CORPORATE GOVERNANCE – CHANGING DIMENSIONS

CORPORATE   GOVERNANCE –  CHANGING   DIMENSIONS

By  RoumitaDey.

(BA.LLB, Fourth  Year,Jogesh  ChandraChoudhuri  College of Law, Kolkata)

 

Abstract
Corporate Governance in India has seen a paradigm shift and has been posing new set of challenges to the top echelons of management in various organizations including organizations from the financial sector. The increasing stringencies and tighter regulatory mechanism have been the compelling reasons for the companies to have stronger focus and orientation on smooth implementation of the corporate governance code in India. The paradigm shift in the manner in which business is conducted across the world in the digital era, warrants a synchronization of the regulatory mechanisms to tackle frauds, and to safeguard the interests of various stakeholders[1]. A clear understanding of the various changing dimensions and perspectives optimally backed by the collective will power of the corporate world as well as the government will ensure the accomplishment of shareholders’ objectives by the various organizations.

Introduction

The term ‘corporate governance’ may be defined as ‘the activity of controlling a company’ (OUP, 2000). ‘Corporate governance deals with the ways in which the suppliers of finance to corporations assure themselves of getting a stream of return on their investments’ (Schleifer et al, 1997)[2]. Corporate Governance is one of the most often talked about topics in business, among the senior echelons of management as well as other stakeholders. Corporate Governance is defined as the compendium of the general set of customs, regulations, habits, and laws that determine to what end a firm should be run. The most challenging part about corporate governance is the lack of clear demarcation between the complex intersections of law, morality, and economic efficiency. Corporate Governance has gradually gained focus,prominence and importance in the curriculam of the leading business schools and has also become one of the hottest contemporary issue on which seminars, conferences and workshops are being organized across the globe to sensitize the various stakeholders about its impact, implications and ramifications on the various stakeholders of the society. It is usually not a distinct academic discipline, but has been integrated into management course of different institutions and universities in India and abroad[3].

The issues pertaining to Corporate Governance is considered to be significant in the light of the manifold issues and dimensions including issues of executive compensation, financial scandals, and shareholders’ activism etc.

Corporate governance is the integration of the various processes, customs, policies, laws, and institutions affecting the way a corporation (or company) is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, management, and the board of directors. Other stakeholders include employees, customers, creditors, suppliers, regulators, and the community at large.

Corporate governance is a multi-faceted subject. An important theme of corporate governance is to ensure the accountability of certain individuals in an organization through mechanisms that try to reduce or eliminate the principal-agent problem.There are yet other aspects to the corporate governance subject, such as the stakeholder view and the corporate governance models around the world.

Global Scenario

USA
Corporate governance practices in the United States are not regulated by any one particular statute but instead are affected by the governing instruments, the corporate law and the court decisions of each issuer’s state of incorporation, and, in the case of many publicly-owned issuers, by the U.S. federal securities laws and requirements of the national securities markets. Matters governed by state law include the voting rights accorded to shareholders, the functions of the board, and the ability of board members and executives to enter into transactions with the company. State corporation laws vary among the 50 states. However, because many corporations choose to incorporate in Delaware, Delaware law is a useful reference point for state corporate governance practices and is referred to throughout this response.

U.S. federal securities laws also affect corporate governance practices, primarily in the areas of disclosure and financial reporting, proxy voting, and the submission of shareholder proposals for consideration at shareholders’ meetings. In addition, the national securities markets impact corporate governance practices through their requirements applicable to issuers of securities traded on their markets. Subject to all of these different laws and regulations as applicable, corporations may establish their own governance practices in their corporate charters and bylaws.

There has been renewed interest in the corporate governance practices of modern corporations since 2001, particularly due to the high-profile collapses of a number of large U.S. firms such as Enron Corporation and MCI Inc. (formerly WorldCom). In 2002, the U.S. federal government passed the Sarbanes-Oxley Act, intending to restore public confidence in corporate governance.

Code on Corporate Governance

This Code supersedes and replaces the Combined Code issued by the Hampel Committee on Corporate Governance in June 1998. It derives from a review of the role and effectiveness of non-executive directors by Derek Higgs and a review of audit committees by a group led by Sir Robert Smith. The Financial Services Authority has said that it will replace the 1998 Code that is annexed to the Listing Rules with the revised Code and will seek to make consequential Rule changes. There will be consultation on the necessary Rule changes but not further consultation on the Code provisions themselves. It is intended that the new Code will apply for reporting years beginning on or after 1 November 2003. The Code contains main and supporting principles and provisions. The existing Listing Rules require listed companies to make a disclosure statement in two parts in relation to the Code. In the first part of the statement, the company has to report on how it applies the principles in the Code. In future this will need to cover both main and supporting principles. The form and content of this part of the statement are not prescribed, the intention being that companies should have a free hand to explain their governance policies in the light of the principles, including any special circumstances applying to them which have led to a particular approach. In the second part of the statement the company has either to confirm that it complies with the Code’s provisions or – where it does not – to provide an explanation. This ‘comply or explain’ approach has been in operation for over ten years and the flexibility it offers has been widely welcomed both by company boards and by investors. It is for shareholders and others to evaluate the company’s statement. While it is expected that listed companies will comply with the Code’s provisions most of the time, it is recognized that departure from the provisions of the Code may be justified in particular circumstances. Every company must review each provision carefully and give a considered explanation if it departs from the Code provisions.

UK Corporate Governance has influenced Corporate Governance regulation in the European Union and United States.A detailed analysis of several UK corporate governance reports, in particular[4]

• the Cadbury Report on “Financial Aspects of Corporate Governance” (December 1992),
• Rutteman Guidance (December 1994), Greenbury Report (July 1995),
• Hamel Report on “Corporate Governance” (June 1998),
• Turnbull Report on “Internal Control: Guidance for Directors on the Combined Code” (September 1999) and
• Higgs Report on the “Review of the role and effectiveness of non-executive directors” (January 2003)

revealed that the UK has been able to influence US corporate governance regulation (Sarbanes-Oxley Act 2002 [SOA] on “Corporate Responsibility”, enacted by the Senate and House of Representatives of the United States of America).

Following recent financial reporting scandals, the requirement to implement standards for the EU capital market to enhance public trust in the audit function in the EU and the need to respond to SOA, the Commission prepared with the Winter report[5]. In September 2003 the Commission published the Communication (2003/236/02) on “Reinforcing the statutory audit in the EU” and in parallel an Action Plan on “Modernising Company Law and Enhancing Corporate Governance in the European Union”. The Directive (2006/43/EC) on “statutory audit of annual accounts and consolidated accounts, amending Council Directive 78/660/EEC and 83/349/EEC and repealing Council Directive 84/253/EEC” was adopted by the European Parliament on the 28.9.2005.

The new modern regulatory audit framework will be applicable to non-EU audit firms performing audit work in relation to companies listed on the EU capital markets. To achieve recognition of the EU regulatory approaches to the protection of investors and other stakeholders, the Commission has had regulatory discussions in particular with the SEC but also with decision makers in US Congress and EU Finance Ministers.[6]

Corporate Governance: Global Financial Crisis

The OECD report analysed and submitted a detailed report on the impact of failures and weaknesses in corporate governance on the financial crisis, including risk management systems and executive salaries[7]. It concluded that the financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements which did not serve their purpose to safeguard against excessive risk taking in a number of financial services companies. Accounting standards and regulatory requirements have also proved insufficient in some areas. Last but not the least, remuneration systems have in a number of cases not been closely related to the strategy and risk appetite of the company and its longer term interests.

Corporate Governance Lessons from the Financial Crisis

The financial crisis in USA can be to an important extent attributed to the various failures and weaknesses in corporate governance arrangements. Qualified board oversight and robust risk management is important. Corporate governance enhancements often followed failures that highlighted areas of particular concern. Understanding the market situation that confronted financial institutions is essential. Default rates on US sub prime mortgages began to rise as of 2006, and warnings were issued by a number of official institutions. By mid-2007 credit spreads began to increase and first significant downgrades were announced, while sub prime exposure was questioned. Financial institutions faced challenging competitive conditions but also an accommodating regulatory environment. While the post-2000 environment demanded the most out of corporate governance arrangements, evidence points to severe weaknesses. The remuneration of boards and senior management also remains a highly controversial and debatable issue in many countries

Corporate Governance in India

In India, the challenge is more in respect of promoter managed companies where balancing of their interest with that of minority shareholders is tough.

Corporate Governance in India: Regulatory landscape

Recent events in India have put the spotlight on corporate governance practices of Indian companies. A key aspect that is being debated in the corridors of India Inc. is whether we need major regulatory changes to improve corporate governance, or whether improved standards of corporate governance could be achieved through adoption of principle-based standards of conduct. India Inc. has generally been proactive in promulgating corporate governance regulations. In doing so, a good balance has been achieved i.e. headway has been made, in terms of helping ensure that regulations are not stifling our entrepreneurial initiatives. From a purely regulatory standpoint, India compares favorably with most other developing and Asian economies as far as its corporate governance rules are concerned.

Good corporate governance

Good corporate governance is characterized by a firm commitment and adoption of ethical practices by an organization across its entire value chain and in all of its dealings with a wide group of stakeholders encompassing employees, customers, vendors, regulators and shareholders (including the minority shareholders), in both good and bad times. To achieve this, certain checks and practices need to be whole-heartedly embraced.

 

Broadening Base for Application to Unlisted Companies and SMEs

The speakers at a recently concluded seminar on corporate governance were of the view that the existing corporate governance norms and structures are good and need no major overhaul, but some fine tuning may be required to make them applicable to unlisted and small and medium enterprises. The speakers also laid stress on the fact the growth and prosperity of a nation depends on the character of its people which in turn depends on the education and value systems inculcated in a person since his childhood.

Manoharan, who was appointed by the central government as a director of the scam-hit Satyam Computers and later its chairman to bring back the company from the brink, was speaking at the ‘Corporate Governance – The Way Forward’, seminar organised at Chennai in association with National Foundation for Corporate Governance. ‘The ramification of a corporate fraud is not restricted only to the jurisdiction where the fraud was committed,’ he said. Speaking about the Satyam Computer balance sheet, he said: ‘On the right side (asset side) nothing was left and on the left side (liabilities) nothing was right. But such frauds are few.’

SanthoshShetty, director, Governance, Risk and Compliance Services practice at KPMG, called for some changes in the corporate governance norms and for a credible disciplinary system. He also asked key advisors like auditors to be more accountable.

Issues in the implementation of the Corporate Governance Code

In one of the recently concluded conference on corporate governance, the moderator – Ganesh Ramamurthy, director, governance risk and compliance services, KPMG India, set the ball for the second session rolling, by establishing that while the corporate governance norms in India are at par with the best in the world, ensuring that these norms are always implemented is where the trouble comes in. Commenting on the difficulty of implementing these norms, Stephen Matthias, partner, Kochhar& Co said that it was important to have all the corporate governance codes together to ensure better implementation rather than have the implementation governed by multiple bodies. KPMG[8] India and various other leading consulting firms have done a pioneering work in the area of smooth implementation of the corporate governance code and have been providing consulting to the various organizations and have been instrumental in ironing out the issues and the bottlenecks in the implementation of the corporate governance code.

 

Striking a balance between transparency and cost of disclosure

As the opening session on a series of discussions on corporate governance, it was only appropriate that it that focus on the most effective framework needed for organizational decision making. KMPG CEO Russell Parera said that what was needed was a culture that encouraged debate and dissent, something one doesn’t always see on Indian boards as people tend to belong to the same inner circle.
Following up on that, Zia Mody, managing partner, AZB Partners added that if a person was on the board of a company as an independent director, he or she was expected to ask awkward questions, which rarely was the case. “However, that in itself cannot help prevent a fraud as directors could be given wrong information,” she added. Of course, it takes a lot more than just having standards in place. It’s also about how these are implemented. It would, for instance, be almost pointless to have a whistleblower policy in place, and link it directly with the CFO. The panel agreed that it was best to give authority to an independent director or board member when it came to matters of compliance and governance.
Lakshminarayana KR, chief strategy officer, Wipro added that a lot also depended on how much time the board members had, to devote to each company on whose board they served, and the amount of access provided by the company to the mid and lower level of employees so that directors could truly get a sense of what was happening. Joseph Massey, MD & CEO of the Multi Commodity Exchange had a relevant point to make. “Corporate governance has to be treated as a normal part of life when running a company-it’s just one more add-on[9].
The focus should be on running the business, corporate governance just gets inculcated,” he said. While shareholder activism in India has still to take off, this is partly also because companies are shielded from the reputational risk that class action lawsuits bring with them. Parera mentioned that as companies would increasingly grow aware of this, shareholder activism too would rise in a healthy way. As the session ended, all the panellists agreed that there was no such thing as too much disclosure and while no one wanted more regulation in the wake of the Satyam scandal, what was needed was better implementation of existing regulations.

Role of Audit Committee in Corporate Governance

The members of board of directors of a company i.e. directors exercise the power vested in a company either directly or through managers appointed by them. (GOWER 1997)[10]. The boards of directors delegate their responsibilities by appointing managers in specialized areas to shoulder their burden as the overall responsibilities cannot be shouldered by few people at the top echelons of management.
One among such tasks is the preparation of financial statements and annual accounts which is a mandatory task. This is an important task from the perspective of the prospective investors as well because the annual report of the company is an indicator of the financial health of the company. Since the annual report represents the financial health of a company, the management of a company might be tempted to present a rosy picture of the same by modifying the numbers and thus avoiding incisive questions by the board as to its performance. In view of this possibility provision for compulsory audit of the annual accounts has been made. The auditors are, based upon the information which they gather from the company; expected to ascertain whether the annual accounts of a company present a ‘true and fair view’ of the company’s financial position or not. However, there have been instances of accounting and audit failure which led to several brainstorming sessions by the regulators who suggested different modes of ensuring that such scandals become events of the past. Instances of such failures like those in the cases of Maxwell, BCCI and Polypeck in the United Kingdom led to the appointment of Cadbury Committee on Financial Aspects of Corporate Governance (Cadbury 2003).

 

Conclusion and Recommendations
India has made significant achievement in the area of corporate governance and is yet to go a long way in ensuring good corporate governance in line with the leading economies of the globe. Indian companies are focusing on good corporate governance so as to accomplish the shot term and long term corporate plans simultaneously ensuring the overall interests of the various stakeholders. The good governance helps an organization in attracting the best talents in various domain areas, as well as in motivating and retaining the talent thereby facilitating the overall process of talent management which acts as a backbone or the engine of any organization. Good corporate governance facilitates the management of visualizing, analyzing and managing the various types of risk so as to ensure a secure and prosperous operating environment to improve the operational performance and productivity.