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Need for Corporate Governance

Importance and need of corporate governance were felt after the Scams such as Satyam and Sahara. It was recognized that good corporate governance not only improves transparency and efficiency in a company but also increases the investor trust in the company. Corporate governance focuses not only on shareholders but on all the stakeholders of the company.
Written by:
Mehak Sharma
Published on
10-Oct-18

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Shareholder value get lost when things are done illegally, when principles of corporate governance are not adhered to, when cohesive action is not taken Cyrus Pallonji Mistry

Corporate governance in India is a system of rules, practices, and processes to control a company. The scope of corporate governance and objective of corporate governance in India has been for the first time inoculated in the theory under the clause 49 of the Listing Agreement of SEBI but it was later included as the concept of the corporate governance provided under the Companies Act, 2013. The scope of corporate governance can be stipulated under various chapters of the Companies Act, 2013 with accounting standards under Section 129 and Section 133 of the Act. The objective of corporate governance can be said to be a test which a company has to pass to make sure that company is working efficiently and effectively. The scope of Corporate governance essentially involves balancing the interests of a company's many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community. 

The one thing that the objective of corporate governance in India focuses on is the stakeholders and not the shareholders. So, to understand the scope of corporate governance distinction between the shareholders and stakeholders have to be understood. Shareholders include only the persons who have invested in the company by way of purchasing its shares whereas stakeholders are the people who have an interest in the company such as employees, customers, government, shareholders etc. 

Corporate governance in India also provides for the framework for attaining of the company objectives so it includes every aspect of the company from internal controls to corporate disclosure. Corporate governance governs the corporate behavior of a company and is a key component of communicating company’s behavior to the investors and community at large. 

One of the important objectives of corporate governance in India is that in a company there has to be a separation of power between the management and board of directors. Thus, it provides that the head of management should be separated from the head of the board, therefore, Chairman and Chief Executive Officer should be two different persons. 

 

Need for Corporate Governance

The need for corporate governance was felt because of the increasing non-compliance of the standards related to the financial reporting and accountability by the board of directors and management which in turn was the reason of the huge losses to the investors of the company.

Not only in India, but companies around the world were not complying with the standards of the financial reporting and the fallout of companies like Enron in US and Satyam in India lead to the emergence and need of corporate governance in India for an enterprise.  As it was said that these companies fall out because of having bad corporate governance policies or framework and because of the corrupt practices followed by the board of directors and the management of the said companies and their financial consulting firms.

The fall out of big companies like them was enough to bring about the importance and need of the corporate governance which is supposed to draw a distinction between the powers of the management and the board of directors which will set a direction for company to work in a good governance structure which is the main objective of corporate governance. The need for corporate governance was also felt to have appropriate and adequate governance processes and procedures. These processes and procedures of the good governance structure lay down that management should be free to manage the affairs of the company and board of directors should be free to monitor and give directions. 

The need of corporate governance is also felt as it provides for the better financial strength of a company by maintaining a competitive environment which further provides for the financial growth of a company and increased improvement in the accountability system which results in risk mitigation substantially. Corporate governance policy laid great emphasis on the transparency and disclosure in the company and provide that if there is transparency in an organization and if an adequate framework of corporate governance is adopted by the company then it will minimize the risk of the happening of scams which have been witnessed by the corporates in the past.

Corporate governance provides for preparing a code of conduct for an organization which will help the company in showcasing the commitment of the company to work ethically on the ethical stance and to maintains a good image in market both domestic and global market.

For having good corporate governance in India the Companies Act, 2013 has mandated the companies to form the following committees to look after the working and managing the affairs of company -

  • Audit Committee,

  • Nomination and Remuneration Committee,

  • Stakeholder Relationship Committee, and

  • Corporate Social Responsibility Committee.

In India, the need for corporate governance was felt by Securities and Exchange Board of India (SEBI) as there are various benefits of corporate governance and for this purpose appointed several committees such as Kumar Mangalam Birla Committee, Naresh Chandra Committee, and Narayana Murthy Committee.

Benefits of Corporate Governance

The following can be said to be the accounts on which the benefits of corporate governance in India can be asserted:

  • Investor-Shareholder Relation: One of the benefits of corporate governance is Investor-shareholder relation. Principles of corporate governance and practices of corporate governance are important for a company who needs an investment from an investor. It has been witnessed that in India companies raise investment at a high value of their shares by presenting a wrong picture to the investors about the company’s profitability and its performance.  Due to this bad governance of the companies investors had suffered a lot as the companies used to perform at a very low speed after raising the capital. Now the investors are also aware and invest in the companies who have and follow the good corporate governance policies and have a proper framework of corporate governance. Therefore to attract investor and to maintain good investor relation corporate governance is very important.

  • Investor Grievances: One of the benefits of corporate governance is investor satisfaction. Practices of corporate governance in India is important to provide a redressal to the grievances of the investors. It was found by the Kumar Mangalam committee on the corporate governance that the Indian companies were not paying adequate attention to the timely dissemination of required information to investors in by India.  Though Reserve Bank of India (RBI) and SEBI has provided certain measures to deal with it but the companies have to redress the grievances of investors themselves and protect their investment by adopting the good practices of corporate governance policy, structure or framework.

  • The efficiency of Performance: Practices of corporate governance is necessary for the efficiency of performance. The importance of corporate governance and the need for corporate governance can essentially be seen from the fact that it enables the company in getting capital for themselves and to perform efficiently. If the company will perform efficiently it will boost the confidence of the investors to invest in the company. Companies with a record of good principles of corporate governance will attract more investors than the companies with the bad corporate governance. Corporate governance also ensures transparency in an organization which improves the efficiency of performance of the company.

  • Global Perspective: The extent to which corporate enterprises observe the basic principles of corporate governance has now become an important factor for attracting foreign investment. In this age of globalization when quantitative restrictions have been removed and trade barriers dis­mantled, the relationship between corporate governance and flows of foreign investment has become increasingly important.

  • Healthy Stock Market: Practices of Corporate governance in India is important for a healthy stock market for a company. To protect investor having a healthy and vibrant stock market is necessary. Thus it is important that company has a good corporate governance framework which restricts the employees from engaging in Insider trading which is a bane on the stock market of any company. 

Issues in Corporate Governance in India

Just like every coin has two sides so does the so does the scope of corporate governance has some issues. There are top 10 issues in corporate governance in India that have been encountered till date which are-

  • Getting the board right

  • Performance evaluation of directors

  • True Independence of Directors 

  • Removal of Independent Directors 

  • Accountability to Stakeholders 

  • Executive Compensation 

  • Founders' Control and Succession Planning 

  • Risk Management 

  • Privacy and Data Protection

  • Board's Approach to Corporate Social Responsibility

Though these are the top 10 issues in corporate governance in India which have been recognized but out of these 10 issues in corporate governance in India there are 5 common issues in corporate governance in India which are as follows :

  • Conflicts of interest

  • Oversight issues

  • Accountability issues

  • Transparency

  • Ethics violations

Corporate Governance and Board of Directors

Board of directors are the direct stakeholders and shareholders of a company who can also influence good corporate governance in an organization. Board of Directors consists of executive directors (insider member), non-executive directors (can be insider or independent) and independent directors. Corporate governance provides that there should be an adequate mix of all kinds of the directors on the board. The directors are appointed by the shareholders and represent the company publically. The Board’s responsibility is to make major important decisions of the company such as the appointment of the corporate officer, executive compensation, and dividend policy. Board’s responsibility, however, does not a constraint to the financial optimization but also goes beyond it such as sometimes when shareholder resolutions call for certain social or environmental concerns to be prioritized.

As already mentioned in the preceding paragraph the board consists of directors both who are insiders as well as who are independent. Insider directors are the ones who are either major shareholder, founder or the executive of the company whereas Independent directors are the ones that do not have relation with the insiders of the company. The appointment of independent directors is based on their experience in managing the other large organizations in the industry. For a good corporate governance, the independent directors are considered necessarily important as they dilute the concentration of power in the board and helps in aligning the interest of the stakeholders with the interest of the insiders of a company.

Further, for having good corporate governance the responsibility of the Board of directors got increased and subsequently, the accountability of board of directors also got increased. Corporate governance added manifolds in the responsibility and accountability of board of directors. The Companies Act, 2013 made it mandatory that one-third of the board must consist of independent directors and to have gender diversity in board the act mandated that the board must contain at least one women director. The women director can be either independent director or the insider director whether executive or not.

Good Corporate Governance and Bad Corporate Governance

Governance is inadvertently a part of an organizational structure. The company can have either a bad corporate governance or a good corporate governance but there is going to be a governance in a company and no one deny or defy that. 

Bad corporate governance creates a doubt on the company’s reliability and integrity which can affect the financial health of an organization. Scandals or Scams whether 2G Scam, Satyam Scam or Sahara Scam etc all are the result of bad corporate governance and we all know what has happened to Raju brothers and their company after the scam. In Satyam Scam, Raju brothers proposed merging with a company called “MAYTAS’ which is nothing but Satyam spelled backward while the minutes of the meeting showed that directors resented to this merger but eventually gave their nod for the merger and a lot of cash inflow was shown in the balance sheet. Thereafter, Raju brother declared themselves as bankrupt and insolvent. Later, Raju brothers got jailed and Satyam was purchased by Mahindra as it was found that the cash inflow was a hoax and PwC also got interrogated for the same.

This scam made the need of corporate governance felt very badly and the importance of good corporate governance was also felt and this is the reason that corporate governance became an integral part of the Companies Act, 2013.

Good corporate governance, on the other hand, provides for rules which are transparent and controls the balance of power between the Board of directors and management. Companies generally strive to achieve a high level of the corporate governance. For many shareholders, it is not enough for a company to merely be profitable; it also needs to demonstrate good corporate governance through environmental awareness, ethical behavior, and sound corporate governance practices.

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