Banking Article, Banking Finance 2020, Banking Finance October 2020

Corporate Governance in India

What is Corporate Governance?

Corporate Governance is a set of practices with the help of which the investors (largely the outside investor) protect themselves from management (insiders).  Since the happening of Satyam fraud, the Corporate Governance has assumed a lot of importance in India.  World over a number of such cases has emerged which bring the limelight to the issue of Corporate Governance e.g. Worldcom, Enron etc.  Corporate Governance includes balancing the varied interest of different stakeholders like financiers, management, investors, customers, suppliers, community etc.

Objectives of the Good Corporate Governance:

Corporate Governance is one of the most important aspects of a company and it is very crucial for the existence and instilling investor confidence in the company.  The prime motive of the Corporate Governance is to increase shareholders wealth and maximize the company’s long term value.  It recognizes the undeniable right of shareholders as the true owner of the company.

Corporate governance ensures that adequate disclosures are made to stakeholders especially investors of the company.  It helps in ethically conducting the business of the company.  It helps in attracting capital from inside and outside of the country who want to benefit from the growth of the company.  It also promotes transparency, accountability and fairness in the conduct of business by the company.  It helps in creating a board at the top that takes objective decision for the benefit of all stakeholders.  It also provides an oversight and control of the management by the board.

Regulatory Framework for Corporate Governance:

In India the Corporate governance mechanism has been listed in the following rules / regulations /acts / listing agreements:

  1. The Companies Act 2013- This consists of the provisions related to the Board, its constitution, meetings, board dealings, independent directors, related party transactions, disclosure requirements etc.
  2. Securities and Exchange Board of India Guidelines- SEBI from time to time issues guidelines pertaining to listed companies, to ensure that interests of the investors are protected.
  3. Standard listing agreement of Stock exchanges.
  4. Accounting standards issued by Institute of Chartered Accountants of India (ICAI).
  5. Secretarial standards issued by Institute of Company Secretaries of India (ICSI).

Corporate Governance in India:

The first initiative in this area started with publication of “Desirable Code of Corporate Governance”- a voluntary code published by Confederation of Indian Industries in 1998.  In 1999, SEBI formed a committee under chairmanship of Sh Kumar Mangalam Birla to promote and raise the standard of Corporate Governance.  This committee recommended a new clause 49 which was included in Stock exchange listing agreements.  This clause prescribed a format in which the Stock exchanges will have to obtain information regarding companies desirous of listing on their exchange.  In order to comply with the provisions of clause 49, a company must follow these principles:

  1. Right of shareholders- Shareholders are the final owner of the company and they should have right to participate in general meeting, questioning and voting.
  2. Rights of stakeholders- A company must take care of its stakeholders.
  3. Disclosure and transparency- Company must disclose all the material information of the company like financials, performance, ownership etc in a timely and transparent manner.
  4. Responsibility of the board- Board member should maintain confidentiality. They should perform their main function like execution of board, preparation of major actions, designing corporate strategy etc

Clause 49 was last amended on 29 October 2004.  This amendment made certain changes like defining the independent directors, improving the quality of financial disclosure, strengthening the audit committee, disclosure about related party, restriction on the terms of independent directors etc.

During the year 2012 to 2013 a slew of measures and reforms were undertaken by SEBI to improve the Corporate Governance standards of companies in India.  Some of these changes are listed below:

  1. The listing agreement has been aligned more with the Companies Act 2013. Issuance of formal letter of appointment, performance evaluation, separate meeting at least once in a year, of Independent Directors is required by SEBI also besides under the Companies Act.
  2. Restriction on the number of Independent Directorships to 7 and restriction to 3 in case the person is also a full time director on board of a company.
  3. Maximum term of an Independent director is restricted to 2 terms of 5 years each with maximum aggregate term of 10 years. They are eligible for re election after a cooling off period of 3 years.
  4. As per clause 49 of Equity listing agreement, if the Chairman of the Board is an Executive Director, then 50% of the board should be of Independent Directors otherwise the Board should have one third Independent Directors.
  5. While the Companies Act requires a majority of Independent Director in Audit committee, the SEBI norm requires two third of the audit committee members to be Independent Directors with Chair of the audit committee to also be an Independent Director.
  6. Related party transactions monitoring has been made more stringent.
  7. The disclosures norms relating to Director’s compensation, performance, training etc have been made more stringent.
  8. E voting has been made mandatory which will improve the say of, minority shareholders in the affairs of the company.

In year 2019, rules pertaining to Significant Beneficial Ownership also came into existence.  These rules defined in detail who is a significant beneficial owner and what are the returns that he needs to file?  The concept of Significant Beneficial Ownership was incorporated to catch those individuals whose name do not appear is register of members and who hold a significant beneficial ownership in a company.

While keeping in view the recent spate of corporate frauds and default towards banks, Ministry of Corporate Affairs (MCA) has introduced new set of Companies (Auditors Report) Order 2020, which has an objective of instilling faith and improve transparency in financial statements.  A new order has extended the applicability of CARO 2020 to FY 2020-21 onward.  Some of the points in CARO 2020 include:

  1. Auditor has to disclose whether company has made any cash loss in current or previous financial year.
  2. When a new auditor has been appointed after resignation of the previous one, the new auditor has to address the concerns raised by the previous auditor.
  3. Auditor need to analyse various financial ratios and comment whether the company will be able to meet its liabilities in next year.
  4. Auditor need to comment whether funds raised for short term purpose have been used for long term.
  5. Auditor has to give a detailed report when the company has raised funds for its subsidiary or Joint venture.
  6. Auditor need to mention if company has defaulted in repayment of loans or interest thereon to ANY of its lenders (includes other than financial institutions or banks).

In recent past there had been appointment of Kotak Committee under the Chairmanship of Sh Uday Kotak on corporate governance.  SEBI accepted some of the following recommendations of the committee:

  1. Eligibility criteria for independent directors, was expanded.
  2. Maximum number of directorship was reduced from 10 to 7 by 01.04.2020.
  3. Role of risk management committee, nomination and remuneration committee and audit committee was enhanced.
  4. Auditor’s credentials, reasons for resignation of auditors, audit fee etc to be disclosed.
  5. Expertise of the directors to be disclosed.

Disclosures to be made under Corporate Governance:

Disclosures are important to ensure and maintain the transparency in the affairs of the company. Few disclosures are made in the annual report of the company like- financial and accounts related disclosures, business information, key employee important information, audit committee related information etc.  Similarly some of the important disclosures have to be posted on the company’s website like- code of conduct, criteria of payment to Non Executive Directors, Quarterly results etc. Disclosures to stock exchanges include quarterly results and quarterly compliance report on Clause 49.

Major Issues and Challenges in Corporate Governance

One of the major issues in India regarding Corporate Governance is the prevalence of Family businesses where promoters are the dominant shareholders.  These dominant shareholders can indulge in related party transaction within the group companies and issue shares on preferential basis.

A few studies have shown that independent directors merely act hands in glove with the management and are actually ineffective.  They do not serve the purpose for which they are appointed.

Till very recently, in a number of cases the post of CEO and Chairman of the board were filled by the same person which compromised the supervisory role of the Chairman.  However now, SEBI has directed that the post of CEO and Chairman of the board have to be filled by separate person.  This essentially means that Chairman has to be a non executive director. (The implementation of this guideline has been deferred as of now).

Examples of Corporate Mis-governance:

A leading drug manufacturer of India indulged in wrong practices.  It fudged the data related to regulatory filings, sold adulterated drugs.  All this happened despite having an illustrious board at the helm of affairs.

The star chairman of a leading technology company manipulated accounts to the tune of 14,000+ Crore rupees with the active connivance of auditors and others.

A large steel company in southern India made donations to an education trust (belonging to an influential person of the state) with the intent to seek a favourable reply to company’s application for mining rights.

So we can see that despite having so many laws, rules, regulations, guidelines, regulatory bodies which enforce the Corporate Governance, fraudsters still find ways to circumvent the system.  However it is no time to stand still but actually think one step ahead of these crooked persons to ensure the integrity of the system.  We have to time and again emphasize upon the need to be proactive with regards to formation of rules and regulation of corporate governance.

Conclusion:

Corporate governance is vital cog in instilling the confidence in investors regarding the functioning of a company.  It is of paramount importance especially in a globalized world.  In India, a number of institutes/ bodies are involved in ensuring the corporate governance.  A number of steps have already been taken and more needs to be done to ensure that corporate governance in India matches global standards.

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