Corporations have become a powerful and dominant institution. They have reached to every corner of the globe in various sizes, capabilities and influences. Their governance has influenced economies and various aspects of social landscape. Shareholders are seen to be losing trust; and their market value has been tremendously affected. Moreover, with the emergence of globalization, there is greater de-territorialization in corporate governance and less of governmental control, which results is a greater need for accountability.
Hence, corporate governance has become an important factor in managing Organizations in the current global and complex environment. There is evidently emerging condition of corporate colonialism. It is in view of the influence of the multi-national corporations (MNCs) through their strategy of corporate colonialism, using economic power, that the researchers have chosen this subject to view the current status of Corporate Governance in India while also presenting the subject as dissertation with definition, theories and practices followed.
Definition In order to understand corporate governance, it is important to highlight its definition. Even though there is no single generally accepted definition of corporate governance, it is necessary to define it: it can be defined as a set of processes and structures for controlling and directing an organization. It constitutes a set of rules, which governs the relationships among management, shareholders and stakeholders (Ching et al, 2006). The term “corporate governance” has a clear origin from a Greek word, “kyberman” meaning to steer, guide or govern.
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From a Greek word, it moved over to Latin, where it was known as “gubernare” and the French version of “governor”. It could also mean the process of decision-making and the process by which decisions may be implemented. Henceforth, corporate governance has much a different meaning to different organizations (Abu-Tapanjeh, 2008). In recent years, with much corporate failures, the countenance of corporate has been scared. Corporate governance extends to all types of firms and its definitions could profitably include covering all of the economic and non-economic activities.
Literature in corporate governance provides some form of meaning on governance, but falls short in its precise meaning of governance. Such ambiguity emerges in words like control, regulate, manage, govern and governance. Owing to such ambiguity, there are many interpretations. It may be important to consider the influences a firm has or by which it is affected, to grasp a better understanding of governance. Due to the vastness of influential factors, the proposed models of corporate governance can be flawed as each social scientist is forming its scope and concern in his own way.
There is no gain-saying the fact that corporate governance is all about ethical conduct in business. Ethics is concerned with the values and principles that enable a person to choose between right and wrong, and therefore, to select from alternative courses of action, one approach, as the best possible alternative. Further, ethical dilemmas arise from conflicting interests of the parties involved. In this regard, managers take decisions based on a set of principles influenced by the values, context and culture of the organization.
Ethical leadership is good for business akin to the ‘General will’ concept as the organization is seen to conduct its business in line with the expectations of all stakeholders. What constitutes good Corporate Governance will evolve with the changing circumstances of a company and must be tailored to meet these circumstances. There can, therefore, be no one single model of Corporate Governance. So, the Corporate Governance is nothing but the moral or ethical or value framework under which corporate decisions are taken.
It is quite possible that in an effort at attaining the best possible financial results or business results, there could be zealous attempts at doing things which are verging on the illegal or outright illegal. There is also the possibility of grey areas where an act is not illegal but considered unethical that is opposed to public policy. This raises moral issues in the corporate inside as much as in its relations with outside world. What is then corporate governance? Corporate Governance is concerned with holding the balance between economic and social goals and between individual’s and community goals.
The corporate governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals, corporations and society - Sir Adrian Cadbury . The primary purpose of corporate leadership is to create wealth legally and ethically. This translates to bringing a high level of satisfaction to five constituencies customers, employees, investors, vendors and the society-at-large.
The raison d'etre of every corporate body is to ensure predictability, sustainability and profitability of revenues year after year. N R Narayana Murthy History of Corporate Governance in India. Unlike South-East and East Asia, the corporate governance initiative in India was not triggered by any serious nationwide financial, banking and economic crisis or collapse. Also, unlike most OECD countries, the initiative in India was initially driven by an industry association, the Confederation of Indian Industry (CII). In December 1995, CII set up a task force to design a voluntary code of corporate governance. The final draft of this code was widely circulated in 1997 In April 1998, the code was released. It was called Desirable Corporate Governance: A Code. Between 1998 and 2000, over 25 leading companies voluntarily followed the code: Bajaj Auto, Hindalco, Infosys, and Dr. Reddy’s Laboratories, Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI and many others. Following CII’s initiative, the Securities and Exchange Board of India (SEBI) set up a committee under Kumar Mangalam Birla to design a mandatory-cum-recommendatory code for listed companies.
The Birla Committee Report was approved by SEBI in December 2000 It became mandatory for listed companies through the listing agreement, and implemented according to a roll-out plan. Following CII and SEBI, the Department of Company Affairs (DCA) modified the Companies Act, 1956 to incorporate specific corporate governance provisions regarding independent directors and audit committees. In 2001-02, certain accounting standards were modified to further improve financial disclosures. These were: Disclosure of related party transactions Disclosure of segment income: revenues, profits and capital employed. Deferred tax liabilities or assets – Consolidation of accounts. Initiatives are being taken to account for ESOPs, further increase disclosures, and put in place systems that can further strengthen auditors’ independence Fundamental Objective of Corporate Governance.Enhancement of Shareholder Value, keeping in view the Interests of other Stakeholders. CG a Way of Life rather than a mere Code to follow mechanically. Constituents of Corporate Governance
Fundamental Corporate Governance Theories
There are many theories on the subject. The important ones are the following: 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, hire the agents to perform work. Principals delegate the running of business to the directors or managers, who are the shareholders’ 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 behaviour and falling short of congruence between the aspirations of the principal and the agent’s pursuits. Even the understanding of risk differs 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, yet 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 those 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 againsta firm with public ownership. (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 needs of shareholders, which may be challenging the governance structure. Stewardship Theory Stewardship theory has its roots in 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”. Viewed in this perspective, stewards are company executives and managers working for the shareholders; they protect their interest and assets and make profits for the shareholders.
Unlike agency theory, stewardship theory stresses not upon the perspective of individualism (Donaldson ; Davis, 1991), but rather on the role of top management as stewards, integrating their functional goals as part of the organization. The stewardship perspective suggests that stewards are satisfied and motivated when organizational success is attained. Agyris (1973) argues that the agency theory looks at the employees or people as an economic being, which suppresses an individual’s own aspirations. However, stewardship theory recognizes the importance of structures that empower the
stewards 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 reputation as decision-makers in organizations, executives and directors are inclined to operate the firm to maximize financial performance as well as shareholders’ profits (wealth). In this sense, it is believed that the firm’s performance can directly impact perceptions of the individual performance of the directors, managers and executives. Indeed, Fama (1980) contends that the executives and directors are also managing their careers in order to be seen as effective stewards of their organizations, whilst Shleifer and Vishny (1997) insist that managers return finance to the respective investors to establish a good reputation so that the organisation can re-enter the market for future finance.
Stewardship model can have linking to or resemblance with the systems followed in countries like Japan, where the Japanese workers assume the role of stewards and take 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 synthesized role as stewards in the organization. It was evident where this operated and experience showed that there would be better safeguarding of the interest of the shareholders in such arrangement.
It was empirically found that the returns have improved by having both these theories (agency and stewardship) combined rather than separated (Donaldson and Davis, 1991). Stakeholder Theory 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 is 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 includes the suppliers, employees and business partners.
And it was argued that this group of network is important, more than owner-manager-employee relationships as in agency theory (Freeman, 1999). On the other hand, Sundaram and Inkpen (2004) contend that stakeholder theory attempts to address the group of stakeholders deserving and requiring Management’s attention. Donaldson and Preston (1995) claimed that all groups participate in a business to obtain benefits. 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 and Preston (1995) argued that this theory focuses on managerial decision-making; the interests of all stakeholders have intrinsic value and no sets of interests are assumed to dominate the other’ interests.
Resource Dependency Theory The stakeholder theory focuses on relationships with many groups for individual benefits; resource dependency theory concentrates on the role of board directors in providing access to resources needed by the firm. Hillman, Canella and Paetzold (2000) contend that resource dependency theory focuses on the role that directors play in providing or securing essential resources to an organization through their linkages to the external environment.
Johnson, et al, (1996) concur with them that resource dependency theorists provide focus on the appointment of representatives of independent organizations as a means for gaining access in resources critical to firm’s success. For example, outside directors who are partners to a law firm, provide legal advice, either in board meetings or in private communication with the firm executives that may otherwise be more costly for the firm to secure. It has been argued that the provision of resources enhances organizational functioning, firm’s performance and its survival (Daily, et al, 2003).
According to Hillman, Canella and Paetzold (2000) that directors bring resources to the firm, such as information, skills, access to key constituents such as suppliers, buyers, public policy makers, social groups as well as legitimacy. In their opinion, Directors can be classified into four categories such as insiders, business experts, support specialists and community influentials. First, the insiders are current and former executives of the firm and they provide expertise in specific areas such as finance and law in the firm itself as well as general strategy and direction.
Second, the business experts are current, former senior executives and directors of other large for-profit firms and they provide expertise on business strategy, decision-making and problem-solving. Third, the support specialists are the lawyers, bankers, insurance company representatives and public relations experts and these specialists provide support in their individual specialized fields. Finally, the community influentials are the political leaders, university faculty, members of clergy, leaders of social or community organizations. Transaction Cost Theory
Transaction cost theory was first initiated by Cyert and March (1963) and later theoretically described and exposed by Williamson (1996). Transaction cost theory was an inte-disciplinary alliance of law, economics and organizations. This theory attempts to view the firm as an organization comprising people with different views and objectives. The underlying assumption of transaction theory is that firms have become so large that they in effect substitute for the market in determining the allocation of resources. In other words, the organization and structure of a firm can determine price and production.
The unit of analysis in transaction cost theory is the transaction. Therefore, the combination of people with transaction suggests that transaction cost theory managers are opportunists and arrange firms’ transactions to their interests (Williamson, 1996). Self-interest cannot all together be sacrificed; it should not, however, take the shape of self-aggrandizement. Political Theory Political theory brings the approach of developing voting support from shareholders, rather by purchasing voting power. Hence, having a political influence in corporate governance may direct corporate governance within the organization.
Public interest is much reserved as the government participates in corporate decision-making, taking into consideration cultural challenges (Pound, 1993). The political model highlights the allocation of corporate power. Profits and privileges are determined via the government’s favour. The political model of corporate governance can have an immense influence on the developments relating to corporate governance. Over the last a couple of decades, the government of a country has been seen to have a strong political influence on firms. As a result, there is an entrance of politics into the governance structure or firms’ mechanism (Hawley and Williams, 1996). This is true of PSES in India. Ethics Theories and Corporate Governance Other than the fundamental corporate governance theories - the agency theory, stewardship theory, stakeholder theory, resource dependency theory, transaction cost theory and political theory - there are other ethical theories that can be closely associated with corporate governance. These include business ethics theory, virtue ethics theory, feminist ethics theory, discourse ethics theory, post-modern ethics theory to mention more prominent ones.
Business ethics is a study of business activities, decisions and situations where the rights and wrongs are addressed. The main reason for this is that the power and influence of business in any given society is stronger than ever before. Businesses have become major providers to the society in terms of jobs, products and services. Business-collapse has a greater impact on society than ever before and the demands placed by the firm’s stakeholders are more complex and challenging.
Only a handful of business giants have had any formal education on business ethics but there seems to be more compromises on this count these days. Business ethics helps us to identify benefits and problems associated with ethical issues within the firm; business ethics is important as it gives us a new light into present and traditional view of ethics (Crane and Matten, 2007). In understanding the ‘rights and wrongs’ in business ethics, Crane ; Matten, (2007) injected morality that is concerned with the norms, values and beliefs fixed in the social process which help right and wrong for an individual or social community.
Ethics is defined as the study of morality and the application of reason which shed light on rules and principles, called ethical theories, that ascertain the right and wrong for a situation. Business ethics theory focuses on the “rights and wrongs’ in business. Feminist ethics theory Feminist ethics theory emphasizes on empathy, healthy social relationships, loving care for each other and the avoidance of harm. In an organization, to care for one another is a social concern and not merely a profit centred motive. Ethics has also to be seen in the light of the environment in which it is exercised.
This is important, as an organization is a network of actions, hence influencing trans-communal levels and interactions (Casey, 2006). Discourse ethics theory Discourse ethics theory is concerned with peaceful settlement of conflicts. Discourse ethics, also called argumentation ethics, refers to a type of argument that tries to establish ethical truths by investigating the pre-suppositions of discourse (Habermas, 1996). Meisenbach (2006) contends that such kind of settlement would be beneficial to promote cultural rationality and cultivate openness. Virtue ethics theory
Virtue ethics theory focuses on moral excellence, goodness, chastity and good character. Virtue is a state to act in a given situation. It is not a habit as a habit can be mindless (Annas, 2003). Aristotle calls it as disposition with choice of decision. For example, if a board member decides to be honest, he takes a decision which strengthens his virtue of honesty. Virtue involves two aspects, the affective and intellectual. The concept of affective in virtue theory suggests “doing the right thing and have positive feelings”, whilst the concept of intellectual suggests “to do virtuous act with the right reason”. Virtues can be instilled with education. Aristotle mentions that knowledge on ethics is just like becoming a builder (Annas, 2003). Through the process of educating and exposure to good virtues, the development of ethical values in a child’s life is evident. Hence, if a person is exposed to good or positive ethical standards, exhibiting honesty, just and fairness, then he would exercise the same and it will be embedded in his will to do the right thing at any given situation. Virtue ethics is eminent to bring about the intangibles into an organization.
Virtue ethics highlights the virtuous character towards developing a morally positive behaviour (Crane and Matten, 2007). Virtues are a set of traits that help a person to lead a good life. Virtues are exhibited in a person’s life. Aristotle believed that virtue ethics consists of happiness not on a hedonistic sense, but rather on a broader positive level. Post-modern ethics theory: Post-modern ethics theory goes beyond the facial value of morality and addresses the inner feelings and ‘gut feelings’ of a situation.
It provides a more holistic approach in which firms may make goals achievement as their priority, foregoing or having a minimal focus on values, hence having a long term detrimental effect. On the other hand, there are firms today which are so value-driven that their values become their ultimate goal (Balasubramaniam, 1999). Recommendations of the Kumar Mangalam Committee Securities and Exchange Board of India (SEBI) constituted a Committee on Corporate Governance under the Chairmanship of Mr. Kumar Mangalam Birla.
The Committee observed that there are companies, which have set high standards of governance for them while there are many more practices in them and other companies which are matters of concern. There is increasing concern about standards of financial reporting and accountability especially after losses were suffered by investors and lenders in the recent past, which could have been avoided or at least detected much before they turned into scams, with better and more transparent reporting practices.
Companies raised capital from the market and the investors who invested suffered due to unscrupulous managements that performed much worse than past reported figures. Bad governance was also exemplified by allotment of promoters’ share at preferential prices unreasonably disproportionate to market value, affecting minority holders’ interests. Many corporates did not pay heed to investors’ grievances. While there were enough rules and regulations to take care of grievances, the inadequate implementation and the absence of severe penalty left much to be desired.
The Kumar Mangalam Committee made both mandatory and non-mandatory recommendations as per such terms of reference. Based on the recommendations of this Committee, a new clause 49 was incorporated in the Stock Exchange Listing Agreements (“Listing Agreements”). The important aspects thereof, in brief, are:
- Board of Directors is accountable to shareholders.
- Boards lay down code of conduct and are accountable to shareholders for creating, protecting and enhancing wealth and resources of the Company, reporting promptly in transparent manner while not involving in day to day management.
- Classification of non-executive directors into those who are independent and those who are not.
- Independent directors not to have material or pecuniary relations with the Company/subsidiaries and if they had, to disclose such interest in the Annual Report.
- Laying emphasis on calibre of non-executive directors especially independent directors.
- Sufficient compensation package to attract talented non-executive directors.
- Optimum combination of not less than 50% of non-executive directors on the boards of companies with non-executive Chairman, to have at least one third of independent directors and, under executive Chairman, at least one half of independent directors.
- Nominee directors to be treated on par with other directors,
- Qualified independent Audit Committee to be set up with minimum of three, all being non-executive directors with one having financial and accounting knowledge.
Corporate Governance report to be part of Annual Report and disclosure on directors’ remuneration, etc., to be included. The compliance certificates of the Statutory Auditors were scrutinized as appearing in the published Annual Reports of Banks and companies for the year ended 31st March, 2010. The selection covered State Bank of India, Canara Bank, ICICI Bank, HDFC Bank, Priyadarshini Spinning Mills Limited, Rana Sugars Limited, Reliance Capital, Reliance Industries Limited, Unitech Limited and Sona Koyo Steering Systems Limited. It was observed that the Statutory Auditors have seen the reports as certified by the Boards of Directors concerned stating that the compliance with regard to Corporate Governance required under clause 49 of the Listing Agreement with the relative Stock Exchange has been complied with. The Annual Reports do contain information under the following heads: Company’s Philosophy on Code of Corporate Governance. Board of Directors (composition – number, Executive and non-executive directors, no. of meetings held and attended by each director, appointment of directors, business interest of directors in the company, no.of directorships).
Board Committees Audit Committee and its members; Remuneration Committee (Directors’ Remuneration) Shareholders’/Investors’ Grievance Committee; Name and address of Compliance Officer; Additional information on Directors retiring by rotation and seeking re-appointment at the Annual General Meeting; General Body Meetings (dates, places, time) CEO’s Certificate on Corporate Governance. Despite mandatory information given, there appears necessity for specific disclosures on large funds lay-out, losses or strategic plans affected the company’s performance and the analysis of grievances handled.
Canara Bank has mentioned even the compliance on Non-mandatory requirements of clause 49 of the listing agreement. As the audit or have disowned responsibility in regard to full verification; they have stated that the responsibility for compliance rests with the management. They have further stated that their certificate is neither an audt nor expression of opinion on the financial statement and similarly on the status of Corporate Governance.
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