CHAPTER – I
INTRODUCTION
1.1 Background:
The concept of Corporate Governance has a long history. In the ancient times, when humans roamed on this earth in tribes, there were tribal communes in existence. The activities of the tribe as well as individual members were supervised by the tribal communes to ensure adherence to tribal norms. Over a period of time, the tribal form gave rise to agrarian communities where the concept of family took hold. The family had a structure based on age and experience and the activities of the family members were viewed by the family councils. In the Roman Empire, specific corporate bodies, such a municipal bodies were developed to manage public affairs with transparency for common good. In the Middle East, the nomadic tribes had their councils to ensure fair play and justice. The evolution of Christianity and Islam in the Middle East placed the responsibility of governance on religions. The Church and the Mullahs were the torchbearers of the concept and practice of governance.
In ancient India, the ruling emperors decided the concept and practice of governance. The treatise on economic administration, Arthashastra, written roughly 315 years before Christ developed a complete structure of governance in a kingdom with clear demarcation of authority, responsibility and accountability. In the Far East, Japan and China also placed the governance in the hands of their kings.
In the post Christ period, with improved navigation and availability of vessels, the traders from Europe, especially the Portuguese and the Dutch explored the known expanse of the earth and gave rise to global trading entities. These entities reported to the kings. This was the beginning of corporate governance. As we approach the 16th century, the most powerful trading nation, England, formed a variety of regulations and regulatory authorities such as joint stock companies and Bank of England to govern all trading activities on a platform of accountability, efficiency, effectiveness and stakeholders’ satisfaction. The concept of corporate governance was the basic platform for these regulations and regulatory authorities and over a period of time the concept and its practice took a firm root for all activities.
1.2 Definition:
The term Corporate Governance is not easy to define. The term governance relates to a process of decision making and implementing the decisions in the interest of all stakeholders. It basically relates to enhancement of corporate performance and ensures proper accountability for management in the interest of all stakeholders. The Cadbury Report of 1991 on Corporate Governance considers it as a system through which corporate are guided and directed. On the basis of this definition, the Core Objectives of Corporate Governance can be defined as under: • Strategic Focus • Predictability • Transparency • Participation • Accountability • Efficiency ; Effectiveness • Stakeholder Satisfaction. The Strategy Focus defines the direction the organization should take to meet its goals and to ensure Stakeholder Satisfaction. The Strategic Focus should be based on Predictability as the evolution of strategies have to consider the dynamic environment within which it has to operate and hence the challenges from the environment need to be anticipated. A well-designed process to evolve and deploy strategy has to have Transparency for all stakeholders so that there is a commitment and an understanding of the result expected from the operations. For proper execution of any processes aimed at achieving the desired end result, Participation of all stakeholders is important and actually necessary. The participation should have a clear goal of Efficiency and Effectiveness of the organization as a whole and this where Accountability is the key. All stakeholders have to have a clear understanding of their accountability for the most effective operations of any organization.
1.3 Prerequisites and Constituents
Today adoption of good Corporate Governance practices has emerged as an integral element for doing business. It is not only a pre-requisite for facing intense competition for sustainable growth in the emerging global market scenario but is also an embodiment of the parameters of fairness, accountability, disclosures and transparency to maximize value for the stakeholders.
Corporate governance is beyond the realm of law. It cannot be regulated by legislation alone. Legislation can only lay down a common framework – the “form” to ensure standards. The “substance” will ultimately determine the credibility and integrity of the process. Substance is inexorably linked to the mindset and ethical standards of management.
Studies of corporate governance practices across several countries conducted by the Asian Development Bank, International Monetary Fund, Organization for Economic Cooperation and Development and the World Bank reveal that there is no single model of good corporate governance.
The OECD (Organization for Economic Co-operation and Development) Code also recognizes that different legal systems, institutional frameworks and traditions across countries have led to the development of a range of different approaches to corporate governance. However, a high degree of priority has been placed on the interests of shareholders, who place their trust in corporations to use their investment funds wisely and effectively is common to all good corporate governance regimes.
The three key constituents of corporate governance are the Board of Directors, the Shareholders and the Management.
The pivotal role in any system of corporate governance is performed by the board of directors. It is accountable to the stakeholders and directs and controls the management. It stewards the company, sets its strategic aim and financial goals and oversees their implementation, puts in place adequate internal controls and periodically reports the activities and progress of the company in the company in a transparent manner to all the stakeholders.
The shareholders’ role in corporate governance is to appoint the directors and the auditors and to hold the board accountable for the proper governance of the company by requiring the board to provide them periodically with the requisite information in a transparent fashion, of the activities and progress of the company.
The responsibility of the management is to undertake the management of the company in terms of the direction provided by the board, to put in place adequate control systems and to ensure their operation and to provide information to the board on a timely basis and in a transparent manner to enable the board to monitor the accountability of management to it.
The underlying principles of corporate governance revolve around three basic inter-related segments. These are:
Integrity and Fairness
Transparency and Disclosures
Accountability and Responsibility
The Main Constituents of Good Corporate Governance are:
Role and powers of Board: the foremost requirement of good corporate governance is the clear identification of powers, roles, responsibilities and accountability of the Board, CEO and the Chairman of the board.
Legislation: a clear and unambiguous legislative and regulatory framework is fundamental to effective corporate governance.
Code of Conduct: it is essential that an organization’s explicitly prescribed code of conduct is communicated to all stakeholders and is clearly understood by them. There should be some system in place to periodically measure and evaluate the adherence to such code of conduct by each member of the organization.
Board Independence: an independent board is essential for sound corporate governance. It means that the board is capable of assessing the performance of managers with an objective perspective. Hence, the majority of board members should be independent of both the management team and any commercial dealings with the company. Such independence ensures the effectiveness of the board in supervising the activities of management as well as make sure that there are no actual or perceived conflicts of interests.
Board Skills: in order to be able to undertake its functions effectively, the board must possess the necessary blend of qualities, skills, knowledge and experience so as to make quality contribution. It includes operational or technical expertise, financial skills, legal skills as well as knowledge of government and regulatory requirements.
Management Environment: includes setting up of clear objectives and appropriate ethical framework, establishing due processes, providing for transparency and clear enunciation of responsibility and accountability, implementing sound business planning, encouraging business risk assessment, having right people and right skill for jobs, establishing clear boundaries for acceptable behaviour, establishing performance evaluation measures and evaluating performance and sufficiently recognizing individual and group contribution.
Board Appointments: to ensure that the most competent people are appointed in the board, the board positions must be filled through the process of extensive search. A well defined and open procedure must be in place for reappointments as well as for appointment of new directors.
Board Induction and Training: is essential to ensure that directors remain abreast of all development, which are or may impact corporate governance and other related issues.
Board Meetings: are the forums for board decision making. These meetings enable directors to discharge their responsibilities. The effectiveness of board meetings is dependent on carefully planned agendas and providing relevant papers and materials to directors sufficiently prior to board meetings.
Strategy Setting: the objective of the company must be clearly documented in a long term corporate strategy including an annual business plan together with achievable and measurable performance targets and milestones.
Business and Community Obligations: though the basic activity of a business entity is inherently commercial yet it must also take care of community’s obligations. The stakeholders must be informed about the approval by the proposed and on going initiatives taken to meet the community obligations.
Financial and Operational Reporting: the board requires comprehensive, regular, reliable, timely, correct and relevant information in a form and of a quality that is appropriate to discharge its function of monitoring corporate performance.
Monitoring the Board Performance: the board must monitor and evaluate its combined performance and also that of individual directors at periodic intervals, using key performance indicators besides peer review.
Audit Committee: is inter alia responsible for liaison with management, internal and statutory auditors, reviewing the adequacy of internal control and compliance with significant policies and procedures, reporting to the board on the key issues.
Risk Management: risk is an important element of corporate functioning and governance. There should be a clearly established process of identifying, analyzing and treating risks, which could prevent the company from effectively achieving its objectives. The board has the ultimate responsibility for identifying major risks to the organization, setting acceptable levels of risks and ensuring that senior management takes steps to detect, monitor and control these risks.
Good corporate governance recognizes the diverse interests of shareholders, lenders, employees, government, etc. The new concept of governance to bring about quality corporate governance is not only a necessity to serve the divergent corporate interests, but also is a key requirement in the best interests of the corporate themselves and the economy.
1.4 Organizational Framework
The organizational framework for corporate governance initiatives in India consists of the Ministry of Corporate Affairs (MCA) and the Securities and Exchange Board of India (SEBI). The first formal regulatory framework for listed companies specifically for corporate governance was established by the SEBI in February 2000, following the recommendations of Kumar Mangalam Birla Committee Report. It was enshrined as Clause 49 of the Listing Agreement.
Thereafter SEBI had set up another committee under the chairmanship of Mr. N. R. Narayana Murthy, to review Clause 49, and suggest measures to improve corporate governance standards. Some of the major recommendations of the committee primarily related to audit committees, audit reports, independent directors, related party transactions, risk management, directorships and director compensation, codes of conduct and financial disclosures.
The Ministry of Corporate Affairs had also appointed a Naresh Chandra Committee on Corporate Audit and Governance in 2002 in order to examine various corporate governance issues. It made recommendations in two key aspects of corporate governance: financial and non-financial disclosures: and independent auditing and board oversight of management.
It had also set up a National Foundation for Corporate Governance (NFCG) in association with the CII, ICAI and ICSI as a not-for-profit trust to provide a platform to deliberate on issues relating to good corporate governance, to sensitize corporate leaders on the importance of good corporate governance practices as well as to facilitate exchange of experiences and ideas amongst corporate leaders, policy makers, regulators, law enforcing agencies and non- government organizations. 1.5 Legal Framework
An effective regulatory and legal framework is indispensable for the proper and sustained growth of the company. In rapidly changing national and global business environment, it has become necessary that regulation of corporate entities is in tune with the emerging economic trends, encourage good corporate governance and enable protection of the interests of the investors and other stakeholders. Further, due to continuous increase in the complexities of business operation, the forms of corporate organizations are constantly changing. As a result, there is a need for the law to take into account the requirements of different kinds of companies that may exist and seek to provide common principles to which all kinds of companies may refer while devising their corporate governance structure.
The important legislations for regulating the entire corporate structure and for dealing with various aspects of governance in companies are Companies Act, 1956 and Companies Bill, 2004. These laws have been introduced and amended, from time to time, to bring more transparency and accountability in the provisions of corporate governance. That is, corporate laws have been simplified so that they are amenable to clear interpretation and provide a framework that would facilitate faster economic growth.
Secondly, the Securities Contracts (Regulation) Act, 1956, Securities and Exchange Board of India Act, 1992 and Depositories Act, 1996 have been introduced by Securities and Exchange Board of India (SEBI), with a view to protect the interests of investors in the securities markets as well as to maintain the standards of corporate governance in the country. 1.6 Guidelines/Principles At International Level
In the changing global scenario, it has become necessary to bring in effective governance practices in the corporate sector. Various important and valuable lessons have been learned from the series of corporate collapses that occurred in different parts of the world. Accordingly, several codes, guidelines and principles have been made and implemented covering varied aspects of corporate governance. They were introduced in order to restore investors’ confidence as well as to enhance corporate transparency and accountability. They seek to establish the accountability standards of Directors and CEOs; as well as define the roles and responsibilities of the Board of Directors and stakeholders in the company.
Over the years, the issue of corporate governance has received a high level of attention. There are several reports and recommendations of the International Committees/ Associations, etc. on the development of appropriate framework for promoting good corporate governance standards, codes and practices to be followed globally. These are:-
Cadbury Committee Report-The Financial Aspects of Corporate Governance (1992)
Greenbury Committee Report on Directors’ Remuneration (1995)
Hampel Committee Report on Corporate Governance (1998)
The Combined Code, Principles of Good Governance and Code of Best Practice, London Stock Exchange (1998)
CalPERS’ Global Principles of Accountable Corporate Governance (1999)
Blue Ribbon Report (1999)
King Committee On Corporate Governance (2002)
Sarbanes Oxley Act (2002)
Higgs Report: Review of the role and effectiveness of non-executive directors (2003)
The Combined Code on Corporate Governance (2003)
ASX Corporate Governance Council Report (2003)
OECD Principles of Corporate Governance (2004)
The Combined Code on Corporate Governance (2006)
UNCTAD Guidance on Good Practices in Corporate Governance Disclosure (2006)
The Combined Code on Corporate Governance (2008)
Walker Review of Corporate Governance of UK Banking Industry (2009)
UK Corporate Governance Code (Revised) 2012
These recommendations and principles have been mainly focused on structure of the company, financial and non-financial disclosures, compliance with codes of corporate governance, competitive remuneration policy, shareholders rights and responsibilities, financial reporting and internal controls, etc. All these efforts at international level, in turn, helps to bring favourable changes in the operating systems of Board of Directors, Company’s management and administration; as well as improve face of relationship between supervisory and executive bodies. 1.7 Benefits and Limitations
The concept of corporate governance has been attracting public attention for quite some time. It has been finding wide acceptance for its relevance and importance to the industry and economy. It contributes not only to the efficiency of a business enterprise, but also, to the growth and progress of a country’s economy. Progressively, firms have voluntarily put in place systems of good corporate governance for the following reasons:
Several studies in India and abroad have indicated that markets and investors take notice of well managed companies and respond positively to them. Such companies have a system of good corporate governance in place, which allows sufficient freedom to the board and management to take decisions towards the progress of their companies and to innovate, while remaining within the framework of effective accountability.
In today’s globalised world, corporations need to access global pools of capital as well as attract and retain the best human capital from various parts of the world. Under such a scenario, unless a corporation embraces and demonstrates ethical conduct, it will not be able to succeed.
The credibility offered by good corporate governance procedures also helps maintain the confidence of investors – both foreign and domestic – to attract more long-term capital. This will ultimately induce more stable sources of financing.
A corporation is a congregation of various stakeholders, like customers, employees, investors, vendor partners, government and society. Its growth requires the cooperation of all the stakeholders. Hence it imperative for a corporation to be fair and transparent to all its stakeholders in all its transactions by adhering to the best corporate governance practices.
Good Corporate Governance standards add considerable value to the operational performance of a company by:
Improving strategic thinking at the top through induction of independent directors who bring in experience and new ideas;
Rationalizing the management and constant monitoring of risk that a firm faces globally;
Limiting the liability of top management and directors by carefully articulating the decision making process;
Assuring the integrity of financial reports, etc.
It also has a long term reputational effects among key stakeholders, both internally and externally.
Also, the instances of financial crisis have brought the subject of corporate governance to the surface. They have shifted the emphasis on compliance with substance, rather than form, and brought to sharper focus the need for intellectual honesty and integrity. This is because financial and non-financial disclosures made by any firm are only as good and honest as the people behind them.
Good governance system, demonstrated by adoption of good corporate governance practices, builds confidence amongst stakeholders as well as prospective stakeholders. Investors are willing to pay higher prices to the corporate demonstrating strict adherence to internally accepted norms of corporate governance.
Effective governance reduces perceived risks, consequently reduces cost of capital and enables board of directors to take quick and better decisions which ultimately improves bottom line of the corporate.
Adoption of good corporate governance practices provides long term sustenance and strengthens stakeholders’ relationship.
A good corporate citizen becomes an icon and enjoys a position of respects.
Potential stakeholders aspire to enter into relationships with enterprises whose governance credentials are exemplary.
Adoption of good corporate governance practices provides stability and growth to the enterprise.
Effectiveness of corporate governance system cannot merely be legislated by law neither can any system of corporate governance be static. As competition increases, the environment in which firms operate also changes and in such a dynamic environment the systems of corporate governance also need to evolve. Failure to implement good governance procedures has a cost in terms of a significant risk premium when competing for scarce capital in today’s public markets.
1.8 Purpose of the Study
The issues of governance, accountability and transparency in the affairs of the company, as well as about the rights of shareholders and role of Board of Directors have never been so prominent as it is today. The corporate governance has come to assume a centre stage in the Board room discussions.
India has become one of the fastest emerging nations to have aligned itself with the international trends in Corporate Governance. As a result, Indian companies have increasingly been able to access to newer and larger markets around the world; as well as able to acquire more businesses. The responses of the Government and regulators have also been admirably quick to meet the challenges of corporate delinquency. But, as the global environment changing continuously, there is a greater need of adopting and sustaining good corporate governance practices for value creation and building corporations of the future.
It is true that the ‘corporate governance’ has no unique structure or design and is largely considered ambiguous. There is still lack of awareness about its various issues, like, quality and frequency of financial and managerial disclosure, compliance with the code of best practice, roles and responsibilities of Board of Directories, shareholders rights, etc. There have been many instances of failure and scams in the corporate sector, like collusion between companies and their accounting firms, presence of weak or ineffective internal audits, lack of required skills by managers, lack of proper disclosures, non-compliance with standards, etc. As a result, both management and auditors have come under greater scrutiny.
But, with the integration of Indian economy with global markets, industrialists and corporates in the country are being increasingly asked to adopt better and transparent corporate practices. The degree to which corporations observe basic principles of good corporate governance is an increasingly important factor for taking key investment decisions. If companies are to reap the full benefits of the global capital market, capture efficiency gains, benefit by economies of scale and attract long term capital, adoption of corporate governance standards must be credible, consistent, coherent and inspiring.
1.9 Rationale
Quality of corporate governance primarily depends on following factors, namely:- integrity of the management; ability of the Board; adequacy of the processes; commitment level of individual Board members; quality of corporate reporting; participation of stakeholders in the management; etc. Since this is an important element affecting the long-term financial health of companies, good governance framework also calls for effective legal and institutional environment, business ethics and awareness of the environmental and societal interests.
Hence, in the years to come, corporate governance will become more relevant and a more acceptable practice worldwide. This is easily evident from the various activities undertaken by many companies in framing and enforcing codes of conduct and honest business practices; following more stringent norms for financial and non-financial disclosures, as mandated by law; accepting higher and appropriate accounting standards; enforcing tax reforms coupled with deregulation and competition; etc.
However, inapt application of corporate governance requirements can adversely affect the relationship amongst participants of the governance system. As owners of equity, institutional investors are increasingly demanding a decisive role in corporate governance. Individual shareholders, who usually do not exercise governance rights, are highly concerned about getting fair treatment from controlling shareholders and management. Creditors, especially banks, play a key role in governance systems, and serve as external monitors over corporate performance. Employees and other stakeholders also play an important role in contributing to the long term success and performance of the corporation. Thus, it is necessary to apply governance practices in a right manner for better growth of a company.
1.10 Suggestions and Opinions
Corporations are the prominent players in the global markets. They are mainly responsible for generating majority of economic activities in the world, ranging from goods and services to capital and resources. The essence of corporate governance is in promoting and maintaining integrity, transparency and accountability in the management of the company as well as in manifestation of the values, principles and policies of a corporation.
Many efforts are being made, both at the Centre and the State level, to promote adoption of good corporate governance practices, which are the integral element for doing and managing business. However, the concepts and principles of good governance are still not clearly known to the Indian business set up.
Hence, there is a greater need to increase awareness among entrepreneurs about the various aspects of corporate governance. There are some of the areas that need special attention, namely:-
Quality of audit, which is at the root of effective corporate governance;
Role of Board of Directors as well as accountability of the CEOs and CFOs;
Quality and effectiveness of the legal, administrative and regulatory framework; etc.
That is, it is necessary to provide the corporate desired level of comfort in compliance with the code, principles and requirements of corporate governance; as well as provide relevant information to all stakeholders regarding the performance, policies and procedures of the company in a transparent manner. There should be proper financial and non-financial disclosures by the companies, such as, about remuneration package, financial reporting, auditing, internal controls, etc.
OBJECTIVES OF THE STUDY
1. 11 The objectives of the present study are:
1. To review the literature on corporate governance.
2. To study and analyze the differences between Indian and foreign companies with reference to corporate governance practices.
3. To examine whether good governance code or best practices code exists in all companies taken for the study.
4. To study how many independent directors (non executive) are there in the boards of the companies selected?
5. To examine the accounting standards and quality of financial reporting system.
6. To evaluate general accountability and transparency of the board and management functions.
7. To study the corporate governance mechanism set by each company.
8. To examine whether the companies selected for the study, follow an honest corporate culture and an internal ethical environment for successful governance.
9. To study the belief of the companies on corporate governance.
10. To evaluate whether corporate governance is able to resolve conflicts between various categories of stakeholders particularly between owners and managers of the company.
1.12 Methodology:
Being it is an extensive study, data will be collected from the secondary (web) sources using internet and from the published sources. Since the present study is qualitative nature, data has been collected from the respective websites of the companies.
The present study aims to examine the governance practices prevailing in the corporate sector (Private & Public) within the Indian regulatory framework and abroad. The study is conducted to assess governance practices and processes followed by Indian corporate houses and abroad companies. The study also aims to assess the substance and quality of reporting of Corporate Governance practices in annual reports.
This study is about corporate governance practices of 50 companies in India (25 Public companies & 25 Private Companies) and 50 abroad companies. Annual reports of 2014-15 and 2015-16 have been used for this study.
The data analysis is done with the help of certain selected parameters. This study highlights the corporate governance practices and processes followed by the Indian Corporate houses and abroad companies. This study focuses on assessing the quality of reporting of various corporate governance practices in annual reports. The parameters cover the statutory requirements as stipulated by the Clause 49 of the listing agreement prescribed by the Securities and Exchange Board of India (SEBI).
1.13 Chapterization
The thesis comprises Eight Chapters, beginning with
Chapter 1 which introduces the topic and provides the background to the study.
Chapter 2 provides Theoretical framework and review of literature on corporate governance practices from years 2001 to 2016.
Chapter 3 provides an introduction, justification, statement of the problem and scope of the study and also explains the conceptual framework and hypothesis development for the study.
Chapter 4 provides the introduction, theory on research methodologies, sample selection, sampling plan, data collection, data collection methodology, types of data collection, design of variables and qualitative analysis.
Chapter 5 provides the introduction, types of board systems worldwide and also explains the data analysis of 100 companies’ corporate governance practices.
Chapter 6 provides the introduction, presents hypotheses and results of testing the hypotheses’.
Chapter 7 reports the summary, findings and conclusions of the study and particularly it provides an overview of the conclusions and differences in Indian and abroad companies related to corporate governance practices. It will also discuss the findings, implications, limitations and future research directions.
