BY VIPIN AGARWAL.
The corporate governance may not dictate the economic prospects of developing countries, it certainly plays an integral role in shaping them. Corporate governance deals with the rights and responsibilities of a company’s management, its board, shareholders and various stakeholders. Corporate governance in a developing-country setting takes on additional importance. Good corporate governance is vital because of its role in attracting foreign investment. The extent of foreign investment, in turn, shapes the prospects for economic growth for many developing countries. While India’s corporate governance framework is advanced for a developing country, it still can be significantly improved.
Why Corporate Governance – Investors primarily consider two variables before making investment decisions—the rate of return on invested capital and the risk associated with the investment. In recent years the attractiveness of developing nations as a destination for foreign capital has increased partly because of the high likelihood of obtaining robust returns and partly because of the decreasing attractiveness of developed nations.
The lure of achieving a high rate of return, however, does not, by itself, guarantee foreign investment: the attendant risk weighs equally in an investor’s decision-making calculus. Good corporate governance practices reduce this risk by ensuring transparency, accountability, and enforceability in the marketplace. While the presence of a good corporate governance framework ensures neither stability nor success, it is widely believed that corporate governance can raise efficiency and growth, especially for countries that rely heavily on stock markets to raise capital.
Strong corporate governance has beneficial consequences even for countries that choose to follow a development strategy that does not focus on attracting foreign investment. Many developing countries are prone to strong distribution cartels that can reduce this wasteful behaviour and, thus, “overcome the obstacles to productivity growth”.
History of Corporate Governance in India – When India attained independence from British rule in 1947, the country was poor, with an average per capita annual income under thirty dollars. However, it still possessed sophisticated laws regarding “trading, and settlements”. It even had four fully operational stock exchanges.
Subsequent laws, such as the 1956 Companies Act, further solidified the corporate governance framework and offered additional rights of investors. The absence of a corporate governance framework exacerbated the situation. Government accountability was negligible, and some private companies that remained on India’s business landscape enjoyed “free reign” with respect to most laws. The western government rarely initiated punitive action, even for nonconformity with basic governance laws. Boards of directors invariably were staffed by families or acquaintances of management, and abuses by dominant shareholders and management were commonplace. India’s equity markets were not liquid or sophisticated enough to punish these abuses.
However, until recently, host institutions were almost entirely non-existent in India, and therefore, the poorly governed Indian firms had little to worry about in terms of following corporate laws once they had raised capital through their initial public offering. Thus, corporate governance in India was in a gloomy condition by the early 1990s.
In 1992, in a defining moment in India’s corporate governance history, the Indian Parliament created the Securities and Exchange Board of India (SEBI) to “protect the interests of investors in securities and to promote the development of, and to regulate the securities market”. In the years leading up to 2000, as Indian enterprises turned to the stock market for capital, it became important to create good corporate governance industry-wide. Additionally, a plethora of firms rocked the Indian business scene, and corporate governance emerged as a solution to the problem of unscrupulous corporate behaviour.
In 1998, the Confederation of Indian Industry (CII), India’s premier business association, unveiled India’s first code of corporate governance. However, since the code’s adoption was voluntary, few firms embraced it. Soon after, SEBI appointed the Birla Committee to fashion a code of corporate governance.
In 2000, SEBI accepted the recommendations of the Birla Committee and introduced “Clause 49” into the Listing Agreement of Stock Exchanges. Clause 49 outlines requirements vis-à-vis corporate governance in exchange-traded companies. The recommendation required, among other things, that the majority and chair of the audit committee be independent and that at least one director be well versed in finance.
In 2003, SEBI instituted the Murthy Committee to scrutinise India’s corporate governance. The committee recommended that companies significantly train Board members in the business model of the company as well as the risk profile parameters of the business. SEBI has since incorporated the recommendations of the Murthy Committee, and the latest revisions to Clause 49 became law on January 1, 2006.
Recent Corporate Governance Developments
The Indian Companies Act of 2013 introduced some progressive and transparent processes which benefit stakeholders, directors as well as the management of companies. Investment advisory services and proxy firms provide concise information to the shareholders about these newly introduced processes and regulations, which aim to improve corporate governance in India.
Corporate advisory services are offered by advisory firms to efficiently manage the activities of companies to ensure stability and growth of the business, maintain the reputation and reliability for customers and clients. The top management that consists of the board of directors is responsible for governance. They must have effective control over affairs of the company in the interest of the company and minority shareholders. Corporate governance ensures strict and efficient application of management practices along with legal compliance in the continually changing business scenario in India.
Corporate governance was guided by Clause 49 of the Listing Agreement before introduction of the Companies Act of 2013. As per the new provision, SEBI has also approved certain amendments in the Listing Agreement so as to improve the transparency in transactions of listed companies and giving a bigger say to minority stakeholders in influencing the decisions of management. These amendments have become effective from 1st October 2014.
Other entities responsible for the enforcement of corporate governance issues include:
• The National Company Law Tribunal (the Tribunal) under the Companies Act, having quasi-judicial powers to decide certain matters under the Companies Act, including the protection of minority shareholders from oppression by majority shareholders and mismanagement, and its appellate authority, the National Company Law Appellate Tribunal.
• The Regional Director (RD), to which certain powers of the Central Government have been delegated. There are seven RDs in India, each with their own territorial jurisdiction, in which they, inter alia, supervise the working of the relevant RoCs and the Competition Commission of India (CCI), created under the aegis of the Competition Act, 2002, which regulates antitrust issues where a company’s actions may have an adverse effect on competition in the relevant Indian market.
The concept of shareholder activist groups or proxy advisory firms is emerging in India. The SEBI (Research Analysts) Regulations, 2014 (the Analyst Regulations) define a “proxy adviser” as any person who provides advice, through any means, to an institutional investor or shareholder of a company, in relation to exercise of their rights in the company, including recommendations on public offer or voting recommendation on agenda item. Institutional Investor Advisory Services India Limited (IiAS) and InGovern, both established in 2010, are prominent proxy advisory firms operating in India. Shareholders Empowerment Services, a corporate governance research and advisory firm, claims to be the first company to have registered as a proxy adviser under the Analyst Regulations. However, these firms are not formally consulted by the authorities prior to promulgation of corporate governance initiatives.
Usually, committee recommendations and proposed regulatory norms are put up for public comment by concerned authorities in order to ensure large-scale participation. The National Foundation for Corporate Governance, set up by the MCA as a not-for-profit trust, in association with the Confederation of Indian Industry, the Institute of Chartered Accountants of India and the Institute of Company Secretaries of India (ICSI), also provides a platform for spreading awareness regarding corporate governance issues.
A Few New Provisions for Directors and Shareholders
• One or more women directors are recommended for certain classes of companies.
• Every company in India must have a resident director.
• The maximum permissible directors cannot exceed 15 in a public limited company. If more directors have to be appointed, it can be done only with approval of the shareholders after passing a Special Resolution.
• Independent Directors are a newly introduced concept under the Act. A code of conduct is prescribed and so are other functions and duties.
• The Independent Directors must attend at least one meeting a year.
• Every company must appoint an individual or firm as an auditor. The responsibility of the Audit Committee has increased.
• Filing and disclosures with the Registrar of Companies has increased.
• Top management recognises the rights of stakeholders and ensures strong co-operation between the company and the stakeholders. Every company has to make accurate disclosures of financial situation, performance, material matters, ownership and governance.
Related Party Transactions (RPT) is the transfer of resources or facilities between a company and another specific party. The company devises policies which must be disclosed on the website and in the annual report. All these transactions must be approved by the shareholders by passing a Special Resolution as per the Companies Act of 2013. Promoter of the company cannot vote on a resolution for a related party transaction.
Another problem plagues India’s legal system is the large backlog of cases in India’s various courts, including almost twenty-two thousand in the Supreme Court of India. Increasing staffing of India’s judiciary would raise judicial efficiency. A lengthy judicial appointment process contributes to the backlog. As of April 2014, the number of judges in India’s High Courts was twenty-five per cent below what is statutorily required, primarily because of delays in the nomination process. The Government of India should ensure that the prescribed staffing requirements are met by speeding up the nomination and selection process.
UDAY KOTAK-LED SEBI COMMITTEE RECOMMENDATIONS: The Uday Kotak-led SEBI committee on corporate governance submitted its report to the regulator, recommending a slew of changes in corporate governance norms.
One of the biggest recommendations made by the panel was splitting up the roles of Chairman and Managing Director or Chief Executive Officer in a company. Some of the other recommendations include making a parent company’s audit committee responsible for checking the books of its group companies as well. The audit committee of any parent or holding company that has invested or lent Rs 100 crore or more to a subsidiary will be responsible to review the use of those funds by the subsidiary. World Bank’s Ease of Doing Business Report 2018 ranks India fourth among 190 countries in “protecting minority shareholders”. The US is ranked at 42 and the UK at 10. The average ranking of the high income OECD (Organisation for Economic Co-operation and Development) region is 47.
Conclusion: Shareholders obviously have the most to lose if a company is prone to bad governance. Creative accounting, related party deals, exorbitant managerial remuneration, freebies to friends and family and risky mergers and acquisitions directly deprive shareholders of profits that are rightfully theirs. But this apart, bad governance practices can have a bearing on all the stakeholders a company deals with—lenders/banks who extend finance, suppliers who sell its goods or services, employees who invest their career in it and customers who put faith in its brand, product or service quality. The ongoing crisis at Infosys has not just decimated the stock price by over 15 per cent, it may also lead to uncertainty for clients and employees. It is therefore in the interests of all those stakeholders that corporate governance is treated with the seriousness it deserves.
On the other hand, poor systems of corporate governance, such as those in the United States before the enactment of the Sarbanes-Oxley Act, often lead to fiascos that can prove very costly. India can be proud of what it has achieved so far in corporate governance practices but, of course, much more needs to be done.
Admittedly, some of these suggestions are idealistic, and India justifiably may decide that its scarce resources are best allocated elsewhere. Many of the recommendations, such as instituting safeguards for whistle-blowers and requiring training of directors, should prove relatively easy to implement and cost-effective. Others, such as reducing corruption and reforming bankruptcy laws, will substantially benefit the Indian economy apart from improving corporate governance. India’s corporate governance destiny will be shaped by how effectively its legislature, judiciary, and SEBI implement transparent and effective corporate governance laws.