CENTRAL UNIVERSITY OF SOUTH BIHAR

SCHOOL OF LAW &GOVERNANCE.

A Project work on “Corporate Governance and its importance in the present-

day world”.

Submitted to:
Dr. Pradip Kumar Das
Associate Professor
Submitted By: School of Law and Governance

Aarya Sharma
CUSB1613125001
9th Semester (BA.LLB Hons.)
Chapterization:

1. Introduction.
2. Definition of Corporate Governance.
3. Concept of Corporate Governance.
4. Importance of Corporate Governance.
5. Critical Analysis.
6. Concluding Remarks and Suggestions.

Literature Review:

1. M. Bhasin, “Audit committee mechanism to improve corporate governance: Evidence

from a developing country,” Modern Economy- This article dealt with Good
corporate governance practices that help corporations and its stakeholders; to do so
various audit committee mechanisms are required.
2. S. Claessens and B. Yurtoglu, “Corporate governance in emerging markets: A
survey,” Emerging Markets Review. Research on corporate governance with respect
to the emerging market in much needed. Various benefits of following better
corporate governance practices are noticed.
3. S. L. Gillan, “Recent developments in corporate governance: An overview,” Journal
of Corporate Finance, vol. 12, pp. 381-402, 2006. A corporate governance
framework needs to be developed by providing a broad overview of recent corporate
governance research. All aspects of corporate governance are important from board
structure to ownership structure.
4. Sifuna, Anazett Pacy (2012). "Disclose or Abstain: The Prohibition of Insider Trading
on Trial". Journal of International Banking Law and Regulation. This provides for the
definition of Corporate governance.

Research Objectives:

The objective of this paper is to explain corporate governance from the point of view of India
and the practices all over the world. Being an emerging economy, it has its own sets of
challenges and weaknesses.

The study was geared to achieve the following objectives:

  To outline the relevant legal provisions pertaining to Corporate Governance.
 To examine the issue of corporate practices and the emerging debates on the issue
especially in the light of leading publications.
 To study the experiences and problems of implementing Corporate Governance.
 To critically review the idea of Corporate Governance and its importance.

Research Questions:

The various questions which came up during my research are dealt in this project those are:

1. What is the meaning of Corporate Governance?

2. The concept of Corporate Governance is valid in present day or not.
3. What are the objectives of Corporate Governance?
4. What is the importance of Corporate Governance?
5. How corporate Governance is relevant in the present market?

Research Methodology:

In accordance with the objectives of the present study, doctrinal and non-doctrinal research
designs have been adopted. The doctrinal design has been used to study the jurisprudential
development in the areas of Corporate Governance. This has been done primarily with the
help of various articles published by renowned jurists. The reports of committees and
commissions have been scanned to sifting the issues relating to the research problem.
Introduction:

Corporate governance is a process, relation and mechanism set up for the corporations and
firms based on certain guidelines and principles by which a company is controlled and
directed. The principles provided in the system ensure that the company is governed in a way
that it is able to set and achieve its goals and objectives in the context of the social, regulatory
and market environment, and is able to maximize profits and also benefit those whose interest
is involved in it, in the long run. The division and distribution of rights and responsibilities
among different participants in the corporation (such as the board of directors, managers,
shareholders, creditors, auditors, regulators, and other stakeholders) and inclusion of the rules
and procedures for making decisions in corporate affairs are identified with the help of
Corporate Governance mechanism and guidelines. The need to make corporate governance in
India transparent was felt after the high-profile corporate governance failure scams like the
stock market scam, the UTI scam, Ketan Parikh scam, Satyam scam, which were severely
criticized by the shareholders. Thus, Corporate Governance is not just company
administration but more than that and includes monitoring the actions, policies, practices, and
decisions of corporations, their agents, and affected stakeholders thereby ensuring fair,
efficient and transparent functioning of the corporate management system. By this paper, the
authors intend to examine the concept of corporate governance in India with regard to the
provisions of corporate governance under the Companies Act 2013.
Definition of Corporate Governance:

The term governance has been derived from the word “Gubernare”, which means to rule or
steer. Originally this term meant to be a normative framework for exercise of power and
acceptance of accountability used in the running of kingdoms, regions and towns. However,
over the years it has found significant relevance in the corporate world. This is basically due
to growing number and size of the corporations, the widening base of the shareholders,
increasing linkages with the physical environment, and overall impact on the society’s
wellbeing as we need a proper administrative system to regulate so many complex things.

The term ‘Corporate Governance’ which was rarely encountered before the 1990s has now
become an all-pervasive term in the recent decade. In today’s scenario this term has become
one of the most crucial and important concepts in the management of companies. The root of
Corporate governance dates back to Adam Smith but its popularity is of recent origin. The
concept of corporate governance can be understood as the system through which shareholders
are assured that their interest will be taken care of by management. In a much wider term,
corporate governance was defined as the methods by which suppliers of finance control
managers in order to ensure that their capital cannot be expropriated and that they earn a
return on their investment.1

Corporate governance specifies the distribution of rights and responsibilities among different
participants in the corporation, such as the board, managers, shareholders and other
stakeholders, and spells out the rules and procedures for making decisions on corporate
affairs. By doing this, it also provides the structure through which the company objectives are
set, and the means of attaining those objectives and monitoring performance.2

Corporate governance has also been more narrowly defined as "a system of law and sound
approaches by which corporations are directed and controlled focusing on the internal and
external corporate structures with the intention of monitoring the actions of management and
directors and thereby, mitigating agency risks which may stem from the misdeeds of
corporate officers.3

1
Prevention of Insider Trading and Corporate Good Governance, Indian Institute of Management, Ahmedabad
Working Paper No. 2003-01-03 by Sandeep Parekh.
2
www.OECD.org.com accessed on 15th September at 13:00 hrs.
3
Sifuna, Anazett Pacy (2012). "Disclose or Abstain: The Prohibition of Insider Trading on Trial". Journal of
International Banking Law and Regulation.
According to Economist and Noble Laureate Milton Friedman, “Corporate Governance is to
conduct the business in accordance with owners or shareholders’ desires, while conforming
to the basic rules of the society embodied in law and local customs” (Economic Times,
2001).4

“Corporate Governance deals with the ways in which suppliers of finance to corporations
assure themselves of getting a return on the investment.”5

“Corporate Governance is the system by which business corporations are directed and
controlled. The Corporate Governance structure specifies the distribution of rights and
responsibilities among different participants in the corporation, such as, the board, managers,
shareholders and other stakeholders, and spells out the rules and procedures for making
decisions on corporate affairs. By doing this, it also provides the structure through which the
company objectives are set, and the means of attaining those objectives and monitoring
performance.”6

“Corporate Governance is a field in economics that investigates how corporations can be

made more efficient by the use of institutional structures such as contracts, organizational
designs and legislation. This is often limited to the question of shareholder value i.e. how the
corporate owners can motivate and/or secure that the corporate managers will deliver a
competitive rate of return. Mathiesen (1999)7

Concept of Corporate Governance:

The concept of corporate governance has existed from the earliest days of social organization
and is evolving. it. Effective corporate governance structures encourage corporations to
create value, through entrepreneurialism, innovation, development and exploration, and
provide accountability and control systems commensurate with the risks involved. Corporate
governance' is the system of rules, practices and processes by which a company is directed
and controlled. It essentially involves balancing the interests of the many stakeholders in a
company- these include its shareholders, management, customers, suppliers, financiers,
government and the community. Since corporate governance also provides the framework for
attaining a company's objectives, it encompasses practically every sphere of management,
from action plans and internal controls to performance measurement and corporate
4
Noble Laureate Milton Friedman, (Economic Times, 2001)
5
The Journal of Finance, Shleifer and Vishny, 1997 (page 737)
6
Sir Adrian Cadbury in the Report on Financial Aspects of Corporate Governance 1992.
7
Mathiesen (1999)
disclosure. Corporate governance includes the processes through which corporations'
objectives are set and pursued in the context of the social, regulatory and market
environment. The interest of the modern corporations in the corporate governance practices,
particularly in relation to accountability, increased because of the high-profile debacles of a
number of large corporations during 2001–2002, most of which involved accounting fraud.

Corporate governance extends beyond corporate law. When it is practiced under a well-laid
out system, it leads to the building of a legal, commercial and institutional framework and
demarcates the boundaries within which these functions are performed. Its fundamental
objective is not mere fulfilment of requirements of law but in ensuring commitment of the
board and its senior officers in managing the company in a transparent manner for, inter alia
maximizing long term shareholders value. There is plethora of laws in this regard but what is
required is the effective enforcement of these laws.8

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. It is about promoting corporate fairness,
transparency and accountability. In other words, 'good corporate governance' is simply 'good
business'. It ensures:

 Adequate disclosures and effective decision making to achieve corporate objectives;

 Transparency in business transactions;
 Statutory and legal compliances;
 Protection of shareholder interests.
 Commitment to values and ethical conduct of business.

Objectives of Corporate Governance:

The fundamental objective of corporate governance is to boost and maximize shareholder

value and protect the interest of other stake holders. World Bank described Corporate
Governance as blend of law, regulation and appropriate voluntary private sector practices
which enables the firm to attract financial and human capital to perform efficiently, prepare
itself by generating long term economic value for its shareholders, while respecting the
interests of stakeholders and society as a whole. Corporate governance has various objectives

8
www.CivilservicesIndia.com accessed on 30th September at 14:00 hrs.
 to strengthen investor's confidence and intern leads to fast growth and profits of companies.
These are mentioned below:

1. A properly structured Board proficient of taking independent and objective decisions

is in place at the helm of affairs.
2. The Board is balanced as regards the representation of suitable number of non-
executive and independent directors who will take care of the interests and well-being of
all the stakeholders.
3. The Board accepts transparent procedures and practices and arrives at decisions on the
strength of adequate information.
4. The Board has an effective mechanism to understand the concerns of stakeholders.
5. The Board keeps the shareholders informed of relevant developments impacting the
company.
6. The Board effectively and regularly monitors the functioning of the management
team.
7. The Board remains in effective control of the affairs of the company at all times.

Importance of Corporate Governance:

The Organisation for Economic Cooperation and Development (OECD) highlights the
importance of good corporate governance in the global and domestic economic environment.
According to OECD, if countries are to reap the full benefits of the global capital market, and
if they are to attract long-term “patient” capital, corporate governance arrangements must be
credible and well understood across borders. Even if companies do not rely primarily on
foreign sources of capital, adherence to good corporate governance practices will help to
improve the confidence of domestic investors, may reduce the cost of capital, and ultimately
induce more stable sources of financing (Principles of Corporate Governance, 1990).

As a result of globalization and the increasing complexity of business there is a greater

reliance on the private sector as the engine of growth in both developed and developing
countries. Corporations are legal entities created by societies because they are an efficient
form of organization and society benefits from their existence. Corporations contribute to
economic growth and development, which in turn leads to improved standards of living as
well as the alleviation of poverty. The end result of all this activity is the creation of more
stable political systems.

Furthermore, as noted by Gregory and Simms (1999), the quality of corporate governance is
important since it has a direct impact on:

a. The efficiency with which a corporation employs assets.

b. Its ability to attract low-cost capital.

c. Its ability to meet the expectations of society.

d. Its overall performance.

Effective corporate governance ensures the optimal use of resources both intra-firm and
inter-firm. With effective systems of corporate governance, debt and equity capital will go to
those corporations capable of investing it in the most efficient manner for the production both
of highly demanded goods and services as well as those with the highest rate of return. This
helps to protect and nurture scarce resources thereby ensuring that societal needs are met. In
all probability this will mean that incompetent managers are replaced. These efficiency
effects both as to scarce resources and the quality of managers should apply whether a firm is
a state-owned enterprise, a private closely held firm owned by a family group, or a publicly
traded corporation on a stock exchange.

Its ability to attract low-cost capital Effective corporate governance also helps to lower the
cost of capital by improving the confidence of both foreign and domestic investors that their
assets will be used for the purposes agreed. A survey of institutional investors by R.F. Felton
et al (1996) found that they would willingly pay on average well over ten percentage points
more for a “well governed” company, all other things being equal. In competitive markets,
this means that managers must constantly evolve new strategies to meet the changing
circumstances. This requires that managers be empowered to make decisions.

However, as observed by that famous 18th century economist Adam Smith, managers may
have incentives to act in their own self-interest under such circumstances. Jensen and
Mackling (1976) found that when firm ownership is separated from control, the manager’s
self-interest may lead to the misuse of corporate assets, for example through pursuit of overly
risky or imprudent projects. Therefore, we need to have in place rules and regulations to
protect the best interests of the providers of capital. They include the following:
 a. Independent monitoring of management.

b. Transparency about the performance, ownership and control of the corporation

c. Participation in certain fundamental decisions by the shareholders.

Its ability to meet the expectations of society for long-term success, corporations must
comply with the laws, regulations and expectations of societies where they operate. Many
corporations take their role as corporate citizens seriously thus contributing to civil society.
Regrettably however, some corporations are opportunistic and seek to profit from child
labour or act without regard for the environment. The latter are not merely failures of
corporate governance but are symptomatic of the larger failures of government to provide the
framework needed to hold corporations responsible for issues that are also important for
society at large.

Its overall performance when corporate governance is effective, it provides managers with
oversight and holds boards and managers accountable in their management of corporate
assets. This oversight and accountability combined with the efficient use of resources,
improved access to lower-cost capital and increased responsiveness to societal needs and
expectations should lead to improved corporate performance. Effective corporate governance
should make it more likely that managers focus on improving firm performance and are
replaced when they fail to do so.9

A study carried out by Millstein and McAvoy in the United States (U.S.) analysing data from
1991-1995 found that U.S. corporations with active and independent boards of directors
generated higher economic profit hence supporting the reasonable assumption that corporate
governance matters to corporate performance. Effective corporate governance also helps to
reduce corruption in business dealings by making it difficult for corrupt practices to develop
and take root in a company 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
9
International Journal of Trade, Economics and Finance, Vol. 5, No. 4, August 2014, Corporate Governance —
Indian Perspective. Ruchi Kulkarni and Balasundram Maniam.
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.

Critical Analysis

Corporate governance has played a very important role in the present economic condition of
India. India successfully started its move towards open and welcoming economy in 1991.
From then onwards it has seen an amazing upward trend in the size of its stock market, that
is, number of listed firms was increasing proportionately. 10 If India wants to attract more
countries for foreign direct investments, Indian companies have to be more focused on
transparency and Shareholders value maximization.11 Even though corporate governance
practices can be backdated to as early as 1961 around the world, India was lagging behind. It
was not until 1991 when liberalization took place and corporate governance established an
international context. The most important initiative of 1992 was the reform of Securities and
Exchange Board of India (SEBI). The main objective of SEBI was to supervise and
standardize stock trading, but it gradually formed many corporate governance rules and
regulations.

The next major change was formation of Confederation of Indian Industry (CII) in 1996,
which developed the set of laws for Indian companies as to initiate the act towards corporate
governance. Then two committees Kumar Mangalam Birla and Narayan Murthy under
Securities and Exchange Board of India started laying the groundwork for formalizing the
best practices on corporate governance. Based on suggestions from these committees, Clause
49 was introduced as part of the listing contract for the companies listed on the Indian stock
exchange. However, due to scandals like Enron, Satyam, WorldCom etc. forced the clause 49
to be reformed to incorporate and overcome the problems that caused these companies to

10
L. Som, “Corporate Governance Codes in India,” Economic and Political Weekly, vol. 41, no. 39, pp. 4153-
4160, 2006.
11
R. Ramakrishnan. (2007). Inter-relationship between business ethics and corporate governance among Indian
companies. [Online]. Available: http://ssrn.com/abstract=1751657
collapse and shatter the economies of the respective countries. 12 Clause 49 of the listing
agreement of Indian stock exchange took effect from 2000 to 2003. It contained all the
regulations and requirement of minimum number of independent directors, board members,
different necessary committees, code of conduct, audit committee rules and limits, etc. Firms
that were not following these principles were removed from the listing and were given
financial penalties.13 We can compare the Sarbanes-Oxley Act of 2002 and Clause 49. Clause
49 was based on the principles of Sarbanes-Oxley Act of 2002.

It was developed for the companies listed on the US stock exchanges. As far as the
responsibilities of management and number of directors were concerned, they are both the
same. They also have same rules regarding insider trading, refusal of loans to directors and so
on. The important difference between the two is under Sarbanes-Oxley legislation if fraud or
annihilation of reports takes place up to 20 years of imprisonment can be charged, but in case
of Clause 49, there is no such condition. Being the controller of the market SEBI can
commence a criminal proceeding. If in case SEBI decides to give a severe punishment then it
can commence a criminal proceeding or raise the fine for not agreeing with Clause 49, which
automatically delists the company.14 Corporate governance affects corporations as well as
countries in different ways such as firm’s access to outside financing increases, which leads
to more investment, better growth opportunities and that causes the job market to flourish.
Capital cost is decreased and so the firms are valued at higher cost. Firms can be attracted by
this, which directs it to growth and again to reduced unemployment. Wealth is generated by
better distribution of resources and good management practices, which is because of better
operational performance.

Concluding Remarks and suggestions.

There is a heightened awareness worldwide that effective corporate governance as manifested

by transparency, accountability as well as the just and equitable treatment of shareholders is
now a pre-requisite towards efforts to promote sustainable development. Towards this end,
there is a need for both public (as represented by governments) and private sector partnership
to raise the awareness of the importance of corporate governance improvements and to assist
in implementing corporate governance reform. However, such efforts must be mindful of the
12
N. Sanan and S. Yadav, “Corporate governance reforms and financial disclosures: A case of Indian
companies,” IUP Journal of Corporate Governance, vol. 10, no. 2, pp. 62-81, 2011.
13
K. Han and Y. Lu, “Corporate governance reforms around the world and cross-border acquisitions,” Journal
of Corporate Finance, 2013.
14
L. J. P. Singh, “Ethics, corporate governance & investment,” Indian Streams Research Journal, vol. 2, issue
12, Jan. 2013.
fact that each country has its own culture as well as differing social and economic priorities.
Similarly, every corporation has its own corporate culture and business goals. All of these
differences will impinge on questions regarding the most practical corporate governance
structures and practices to be adopted both by sovereign nations and individual corporations.
Therefore, at this point in time, to get a consensus on a single model of corporate governance
or a single set of detailed governance rules is both unlikely and unnecessary. It is expected
that over time the dictates of the capital market will lead to increasing convergence in
practice between countries. This together with globalization and the attendant fall in
regulatory barriers between countries will ensure that investment capital flows to those
corporations that have adopted efficient corporate governance standards including
internationally acceptable accounting and auditing standards; adequate investor protection
mechanisms as well as board practices designed to provide independent and accountable
oversight of managers.