Regulatory Framework of Corporate Governance 3.1 Emergence of Corporate Governance: The seeds of modern corporate governance were sown by the Watergate scandal in the United States. Detailed investigations was conducted by the U.S. Regulatory and Legislative body. It was detected that the loopholes in the control mechanism paved way to several major corporations to make illegal political contributions and to bribe government officials. This necessitated the development of foreign and corrupt practice Act 1977. The act contained specific provisions related to establishment, maintenance and review of systems of internal control. In 1979, the Securities and Exchange Commission of the U.S.A s proposals for mandatory reporting on internal financial controls came to be enforced. The year 1985 has witnessed a series of high profile business failures in U.S.A., the most notable one among them being the Savings and Loan collapse. Therefore, the Tread Way Commission was formed. The primary role of this commission was to identify the main causes of misrepresentations in financial reports and to recommend ways of reducing such misrepresentations. The Tread Way Report published in 1987, highlighted the need for a proper control environment, independent Audit committees and objective Internal Audit Function. It called for published reports on the effectiveness of internal control. In a way, it motivated the sponsoring organizations to come forward with an integrated set of internal control criteria to facilitate companies to improve their control systems. As a result the Committee of Sponsoring Organization (COSO) was born. In the year 1992, the committee produced a report that stipulated a control framework which has been endorsed and refined in the subsequent United Kingdom reports. 86
The issue of corporate Governance became particularly significant in the context of globalization because one special feature of the late 20th century / 21st century, globalisation, is that in addition to the traditional three elements of the economy namely physical capital in terms of plant and machinery, technology and labour, the volatile elements of financial capital invested in the emerging markets and in the third world countries is an important element of modern globalization and has become particularly powerful. The significance and the impact of the volatility of the financial capital was realized when in June 1997, the currency of South East Asian countries started melting down in countries like Thailand, Indonesia and South korea. It was realized by the world bank and all investors that it is not enough to have good corporate management but one should have also good corporate governance because the investors want to be sure that the decisions taken are ultimately in the interests of all stakeholders. Honesty is the best policy is a fact that is being rediscovered. 3.2 Corporate Governance Reports across globe 1. Organization for Economic Co-operation and Development: The Organization for Economic Co- operation and Development (OECD) in its principles of good governance has identified requisite elements of good corporate governance. The first requisite is that majority of directors should come from outside the company and should not have business or personal ties with it. This would imply that shareholder promoter directors should be in minority in the board. This requisite is not met in public Sector and Banks where the reverse is true with outside directors being in minority. Even in the private sector, barring a few professionally managed companies, this condition is not met. The other conditions are that the board should protect the rights of shareholders 87
including minority shareholders, provide timely and accurate disclosure of the company s financial performance and effectively monitored management. 2. Greenbury Committee: Greenbury Committee was set up under the chairmanship of Sir Richard Green Bury in July 1995. The committee, in its report recommended a code of best practice based on the fundamental principles of accountability and transparency and linkage of rewards to performance. The committee also gave recommendations related to Directors remuneration. It also recommended setting up of remuneration committee in each company to solve remuneration related matters. Further, the above report focused on some points like formation of a Board Remuneration Sub Committee consisting of nonexecutive Directors to settle the remuneration of their executive colleagues, reduction of notice periods in Executive Service contracts to 12 months, improved disclosure of directors remuneration in annual reports and access to the remuneration committee chairman at annual general meetings for proper interaction. It also recommended that the Directors need to delegate responsibility for determining executive remuneration to a group of people with good knowledge of the company and the same group shall submit a full report to the shareholders each year explaining the company s approach regarding executive remuneration and providing full disclosures of all elements in the remuneration of individual directors. 3. Cadbury Committee: It was set up under the chairmanship of Sir Adrain Cadbury in May 1992 by the Financial Reporting council of London Stock Exchange and accounting profession (United Kingdom). The committee submitted its report in December 1992 wherein it 88
recommended guidelines for the Board of Directors. The Cadbury Code of Best Practices had 19 recommendations. The guidelines specifically referred to the various components of the boards as Non Executive Directors, Executive Directors and Independent Directors. The recommendations themselves were not mandatory, the companies listed on London Stock Exchange were asked to explicitly state in their accounts whether or not the code had been followed. The companies who did not comply were required to explain the reasons for that. The committee recommended independent judgement for the nonexecutive directors, division of responsibility, effective control over company affairs and regular meetings of the Board of Directors. The majority of directors should be independent directors because of their attitude of impartiality rewards other stakeholders. 4. The Hample Committee: It was set up on Corporate Governance under the chairmanship of Sir Ronald Hample in 1998 in UK to review the impact of the Cadbury Code. Hample committee not only focused on broad governance principles that emphasize on business performance but also on the accountability of business towards large stakeholders. The committee suggested that the companies should organize their own governance arrangements and disclose them to shareholders. For example, if a company wishes to combine the roles of chairman and Chief executive, it should do so and explain the decision to shareholders. The committee issued a list of governance principles related to the role of directors, director remuneration, role of shareholders accountability and audit committee. It also acknowledged the fact that the importance of Corporate Governance lies in its contributions both in terms of attaining business prosperity and ensuring accountability of board. 89
5. The Blue Ribbon Committee The Blue Ribbon Committee was jointly sponsored by the New York Stock Exchange (NYSE) and National Association of Security Dealers (NASD) for improving the working of corporate audit committees. The Committee has given certain recommendations specifically for the Audit Committees. The recommendations are: 1. The members of the Audit Committee should be independent directors and financial literate. 2. External auditors being the representatives of shareholders should periodically discuss the quality of company s accounting principles in relation to General Accepted Accounting Principles (GAAP) with the audit committees. 3. Statutory auditors should maintain their independence in discharging their professional responsibilities, and 4. On an annual basis, the committee should review and discuss with the accountants all significant relationships the accountants have with the corporation to determine the accountants independence. Blue Ribbon committee has also recommended that Audit committee should have a formal written charter. 6. The Mevyn King Committee The Mevyn King Committee was set up in 1994 in South Africa at the instance of the Institute of Directors of South Africa with support from the South African Chamber of Business and the Chartered Institute of Secretaries and Administrators. The King 90
Committee s terms of reference were much wider than those of the Cadbary Committee as is evident from the following term of reference: (1) To consider and make recommendations on a code of practice on the financial aspects of corporate governance in South Africa. (2) To recommend simpler reporting without sacrificing the quality of information. (3) To lay down guidelines for ethical practices on business enterprises in South Africa. (4) To keep in view the special circumstances in South Africa concerning entry of disadvantaged communities into business. The Committee has also given certain recommendations for improving the quality of the governance of enterprises in South Africa. The recommendations are as follows: (1) The Boards should be balanced between Executive and Non- Executive Directors (2) Roles of Chairperson and Chief Executive Officer should be split and in the absence of split there should be at least two non-executive directors (3) The Director s report should incorporate statements on their responsibilities in respect of financial statements, accounting records, internal audit, adherence to the code of corporate practice and conduct along with details of non- adherence (4) Share-holders should properly use the meetings by asking questions on the accounts for which form should be provided in the annual reports and (5) Corporate should have effective internal audit committee with written terms of reference from the board. 91
Table no. 3.2 Committees across the globe Year Name of the Committee Area/Aspects Covered 1992 Sir Adrian Cadbury Committee, UK Financial Aspects of Corporate Governance 1994 Mervyn E. King s Committee, South Corporate Governance Africa 1995 Green bury Committee, UK Independent Director s Remuneration 1998 Hampel committee, UK Combined Code of Best Practices 1999 Blue Ribbon Committee, US Improving the Effectiveness of Corporate Audit Committee 1999 OECD Principles of Corporate Governance 1999 CACG Principles for corporate Governance in Common Wealth 2003 Derek Higgs Committee, UK Review of role of effectiveness of Nonexecutive Directors 2003 ASX Corporate governance council, Australia Principles of Good Corporate governance and Best Practice Recommendations Source: Corporate Governance in Asia, R.K. Mishra and J.Kiranmai 3.3 Models of Corporate Governance: In general, there are two corporate systems prevailing in the various countries to be distinguished. They are as follows: 1. Continental 2. Anglo Saxon model 92
In the continental model (known as insider model), the interests of the management, employees and banks are integrated. The stakeholders have a long term and intense relationship with the company: mostly prevailing in continental European countries like France, Germany and Italy which have relatively small equity markets and hence pay little attention for protecting minority shareholder rights. In the Anglo- Saxon model, the corporation is an extension of the shareholder. The widely spread shareholding and the related conflict of interests between managers and shareholders lead to the liberal and active market of corporate control. This model followed in the English Speaking countries like India, U.S.A and U.K., is called as Outsider model also. From the above discussion, it is thus clear that no two countries share the same code of corporate governance and every country formulates its own guidelines and principles of corporate governance according to the environment prevailing in their respective regions and the country. Good Governance as Code of best corporate practices, ethics, a strong and responsible Board of Directors All these are prerequisites for survival and excellence in today s competitive world. These should hence be part of any organization s corporate strategy. The march has already begun, the journey being long, good sense with necessary commitment should bring about the desired rules and standards for better corporate governance. 93
3.4 Players in Corporate Governance: Corporate Governance comprises of many players such as Board of Directors, Non- Executive Directors, Institutional Directors, Audit Committee, Company Secretaries, Accounting Professionals, Government and other law making agencies, Small investors, consumers, Vendor and Strategic partners, employees, media etc. Board of Directors: The Board of Directors is entrusted with the responsibility of overall direction and management of the affairs of the company. They are bound to comply with the provisions of the Companies Act 1956 and to perform the general and specific duties imposed by the Articles of Association. They are responsible for preparing annual accounts and also maintain proper records as per the requirement of companies Act for preventing and detecting frauds and irregularities. The need of the hour is to select only capable Board of Directors so that they may manage and guide the operations of the company efficiently, effectively, and diligently and protect the interest of stakeholders. They shall ensure that adequate information, audit and control system exist in the company and to see that the company complies with legal and ethical standards. The Head of board of directors is called Chairman, who should have a dynamic outlook, professional experience, clear vision and leadership qualities.. Non Executive Directors: The non-executive directors are other than managing director and functional. The directors are nominated by the government from various fields. They must have very rich professional experience. Their appointment and reappointment should not be automatic but based on their previous performance. Today, in the age of competition and integration with global markets, the Non-Executive 94
Directors should, as eyes and ears of the chairman, convey their independent and expert views to the chairman and maintain balance between the chairman and objectives of the company. They should try to protect the interest of all stake holders rather than acting as Yes man of the Chairman. Institutional Director: In changing corporate environment, the role of Institutional Director s has changed from mere spectators to big key players. Financial Institution s hold major chunk of shares in company, hence their role has become very important in transparency and accountability.in pursuit of this objective, the Financial Institution s have prescribed a 19 point agenda for nominees in companies. These objectives included long-term dividend policy, depreciation, investment in unlisted companies, merger and acquisitions, loans and advances, further issues of shares or raising loans for companies and award of contracts. Institutional Director s are expected to play a key role in these areas for good governance. However the list of areas cannot be assumed as final. Audit committee: It is a sub-committee of the Board of Directors consisting of a minimum of three independent non-executive directors and is answerable to the Board. The basic function of an Audit committee is like that of a watchdog. Its role is to ensure that the auditors of the company perform their duties satisfactorily and to the best interest of the shareholders. The presence of audit committee would improve the quality of financial reporting, create a climate of financial discipline and control and increase public confidence in the credibility and objectivity of financial statements besides providing a forum to finance director and external and internal auditors to discuss their problems and issues of concern. Although the concept of Audit Committee is new to India, its role in 95
upgrading the standard of corporate governance has since long been well recognized in the West. For instance, since 1978 the New York Stock Exchange requires all listed companies to set up audit committees consisting of independent non-executive Directors. Similarly in the U.K. after the Cadbury committee Report on Corporate Governance, the setting up of audit committee has become a common feature among large corporations. In India, the Ministry of Petroleum and Natural Gas has issued guidelines to the entire public sector oil corporation to set up audit committees in August 1997.Oil and Natural Gas Corporation (ONGC) was the first to establish audit committee in pursuance of these guidelines. Company Secretary (CS): The job of a Company Secretary is to ensure that the company s multifarious activities are performed smoothly and conform to the provisions of law. According to Cadbury committee, The CS has to play a very important role in ensuring that Board procedures are not only scrupulously followed but also regularly reviewed. The Chairman and the Board mostly depend on the Company Secretary for guidance as to how they should discharge their responsibilities under the stipulated rules and regulations. All directors should have access to the advice and services of CS and should recognize that the Chairman is entitle to the strong and positive support of the CS in ensuring effective functioning of the Board. The Company Secretary has to play a major role in Corporate Governance and to submit his professional advise to Board of Directors. Accounting Professional (AP): With the changing corporate environment the role of Accounting Professional is also changing. They provide non-financial trading services 96
apart from traditional auditing work. The Working Group on recently amended Companies Act, 1997 observed, Integrity of accounting and auditing procedures and the quality of financial disclosures are fundamental to corporate transparency and longterm shareholders support. In the present day, auditor is not only responsible to management and shareholder but also to all the stakeholders of the company. Therefore the auditors should also try to bring out even the least matter before the stakeholders of the company to enable them to add value to every role they play. They should also express their expert opinion regarding product profitability, strategic planning, transparency etc. Government and other law making agencies: Since the introduction of Companies Act 1956, the Government of India enacted many legislations such as Monopolistic and Restrictive Trade Practices Act (MRTP ACT) 1973, Consumer Protection Act 1986, Securities Exchange Board of India (SEBI) guidelines regarding Capital markets, insider trading and prohibition of Fraudulent and unfair trade practices, takeover code etc., to make corporate sector more accountable. Reserve Bank of India and SEBI have been modifying their provisions from time to time with changes environment. Though by enacting laws the level of responsibility and accountability can be increased, the implementing agencies have to play a major role for implementation of the enacted laws for good Corporate Governance. Small Investors: The ownership and management of the company are in different hands. The number of shareholders is very large and they are spread over all corners of the land. It is not feasible for them to manage the affairs of the company. Majority of the shareholders feel satisfied when they receive dividend and they don t care to see even 97
annual reports of the company. But in changing environment they should not be satisfied with dividend only. They should take interest in reading and analyzing annual reports of the company. They should not hesitate in demanding additional information from directors and unite themselves for good Corporate Governance. Consumers: Consumers who are sometimes shareholders too, decide about the future of the company and no consumer would like to deal with the company which is not transparent and consumer friendly. If the company does not redress the grievances of the consumer, they will be dissatisfied and go for the product of the other company which is more transparent and consumer oriented. Therefore the company should behave as a responsible citizen because the company has to sustain the society and the consumers are an inevitable part of the society. Vendor and Strategic Partners: No company can think of its progress without the help of it s vendor network. It is unlikely that the consumers will accept every product that the company produces and now in the age of competition vendors are also becoming selective as consumers. Some good companies are offering shares to their vendors and strategic partners to make them more responsible. By becoming shareholders they would work for good Corporate Governance. Employees: Employees know the correct inside information of the company and they should not hesitate in pointing out the shortcoming of their superiors. Their responsibility rises further, if they are also the shareholder of the company. In the wake of new developments the companies are largely off-loading their shares to their own employees in order to make them more responsible and also for giving a sense of belongingness and 98
security. For good corporate governance, they should not be satisfied with their salary only and should be alert about the day to day functioning of the company, since their future is also at stake along with the company. Media: Media covering corporate news has become very popular in the recent years. The experts employed by the media keep a close watch on almost each and every activity of the company and gives an opportunity to the general public including the shareholders to know about the company affairs. Profit and Loss A/C, P/E ratio, Earning Per Share etc., are analyzed by a team of experts involved in the program to be telecasted and their discussions,findings and critical analysis if the situation are very useful for the people directly or indirectly related to the business. These experts give their opinions and experiences highlighting the different aspects of the company and giving the stakeholders an insight of the companies. It was Jain T.V. that prevented BSEs takeover by Reliance industries. It is a good example to show the potency of the media in corporate governance. 3.5 Principles of corporate Governance: Contemporary discussions of Corporate Governance tend to refer to principles raised in three documents released since 1990: The Cadbury Report (U.K., 1992), the Principles of Corporate Governance (OECD, 1998 and 2004), the Sarbanes Oxley Act of 2002 (US, 2002). The Cadbury and OECD reports lay down the general principles of proper governance to be followed by business establishments. The Federal Government in the United States enacted the Sarbanes Oxley Act, informally referred to as Sarbox or Sox, 99
to bring about legislation on several of the principles recommended in the Cadbury and OECD reports. Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by openly and effectively communicating information and by encouraging shareholders to participate in general meetings. Interests of other stakeholders : Organizations should recognize that they have legal, contractual, social, and market driven obligations to non-shareholder stakeholders, including employees, investors, creditors, suppliers, local communities, customers, and policy makers. Role and responsibilities of the Board: The Board should comprise of personnel with rich and varied experience, necessary skills and understanding to review and to face the challenges posed by management performance apart from adequate size and appropriate levels of independence and commitment. Integrity and ethical behaviour : The fundamental requirement in choosing corporate officers and Board members should be the element of integrity. Under no circumstances it can be compromised. And for the purpose of promoting ethical and responsible decision making the organisations should develop a code of conduct for their directors and executives. Disclosure and transparency: It shall be the bounden duty of the Organizations to clarify and make it public the roles and responsibilities of Board and Management. This measure will provide stakeholders with a level of accountability and also enable them to brim with confidence about the safety of their investments. 100
Necessary procedures to independently verify and safeguard the integrity of the company's financial reporting should be sincerely and diligently followed. The onus should be on the organisation for timely and balanced disclosure of material matters to ensure that all investors have access to factual information in its true sense. 3.6 Brief History of Corporate Governance in India: The history of corporate governance in India can be divided into the following stages: 1. Pre-Liberalization: India attained Independence from British rule in 1947. Then the country was poor. Although the average per- capita annual income was just under thirty dollars, it still posessed sophisticated laws regarding listing, trading, and settlements. There were already four fully operational stock exchanges. Subsequent laws, especially the companies Act, 1956 further strengthened the rights of investors. In the decades that followed India s independence the country deviated from its capitalism past and embraced socialism. The 1951 Industries Act mandated that all industrial units obtain licenses from the central government. Further, it was clear from the 1956 Industrial Policy resolution that the public sector would dominate the Indian economy. Due to the absence of Corporate Governance framework the situation was getting worst and the Government accountability was minimal. The few private companies that remained on India s business landscape, enjoyed free reign with respect to most laws: the government rarely initiated punitive action, even for non-conformity with basic governance laws. Thus, Corporate Governance in India was in a dismal condition during early 1990 s. 101
2. Post Liberalization: It augurs well to state that the corporate governance initiative in India was not triggered by any serious nationwide financial, banking and economic collapse as witnessed in South East and East Asia. Further, contrary to most OECD countries, the initiative in India was primarily driven by an industry association - the Confederation of Indian Industry. In December 1995, a task force was established by CII and it was assigned to work out a voluntary code of Corporate Governance. The final draft of this code was widely circulated in 1997 and it was released in April 1998, the code was released. It was called Desirable Corporate Governance: A Code. During 1998 and 2000, over 25 leading companies including Bajaj Auto, Hindalco, Infosys, Dr. Reddy s Laboratories, Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI and many others voluntarily followed the Board. Following CII s initiative, the Securities and Exchange Board of India ( SEBI) set up a committee under the chairmanship of Kumar Mangalam Birla. It was tasked 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. It was implemented according to a rollout plan which is as follows: 2000-2001: All Group A companies of the BSE or those in the S&P CNX Nifty index as on 1 Jan. 2000, having more than 80 percent of market capitalization 2001-2002 : All companies with paid up capital of Rs. 100 million or more or net worth of Rs.250 million or more. 2002-2003: All companies with a paid up capital of Rs.30 million or more. 102
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 committee. In 2001-02, steps were taken to modify certain accounting standards which are as follows: Disclosure of Related Party transaction Disclosure of significant income revenues, profits and capital employed Deferred tax liabilities or assets Consolidation of accounts Initiatives are being taken to (I) account for ESOP s (II) further increase disclosures and (III) put in place systems that can further strengthen auditor s independence. 3.7 The current state of Corporate Governance in India: Corporate Governance reform in India has focused primarily on the role and composition of the Board of Directors. Each of the three sets of recommendations the CII code recommendations from 1997, the Kumar Mangalam Birla Committee recommendations from 2000 and the Murthy Committee recommendations from 2003 were aimed at a sophisticated understanding of Corporate Governance. The CII code was silent on the financial literacy levels expected of directors. The Murthy Committee recommended that companies train their Board members in the business model of the company as well as the risk profile of the business parameters of the company. The notable recommendation of the Murthy Committee was that, the Audit committee be comprised entirely of financial literate non-executive members with at least one member having knowledge of accounting or related financial matters. 103
3.8 Corporate Governance Committees in India: In India, the issue of Corporate Governance came to the fore in the last couple of years. It was not so in the case of the United States or Europe were the subject of Corporate Governance was hotly debated over the last decade or two. Obviously, in India, the discussion mostly revolved around the American and British literature on Corporate Governance. Therefore, the participants who were involved in the issue of providing effective Corporate Governance in India deliberated largely on the same type of issues and offered the same type of solutions. In this way, the Corporate Governance Code proposed by Confederation of Indian Industry (CII) (Bajaj, 1997) is modeled on the lines of the Cadbury Committee (Cadbury, 1992) in the United Kingdom. Unlike in the U.S. and the U.K. were the main issue to be tackled is the conflict between management and owners, but whereas in India it is to protect the interest of majority shareholders and minority shareholders. In India, the need for Corporate Governance arouse because of the alarming level of scams that occurred since the emergence of the concept of liberalization since 1991, such as Harshad Mehta scam, Ketan Parekh scam, UTI scam, Vanishing Company scam, Bhansali scam and so on. Infact, these unruly scams shook the very conscience of the Indian Economy and the trust of gullible investors. There, is therefore, a need to induct global standards in to the Indian corporate scenario, so as to reduce the scope of scams to a bare minimum. The bigger challenge in India, lies not in framing the rules for better governance but lies in careful scrutiny and proper implementation of those rule by all consent at all levels. The key to better governance in India, today, lies in a more efficient and vibrant capital market. If adequate steps are not taken to ensure transparency, 104
accountability, integrity and to punish the guilty promptly, then, it is also possible that the Indian corporate structure may steadily move towards the Anglo - American pattern of near complete separation of Management and Ownership. Now, that the awareness is growing at the peak level, both the Industrial Organizations and Chambers of Commerce are inclined to ensure an improved Corporate Governance. Therefore, the future of Corporate Governance in India promises to be exceedingly well. The issue of Corporate Governance is haunting the developing countries, particularly, since the Asian Crisis. It is largely believed to have been caused by poor governance and lack of transparency in running the corporate in East Asian countries. There are certain common features that affect the governance practices in Asian economies. Concentrated Ownership and preponderance of family control or state controlled seemed to be the salient features of the corporate sector in most Asian countries. The net result, therefore, is pyramiding of corporate control, tunneling of corporate gains to other family owned entities and expropriation of minority shareholder value. Because of these practices, the legal framework for Corporate Governance in these Asian countries and India comes under strict scrutiny. In terms of corporate laws and financial regulations, India has emerged far better than other East Asian countries. The Companies Act 1956 has been the foundation of Corporate Governance and Accounting Systems in India. Since liberalization wide ranging changes were brought about in the laws and regulations relating to the financial markets. The single most important development has been the establishment of Securities and Exchange Board of India (SEBI) in 1992. SEBI has played a crucial role in 105
establishing the basic minimum compliance norms for corporate governance by listed companies. 1. The CII Initiative: With the opening of the economy and increased competition under the liberalized regime concerns were raised regarding corporate governance practices in India. The process of restructuring of the corporate governance framework and development of a Code of Corporate Governance was initiated by CII in 1996. A National Task Force was set up under the Chairmanship of Rahul Bajaj, past President of CII and presently Chairman of the Bajaj Group. The Task force made a number of recommendations relating to board constitution, role of non executive directors, role of audit committees and others. The committee submitted its Code in 1998. 2. National Code on Corporate Governance: In late 1999, government appointed committee under the leadership of kumar Mangalam Birla released a draft of India s first National Code on Corporate Governance for listed companies. With the due approval of the Code by SEBI in early 2000, it was implemented in stages in the following two years. The Committee made it a point to be its primary objective to view corporate Governance from the perspective of the investors and shareholders and to prepare a Code conducive to the Corporate Environment of India. The shareholders, the Board of Directors and the Management were identified by the committee as the three important constituents of Corporate Governance and focused mainly on the roles and responsibilities as well as the rights of each of these constituents as far as the good governance is concerned. 106
3. SEBI sets up Kumar Mangalam Birla Committee: In 1999, SEBI set up a committee under the Chairmanship of Kumar Mangalam Birla, to suggest suitable recommendations for the Listing Agreement of Companies with their Stock Exchanges to improve the existing standards of Corporate Governance in the listed companies. The committee paid much attention to role and composition of the Board of directors, disclosure laws and share transfers. Recognizing that accountability, transparency and equal treatment of all stakeholders are the key elements of corporate governance the Committee evolved a Code of Governance in the context of the prevailing conditions in the capital market. The Code was accepted in 2000 by SEBI and incorporated into a new Clause 49, which was inserted into the Listing Agreement of Companies with their Stock Exchanges. Clause 49 (2000): In February 2000, the SEBI revised its Listing Agreement to incorporate the recommendations of the country s new Code on Corporate Governance, produced in late 1999 by Birla Committee. These rules comprising a new section, Clause 49, of the listing Agreements were circulated by SEBI through its circular dated February 21, 2000. It took effect in phases over a period from 2002 to 2003. All the listed companies with a paid up capital of Rs. 3 crores and above or net worth of Rs. 25 crores or more at any time during the life of the company as of March 31, 2003 are governed by these principles. 107
4. RBI Advisory Group headed by Dr. R H Patil: The recommendations of this Group which were submitted to SEBI in 2001, covered some more Codes and principles of private sector companies including consolidation of accounts incorporating performance of subsidiaries, criteria of independent directors and disclosures. 5. N R Narayan Murthy Committee: In 2002, SEBI constituted another committee under the Chairmanship of N R Narayan Murthy the then Chief Mentor of Infosys Technologies Ltd., to further streamline the provisions of Clause 49. Based on the recommendations of the Committee SEBI revised some sections of the Clause in August 2003 and later once again after further deliberations in December 2003. In October 2004, SEBI published a revised Clause 49, relating to corporate governance, which set forth a schedule for newly listed companies and those already listed to comply with the revisions. Major changes in the Clause included amendments /additions to provisions relating definition of independent directors, strengthening the responsibility of Audit Committees and requiring Boards to adopt a formal Code of Conduct. Later the date for compliance with these new provisions was extended to December 2005, since a large number of companies were unprepared to fully implement the changes. In January 2006, SEBI issued some further clarifications on Clause 49 which included: 1. The maximum time gap between board meetings of listed companies to be increased from three to four months. 108
2. Sitting fees paid to non executive directors would not require the previous approval of shareholders 3. Certifications of internal controls and internal control systems by CEOs and CFOs would cover financial reporting only. The revised Clause 49, came into effect on January 13, 2006. Further amendments were made in some of the provisions of the Clause in July 2007 which dealt with quarterly reporting. SEBI made it optional for companies to either present an unaudited or audited quarterly result or year to date financial results to Stock Exchanges within one month from the end of each quarter. If the option is to present unaudited results then the results will be subject to limited review and the report will have to be submitted to SEs within two months from the end of the quarter. Table no. 3.8 Corporate Governance Committees in India Year Name of the committee/body Area / Aspect Covered 1998 Confederation of Indian Industry (CII) Desirable Corporate Governance A code 1999 Kumar Mangalam Birla Committee Corporate Governance 2002 Naresh Chandra Committee Corporate Audit and Governance 2003 NR Narayana Murthy Committee Corporate Governance 6. Revised Provisions under Clause 49 of the Listing Agreement: In its final form the Clause 49 of the Listing Agreement covered the following provisions regarding corporate governance by listed companies. 109
1. Mandatory Provisions I. Board of Directors: Composition of the Board, Definition of Independent directors and proportion of Independent Directors in the total board strength, Compensation of non executive directors and disclosures, Board meetings, Information to be made available to the Board, membership of Board level committees by the directors and Code of Conduct II. Audit Committee: Its constitution, its meetings, role, powers and review of information, III. Subsidiary companies: Number of subsidiaries, review of financial statements of the subsidiaries by the holding company, transactions of the listed holding company with the subsidiaries and other related disclosures IV. Disclosures: These include a series of mandatory disclosures like basis of Related Party Transactions, Accounting treatment, Risk management, Utilization of proceeds of public issues, Remuneration of Directors, Management Discussion and Analysis Report in the company s Annual Report, setting up of Shareholders/Investors Grievances committee and other items to be reported to the shareholders. V. CEO/CFO Certification: This certification relates to the review of financial statements and cash flow statements by the CFO, compliance with existing accounting standards, laws and regulations, responsibility for maintaining internal controls, etc. VI. Separate Section in the Company s Annual Report on Corporate Governance VII. Compliance certificate from Auditors or practicing Company Secretaries 110
2. Non mandatory Requirements: These included provisions regarding the following: I. Tenure of Independent directors II. III. Constitution of the Remuneration Committee Declaration of Half yearly Financial Performance including summary of significant events to be sent to shareholders residences IV. Progression towards a regime of Unqualified Financial Statements V. Training of Board members in the business model and risk profile of business parameters of the company including their responsibilities. VI. Evaluation of Non executive Board members VII. Whistle Blower Policy To curb the recurrence of accounting scandals like the one at Satyam Computers, a panel of experts was set up at SEBI. This panel recommended: i) Rotation of Audit Partners ii) iii) iv) Selection of CFO by the company s Audit Committee Standardization of disclosure of earnings Streamlining the submission of financial results. SEBI has amended the listing agreement to include the above recommendations. Since then SEBI issued several circulars relating to amendments regarding applicability and enforcement of corporate governance provisions..(www.sebi.gov.in) 111
3.9 Corporate Governance Voluntary Guidelines 2009: During India Corporate Week in December 2009, the Ministry of Corporate Affairs brought out a set of Voluntary Guidelines for improvement of corporate governance practices by the listed companies. The objective of the guidelines was to encourage the use of better governance practices through voluntary adoption. The Guidelines issued a series of recommendations elaborating the various mandatory and non mandatory provisions of Clause 49 of the Listing Agreement and suggested that the companies could adopt them on a voluntary basis in order to further improve their governance practices. The major recommendations referred to: I. Board of Directors: Appointment of Directors, Separation of offices of Chairman and CEO, Nomination Committee and maximum limit of directorships in public limited and private companies that are either holding or subsidiary companies of public companies. II. Independent Directors: Attributes of Independent Directors and their certification of Independence, Tenure of Independent Directors (not more than six years). III. Remuneration of Directors: Guiding principles relating to Remuneration of Directors including Non Executive and Independent Directors suggested which should link corporate and individual performance. Incentive schemes to be designed around appropriate performance benchmarks with rewards for materially improved company performance. Suitable balance between fixed and variable remuneration. Performance related component of remuneration to form significant proportion of the package. Remuneration policy for Board members and key executives to be announced 112
IV. Remuneration of Non Executive and Independent Directors: Non executive Directors to be paid a fixed contractual remuneration subject to an appropriate ceiling and an appropriate percent of net profits of the company. Uniform remuneration for all Non Executive Directors. Independent Directors to be paid adequate sitting fees depending on criteria of Net worth and Turnover. No stock options for Independent Directors so as not to compromise their independence. V. Responsibilities of Remuneration Committee and Procedures relating to Annual Evaluation of Performance of Directors. VI. VII. Training of Directors: Through suitable methods to enrich their skills. Risk Management: Board to affirm and report the framework and oversee the system every six months. VIII. Board Evaluation: Performance of Directors and Committees thereof to be evaluated. IX. Audit Committee of the Board: More elaborations on the Powers, Role and Responsibilities of the Audit Committee X. Appointment of Internal Auditors: Internal auditor should not be an employee of the company to ensure credibility and independence of the audit process. XI. Certification of Independence from Auditors: Affirmation of arm s length relationship with the auditors XII. Rotation of Audit Partners and Audit Firms: Audit partners every three years and Audit Firm every five years. XIII. Secretarial Audit. XIV. Institution of Mechanism for Whistle Blowing. 113
These guidelines are expected to serve as a benchmark for the corporate sector and would also help the sector in achieving the highest governance standards. Adoption of the guidelines would also translate into much higher level of stakeholder confidence which is crucial to ensure long term sustainability and value generation by businesses. These guidelines were very detailed and not all companies are known to have fully adopted these guidelines. 3.10 National Voluntary Guidelines for Social, Environmental and Economic Responsibilities of Business July, 2011: These form a refinement over the earlier Corporate Social Responsibility Voluntary Guidelines, 2009 and are designed for all businesses irrespective of size, sector or location. The Guidelines have nine basic principles: I. Businesses should conduct and govern themselves with Ethics, Transparency and Accountability II. Businesses should provide goods and services that are safe and contribute to sustainability throughout their life cycles III. Businesses should promote the wellbeing of all employees IV. Businesses should respect the interests of and be responsible towards all stakeholders, especially those disadvantaged, vulnerable and marginalized V. Businesses should respect and promote human rights VI. Businesses should respect, protect and make efforts to restore the environment VII. Businesses when influencing public and regulatory policy should do so in a responsible manner VIII. Businesses should support inclusive growth and equitable development 114
IX. Businesses should engage with and provide value to their customers and consumers in a responsible manner 3.11 The Companies Act 1956: The Companies Act, 1956 provides the legal framework for corporate entities in India. The Act has made provisions for some aspects of corporate governance which include number, role, powers, duties and liabilities of directors and restrictions placed on them. Other provisions include number and frequency of board meetings, rights of minority shareholders, maintenance of books of accounts and development of accounting standards, audit obligations and report of auditors. Since 1956, as many as 24 amendments have been made in the Act providing statutory provisions relating to corporate governance. Several major amendments had been proposed in the Companies (Amendment Bill) 2003. But their consideration has been held back in anticipation of a comprehensive review of the Company Law through a Consultative process. In view of the changes in the national and international economic environment and the expansion and growth of our economy the Central Govt. had decided to repeal the Companies Act 1956 and enact a new legislation to provide for renewed provisions to enable an accelerated growth of the economy. As a first step of the review a Concept Paper on Company law was drawn and put up on the electronic media for opinions and suggestions from all interested parties. The need was to bring about harmony between SEBI s Clause 49 provisions and those of corporate governance in the Company s Act. 115
J. J. Irani Committee: As a number of suggestions were received from various bodies on the Concept Paper, it was felt that these proposals should be evaluated by an expert committee. Hence in December 2004, a Committee was constituted under the chairmanship of Dr. J J Irani the then Director of Tata Sons. The objectives of the Committee were to address the changes in the national and international scenario facing listed companies, enable internationally accepted best practices and provide adequate flexibility for timely evolution of legal reforms in response to the changing business models. The report of the Committee was submitted in May, 2005. 3.12 The Companies Bill, 2008: On October 23, 2008, the Minister for Corporate Affairs, introduced the new Companies Bill, 2008 into the parliament. It was subsequently referred to the Department related Parliamentary Standing Committee on Finance for examination and report. The Bill sought to enable the corporate sector in India to operate in a regulatory environment of best international practices that foster entrepreneurship, investment and growth. A number of other improvements were proposed in the new bill including board meetings to be conducted through video conferencing and recognizing votes cast through e mail. Before the report could be submitted by the parliamentary committee the Loksabha was dissolved and the Bill lapsed. It was later reintroduced without any change in August, 2009. It was again referred to the Parliamentary Standing Committee on Finance for examination and report. The Committee gave its Report on Aug. 31, 2010. During the period Central Government had received several suggestions from various stakeholders for amendments in the Bill. The Parliamentary Committee had also made a large number 116