and constituted a committee in December 2004
under the chairmanship of Dr. J.J. Irani with the task of advising the government on the
proposed revisions to the Companies Act 1956.
Meaning
The concept of "governance" is not new. It is as old as human civilization. Simply put
"governance" means: the process of decision-making and the process by which decisions are
implemented (or not implemented). Governance can be used in several contexts such as
corporate governance, international governance, national governance and local governance. It
is participatory, consensus oriented, accountable, transparent, responsive, effective and
efficient, equitable and inclusive and follows the rule of law. It assures that corruption is
minimized, the views of minorities are taken into account and that the voices of the most
vulnerable in society are heard in decision-making. It is also responsive to the present and
future needs of society.
Significance
Definition:
(1) “Corporate governance means that company managers 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.” – Catherwood.
(2) “Corporate governance is the system by which companies are directed and controlled.” –
The Cadbury Committee (U.K.)
Need for Corporate Governance
“A code of corporate governance cannot be imported from outside, it has to be developed
based on the country’s experience. There cannot be any compulsion on the corporate
sector to follow a particular code. An equilibrium should be struck so that corporate
governance is not achieved at the cost of the growth of the corporate sector”
(vii) Globalisation:
Desire of more and more Indian companies to get listed on international stock exchanges also
focuses on a need for corporate governance. In fact, corporate governance has become a
buzzword in the corporate sector. There is no doubt that international capital market recognises
only companies well-managed according to standard codes of corporate governance.
(i) Transparency:
Transparency means the quality of something which enables one to understand the truth easily.
In the context of corporate governance, it implies an accurate, adequate and timely disclosure
of relevant information about the operating results etc. of the corporate enterprise to the
stakeholders.
In fact, transparency is the foundation of corporate governance; which helps to develop a high
level of public confidence in the corporate sector. For ensuring transparency in corporate
administration, a company should publish relevant information about corporate affairs in
leading newspapers, e.g., on a quarterly or half yearly or annual basis.
(ii) Accountability:
Accountability is a liability to explain the results of one’s decisions taken in the interest of
others. In the context of corporate governance, accountability implies the responsibility of the
Chairman, the Board of Directors and the chief executive for the use of company’s resources
(over which they have authority) in the best interest of company and its stakeholders.
(iii) Independence:
Good corporate governance requires independence on the part of the top management of the
corporation i.e. the Board of Directors must be strong non-partisan body; so that it can take all
corporate decisions based on business prudence. Without the top management of the company
being independent; good corporate governance is only a mere dream.
SEBI guidelines
(ii) The number of independent directors would depend on whether the chairman is executive
or non-executive.
In case of non-executive chairman, at least, one third of the Board should comprise of
independent directors; and in case of executive chairman, at least, half of the Board should
comprise of independent directors.
The expression ‘independent directors’ means directors, who apart from receiving director’s
remuneration, do not have any other material pecuniary relationship with the company.
(iii)The Chairman shall be present at the Annual General Meeting to answer shareholders’
queries.
(ii) Details of fixed component and performance linked incentives, along with performance
criteria.
(ii) (ii) A director shall not be a member of more than 10 committees or act as chairman
of more than five committees, across all companies, in which he is a director.
(e) Management:
A Management Discussion and Analysis Report should form part of the annual report to the
shareholders; containing discussion on the following matters (within the limits set by the
company’s competitive position).
(f) Shareholders:
Some points in this regard are:
(i) In case of appointment of a new director or reappointment of a director, shareholders must
be provided with the following information:
1. A brief resume (summary) of the director
(ii) A Board Committee under the chairmanship of non-executive director shall be formed to
specifically look into the redressing of shareholders and investors’ complaints like transfer of
shares, non-receipt of Balance Sheet or declared dividends etc. This committee shall be
designated as ‘Shareholders / Investors Grievance Committee’.
(h) Compliance:
The company shall obtain a certificate from the auditors of the company regarding the
compliance of conditions of corporate governance. This certificate shall be annexed with the
Directors’ Report sent to shareholders and also sent to the stock exchange.
Much attention to corporate governance issues in emerging markets among policymakers and
academics has focused on the role governance can play in improving access for emerging
market companies to global portfolio equity. An increasing volume of empirical evidence
indicates that well-governed companies receive higher market valuations.* However,
improving corporate governance will also increase all other capital flows to companies in
developing countries: from domestic and global capital; equity and debt; and from public
securities markets and private capital sources.
Improving performance.
Equally important and, irrespective of the need to access capital, good corporate governance
brings better performance for clients. Improved governance structures and processes help
ensure quality decision-making, encourage effective succession planning for senior
management and enhance the long-term prosperity of companies, independent of the type of
company and its sources of finance.
Adding value.
Corporate governance is a priority because it presents opportunities to manage risks and add
value to clients. In addition to the benefits to individual client companies, working to improve
corporate governance contributes more broadly to the mission that promote sustainable private
sector investment in developing countries.
Improving corporate governance contributes to the development of the public and private
capital markets. Poor standards of governance, particularly in the area of transparency and
disclosure have been a major factor behind instability in the financial markets across the globe.
This was seen in the case of the East Asian financial crisis of 1997, where so-called "crony
capitalism" combined with macroeconomic imbalances to interrupt decades of outstanding
economic growth. Most recently, poor corporate governance contributed to the spread of
corruption and fraud that led to the dramatic corporate failures in United States and Western
Europe.
Agency theory:
This theory is about the conflicts that arise between the Principal and the Agent because of
differences in the goals resulting in additional costs to the firm thereby eroding the wealth of
the firm and its shareholders. Study by Berle and Means (1932) has brought into focus the
divergence in the profit maximizing and cost minimizing ideals of the firm’s behavior. This
causes agency costs, since managers and owners, having conflicting objectives, try to control
each other. Owners’ expect managers/agents to operate the businesses with planned outcomes
to enhance shareholders’ wealth, which the managers may not do.
Stewardship theory:
This theory focuses on the resources the directors can provide to the firm for its effective
operations and profitability. Some suggest that the boards have a critical role to play in
achieving economic efficiency and since some directors may have access to some strategic
resources required by the firm, they may be appointed to the board. Some suggest that directors
may also bring in specialized skills and expertise which will help them to cope with uncertainty
by connecting with external resources and held that environmental linkages could reduce
transaction costs associated with environmental interdependency.
Stakeholder Theory:
Stakeholder is a term originally introduced by the Stanford Research Institute (SRI) referring
to “those groups without whose support the organization would cease to exist”. Stakeholders
of a firm include suppliers, buyers, public policy decision makers, social groups and
Government. The conventional view that the success of the firm is dependent only on
maximizing shareholders’ wealth has limitations due to negative externalities imposing
external costs on the society. This theory states that the success of the firm is dependent on the
relationship that a firm has with its stakeholders. Stakeholder theory states that, managers and
entrepreneurs must take into account the legitimate interests of those groups and individuals
who can affect or be affected by their activities. Some suggest that the firms should carry out
socially responsible activities to reduce the risk of governmental intrusions that may affect firm
value. The underlying emphasis of this theory is that managers should have broad stake holder
orientations rather than narrow shareholder orientations.
Managerial hegemony theory states that CEOs and Management dominate the boards of
directors resulting in passive roles for NED and independent directors. This is because CEOs
dominate the director selection process and therefore control the board. Vancil (1987) is also
skeptical about the ability of outside directors to make independent judgments on firm
performance due to the dominant role played by CEOs in selecting outside directors. Stiles and
Taylor (1993) cited Sir Adrian Cadbury’s quote that up to 80 % of outside appointments to the
boards of large British companies were made on the old boys’ network. All these may
negatively influence the board cohesiveness since Non executive and independent directors are
involved in the decision-making process of the firm and, at the same time, act as monitors of
management. This conflict of interest will impair the efficiency of the firm despite being
dominated by outside directors.
Many firms of Japan are a part of intricate shareholding structures called keiretsus. A Japanese
Keiretsu is a network of different businesses that hold interest in each other to form a type of
security blanket. In a horizontal keiretsu firms are financed by a main bank with a system of
cross-share holding and horizontal network of interlinked corporations. While the central figure
in a horizontal Keiretsu is a central bank, in a vertical Keiretsu it would be a big manufacturing
company such as Toyota. Managers do not have a fiduciary responsibility only to shareholders
but also to the stakeholders. In practice the managers are expected to pursue the interests of a
wider set of stakeholders, including employees, customers and Shareholders who are
considered part of it.
German Model: (G-form)
In the German model of Corporate Governance even though the shareholders own the
corporation, they do not directly control the governance mechanism. In fact in Germany the
legal system is quite explicit that firms do not have a sole duty to pursue the interests of
shareholders because of the system of codetermination. In large corporations employees have
an equal number of seats on the supervisory board of the company which is ultimately
responsible for the strategic decisions of the company .Half of the supervisory board is elected
by the labour unions which ensure that the workers participation in the governance mechanism
is ensured. Another feature is that there is a heavy presence of banks in the equity structure of
German firms.
Chaebol refers to a South Korean form of business conglomerate. They are powerful global
multinationals owning numerous international enterprises. The traditional structure of Korean
chaebol can be explained by two of their features; their absolutely closed concentration of
ownership within the family of the founder, and their highly diversified business structure. The
founding family possesses bulk of the stocks and holds the decision making right as top
management. Chaebols suffer from a number of problems such as entrenchment, agency
conflicts, tunneling, etc (
Anglo-American Model:
The regulations related to Corporate Governance have been significantly influenced by the
regulations of UK, USA and Europe. Following are some of the important enactments which
form the core element of governance systems, not only in India, but across the world.
There were a series of governance failures in UK around the years 1990-92; Bankruptcy of
Maxwell's; Insolvency of BCCI; Polly Peck and others. These events led to the formation of a
committee chaired by Sir Adrian Cadbury whose aims were to suggest improvements and
restore investor confidence in the British Corporate Governance system. The committee made
recommendations on the arrangement of company boards and accounting systems to mitigate
Corporate Governance risks and failures. The report's recommendations have been adopted in
varying degrees by the European Union, the United States, the World Bank, and other common
wealth countries.
In late 90’s, East Asian economies came to limelight due to the quick boom and burst
phenomenon disrupting the economies of not only Asian countries but many countries of the
world. The East Asian financial crisis (AFC) was primarily attributed to poor governance and
it undoubtedly established the importance of having effective Corporate Governance structures
for corporations particularly PLCs. Subsequently, World Bank brought in a series of Corporate
Governance reforms, primarily in countries to which it lends, to avoid such crisis.
Enron’s scandal has been one of the serious lapses in the Corporate Governance history. Since
many world markets were inter-connected it had wider and serious ramifications resulting in
loss of billions of dollars, affecting many countries. Enron’s Governance fiasco led to the
enactment of the Sarbanes Oxley Act, 2002.This has been one of the most sweeping reforms
in the past 70 years of the Corporate Governance history Because of global importance of US
financial markets, many countries of the world reviewed their Governance regulations on the
basis of this Act. Foreign Firms which are listed in US and Subsidiaries of US firms have to
comply with its stringent internal control and financial reporting requirements of this Act.
It is dubbed as Europe’s Enron. Parmalat was Italy's largest food company. Primarily there was
disappearance of more than $10 billion in declared assets which came into limelight during the
auditor rotation. Subsequent to this scandal there were regulatory amendments, particularly in
the area of Auditing and Audit committee.