The previous chapter of thesis analyzed corporate governance reforms and development around the world sequel to scandals and crisis with an extensive discussion on the recent global financial crisis. This chapter situates and analyze corporate governance in India with contextual developments, reforms and contemporary state. Section 4.1 of the chapter gives brief overview of the of Indian economy and the prevailing institutional and regulatory framework of corporate governance in the country. In this section, the regulatory framework of corporate governance enshrined in the Clause 49 of Listing Agreement and Companies Act is undertaken in detail. Section 4.2 of the chapter examines historical perspectives of corporate governance in India from the pre - independence period till pre-liberalization time (prior to 1990s), tracing and analyzing governance models in the country and prevailing issues. Section 4.3 underscores corporate governance concerns and developments in the post liberalization period. Section 4.4 investigates the corporate governance inadequacies observed in the Satyam scandal. Section 4.5 gives review of corporate governance reforms undertaken in India in the sequel to Satyam scam and global financial crisis. The following section of the chapter (section 4.6) highlights corporate governance issues and concerns in the contemporary scenario in India. In the last section, summary and conclusions are presented.
4.1.1 Indian Economy : Brief Overview
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The Indian economy has grown robustly after initiation of liberalization and reform programs in 1991. India is one of the fastest emerging economy of the world with average growth rate of 8.5 % in last six years. India is 4th largest economy of the world in terms of purchasing power parity (PPP) with the Gross National Income (GNI) standing at 4.16 US $ trillion in 2010. In terms of gross domestic product (GDP), India is the 11th largest economy with a GDP of 1.727 US $ trillion. India forms the core of BRICS nations, and also included in the G20. Foreign investment in India has grown substantially from 3.5 US $ billion in 2000 to 24.16 US $ billion in 2010. It is one of the favored nation for foreign investment in the world after the China and US. The country'sÂ per capita income (GNI per capita) stands atÂ 3400 US$, which makes it a lower-middle income economy.
Table 4.1 Indian Economic Indicators 2005-2010
Gross Domestic Product ( GDP) (current US$ Billion)
GDP Growth (annual %)
Gross National Income , PPP (GNI)
(Current US$ Billion)
GNI growth (annual %)
GNI per capita, PPP
(Current US$ )
Gross Domestic Savings (% of GDP)
GDP per Capita (current US$ )
Exports of goods and services (current US$ Billion)
Imports of goods and services (current US$ Billion)
Trade (% of GDP)
Foreign Direct Investment (FDI) (current US$ Billion)
( Source: World Bank Database)
The Indian capital markets have grown steadily in last two decades after the liberalization of the economy. India has world'sÂ 8th largestÂ equity market with approximate market capitalization of all the listed amounting to 1.6 US $ trillion. India has an investor base of over 20 million shareholders, which is the third largest in the world after the US and Japan. There are about 5000 companies that are listed on the 22 Indian stock exchanges. National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are two major national stock exchanges of India, on which majority of equity transaction occurs. BSE is one of the world oldest (165 years) stock exchange, and has the most number of listed companies in the world after the New York Stock Exchange (NYSE). National Stock Exchange (NSE), operates with a fully automated screen based system and accounts for the most of trading volumes that occur in the country. The strength of Indian capital markets has grown over the years. In year 2010, the ratio of market capitalization of listed companies to the GDP stood at 93.56 % .
Table 4.2 Indian Capital Market and its Strength
Always on Time
Marked to Standard
Listed domestic companies, total ( on national stock exchanges)
Market capitalization of listed companies (current US$ Billion)
Market capitalization of listed companies (% of GDP)
S&P Global Equity Indices (annual % change)
Stocks traded, total value (current US$ Billion)
Stocks traded, total value (% of GDP)
Stocks traded, turnover ratio (%)
( Source: World Bank Database)
4.1.2 Institutional and Regulatory Framework of Corporate Governance in India
Institutional and regulatory framework determines the effectiveness of corporate governance in any country. Institutional framework sets precondition for corporate governance, and guides in promoting transparency and accountability. In India's institutional framework, there are three key players: the Ministry of Corporate Affairs (MCA); securities regulator, the Securities Exchange Board of India (SEBI); and two national level stock exchanges, the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). The Ministry (MCA) is primarily concerned with the administration of the Companies Act, 1956, other allied Acts and rules & regulations framed thereunder mainly for regulating the functioning of the corporate sector in accordance with law. The Ministry enforces the Companies Act, 1956 on both listed and non-listed through the Company Law Board (CLB) and through the courts. The SEBI established in 1992 under Securties Exchange Board of India Act of 1992 (SEBI Act), acts as a securities market regulator and looks after all the companies listed on the recognized stock exchanges. SEBI has independent statutory authority over securities regulation, but it is required to submit an annual report to the legislature. SEBI regulates the stock exchanges, stock brokers, share transfer agents merchant banks, portfolio managers, market intermediaries, collective investment schemes and primary issues (World Bank, 2004). SEBI guides the listed companies through its Listing Agreement, which contains rules and procedures that companies must follow to remain listed on a given stock exchanges. SEBI through its Listing Agreement, can introduce norms of corporate governance for the listed companies to follow. In India, there are two national level stock exchanges - the BSE and the NSE. These are self regulatory organizations, which are regulated and controlled by SEBI. The companies that seek to list on these exchanges are required to comply to with their respective Listing Agreement.
In addition to these key determinants of the institutional framework of corporate governance, there are few other important organizations. Reserve Bank of India ( RBI), Registrar of Companies (RoC), Competition Commission of India and Serious Fraud Investigation Office (SFIO) are other important organizations that play a crucial role in the corporate governance regime of India. Further, the Institute of Chartered Accountant of India (ICAI), a self regulatory government organizational undertakes to review the accounting standard and regulates financial reporting standards of Indian Companies. Along these, Institute of Companies Secretaries of India (ICSI) and National Foundation for for Corporate Governance (NFCG) are other important self regulatory organizations that address issues of corporate governance in India.
All listed companies in India are guided by the regulatory framework enshrined in the Companies Act, 1956 along with the rules and regulations of the prescribed in the SEBI Act 1992; the Securties Contrcat Regulation Act 1956; the Depositories Act, 1996; the Sick Industrial Companies Act (SICA), 1985 and the rules of Listing Agreement. However, corporate governance regulatory provisions of all the listed companies are mainly encapsulated in the Clause 49 of the Listing Agreement read along with the provisions of the Companies Act of 1956. The following part of this section makes reference to the stipulations of Clause 49 of Listing Agreement and the Companies Act 1956 that provide that provide the regulatory framework for the functioning of corporations in India.
188.8.131.52 Clause 49 of the Listing Agreement
Clause 49 of Listing Agreement constitutes the first formal statutory milestone in Indian corporate governance. This has been termed as 'watershed event in Indian corporate governance' and has 'established a new corporate governance regime' providing a structured corporate governance regulatory framework for Indian public listed companies (Afsharipour, 2009; Black & Khanna, 2007). This Clause was incorporated in the Listing Agreement by SEBI in 2000 based on the recommendations of the Birla Report. Initially introduced for BSE 200 companies on 31 March 2001, provisions of Clause 49 of the Listing Agreement were made mandatory in a phased manner, and companies' having paid up capital of Rs. 3 Cr was required to comply by the end of March 2003. In 2003, SEBI endorsed the recommendations of the Murthy Committee by incorporating them in Clause 49. On 1 January 2006 all listed companies came under its purview. Cardinal stipulations of the Clause 49 of Listing Agreement include:
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(1) Insofar as the Board of Directors of public listed companies are concerned, the following stipulations are mandated in Clause 49:
(ai) Companies having an executive director as Chairman must necessarily have half of the Board comprising of independent directors;
(aii) In other cases, the Board shall have at least one third independent directors;
(b) The criterion for "independence" includes (i) no pecuniary relationship or transactions with the company, its promoters, management & subsidiaries; (ii) no relationship with any of the Board members or with executives holding positions one level below the Board; (iii) no relationship with the company for at least the preceding three years. Directors nominated to the Board in pursuance of loan agreements by financial institutions shall be considered "independent";
(c) Companies to prescribe a Code of Conduct for Directors;
(2) With regard to "audit committees", the following are prescribed in Clause 49:
(a) "Audit Committees" shall consist of at least three directors, all of whom shall be financially literate with at least one of them having accounting or financial experience;
(b) At least two-thirds of the directors on the audit committee should be independent directors, one of whom shall be the Chairman of the Committee;
(c) The audit committee shall meet at least four times in a year and shall have the responsibilities of (i) reviewing the statutory and internal auditors and the internal audit function; (ii) supervising the company's financial reporting process, disclosures of financial information etc.
(d) The audit committee shall enjoy the powers of (i) investigating any activity that falls within its domain; (ii) seeking information from the employees of the company; (iii) seeking outside legal and professional advice as it may deem necessary etc.
(3) Clause 49 also mandates the following disclosure requirements for listed companies:
(a) Related party transactions;
(b) Accounting policies and any departures from standards;
(c) Directors' Remuneration and other forms of compensation;
(d) Instances of non-compliances for the preceding three years;
(e) The company's annual report to include a special chapter "Management Discussions & Analysis" that would explain the management's perspective in relation to industry structure & developments, future outlook for the business, opportunities and threats, existence and adequacy of internal control systems, segment & product wise performance etc.;
(f) Details of provisions of corporate governance that have been adopted by the company and explicit information on the non-compliance with any mandatory requirements and the justification therefore;
(g) Disclosure of the brief profile, areas of expertise and other directorships in respect of each candidate who is proposed to be inducted as a director;
(4) Clause 49 contains following provisions on internal control and certification:
(a) Financial statements, effectiveness of internal controls, legal transactions must be certified by the CEOs & CFOs who shall also inform the audit committee of any significant changes therein;
(b) Compliance with corporate governance mandates shall also be certified by the Company Secretary or the company's auditor.
(5) In addition, Clause 49 contains some non mandatory recommendations:
(a) Tenure of independent director not to exceed nine years in aggregate;
(b) Remuneration Committee comprised of non-executive directors;
(c) Half yearly financial disclosure to all shareholders;
(d) Training of board members;
(e) Evaluation of performance of non-executive directors;
(f) Unqualified audit reports;
(g) Whistle blower policy.
184.108.40.206 The Companies Act, 1956
The Companies Act, 1956 contains several provisions related to corporate governance but in an unstructured way, e.g. provisions in relation to the form and contents of prospectus (Sections 55-61, 64-67) and penalties for misleading statements therein (Sections 62-63, 68), form and content of the Annual Accounts and Returns (Sections 159-162, 209-216, 218-223), audit and auditors (Sections 224-233B), Directors' Report (Section 217), notice, agenda, time and place of various meetings (Sections 165-197, 285-290), appointment of directors (Sections 252-255, 257-260, 262, 265-266), their retirement by rotation (Section 256), their disqualifications (Section 274, 283-284), their transactions with the company (Sections 299-302), shareholder sponsored investigation into the affairs of the company by government agencies (Sections 235-247), prevention of oppression and mismanagement (Sections 397-409), etc.
Several corporate governance issues of importance, however, are left unattended in the Companies Act 1956, e.g. composition of the board, independence criteria for directors, minimum academic qualifications for directorship, etc. (Batra, 2006). Scant protection is provided to minority shareholders, for example, only in cases of oppression and mismanagement. There is also very modest focus on transparency and disclosures (Afsharipour, 2009; Companies Act, 1956; Varottil, 2010). In order to have some necessary corporate governance stipulation in the Companies Act 1956, it was amended by the Companies (Amendment) Act, 2000, which introduced many provisions relating to corporate governance, such as additional grounds of disqualifications for directors, setting up of audit committees, inclusion of director responsibility statement in the director's report and the introduction of the mandatory postal ballot for specified items of business in the general meeting ( Singh & Kumar, 2011).
4.2. Corporate Governance in India: Historical Perspective
This section looks into the historical perspective of corporate governance in India. The main aim of retracing and analyzing corporate governance of the past period is that it would help us with a sound understanding of the current issues and governance model of India. Corporate governance in India before liberalization period is analyzed by dividing into two parts. First part of the section examines corporate governance of pre-independent India, while the second part looks into post independent India till the start of liberalization programs (1990s).
4.2.1 Pre Independence Era: Colonial Period
Modern corporations of contemporary India owe their genesis to the colonial period. The "managing agency system" forms the bedrock on which these corporations evolved in the pre independence era (Bhasa, 2006; Mukherjee Reed, 2002). Over more than a century, with the advent of joint stock limited companies in the latter part of the 19th century, managing agencies dominated business scenario in India by virtue of their power, control and expertise.
"Managing agents or managing agencies" were the individuals or apex firms that through a legal contract with joint stock limited liability companies were delegated responsibility of managing it in lieu of return of certain commission (Bhasa, 2006; Mukherjee Reed, 2002). Managing agency system attracted several mercantile families in India, as allowed them to mobilize their small capital in various ventures and quickly earn profits without too much of the risk. Tatas, Birlas, Poddars, Singhanias, Dalmias, and Ruias were among few noted managing agencies in India (Bhasa, 2006). The " nexus between the managing agency and the business family established the structural basis for the family- controlled conglomerates that have dominated the Indian economy since independence" (Mukherejee Reed, 2002 p. 251).
Managing agents and agencies in colonized in India served three important corporate governance functions (Mukherjee Reed, 2002). Firstly, they promoted new companies with their own capital and as the company become successful, they would sell off most or all of the shareholdings, but would still retain the control through managing agency contract. Secondly, they acquired enough technical expertise and managerial experience to handle the administration and management of the company. Thirdly, managing agencies performed the role of attracting new investors for the firms and arranging capital for the company, especially in the period when credit system was still in infancy.
The managing agency system, where solved many of the corporate governance problems faced by corporations in that period of time, it also induced severe governance issues. The system gave rise to the vital governance issue in most of the corporations in today's context in the form of separation of ownership and control (Bhasa, 2006). Managing agencies were able control the corporations even with low equity base, by interlocking directorship on the board, intercorporate investment, or through managing agency contract (Goswami, 2002; Gollakota & Gupta, 2006; Muhkerjee Reed, 2002; Sehgal & Mulraj, 2008). Managing agencies' control rights sufficiently exceeded their ownership or cash flow rights (Chakrabarti et al., 2008; Goswami, 2002). The agency contract corporation entered with managing agencies favored excessive power to the managing agencies allowing them to pursue governance anomalies. "Managing agents quite blatantly violated the basic rights of the shareholders, and sought consciously to exclude them from having any effective voice in which firms were run " ( Rungta 1970 as cited Mukherjee Reed, 2002 p. 252). Managing agencies were involved corporate governance misdemeanors, where they were able to tunnel money from a profitable business expropriating the shareholders, turning them loss-making to start a new venture ( Bhasa, 2006). Interlocking directorship that could have served the governance purpose, were in contrast were central to the corporate malaise.
The corporate governance, however, in the pre-independence period was good and comparable with many industrialist nations of that time. Colonized India had well developed corporate law, functioning stock exchanges, relatively stable banking system, as being part of the English colony (Chakrabarti, 2005; Goswami, 2002). The Indian Companies Act, was promulgated as early as 1866 and revised in 1882 and 1913, that provided sound ground for the functioning of both private and public companies. Laws were also placed to deal with activities of trusts and banks ( Rungta, 1970; Sharma, 2012). There were four developed stock exchanges at Mumbai, Kolkata, Ahmadabad and Chennai, with prudent norms for stock trading (Goswami, 2000). By independence, there 800 listed firms on stock exchanges, so equity culture well developed among India population (Goswami, 2002). The banking system was also relatively stable, with most of the banks being private.
India, at time independence, had sizeable corporate sector that contributed about 10% of GDP ( Goswami, 2002). The corporate laws, banking system and stock exchanges, all were relatively sound by the end of 1947. Managing agency system, provided its own advantages, but that also along several governance issues and instances. India, therefore, at time of decolonization, was having a relatively good state of corporate governance and the economy (Howson & Khanna, 2010). But, this advantage was squandered in the period after that of independence, which is explained in the next part of this section.
4.3.2 Post Independence Era: License Raj Period
India, after its independence in 1947 from the British rule was led by Pandit Nehru, who turned left to pursue a socialist approach to development. The era after independence till 1991, when liberalization started, was marked by heavy regulation and 'established a tightly controlled regime covering almost all the aspects of corporate management' (Armour & Lele, 2008). The socialist accent of the country's governance in the 1960s led to an era of thicket regulation called "License Raj" in which only large companies managed to survive (Chakrabarti et al., 2008; Gollakota & Gupta, 2006). During License Raj period, the business house model graduated over the managing agency system, with the latter system finally dissolved in 1969 through amendment in the Companies Act, 1956 ( Bhasa, 2006; Sehgal & Mulraj, 2008). Leading managing agents of the pre - independence era, that were actively engaged in promoting the business, by virtue of their position, provided sound ground to become business conglomerates or "business houses" in independent India (Mukherjee Reed, 2002).
In India, soon after independence, a series of important laws and regulations were promulgated that significantly influenced the economic activities and corporate governance regime. This started with the enactment of Industries (Development and Regulation) Act, 1951, which mandated all the existing and proposed industrial units to obtain licenses for their operation and even for expanding their capacity (Goswami, 2002; Gollakota & Gupta, 2006; Khanna, 2010; Mukherjee Reed, 2002). Another impediment to free business activities was Industrial Policy Resolution of 1956, which granted exclusive right to Government in 17 industries. Along with this, the Foreign Exchange Regulation Act and the Import and Export Control Act of 1947 imposed serious restriction of foreign exchange and import and export. Import substituting industrialization (ISI) based government policy, which was based "License Raj System" created a regime protected market that bolstered excessive rent seeking, corruption and unethical nexus between bureaucracy and business elites (Goswami, 2002; Howson & Khanna, 2010; Mukherjee Reed, 2002; Reed, 2002). Domestic business was highly protected, insulated from the foreign competition, with obligations of seeking a license for manufacturing products that promoted uncompetitive markets with no incentive for efficient operations, which provided a fertile ground for corporate mis-governance in post-colonized India (Goswami, 2002; Howson & Khanna, 2010; Sehgal & Mulraj, 2008).
This era was marked by the development of Public Financial Institution (PFIs) as capital markets remained nascent and illiquid due to government control and regulation (Chakrabarti et al., 2008). The country lost the advantage of having one of the oldest stock exchanges (BSE), by setting up the office of Controller of Capital Issues (CCI). It determined the equity prices for new issuances based on a preset formula, by which issue prices were set so low that there remained no incentive to good corporate governance for higher market valuation through equity (Sehgal & Mulraj, 2008). The regulated capital market limited private investment through equity. The focus during the period was on debt financing through government owned financial institutions (Howson & Khanna, 2010). The government established three PFIs during this period: the Industrial Financial Corporation of India ( IFCI); the Industrial Development Bank of India ( IDBI), and the Industrial Credit and Investment Corporation of India (ICICI). These PFIs along with another 30 State Financial Corporations catered the need of industrial credit to corporations (Goswami, 2002; Chakrabarti et al., 2008). Government, in this period, also established insurance and mutual fund investment institutions like Life Insurance Corporation of India (LIC), Unit Trust of India (UTI) and General Insurance Corporation (GIC) of India. These institutions held a significant block of shares of the corporations, in which invested. In 1970s, Government nationalized all banks and rein control over the entire banking system. Therefore, in post independence era, the entire financial system was commanded by the Government, impounding several corporate governance problems.
The PFIs supplied credit to companies without having enough incentive to monitor the management as these were appraised based on the amount of credit sanctioned rather than quality of credit (Howson & Khanna, 2010). Financial institutions having a substantial equity stake can instigate nominee directors on the board for monitoring the management of the company. However, as mentioned earlier, with no incentive nominee directors remained a passive observer, and acted only as rubber stamps. The tradition of large borrowings from financial institutions led to a higher debt equity ratio, a ratio in excess of 2.5 to 1 was common during this regime. The inept monitoring by PFIs with high debt equity raised the moral hazard problem of governance in corporations (Howson & Khanna, 2010). The promoters, with even small equity, controlled the corporations, and easily recouped their investment from the firm within one or two years its instigation. This was motivated by regulatory model that had a mishmash of high taxes and low valuations, which offered little enticement for companies and their promoters to show higher profits and enhance shareholder value (Singh, Kumar & Uzma, 2010). So, most of the promoters were involved self-dealing transactions, expropriating shareholder rights, making the business unviable in the following years after recovery of their initial investment. Therefore, in post, independence period, indirect state ownership with inept monitoring against the backdrop of implementation of poor bankruptcy laws bolstered pervasive corporate mis-governance (Goswami, 2002; Sehgal & Mulraj, 2008).
In post-independence era, Companies Act, 1956 and Securities Contract Regulation Act (SCRA), 1956 endowed the regulatory and legal framework for operation of companies (Singh & Kumar, 2009). The corporate boards were governed by framework listed in section 252 to 269, but they were very minimal in some regard as compared to the laws of the developed countries. It was very opaque in terms of disclosure and transparency norms, and provided very little protections to minority shareholder. The Institute of Chartered Accountants in India (ICAI) was not having right of legal enforcement, which resulted in noncompliance with disclosure. The companies Act under its statutory framework of corporate governance provided protection to shareholders against oppression and mismanagement only. However, these laws were not able to protect the right of minority shareholders in real terms, who were more often than not defrauded by companies (Chakrabarti, 2005). The expropriation of minority shareholders' rights was common, facilitated by lax oversight by nominee directors of financial institutions and inadequate legal provisions (Goswami, 2002). These inadequate laws let company promoters have friends and allies on the board. "Boards of directors have largely been ineffective in India in their monitoring role, and their independence is more than not highly questionable" (Chakrabarti et al., 2008 p. 63). Directors' fee was regulated and board meetings were mere routine exercises (Sehgal & Mulraj, 2008). Laws were inadequate to protect the rights of creditors. During this period, "governance structures were opaque as financial disclosure norms were poor" (Varottil, 2009). Non-compliance with disclosure norms was common and not punished (Chakrabarti, 2005). In essence, corporate governance during this era was hallmarked by a scanty and inconsistent legislative framework, weak enforcement machinery with consequential poor compliance and an even poorer prosecution/conviction rate (Goswami, 2002).
Thus, in the post - independence era, the License Raj period, corporate governance in India aggravated, manifested by the emergence of government as important owner and detrimental economic policies (Gollakota & Gupta, 2006). The problem of corporate governance seeded by managing agency system in colonized period got worse partly by dysfunctional supply and monitoring of capital by Government backed PFIs, and partly by inadequacy in legislation, and its enforcement. The pervasive corporate mis-governance prevalent in the License Raj Period, seriously set back the whole economy leading to economic crisis in early 1990s, forcing the country to carry economic liberalization.
4.3 Corporate Governance in Post Liberalization Period : Era of Reforms
4.3.1 Economic Crisis, Scandals and Impetus for Corporate Governance Reforms
The inefficiency prevailing in the country resulted in the poor economic performance of the country and finally took the form of the economic crisis of 1990, with huge fiscal deficit, low foreign exchange reserves and large number of loss making public sector undertakings (Kumar & Singh, 2011). The economic pressures arising in the early 1990s marked by failure of the business house model of governance provided the necessary impetus for government to change its policies of "License Raj" period (Afsharipour, 2009; Mukherjee Reed, 2002; Reed, 2002). The economic crisis of 1991, forced the Indian government to turn towards the International Monetary Fund (IMF) and the World Bank to get out of this crisis. "As a condition of renegotiating loans, international finance body imposed structural adjustment programs"â€¦â€¦â€¦ that "included a variety of features that induced a move to an Anglo-Saxon model of governance" (Reed, 2002, p. 230). Indian government carried several reform activities, such as - opening up of the financial sector, reduced control on the import and its tariffs and allowance foreign equity in certain sectors, to liberate the economy by dismantling existing control regime that it was following (Chakrabarti et. al, 2008; Gollakota & Gupta, 2006; Goswami, 2002).
The economic liberalization of the country followed with a series of corporate scandals and frauds. First in the series was Harshad Mehta securities market scam of 1992, involving several banks with an estimated loss to the tune of Rs 100 thousand Cr (Sehgal & Mulraj, 2008). This followed by burst of cases (in 1993) involving unfair governance practices of issuing preferential shares to promoters of company at heavily discounted prices, and the disappearing companies' fraud (in 1993). In the preferential share allotment scam, retail investors lost about Rs 5 thousand Cr, whereas 3911 companies vanished after raising Rs 25 thousand Cr from the capital market even without starting their business (Sehgal & Mulraj, 2008). Both the scandals greatly shattered shareholder confidence, where they lot of money. Ketan Parikh scam of 2001 and the failure of UTI in 2001, again shocked investors, which ushered in capital market reforms rapidly and focused attention on corporate governance norms (Chakrabarti et al., 2008; Goswami, 2002; Mchold & Vasudevan, 2004; Sehgal and Mulraj, 2008)
The economic crisis immediately followed securities market scam (Harshad Mehta scam) underscored the urgent need for significant overhaul of corporate governance system in the country (Afsharipour, 2009). A comprehensive overhaul of the financial sector regulatory structure was carried out in the 1990s with a view to make it compatible with the liberalization/globalization program of the government. Radical transformations included the abolition of the office of CCI and the induction of the free market-pricing regime for security issues. Simultaneously, therewith, an autonomous board christened in 1992. "The Securities and Exchange Board of India (SEBI)" was formulated pursuant to the enactment of the SEBI Act with the objective of establishing a single window overseeing mechanism for all aspects of securities market operations. Establishment of SEBI was a major step towards step reforming and improving corporate governance in the country in time to come.
4.3.2 First Phase of Anglo-American Based Corporate Governance Reforms
The concern for corporate governance following the spate of scams, coupled with urgency to deal with increased competition due to globalization and international developments (instigation of corporate governance code like Cadbury Report) attracted both industry and regulators to carry out corporate governance reforms in the country (Chakrabarti et al., 2008). These reforms channeled through different routes by different agencies and fraught with significant conflict were aimed at improving corporate in India, and certainly guided by Anglo-American corporate governance philosophy. Here, a brief discussion on first phase of corporate governance reforms, precursor to Satyam scandal is presented.
220.127.116.11 Desirable Corporate Governance: A Code (CII Code, 1998):
The CII Code, a voluntary corporate governance code, emanated in April 1998 from the recommendations of the task force set up by the Confederation of Indian Industry (CII) in 1996. The said code, based on the Anglo-American system of corporate governance, contained detailed governance provisions for listed companies with a focus on the relationship between the Board of directors of the company and its shareholders (Afsharipour, 2010). However, being voluntary in its implementation, it did not prove to be as audacious as envisaged (Singh & Kumar, 2009).
18.104.22.168 Kumar Mangalam Birla Committee (Birla Report, 1999)
The Kumar Mangalam Birla Committee was constituted by SEBI on April 7, 1999 to recommend on the introduction of a mandatory corporate governance code. The committee was of the view that "strong corporate governance is indispensable to resilient and vibrant capital markets and important instrument of investor protection" (Birla Report, 1999).The Birla Committee's recommendations were again, on the lines of the US corporate governance framework, especially influenced Blue Ribbon Committee guidelines on independent directors.The report provided statutory directives relating to the structure and functioning of corporate boards (with emphatic provisions on the induction of "independent" directors on the boards, as also the criterion by which such "independence" needs to be assessed) and disclosures to shareholders. The report suggested the incorporation of a separate section in the corporate annual reports comprising of "Management Discussion & Analysis" as well as the constitution of a Committee under the Chairmanship of a non-executive director to look into shareholders' grievances received by the company.
The recommendations of the Birla Committee soon saw the light of day with SEBI responding by amending the Listing Agreement, incorporating therein Clause 49 in less than five months. This clause constituted the first formal statutory milestone in Indian corporate governance (Black & Khanna, 2007).
22.214.171.124 Naresh Chandra Committee (Chandra Report, 2002)
Sequel to the enactment of the SOX Act in the US after some profile scandals, Government of India, Department of Company Affairs constituted a Committee under the Chairmanship of Shri Naresh Chandra to look into the reformation of the Companies Act, 1956 with a view to strengthening the corporate governance provisions of the said Act. The said Committee made several recommendations primarily aimed at streamlining the provisions of the Act relating to auditors and auditing with important one focusing on disqualification of auditors, rotation of audit partners, type of services an auditor can render. It also addressed certain issues of disclosures in communications between the company and its members. However, the recommendations of the Chandra Committee never found their way into the statute book, but some were included in Clause 49 of the Listing Agreement on the recommendations of the Murthy Report (Dalal, 2003).
126.96.36.199 Naryana Murthy Committee (Murthy Report, 2003)
The Securities Exchange Board of India ( SEBI) in response to the constitution of the Chandra Committee by MCA, formed a parallel Committee under the Chairmanship of Shri N R Narayanamurthy with terms of reference substantially overlapping with the Chandra Committee in 2002. The Murthy Committee was constituted, ostensibly in the backdrop of the Enron & WorldCom scandals in the US in that year, to advise on the adequacy and efficacy of the provisions of Clause 49 of the Listing Agreement, and to suggest measures for the improvement of the prevailing corporate governance practices with a view to "enhancing the transparency and integrity of the Indian stock markets". It was also directed to recommend measures so that Indian corporates adhered to the corporate governances, not merely in letter but also in spirit.
The Murthy Committee submitted its report on February 8, 2003. Some of its recommendations were radical with far reaching ramifications. The prominent ones include (a) the strengthening of the definition of "independence" in context of Board members; (b) "nominee directors" i.e. directors nominated by financiers in pursuance of loan agreements be not considered as "independent directors" and be subject to the same responsibilities & liabilities as normal directors; (c) enhancing and redefining the constitution and the role of "audit committees"; (d) protection of whistle blowers etc.
As in the case of the Birla Committee, the Murthy Committee recommendations were also rapidly introduced into the corporate governance code through the amendment of Clause 49 of the Listing Agreement. In particular, the upgraded provisions in relation to the corporate boards, audit committees, transparency, disclosures and certifications as advocated by the Murthy Committee were assimilated in Clause 49.
188.8.131.52 JJ Irani Committee (Irani Report 2004)
Sequel to the implementation of the views of the Murthy Committee through amendments in Clause 49 of the Listing Agreement, the MCA constituted another Committee in December 2004 under the Chairmanship of Shri J J Irani to make its presence felt. The mandate to the Committee was to revamp and reorganize the Companies Act, 1956 with a view to incorporating therein the internationally acknowledged best practices in this regard. The Irani Committee came up with several recommendations that were in conflict with the extant Clause 49 of the Listing Agreement and/or the views of the Murthy Committee e.g. (a) providing for several exemptions based on size and extent of public ownership in a mandatory corporate governance framework so as to optimize compliance costs, while maintaining a desired level of regulatory rigour; (b) the criteria for "independence" of "independent directors" is proposed to be weakened significantly; (c) the mandatory requirement of independent directors to constitute one-half of the Board be weakened to one-third of the total members of the Board (d) abolition of age limits for independent directors that were prescribed by the Murthy Committee (Irani Committee, 2005).
184.108.40.206 Companies Bill, 2009
The Irani Committee submitted its report on May 31, 2005. Concurrently, the MCA had introduced a 'Concept Paper on new Company Law' through its website on 4th August, 2004 inviting comments from various sections of the society. In conjunction with inputs received from the Expert Committee & several other sources that included the Ministry of Law, the MCA set about the task of a comprehensive revamping of the Companies Act, 1956. The efforts culminated in the introduction of the Companies Bill, 2008 in the Lok Sabha on October 23, 2008 in the 14th Lok Sabha. The Bill was subsequently referred to the appropriate Parliamentary Standing Committee on Finance for examination and report. Before the said Committee could present its report, 14th Lok Sabha was dissolved and the Companies Bill, 2008 lapsed under the provisions of clause (5) of Article 107 of the Constitution of India. In view of this, the Companies Bill, 2009 was introduced in Parliament on August 5, 2009, without any change in the earlier version of 2008.
4.3.4 Evaluation of Anglo-American Based Corporate Governance Reforms
The reforms introduced by Clause 49 of the Listing Agreement have improved the overall state of corporate governance in the country (Patibandla, 2006). Black and Khanna (2007) analyzed the effect of Clause49 of Listing Agreement as a measure of good corporate governance through an event study method . They report share prices of most affected companies increased by almost 4%, when SEBI introduced Clause 49 of the Listing for compliance (Black & Khanna, 2007). Balasubramanium , Black & Khanna (2008) in their study conducted on 370 firms for the year 2006 find that better governed firm had higher valuations ( Tobin's Q). Dharmapala and Khanna (2008) find that corporate governance reform through the implementation of Clause 49 of Listing Agreement had substantially increased firm value. Further, they conclude that reformative effects of the 2004 amendment to Clause 49 were more pronounced than those of its initial adoption due to enhanced sanctions and enforcement provisions for non-compliance with Clause 49 (Dharmapala & Khanna, 2008). The Indian corporate governance framework has also been gauged on OCED Principles of Corporate Governance in World Bank Report (2004) on the Observance of Standards and Codes. The report states that India has come a long way by introducing reforms and overhauling its corporate governance framework. The developments over this period have "improved the level of responsibility/ accountability of insiders, fairness in the treatment of minority shareholders and stakeholders, board practices and transparency". A study by ICRA (2005) has also reported that corporations have made sound progress in their governance practices that may be benchmarked against practices in the developed world.
The inadequacy and inefficacy of the corporate governance framework of India come out with massive corporate disaster at Satyam Computers. The fiasco at Satyam has brought into limelight the inherent shortcomings in the present corporate regulatory system. The next section analysis of corporate fraud at Satyam, and corporate governance failure implicated there upon.
4.4 Satyam Scandal: the Massive Financial Scam
Satyam Computers Services Limited (Satyam) was founded by B Ramalinga Raju in 1987, to provide services in the Information Technology (IT) sector. It soon prospered to become the country's fourth largest software company with a customer base spread across 66 countries. Stocks of Satyam were traded on the Bombay Stock Exchange (BSE), National Stock Exchange (NSE), New York Stock Exchange (NYSE) and Euronext (Amsterdam, Europe). Satyam featured at the 185th rank in the list of Fortune 500 companies at the time of the fiasco (The Economist, 2009).
'Satyam' that means 'truth' in Sanskrit, is the India largest accounting fraud, which by many termed as 'India's Enron' (The Economist, 2009). In a shocking confession, Satyam's Chairman B Ramalinga Raju, in his letter of January 7, 2009, unveiled the biggest corporate fraud in the history of India with manipulations involving direct monetary implications of Rs. 7,136 Cr. Further revelations by the Central Bureau of Investigation (CBI) sequel to their inquiries this figure extended to Rs. 12,000 Cr. Besides, investors in Satyam have lost not less than Rs. 14,000 Cr as per the new disclosures (Tellis, 2009). In this backdrop, a brief overview and facts are presented about how the Satyam fraud precipitated, and where were governance failure.
4.4.1 Revisiting Satyam Fiasco
On December 16, 2008, the Satyam Board met to decide on the investment of US $1.47 billion in Maytas Properties and Maytas Infrastructure, both closely held companies under the controllership of Ramalinga Raju (also Chairman of Satyam) and engaged in the completely unrelated business of real estate development. The proposal was cleared by the Board which had more than 50% representation of non-promoter directors on the Board. However, this Board decision evoked a massive adverse reaction at the bourses and the company's stocks plummeted on the US stock exchanges. Market analysts perceived the proposal as a strategy to siphon off resources from Satyam into family-run business ventures. This created panic at the company's headquarters and the proposed investment was called off at a reconvened meeting of the Board on the same day (Garg, 2008). The next two days witnessed hectic activity at Satyam's headquarters. Four directors on the Board that included the non-executive director Krishna Palepu and three independent directors Mangalam Srinivasan, Vinod Dham and M Rammohan Rao, all respected personalities in corporate circles, tendered their resignation. It was later revealed that it was the last ditch effort of saving Satyam through the Maytas deal. It boomeranged on Raju and the corporate demise of Satyam was inevitable and imminent. Raju had exhausted all his options leading to his confessional statement while tendering his resignation from the Board (India Knowledge@Wharton, 2009).
Raju's resignation was immediately followed by that of Satyam's CFO, Srinivas Vadlamani. Ramalinga Raju and his brother, Rama Raju, the Managing Director of Satyam, were arrested on January 9, 2009. Satyam's Board was disbanded by the Government of India acting through the Company Law Board. An interim Board was appointed in proceedings on January 9/10/11, 2009 and an investigation into the affairs was initiated by the SEBI. Committed efforts by the interim Board to find an appropriate suitor bore fruit and the deck was cleared for the takeover of Satyam by Tech Mahindra, in April 2009 (Singh & Kumar, 2009).
4.4.2 Corporate Governance Failure at Satyam Computers with Reference to Existing Regulatory Framework
An intriguing, rather paradoxical perspective of the failure of corporate governance at Satyam is provided by the fact that Satyam was awarded the 'Golden Peacock Award' in 2008 for global excellence in Corporate Governance. The award, however, was taken back after precipitation of the fraud at Satyam.
The Satyam scandal seriously called into question the efficacy of all effective mechanisms of corporate governance. 'Satyam' signified a complete decimation of not only the Indian corporate governance framework, but also the contemporary statutory listings on accounting and auditing. To put the above reality in perspective, it is opportune at this point to reproduce an extract of the infamous letter of Raju dated January 7, 2009 addressed to Satyam's Board (The Financial Express, 2009):
1. The Balance Sheet carries as of September 30, 2008
â€¢ Inflated (non-existent) cash and bank balances of Rs. 5,040 Cr (as against Rs. 5,361 Cr reflected in the books),
â€¢ An accrued interest of Rs. 376 Cr which is non-existent,
â€¢ An understated liability of Rs. 1,230 Cr on account of funds arranged by me,
â€¢ An over stated debtors position of Rs. 490 Cr (as against Rs. 2,651 [Cr.] reflected
in the books).
2. For the September quarter (Q2) we reported a revenue of Rs. 2,700 Cr and an operating margin of Rs. 649 Cr (24% of revenues) as against the actual revenues of Rs. 2,112 Cr and an actual operating margin of Rs. 61 Cr (3% of revenues). This has resulted in artificial, cash and bank balances going up by Rs. 588 Cr in Q2 alone. While admitting the fraud in his resignation letter, Raju asserted that he and his brother Rama Raju had obtained no financial benefit from the overstated revenues. He also claimed that other board members were not aware of the true position of the company. The following extract of his letter reveals how all this started and why he has made the self-confession (The Financial Express, 2009):
"The gap in the Balance Sheet has arisen purely on account of inflated profits over a period of the last several years (limited only to Satyam stand-alone, books of subsidiaries reflecting true performance). What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years. As the promoters held the small percentage of equity, the concern was that poor performance would result in a takeover, thereby exposing the gap. The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with real ones. It was like riding a tiger, not knowing how to get off without eaten."
The charge sheet filed by CBI estimated the quantum of deception at Rs. 11,875 Cr, having found evidence of siphoning of additional Rs. 4,739 Cr by the Rajus' through (The Hindu Business Line, 2009):
â€¢ Pledging of shares: Rs. 1,931 Cr;
â€¢ Offloading of shares: Rs. 748 Cr;
â€¢ Forged board resolutions to secure loans and advances: Rs. 1,220 Cr;
â€¢ Dividends on highly inflated profits: Rs. 230 Cr;
â€¢ Fake customers and fake invoices against these customers to inflate revenues: Rs. 430 Cr;
â€¢ Falsification of accounts: Rs. 180 Cr.
As discussed previously, the Indian corporate governance regulatory framework (predominately, the Clause 49 of the Listing Agreement) in the country is administrated through four important limbs: (1) Corporate Board with independent directors; (2) Audit Committees with appropriate overseeing functionalities and powers and Auditors; (3) Transparency and disclosures; and (4) certification of financial statement and accountability. Administration of the corporate governance regulatory framework is usually manifested through statutory provisions dictating the implementation of this set of axioms. Therefore, the failure of corporate governance at Satyam is here examined with reference to each of these premises.
220.127.116.11 Corporate Board and Independent Directors (IDs)
The scandal at Satyam Computers put the concept in 'Independent Directors' as a device of administering corporate governance to serious scrutiny. Satyam had duly complied with the provisions of Clause 49 of the Listing Agreement insofar as they relate to independent directors. The Satyam Board comprised of 9 directors, of which majority were independent directors. Infamous Satyam Board ( end of 2008) consisted of following directors (Varottil, 2010) :
(1) B. Ramalinga Raju, Promoter Chairman;
(2) B. Rama Raju, Managing Director and CEO
(3) Ram Mynampati, Whole time Director;
Non-Executive, Non-Independent Directors:
(4) Prof. Krishna G. Palepu, Professor of Business Administration at Harvard Business School;
(5) Dr. Manglam Srinivasan, visiting professor at US universities;
(6) Vinod K Dham, Vice President and General Manager at Broadcom Corporation;
(7) Prof. M. Rammohan Rao, Dean, Indian School of Business;
(8) T.R. Prasad, former Cabinet Secretary, Government of India;
(9) Prof. V.S. Raju, former Director, IIT Madras.
The Satyam board, therefore, comprised of eminent persons. It consisted of six were non-executive directors (out of which, five were independent directors), four of them were academicians, one former Cabinet Secretary and one former CEO of a technology company. Analysts commented that the passivity of these directors in the occurrences at Satyam can, at best, be described as callous negligence bordering on 'collusion' with the perpetrators of India's largest corporate fraud. The following points were raised to support the above argument of negligence.
Investigations revealed that Raju and Co., were dishing out fabricated accounts to the Board for the last six years (Aneja, 2009) and yet there subsists no evidence of any adverse recording by any of the directors including the independent directors.
The proposed investment in Maytas that was placed for consideration at the Board meeting of December 16, 2008 had sufficient ingredients to arouse the curiosity (read suspicion) for the following reasons (Prasad and Srinivasan, 2008; and Chandrasekhar, 2009):
a) The ownership structure of Maytas (both investee firms were closely held companies promoted by family members of Ramalinga Raju);
b) The investee companies were engaged in the business of real estate development that could not, even by extended imagination, be expected to lead to synergistic benefits;
c) The sheer magnitude of the investment (being US $1615. 11 million);
However, there seems to be no record of any of the Board members having expressed any reservations about the deal or otherwise qualified his opinion thereon ( Varottill, 2010).
â€¢ The meeting at which the impugned deal was adopted was convened at a three day advance notice and the agenda thereof was circulated only half a day earlier (Reddy & Mohan, 2009). Listing guidelines, therefore, do not seem to be adhered to. Further Nevertheless, the directors seemed to be unfettered by the antics of Raju;
Whether the proposed deal attracted the provisions of Section 293 and/or Section 372 read with Section 17 of the Companies Act, 1956 would have depended on the various specific parameters elucidated therein. All the same, 'good governance' unambiguously decrees that deals of such dimensions that would significantly, if not completely, reshape the destiny of the company, should go to the shareholders for affirmation. However, the Board seemed to have been kowtowing the promoters' line (who, incidentally, held only about 3.6% of the company's shareholding as on January 07, 2009) to the detriment of millions of other stakeholders of the company (Aneja, 2009).
18.104.22.168 Auditing and Accounting
India's corporate sector is regulated by a set of well-structured accounting and auditing provisions for compliance, administered through the Companies Act, 1956, Accounting and auditing standards/pronouncements of the ICAI, Guidelines on disclosures and investor protection issued by the SEBI, and extensive provisions of the Clause 49 of Listing Agreement (for companies listed on stock exchanges).
Despite all these plethora of statutes, rules, regulations, procedures and guidelines, Mr. Raju was able to siphon off thousands of crores of rupees by falsification of accounts that included reporting non-existent bank balances, interest receipts that were never received, fake customer billings, borrowings on fabricated board resolutions with the consequential reporting of non-existent assets of equal magnitudes (The Financial Express, 2009, The Hindu Business Line, 2009). All this was done under the auditorship of Price Waterhouse Coopers (PWC), an auditing firm with international credentials-the manipulations are believed to have extended over a seven year period at least (Outlook India, 2009). Two partners of PWC have been arrested for their involvement in the scam (Express India, 2009). The dimensions and modus operandi of the fraud is a clear indicator of the culpable intentions of the auditors, commented the analysts. It is emphasized here that exceeding a certain threshold should necessarily be taken cognizance of, as 'culpable', particularly so, when such negligence leads to detriment and damage to the property of millions of people worldwide.
With the role of the statutory auditors being suspected, it is not surprising that the 'internal control machinery' also failed completely. Indian corporate laws envision an elaborate 'internal control' setup through the internal audit framework. In fact, the system has been recently strengthened through the enactment of Section 292A of The Companies Act, 1956 mandating the constitution of 'audit committees' comprising of independent directors to augment the overseeing network of accounts and audit. These audit committees are vested with powers equivalent to those of auditors, and can examine all documents, vouchers as well as question the personnel of the enterprise. Unfortunately, i.e., the Satyam fiasco presents an assemblage of 'failures and collusions' with the internal auditors and audit committees being miniscule constituents thereof.
22.214.171.124 Disclosure and Transparency and Accountability
The transparency and disclosure were of significant concern at Satyam scandals. All information of significance bequeathed to the Board, the auditors, audit committees, statutory authorities (SEBI and Registrar of Companies) and the stock exchanges was found to be fabricated. There was another related aspect to this and that was the inadequacy of the disclosure norms, and the fallibility thereof in the hands of audacious corporate managers bent on hoodwinking the investing public for ulterior gains. By way of illustration, there was significant offloading of shares by Raju in the period between January 2001 to January 2009, bringing down his stake in the company from 25.6% to 3.6%, but this cardinal pointer was nowhere highlighted (Chandrasekhar, 2009; The Hindu Business Line, 2009). Interestingly, the company's top management offloaded 6.01 lakh shares in the financial year immediately preceding Raju's confession which also escaped the attention (Aggarwal, 2008).
Clause 49 of the Listing agreement mandates that the CEO and CFO certify the financial statements and the adequacy of internal control system in the company. It also stipulates filing of a corporate governance report duly certified by the company's auditors or a Company Secretary. All these provisions seem to have been duly complied with, in Satyam case- only that the duly certified statements were false. This provides testimony of the deterrent effect (or rather, the lack of it) that is encapsulated in the statutory provisions. Stated in plain words, the penalties for false certifications are grossly inadequate and carry little incentive to relinquish massive returns that accompany such frivolous certifications. The perpetrators of the fraud were unperturbed by the corporate governance enforcement mechanism of the country.
4.5 Corporate Governance in the aftermath of Satyam : Second Phase of Reforms
The scandal at Satyam computers, with several revelations of corporate governance shortcomings shocked both regulators and industry. It acted as catalyst to carry second phase of reforms in the country to address the lacunae. Both industry and regulators have initiated a number of efforts to reform corporate governance in the country. Here a brief overview of the second phase of reforms in the aftermath of Satyam in presented:
5.5.1 Industry Groups Response
The confederation of Indian Industry (CII), soon after, revelation of fraud at Stayam, began examining issues of corporate governance. It constituted a task force under the leadership of Shri Naresh Chandra, which made reforms several recommendations in late 2009. The CII task force observed Satyam as one of the case, and favored corporate governance reforms through voluntary way ( Afsharipour, 2010).
The National Association of Software and Service Companies (NASSCOM), too constituted a Corporate Governance and Ethics Committee head by Shri Naryana Murthy to underscore the need for reforms. The Committee submitted its report in 2010, making several recommendations, with emphasis on the audit committee, whistle-blower policy and protection of shareholder rights.
5.5.2 SEBI Initiatives
The SEBI constituted a Committee on Disclosure and Accounting Standards in November 2009 and issued a discussion paper to consider several proposals for improving corporate transparency. Based on this, SEBI amended the Listing agreement on April 5, 2010. The amendments included the appointment of CFO by the audit committee (Clause 49 of Listing Agreement), voluntary adoption of IFRS for consolidated financial reports, additional financial disclosure of half yearly balance sheet and insistence on peer review audit (Clause 41of the Listing Agreement). These changes are not substantial considering scope in improvement in corporate governance ( Afsharipour, 2010).
5.5.3 MCA Efforts of Reforms
Corporate Governance Voluntary Guidelines (2009) : MCA inspired by the industry efforts for corporate governance reforms, instigated a set voluntary guidelines on corporate governance on 24th December, 2009. The guidelines aimed at addressing issues of corporate governance and included several recommendations on board and independent directors, appointment and remuneration of directors, audit committee, auditors and whistle blowing mechanism for improving corporate governance in the country (Varottil, 2010). Some of the specific provisions of the this guideline for companies include: the separation of the office of the Chairman and the CEO; Consitution of nomination committee; Training and performance evaluation of the directors; Limitation of number of di