GOV & SOCIAL ISSUES
What is Corporate Governance?
Corporate Governance is a concept that revolves around the proper management and control of a company.
Corporate governance is the system of rules, practices and processes by which a firm is directed and controlled.
The Cadbury Report, headed by Sir Adrian Cadbury, defines Corporate Governance as, “Corporate governance is the system by which companies are directed and controlled.”
Corporate governance essentially involves balancing the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community.
Why is Corporate Governance Needed?
Companies have shareholders and stakeholders. Shareholders are those who own shares in the company, i.e. part owners of the company. Stakeholders are persons who have an interest in the company. This could be anyone, including shareholders, vendors/suppliers, customers, employees, society and even the government.
The management of the Company rests in the hands of a few key personnel – the Board of Directors and Key Managerial Personnel. The management of the company needs to be held accountable to the stakeholders of the company and responsible for its management and performance of the company. This not only extends to the profit-making aspect, but also to how the company is run, how it is giving back to society, how it treats its employees, etc. Hence, rules of Corporate Governance were introduced, to improve fairness and transparency in the management of companies.
At the turn of the 21st Century, the need for Corporate Governance was highlighted due to various scams hat have shocked the business world, such as the Enron Scam, the Satyam Scam etc.
Corporate Governance Initiatives Internationally
Cadbury Committee Report (1992) (UK) –
The Corporate Governance Committee was set up in May 1991 by the Financial Reporting Council, the Stock Exchange and the accountancy profession in response to continuing concern about standards of financial reporting and accountability in the UK.
The final report ‘The Financial Aspects Of Corporate Governance’ (usually known as the Cadbury Report) was published in December 1992 and contained a number of recommendations to raise standards in corporate governance.
Sarbanes Oxley Act (2002) (USA) – (Popularly known as the SOX Act)
Enacted in response to highly publicized corporate financial scandals involving Enron Corporation, Tyco International plc, and WorldCom.
The Act created strict new rules for accountants, auditors, and corporate officers and imposed more stringent recordkeeping and disclosure requirements.
The Act also added new criminal penalties for violating securities laws.
OECD Principles of Corporate Governance (2004) –
The G20/OECD Principles of Corporate Governance help policy makers evaluate and improve the legal, regulatory, and institutional framework for corporate governance, with a view to supporting economic efficiency, sustainable growth and financial stability.
UNCTAD Guidance on Good Practices in Corporate Governance Disclosure (2006) –
Provides a benchmark of more than 50 corporate governance disclosure items, which serves as a key measurement tool in UNCTAD’s multi-year research programme on corporate governance disclosure.
Corporate Governance in India
The Corporate environment in India is governed by various legislations such as:
The Companies Act, 2013 – The Companies Act, along with its various regulations and amendments govern every aspect of the life of a company, whether public, listed, or private, since incorporation to winding up. It contains laws governing the appointment and conduct of directors, promoters, related party transactions, shareholder meetings, corporate social responsibility (CSR), etc.;
The Securities Contracts Regulation Act, 1956 – enacted to prevent undesirable exchanges in securities and to control the working of stock exchange in India;
The SEBI Act, 1992 – Established the Securities Exchange Board of India (SEBI), which regulates listing and trading of securities;
The Foreign Exchange Management Act, 1999 – relates to foreign exchange management in India.
Apart from the above legislations, there is a high level of regulatory scrutiny in the corporate sector in India. Some of the players in this regulatory framework include:
Ministry of Corporate Affairs (MCA) – All companies are required to register with the Registrar of Companies (ROC) under the MCA and submit all public documents, such as annual reports, certificate of incorporation and commencement of business, charges created on company assets etc. with the ROC.
SEBI – As mentioned above, the SEBI is the regulator of stock exchanges and all listed securities in the country. All companies wishing to have their securities listed on any stock market in the country are required to comply with all the Rules and Regulations of SEBI. In 2015, the Listing Agreement, which companies had to enter into to list their securities on the market was replaced by the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR). The LODR increased the compliance and disclosure requirements for companies in an effort to increase the transparency among listed companies.
Accounting Standards issued by the Institute of Chartered Accountants of India (ICAI) – ICAI is an autonomous body, which issues accounting standards providing guidelines for disclosures of financial information.
Secretarial Standards issued by the Institute of Company Secretaries of India (ICSI) – ICSI is an autonomous body, which issues secretarial standards in terms of the provisions of the New Companies Act.
In 2018, SEBI accepted most of the recommendations of the Uday Kotak Panel, which included:
Minimum of 6 directors on the board of a public listed company;
At least one independent director must be a woman;
Chairperson of a listed company will be a non-executive director to ensure independence from the management;
Splitting up the role of CEO, MD, and Chairperson for the top 500 listed companies from April 2020;
Directors must attend at least half the total number of board meetings held in a financial year, failing which the director must obtain the consent of the shareholders to continue serving on the Board;
An independent director cannot serve on the Board of more than 8 listed companies and a Managing Director can hold the post of an independent director in only 3 listed companies;
Increase in the number of board meetings to 5 per year, and every meeting must have the presence of an independent director;
Increase in the number of independent directors of the company from 33% to 50%; and
Clear powers to SEBI to act against auditors under securities law.
Around the world, there has been a considerable increase in shareholder activism in recent years.
Indian companies are largely family owned, with majority of the shares being held by close members of the promoter family. This puts India in a unique position, where the rights of the minority shareholders have to be safeguarded.
India is also seeing a rise in shareholder activism, but given that the general public forms largely the minority shareholder community, activism has not yet gained solid ground.
Various legislations in India provide for several rights and remedies to minority shareholders in India. Companies act of 2013, provide more power to the minority shareholder in India and allow the minority shareholders to question the actions of the majority shareholders/promoters of the company through provisions protecting from Oppression & Mismanagement, appointment of Independent Directors etc.
Ethical Issues and Challenges
Composition of the Board –
There are no clear guidelines for how the Board of Directors of a company ought to be constituted, nor specific rules for qualification to be a Director. Appointments are commonly made by way of word of mouth, or within the societal circles or families.
Friends and family of promoters and management commonly appointed as board members.
True Independence of Directors –
Independence of a director is questionable and more often than not, IDs tend to toe the line of the promoters, to continue to remain a part of the board.
The purpose of appointing independent directors is lost as they rarely question the executive directors or stand-up for minority interests against the promoter.
Removal of Independent Directors –
Instances of independent directors not agreeing with promoter have led to them being removed from the board of directors.
Accountability to Stakeholders –
Lack of enforcement action and delays in the judicial system lead to directors not carrying out their duties toward stakeholders of the company, including minority shareholders.
Women Directors –
The requirement to appoint women directors to the board is subverted by appointing women from within the promoter group, which defeats the purpose of having women represented on the board.
Examples of Corporate Governance Failures that have spurred the need for appropriate regulations.
Enron Corporation Scam – Hailed as one of the largest accounting and audit failures of the time, the scam involved Enron Corporation, a burgeoning energy company in the US that went from being one of the highest traded stocks on the NASDAQ in 2000 to filing for bankruptcy in 2001. The financial officers and external auditors of the company were involved in hiding losses, false reporting of the company’s financial position, and destruction of documents that prevented SEC investigation into the company. The SOX Act was enacted as a direct consequence of this scandal.
Harshad Mehta Scam – Popularly known as the Big Bull, Harshad Mehta was a stockbroker in the early 1990s, involved in illegally financing his trading from money from SBI’s reserves, and artificially driving up the prices in the stock market. The fraud involved borrowing money from SBI without issuance of Bank Receipts or securities in exchange for money lent. The scam was exposed by journalist Sucheta Dalal in April, 1992. Harshad Mehta was convicted of 4 charges out of 27 charges before his sudden death in 2001. As a direct consequence of this scam, the SEBI introduced new, stricter rules for trading in the stock market.
Satyam Scam – In 2009, setting of the downfall of the fourth largest IT company in India, the Chairman of Satyam Computers, Ramalinga Raju, wrote to the SEBI as well as the stock exchanges confessing that he had falsified the accounts of the company and inflated the cash and bank balances of the company. It was eventually revealed that scandal was a case of financial misstatements to the tune of approximately INR 12,320 crore. Pricewaterhouse Cooper, the external auditor of Satyam was held guilty by SEBI in the scam was barred from auditing any listed company for a period of two years. This case was a watershed moment for corporate governance in India. The scam highlighted several loopholes in the Indian corporate governance structure - unethical conduct, fraudulent accounting, insider trading, oversight by auditors, ineffectiveness of Board, failure of independent directors and non-disclosure of material facts to the stakeholders. In the aftermath of the scandal, Indian Corporate Governance has seen a marked improvement. Among others, the SEBI LODR Regulations were introduced in 2015, the old Companies Act, 1956 was overhauled and replaced by the new Companies Act, 2013, with stricter disclosure regulations, control over related party transactions, better vigil mechanisms, protection for whistle-blowers and rules protecting minority shareholder interests.
Kingfisher Airlines Scam – One of the most (in)famous cases of the last decade is that of Vijay Mallya’s failed attempt to save the fate of his failing airlines business by restructuring debt from public sector banks. Vijay Mallya is currently settled in Britain, because of which Indian Courts have been unable to prosecute for the scandal. Following the Kingfisher scam, the Central Vigilance Commission (CVC) directed the PSU banks to make the loan verification more robust and stricter by hiring consultancies or by setting up a new division for the second time verification of the documents based on which the loans are granted by the banks. Moreover, SBI affirmed to protect the bank’s interest and public money after the lessons learned from the kingfisher scam.
PNB Scandal – The PNB scandal involving India’s Diamond Baron Neerav Modi and his family members, most notably, Mehul Choksi who is allegedly said to have engineered the racket. Punjab National Bank issued Letters of Understanding (LoU) to various banks, fraudulently securing debt taken by Neerav Modi without any security as collateral. Neerav Modi absconded in 2018, days before the scandal broke, but was caught and arrested in London in 2019, where he is under trial for extradition to India. In the aftermath of this scandal, the Indian Government passed the Fugitive Economic Offenders Act, 2018 which gives powers to the government to confiscate all properties and assets of economic offenders who are charged in offences measuring over INR 100 crores and are evading prosecution by remaining outside the jurisdiction of Indian courts. Further, in March 2018, the RBI scrapped banking instruments such as the Letter of Understanding (LoU) and Letter of Comfort (LoC) in an attempt to plug a loophole and improve banks’ due diligence in trade credit.
The regulation over Corporate Governance in India has advanced with every successive scandal. Some important things to be considered are:
Shifting of focus from role of independent directors to limitation of the power of the promoters;
Incentivising the appointment of women from diverse backgrounds and industry knowledge to boards, rather than members of the promoter family;
Greater teeth to be given to SEBI, ICAI and ICSI to handle corporate failure, rather than relying entirely on the judiciary;
Investment of time and money into data protection initiatives;
Greater protection and incentivisation of whistle-blowers;
Strengthened vigil mechanism.