Corporate Governance – Conceptual Framework

The great Indian master of Political Science Kautilya mentioned four functions of a king in his well-known book Arthashastra

1. Raksha or protection

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2. Vriddhi or enhancement
3. Palana or maintenance
4. Yogakshema or wellbeing or safeguard.

It is the sacred duty of the state to protect the person and property of its subject to enhance their wealth, to maintain them and to safeguard their interest in general. This noble concept can be applied with equal force to company management for corporate governance. The Board of Directors and the CEO or MD are the rulers and the shareholders and other stakeholders associated with the company are the subject.

The company should be managed in a way that would protect the interest of shareholders, would increase the value of their wealth and their prosperity, would lead to the welfare of the society and would increase their accountability to them. The corporate world has become so powerful in recent years that corporate governance has caught the imagination and attention of one and all.India has globalised its economy and has widened the doors for the entry of multinationals. With the onset of globalization, the competition that the corporate sector has been facing has been increased. Technology up-gradation, warranted because of intense competition, has necessitated the Indian corporate sector to seek funds not only from India but also from abroad by floating Global Depository Receipts (GDRs). Large number of foreign institutional investors is now actively participating in the Indian Capital Market. This has also necessitated the need for good governance since capital easily flows towards companies which are effectively governed and which have the motive of increasing the value of shareholders as well as the society.

Concept

In broad sense, Corporate Governance examines how the company is being governed for the benefit of its various stakeholders like equity shareholders, preference shareholders, bond-holders, employees, customers, dealers, suppliers, society, government etc. Thus, corporate governance may be understood as the system by which corporates are directed and controlled by their managements in the best interest of their stakeholders and the general public. In its endeavour to ensure a higher standard of transparency and timely financial reporting, corporate governance system involves the full disclosure of all relevant information for the stakeholders to arrive at informed decisions. Corporate governance comprises the systems and processes which ensure the efficient functioning of the firm in a transparent manner for the benefit of all the stakeholders and those accountable to them. The focus is on the relationship between the owners and the Board in directing and controlling companies as legal entities perpetually. A company’s ability to create wealth for its owners, however, depends on the role and freedom given to it by the society. The corporate governance broadly identifies two sectors namely shareholders and stakeholders to whom the corporate sector has to be responsible.

Any corporation that satisfies only one sector at the cost of the other is not likely to be favoured by any and it has to have a balanced approach in meeting the needs of these two sectors.The focus on corporate governance arises out of the large dependence of companies on financial markets as the pre-eminent source of capital. The quality of corporate governance shapes the future and the growth of the Capital Market. Strong corporate governance is indispensable to resilient and vibrant capital market. But capital markets in general can function properly if individuals have access to accurate basic information about the companies they invest. The link between a company’s Management, Board and its Financial Reporting System is crucial.In the context of globalization, capital is likely to flow to markets which are well regulated and practice high standards of transparency, efficiency and integrity.

Aims of governance

Successful corporate governance lies in balancing the various conflicting interest and interest groups viz. , investors, creditors, labour, government and society at large. Corporate Governance in the context of changed socio- economic milieu does not merely confine to securing a fair return on the investment but also extends to discharging the various social responsibilities.The basic governance issues relates to the effectiveness and the accountability of Board of Directors. Effectiveness is measured by performance. How well can boards run their companies and how can they be encouraged to run them better? Effectiveness is, therefore, a measure of the equality of the leadership which Boards are giving to their companies and the taste of effectiveness is the result which those companies achieve. Accountability is largely a matter of disclosure, of transparency, of explaining a company’s activities to those to whom the company has responsibilities.

It raises the question to whom are companies answerable and to whom should they be responsible? Board of Directors is seen as having power and relative freedom to exercise that power within the law. The demand for Boards to become more accountable is, therefore, part of a wider movement for openness by institution.

Need for corporate governance

With the sweeping changes in Indian economy, the growing aspiration of Indian industries to compete with the MNCs and to increase their market share, profitability, etc. have side by side enhanced their responsibility.Although the reforms initiated during the last ten years witnessed some radical changes in the rules and regulations to improve the stakeholders’ confidence. The levels of transparency and standards of disclosures observed by Indian Companies leave much to be desired. The practice of placing personal interest above those of stakeholders is quite widespread.

There had been several instances in India over the last few years when Industrial shareholders and independent directors on the Board of a Company have raised concern over the decisions of the management or promoters.The efficient Corporate Governance has become the need of the hour due to various reasons. These reasons can be pointed out as follows:

1. Significant changes taking place in global economic and business field.
2. Seizure of global opportunities and threats from competitors.
3. Need for strategic management.
4. Making optimum use of scarce resources and developing skills.
5. Acceptance of international standards of management.
6. Increasing share of institutional investors like UTI, mutual funds, Foreign Institutional Investors (FII) etc.
7. Awareness among investors and lending institutions.
8. Protection of investors and promotion of public interest.
9. Increasing effectiveness of management.
10. Real transparency of performance.
11. Enhancing shareholder’s net worth and wealth.
12. Representing accountability and responsibility towards shareholders and others having the direct or indirect interest in the company.

Benefits of good governance

• Good governance leads to congruence of interest of board, management including owner managers and shareholders.
• Good governance provides stability and growth to the company.
• Good governance system builds confidence among investors.
• Good governance reduces perceived risks, consequently reducing cost of capital.
• Well governed companies enthuse employees to acquire and develop company specific skills.
• In the knowledge driven excellence, the soft skills like management will be the ultimate tool for corporate to leverage a competitive advantage in the financial market.
• Adoption of good corporate practices promotes stability and long-term sustenance of stakeholders’ relationship.
• A good corporate citizen becomes an ethical icon and enjoys a position of pride in corporate culture. Potential stakeholders aspire to enter into relationships with enterprises whose governance credentials are exemplary.

Emergence of corporate governance in India

The need to formulate a code of principles embodying good governance was felt in India as early as 1995-96. In India, initiative on corporate governance began with the Confederation of Indian Industries [CII] setting up in 1996 a National Task Force under the Chairmanship of Mr. Rahul Bajaj. The task force presented its recommendations and Code for Corporate Governance in 1997 which were then debated publicly.SEBI, the corporate regulator, appointed a Committee on 7th May, 1999 under the Chairmanship of Mr. Kumar Mangalam Birla to frame the guidelines for corporate governance in India. The Committee had made 25 recommendations in all.

Of them, 19 are mandatory and the remaining is non mandatory. The mandatory recommendations broadly includes new listing norms to be followed by the company, conducting Board meetings at least four times a year, constitution of audit committee, optimal blend of executive and non executive directors as well as appointment of independent directors, issue of quarterly reports etc.On the other hand, non mandatory recommendations suggest that investment institutions are not to be permitted by the Board. The Department of Company Affairs has initiated a legislative action in the Lok Sabha on 6th December, 1999 for the amendment of the Companies Act.

Factors influencing corporate governance

SEBI has summarized the factors which influence quality of governance in Indian Companies.

• Integrity of the Management.
• Ability of the Board.
• Adequacy of providing the Board with relevant and timely information.
• Commitment level of individual Board members.
• Quality of Corporate Reporting.
• Participation of stakeholders in the management.

Role of major players in corporate governance

Where the Government and other regulatory agencies provide a platform through legislations and rules, the Board of directors, auditors, shareholders, financial institutions, company secretaries and the employees play their individual role for proper governance. Role of the BOD: A Working Group has recommended a Statement of Director’s Responsibility [SDR] to be attached along with the annual accounts for better transparency. The Directors must specify whether applicable accounting standards have been followed or not. The Directors are also responsible for maintaining adequate accounts for safeguarding the assets of the company and for detecting fraud and irregularities.

Role of Accounting Professionals

The growing complexities of business have changed the traditional role of accounting professional. On the wake of demand for good corporate governance from every quarter, the need arises for redefining their role. The activity should not only look at the reliability of accounting and reporting, it must cover all relevant business processes from brand management to customer service.Role of Company Secretaries: The Chairman and the Board will look to the Secretary for guidance on what their responsibilities are under the rules which they are subject and how those responsibilities should be discharged. There is also need for secretarial audit before financial audit to ensure compliance of all requirements of law. Role of employees: A good team of employees is the backbone of the company. However, their individual ethical standard is of a greater concern.

A responsible employee should point out the mistake of even his superior.When the employees are shareholders, their responsibilities rise even further.

Corporate governance in India

In India, while the predominant form of Corporate Governance is much closer to the East Asian models, there are a number of firms that resemble the European version where the control is maintained through pyramidal form of ownership and control. The concept of industrial house which controls several companies is quite commonly accepted although the founding family does not own the company. There are quite a few companies whose practice of corporate governance is a matter of concern.Dilution of accounting and reporting standards have allowed corporations from manipulating resources for their own vested interests sidelining the stakeholders of the company. Investors have suffered on account of unscrupulous management of the companies, which have raised capital from the market at high valuations and have performed much worse than the past reported figures.

There are also many companies which are not paying adequate attention to basic procedures for shareholders services as many do not pay adequate attention to address investor’s grievances.It has to be emphasized that there is considerable synergy between economic efficiency and corporate governance. The US and UK models of Corporate Governance are an integral part of the market oriented economy. Several developments such as international integration of financial markets, requirements of foreign institutional investors and listing securities in the international stock exchanges make it imperative for companies in India to be transparent in regard to norms of corporate governance adopted by them.While sound corporate governance is necessary, it is not sufficient to improve operational efficiency and profitability.

Corporate governance in Indian companies

The first systematic study on Corporate Governance was conducted by Business Today- AIIMS of the Best Boards in 1997. A total of 659 respondents in Bangalore, Kolkata, Chennai, Delhi and Mumbai, comprising 11 FIs, 10 FIIs, 23 stock brokers, 200 finance companies, 11 banks and 584 individual investors were surveyed.

The parameters set for the evaluation were:

• Accountability to share holders.
• Transparency of disclosure.
• Quality of directors.
• Independence of decision making.

Corporate governance abroad

The need to well manage a company is felt all over the world. Corporate sectors around the world are tuning their activities in accordance with the good principles of corporate governance. A committee in UK observed that ‘transparency’ is the basis of corporate governance. The London Stock Exchange has made it mandatory for companies to reveal their balance sheets whether or not they have followed the financial aspects of corporate governance.The Toronto Stock Exchange had constituted a committee which was of the view that ‘increasing the shareholders’ value’ should be the prime objective of corporate governance. Attaching significance to the Board, the committee specified that the main responsibility of the Board if Directors is to supervise and control the Board’s activities. They should also seek to ensure orderly succession of senior executives by selecting, training, and supervising their activities at appropriate time.

A Stakeholder, Alliance in North America has come out with its own “Sunshine Standards” to provide direction to the corporate sector reporting to the stake holders. The Alliance demands that all information relevant to the stakeholders should be provided.

Issues of corporate governance

Good company governance is the need of the day for which the consciousness is increasing. But, it has to face a number of problems which are as follows: Facing impact of globalization: Globalization has a radical impact on company governance.Now, the traditional management has given place to professional management, the international standards of corporate governance have to be adopted, the mobility of resources has to be increased and foreign law and regulations have t be abided by. Challenges of drastic changes in economy: The radical changes are taking place in Indian economy. Due to globalization, all sectors of the economy are being opened up to worldwide competition, controls are being removed day by day over industries and trade and to integration of Indian industries with the world industries, a number of problems have arisen before corporate governance.

Pressure of public opinion and investors for financial reporting and transparency: Due to awareness among investors and public at large, they are demanding more and more information about companies’ objectives, about its performance, more frequent financial reporting and more transparency in its management, which is challenge to the company governance. It requires increased awareness on the part of corporate management to satisfy these demands. Challenge of global competition: the corporate management is required to face worldwide competition. The competition has reached international level for Indian companies due to liberalization and globalization. The management has to make adjustment in policies and practices of corporate governance to meet this challenge. Criticism of sudden failures and accountability: A number of companies have failed and closed down all of a sudden for which the accountability of the Board has been selected to serious criticism. Such weak and unscrupulous companies do not report their true financial position and true profitability before the investors and the public. The Directors are held liable for this situation.

Suggestions for effective corporate governance

Effective honest and transparent corporate governance is required for enhancing the wealth and worth of the company, for promoting welfare of the society, for the success of the company, for protecting the interest of investors and other stakeholders and for fulfilling the responsibility and accountability of directors. Hence the following suggestions may be useful in meeting challenges before them and for solving a number of problems which ahs been created during recent times.

• Downsizing: One theoretical step towards instilling ethical values in the modern corporation is to downsize or breakup the corporate entity. Autonomy would eliminate long bureaucratic chains and increase personal motivation, communication and accountability.
• Long-termism: The emphasis on short term profitability creates a significant degree of instability within corporations and lead to short termism. Markets require quick results and generally discourage long term investment. This leads to an unnecessary dissipation of corporate resources towards meaningless ends.
• Dealing with risk and uncertainty: The economic and technological environment is fast changing than ever before which results in great difficulty in planning reliably for the long term. In such a scenario, ethical endeavor drawn from longer planning suffers significantly.
• Curbing Corporate Power: The modern corporation commands significant power which has a profound influence on government and legislative process. In a recent GAAT agreement, it had been alleged that governments merely act as pawns – it was the corporate lobbyist and agents who drafted the agreement and pushed governments into signing it.
• Limit on the number of Directors: The number of companies in which a person can work as director has been kept at 20. This should be reduced to 10 in order that the director has to attend a few companies and play an effective role in company management.
• Bringing down the number of part time directors: For efficient corporate governance it is essential that directors devote as much of their time as possible. This will be possible only when the number of part-time directors is reduced and full time directors are appointed.
• Frequent reporting and transparency: Quarterly un-audited financial statements are required to be published. Accounts must be audited in time and social audit must also be undertaken. In all respects, transparency would infuse confidence in investors and would make the directors more conscious of their accountability.
• Appointment of audit committees should be made compulsory: It is advocated that audit committees should be compulsorily appointed consisting three independent directors who will go through the progress, policies and practices adopted by the Board. SEBI has recommended that appointment of audit committees should be made compulsory by law.
• Adjustments to be made along with changing times: The corporate governance has to adjust itself to environmental factors, population constituents, political position, economic factors, social factors and technological changes and must solve the problems arising out of such a situation in rational and logical manner.
• High ethical standards to be maintained: Maintaining high ethical standards is one of the most powerful features of good corporate governance which would include working with honest policies and practices, not accepting any secret commission, not indulging in competitive collision and not to indulge in untrue and misleading advertisements.
• The non executive directors should be given due importance: Non Executive directors must be given due importance and their opinions and advice must also be needed.
• Regular board meetings: Regular board meetings would make corporate governance more effective as policies and strategies would be framed and discussed frequently and performance evaluations would be undertaken.

Conclusion

In India, the existing corporate governance framework has failed to encourage corporate sector to voluntarily adopt higher corporate governance standards, necessary to compete both nationally and internationally. The availability of effective legal remedies of the stakeholders in case of mismanagement, the exercise of which requires reliable and adequate information, is essential. Disclosures by the management on a timely basis can provide stakeholders with the information required to arrive at informed decisions regarding the corporation.

The ability of the market to regulate is rather doubtful. Therefore, the essential nature of regulatory institutions and mechanisms, both inside and outside the corporation, cannot be overemphasized.Self regulation can significantly assist in achieving the right regulatory framework. In the corporate structure, the role of the different stakeholders should be more clearly defined. If “Good Corporate Governance” is to become a reality, it is necessary that the company and its promoters adopt a transparent policy regarding the proper use of funds and properties of the company. The promoters should realize that they are the custodian of the company as trustee for the people connected with it. The promoters’ stress should be for the best use of the company’s resources for its benefits.

The axiom of “least governed is the best governed” should become a reality by enforcing self discipline by the promoters leading gradually to a minimum control by outside agencies including the government.

References

1. Corporate Governance - N. P. Agarwal Sugan C. Jain
2. Corporate Governance - H.R. Machhiraju
3. Taxman’s Chartered Accountants Today - March 16-31,2005 December 16-31,2005

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