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Definitions : Corporate Governance may be defined “as a set of systems, processes and principles

which ensure that a company is governed in the best interest of all stakeholders”.It is the system by
which companies are directed and controlled.

Corporate governance is defined as an act of controlling, directing and evaluating the activities of an
organization. The structure of corporate governance specifies that the others taking part in the
organization, such as the board managers, board of directors, shareholders and other stakeholders
must be provided with some rights and responsibilities. Providing powers to the participants of the
organization results in the monitoring of performance of the employees in an organization. Corporate
governance helps the organization achieve the goals and objectives of an organization in a desired
manner.

Corporate governance comprehends the framework of rules, relationships, systems and processes
within and by which fiduciary authority is exercised and controlled in corporations. Relevant rules
include applicable laws of the land as well as internal rules of a corporation. Relationships include
those between all related parties, the most important of which are the owners, managers, directors of
the board (when such entity exists), regulatory authorities and to a lesser extent, employees and the
community at large. Systems and processes deal with matters such as delegation of authority,
performance measures, assurance mechanisms, reporting requirements and accountabilities.

Standard and Poors defined corporate governance as “the way in which a company organizes and
manages itself to ensure that all financial stakeholders receive their fair share of a company’s earnings
and assets” is increasingly a major factor in the investment decision-making process. Poor corporate
governance is often cited as one of the main reasons why investors are reluctant, or unwilling, to
invest in companies in certain markets.

The simplest definitions, is given by a Cadbury Report (UK). ‘Corporate Governance is the system by
which businesses are directed and controlled’.

According to the J. Wolfensohn, ‘Corporate governance is about promoting corporate fairness,


transparency and accountability.’

An article from Financial Times has defined corporate governance as ‘the relationship of a company to
its shareholders or, more broadly, as its relationship to society’.

Introduction

Corporate governance is a central and dynamic aspect of business. The term ‘governance’ is derived
from the Latin word gubernare, meaning ‘to steer’, usually applying to the steering of a ship, which
implies that corporate governance involves the function of direction rather than control. In fact, the
significance of corporate governance for corporate success as well as for social welfare cannot be
overstated. Recent examples of massive corporate collapse resulting from weak systems of corporate
governance have highlighted the need to improve and reform corporate governance at international
level. In the wake of Enron and other similar cases, countries around the world have reacted quickly
by pre-empting similar events dramatically.

"Capitalism with integrity outside the government is the only way forward to create jobs and solve the
problem of poverty. We, the business leaders are the evangelists of capitalism with integrity. If the
masses have to accept this we have to become credible and trustworthy. Thus we have to embrace
the finest principles of corporate governance and walk and the talk." (Narayan Murthy)
Corporate governance has in recent years succeeded in attracting a good deal of public interest
because of its apparent importance for the economic health of corporations and society in general.
However, the concept of corporate governance is poorly defined because it potentially covers a large
number of distinct economic phenomena. As a result, different individuals have come up with
different definitions that basically reflect their special interest in the field. It is hard to see that this
'disorder' will be any different in the future so the best way to define the concept is perhaps to list a
few of the different definitions.

 It involves a set of relationships between a company’s management, its board, its shareholders
and other stakeholders.
 It deals with prevention or mitigation of the conflict of interests of stakeholders.Ways of
mitigating or preventing these conflicts of interests include the processes, customs, policies, laws,
and institutions which have impact on the way a company is controlled.
 An important theme of corporate governance is the nature and extent of accountability of people
in the business, and mechanisms that try to decrease the principal–agent problem.
 Relationships among various participants in determining the direction and performance of a
corporation.
 Effective management of relationships among
 Shareholders
 Managers
 Board of directors
 employees
 Customers
 Creditors
 Suppliers
 Community

The Need for Corporate Governance

There are various reasons for the need for corporate governance in an organization. These are:

1. A corporation, which is a union of many stakeholders, such as employees, customers, investors,


vendors, and so on, must be fair and transparent to its stakeholders in all its dealings. It is very
important in today’s globalized business world, where corporations require to have access to global
pools of capital attract and retain the best human resource from all parts of the globe. If a corporation
does not take up and show ethical conduct, it is not considered to be successful.
2. Corporate governance covers ethical conduct in business, the code of values and principles that helps
an individual to choose between right and wrong or make the right selection from the options or
alternatives provided. Managers decide on certain actions on the basis of an principles that are
governed by the culture, context and values of an organization. An organization that follows ethical
values feel that it is better for the business, as it helps in the long run and the stakeholders observe
that the management is running the organization in the desired way.
3. It is beyond the sphere of law, i.e., it stems from the background and outlook of the management and
cannot be regulated by legislation alone. It deals with running the affairs of a company in such a way
that it is fair to all the stakeholders and that its dealings benefit the greatest number of stakeholders. It
is about honesty, integrity and responsibility. Laws should set up a common framework to maintain
standards. Since substance is very much linked with the mindset and ethical standards of management,
it shall in the end lay down the creditability and integrity of the process.
4. Corporations should realize that it is necessary for all the stakeholders to cooperate in order to
facilitate development. Such cooperation and support can only be possible by adhering to the best
practices of corporate governance. In this context, management has to take the responsibility of the
shareholders at large and stop any unbalanced benefits of the varied sections of the shareholders.
5. The economic competence of a company can be improved through corporate governance. Corporate
governance also ensures that corporations consider the interests of a wide range of constituencies and
also of the communities within which they function. Corporate governance also makes sure that the
boards of directors are responsible to the shareholders. This even helps to ensure that corporations
work for the benefit of the society at large, including the society’s concerns about labour and
environment.
6. If the execution of good governance fails, heavy losses can result in terms of cost other than regulatory
problems. Many organizations that do not give due importance to corporate governance end up paying
a large risk premium while contending for scarce capital in the public markets. Of late, stock market
analysts have started realizing, accepting and appreciating the relationship between returns and
corporate governance.
7. The confidence of both foreign and domestic investors is maintained and upheld due to the
trustworthiness that comes from good measures of corporate governance. The cost of capital should
be brought down so that more long-term investment is attracted.
8. Often, importance and attention is given to corporate governance in times of financial crisis. In the US,
when scandals disturbed the otherwise calm and contented corporate environment, new initiatives
thrown up by them led to fresh debates in Asia and the European Union. With many instances of
corporate misdemeanour coming into limelight, the emphasis now is on compliance with substance,
rather than on form. It has also brought to the fore the need of intellectual honesty and integrity. The
financial and other disclosures made by firms are only as good as the people who make it.
9. Corporate governance is aimed at increasing the long-term value of an organization for not only its
shareholders, but also partners. It represents an amalgamation of all those involved in a process that is
socioeconomic. It is imperative for all organizations to govern and manage. Corporate governance
includes the entire stakeholder and at the same time the process is economic as well as social.
10. Studies related to corporate governance practices conducted worldwide by various institutions clearly
indicate that no single model is available for good corporate governance. The OECD also recognizes
this. It also accepts the fact that a wide range of approaches to corporate governance have developed
due to the differences that exist in institutional frameworks, legal systems as well as traditions in
various countries. All good corporate governance regimes place high preference on the interests of
shareholders, as the latter place their trusts on corporations to use their investment funds in an
effective and wise manner.

Scope of Corporate Governance

Corporate governance covers the following functional areas of governance:

1. Preparation of company’s financial statements: Financial disclosure is a very important and critical
component of corporate governance. The company should implement procedures to independently
verify and safeguard the integrity of the company’s financial reporting. Disclosure of material matters
concerning the organization should be timely and balanced to ensure that all investors have access to
clear, factual information.
2. Internal controls and the independence of entity’s auditors: Internal control is implemented by the
board of directors, audit committee, management, and other personnel to provide assurance of the
company achieving its objectives related to reliable financial reporting, operating efficiency, and
compliance with laws and regulations. Internal auditors, who are given responsibility of testing the
design and implementing the internal control procedures and the reliability of its financial reporting,
should be allowed to work in an independent environment.
3. Review of compensation arrangements for chief executive officer and other senior executives:
Performance-based remuneration is designed to relate some proportion of salary to individual
performance. It may be in the form of cash or non-cash payments such as shares and share options,
superannuation or other benefits. Such incentive schemes, however, are reactive in the sense that they
provide no mechanism for preventing mistakes or opportunistic behaviour, and can elicit myopic
behaviour.
4. The way in which individuals are nominated for the positions on the board: The Board of Directors
have the power to hire, fire and compensate the top management. The owners of a business who have
decision-making authority, voting authority, and specific responsibilities, which in each case is separate
and distinct from the authority, and responsibilities of owners and managers of the business entity.
5. The resources made available to directors in carrying out their duties: The duties of the directors are
the fiduciary duties similar to those of an agent or trustee. They are entrusted with adequate power to
control the activities of the company.
6. Oversight and management of risk: It is important for the company to be fully aware of the risks facing
the business and the shareholders should know that how the company is going to tackle the risks.
Similarly the company should also be aware about the opportunities lying ahead.

Participants to Corporate Governance

Corporate governance is concerned with the governing or regulatory body (e.g. the SEBI), the CEO, the board of
directors and management. Other stakeholders who take part include suppliers, employees, creditors,
customers, and the community at large.

Shareholders delegate decision rights to the managers. Managers are expected to act in the interest of
shareholders. This results in the loss of effective control by shareholders over managerial decisions. Thus, a
system of corporate governance controls is implemented to assist in aligning the incentives of the managers
with those of the shareholders in order to limit self-satisfying opportunities for managers.

The board of directors plays a key role in corporate governance. It is their responsibility to endorse the
organisation’s strategy, develop directional policy, appoint, supervise and remunerate senior executives and to
ensure accountability of the organisation to its owners and authorities.

A key factor in an individual’s decision to participate in an organisation (e.g. through providing financial capital
or expertise or labour) is trust that they will receive a fair share of the organisational returns. If somebody
receives more than their fair return (e.g. exorbitant executive remuneration), then the participants may choose
not to continue participating, potentially leading to an organisational collapse (e.g. shareholders withdrawing
their capital). Corporate governance is the key mechanism through which this trust is maintained across all
stakeholders
Accountability
 Ensure that management is accountable to the Board.
 Ensure that the Board is accountable to shareholders.
FAIRNESS
 Protect Shareholders rights.
 Treat all shareholders including minorities, equitably.
 Provide effective redress for violations.
TRANSPARENCY
• Ensure timely, accurate disclosure on all material matters, including the financial situation,
performance, ownership and corporate governance
INDEPENDENCE
 Procedures and structures are in place so as to minimise, or avoid completely conflicts of
interest.
 Independent Directors and Advisers i.e. free from the influence of others

OBJECTIVES

 A properly structured board capable of taking independent and objective decisions is in place
at the helm of affairs.
 The board is balance as regards the representation of adequate number of non-executive and
independent directors who will take care of their interests and well-being of all the
stakeholders.
 The board adopts transparent procedures and practices and arrives at decisions on the
strength of adequate information.
 The board has an effective machinery to subserve the concerns of stakeholders.
 The board keeps the shareholders informed of relevant developments impacting the company.
 The board effectively and regularly monitors the functioning of the management team.
 The board remains in effective control of the affairs of the company at all times.

ADVANTAGES OF CORPORATE GOVERNANCE

 Enhanced Performance- helps a company improve overall performance.


 Without corporate governance, a company tends to be weak and sluggish.
 Access to Capital- The better corporate governance a company has, the more easily it can
access outside capital that the business can use to fund its projects.
 Since corporate governance includes major shareholders, it connects investors with the
business itself, and these investors use their resources and contacts to support the company
monetarily.
 Better Standards- Corporate governance makes many decisions about business operations,
but one of the most important decisions involves corporate standards.
 Standards affect the quality of products and the goals that the business has in technology,
customer service, and marketing.
 Better Talent Utilization- With a strong corporate governance structure, people can find
positions that utilize their talents more effectively, and the board of directors and top leaders
of the business are always looking to add more talented people to their numbers.
DISADVANTAGES OF CORPORATE GOVERNANCE
 Easily Corruptible-Corporate governance needs a certain level of government oversight to
avoid increasing levels of corruption. The lack of governmental oversight in corporate
governance lead to a misallocation of credit that actually worked against competition.
 Family-Owned Companies- Corporate governance works at its best when shareholders and
board members are able to make objective decisions that are in the best interest of the
company. According to Ibis Associates, a business planning firm, family-run corporations
(founding family members own controlling share of the company), such as Ford and WalMart,
lose objectivity in business making decisions due to the family's financial investment in the
business' performance and the emotional ties associated with building a worldwide
corporation from the ground up.
PRINCIPLES OF CORPORATE GOVERNANCE

 Rights and equitable treatment of shareholders-- Organizations should respect the rights of
shareholders and help shareholders to exercise those rights. They can help shareholders
exercise their rights by openly and effectively communicating information and by encouraging
shareholders to participate in general meetings.
 Interests of other stakeholders:- Organizations should recognize that they have legal,
contractual, social, and market driven obligations to non-shareholder stakeholders, including
employees, investors, creditors, suppliers, local communities, customers, and policy makers.
 Role and responsibilities of the board- The board needs sufficient relevant skills and
understanding to review and challenge management performance. It also needs adequate size
and appropriate levels of independence and commitment.
 Integrity and ethical behavior- Integrity should be a fundamental requirement in choosing
corporate officers and board members. Organizations should develop a code of conduct for
their directors and executives that promotes ethical and responsible decision making.
 Disclosure and transparency- Organizations should clarify and make publicly known the roles
and responsibilities of board and management to provide stakeholders with a level of
accountability. They should also implement procedures to independently verify and safeguard
the integrity of the company's financial reporting. Disclosure of material matters concerning
the organization should be timely and balanced to ensure that all investors have access to
clear, factual information.

GOVERNANCE THEORIES

Corporate governance is often analyzed around major theoretical frameworks. The most common are agency
theories, stewardship theories, resource-dependence theories, and stakeholder theories.

Agency Theories

Agency theories arise from the distinction between the owners (shareholders) of a company or an organization
designated as "the principals" and the executives hired to manage the organization called "the agent." Agency
theory argues that the goal of the agent is different from that of the principals, and they are conflicting (Johnson,
Daily, & Ellstrand, 1996). The assumption is that the principals suffer an agency loss, which is a lesser return on
investment because they do not directly manage the company. Part of the return that they could have had if they
were managing the company directly goes to the agent. Consequently, agency theories suggest financial
rewards that can help incentivize executives to maximize the profit of owners (Eisenhardt, 1989). Further, a
board developed from the perspective of the agency theory tends to exercise strict control, supervision, and
monitoring of the performance of the agent in order to protect the interests of the principals (Hillman & Dalziel,
2003). In other words, the board is actively involved in most of the managerial decisionmaking processes, and is
accountable to the shareholders. A nonprofit board that operates through the lens of agency theories will show a
hands-on management approach on behalf of the stakeholders.

Agency theory having its roots in economic theory was exposited by Alchian and Demsetz (1972)
and further developed by Jensen and Meckling (1976). Agency theory is defined as “the relationship
between the principals, such as shareholders and agents such as the company executives and
managers”. In this theory, shareholders who are the owners or principals of the company, hires the
gents to perform work. Principals delegate the running of business to the directors or managers, who
are the shareholder’s agents (Clarke, 2004). Indeed, Daily et al (2003) argued that two factors can
influence the prominence of agency theory. First, the theory is conceptually and simple theory that
reduces the corporation to two participants of managers and shareholders. Second, agency theory
suggests that employees or managers in organizations can be self-interested.

The agency theory shareholders expect the agents to act and make decisions in the principal’s
interest. On the contrary, the agent may not necessarily make decisions in the best interests of the
principals (Padilla, 2000). Such a problem was first highlighted by Adam Smith in the 18th century and
subsequently explored by Ross (1973) and the first detailed description of agency theory was presented
by Jensen and Meckling (1976). Indeed, the notion of problems arising from the separation of
ownership and control in agency theory has been confirmed by Davis, Schoorman and Donaldson
(1997).

In agency theory, the agent may be succumbed to self-interest, opportunistic behavior and falling
short of congruence between the aspirations of the principal and the agent’s pursuits. Even the
understanding of risk defers in its approach. Although with such setbacks, agency theory was
introduced basically as a separation of ownership and control (Bhimani, 2008). Holmstrom and
Milgrom (1994) argued that instead of providing fluctuating incentive payments, the agents will only
focus on projects that have a high return and have a fixed wage without any incentive component.
Although this will provide a fair assessment, but it does not eradicate or even minimize corporate
misconduct. Here, the positivist approach is used where the agents are controlled by principal-made
rules, with the aim of maximizing shareholders value. Hence, a more individualistic view is applied in
this theory (Clarke, 2004). Indeed, agency theory can be employed to explore the relationship between
the ownership and management structure. However, where there is a separation, the agency model can
be applied to align the goals of the management with that of the owners. Due to the fact that in a family
firm, the management comprises of family members, hence the agency cost would be minimal as any
firm’s performance does not really affect the firm performance (Eisenhardt, 1989). The model of an
employee portrayed in the agency theory is more of a self-interested, individualistic and are bounded
rationality where rewards and punishments seem to take priority (Jensen & Meckling, 1976). This
theory prescribes that people or employees are held accountable in their tasks and responsibilities.
Employees must constitute a good governance structure rather than just providing the need of
shareholders, which maybe challenging the governance structure.
Stewardship Theories

Stewardship theories argue that the managers or executives of a company are stewards of the owners, and
both groups share common goals (Davis, Schoorman, & Donaldson, 1997). Therefore, the board should not be
too controlling, as agency theories would suggest. The board should play a supportive role by empowering
executives and, in turn, increase the potential for higher performance (Hendry, 2002; Shen, 2003). Stewardship
theories argue for relationships between board and executives that involve training, mentoring, and shared
decision making (Shen, 2003; Sundaramurthy & Lewis, 2003).

Stewardship theory has its roots from psychology and sociology and is defined by Davis, Schoorman
& Donaldson (1997) as “a steward protects and maximises shareholders wealth through firm
performance, because by so doing, the steward’s utility functions are maximised”. In this perspective,
stewards are company executives and managers working for the shareholders, protects and make profits
for the shareholders. Unlike agency theory, stewardship theory stresses not on the perspective of
individualism (Donaldson & Davis, 1991), but rather on the role of top management being as stewards,
integrating their goals as part of the organization. The stewardship perspective suggests that stewards
are satisfied and motivated when organizational success is attained.

Agyris (1973) argues agency theory looks at an employee or people as an economic being, which
suppresses an individual’s own aspirations. However, stewardship theory recognizes the importance of
structures that empower the steward and offers maximum autonomy built on trust (Donaldson and
Davis, 1991). It stresses on the position of employees or executives to act more autonomously so that
the shareholders’ returns are maximized. Indeed, this can minimize the costs aimed at monitoring and
controlling behaviours (Davis, Schoorman & Donaldson, 1997).

On the other end, Daly et al. (2003) argued that in order to protect their reputations as decision
makers in organizations, executives and directors are inclined to operate the firm to maximize financial
performance as well as shareholders’ profits. In this sense, it is believed that the firm’s performance can
directly impact perceptions of their individual performance. Indeed, Fama (1980) contend that
executives and directors are also managing their careers in order to be seen as effective stewards of
their organization, whilst, Shleifer and Vishny (1997) insists that managers return finance to investors
to establish a good reputation so that that can re-enter the market for future finance. Stewardship model
can have linking or resemblance in countries like Japan, where the Japanese worker assumes the role of
stewards and takes ownership of their jobs and work at them diligently.

Moreover, stewardship theory suggests unifying the role of the CEO and the chairman so as to reduce
agency costs and to have greater role as stewards in the organization. It was evident that there would be
better safeguarding of the interest of the shareholders. It was empirically found that the returns have
improved by having both these theories combined rather than separated (Donaldson and Davis, 1991).
Resource-Dependence Theories

Resource-dependence theories argue that a board exists as a provider of resources to executives in order to
help them achieve organizational goals (Hillman, Cannella, & Paetzold, 2000; Hillman & Daziel, 2003).
Resource-dependence theories recommend interventions by the board while advocating for strong financial,
human, and intangible supports to the executives. For example, board members who are professionals can use
their expertise to train and mentor executives in a way that improves organizational performance. Board
members can also tap into their networks of support to attract resources to the organization. Resource-
dependence theories recommend that most of the decisions be made by executives with some approval of the
board.

Stakeholder Theories
Stakeholder theories are based on the assumption that shareholders are not the only group with a stake in a
company or a corporation. Stakeholder theories argue that clients or customers, suppliers, and the surrounding
communities also have a stake in a corporation. They can be affected by the success or failure of a company.
Therefore, managers have special obligations to ensure that all stakeholders (not just the shareholders) receive
a fair return from their stake in the company (Donaldson & Preston, 1995). Stakeholder theories advocate for
some form of corporate social responsibility, which is a duty to operate in ethical ways, even if that means a
reduction of long-term profit for a company (Jones, Freeman, & Wicks, 2002). In that context, the board has a
responsibility to be the guardian of the interests of all stakeholders by ensuring that corporate or organizational
practices take into account the principles of sustainability for surrounding communities.

Stakeholder theory was embedded in the management discipline in 1970 and gradually developed by Freeman
(1984) incorporating corporate accountability to a broad range of stakeholders. Wheeler et al, (2002) argued
that stakeholder theory derived from a combination of the sociological and organizational disciplines. Indeed,
stakeholder theory is less of a formal unified theory and more of a broad research tradition, incorporating
philosophy, ethics, political theory, economics, law and organizational science.

Stakeholder theory can be defined as “any group or individual who can affect or is affected by the achievement
of the organization’s objectives”. Unlike agency theory in which the managers are working and serving for the
stakeholders, stakeholder theorists suggest that managers in organizations have a network of relationships to
serve – this include the suppliers, employees and business partners. And it was argued that this group of
network is important other than owner-manager-employee relationship as in agency theory (Freeman, 1999).
On the other end, Sundaram & Inkpen (2004) contend that stakeholder theory attempts to address the group
of stakeholder deserving and requiring management’s attention. Whilst, Donaldson & Preston (1995) claimed
that all groups participate in a business to obtain benefits. Nevertheless, Clarkson (1995) suggested that the
firm is a system, where there are stakeholders and the purpose of the organization is to create wealth for its
stakeholders.

Freeman (1984) contends that the network of relationships with many groups can affect decision making
processes as stakeholder theory is concerned with the nature of these relationships in terms of both processes
and outcomes for the firm and its stakeholders. Donaldson & Preston (1995) argued that this theory focuses on
managerial decision making and interests of all stakeholders have intrinsic value, and no sets of interests is
assumed to dominate the others.
REGULATION AND THERE ENFORCEMENT

 Since corporate governance failures have proved to be harmful not just for the organizations
but also for the economy and the general public at large as well, there have been public
pressures on the government and regulatory authorities to reform business practices and
increase transparency.

 Consequently, it has become a part of the government’s duty to ensure accountability and
responsibility in corporate behavior.

 Effective disposal of this responsibility basically revolves around two things:-

 First, the designing of regulatory commands i.e. the regulations and laws to ensure good
corporate governance and

 Second is the enforcement of regulations.

RISK MANAGEMENT AND EFFECTIVE GOVERNANCE


 In today’s world, frauds are an undeniable fact of business life.

 Once suspected or discovered, investigating fraud is a specialist task requiring experience and
technical skill and can be very costly. Thus, there is no doubt that fraud is best prevented,
rather than dealt with after the fact. The most effective and appropriate response to the
problem of fraud involves a combination of risk management techniques.

These techniques include:

 Setting up inherent control based upon soft controls that occur continuously and consistently
throughout the organization. Such controls should be embedded in normal business practice
and be designed in such a way that they are to a large extent self sustaining.

 Setting up formal control processes of monitoring, reviewing and reporting.

Why corporate governance????


 Better access to external finance
 Lower the cost of capital- interest rates on loans
 Improved company performance- sustainability
 Higher firm valuation and share performance
 Reduce risk of corporate crisis and scandals.

Corporate Governance at different levels

 AT NATIONAL LEVEL :-

• As barriers to the free flow of capital fall, it becomes imperative to recognize that the quality
of corporate governance is relevant to capital formation and that sound corporate governance
principles is the foundation upon which the trust of investors is built.

• Corporate governance represents the ethical the moral framework under which business
decisions are taken. Thus, any investor, when making investments across the borders or even
otherwise, wants to be sure that not only are the capital markets or enterprises with which
they are investing are being run competently but they also have good corporate governance.

• Consequently, lack of sound corporate governance practices in any country can badly affect
the confidence of foreign investors, in turn causing damage to the amount of foreign
investments flowing in.

At the Company and Individual level


 It is self evident that sound corporate governance is essential to the well being of an individual
company and its stakeholders, particularly its shareholders and creditors.
 We need only remind ourselves of the many companies, across the world, whose financial
difficulties and, ultimate demise have been substantially attributable to weak corporate
governance.
 On the other hand, there are several areas of self-interest that should drive companies to
embrace more effective governance.
These areas are:
1. Effective governance helps to minimize reputational risks and thus, protecting the
brand;
2. It helps to instill trust in customers and vendors;
3. It also helps to assure effectiveness and integrity of a company’s business
processes.
4. Further, in many cases, the punishment, in terms of penalties or imprisonment, for
white-collar crimes are now in excess for such criminal acts such as armed
robbery, assault, and negligent murder. Even to escape such punishments, ensuring corporate
governance compliance is a must.

CORPORATE GOVERNANCE IN PRIVATE AND PUBLIC COMPANIES


Corporate Governance in Private Companies

• Most of the regulations made, such as SOX in US and Clause 49 of Listing Agreement in India,
are applicable only to publicly-registered or listed companies and private companies are out of
the ambit of these regulations.

• However, today we see that private companies are also becoming big in size and impact.

• Very near examples would include joint ventures being organized as private companies within
the insurance industry in India.

• Thus, failure of corporate governance within these private companies as well can very badly
harm the general public at large. And also since new standards of corporate governance, while
only required by law at public companies, are for forming “best practices” in many will
governed private companies, we strongly feel that the applicability of such regulations, after
suitable modifications, be extended to private companies as well.

• Apart from the necessity as above, it is also in the self-interest of private companies to ensure
good corporate governance. This is primarily because:

1. Usually, in most private companies, controls are informal or even if there are formal controls, they
tend to be detective rather than preventive. This makes private companies unprotected against risks,
which needs to be mitigated.

2. Good corporate governance increases creditworthiness of the company and thus, enables it to raise
funds at cheaper cost. Good corporate governance is also a must for companies that are planning to
seek stock exchange listing and raise money from markets by converting them into public company.

3. Finally, if the owners of a private company are considering the sale of all or part of the entity, or are
seeking private equity financing, effective controls can increase prospective buyers’ willingness to pay
a premium for the acquisition.

Controls enhancements can also help attract new business partners.

PUBLIC SECTOR CORPORATE GOVERNANCE

 Although the private sector model view shareholders as main stakeholders.

 In public sector specific users group those directly responsible for funding and the community
at large assume great importance as stakeholders.

 Stewardship and accountability of use of funds and assets is particularly important in public
sector. It is becoming more important to focus on corporate governance in public sector to
maintain faith in system and promote better service to the public sector to maintain faith in
the system and promote better service to the public.

Good institutional governance should be instilled by the development of governance systems in


ministries and authorities, with the aim of focusing on enhancing the quality of public services
consistent with citizen expectations, promoting compliance and conformance, with appropriate
transparency and flexibility.

STRUCTURE OF CORPORATE GOVERNANCE

Corporate Governance in India

 The Indian corporate scenario was more or less stagnant till the early 90s.

 The position and goals of the Indian corporate sector has changed a lot after the liberalization
of 90s.

 India’s economic reform programme made a steady progress in 1994.

 India with its 20 million shareholders, is one of the largest emerging markets in terms of the
market capitalization.

Corporate Governance of India has undergone a paradigm shift

 In 1996, Confederation of Indian Industry (CII), took a special initiative on Corporate


Governance.

 The objective was to develop and promote a code for corporate governance to be adopted
and followed by Indian companies, be these in the Private Sector, the Public Sector, Banks or
Financial Institutions, all of which are corporate entities.
 This initiative by CII flowed from public concerns regarding the protection of investor interest,
especially the small investor, the promotion of transparency within business and industry

Securities and Exchange Board of India


 The Government of India's securities watchdog, the Securities Board of India, announced strict
corporate governance norms for publicly listed companies in India.
 The Indian Economy was liberalized in 1991. In order to achieve the full potential of
liberalization and enable the Indian Stock Market to attract huge investments from foreign
institutional investors (FIIs), it was necessary to introduce a series of stock market reforms.
 SEBI, established in 1988 and became a fully autonomous body by the year 1992 with defined
responsibilities to cover both development and regulation of the market.
 On April 12, 1988, the Securities and Exchange Board of India (SEBI)was established with a dual
objective of protecting the rights of small investors and regulating and developing the stock
markets in India.
 In 1992, the ‘BSE’ ,the leading stock exchange in India, witnessed the first major scam
masterminded by Harshad Mehta.
 Analysts felt that if more powers had been given to SEBI,the scam would not have happened.
 •As a result the ‘GoI’ brought in a separate legislation by the name of ‘SEBI Act 1992’and
conferred statutory powers to it.
 Since then, SEBI had introduced several stock market reforms. These reforms significantly
transformed the face of Indian Stock Markets
SEBI and Clause 49

 SEBI asked Indian firms above a certain size to implement Clause 49, a regulation that
strengthens the role of independent directors serving on corporate boards.
 On August 26, 2003, SEBI announced an amended Clause 49 of the listing agreement which
every public company listed on an Indian stock exchange is required to sign. The amended
clauses come into immediate effect for companies seeking a new listing.
The major changes to Clause 49…

 Independent Directors:- 1/3 to ½depending whether the chairman of the board is a non-
executive or executive position.
 Non-Executive Directors:- The total term of office of non-executive directors is now limited to
three terms of three years each.
 Board of Directors:- The board is required to frame a code of conduct for all board members
and senior management and each of them have to annually affirm compliance with the code.
 Audit Committee:- Financial statements and the draft audit report of management discussion
and analysis of…
• Financial condition
• Result of operations of compliance with laws
• Risk management letters
• Letters of weaknesses in internal controls issued by statutory
• Internal auditors
• Removal and terms of remuneration of the chief internal auditor
 Whistleblower Policy :- This policy has to be communicated to all employees and
whistleblowers should be protected from unfair treatment and termination.
 Subsidiary Companies:- 50% non-executive directors & 1/3 & ½independent directors
depending on whether the chairman is non-executive or executive.

Corporate governance was guided by Clause 49 of the Listing Agreement before introduction of the
Companies Act of 2013. As per the new provision, SEBI has also approved certain amendments in the
Listing Agreement so as to improve the transparency in transactions of listed companies and giving a bigger
say to minority stakeholders in influencing the decisions of management. These amendments have become
effective from 1st October 2014.
A Few New Provision for Directors and Shareholders
 One or more women directors are recommended for certain classes of companies
 Every company in India must have a resident directory
 The maximum permissible directors cannot exceed 15 in a public limited company. If more directors have to be
appointed, it can be done only with approval of the shareholders after passing a Special Resolution
 The Independent Directors are a newly introduced concept under the Act. A code of conduct is prescribed and so are
other functions and duties
 The Independent directors must attend at least one meeting a year
 Every company must appoint an individual or firm as an auditor. The responsibility of the Audit committee has
increased
 Filing and disclosures with the Registrar of Companies has increased
 Top management recognizes the rights of the shareholders and ensures strong co-operation between the company and
the stakeholders
 Every company has to make accurate disclosure of financial situations, performance, material matter, ownership and
governance
Additional Provisions
 Related Party Transactions – A Related Party Transaction (RPT) is the transfer of resources or facilities between a
company and another specific party. The company devises policies which must be disclosed on the website and in the
annual report. All these transactions must be approved by the shareholders by passing a Special Resolution as the
Companies Act of 2013. Promotors of the company cannot vote on a resolution for a related party transaction.
 Changes in Clause 35B – The e-voting facility has to be provided to the shareholder for any resolution is a legal
binding for the company.
 Corporate Social Responsibility – The company has the responsibility to promote social development in order to
return something that is beneficial for the society.
 Whistle Blower Policy – This is a mandatory provision by SEBI which is a vigil mechanism to report the wrong or
unethical conduct of any director of the company.

Why is Corporate Governance in India Important?


A company that has good corporate governance has a much higher level of confidence amongst the
shareholders associated with that company. Active and independent directors contribute towards a positive
outlook of the company in the financial market, positively influencing share prices. Corporate Governance
is one of the important criteria for foreign institutional investors to decide on which company to invest in.

The corporate practices in India emphasize the functions of audit and finances that have legal, moral and
ethical implications for the business and its impact on the shareholders. The Indian Companies Act of 2013
introduced innovative measures to appropriately balance legislative and regulatory reforms for the growth
of the enterprise and to increase foreign investment, keeping in mind international practices. The rules and
regulations are measures that increase the involvement of the shareholders in decision making and
introduce transparency in corporate governance, which ultimately safeguards the interest of the society and
shareholders.
Corporate governance safeguards not only the management but the interests of the stakeholders as well and
fosters the economic progress of India in the roaring economies of the world.

SEBI Code of Corporate Governance:

To promote good corporate governance, SEBI (Securities and Exchange Board of India) constituted a

committee on corporate governance under the chairmanship of Kumar Mangalam Birla. On the basis

of the recommendations of this committee, SEBI issued certain guidelines on corporate governance;

which are required to be incorporated in the listing agreement between the company and the stock

exchange.

An overview of SEBI guidelines on corporate governance is given below, under

appropriate heads:
(a) Board of Directors:

Some points in this regard are as follows:

(i) The Board of Directors of the company shall have an optimum combination of executive and non-

executive directors.

(ii) The number of independent directors would depend on whether the chairman is executive or non-

executive.

In case of non-executive chairman, at least, one third of the Board should comprise of independent

directors; and in case of executive chairman, at least, half of the Board should comprise of independent

directors.

The expression ‘independent directors’ means directors, who apart from receiving director’s

remuneration, do not have any other material pecuniary relationship with the company.
(b) Audit Committee:

Some points in this regard are as follows:

(1) The company shall form an independent audit committee whose constitution would

be as follows:

(i) It shall have minimum three members, all being non-executive directors, with the majority of them

being independent, and at least one director having financial and accounting knowledge.

(ii)The Chairman of the committee will be an independent director.

(iii)The Chairman shall be present at the Annual General Meeting to answer shareholders’ queries.

(2) The audit committee shall have powers which should include the following:

1.To investigate any activity within its terms of reference

2.To seek information from any employee


3. To obtain outside legal or other professional advice

4. To secure attendance of outsiders with relevant expertise, if considered necessary.

(3) The role of audit committee should include the following:

(i) Overseeing of the company’s financial reporting process and the disclosure of its financial

information to ensure that the financial statement is correct, sufficient and credible.

(ii) Recommending the appointment and removal of external auditor.

(iii) Reviewing the adequacy of internal audit function

(iv) Discussing with external auditors, before the audit commences, the nature and scope of audit; as

well as to have post-audit discussion to ascertain any area of concern.

(v) Reviewing the company’s financial and risk management policies.


(c) Remuneration of Directors:

The following disclosures on the remuneration of directors shall be made in the section

on the corporate governance of the Annual Report:

(i) All elements of remuneration package of all the directors i.e. salary, benefits, bonus, stock options,

pension etc.

(ii) Details of fixed component and performance linked incentives, along with performance criteria.
(d) Board Procedure Some Points in this Regards are:

(i) Board meetings shall be held at least, four times a year, with a maximum gap of 4 months between

any two meetings.

(ii) A director shall not be a member of more than 10 committees or act as chairman of more than five

committees, across all companies, in which he is a director.


(e) Management:

A Management Discussion and Analysis Report should form part of the annual report to the

shareholders; containing discussion on the following matters (within the limits set by the company’s

competitive position).

(i) Opportunities and threats

(ii) Segment-wise or product-wise performance

(iii) Risks and concerns

(iv) Discussion on financial performance with respect to operational performance

(v) Material development in human resource/industrial relations front.


(f) Shareholders:

Some points in this regard are:

(i) In case of appointment of a new director or reappointment of a director,

shareholders must be provided with the following information:


1.A brief resume (summary) of the director

2.Nature of his expertise

3. Number of companies in which he holds the directorship and membership of committees of the

Board.

(ii) A Board Committee under the chairmanship of non-executive director shall be formed to

specifically look into the redressing of shareholders and investors’ complaints like transfer of shares,

non-receipt of Balance Sheet or declared dividends etc. This committee shall be designated as

‘Shareholders / Investors Grievance Committee’.


(g) Report on Corporate Governance:

There shall be a separate section on corporate governance in the Annual Report of the company, with a

detailed report on corporate governance.


(h) Compliance:

The company shall obtain a certificate from the auditors of the company regarding the compliance of

conditions of corporate governance. This certificate shall be annexed with the Directors’ Report sent to

shareholders and also sent to the stock exchange.