CORPORATE GOVERNANCE

PROJECT-1

COMPANIES BILL 2011 AND CORPORATE GOVERNANCE IN INDIA

SUBMITTED TO: SUBMITTED BY:

ACKNOWLEDGEMENT

I have taken efforts in this project. However, it would not have been possible without the kind support and help of many individuals. I am highly indebted to Miss Sujata Bali, my subject teacher for her guidance and constant supervision as well as for providing necessary information regarding the project & also for her support in completing the project.

CONTENTS

(1) ABSTRACT....................................................PAGE 4(2) INTRODUCTION TO THE TOPIC.............................PAGE 5(3) HISTORY AND EVOLUTION OF CORPORATE GOVERNANCE IN INDIA............................PAGE 6-12(4) CRITICAL ANALYSIS...............................PAGE 13-14(5) CONCLUSION.............................................PAGE 15-16

ABSTRACT

Corporate scandals involving companies like the Maxwell Group, Enron, WorldCom and the recent banking crisis have influenced the corporate governance norms in the United States, the UK and India. The Satyam computers scandal highlighted deficiencies in the Indian corporate governance regime and its implementation. This project examines the key differences between the corporate governance regimes in the UK and India and highlights the corporate governance issues relevant for Indian companies on the growth path.

INTRODUCTION

Corporate Governance is the interaction between various participants (shareholders, board of directors, and companys management) in shaping corporations performance and the way it is proceeding towards. The relationship between the owners and the managers in an organization must be healthy and there should be no conflict between the two. The owners must see that individuals actual performance is according to the standard performance. These dimensions of corporate governance should not be overlooked.Corporate Governance deals with determining ways to take effective strategic decisions. It gives ultimate authority and complete responsibility to the Board of Directors. In todays market- oriented economy, the need for corporate governance arises. Also, efficiency as well as globalization are significant factors urging corporate governance. Corporate Governance is essential to develop added value to the stakeholders.Corporate Governance has a broad scope. It includes both social and institutional aspects. Corporate Governance encourages a trustworthy, moral, as well as ethical environment.Whilst corporate regulations may lead in part to improve governance, which is mainly about how companies are directed and controlled, the prime responsibility for superior governance ought to lie within the company rather than outside it. For example, the balance sheet is the result of structural and strategic decisions and activities across the organization, from stock options to risk management, from the board of directors' composition to the decentralization of decision-making process.[footnoteRef:1] [1: Why We Need Corporate Governance, ByYahya Shakweh]

CG is known to be one of the criteria that foreign institutional investors are increasingly depending on when deciding on which companies to invest in. As far as corporate transparency is concerned, too few companies are genuinely transparent in the Middle East, thus the regional leaderships, board of directors as well as CEO's, are encouraged to voluntarily design good CG, that addresses the managements' concerns over government regulation and strict internal procedures and how it could adversely impact their ability to manage their business effectively. Investors, board members, and CEO's have to recognize the need for trade-off between enhancing corporate reputation and delivering growth.

HISTORY AND EVOLUTION OF CORPORATE GOVERNANCE IN INDIA

The evolution of Corporate Governance in India began in early 90s. The starting point was the recommendations of the Cadbury Committee Report after which followed various committees, leading to a formal Corporate Governance Code. This code was notified by Securities Exchange Board of India (SEBI) by inserting a new Clause 49 in the listing guidelines to the Stock Exchanges making it mandatory for the listing companies to follow the requirements of Clause 49 effective January 01, 2006. The major areas of compliance in Clause 49 are

Appointment of required number of independent directors Larger role of Audit Committee CEO/CFO Certification of Accounts (will become applicable for 2005-06 Accounts) Code of Conduct for Board / Senior Management Risk Minimization Report to the Board Legal Compliance Report to the Board Compliance relating to Subsidiary Companies Information items to Board

Global Landmarks in the Emergence of Corporate Governance

There were several frauds and scams in the corporate history of the world. It was felt that the system for regulation is not satisfactory and it was felt that it needed substantial external regulations. These regulations should penalize the wrong doers while those who abide by rules and regulations, should be rewarded by the market forces. There were several changes brought out by governments, shareholder activism, insistence of mutual funds and large institutional investors, that corporate they invested in adopt better governance practices and in formation of several committees to study the issues in depth and make recommendations, codes and guidelines on Corporate Governance that are to be put in practice. All these measures have brought about a metamorphosis in corporate that realized that investors and society are serious about corporate governance.

Developments in UK

In England, the seeds of modern corporate governance were sown by the Bank of Credit and Commerce International (BCCI) Scandal. The Barings Bank was another landmark. It heightened peoples awareness and sensitivity on the issue and resolve that something ought to be done to stem the rot of corporate misdeeds. These couple of examples of corporate failures indicated absence of proper structure and objectives of top management. Corporate Governance assumed more importance in light of these corporate failures, which was affecting the shareholders and other interested parties.As a result of these corporate failures and lack of regulatory measurers from authorities as an adequate response to check them in future, the Committee of Sponsoring Organizations (COSO) was born. The report produced in 1992 suggested a control framework and was endorsed a refined in four subsequent UK reports: Cadbury, Ruthman, Hampel and Turbull.Several companies, which saw explosive growth in earnings, ended the decade in a memorably disastrous manner. Such spectacular corporate failures arose primarily out of poorly managed business practices. The publication of a serious of reports consolidated into the Combined Code on Corporate Governance (The Hampel Report) in 1998 resulted in major changes in the area of corporate governance in United Kingdom. The corporate governance committees of last decade have analyzed the problems and crises besetting the corporate sector and the markets and have sought to provide guidelines for corporate management. Studying the subject matter of the corporate codes and the reports produced by various committees highlighted the key practical problem and concerns driving the development of corporate governance over the last decade.[footnoteRef:2] [2: A.C.Fernando (2006), Corporate Governance, Principles, Policies andPractices. pp 77, Pearson]

Corporate Governance Committeesa) Cadbury committee on Corporate Governance 1992[footnoteRef:3] [3: Cadbury Committee Report : A report by the committee on the financialaspects of corporate governance. The committee was chaired by Sir AdrianCadbury and issued for comment on (27 may 1992)]

The stated objectives of the Cadbury Committee5was To help raise the standards of corporate governance and the level of confidence in financial reporting and auditing by setting out clearly what it sees as the respective responsibilities of those involved and what it believes his expected of them. The committee investigated the accountability of the board of directors to shareholders and to society. It submitted its report and associated Code of Best Practices in 1992 wherein it spelt out the methods of governance needed to achieve a balance between the essential power of the board of directors and their proper accountability. Its recommendations were not mandatory. The Cadbury recommendations are in the nature of guidelines relating to the board of directors, non-executive directors, executive directors and those on reporting and control. The stress in the Cadbury committee report is on the crucial role of the board and the need for it to observe the Code of Best Practices. Its important recommendations include the setting up of an audit committee with independent members. Code of best practices had 19 recommendations. The recommendations are in the nature of guidelines relating to the board of directors, non-executive directors, executive directors and those on reporting. The stress in the Cadbury committee report is on the crucial role of the board and the need for it to observe the Code of Best Practices. Its important recommendations include the setting up of an audit committee with independent members.To reduce the power of executive directors in the boardroom the committee recommended a greater role for non-executive directors, changes in board operations, and a more active role for auditors.

b) The Paul Ruthman CommitteeThe committee was constituted later to deal with the said controversial point of Cadbury Report. It watered down the proposal on the grounds of practicality. It restricted the reporting requirement to internal financials controls only as against the effectiveness of the companys system of internal control as stipulated by the Code of Best Practices contained in the Cadbury Report.

c) Hampel CommitteeThe final report submitted by the Committee chaired by Ron Hampel had some important and progressive elements, notably the extension of directors responsibilities to all relevant control objectives including business risk assessment and minimizing the risk of fraud.The Hampel Report (Committee on Corporate Governance) in 1998 was designed to be a revision of the corporate governance system in the UK. The remit of the committee was to review the Code laid down by the Cadbury Report. It asked whether the code's original purpose was being achieved. Hampel found that there was no need for a revolution in the UK corporate governance system. The Report aimed to combine, harmonise and clarify the Cadbury and Greenbury recommendations.

c) The Greenbury Committee[footnoteRef:4] [4: Greenbury Committee Report (1994) investigating board membersremuneration and responsibilities]

This committee was setup in January 1995 to identify good practices by the Confederation of British Industry remuneration and to prepare a code of such practices for use by public limited companies of United Kingdom. The committee aimed to provide an answer to the general concerns about the accountability by the proper allocation of responsibility for determining directors remuneration, the proper reporting to shareholders and greater transparency in the process. The committee produced the Greenbury Code of Best Practice which was divided into the four sections: Remuneration Committee, Disclosures, Remuneration Policy and Service Contracts and Compensation. The Greenbury committee implement the code as set out to the fullest extent practicable, that they should make annual compliance statements, and that investor institutions should use their power to ensure that the best practice is followed. (CBI), in determining directors recommended that UK companies should use their power to ensure that the best practice is followed.d) The Turnbull Report" Internal Control: Guidance for Directors on the Combined Code" , published by the Internal Control Working Party of the Institute of Chartered Accountants in England and Wales - sets out how directors of listed companies should comply with the UK's Combined Code requirements in respect of internal controls, including financial, operational, compliance and risk management. Organisations that wish to be good corporate citizens, whether publicly quoted, privately owned or in the public sector, look to the Combined Code - and therefore to the Turnbull Report - for guidance on how to do this.e) UK Combined Code on Corporate GovernanceUK incorporated companies listed on the UK Stock Exchangeare subject to the Combined Code on Corporate Governance. The most recent (2003) version of the Code combines the Cadbury and Greenbury reports on corporate governance, the Turnbull Report on Internal Control (revised and republished as the Turnbull Guidance in 2005), the Smith Guidance on Audit Committees and elements of the Higgs Report. The Combined Code is, in 2006, subject to a review.
The Financial Reporting Council (FRC) is the independent UK regulator and is also responsible for the statutory oversight and regulation of auditors and of the professional accountancy and actuarial bodies. The UK Combined Code works on what is known as a Comply or explain basis; in other words, companiesmay choose not to comply with specific provisions but, in that case, will have to provide a proper public explanationof their decision. World Bank on Corporate GovernanceThe World Bank, involved in sustainable development was one of the earliest economic organization study the issue of corporate governance and suggest certain guidelines. The World Bank report on corporate governance recognizes the complexity of the concept and focuses on the principles such as transparency, accountability, fairness and responsibility that are universal in their applications. Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals. The governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible, the interests of individuals, organizations and society. The foundation of any corporate governance is disclosure. Openness is the basis of public confidence in the corporate system and funds will flow to those centers of economic activity, which inspire trust. This report points the way to establishment of trust and the encouragement of enterprise. It marks an important milestone in the development of corporate governance.

Corporate governance: History in India

There have been several major corporate governance initiatives launched in India since the mid-1990s. The first was by the Confederation of Indian Industry (CII), Indias largest industry and business association, which came up with the first voluntary code of corporate governance in 1998. The second was by the SEBI, now enshrined as Clause 49 of the listing agreement. The third was the Naresh Chandra Committee, which submitted its report in 2002. The fourth was again by SEBI the Narayana Murthy Committee, which also submitted its report in 2002. Based on some of the recommendation of this committee, SEBI revised Clause 49 of the listing agreement in August 2003. Subsequently, SEBI withdrew the revised Clause 49 in December 2003, and currently, the original Clause 49 is in force.

Recommendations of various committees on Corporate Governance in India

CII Code recommendations(a) No need for German style two-tiered board. (b) For a listed company with turnover exceeding Rs 100 crores, if the chairman is also the MD, at least half of the board should be independent directors, else at least 30%.(c) No single person should hold directorships in more than 10 listed companies.(d) Non-executive directors should be competent and active and have clearly defined responsibilities like in the Audit committee.(e) Directors should be paid a commission not exceeding 1% (3%) of net profits for a company with (out) an MD over and above sitting fees. (f) Stock options may be considered too.(g) Attendance record of directors should be made explicit at the time of re-appointment. Those with less than 50% attendance shouldnt be re-appointed. (h) Key information that must be presented to the board is listed in the code.(i) Audit Committee: Listed companies with turnover over Rs. 100 crores or paid-up capital of Rs. 20 crores should have an audit committee of at least three members, all non-executive, competent and willing to work more than other non-executive directors, with clear terms of reference and access to all financial information in the company and should periodically interact with statutory auditors and internal auditors and assist the board in corporate accounting and reporting. (j) Reduction in number of nominee directors. (k) FIs should withdraw nominee directors from companies with individual FI shareholding below 5% or total FI holding below 10%.

Birla Committee (SEBI) recommendations (2000)(a) At least 50% non-executive members.(b) For a company with an executive Chairman, at least half of the board should be independent directors, else at least one-third. Non-executive Chairman should have an office and be paid for job related expenses.(c) Maximum of 10 directorships and 5 chairmanships per person. Audit Committee: A board must have a qualified and independent audit committee, of minimum 3 members, all non-executive, majority and chair independent with at least one having financial and accounting knowledge. (d) Its chairman should attend AGM to answer shareholder queries. (e) The committee should confer with key executives as necessary and the company secretary should be the secretary of the committee.(f) The committee should meet at least thrice a year -- one before finalization of annual accounts and one necessarily every six months with the quorum being the higher of two members or one-third of members with at least two independent directors. (g) It should have access to information from any employee and can investigate any matter within its TOR, can seek outside legal/professional service as well as secure attendance of outside experts in meetings. (h) It should act as the bridge between the board, statutory auditors and internal auditors with arranging powers and responsibilities.(i) Remuneration Committee: The remuneration committee should decide remuneration packages for executive directors. It should have at least 3 directors, all Nonexecutive and be chaired by an independent director.(j) The board should decide on the remuneration of non-executive directors and all remuneration information should be disclosed in annual report.(k) At least 4 board meetings a year with a maximum gap of 4 months between any 2 meetings. Minimum information available to boards stipulated.

Narayana Murthy committee (SEBI) recommendations (2003)(a) Training of board members suggested.(b) There shall be no nominee directors. (c) All directors to be elected by shareholders with same responsibilities and accountabilities.(d) Non-executive director compensation to be fixed by board and ratified by shareholders and reported.(e) Stock options should be vested at least a year after their retirement. (f) Independent directors should be treated the same way as non-executive directors.(g) The board should be informed every quarter of business risk and risk management strategies.(h) Boards of subsidiaries should follow similar composition rules as that of parent and should have at least one independent directors of the parent company.(i) The Board report of a parent company should have access to minutes of board meeting in subsidiaries and should affirm reviewing its affairs.(j) Performance evaluation of non-executive directors by all his fellow Board members should inform a re-appointment decision.(k) While independent and non-executive directors should enjoy some protection from civil and criminal litigation, they may be held responsible of the legal compliance in the companys affairs.(l) Code of conduct for Board members and senior management and annual affirmation of compliance to it.

Law can only provide a minimum code of conduct for proper regulation of human being or company.[footnoteRef:5] Law is made not to stop any act but to ensure that if you do that act, you will face such consequences i.e. good for good and bad for bad. Thus, in the same manner, role of law in corporate governance is to supplement and not to supplant. It cannot be the only way to govern corporate governance but instead it provides a minimum code of conduct for good corporate governance. Law provides certain ethics to govern one and all so as to have maximum satisfaction and minimum friction. It plays a complementary role. Role of law in corporate governance is in Companies Act which imposes certain restrictions on Directors so that there is no misrepresentation of documents, there is no excessive of power, so that it imposes duty not to make secret profit and make good losses due to breach of duty, negligence, etc, duty to act in the best interest of the company etc. [5: Report of the Company Affairs Committee of the Confederation of the British Industry, Page 71]

CRITICAL ANALYSIS

The Satyam debacle has exposed the chinks in Indian corporate governance mechanism and the monitoring authorities. It has raised many questions about corporate governance in Indiathe role of boards, of independent directors, of the auditors, of investors and of analysts. Unanimously it has been a gross failure of corporate governance standards in India and protection of rights of minority investors.The board of directors is central to good governance, and the role of the board has featured prominently in discussions about Satyam. The board is the body charged with having oversight of the operations of the firm and setting its strategy. It should ensure that the company is upholding high standards of probity and conduct, and provide a probing analysis of the activities of management. In particular, non-executive directors are supposed to give an independent assessment of the quality of management. But time and time again, failures of corporate governance suggest that they do not. The infractions of law have arisen despite independent directors which were stopped by external forces. There are several reasons pointing to these anomalies-First, it is difficult to appoint truly independent directors. This is particularly hard to achieve in countries such as India where family ownership is widespread and there is a close-knit group of corporate leaders. It is difficult for non-executive directors to perform a scrutiny objective at the best of times, but it is particularly difficult to do so when faced with a dominant CEO who expects support not criticism from the companys board. Many countries have sought to separate the roles of chairman and CEO. However, it can inhibit firms from implementing effective strategies, especially in companies operating with new technologies, such as Indian IT/ITES firms, requiring visionary strategies. Next, the very idea of independent directors is to ensure commitment to values, ethical business conduct and about making a distinction between personal and corporate funds in the management of a company. Yet, most independent directors have become sidekicks for the management, eying their commission and fees, forgetting their very purpose of appointment. In the process, they implicitly transform into dependent directors.To add to that the present corporate governance modelled on the Western Anglo-Saxon model which does not address many of the current crises faced by India Inc. Professor Jayant Rama Verma of IIM Bangalore had extensively commented on the unsuitability of the Western Code of Corporate Governance in his well-researched paper on the subject titled 'Corporate Governance in India - Disciplining the dominant shareholder' (1997): According to him, the governance issue in the Anglo-Saxon world aims essentially at disciplining the management which is unaccountable to the owners. In contrast, the problem in the Indian corporate sector, he pointed out, is disciplining the dominant shareholder and protecting the minority shareholders, vindicated in the recent Satyam case. To understand the issues that driving corporate governance in the West, a brief idea about it is inevitable. After successfully working over the decades separating ownership and management, owners, (especially, institutional owners) realised that they have lost control over the management or the board. Professor Verma points out succinctly," The management becomes self-perpetuating and the composition of the board itself is largely influenced by the whims of the CEO. Corporate governance reforms in the US and the UK have focussed on making the board independent of the CEO. In contrast, the issues in India are entirely distinct - primarily due to our overall social-economic conditions. Therefore the issue in Indian corporate governance is not a 'conflict between management and owners' as elsewhere, but 'a conflict between the dominant shareholders and the minority shareholders'. And Professor Verma rightly concludes, The board cannot even in theory resolve this conflict" and that some of the most glaring abuses of corporate governance in India have been defended on the principle of shareholder democracy since they have been sanctioned by resolutions of the general body of shareholders."By now it is increasingly obvious that the very concept of corporate governance modelled on the Western system is un-workable in a country like India. These efforts are akin to taking a hair of an elephant, transplanting it on the head of a bald man and making him look like a bear. In the West the focus is on ownerless, CEO-driven paradigm. In India, it is still family-controlled, owner-driven paradigm. CEOs do not matter much in the management of the company. Yet, the general discussion centres on a standard, global prescription to manage diverse situations. Needless to emphasise, the solution to these problems in India lies not within the company, but outside. This is precisely what happened in the Satyam case where outsiders of the company took the lid off the fraud.In spite of numerous suggestions by the Securities and Exchange Board of India (SEBI), for peer reviews of audits among the companies listed in the Nifty and Sensex indices they have fallen flat on the industry fraternity. Presumably, SEBI will allocate the audits to firms that are part of a panel of reputed auditors. The simple solution would be for the regulator to make this course of action mandatoryauditors could be allotted audits by the regulator. To avoid the allegations of overregulation, companies can submit a list of their preferred auditors, from which the regulator will have to choose. Audits could also be rotated annually, keeping them on their toes. And these same rules could also be applied to rating agencies, internal auditors, independent directors etc. From time to time these mechanisms can be fine-tuned and made more practical.The moot question is why these reformative suggestions have not been implemented? The answer is that it depends on whos got more lobbying power. In the US, the large pension funds that have been instrumental in getting more transparency from company managements. India, on the other hand, has no tradition of shareholder activism, despite organisations such as the Life Insurance Corporation of India having substantial stakes in companies. The dependence of political parties on business interests to fund elections also doesnt help. The failure of governments and regulators to pass what seems like very basic safeguards preventing conflicts of interest, not only in India, but across the world, clearly establishes the clout that corporate interests have. Corporate governance is thus a charade, a cosmetic exercise rather than an attempt to get to the root of the problem.

CONCLUSION

After a slew of scandals, politicians and regulators, executives and shareholders are all preaching the governance gospel. Corporate governance has come to dominate the political and business agenda.There is a growing concern among executives that hasty regulation and overly strict internal procedures may impair their ability to run their business effectively. CEOs have to bear in mind the potential trade-off between polishing the corporate reputation and delivering growthfor all the headlines on corporate responsibility, are investors prepared consistently to sacrifice earnings for the sake of ethics?Regulations are only one part of the answer to improved governance. Corporate governance is about how companies are directed and controlled. The balance sheet is an output of manifold structural and strategic decisions across the entire company, from stock options to risk management structures, from the composition of the board of directors to the decentralisation of decision-making powers. As a result, the prime responsibility for good governance must lie within the company rather than outside it.Designing and implementing corporate governance structures are important, but instilling the right culture is essential. Senior managers need to set the agenda in this area, not least in ensuring that board members feel free to engage in open and meaningful debate. Not all board members need to be finance or risk experts, however. The primary task for the board is to understand and approve both the risk appetite of a particular company at any particular stage in its evolution and the processes that are in place to monitor risk.Culture is necessary but not sufficient to ensure good corporate governance. The right structures, policies and processes must also be in place. Transparency about a companys governance policies is critical. As long as investors and shareholders are given clear and accessible information about these policies, the market can be allowed to do the rest, assigning an appropriate risk premium to companies that have too few independent directors or an overly aggressive compensation policy, or cutting the costs of capital for companies that adhere to conservative accounting policies. Too few companies are genuinely transparent, however, and this is an area where most organisations can and should do much more.If any institution, inside or outside the company, deserves scrutiny, it is the board of directors. Executives have a clear responsibility consciously to define and implement corporate governance policies that offer a decent level of reassurance to employees and investors. Thereafter, disclosure is the most effective way for companies to resolve the thorny tensions that do exist between vision and prudence, innovation and accountability.There is an inherent tension between innovation and conservatism, governance and growth. Asked to evaluate the impact of strict corporate governance policies on their business, executives thought that M&A deals would be negatively affected because of the lengthening of due-diligence procedures, and that the ability to take swift and effective decisions would be compromised.Scheduling regular meetings of the non-executive board members from which other executives are excluded. Non-executives are there to exercise constructive dissatisfaction with the management team. They need to discuss collectively and frankly their views about the performance of the executives, the strategic direction of the company and worries about areas where they feel inadequately briefed.Explaining fully how discretion has been exercised in compiling the earnings and profit figures. These are not as cut and dried as many would imagine. Assets such as brands are intangible and with financial practices such as leasing common, a lot of subtle judgments must be made about what goes on or off the balance sheet. Use disclosure to win trust.Checking that non-executive directors are independent. Weed out members of the controlling family or former employees who still have links to people in the company.Auditing non-executives performance and that of the board. The attendance record of nonexecutives needs to be discussed and an appraisal made of the range of specialist skills. The board should discuss annually how well it has performed.Broadening and deepening disclosure on corporate websites and in annual reports. Websites should have a corporate governance section containing information such as procedures for getting a motion into a proxy ballot. The level of detail should ideally include the attendance record of non-executives at board meetings.Corporate governance is not just a box ticking exercise, companies need an exchange of practical guidance in order to conceive and implement successful governance mechanism. Instead of a menu of corporate governance options it would be more appropriate to present best practice guidelines applicable to businesses. These will serve as a benchmark for appropriate customization in different companies. Corporate governance should be considered as an obligation not a luxury. Its spirit is going to expand further and deeper in the future.