Corporate Governance in India: Past, Present and Future

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"Corporate governance is not a matter of right or wrong - it is more nuanced than that."

Advocate Johan Myburgh

"Corporate governance is about owners and the managers operating as the trustees on behalf of every shareholder - large or small."

N. R. Narayana Murthy,

Chief Mentor, Infosys Technologies Limited

As Mr. Myburgh rightly says that Corporate Governance (referred as CG hereafter) is not just a matter of right or wrong, rather it has much broader & different implications. Let us first define CG in the light of available literature, it says:

"CG is the set of processes, customs, policies, laws, and institutions affecting the way a corporation (or company) is directed, administered or controlled. CG also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, the board of directors, employees, customers, creditors, suppliers, and the community at large."

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From the above definition, we can easily say that CG is a multi-faceted subject. One of the important tasks of CG is to ensure the accountability of certain individuals in an organization through mechanisms that try to reduce or eliminate the principal-agent problem.

As we are studying the scenario of CG in the Indian context, let us consider the definition of CG given by Securities & Exchange Board of India (SEBI) as well. According to them, CG is:

"The acceptance, by management, of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company."

This definition has been drawn from the Gandhian principles of trusteeship and the Directive Principles of the Indian Constitution where CG is viewed as business ethics and a moral duty.

From the diagram shown below, we can understand that CG needs a proper framework of the following items for its proper implementation & safeguarding the interests of all associated parties:

Board of Directors

Business Practices and Ethics

Legal and Regulatory policies

Disclosure and Transparency

Proper Communication

The Indian CG Story: In India CG is used in Governance with reference to all kinds of organizational structures like:

NGO - not for profit organizations

Municipal Corporation/Gram Panchayats

Central/ State Government

Partnership firm/Large Corporations

To ensure proper governance various steps have been taken by the government, as depicted by the following table:

Year

Name of Committee/Body

Areas/Aspects Covered

1998

Confederation of Indian Industry (CII)

Desirable Corporate Governance - A Code

1999

Kumar Mangalam Birla Committee

Corporate Governance

2002

Naresh Chandra Committee

Corporate Audit & Governance

2003

N. R. Narayana Murthy Committee

Corporate Governance

2005

J.J. Irani Committee

Suggestions for improvement in CG

The main objectives of the above committees are:

Strengthening the management oversight functions and accountability

Balancing skills, experience and independence of the board appropriate to the nature and extent of company operations

Establishing a code to ensure integrity

Safeguarding the integrity of company reporting

Risk management and internal control

Disclosing all relevant and substantial matters

Recognition and preservation of needs of shareholders

Current Scenario in India: As we have seen that the government has taken ample steps to ensure effective CG, but when we consider India's situation in the global context, the picture starts to get a little hazy.

India has shown most of its improvement in the last five years in terms of ease of doing business, among South Asian countries, but still ranks very low at 134th, in sharp contrast to its stature as a rising economic power and the second fastest growing economy in the world.

The World Bank and the International Finance Corporation's annual 'Doing Business' report for 2011 noted that India has made progress in making business easier, but that is not enough relative to others. India has only moved a rank up from last year, even though it implemented 18 business regulation reforms in various sectors.

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Even among the nine South Asian countries that appear in the report, India again ranks low at the 7th position, above only Bhutan and Afghanistan. Singapore ranks at the top in the world in terms of ease of doing business.

This ranking was based on nine parameters:

Starting a business

Dealing with construction permits

Registering property

Getting credit

Protecting investors

Paying taxes

Trading across borders

Enforcing contracts

Closing a business

As per a report, India is one of the most difficult places to start a business, as it has the most procedures and the maximum cost to set up a business.

The number of procedures required in India in order to get construction permits, is the maximum. In addition, the costs of dealing with these permits are also the second highest, the largest being that in war-torn Afghanistan.

However, India has lesser procedures and takes lesser time to register property, the same report shows. It is more difficult to enforce contracts in India than in other South Asian countries. "Where contract enforcement is efficient, firms have greater access to credit and are more likely to engage with new borrowers or customers," says the report highlighting its impact.

Other negative points that make business environment difficult in India are the hurdles that exist in the country for closing a business. It takes 7 years for a company to go through insolvency in the country and yields the third lowest recovery rate after an insolvency process. The cost of insolvency is also the highest, way above the regional average.

India requires start-up businesses to pay 56 taxes a year, the second largest in the South Asian region, but it takes less time to do so, which saves costs for companies.

Although, South Asia is the most difficult region in the world to get credit for business and provides least credit information, India fares well in this crucial segment as well. The report notes that the country has good collateral and bankruptcy laws, which facilitate lending by protecting the rights of borrowers and lenders.

"Stronger investor protections matters for the ability of companies to raise the capital needed to grow, innovate, diversify and compete," it says taking note of India's good record.

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Reasons for emergence of CG in India: There are various reasons for the emergence of CG, to name a few:

Corporate Scandals

The stock market scandal (Harshad Mehta) in 1992.

Ketan Parekh scandal in 2001

Tata Finance scandal (Serious financial irregularities).

Vanishing companies scam.

Satyam Scam.

3G Scam.

Radia's recent political lobbying scam.

Citi Banks Rs. 400 Cr fraud.

In order to compete in the global market, India needs a set of good corporate governance doctrines.

Trends of Corporate frauds in India:

Corporate Fraud is rising at an alarming rate in India: Corporate fraud, mostly involving financial statements, is on the rise in India and internal controls are unable to prevent such abuses. 45% of the 1,000 respondents from leading Indian businesses stated that fraud had increased within their organization.

Corporate fraud has become an increasingly topical issue in India since leading outsourcer Satyam Computer stunned the nation's financial world in 2009 with the admission that its profits had been overstated for years. Satyam's founder B. Ramalinga Raju declared that he had inflated profits and jacked up the company's balance sheet by more than one billion dollars in what was India's biggest accounting fraud.

Weak internal control systems, corroding ethical values and a reluctance on the part of the line managers to take vital action against the perpetrators are cited as the most vibrant underlying reasons for frauds being on the rise.

Outsourcing, increase in the use of third parties and technology have combined to open up new avenues of frauds like e-crime and intellectual property theft.

Corporate fraud thrives on higher attrition: Nearly 1 in every 13 corporate houses in India had suffered losses (Rs. 40 lakh<Losses< Rs. 4 crore) due to corporate frauds while nearly half had faced such frauds in the past three years. Nearly 1 in 2 corporates believe that at present corporate fraud is much more prevalent in India than three years ago.

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New technologies, new inventions and expansions into new markets have opened the door to various forms of fraud, while the threat has increased mainly because of high rate of attrition. Particularly in industries like IT & BPO. These were some of the major findings of a report on fraud perception among top corporates around the globe by Economist Intelligence Unit (EIU) for Kroll Inc.

Amusingly in Asia, the increase in threat does not lead to higher levels of counter measures, but it is just the contrary. While in India 1 out of 2 survey respondents said they did not apply any counter measures for probable frauds, whereas in China nearly 2 out of 3 respondents didn't deploy any fraud mitigation measures.

A large chunk of corporates feel that high staff turnover is one of the main reasons for their increased exposure to fraud. In India, several recent cases of fraud have been identified in BPO firms, known for their high attrition rates.

Anne Tiedemann, regional MD, Greater China & Southeast Asia, Kroll Inc said as IT frauds, including data theft, become more advanced, corporates need to increase "compliance, put in place systems for (IT) health checks and look for early warning sings", to avoid being hit by frauds and thus lose money.

On the sectorial front, the survey pointed out that financial services, healthcare, pharmaceuticals & biotechnology and natural resources sectors lost the most due to frauds of various kinds.

Regulators of CG in India:

Indian Companies Act, 1956

SEBI Act, 1992

Stock Exchanges-Listing Agreement

ICAI Act, 1949 (Institute Of Chartered Accountants Of India)

ICSI (The Institute Of Company Secretaries Of India)

ICWAI (The Institute Of Cost & Works Accountants Of India)

Awards for fair CG: Some companies that got awards for good governance are listed below:

ITC Ltd and Abhishek Industries Ltd. have received the ICSI's National Award for Excellence in Corporate Governance in the year 2006.

ITC Ltd has won the 'Golden Peacock Award for Excellence in Corporate Governance 2005', instituted by the Institute of Directors, New Delhi. *****************

Satyam, India's top 5 software making company, also received this prestigious 'Golden Peacock Award for Excellence in Corporate Governance' before it got involved in the scam.

Certain associations like ICSI have consistently refused to rank companies for their CG. According to them their award process judges the companies but does not rate companies for their governance performance.

Instead, there has to be a large number of companies effectively involved in CG before the best can be selected.

Trends: As we have seen that there have been a lot many changes in the regulations for CG, yet these scams keep coming particularly in India. Still there exists many loop holes in the systems.

To name a few:

The biggest number of directorial positions occupied by a single is 15, with four such persons in the list of the firms surveyed by a particular company. These are either chartered accountants or corporate lawyers.

Because of the distrust among Indian auditors, most of the MNCs have insisted that the parent company's auditor should also audit the subsidiary companies in India, sometimes at much higher costs.

The Board of Directors of a company has become a gizmo that can be manipulated as per company's requirements.

India has many companies listed on NSE & BSE, and the amount of data provided is mind-boggling. To read the huge data and take a policy decision is difficult and time consuming.

The system of CG has not really caught on in India except for a few companies. For example, Mr. Anil Ambani raised the issue when he fell out with his brother, Mukesh. He accused his brother of several CG failures. Subsequently, an arrangement was worked out between the brothers and the issues were pushed under the carpet. The issue is not only between the two, but also of several thousands of investors is involved.

Many Indian companies are controlled by families and it is tough to persuade them to change their style of functioning and adopt CG norms.

The Chartered Accountants Act, the Company Secretaries Act, and the Cost and Works Accountants Act provide the framework for taking disciplinary action against members. More often than not, disciplinary action is either not taken against auditors, or there is so much delay in bringing action against the auditors, that such action becomes irrelevant.

Sections 232 and 233 of the Indian Companies Act prescribe the penalties for any company's failure to comply with the provisions and section 233 sketches penalties for auditor's non-compliance. But unfortunately, the penalties are so trivial that they are unlikely to deter anyone from non-compliance.

Audit firms in India receive scanty remuneration, thus explaining why they engage in non-audit work.

An investigation of the board compositions of around 1,500 companies listed on the BSE shows that 58 individuals occupy over 10 directorship positions each in these firms, with several of them holding up to 15 directorial slots.

Views of World Bank:

According to World Bank, Indian companies' disclosure of financial information is still very poor & pressure from Indian investors to improve corporate transparency remains low. With the exception of a handful of large businesses houses, most companies do not follow international best practice in disclosing information to investors, despite reforms in Indian CG regulations. Apart from weak enforcement, the World Bank also cites a lack of interest from investors as a key reason for the failure of these laws to improve disclosure.

What are the advantages of good CG:

Good corporate governance helps an organization achieve several objectives and some of the more important ones include:

Making appropriate strategies that result in achieving stake-holder's objectives.

Attracting, motivating and retaining talent.

Forming a secure and prosperous operating environment and improving operational performance.

Managing and moderating risk and protecting and enhancing the company's reputation.

How can we improve CG in India:

According to a CG survey report by KPMG, whose participants were CEOs, CFOs & Directors of 90 leading companies in India, there are ways to improve CG by:

• 85% of the respondents think that the remuneration of CEO should be significantly linked to company performance.

• Most respondents believe that while steps at introducing the code of conduct and whistle blower policy have been introduced, there exists a significant need to enhance integrity and ethical values in the larger eco-system.

• 72% of the respondents believe that it is necessary for an independent and transparent process to evaluate performance of board members.

• 66% believe that exclusive sessions of independent directors are essential.

• 47% feel that the effectiveness of corporate governance should be monitored through audits by CG specialists.

Clause 49: This clause of the listing agreement with stock exchanges provides the code of CG prescribed by SEBI for listed Indian companies. With the introduction of clause 49, compliance with its requirements is mandatory for such companies.

According to the KPMG's report not many people believe that CG has/will improved significantly with the advent of clause 49. An excerpt from the report explains it well:

What most of the people do believe is that this clause can be significantly improved with slight modifications:

The penalties considered for improper CG are not strong enough to prevent people from unfair activities. The image below shows what experts believe:

One more factor for such a low level of confidence in the clause 49 is inefficient audit committees. People in the top management find these committees to be very laggard when compared to those in other developed & developing countries like China. Their view is:

The above graph clearly shows the level trust that high management people show in audit committees. This is also the reason for frequent corporate scams like Satyam, Citi bank etc.

Road ahead for India: In order to ensure a safer future, certain factors should be taken into account like:

Linking CEO rewards to performance: This will ensure better participation & care for shareholders on the part of CEOs.

Integrity and ethical values: Indian companies have been focusing on code of conduct and whistle blower mechanism as a fundamental of good governance. Still, majority of the people feel that although Indian companies give similar importance to integrity and ethical values, significant scope exists to enhance integrity and ethical values within the organization and the eco-system.

Improving corporate governance levels; some positive steps: Many people believe that an independent and transparent process to evaluate the performance of board members can improve CG. For this exclusive sessions should be conducted with independent directors, and board members related to the promoter group should not vote on the appointment of a director related to the promoter group.

Monitoring effectiveness of corporate governance: These CG policies should be monitored regularly & continuous improvements should be done to ensure they work effectively.

The graph below explains a similar need as felt by industry practitioners:

It is apparent that these trends would be strengthened by a variety of forces that are acting today and would become stronger in years to come:

Deregulation: Economic reforms have not only increased the growth prospects, but also they have made markets more competitive. This means that in order to survive companies will need to invest continuously on a large scale.

Disintermediation: Financial sector reforms have made it imperative for firms to rely on capital markets to a greater degree for their needs of additional capital.

Institutionalization: The increasing institutionalization of the capital markets has immensely enhanced the disciplining power of the market.

Globalization: This has exposed issuers, investors and intermediaries to the higher standards of disclosure and CG that prevail in more developed capital markets.

Tax reforms: Tax reforms coupled with deregulation and competition have tilted the balance away from black money transactions.

While these factors will make the capital markets more effective in disciplining the dominant shareholder, there are many things that the government and the regulators can do to enhance this ability:

Disclosure of information is the pre-requisite for the minority shareholders or for the capital market to act against sinful managements. The regulator can enhance the scope, frequency, quality and reliability of the information that is disclosed.

Reforms in bankruptcy and other related laws would bring the disciplining power of the debt holders to bear upon recalcitrant managements.

Large blocks of shares in corporate India are held by public sector financial institutions who have evidenced to be passive spectators. These shareholdings could be transferred to other investors who could exercise more effective discipline on the company managements.

Alternatively, these institutions could be restructured and privatized to make them more vigilant guardians of the wealth that they control.

Finally, to conclude, we can say that a lot of scope for improvement is available provided they come on time. For this to happen we should have good leaders who can ensure that these regulations are exercised & suitable actions are taken against defaulters as,

"Governance and leadership are the yin and the yang of successful organizations. If you have leadership without governance you risk tyranny, fraud and personal fiefdoms. If you have governance without leadership you risk atrophy, bureaucracy and indifference."

- Mark Goyder, Director of Tomorrow's Company