CORPORATE

GOVERNANCE
National Law School of India University

Class 1
November 21, 2018
Structure of the Course
 Objectives
 To understand the various concepts and theories
in corporate governance
 To understand Indian corporate governance
norms in the global context
 A comparative perspective
 To analyse the practical application of corporate
governance structures and norms
Structure of the Course
Structure of the Course
 Course materials
 Readings distributed
 Slides
 Optional materials
 Assessment
 Final exam
 Structure, expectations
 Class participation / discussions
Corporate Governance
Background & Theory
Features of a Company

Basic Legal Characteristics

The Concept
 System by which companies are directed and
controlled
 Checks and balances with the corporate
structure – to create long-term value
enhancement for stakeholders
 Defines various relationships

 Cadbury Committee reforms in the UK

(1990s) – major impact on India
The Concept

Consumers

Control Creditors

Employees
Shareholders

Board of Environment
Directors
Managers
Company

Shareholder Theory Stakeholder Theory

Agency Problems Analysis
 Economic perspective
 Not agency as we understand in law – broader
in nature
 Fiduciary relationship
 Possible problems – shirking & rent-seeking
 Agency costs – monitoring by principal
Agency Problem Types
Agency Problem Types
Agency Problem Types
Outsider vs. Insider Model
 Outsider
 Diffused shareholding – e.g. Berle & Means
corporation
 Collective action problems
 Companies are board / management driven
 US and UK largely follow this model
Outsider vs. Insider Model
 Insider Model
 Concentrated shareholding (average of 48% in
Indian companies)
 By family or state
 Controlling shareholders dominate board and
management
 Most other jurisdictions (including India) follow
this model
Agency Problems
 Outsider Model  Insider Model

Control

Shareholders Shareholders
Agency
Problems
Agency problems

Board of Board of
Directors Directors
Managers Managers
Company Company
Strategies
 Compliance and enforcement
 Public enforcement
 Private enforcement
 Gatekeeper control

 Disclosure – Transparency
 Initial – e.g. IPO, public offering (prospectus)
 Continuing
Some Theories of Governance
 “Law Matters” Thesis
 Corporate governance and investor protection
depends on nature of legal system
 Common law vs. civil law
Some Theories of Governance
 Shareholder model (diffused + concentrated)
 Bank model
 Present in continental Europe (civil law orientation)
 Universal banks (influence in companies)
 Dual board structure (as opposed to unitary board
in common law countries)
 Supervisory board
 Management board
Some Theories of Governance
 Co-determination
 Workers’ participation on board

 Common law is associated with shareholder

theory of governance
 Civil law pays regard to other stakeholders as
well (primarily employees)
Some Theories of Governance
 The End of History in Corporate Law
 Henry Hansmann & Reinier Kraakman,
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2
04528
 A Theory of Path Dependence in Corporate
Ownership and Governance
 Lucian Bebchuk & Mark Roe,
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2
02748
Evolution of Corporate
Governance Norms in
India
Governance in India
 Previously determined under the Companies Act,
1956
 1997-98 – CII Code – a voluntary initiative
 Largely based on the Cadbury Committee report in the
UK
 2000 – KM Birla Committee report – need to make
governance mandatory
 Clause 49 introduced into the listing agreement
between companies and stock exchanges
 This details corporate governance norms for Indian listed
companies
Governance in India
 2002 – Enron, WorldCom, Tyco
 Enactment of Sarbanes-Oxley in the US
 2003 – NRN Murthy committee appointed in
India to strengthen corporate governance
norms
 New (and tightened) rules introduced with
effect from January 1, 2006
Motivating Factors
 Internationalization of Indian capital markets
 Domestic IPOs take on an international flavour
 QIP portion heavily subscribed by foreign investors
 Rule 144A process, etc.
 Need for governance norms that foreign investors are
familiar with
 Secondary markets – need to attract foreign institutional
investment
 E.g. CalPERS
Motivating Factors
 Cross-listing
 Indian companies listing on foreign exchanges
 Better valuations and premium
 Building reputation capital
 Infosys ADR issue – a watershed event
 See
 Tarun Khanna & Krisha Palepu, Globalization &
Convergence in Corporate Governance: Evidence
from Infosys and the Indian Software Industry,
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10
.1.1.469.851&rep=rep1&type=pdf
Some Path Defining Events
Regulatory Efforts
 Several committees and task forces established –
CII, ICSI
 Resulting in issue of Voluntary Guidelines by
MCA
 Companies Bill, 2009 (no resulting changes)

 No knee-jerk reaction
 Preference for voluntary mechanism rather than a
mandatory process
Regulatory Efforts
 But, the company law reform process took
note of the deficiencies in prevalent norms
 Companies Bills
 Parliamentary Standing Committee Reports
 Companies Act, 2013
 Extensive regulation of corporate governance
matters
 Board independence, audit matters, etc.
Regulatory Efforts
 SEBI (Listing Obligations and Disclosure
Requirements) Regulations, 2015 (LODR
Regulations)
 Substitutes clause 49 of the Listing Agreement
 Consider consequences of non-compliance
 Kotak Committee Report 2017
 Subsequent changes to LODR Regulations
Regulatory Efforts
 Voluntary vs. mandatory norms
 “Soft law” vs. “hard law”

 Voluntary norms
 Codes of conduct (“comply-or-explain”)
 Pre-requisites
 Legal tradition
 Presence of institutional investors
 Active monitoring
Regulatory Efforts
 Mandatory law/rules
 Varied legal tradition
 Limited role of institutional investors
 Presence of concentrated shareholdings

 Source of mandatory rules

 Stock exchange rules
 Regulations laid down by securities regulator
 Law laid down in statute
Regulatory Efforts
 Companies Act, 2013
 Statutory focus on corporate governance in India
 “Ultra mandatory” approach

 Discuss: What are the pros and cons?

 Do you agree with this approach?
Optional Readings
 Further references relating to Class 1
 Umakanth Varottil, The Evolution of Corporate
Law in Post-Colonial India: From Transplant to
Autochthony, http://ssrn.com/abstract=2557809
 Vikramaditya Khanna, Corporate Governance in
India: Past, Present and Future?, 1 Jindal Global
Law Review 171 (2009)
DIRECTORS AND
BOARD INDEPENDENCE

37
Allocation of Corporate Powers

38
Board Composition

39
Evolution of IDs
 Concept of independent directors originated in the
US
 Received impetus in the UK too

 Rapidly spread to other economies as well

 Emerging economies have wholeheartedly embraced

the concept over the last couple of decades
 India
 Clause 49 of the listing agreement introduced by SEBI (2000)
40
Evolution of IDs
 Example of a legal transplant
 Note debate regarding effectiveness of legal
transplants

 Now receives significant attention under Indian

corporate law

 Companies Act, 2013

 Provisions effective April 1, 2014

 SEBI LODR Regulations, 2015

41
Need for IDs

42
Number of IDs
 Companies Act, 2013 requires 1/3rd of the board to be
independent

 But, clause 49 provides that ½ of the board is to be

independent, if:
 The chairman is executive or is related to the controlling
shareholder (also known in India as the “promoter”)

 Why have IDs if they do not constitute a majority?

43
Who are IDs?
 The definition of IDs takes on importance

 Sec. 149(6) of the Companies Act, 2013

 Any director who:

 In the opinion of the board, has integrity with the relevant

expertise and experience

 Is not a promoter of the company or related companies

44
Who are IDs?
 Has no pecuniary relationship with the company

 Has not been an employee of the company in recent

years

 Is not a partner or proprietor of a firm of auditors or

company secretaries of the company;

 Is not a partner or proprietor of a law firm who

obtains 10% or more of its turnover from the
company
45
Who are IDs?
 Is a CEO or director of a non-governmental
organisation (NGO) that receives 25% or more
receipts from the company

46
Appointment of IDs
 They are elected to office like any other director

 Consequences of such election process under the

“insider” model
 Significant influence of controlling shareholders in
the election process

 Recent mechanisms in India to address this issue

47
Appointment of IDs
 Requirement of a nomination committee for selecting
IDs

 Transparency in the process as the committee must

disclose its process for selecting ID nominees

 But, voting still by shareholders whereby controlling

shareholders wield significant power

 Requirement of a database for IDs – s. 150

48
Appointment of IDs

49
Term of the IDs, etc.
 Section 149(10) of the Companies Act, 2013

 Two terms of 5 years each

 To prevent familiarity and coziness in the
relationship

 Limits on other directorships

 On both independent directors as well as other
directors

50
Remuneration of IDs
 Limits on amounts of compensation

 Sitting fees
 Commissions
 Stock options not permitted (but recent change)

 Debate regarding the appropriate level of

compensation for IDs
51
CORPORATE
GOVERNANCE
National Law School of India University

Class 2
November 22, 2018
Role of IDs
 Functions and responsibilities of IDs are set out
in detail in Schedule IV of the Companies Act,
2013

 They include:

 To help bring independent judgment to the board

 To safeguard the interests of all stakeholders,

particularly of the minority shareholders
53
Role of IDs
 To strive to attend all board and committee
meetings and to participate actively and
constructively

 To pay sufficient regard to related party

transactions

 To report concerns about unethical behaviour,

fraud or violation of code of conduct or ethics
policy of the company
54
Role of the IDs

55
Optional Readings
 Vikramaditya Khanna & Shaun Mathew, The
Role of Independent Directors in Controlled
Firms in India: Preliminary Interview
Evidence, http://ssrn.com/abstract=1690581
 Umakanth Varottil, Evolution and
Effectiveness of Independent Directors in
Indian Corporate Governance,
http://ssrn.com/abstract=1548786
Directors’ Duties
 Common law duties

 Skill, care and diligence

 Fiduciary duties

 To act in the best interest of the company

 To not put oneself in a position of conflict
 To act for proper purpose
57
Directors’ Duties
 The Companies Act, 2013 for the first time
codifies these duties (section 166)
 To act in accordance with the articles of
association of the company

(2) A director of a company shall act in good faith in order to promote the
objects of the company for the benefit of its members as a whole, and in the
best interests of the company, its employees, the shareholders, the
community and for the protection of environment.

58
Directors’ Duties
 To exercise duties with due care, skill and diligence
and to exercise independent judgment

 To not be involved in a situation of direct or indirect

conflict with the interests of the company

 To not achieve any undue gain or advantage

 Lack of clarity as to whether broad common law

duties continue to operate
59
Duties
owed

Interests
to consider

60
 Companies Act, 2013
India
◦ s. 166(2)
 Pluralist approach
 All stakeholders treated on
par, as an end in itself
 Companies Act 2006
◦ s. 172
 Enlightened Shareholder
Value (ESV) model
 Regard to stakeholders as a
means to enhancing
shareholder value
United Kingdom (UK)
61
 Companies Act, 2013, s. 166(2)

 A director of a company shall act in good faith in

order to promote the objects of the company for
the benefit of its members as a whole, and in the
best interests of the company, its employees, the
shareholders, the community and for the
protection of environment.

62
 Genesis of the provision

◦ Irani Committee Report (2005)

◦ Review of the legislative proposals by the Parliamentary Standing

Committee on Finance (2010)

◦ Need to protect stakeholder interests

◦ Consistent with the move towards corporate social responsibility

(CSR)

◦ Possibly as a way of mitigating the negative impact of scandals

63
 Companies Act 2006, s. 172(1)

(1) A director of a company must act in a way that he considers, in

good faith, would be most likely to promote the success of the
company for the benefit of its members as a whole, and in doing so
have regard (amongst other matters) to —
…
(b) the interests of the company’s employees,
(c) the need to foster the company’s business relationships with suppliers,
customers and others,
(d) the impact of the company’s operations on the community and the
environment,
…
64
 Choice between pluralist approach and the ESV
model

 Hierarchical approach
 Stakeholder interests are only a means to enhance
shareholder value
 In case of a conflict, shareholder value trumps

 Hence, fundamental differences to the

approaches in India and the UK
65
Optional Readings
 Mihir Naniwadekar & Umakanth Varottil,
The Stakeholder Approach Towards
Directors’ Duties Under Indian Company
Law, http://ssrn.com/abstract=2822109
Liabilities of Directors
 Different types of liabilities

 Statutory liabilities set forth in the Companies

Act (both civil & criminal)

 Misstatements in prospectus
 Breach of solvency declaration
 Breach of directors’ duties
 Fraudulent trading
67
Liabilities of Directors
 Civil liabilities for breach of directors’ duties
 E.g. through shareholder actions

 Mitigating factors against liability

 Relief or safe harbour provisions

 General excuse provisions on the ground of having acted

honestly and reasonably (s. 463, Companies Act, 2013)
68
Liabilities of Directors
 New safe harbour provision for independent
directors (section 149(12) of the Companies Act,
2013):
 An independent director is liable “only in respect of
such acts of omission or commission by a company
which had occurred with his knowledge, attributable
through board processes, and with his consent or
connivance or where he had not acted diligently”

 Indemnities from company to directors

69
Liabilities of Directors
 Directors’ and officers’ (D&O) liability insurance
policies

 With the cost of premium being borne by the

company

70
Practical Measures for Boards & IDs
 Adequate participation by directors in the affairs
of the company

 Encouraging directors to raise relevant questions

and seek proper explanation from management

 Maintaining regular communication between

board and management
71
Practical Measures for Boards & IDs
 Establishing internal monitoring and reporting
systems

 Placing reliance on relevant employees and

experts – on the basis of good faith

 Pursuing any “red flags” that are waved

 Clarity on voting by directors on specific board

items, and recording in the minutes
72
Practical Measures for Boards & IDs
 Enhancement of board evaluation mechanisms
that may improve director performance

 Appointing separate legal counsel, investment

banker or valuer on crucial transactions such as
large M&A or related party transaction

 Conduct periodic executive sessions

73
Board Diversity
 Requirement for a woman director
 For listed companies
 And other companies based on paid-up share capital and
turnover

 SEBI – extended the application of the requirement in

clause 49 until April 1, 2015

 Discuss
 Need for board diversity
 Effect of diversity in Indian circumstances
CORPORATE
GOVERNANCE
National Law School of India University

Class 3
November 23, 2018
SHAREHOLDER ACTIVISM
Definition

Shareholder activism is defined as

“proactive efforts to change firm behavior
or governance rules”

 - Professor Bernard Black

Shades of the Spectrum
The Issue
Voting Opportunities
Voting Opportunities
Voting Opportunities
Voting Opportunities
Voting Opportunities
 Companies (Management and
Administration) Rules, 2014
 Requirement of e-voting

 Wadala Commodities Limited and Godrej

Industries Limited
 Bombay High Court (2014)
Voting Opportunities
SEBI’s Efforts
New Trend
 Emergence of proxy advisory firms over the
last few years
 3 already established
Proxy Advisors
Proxy Advisors
Proxy Advisors
Interactive or Combative Activism
Interactive Approaches
Combative Approaches
Why Have Shareholder Actions?
 Importance of enforcing corporate laws

 Multiple modalities
 Public enforcement
 Private enforcement

 Utility of private enforcement

 Availability of information with litigants
 Enhancement of liquidity in markets

 Types of private enforcement

 Direct actions
 Derivative actions
Shareholder Actions
DA: Law & Practice in India
 Over the last 60 years

 Findings show only about 10 derivative actions

have reached Supreme Court or High Courts

 Out of these, only 3 have been allowed to proceed

 Compare: corporate population and litigiousness

DA: Law & Practice in India
 Common law action

 No statutory recognition

 An uncommon factor: compare

 Singapore, Hong Kong, China

 UK: Companies Act, 2006
Recommendations
 Although derivative actions are a desirable and
important mechanism for enhancing governance
in India, they are rare

 Recommendations for the future

 Introduce specific statutory provisions
 Introduce clarity in procedure for such actions
 Remove uncertainty regarding costs and the
associated disincentives
 Clarify duties of directors & controlling shareholders
Direct Actions
 Availability of other remedies
 Oppression
 Mismanagement

 Sections 241-244, Companies Act, 2013

“... any member or members holding not less than one-
tenth of the issued share capital of the company ...”
Recent Reforms
 The new Companies Act, 2013 recognises
shareholder class actions in section 245

 Expressly recognises the concept of a “class” of

shareholders affected

 Actions can be brought to

 Restrain the company and directors from breaching

the statute or their duties
100
Recent Reforms
 Claim damages or compensation from the company,
directors, auditors, expert or advisor
 Wide ambit of persons who can be sued
 Provides relief to victims through damages

 Jurisdiction for hearing such cases is with the National

Company Law Tribunal (NCLT)
 Bypasses the regular court system
 May address the issues of delays and costs

 But, questions arise regarding independence and

capabilities
101
Recent Reforms
 However, minimum support required to bring
shareholder actions

 Either 100 shareholders or those holding at least 10%

of the “issued share capital” of the company
 Filter mechanism to curtail frivolous and vexatious
legal actions

 Also, unclear whether this includes both direct

and derivative actions

102
Evaluating the Impact
Evaluating the Impact
CORPORATE
GOVERNANCE
National Law School of India University

Class 4
November 24, 2018
CORPORATE SOCIAL
RESPONSIBILITY (CSR)
CSR: The Concept
Consumers
Control
Creditors

Shareholders Employees

Board of Environment
Directors
Managers
Company

Shareholder Theory Stakeholder Theory 109

CSR: The Concept
 A possible definition of CSR

 a “view of the corporation and its role in society

that assumes a responsibility among firms to
pursue goals in addition to profit
maximization and a responsibility among a
firm’s stakeholders to hold the firm
accountable for its actions.”

110
CSR: The Concept
 Positive and negative aspects of CSR (Bhagwati)

 Positive: contribute to society through their

activities and philanthropy

 Negative: not to carry out activities that are

destructive to the stakeholders, community and
society
111
CSR: The Concept
 Reasons for CSR

 Consistent with business activities – enables shareholders

as well to enjoy greater benefits

 E.g. reputation, brand-building

 Customer attraction
 Investor attraction (social investments – new concept of social
responsible investing (SRI))

 A prophylactic against greater state regulation

 Especially in the wake of the global financial crisis

112
CSR: The Concept
 Opposition to CSR

 Corporate law is about protection of shareholder

interests, which are paramount

 E.g. Dodge v. Ford (Michigan, 1919)

 The court held that shareholder interests were to be given
preference over other stakeholders

 Berle vs. Dodd debate in the 1930s

113
CSR: The Concept
 Milton Friedman
 The only (social) responsibility of a corporation is to make
profits for its shareholders

 More recently, Aneel Karnani

 Questioning whether social responsibility can co-exist with
business and profit-making goals of a corporation

 Diversity of stakeholder interests

 That make it difficult for companies and boards to measure
performance
 Shareholder interest is tangible – through share price on the
stock exchange
114
CSR: The Concept
 Some examples of CSR issues being highlighted

 Rana Plaza incident in Bangladesh

 Factory building manufacturing apparels for multinational
brands collapsed due to a fire in which scores of workers were
killed
 Problems of contract manufacturing
 Responsibility for social issues

 Apple’s contract manufacturing facilities in China –

Foxconn
 Employee welfare issues

115
CSR and the Asian Economies
 Factors that promote CSR

 Socialistic origins of economies such as China and India

 Where stakeholder interests have received historical recognition

 Heavy state involvement in business activity

 Thereby considering “public interest”

 Role of business families

 Philanthropic bent of mind
 E.g. Tatas, Birlas in India
116
CSR in India
 Gandhian philosophy of “trusteeship” model of
business
 Followed by several business families
 Received recognition in recent business literature as well
 See Colin Mayer, The Firm Commitment

 Role of stakeholders recognised under corporate law

 Employees – in case of mergers, corporate insolvency
 Creditor interests

117
CSR in India
 Role of “public interest” in corporate law
 An aspect to be considered by the court while
approving mergers and corporate restructuring

 CSR introduced in 2009 as a voluntary matter

through Government guidelines
 Companies to introduce CSR policies
 Environmental and social governance (ESG)

118
Legal Framework: Evolution
Voluntary Efforts Drivers
• Perceptions about the
corporate sector
• Worldwide phenomenon
• Global financial crisis
• Corporate governance
scandals in India

119
CSR in India
 Companies Act, 2013 introduces significant
reforms on CSR, which is now codified in statute

 Director’s duties as to stakeholder interests

 Section 166
 A director of a company shall act in good faith in
order to promote the objects of the company for the
benefit of its members as a whole, and in the best
interests of the company, its employees, the
shareholders, the community and for the
protection of environment. 120
CSR in India
 Section 135 of Companies Act, 2013

 Large companies to constitute a CSR Committee

consisting of at least 3 directors, with at least 1
independent director

 Board to formulate and approve a CSR policy

 To widely disclose the CSR policy, including on

the company website
121
Companies Act, 2013

122
Companies Act, 2013
 Section 135
 Applicability – 3 tests
 Net worth – Rs. 5,000 million (US$ 74 million)
 Turnover – Rs. 10,000 million (US$ 148 million)
 Net profit – Rs. 50 million (US$ 740,000)
 Obligations
 CSR Committee
 3 directors of which 1 shall be independent
123
Companies Act, 2013
 Committee to formulate
a CSR policy
 To disclose contents on
the board’s report and
also company’s website
 More importantly, CSR
spending of 2% of
average profits for the
previous 3 years
 List of activities
specified in Schedule VII
124
 Eradicating hunger, poverty and
malnutrition;
 Promoting education;
 Promoting gender equality;
 Ensuring environmental
sustainability;
 Protection of national heritage, art
and culture;
 Measures for the benefit of armed
forces veterans;
 Training to promote rural sports;
 Contribution to the Prime Minister’s
National Relief Fund;
 Contributions or funds to technology
incubators; and
 Rural development projects.
Companies Act, 2013
 Disclosure Requirements
 A brief outline of the company’s CSR policy;
 The composition of the CSR committee;
 Average net profit of the company for the last three years;
 Prescribed CSR expenditure (i.e. two percent of the above);
 Details of CSR spend during the financial year
 Total amount to be spent for the financial year;
 Amount unspent, if any;
 Manner in which the amount is spent during the financial year (in
a tabular form containing various details).

125
CSR in India
 Compromise solution found in the final statute

 Language appears mandatory

 But, if company cannot comply with the
minimum spend, then it is to disclose the reasons

 “Comply-or-explain” policy
 Effect remains somewhat unclear, particularly in the
Indian context
126
CSR in India
 Problems in interpretation of the law on CSR
policy

 CSR excludes activities carried on in the normal

course of business

 CSR excludes employee benefits

 CSR covers only spending carried out locally in India

and does not cover spending on overseas business
presence
127
CSR in India
 Larger policy questions

 Is there an overlap between CSR and corporate

philanthropy? Should they be distinguished?

 Does CSR spend amount to an additional form of

taxation?

 Does it amount to the state abdicating a part of its

public duty towards corporations?
128