Corporate Governance iIndia: evolution and challenges ahead "Good corporate governance is about 'intellectual honesty' and not just sticking to rules and regulations, capital flowed towards companies that practised this type of good governance" - Mervyn King While it is unlikely that Mervyn King had foreseen a Satyam scandal while he said the aforesaid sentence, Lex Witness takes you through a journey as we navigate the sea of corporate governance in India .... • Avinash Mohapatra robably, the CWG scam didn't attract as much international attention as the Satyam Scandal. Corporate governance has been hotly debated in the USA and Europe over the last two decades. It would be fair to say that, in India, this debate has come up only in the last couple of years, more or less after the Satyam scandal. It is universally acknowledged strengthening that the Board of Directors of a CORPORATE GOVERNANCE CODE company is the best bulwark against insufficient governance. Experts are of the The corporate governance code rem, the of Commerce Associated Chambers and Industry opinion that a careful balancing of various proposed by the Confederation factors, including adequate information to Industry is modeled on the lines of the Exchange Board of India (SEBI) directors; accountability; competence Cadbury Committee 1992) in constituted Committees to recommend activism from promoters may aid in Governance. implementing governance 12 I effective corporate in India. LEXWITNESS I August 2011 and (Cadbury, of Indian Industry (ASSOCHAM) and the Securities and the United Kingdom. On account of the initiatives in Corporate interest generated by Cadbury Committee main objective of it was to develop and Report, the Confederation promote a code for Corporate of Indian The Govern ajiv Luthra Managing Partner. Ketan Parikh Company Scam. or even detect. We had the dian corporate so that at with the ultimate governance. Considering this. such a spectacular fraud. Block shareholders to the by the of the board of directors 1east while the scope for scams may still minimum. Clause 49 of the Listing Agreement. trusts financial markets from 1991. are absolutely imperative. Vanishing American of Lex Witness Bureau In the Indian context. the need financial systems. the market-based system typified by Japan !:zig:b.lightedbecause emergence There are two broad categories system exemplified In the Indian context. the need for corporate TYPES OF CORPORATE GOVERNANCE MECHANISMS Mohopotra have relatively less power though financial for corporate governance has been highlighted because of the scams occurring frequently since the emergence of the concept of liberalization from 1991.. Ketan Parikh Scam. UTI Scam. marked of ownership and control. there is a need induct global standards e ce systems and the bank-based The market-based and Germany. We had the Harshad Mehta Scam. and followed by Indian be these in the Private Sector. This demonstrates that good corporate governance is something that needs to be embedded in the psyche of the managers and officers of a company. However. all of which are governance has been of the scams occurring since the frequently of the concept R>eralization Harshad Mehta Scam. of by the British and with effective distancing of Scam. os told to Avinosh :0 be adopted companies. requirements such as having independent directors on the board and an audit committee with defined responsibilities. it can be at least reduced management. In the Indian corporate scene. Bhansali Scam and so on. Banks or Rnancial Institution. August 2011 I LEXWITNESS I 13 . following the spirit of the law is as imperative as following its letter. In the scene. but they still failed to prevent.in focus Q. Bhansali Scam and so on. there is a need to induct global standards so that at least while the scope for scams may still exist. and this is perhaps one area where we need to improve. it can be at least reduced to the minimum. No law can ensure that a director asks the right questions in a board meeting. New Delhi ' .. Luthra & Luthra Law Offices. when it comes to good corporate governance. and no regulation can ensure that a whistleblower feels safe enough to report unethical behavior. chairman role of corporate It is characterized is accountable shareholders who to a group of who generally find selling shares an easier way to express their dissatisfaction with inefficient exist. The board of Sat yam was supposedly in compliance with all the Clause 49 requirements in relation to independent directors. cnrporate entities. UTI Scam. India has a very high ratio of companies controlled by their founding families. goes a long way towards integrating these and other concepts in the structures and processes of Indian companies. system. When compared against the global average. particularly after the amendments which have come in after the Narayana Murthy Committee report. the Public Sector. Is Clause 49 of the Listing Agreement a bold initiative towards strengthening corporate governance in India? A. Vanishing Company Scam. • Particulars regarding conservation energy technological absorption an . the report of of day-to-day activity. however. In Germany for structure is market-based system. which was also reflects the Companies Bill 1997. Though the basic corporate legal function quite differently. Share provide the following information: SECTION 217 (2M) OF COMPA ACT 1956 Under this provision. ballot given in the Companies Act. Banks have practically representation. The board structure ownership and board representation of • State of companies affair is substantially different with corporations financial institutions give these bodies the • Amount. are very close relationship with its Hausbank. considerably limited as compared to those a universal bank that owns shares in the in. corporations in the bank as a combination of these two conflicting based systems in Germany andJapan models. if recommended for the payment of dividends. institutions like pension funds do hold big company and usually has board There is a prescribed procedure for pc chunks of stocks. The company has a relationship. 14 I LEXWITNESS I August 2011 • Amount. share ownership is less diffuse ownership is far less dispersed and Board of Directors is to be attached t and banks playa much more important financial institutions playa much bigger balance sheet and it is manadatory tc role as providers of fmance and monitors role in fmancing corporate activity. With a view to strengthening shareholders' democrac is felt that all the shareholders of a A director who as an interest in a company transaction is under a duty to ensure that the provision of the Act and of Articles are complied with namely. The powers. his declaration of interest and the names of the directors who voted is recorded in the minutes of the Board Meeting company should be given the right to on certain critical matters through a f ballot system. This section enables members to e their voting right sitting at home throu the postal ballot which they might not otherwise done because of their inabili attend meetings or to appoint proxies.in focus LEGAL PROVISIONS ON CORPO GOVERNANCE SEC 192A OF COMPANIES ACT 1 A committee on Corporate Govern set up by the SEBI under the Chairmanship of Shri KumaramangL Birla suggested that voting at the gem meeting of companies is the most vall and fundamental mechanism by whic shareholders would either accept or I\ the proposals of the Board of Directo Voting is the only mechanism availab through which the shareholders can exercise an external check on the BO! and the management.typical bank-based systems. share instance. if any proposed to be car being run by giant sized supervisory abilities to serve as important monitors of to any reserves in the balance shee boards and the management is carried out management activities though the by another board. little control over management. The Indian situation may be thought of Whereas. governance stage. Reasons for the failure. foreign exchange ~ Vinay Ahuja earnings.. A director is under a duty to CLAUSE 49 OF THE LISTING AGREEMENT With the introduction the Listing Agreement. to complete - the buy back within Legal Adviser. Laos 12 months • Directors responsibility Q) What efforts have been made to statement Board's report to include Director's Responsibility Statement: was inserted Amendment) Directors This provision by the Companies Act Act. transparent and aligned to the company's needs. improving the quality of financial disclosures. Review of information by Audit Committee: The Audit Committee shall mandatorily review the following information:• Management Financial discussion and analysis of condition.. Gordon Woodroff Ltd. if any. the position of nominee directors. .of the Act and of improve Articles are complied governance with namely. board members and senior management to lead by example. making the selection of independent directors more rigorous. SECTION 299 1956 OF COMPANIES ACT enhance corporate governance in India? Have they been implemented successfully? A. The efforts for enhancement of corporate governance in India was mainly started by the constitution of the Committee on Corporate Governance in 2002 under Securities and Exchange Board of India. Corporate a Committee Governance Chairmanship of the Board Meeting. the issue of centre- to of corporate in India. This section applies to all private as well as public companies and states that there should be clear and specific allegation facts creating duty of disclosure violation the directors minutes who voted is recorded in the to as was held in Woodroff & Co. • Statement of significant related party transaction. Primarily... SEBI issued a circular on August 26. I believe that India is certainly lagging behind and needs to go a long way for implementation of good corporate governance practices. compensation of executive directors flowing from an objective performance evalution process conducted by the board. introducing responsibilities on boards to adopt formal codes of conduct. 2000 to include in the Report- • A statement that Accounting Standards have been followed and explanation for material departure • Accounting policies adopted • Care taken for the maintenance accounting of records • Accounts prepared on a "going concern" concept. In its constant ensure that the provision .. Based on the recommendations There should be intention defraud shareholders company of interest and the names of of that duty should be established. in October of and public comments of the corporate sector in meeting the norms of corporate determine responding to review the progress governance the role of companies to rumour August 2011 and to in and other price- I LEXWITNESS I 15 . Ltd V. developing criteria that focus on substance of governance. 2003 revising Clause 49 of the Listing Agreement.. corporate who as an interest in a transaction 2002. constituted on under the of Shri N. Gordon of and declaration his the standards the said Committee received of Clause 49 in has acquired endeavour thereof.. '. SEBI. requiring corporate executive boards to assess and disclose business risks in the annual reports of companies. The key points of focus in limited time have been on strengthening the responsibilities of audit committees. (1997)97 Com Cases 582. Narayana Murthy. and greater transparency and disclosure of executive performance criteria including financial and non-financial measures. • Internal audit reports. in order to evaluate the adequacy of existing corporate governance practices and further improve these practices. including those related to related party transactions and proceeds from initial public offerings. DFDL Mekong Law Group. and stock holder approval and improved disclosures relatinq to compensation paid to non-executive directors. With scams like Sat yam Computers which have haunted the corporate governance regime in India. all the large corporate houses /& institutions need to evolve certain initiatives and practices like codes of conduct and whistle blower policies. focus on the sustainability of business models. R. the ratio of stock market capitaLization to GDP in countries in the highest quartile of shareholder ri enactment and enforcern is about four times as lar as that for countries in th lowest quartile. 'compensation committee'. • Strengthening the responsibilities of audit committees. We have aLsoLearnt from the west world that. new Clause 49 are as follows : • Amendments/additions • Requiring Boards to adopt formal c to provisions • Improving disclosures to sharehold relating to definition of independent directors. the major changes in the Major changes have been made to the definition of 'independent 'nomination I August 2011 of conduct and also for senior management. Accordingly.in focus Effective corporate governance enhances acc to external financing by firms. poor corpora governance aLso hinders creation and developmen of new firms. • Requiring CEO/CFO certification financial statements. the responsibilities 'improving of audit the quality of financial disclosures' and finally. the statistics suggest. companies are now required to form various committees like a 16 I LEXWITNESS committee'. • Improving quality of financial disclosures. to Hence. sensitive information circulating in the market in order to enhance the transparency and integrity of the market players and participants. directors'. the board as a whole has been tasked with the adoption of a formal code of conduct for senior management and the certification of financial statements issued by the CEO. Leading to greater investment as well as hig growth and employment. 'strengthening committee'. like CONFLUENCE WITH CORPORATE SOCIAL RESPONSIBILITY Erasing the distinction between corporate governance responsibility and corporate reveals the challenge of • Related party transactions developing • Proceeds from public/rights/preferential it is submitted that it would be difficu issues. a well-rooted programme separate the two. The Ministry of . summing up. 'governance committee' adhere to corporate governance. in practices. Pune. Having said that. This would mean that the and creates higher firm valuation once large Indian companies will be forced by wth of the corporate sector. As the and improve social and labour important statistics suggest. Avinosh holds on LLM in International Finance Laws from King's College London and hos also worked with a law firm in London. Asian Crisis of 1997. poor corporate also hinders the creation and in the country in remains that while important lowest quartile. We have also learnt from development the nature question. investor protection legislations are on paper. the ratio of stock market relationships of corporate governance capitalization environmental highest quartile of shareholder enactment and enforcement can remove mistrust between protection). facilitator and regulator for effective functioning and J (SPCC) has recommended additionally zovemance practices. t the business to adopt responsible potential of significantly reducing the risk bankers to move to Big Four and the mid- of nation-wide financial crises. right is about four rimes as large as that for countries in the governance two important and to what extent the enhances access to external financing by to GDP in countries in the in a country and protecting the rights of Such financial crises have massive DVANTAGES OF EFFECTIVE CORPORATE GOVERNANCE banks and financial institutions stay away from. Both these aspects play reduce legal costs and external economies like roles in determining EPILOGUE The Companies Bill. as higher growth and employment. I I~· •••• 57_00 •• to -. The legal economic and social costs and can set a environment country several years back in its path to aspects . However. the fact protection. 2008 and even the implementation leaves a lot to be desired to the international 2009 Bill (drafted after Satyam scandal) when compared does not provide for rotation. leading to greater investment as well different stakeholders. the MOCA has endeavoured Corporate to bring out a set of Social Responsibility roluntary guidelines in December 2009. These guidelines have been prepared between the quality of corporate governance (CSR) currency depreciation. the Select Parliamentary Consultative ABOUT Committee THE AUTHOR: IJ l. f i- Avinash Mohapatra is the Resident Editor ~for Lex Witness. The legal system of a country plays a crucial role in creating an effective norms are taking into account the governance believed to be the key reasons behind the challenges faced in India. their the western world that. private equity investors and international . There is a tier Indian firms will be left with those strong inverse relationship companies which the international e role of an enabler. . (de jure protection) Efficient corporate encompasses offered in the laws laws are enforced in real life (de facto governance firms. Mr Mohopatra is a practising Advocate and happens to be on alumnus of Symbiosis Law School. ~ of new firms. corporate governance Effective corporate governance mechanism investors and creditors.in focus Corporate Affairs (MOCA) has adopted Good corporate governance rotation of lowers the cost of capital by reducing risk audit firms.=--~- August 2011 I LEXWITNESS I 17 . In order to again boosting real investments.the protection development. and Poor transparency and corporate governance after It has the best the wake of the Satyam saga.