CORPORATE GOVERNANCE IN INDIA: CONCEPT,

COURSE OF ACTION AND COMPLIANCE

Mr. Pradeep Kumar Gupta
Associate Lecturer, L M Thapar School of Management, Patiala

ISSN – 163
Year: February 2009 Volume 3, Issue 1/4

Abstract: While corporate governance may not state the economic prospects of developing countries, it
certainly takes part in shaping them. Good corporate governance is vital because of its role in attracting investors to
invest both in the domestic and in the international capital markets.

Investors primarily consider two variables before making investment decisions in the companies – the rate of return
on invested capital and the risk associated with the investment. Good corporate governance practices reduce this risk
by ensuring transparency, accountability, and enforceability in the capital marketplace. As a result, the investors
expect the Board and the Management in the companies to act in their best interests at all times so as to earn a risk
adjusted rate of return that is higher than the cost of capital.

Practices that the Board of Directors of a listed entity follows to fulfill the expectations of all stakeholders (i. e.
Shareholders, employees, creditors, customers, government, regulatory authorities and society at large) is called
corporate governance practices. While sound corporate governance practices ensure a company’s long-term success,
weak practices often lead to serious problems.

Key Words: Corporate, Good, Governance, Board, Management, Director, Stakeholder, Practices, Framework

INTRODUCTION underlying principles of corporate

(1) Companies pool capital from a large
investor base both in the domestic and in the
international capital markets. (2) In this
context, investment is ultimately an act of
faith in the ability of a company’s
management. In order to manage the affairs
of a company and to act in the best interests
of all at all times, there must be a system
whereby the directors are entrusted with
responsibilities and duties in relation to the
direction of the company affairs.
(3) Corporate governance is a system of
making Management accountable towards
the stakeholders for effective management
of the companies. (4) Corporate governance
is also concerned with the morals, ethics,
values, parameters, conduct and behaviour
of the company and its management. (5) The
governance revolve around three basic inter-
related segments. These are:
ƒ Integrity and Fairness
ƒ Transparency and Disclosures
ƒ Accountability and Responsibility
(6) According to the Confederation of Indian
Industry (CII), corporate governance deals
with laws, procedures, practices and implicit
rules that determine the ability of the
company to make managerial decisions vis-
à-vis its claimants – in particular, its
shareholders, creditors, customers, the State
and employees.
(7) Corporate governance mainly consists of
two elements i.e., A long-term relationship,
which has to deal with checks and balances,
incentives of managers and communications
1
between Management and investors. The (10) In an open financial market, investors
second element is a transactional choose from a variety of investment
relationship involving matters relating to vehicles. The existence of a corporate
disclosure and authority. In other words, governance system is likely a part of this
'good corporate governance' is simply 'good decision-making process. In such a scenario,
business'. companies that are more open and
transparent, and thus well governed, are
(8) Practices that the Board of Directors of a more likely to raise capital successfully
listed entity follows to fulfill the because investors will have the information
expectations of all stakeholders (i. e. and confidence necessary for them to lend
Shareholders, employees, creditors, funds directly to such companies. Moreover,
customers, government, regulatory well-governed companies likely will obtain
authorities and society at large) is called capital more cheaply than companies that
corporate governance practices. have poor corporate governance practices
because investors will require a smaller “risk
NEED, IMPORTANCE AND premium” for investing in well-governed
OBJECTIVES OF CORPORATE companies.
GOVERNANCE
Thus, in an efficient capital market,
In order to overcome the under noted serious investors will invest in companies with
concerns within the business community, better corporate governance frameworks
there is a need to introduce a system of because of the lower risks and the likelihood
corporate governance that will ensure the of higher returns. Good corporate
transparency, integrity and accountability of governance practices also enable
Management including non-executive Management to allocate resources more
directors. efficiently, which increases the likelihood
(9) that investors will obtain a higher rate of
• Concentration of greater financial return on their investment. (11) Moreover,
power and authority in a lesser Good corporate governance practices
number of individuals, ensure:
• Violations of foreign exchange rules
and regulations, ƒ Adequate disclosures and effective
• Large scale diversion of funds to decision making to achieve corporate
associate companies and risky objectives;
ventures, ƒ Transparency in business
• Unfocussed business decisions transactions;
leading to losses, ƒ Statutory and legal compliances;
• Preferential allotment of shares to ƒ Protection of shareholder interests;
promoters at low prices, ƒ Commitment to values and ethical
• Exploited the weaknesses in the conduct of business.
Accounting Standards to inflate ƒ Long-term survival of the
profits and understate liabilities, companies.
• Frequent changes in Board
structures, (12) Corporate governance in a developing
country setting takes on additional
• Spinning off profitable business
importance. Good corporate governance is
operations to subsidiary companies,
vital because of its role in attracting foreign
and
investment. The extent of foreign
• Charging of royalty for use of brand
investment, in turn, shapes the prospects for
name by the parent company by
economic growth for many developing
leading companies.
countries. Generally developing countries
2
that have good corporate governance
structures consistently outperform
developing countries with poor corporate
governance structures. Moreover, corporate
governance can play a role in reducing
corruption, and decreased corruption
significantly enhances a country’s
development prospects. Ultimately, the
concept of corporate governance is not just
one of those imported western luxuries; it is
a vital consideration to be enforced
successfully.
(13) The aim of "Good Corporate
Governance" is to ensure commitment of the
board in managing the company in a
transparent manner for maximizing long-
term value of the company for its
shareholders and all other partners. It
integrates all the participants involved in a
process, which is economic, and at the same
time social.
(14) The fundamental objective of corporate
governance is to enhance shareholders' value
and protect the interests of other
stakeholders by improving the corporate
performance and accountability. Hence it
harmonizes the need for a company to strike
a balance at all times between the need to
enhance shareholders' wealth whilst not in
any way being detrimental to the interests of
the other stakeholders in the company.
Further, its objective is to generate an
environment of trust and confidence
amongst those having competing and
conflicting interests.
(15) There is a global consensus about the
objective of ‘good’ corporate governance:
maximizing long term shareholder value.
Since shareholders are residual claimants,
this objective follows from a premise that, in
well performing capital market, whatever
maximizes shareholder value must
necessarily maximize corporate prosperity,
and best satisfy the claims of creditors,
employees, customers, shareholders and the
State.
TESTS OF CORPORATE
GOVERNANCE
(16) Broadly, the test of corporate
governance should cover the following
aspects:
• Whether the funds of the company
have been deployed for pursuing the
main objects of the company as
enshrined in the Memorandum?
• Whether the funds acquired from
financial institutions and the capital
market have been utilized for the
purpose for which they were
intended?
• Whether the company has the core
competence to effectively manage its
diversifications?
• Whether there has been proper
diversion of funds by way of loans
and advances or investments to
subsidiary?
• Whether the provisions of the
Companies Act, the Foreign
Exchange Management Act, the
Factories Act and other statutes are
complied with in letter and in spirit?
• Whether the practices adopted by the
company and its Management
towards its shareholders, customers,
suppliers, employees and the society
at large are ethical and fair?
• Whether the directors are provided
with the information on the working
of the company and whether the
institutional and non-executive
directors play an active role in the
functioning of the companies?
• Whether the internal controls in
place are effective?
• Whether there is transparent
financial reporting and audit
practices and the accounting
practices adopted by the company
are in accordance with Accounting
Standards of The Institute of
Chartered Accountants of India
(ICAI)?
3
CONSTITUENTS OF CORPORATE GOVERNANCE

(17) The three key constituents of corporate governance are the Board of Directors or Board, the
Shareholders and the Management. These can further be detailed as:

• Role and Powers of Board • Board Meetings

• Composition of Board • Board Induction and Training
• Legislation • Monitoring the Board Performance
• Code of Conduct • Management Skills and
• Board Independence Environment
• Board Skills • Business and Community
• Role and Powers of Shareholders Obligations
• Board Appointments • Audit Committee
• Financial and Operational
Reporting
• Risk Management

FRAMEWORK OF CORPORATE GOVERNANCE (Refer Annexure)

(A) Organizational Framework: The latest revisions to Clause 49 became law on

organizational framework for corporate January 1, 2006 (SEBI, vide circular
governance initiatives in India consists of SEBI/CFD/DIL/CG/1/2006/13/1 dated 13th
the Ministry of Corporate Affairs (MCA), January, 2006). The main provisions of
the Confederation of Indian Industry (CII) Clause 49 as inserted vide SEBI F.No.
and the Securities and Exchange Board of SMDRP/Policy Cir 10/2000 dated
India (SEBI). 21.02.2000 in the Listing Agreement of
Stock Exchange are:
(18) In 1998, the Confederation of Indian I. Board of Directors;
Industry (CII), "India's premier business II. Audit Committee;
association," unveiled India's first code of III. Remuneration of Directors;
corporate governance. However, since the IV. Board Procedure;
Code's adoption was voluntary, few firms V. Management;
embraced it. Soon after, SEBI appointed the VI. Shareholders;
Kumar Mangalam Birla Committee to VII. Report on Corporate Governance;
fashion a code of corporate governance. In and
2000, SEBI accepted the recommendations VIII. Compliance Certification
of the Kumar Mangalam Birla Committee
and introduced Clause 49 into the Listing (19) The Ministry of Corporate Affairs
Agreement of Stock Exchanges. Clause 49 (MCA) had appointed a Naresh Chandra
outlines requirements vis-a-vis corporate Committee on Corporate Audit and
governance in exchange-traded companies. Governance in 2002 in order to examine
In 2003, SEBI instituted the N.R. Narayan various corporate governance issues. It made
Murthy Committee to scrutinize India's recommendations in two key aspects of
corporate-governance framework further corporate governance: financial and non-
and to make additional recommendations to financial disclosures: and independent
enhance its effectiveness. SEBI has since auditing and board oversight of
incorporated the recommendations of the management.
N.R. Narayan Murthy Committee, and the
4
(20) The Ministry of Corporate Affairs
(MCA) 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. The foundation
has been set up with the mission to:
1. Foster a culture for promoting good
governance, voluntary compliance and
facilitate effective
participation of different stakeholders;
2. Create a framework of best practices,
structure, processes and ethics; and
3. Make significant difference to Indian
corporate sector by raising the standard
of corporate
governance in India towards achieving
stability and growth.
(B) Legal Framework: (21) An effective
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. The Legal framework for
corporate governance consists of the
Company Laws and the SEBI Laws.
Company Laws: The Ministry of Corporate
Affairs (MCA) is the main authority for
regulating and promoting efficient,
transparent and accountable form of
corporate governance in the Indian corporate
sector. The important legislations governed
by MCA 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.
The Companies Act, 1956 is the central
legislation in India that empowers the
Central Government to regulate the
formation, financing, functioning and
winding up of companies. The Companies
Act, 1956 has elaborate provisions relating
to the Governance of Companies, which
deals with management and administration
of companies. It contains special provisions
with respect to the accounts and audit,
directors remuneration, other financial and
non-financial disclosures, corporate
democracy, prevention of mismanagement,
etc. The main two Sections of this Act
related to the corporate governance are
Section 292A and Section 211.
• Section 292A: (22) The concept of
Corporate Governance receives
statutory recognition, with the
insertion of Section 292A in the
Companies Act, 1956 with an
amendment made to it through the
Companies (Amendment) Act 2000.
The New Section 292A made it
obligatory upon a public company
having a paid-up capital of Rs. 5
crores or more to have an audit
committee comprising at least three
directors as members. Two-thirds of
the total number shall be non-
executive directors.
• Section 211: (23) As per this
Section, every Profit and loss
account and Balance sheet of the
company shall comply with the
Accounting Standards, issued by the
Institute of Chartered Accountants of
India as may be prescribed by the
Central Government in consultation
with National Advisory Committee
on Accounting Standards, and the
Statutory auditors of every company
5
 are required to report whether the
Accounting Standards have been
complied with or not. The Securities
Exchange Board of India (SEBI) has
added a new clause in the Listing
Agreement to provide that listed
enterprises shall compulsory comply
with all the Accounting Standards
issued by ICAI from time to time.
(24) The Companies Bill 2004 has been
introduced to provide the comprehensive
review of the company law. It contained
important provisions relating to corporate
governance, like, independence of auditors,
relationship of auditors with the
management of company, independent
directors with a view to improve the
corporate governance practices in the
corporate sector. It is subjected to greater
flexibility and self-regulation by companies,
better financial and non-financial
disclosures, more efficient enforcement of
law, etc. This amendment to the Companies
Act 1956 mainly focused on reforming the
audit process and the board of directors. It
mainly aimed at :- (i) laying down the
process of appointment and qualification of
auditors, (ii) prohibiting non-audit services
by the auditors; (iii) prescribing compulsory
rotation, at least of the Audit Partner; (iv)
requiring certification of annual audited
accounts by both CEO and CFO; etc. For
reforming the boards, the bill included that
remuneration of non-executive directors can
be fixed only by shareholders and must be
disclosed. A limit on the amount which can
be paid would also be laid down. It is also
envisaged that the directors should be
imparted suitable training. However, among
others, an independent director should not
have substantial pecuniary interest in the
company’s shares.
SEBI Laws: (25) Improved corporate
governance is the key objective of the
regulatory framework in the securities
market. Accordingly, Securities and
Exchange Board of India (SEBI) has made
several efforts with a view to evaluate the
adequacy of existing corporate governance
practices in the country and further improve
these practices. It is implementing and
maintaining the standards of corporate
governance through the use of its legal and
regulatory framework, namely, The
Securities Contracts (Regulation) Act, 1956,
Securities and Exchange Board of India Act,
1992 and the Depositories Act, 1996.
REASONS FOR CORPORATE
GOVERNANCE FAILURES
(26) If the Board is in awe of the family
executive, it makes it difficult for the Board
sometimes to ask tough questions or at other
times the right questions at the right time in
order to serve the interests of the
shareholders better. As a result truly
independent directors are rarely found in
Indian companies.
(27) Serving on multiple boards is
problematic because doing so can
overburden directors, thus hampering their
performance, and increase the potential for
directors to experience conflicts of interest
between the various corporations they serve.
(28) It is admitted that contribution of the
independent directors is limited because the
average time spent in Board meetings by
these directors is barely 14 to 16 hours in a
year.
In some cases, it has been found that no
proper training and orientation regarding the
awareness of rights, responsibilities, duties
and liabilities of the directors is provided to
an individual before appointing him/her as a
director in the Board. (29) Also there is
unseen but the active participation of
political class.
(30) The directors on the board are largely
reliant on information from the
management and auditors, with their
capacity to independently verify financial
information being quite limited, while
auditors, as this case suggests, have also
been equally reliant on management
information. The relevant issue here is the
extent and the depth of auditors’ effort in
6
their exercise of due diligence. Excessive
reliance on information from the
management is symptomatic of the
ownership or control of companies in India
by business families, and that poses a
particular challenge for corporate
governance in India.
(31) The greatest drawback of financial
disclosures in India is the absence of
detailed reporting on related party
transactions. In addition, poor quality of
consolidated accounting and segment
reporting leads to misrepresentation of the
true picture of a business group.
(32) Although India's investor-protection
laws are sophisticated, litigants must wait a
long time before receiving a judgment. (33)
Delays in the delivery of verdicts, high
costs of litigation and the lengthy judicial
appointment process in courts make the
legal enforcement mechanism ineffective.
(34) According to the OECD, “the
credibility and utility of a corporate
governance framework rest on its
enforceability.”
(35) In India, the two audit-related issues
which are commonly recognized are that of
auditor independence (which is a problem
worldwide) because of the large if
segmented market in accounting services,
and the perceived powerlessness of auditors
in the face of corporate pressure. In many
cases, they are ill-equipped to handle the
needs of large companies, because in the
face of an audit failure, it is very difficult to
discern whether the auditors were
complacent or they were pressurized by the
concerted efforts of the insiders.
There is no proper system to monitor the
work of audit firms or to review the
accounts prepared by the company’s
statutory auditors. However, (36) in the
aftermath of the Satyam case, the SEBI has
decided to introduce a peer review
mechanism to review the accounts prepared
by a company’s statutory auditor. In
addition, the SEBI has also decided to
constitute a panel of auditors to review the
financial statement of all BSE Sensex and
NSE Nifty companies. Also there is no
statutory compliance for the companies to
obtain a report on Corporate Governance
Rating by the Credit Rating Agencies in
India.
REQUIREMENTS TO STRENGTHEN
CORPORATE GOVERNANCE
ƒ To promote or to increase awareness
among entrepreneurs adoption of
good corporate governance practices,
which are the integral element for
doing and managing business.
ƒ To ensure the quality of audit that is
at the root of effective corporate
governance by making the Auditor
accountable for the disclosure of
financial information.
ƒ To make the Board of Directors as
well as the CEOs and CFOs
accountable for the discharge of their
duties with the proper use of their
rights within the powers.
ƒ To form an appropriate system in
order to check the Directors
independence in the board and to
monitor the work of Audit firms.
ƒ To pay special attention in the
quality and effectiveness of the legal,
administrative and regulatory
framework.
ƒ To increase the shareholder activism
i.e. the exercise and enforcement of
rights by minority shareholders with
the objective of enhancing
shareholder value over the long term
(37).
ƒ To infuse India’s Business Culture
with a “Spirit of Corporate
Governance” in order to maintain
sustainable and effective corporate
governance (38).
ƒ To implement more robust
Bankruptcy Laws which are a key
component of any corporate
governance system (39).
ƒ To eliminate “Regulatory Arbitrage”
i.e. to establish a clear mandate for
7
 each regulatory Authority for the
enforcement of Clause 49 of the
Listing Agreement, thereby
improving India’s corporate
governance enforcement mechanism
(40).
ƒ To resolve the conflict between the
dominant shareholders and the
minority shareholders by improving
the rights of minority shareholders.
ƒ To make a statutory compliance for
the listed companies to compulsorily
obtain a report on Corporate
Governance Rating (CGR) from a
Credit Rating Agency in India.
FUTURE PROSPECTS FOR
CORPORATE GOVERNANCE
To highlight the frauds and irregularities in
the corporate sector (41) 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 as prominent as it is today. With the
integration of Indian economy with global
markets, industrialists and corporations 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.
(42) 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. but we
cannot eliminate the possibility of frauds
and scams as seen in the recent Satyam case.
(43) Scams are an integral part of corporate
history. They come to light only when the
going gets rough. Only when the tide goes
out we see all those swimming naked. Such
scams are an opportunity for self-renewal;
neither self-denial nor blame game. The
frequency and scale of such scams has been
far more in the West than in India. We need
to take such types of scams as an
opportunity in future for overhauling the
system of corporate governance in India.
CONCLUSION
(44) Good corporate governance may not
be the engine of economic growth, but it is
essential for the proper functioning of the
engine. (45) The investors both National
and International would be loyal to invest
in the Indian companies if they follow all
the standards of corporate governance
practices. (46) Further, to nurture and
strengthen this loyalty, our companies need
to give clear-cut signal that the words “your
company” have real meaning. That requires
well functioning Board, greater disclosure,
better management practices, and a more
open, interactive and dynamic corporate
governance environment. Quite simply,
share holders’ and creditors’ support are
vital for the survival, growth and
competitiveness of India’s companies.
(47) 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
companies 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.
Thus, the essence of corporate governance
8
 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. In order to make
an honest and objective assessment on
corporate governance practices we do need
more laws but better enforcement because
Annexure
FRAMEWORK OF CORPORATE GOVERNANCE
Corporate Governance Framework
the effectiveness and the utility of good
corporate governance practices rest on its
enforceability. Ultimately, good corporate
governance practices in India will be
shaped by our administrative and regulatory
authorities like SEBI, MCA, etc. by
implementing transparent and effective
corporate governance laws.

Organizational Framework Legal Framework

Ministry of Corporate SEBI* Confederation Company Laws SEBI Laws

affairs (MCA) of Indian Industry (CII)
Recommendations
(1997-98)

Companies Act, 1956 Companies Bill, 2004

Section 292A Section 211

(Setting up an (Statutory Compliance of
Audit Committee) Accounting Standards)

Kumar Manglam N R Narayan

Birla Committee Murthy Committee
Report (2000-01) Report (2003)
(Listing Agreement) (Amended Clause 49)
Clause 49

Securities SEBI Depositories

Naresh Chandra National Foundation Contracts ACT,
for Corporate Act, 1996
Committee Report on (Regulation) 1992
Corporate Audit and Governance (NFCG) Act, 1956
Governance 2002 (association with CII,
ICAI, ICSI)
* Securities Exchange Board of India.
9
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10
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