Corporate Governance is essentially all about how organizations are directed, controlled and held accountable to the shareholders. Securities and Exchange Board of India is continuously working in regulating the corporate in India to protect the interest of various stakeholders. A voluntary disclosure, which was started by some of the well-managed socially concerned companies, has become an order of the day in corporate reporting. The ability of the Board, the commitment of the individual members of the Board, the integrity of the management team, alertness of the inspection and audit team, adequacy and quality of the process and reporting are the real factors which will ensure good corporate governance. The positive side of adherence to corporate governance practices has increased importance of corporate governance as investment criteria among large investors, Improved Equity Price Performance, Higher Valuations, Access to global markets and increased investor goodwill & confidence. This paper traces the origin and development of corporate governance practices in India starting from CII Code on Corporate Governance, Birla committee report and Narayan Murthy committee report and examines the recent amendments to Clause 49 of listing agreement in India.
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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. The objective of any corporate governance system is to simultaneously improve corporate performance and accountability as a means of attracting financial and human resources on the best possible terms and of preventing corporate failure. 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.
Corporate governance has three key constituents namely: the Shareholders, the Board of Directors & the Management. Other stakeholders include employees, customers, creditors, suppliers, regulators, and the community at large. The concept of corporate governance identifies their roles & responsibilities as well as their rights in the context of the company. It emphasizes accountability, transparency & fairness in the management of a company by its Board, so as to achieve sustained prosperity for all the stakeholders. Corporate governance is a synonym for sound management, transparency & disclosure. Transparency refers to creation of an environment whereby decisions & actions of the corporate are made visible, accessible & understandable. Disclosure refers to the process of providing information as well as its timely dissemination.
Governance is the definition of where efficiency becomes an adjective, as it checks one's ability to achieve maximum results with minimum resources. Corporate governance is not applicable only to the business sector but to the entire governance arena. Fairness is a term that demands transparency, and it is transparency that compels a being to realize oneâ€Ÿs responsibility. Hence, good governance is integral to the existence of a company. (Asia law, Corporate governance under the Indian Companies Act, 1956)
Finance literature in particular has come a long way in explaining the various financial theories of firms and the behaviors associated with them. The foundational argument of corporate governance as seen by both academic as well as other independent researchers can be traced back to the pioneering work of Berle and Means (1932) who observed, as early as the 1930s, that the modern corporations having acquired a very large size can create the possibility of the separation of control over a firm from its direct ownership (Bhasa, nd).The separation of ownership and control has been a long standing concern in corporate finance (Kumar, 2003). A lot of concerns are there regarding the survival of organizations in which important decision agents do not bear a substantial share of the wealth effects of their decisions. But it has been found that such separation of decision and risk-bearing functions survives in these organizations in part because of the benefits of specialization of management and risk bearing but also because of an effective common approach to controlling the agency problems caused by separation of decision and risk bearing functions.(Fama and Jensen, 1983 & 1998) The modern day uproar over corporate governance problems of insider trading, excessive executive compensation, managerial expropriation of shareholders' wealth, false reporting, non-disclosure of certain accounting and governance malpractices and self-dealing among others, are assumed to be related to the theory of separation of ownership and control. (Bhasa,nd)
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Further exploring the effects of ownership and governance systems on corporate entrepreneurship it was found that corporate entrepreneurship is also positively associated with future company performance. It is widely recognized as an effective means for enhancing a companyâ€Ÿs competitive position and performance in both domestic and international markets (Zahra et al., 2000). If better corporate governance is related to better corporate performance, better-governed companies should perform better than worse-governed companies (Brown and Caylor 2004).
NEED FOR CORPORATE GOVERNANCE IN INDIA
A corporation is a congregation of various stakeholders, namely customers, employees, investors, vendor partners, government and society. In this changed scenario an Indian corporation, as also a corporation elsewhere should be fair and transparent to its stakeholders in all its transactions. This has become imperative in today's globalized business world where corporations need to access global pools of capital, need to attract and retain the best human capital from various parts of the world, need to partner with vendors on mega collaborations and need to live in harmony with the community. Unless a corporation embraces and demonstrates ethical conduct, it will not be able to succeed.
Corporations need to recognize that their growth requires the cooperation of all the stakeholders; and such cooperation is enhanced by the corporations adhering to the best Corporate Governance practices. In this regard, the management needs to act as trustees of the shareholders at large and prevent asymmetry of benefits between various sections of shareholders, especially between the owner-managers and the rest of the shareholders.
CORPORATE GOVERNANCE: AIMS AND OBJECTIVES
Corporate governance, in plain terms, refers to the rules, processes, or laws by which businesses are operated, regulated, and controlled. The term can refer to internal factors defined by the officers, stockholders or constitution of a corporation, as well as to external forces such as consumer groups, clients, and government regulations. However, enforced corporate governance provides a structure that, at least in theory, works for the benefit of everyone concerned by ensuring that the enterprise adheres to accepted ethical standards and best practices as well as to formal laws. To that end, organizations have been formed at the regional, national, and global levels. In recent times, corporate governance has received increased attention because of high-profile scandals involving abuse of corporate power and, in some cases, alleged criminal activity by corporate officers. An integral part of an effective corporate governance regime includes provisions for civil or criminal prosecution of individuals who conduct unethical or illegal acts in the name of the enterprise.
Aims and Objectives
It is said that good corporate governance helps an organization achieve several objectives and some of the more important ones include:
â€¢ Developing appropriate strategies that result in the achievement of stakeholder objectives
â€¢ Attracting, motivating and retaining talent.
â€¢ Creating a secure and prosperous operating environment and improving operational performance.
â€¢ Managing and mitigating risk and protecting and enhancing the company's reputation.
5. IMPLEMENTATION OF THE RECOMMENDATIONS OF BIRLA COMMITTEE REPORT CLAUSE 49
Clause 49 of the Listing Agreement to the Indian stock exchange comes into effect from 31 December 2005. It has been formulated for the improvement of corporate governance in all listed companies. In corporate hierarchy two types of managements are envisaged: i) companies managed by board of directors; and ii) those by a managing director, whole-time director or manager subject to the control and guidance of the board of directors. As per Clause 49, for a company with an Executive Chairman, at least 50 per cent of the board should comprise independent directors. In the case of a company with a non-executive Chairman, at least one-third of the board should be independent directors.
It would be necessary for chief executives and chief financial officers to establish and maintain internal controls and implement remediation and risk mitigation towards deficiencies in internal controls, among others. Clause VI (ii) of Clause 49 requires all companies to submit a quarterly compliance report to stock exchange in the prescribed form. The clause also requires that there be a separate section on corporate governance in the annual report with a detailed compliance report. A company is also required to obtain a certificate either from auditors or practicing company secretaries regarding compliance of conditions as stipulated, and annex the same to the director's report. The clause mandates composition of an audit committee; one of the directors is required to be "financially literate". It is mandatory for all listed companies to comply with the clause by December 31, 2005.
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Clause 49, when it was first added, was intended to introduce some basic corporate governance practices in Indian companies and brought in a number of key changes in governance and disclosures (many of which we take for granted today). It specified the minimum number of independent directors required on the board of a company. The setting up of an Audit committee, and a Shareholders' Grievance committee, among others, were made mandatory as were the Management's Discussion and Analysis (MD&A) section and the Report on Corporate Governance in the Annual Report, and disclosures of fees paid to non-executive directors. A limit was placed on the number of committees that a director could serve on. In late 2002, SEBI constituted the Narayana Murthy Committee to assess the adequacy of current corporate governance practices and to suggest improvements. Based on the recommendations of this committee, SEBI issued a modified Clause 49 on October 29, 2004 (the 'revised Clause 49') which came into operation on January 1, 2006. The revised Clause 49 has suitably pushed forward the original intent of protecting the interests of investors through enhanced governance practices and disclosures. Five broad themes predominate. The independence criteria for directors have been clarified. The roles and responsibilities of the board have been enhanced. The quality and quantity of disclosures have improved. The roles and responsibilities of the audit committee in all matters relating to internal controls and financial reporting have been consolidated, and the accountability of top management-specifically the CEO and CFO-has been enhanced. Within each of these areas, the revised Clause 49 moves further into the realm of global best practices and sometimes, even beyond.
6. CLAUSE 49 - MANDATORY REQUIREMENTS
I. BOARD OF DIRECTORS
Composition of Board:
The Board of directors of the company shall have an optimum combination of executive and non-executive directors with not less than fifty percent of the board of directors comprising of non- executive directors.
Where the Chairman of the Board is non- executive directors, at least one third of the Board should comprise of independent directors and in case he is an executive director, at least half of the Board should comprise of independent directors.
For the purpose of sub - clause (ii) the expression 'independent director' shall mean a non executive director of the company who:
Apart from receiving director's remuneration, do not have any material pecuniary relationships or transactions with the company, its promoters, its directors its senior management or its holding company, its subsidiaries and associated which many affects independence of the director.
Is not related to promoters or persons occupying managements positions at the board level or at one level below the board;
It not been executive or was not partner or an executive during the preceding three years, of any of the following:
Is not a partner or an executive or was not partner or an executive during the preceding three years, of any of the following:
The statutory audit firm or the internal audit firm that is associated with the company, and ;
The legal firm(s) and consulting firm(s) that have a material association with the company
Is not a material supplier, service provider or customer or a lessor or lessee of the company, which may affect independence of the directors; and
Is not a substantial shareholder of the company i.e. owning two percent or more of the block of voting shares.
Nominee directors appointed by an institution which has invested in or lent to the company shall be deemed to be independent directors. However if the Dr. J.J. irani Committee recommendations on the proposed new company law are accepted, then directors, nominated by financial institutions and the government will not be considered independent.
Non executive director's compensation and disclosures:
All fees/ compensation and disclosures: all fees/ compensation , if any paid to non executive directors, including independent directors, shall be fixed by the Board of Directors and shall require previous approval of shareholders in general meeting. The shareholders' resolution shall specify the limits for the maximum number of stock options that can be granted to non- executive directors, including independent directors, in any financial year and aggregate. However as per SEBI amendment made vide circular SEBI/ CFD/DIL/CG dated 12/1/06 sitting fees paid to non-executive directors as authorized by the Companies Act 1956, would not require the previous approval of shareholders.
Other provisions as to Board and Committees:
The board shall meet at least four times a year, with a maximum time gap of three months between any two meetings. However SEBI has amended the clause 40 of the listing agreement vide circular SEBI/CFD/DIL/CG dated 12-1-06 as per which the maximum gap between two board meetings has been increased again to 4 months.
A director shall not be a member in more than 10 Audit and / or Shareholders grievance Committee or act as chairman of more than five Audit Shareholders Grievance committee across all companies in which he is a director. Furthermore it should e mandatory annual requirement for every director to inform the company about the committee positions he occupies in other companies and notify changes as and when they take place.
Code of conduct:
The Board shall lay down a code of conduct for all Board members and senior management of the company. The code of conduct shall be posted the website of the company,
All Board members and senior management personnel shall affirm compliance with the code on an annual basis. The Annual report of the company shall contain declaration to this effect signed by CEO.
II- AUDIT COMMITTEE
Qualified and Independent Audit Committee:
A qualified and independent audit committee shall be set up, giving the terms of reference subject to the following:
The audit committee shall have minimum three directors as members. Two thirds of the members of audit committee shall be independent directors.
All members of audit committee shall be financially literate and at least one member shall have accounting or related financial management expertise.
The chairman of the Audit Committee shall be an independent director.
The chairman of the Audit Committee shall be present at annual General Meeting to answer shareholder queries;
The audit committee may invite such of the executives, as it considers appropriate (and particularly the head of the finance function) to the present at the meetings of the committee. The finance director, head of internal audit and representative of the statutory auditor may be present as invitees for the meeting of the audit committee;
The Company Secretary shall act as the secretary to the committee.
Meeting of Audit Committee:
The audit committee should meet at least four times in a year and not more than four months shall elapse between two meetings. The quorum shall be either tow members or one third of the members of the audit committee whichever is greater, but there should be minimum of two independent members present.
Powers of Audit Committee:
The audit committee shall have powers:
To investigate any activity within the terms of reference;
To seek information from any employee;
To obtain outside legal or other professional advice;
To secure attendance of outsiders with relevant experts, if any.
Role of Audit Committee:
The role for the audit committee shall include the following:
Oversight of the company's financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible.
Recommending to the Board, the appointment re- appointment and if required the replacement or removal of the statutory auditor and the fixation of audit fees.
Approval of payment too statutory auditors for any other services rendered by the statutory auditors.
Reviewing, with the management the quarterly and annual financial statements before submission to the board for approval with reference to Director's Responsibility statement under section 217 (2AA)k, significant adjustments made in financial statements, compliance with listing requirements, disclosure of any related pending transaction etc.
Reviewing with the management performance of statutory and internal auditor and adequacy of the internal control systems.
Discussion with internal auditors regarding any significant findings including suspected frauds or irregularities and follow up thereon.
Reviewing the findings of any internal investigation by the internal auditors into matters where there is suspected fraud or irregularity or a failure of internal control system of a material nature and reporting the matter to the board.
Discussion with statutory auditors before the audit commence, about the nature and scope of audit as well as post- audit discussion to ascertain any area of concern.
To look into the reason of substantial defaults in the payments to the depositors, debenture holders, shareholders (in case of nonpayment of declared dividends) and creditors.
To review the functioning of the Whistle Blower mechanism, in case the same is existing.
Carrying out any other function as it mentioned in the terms of reference of the Audit Committee.
III- SUBSIDIARY COMPANIES
At least one independent director on the Board of Director of the holding company shall be a director on the Board of Directors of a material non listed Indian subsidiary company.
The audit committee of the listed holding company shall also review the financial statements, in particular, the investment made by the unlisted subsidiary company.
The minutes of the Board meeting of the unlisted subsidiary company shall be placed at the Board meeting of the listed holding company, the management should periodically bring to the attention of the Board of Directors of the listed holding company, a statement of all significant transaction and arrangements entered into by the unlisted subsidiary company.
Basis of related party transactions:
A statement in summary form of transactions with related parties shall be placed periodically before the audit committee.
Details of material individual transactions with related parties which are not in the normal course of business shall be placed before the audit committee.
Disclosure of Accounting Treatment:
where in the preparation of financial statements, a treatment different from that prescribed in an Accounting Standard has been followed, the fact shall be disclosed in the financial statements, together with the management's explanation as to why it believes such alternative treatment is more representative of the true and fair view of the underlying business transaction in the Corporate Governance Report.
Board Disclosure- Risk Management:
The company shall lay down procedures to inform Board members about the risk assessment and minimization procedures.
Proceeds from public issues, rights issues , preferential issues etc. :
When money is raised through an issue (public issues rights issues, preferential issues etc.), it shall disclose to the Audit committee, the uses/ applications of funds by major category (capital expenditure,, sales and marketing, working capital, etc.), on a quarterly and annual basis.
Remuneration of Directors :
All pecuniary relationship or transactions of the non- executive directors vis-à-vis the company shall be disclosed in the Annual Report.
Further, certain prescribed disclosures on the remuneration of directors shall be made in the section on the corporation governance of the Annual Report;
The company shall disclose the number of shares and convertible instruments held by non-executive directors in the annual report.
Non executive directors shall be required to disclose their shareholding (both own or held by/ for other persons on a (beneficial basis) in the listed company in which they proposed to be appointed as directors, prior to their appointment. These details should be disclosed in the notice to the general meeting called for appointment of such directors.
As part of the directors' report or as an addition there to a Management Discussion and Analysis report, the following should form part of the Annual Report to the shareholders. This includes discussion on:
Industry structure and developments.
Opportunities and threats.
Segment wise or product wise performance
Risks and concerns.
Internal control systems and their adequacy
Discussion on financial performance with respect to operational performance.
Material developments in Human resources/ industrial Relations front including number of people employed.
In case of the appointment of a new directors or reappointment of a director the shareholders must be provided with the following information:
A brief resume of the director
Nature of his expertise in specific functional areas;
Names of companies in which the persons also holds directorship and the membership Committees of the Board; and
Shareholding of non - executive directors.
A board committee under the chairmanship of a non- executive director shall be formed to specifically look into the redressal of shareholder and investor complaints like transfer of shares, non receipt of declared dividends etc. this committee shall be designated as 'Shareholders/Investors Grievance Committee'.
To expedite the process of share transfer, Board of the company shall delegate the power of share transfer to an officer or a committee or to the registrar and share transfer agents. There delegated authority shall attend to share transfer formalities and least once in a fortnight.
V- CEO/CFO CERTIFICATION
Through the amendment made by SEBI vide circular SEBI /CFD/DIL CG DATED 12-1-06, in Clause 49 of the Listing Agreement, certification of internal controls and internal control system
CFO/CEO would be for the purpose of financial reporting. Thus the CEO, i.e. the Managing Director or Manager appointed in terms of the Companies Act, 1956 and the CFO i.e. the whole - time Finance Director or any other Person heading the finance function discharging that function shall certify to the Board that:
They have reviewed financial statements and the cash flow statement for the year and that to the best of their knowledge and belief:
These statements do not contain any materially untrue statement or omit any material fact or contain statements that might be misleading;
These statements together present a true and fair view of the company's affairs and are in compliance within existing accounting standards, applicable laws and regulations.
There are, to the best of their knowledge and belief, no transactions entered into by the company during the year which fraudulent, illegal or volatile of the company's code of conduct.
They accept responsibility for establishing and maintaining internal controls and they have evaluated the effectiveness of the internal control system of the company pertaining to financial reporting and they have disclosed to the auditors and the Audit Committee, deficiencies in the design or operation of internal controls, if an, of which they are aware and the steps they have taken or propose to take to rectify these deficiencies
They have indicated to the auditors and the Audit Committee significant changes in internal control over financial reporting during the year, significant fraud of which they have become aware and the involvement there in if any, of the management or an employee having a significant role in the company's internal control system over financial reporting.
VI- REPORT ON CORPORATE GOVERNANACE
There shall be separate section on Corporate Governance in Annual Reports of Company with a detailed compliance report on Corporate Governance. Non compliance of any mandatory requirement of this clause with reason there of and the extent to which the non- mandatory requirements have been adopted should be specifically highlighted.
The companies shall submit a quarterly compliance report to the stock exchange within 15 days from the close of quarter as per the format given in
The report shall be signed either by the Compliance Officer or the Chief Executive Officer of the company.
The company shall obtain a certificate from either the auditor or practicing company secretaries regarding compliance of conditions of corporate governance as stipulated in this clause and annex the certificate with the directors' report, which is sent annually to all the shareholders of the company. The same certificate shall also be sent to the Stock Exchanges along with the annual report filed by the company.
The non- mandatory requirements may be implemented as per the discretion of the company. However, the disclosures of the compliance with mandatory requirements and adoption / non- adoption of the non mandatory requirements shall be made in the section on corporate governance of the Annual Report.
Since the late 1990s, significant efforts have been made by the Indian Parliament, as well as by Indian corporations, to overhaul Indian Corporate Governance. The current Corporate Governance regime in Indian straddles both voluntary and mandatory requirements like Voluntary Guidelines by Ministry of Corporate Affairs. And for listed companies, the vast majority of Clause 49 of the listing agreements requirements is mandatory. The voluntary guideline on Corporate Governance by Ministry of Corporate Governance is a benchmark for the Corporate Governance practices in the Indian corporations, and hopefully the corporate world will make the best use of it. Efforts are also being made by the legislature to amend the Companies Act 1956. As a result, amendments relating to Corporate Governance are expected to be brought before Parliament in The Companies Bill 2009. India has one of the best Corporate Governance legal regimes but poor implementation together with socialistic policies of the pre-reform era has affected corporate governance.