Corporate Governance in India

Corporate Governance deals with how a corporate is governed. It is all about promoting corporate fairness, transparency and accountability. Some of the objectives of Corporate Governance are – attaining disclosure and transparency in the way corporate is governed; fixing accountability of controllers and managers towards other stakeholders; fixing corporate responsibility; integrity and probity in financial reports etc.

The corporate governance in India is not very old. In 1995, the Confederation of Indian Industries (CII) had set up a task force under Rahul Bajaj, which is probably one of the first task forces of its kind in India. The CII came up with a voluntary code called “Desirable Corporate Governance” in 1998. The second was by the SEBI. The SEBI principles were enshrined in the Clause 49 of the listing agreement. SEBI had set up a Commission under Kumarmanlagam Birla, whose report came up in 2000 covering issues such as protection of investor interest, promotion of transparency, building international standards in terms of disclosure of information. This clause was amended as per recommendations of the Naresh Chandra Committee (2002) and Narayana Murthy Committee (2002).

• Out of them, the Naresh Chandra committee extensively covered the statuary auditor-company relationship, rotation of statutory audit firms/partners, procedure for appointment of auditors and determination of audit fees, true and fair statement of financial affairs of companies.
• The Narayan Murthy Committee focused on responsibilities of audit committee, quality of financial disclosure, requiring boards to assess and disclose business risks in the company’s annual reports.

Clause 49

In our country, the Corporate Governance Principles of the SEBI were enshrined in the Clause 49 of the listing agreement. This agreement was so far required by the all listed (in stock exchanges) companies. It has been amended from time to time and is in action since 2005. It has both mandatory and non-mandatory provisions. Mandatory provisions include those which are absolutely essential for corporate governance, can be defined with precision and which can be enforced without any legislative amendments. The Non-mandatory provisions are those which are either desirable or which may require change of laws. The non-mandatory requirements may be implemented at the discretion of the company.

The Mandatory provisions inter alia include the following:

• Composition of Board and its procedure – frequency of meeting, number of independent directors, code of conduct for Board of directors and senior management;
• Audit Committee, its composition, and role
• Provision relating to Subsidiary Companies
• Disclosure to Audit committee, Board and the Shareholders
• CEO/CFO certification
• Quarterly report on corporate governance
• Annual compliance certificate

The Non-mandatory provisions inter alia include the following:

• Constitution of Remuneration Committee
• Training of Board members
• Peer evaluation of Board members
• Whistle Blower policy

One of the major changes in the recently released (2014) norms is that the Whistleblower policy is no more a Non-mandatory provision but is among the mandatory provisions. Apart from the Clause 49, the Companies Act 2013, which has replaced the 1956 act, has also such provisions.

Why Corporate Governance reforms are needed?

A corporation includes various stakeholders’ viz. investors, share holders, customers, employees, vendor partners, government and society. Its objective should not be confined to maximizing the shareholder value but should be responsible to all stakeholders. Its governance should be fair and transparent to its stakeholders in all its transactions. Thus, corporate governance becomes imperative in today’s globalized world where corporations need to access global pools of capital, need to attract and retain the best human capital from various parts of the world, need to partner with vendors on mega collaborations and need to live in harmony with the community.

On the other hand, the Liberalization and related developments such as deregulation, privatization and extensive financial liberalization render the Corporate Governance very crucial. All the fruits of capital market reforms can be lost to corporate frauds, malpractices etc. Thus, Independent and effective corporate governance reforms are necessary to maintain the market credibility confidence.

Why Reforms were needed in India’s Corporate Governance Regime?

In 2000, the SEBI had amended its Equity Listing Agreement to add a new clause to specify certain corporate governance standards for listed companies. This is known as Clause 49 and with this was born the requirement that half the directors on a listed company’s board must be Independent Directors. In the same clause, the SEBI had put forward the responsibilities of the Audit Committee, which was to have a majority Independent Directors.

Despite of all the mandatory and non-mandatory requirements as per Clause 49, India is still not in a position to project itself having highest standards of corporate governance. However, this reflected SEBI’s first moves towards a new era of accountability in corporate. After the newly enacted Companies Act, 2013, the Clause 49 needed to be amended so that new safeguards such as independent director rotation and audit firm rotation, as mandated in the new Companies Act can be incorporated in Corporate Governance principles. The recent changes in Clause 49 were focussing towards achieving the following objectives:

• To align the provisions of the listing agreement with the provisions of the newly enacted Companies Act, 2013
• To provide additional requirements to strengthen the Corporate Governance framework for the listed companies in India.

Some of the other major reasons are as follows:

• The trust in political and business institutions in India has seen a sharp decline in the last few years because of a series of corruption scandals and the global financial doldrums. One such loss of trust is seen in the retail investors segment. Since 2008, these investors have been heavy sellers mainly because of lack of trust in India’s volatile markets. Thus, the crisis of confidence has been the major challenges for SEBI as well as the government.
• There was an urgent need to make the Corporate Governance regime tough, which should be able to take punitive action on erring firms. As per an statement of U K Sinha (SEBI head), nearly one-fifth of listed companies in India do not even comply with basic shareholding reporting norms set by the regulator. Further, the quality of filings companies make is extremely poor.
• Poor corporate governance standards in India have been a major grievance of domestic as well as foreign investors. In its recent financial sector assessment report on India, IMF also highlighted the lack of compliance with listing obligations as a key weakness.

What are the new norms as per amended Clause 49?

The new norms are based on recommendations made by Adi Godrej Committee (2012).  The objective of the amended clause 49 aka new corporate governance code is to improve transparency and disclosure standards of listed companies in India.

• They aim to protect small investors as well as to reduce the power held by so-called “promoters” of a company, or key stakeholders who have a disproportionate say on management appointments and day-to-day operations.
• The new rules will require listed companies to expand the role of their audit committees, seek shareholder approval for all material related-party transactions (RPTs) and adopt a whistleblower policy as mandatory provision.
• They will have to follow more stringent rules related to the presence of independent directors on their boards.

This has been brought in by the following:

New Norms on Independent Directors

• Conduct a performance evaluation of all directors, including independent directors. Independent directors will be required to hold separate meetings. Till now, the independent directors were not required to hold independent meetings and this often results in approval for board decisions that may be serving only the promoters’ interests. We note here that independent directors are primarily meant to oversee the functioning of the board and ensure that the decisions it makes do not hurt the interests of minority shareholders. The new norms also make sure that two third members of the Audit Committee and the Chairman shall be Independent.
• Maximum number of listed companies in which a person can serve as an independent director at seven. If a person serves as a whole-time director, he cannot be an independent director in more than three listed firms. An Independent Director who has already served on a company’s board for 5 years can serve only one more term of 5 years. Companies will be now required to disseminate Independent Director’s resignation letter to Stock Exchanges & on company website.

New Norms on Risk Management Committee

• Every listed company must have a Risk Management Committee.

New Norms on Related Party Transactions (RPTs)

• There are changes in rules for RPTs (Relative Party Transactions) to enhance transparency in all material dealings by company promoters and to ensure that business decisions are not against the interests of small and minority shareholders. We note here that an RPT is a business deal between two parties who are joined by a special relationship prior to a transaction being carried out. In simple words, it refers to transactions within group firms. The new norms say that a prior audit committee approval is now mandatory for all material RPTs. Moreover, all such transactions will need shareholder approval through a special resolution, with related parties abstaining from voting. SEBI has also widened the scope of definition of RPT, bringing transactions involving key management personnel within its scope.

New norms on Top Level remuneration

• To check the tendency of fixing unreasonably high compensations for promoters and top-level executives, the new norms have mandatory constitution of a nomination and remuneration committee with an independent chairman. Moreover, all companies will need to follow enhanced disclosures norms on remuneration. These disclosure norms mandate the company to disclose the ratio of remuneration of top executives to median remuneration.

Audit Committee and whistleblower mechanism

• The new norms expand the role of audit committee in listed firms and direct them to adopt a compulsory whistleblower mechanism to curb unfair business practices and protect the interest of minority stakeholders.

Conclusion

The above description makes it clear that SEBI has taken a welcome and much needed step to bring corporate governance in India at part with best norms globally. The norms such as separate meeting of independent directors, the establishment of a whistle blower mechanism, and greater scrutiny and disclosure of related-party transactions are on the right track. These will not only increase the confidence of shareholders but also make possible increased financing from the public. These norms will be easy to comply with for honest and ethical companies. The new norms make the life of the crooked companies difficult.