CORPORATE GOVERNANCE

Corporate Governance may be defined “as a set of systems, processes and principles which ensure that a company is governed in the best interest of all stakeholders”. It is the system by which companies   are directed and controlled. It is about promoting corporate fairness, transparency and accountability. The system of rules, practices and processes by which a company is directed and controlled. Corporate governance essentially involves balancing the interests of the many stakeholders in a company                 –   these include its shareholders, management, customers, suppliers, financiers, government and the community.

Corporate governance is the system by which organizations are governed and controlled. It is concerned with the ways in which corporations are governed generally and in particular with the relationship between the management of an organization and its share holders. In this respect, several control mechanisms, often in the form  of committees, are implemented within in order to monitor its management activities and functioning. As a part of critical          corporate governance        mechanisms, the audit committee has an oversight function dealing with  different managerial activities, corporate reporting, and auditing. This oversight includes ensuring the quality of accounting policies, internal controls, and independent auditors to enhance control mechanisms, anticipate financial risks, and promote accurate, transparent, and timely disclosure of corporate information to various users of the organization’s financial information.

Concept

• It involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders.
• It deals with prevention or mitigation of the conflict of interests of stakeholders.  Ways  of  mitigating  or  preventing  these  conflicts of interests include the processes, customs, policies, laws,  and  institutions          which  have  an    impact on the way a company is controlled.
• An important theme of corporate governance is the nature and extent of accountability of people in the business, and mechanisms that try to decrease the principal–agent problem.

Objective

• A properly structured board capable of taking independent and objective decisions is in place at the helm of affairs.
• The board is balance as regards the representation of an adequate number of non-executive and independent directors who will take care of their interests and well-being of all the stakeholders.
• The board adopts transparent procedures and practices and arrives at decisions on the strength of adequate information.
• The board has an effective machinery to subserve the concerns of stakeholders.
• The board keeps the shareholders informed of relevant developments impacting the company.
• The board effectively and regularly monitors the functioning of the management team.
• The board remains in effective control of the affairs of the company at all times.

Advantage of corporate governance

• Enhanced Performance- helps a company improve overall performance.
• Without corporate governance, a company tends to be weak and sluggish.
• Access to Capital- The better corporate governance a company has, the more easily it can access outside capital that the business can use to fund its projects.
• Since corporate governance includes major shareholders, it connects investors with the business itself, and these investors use their resources and contacts to support the company monetarily.
• Better   Standards-  Corporate    governance  makes many decisions about business operations, but one of the most important decisions involves corporate standards.
• Standards affect the quality of products and the goals that the business has in technology, customer service, and marketing.
• Better Talent Utilization- With a strong corporate governance structure, people can find positions that utilise their talents more effectively, and the board of directors and top leaders of the business are always looking to add more talented people to their numbers.

Disadvantage of corporate governance

• Easily Corruptible-Corporate governance needs a certain level of government oversight to avoid increasing levels of corruption. The lack of governmental oversight in corporate governance leads to a misallocation of credit that actually worked against competition.
• Family- Owned Companies - Corporate governance works at its best when shareholders and board members are able to make objective decisions that are in the best interest of the company. According to Ibis Associates, a business planning firm, family-run corporations (founding family members        own controlling share of the company), such as Ford and Walmart, lose objectivity in business making decisions due to the family’s financial  investment  in  the  business’  performance and the emotional ties associated with building a worldwide corporation from the ground up.
• Costs of Monitoring- To effectively govern a publicly traded corporation, shareholders must speak with one voice and have enough votes to allow that voice to have any real weight. This requires individuals that have a collective vision for the company to pour more money into that company to gain a controlling share.

FACTORS AFFECTING CORPORATE GOVERNANCE

Regulation & TheirEnforcement

• Since corporate governance failures have proved to be harmful not just for the organizations but also for the economy and the general public at large as well, there have been public pressures on the government and regulatory authorities to reform business practices and increase transparency.
• Consequently, it has become a part of the government’s duty to ensure accountability and responsibility in corporate behavior.
• Effective disposal of this responsibility basically revolves around two things:
• First, the designing of regulatory commands i.e. the regulations and laws to ensure good corporate governance; and
• Second is the enforcement of regulations.

RISK MANAGEMENT & EFFECTIVE GOVERNANCE

• In today’s world, frauds are an undeniable fact of business life.
• Affecting all types of businesses. New technologies such as the Internet, and the development of fully automated accounting systems, have increased the opportunities for fraud to be committed.
• Once suspected or discovered, investigating fraud is a specialist task
• Requiring experience and technical skill and can be very costly. Thus, there is no doubt.
• That fraud is best prevented, rather than dealt with after the fact. The most effective and appropriate response to the problem of fraud involves a combination of risk management techniques.

These techniques include:

• Setting up inherent control based upon soft controls that occur continuously and consistently throughout the organization. Such controls should be embedded in normal business practice and be designed in such a way that they are to a large extent self sustaining; and
• Setting up formal control processes of monitoring, reviewing and reporting

Factors affecting for investors and companies-

For example, a significant issue many corporate executives face every year is their annual meeting planning as well as understanding current shareholder sentiment. Through our annual meeting planning sessions, we are able to analyze your constituent bases to ensure even the vocal minority concerns are being addressed and heard.

Based             on their shareholder makeup, each company could have different concerns on both sides of the table.  One of the first steps   to obtaining shareholder identification is to conduct a detailed shareholder analysis. We will identify the constituents; work with your team to build a plan, and create an outreach program that is in  step with your annual meeting and board reelection efforts.

Principles of corporate governance

• Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by openly and effectively communicating information and by encouraging shareholders to participate in general meetings.
• Interests of other stakeholders: Organizations should recognize that they have legal,  contractual,  social, and  market driven obligations to non-shareholder stakeholders, including employees, investors, creditors, suppliers, local communities, customers, and policy makers.
• Role and responsibilities of the board: The board needs sufficient relevant skills and understanding to review and challenge management performance. It also needs adequate size and appropriate levels of independence and commitment.
• Integrity and ethical behavior: Integrity should be a fundamental requirement in choosing corporate officers and board members. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making.
• Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide stakeholders         with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company’s financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information.

Models:

Different models of corporate governance differ according to the variety of capitalism   in which             they are            embedded. The   Anglo- American “model” tends to emphasize the interests of shareholders. The coordinated or Multi stakeholder Model associated with Continental Europe and Japan also recognizes the interests of workers, managers, suppliers, customers, and the community. A related distinction is between market- orientated and network- orientated models of corporate governance.

Indian model

The Securities and Exchange Board of          India Committee on Corporate Governance defines corporate governance as    the “acceptance by management of       the inalienable          rights of shareholders as the true owners of the corporation and of their own role        as          trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company.”

Why corporate governance?

AT NATIONAL LEVEL:-

• As barriers to the free flow of capital fall, it becomes imperative to recognize that the quality of corporate governance is relevant to capital formation and that sound corporate governance principles is the foundation upon which the trust of investors is built.
• Corporate governance represents the ethical the moral framework under which business decisions is taken. Thus, any investor, when making investments across the borders or even otherwise, wants to be sure that not only are the capital markets or enterprises with which they are investing are being run competently but they also have good corporate governance.
• Consequently, lack of sound corporate governance practices in any country can badly affect the confidence of foreign investors, in turn causing damage to the amount of foreign investments flowing in.

At the company and individual level:-

• It is self evident that sound corporate governance is essential to the well being of an individual company and its stakeholders, particularly its shareholders and creditors.
• We need only remind ourselves of the many companies, across the world, whose financial difficulties and,
• Ultimate demise has been substantially attributable to weak corporate governance.
• On the other hand, there are several areas of self-interest that should drive companies to embrace more effective governance.

These areas are:

• Effective governance helps to minimize reputational risks and thus, protecting the brand;
• It helps to instill trust in customers and vendors;
• It also helps to assure effectiveness and integrity of a company’s business processes.
• Further, in many cases, the punishment, in terms of penalties or imprisonment, for White-collar crimes is now in excess for such criminal acts such as armed robbery, assault, and negligent murder. Even to escape such punishments, ensuring corporate governance compliance is a must.

CORPORATE GOVERNANCE IN DIFFERENT TYPE OF COMPANIES

Corporate governance in private companies-

Most of the regulations made, such as SOX in US and Clause 49 of Listing Agreement in India, are applicable only to publicly-registered or listed companies and private companies are out of the ambit of these regulations.

However, today we see that private companies are also becoming big in size and impact.

Very near examples would include joint ventures being organized as private companies within the insurance industry in India.

Thus, failure of corporate governance within these private companies as well can very badly harm the general public at large. And also since new standards of corporate governance, while only required by law at public companies, are for forming “best practices” in many will governed private companies, we strongly feel that the applicability of such regulations, after suitable modifications, be extended to private companies as well.

Apart from the necessity as above, it is also in the self-interest of private companies to ensure good corporate governance. This is primarily because:-

• Usually, in most private companies, controls are informal or even if there are formal controls, they tend to be detective rather than preventive. This makes private companies unprotected against risks, which needs to be mitigated.
• Good corporate governance increases creditworthiness of the company and thus, enables it to raise funds at cheaper cost. Good corporate governance is also a must for companies that are planning to seek stock exchange listing and raise money from markets by converting them into public company.
• Finally, if the owners of a private company are considering the sale of all or part of the entity, or are seeking private equity financing, effective controls can increase prospective buyers’ willingness to pay a premium for the acquisition. Controls enhancements can also help attract new business partners.

Public sector corporate governance-

• Although the private sector model view shareholders as main stakeholders.
• In public sector specific users group those directly responsible for funding and the community at large assumes great importance as stakeholders.
• Stewardship and accountability of use of funds and assets is particularly important in public sector.
• It is becoming more important to focus on corporate governance in public sector to maintain faith in system and promote better service to the public sector to maintain faith in the system and promote better service to the public.

Regulatory framework on corporate governance

The Indian statutory framework has, by and large, been in consonance with the international best practices of corporate governance. Broadly speaking, the corporate governance mechanism for companies in India is enumerated in the following enactments/ regulations/ guidelines/ listing agreement:

• The Companies Act, 2013 inter alia contains provisions relating to board constitution, board meetings, board processes, independent directors, general meetings, audit committees, related party transactions, disclosure requirements in financial statements, etc.
• Securities  and  Exchange  Board  of  India  (SEBI) Guidelines: SEBI is a regulatory authority having jurisdiction over listed companies and which issues regulations, rules and guidelines to companies to ensure protection of investors.
• Standard Listing Agreement of Stock Exchanges: For companies whose shares are listed on the stock exchanges.
• Accounting Standards issued by the Institute of Chartered Accountants of India (ICAI): ICAI is an autonomous body, which issues accounting standards providing guidelines for disclosures of financial information. Section 129 of the New Companies Act inter alia provides that the financial statements shall give a true and fair view of the state of affairs of the company or companies, comply with the accounting standards notified under s 133 of the New Companies Act. It is further provided that items contained in such financial statements shall be in accordance with the accounting standards.
• Secretarial Standards issued by the Institute of Company Secretaries of India (ICSI): ICSI is an autonomous body, which issues secretarial standards in terms of the provisions of the New Companies Act. So far, the ICSI has issued Secretarial Standard on “Meetings of the Board of Directors” (SS-1) and Secretarial Standards on “General Meetings” (SS-2). These Secretarial Standards have come into force w.e.f. July 1, 2015. Section 118(10) of the New Companies Act provide that every company (other than one person company) shall observe Secretarial Standards specified as such by the ICSI with respect to general and board meetings.

Key legal framework for corporate governance in India The Companies Act, 2013

The Government of India has recently notified Companies Act, 2013 (“New Companies Act”), which replaces the erstwhile Companies Act, 1956. The New Act has greater emphasis on corporate governance through the board and board processes. The New Act covers corporate governance through its following provisions:

•   New Companies Act introduces significant changes to the composition of the boards of directors.
•   Every company is required to appoint 1 (one) resident director on its board.
•   Nominee directors shall no longer be treated as independent directors.
•   Listed companies and specified classes of public companies are required to appoint independent directors and women directors on their boards.
•   New Companies Act for the first time codifies the duties of directors.
•   Listed companies and certain other public companies shall be required to appoint at least 1 (one) woman director on its board.
•   New Companies Act mandates following committees to be constituted by the board for prescribed class of companies:
• Audit committee
• Nomination and remuneration committee
• Stakeholders relationship committee
• Corporate social responsibility committee

Listing agreement – Applicable to the listed companies

SEBI has amended the Listing Agreement with effect from October 1, 2014 to align it with New Companies Act.

Clause 49 of the Listing Agreement can be said to be a bold initiative towards strengthening corporate governance amongst the listed companies. This Clause intends to put a check over the activities of companies in order to save the interest of the shareholders. Broadly, cl 49 provides for the following:

• Board of Directors

The Board of Directors shall comprise of such number of minimum independent directors, as prescribed. In case where the Chairman of the Board is a non-executive director, at least one-third of the Board shall comprise of independent directors and where the Chairman of the Board is an executive director, at least half of the Board shall comprise of independent directors. A relative of a promoter or an executive director shall not be regarded as an independent director.

• Audit Committee

The Audit Committee to be set up shall comprise of minimum three directors as members, two-thirds of which shall be independent.

• Disclosure Requirements

Periodical disclosures relating to the financial and commercial transactions, remuneration of directors, etc, to ensure transparency.

• CEO/ CFO Certification

To certify to the Board that they have reviewed the financial statements and the same are fair and in compliance with the laws/ regulations and accept responsibility for internal control systems.

• Report and Compliance

A separate section in the annual report on compliance with Corporate Governance, quarterly compliance report to stock exchange signed by the compliance officer or CEO, company to disclose compliance with non-mandatory requirements in annual reports.

MECHANISMS OF CORPORATE GOVERNANCE

A certain set of authorities and responsibilities which have an influential power on management decisions and eliminates the managers’ discretionary space is termed as corporate governance mechanisms. These mechanisms act as a controlling tool for creating a balance between principals and agents cost and further ensures in safeguarding the interests of stakeholders.

According to Hill & Jones, 2004, corporate governance mechanisms are the systems that make a better coordination between the agent and principal relationship. Basically, two types of mechanisms revolve around the corporation environment depending upon the influence and relative importance of these tools. The two mechanisms are constituted by internal and external mechanisms within and outside the firm. The association of internal mechanism includes board of directors, stakeholders, employee’s compensation schemes and other internal processes and systems.

The need for internal control or mechanism arises when the business goes off track and requires proper monitoring in internal proceedings and further corrective measures are required to be taken. As part of monitoring internal governance, reporting lines are properly defined, operations of business work smoothly which further assist in creating a right path for the organisation by segregating the roles of responsibility, authority, and control in policy development. External governance mechanisms are the tools including auditors, market accessories like market competition, product branding and selling policies, regulatory environment affecting the product, governance code of conduct to be adopted, fluctuations of stock exchanges, creditors and debtors and so on.

Generally, external governance mechanism is created by stakeholders of a firm in order to make company operations in accordance with the parties associated with the firm either independent or independent way. External parties at the time of annual general meeting provide suggestions and guidelines to the firm for their best business operations but it is in the hands of organisation whether to follow or ignore them.

Internal Corporate Governance Mechanisms

Internal mechanisms are the ways and methods used by the firms which help the management in enhancing the value of shareholders. The constituents of internal mechanisms include ownership structure, the board of directors, audit committees, compensation board and so on.

• The Board of Directors: Board of the Directors is the main peoples of the firm and for the few companies they are the backbones of the business. They have more authorities and responsibilities of the business firm and they keep track on monitoring and controlling all activities of the management in order to maintain the business performance on the track as well as safeguard the interest of stakeholders. Moreover, board of directors is accountable legally for the decisions they make on behalf of their firm and also they are more authorised to hire a new member or employee for the firm. At the time of auditing, they are highly accountable for the financial information provided to them concerning with the firm. There are three types of directors: internal, external and independent directors. Internal directors work within the organisation, external director’s work from outside business, they work for several companies on board, independent directors maintain their reputation objectively and present their own way of decisions.
• Board Committees: Board committees are the additional part of the board of directors. They are involved in those activities which are assigned by the board of members to them. According to the nature of business, board committees are regulated by the laws and regulations issued by the company. It totally depends on the country’s laws and regulations whether the creation of these types of committees should be mandatory for the firm or not.
• Financial Statements and Auditors: Financial statements are the information which contains the company data and transactions. Every company needs to present their financial reports on the quarterly and annual basis and get them checked with the auditors. The real picture presented by the auditors reveals the true financial picture of the firm which further becomes the information for the parties involved with the firm either directly or indirectly. On the basis of these financial statements, stakeholders create their statements of action towards the firm. In case they found the reports in positive track, they make up their mind to invest in those firms, on the other side if the stakeholders find the report in the negative side, it will further hamper their trust level in favour of the firms.
• Ownership Structure: This is another means of controlling the management part of the company. This way a business can maintain its best monitoring and controlling system for the better performance of all the functioning of the business firm.
• Stock-Based Compensation: To eradicate the principle and agent costs issue, the best solution is to provide shareholders interest on time and proper compensation to the employees. Stock- based compensation helps the shareholders in motivating the internal managers for achieving the long terms objectives of the company.

External Corporate Governance Mechanisms

Sometimes internal mechanism lacks in itself while performing the best for the company. This time external factors play a vital role in controlling the corporate governance mechanism of the business

firm. The constituents of external governance mechanism include market factors, intermediaries, goods and services prevailing in the market, managers of labour market etc.

• The Financial Market: Stock market plays a significant role in firm’s ups and downs. There is a direct relation between the market value of the firm and the efficiency of the managers. In case if the shareholders start selling the shares of the company due to somehow reason and if the process is going on in large number further then naturally the market value of the firm starts declining. This way the company who is losing its market value may become the target of acquisition with the help of other big company. Due to the threat of acquisition, the management of the firm can adopt the negative actions like adopting agency costs policy or any other strategy in order to safeguard their business.
• The Market of Goods and Services: Competition is another factor which leads the business firm. If the society does not like the products and services offered by a business firm then it becomes natural that their business starts declining and further it may lead to a reduction in the profits ratio of the business firm. Thus company needs to adopt timely researchers and survey in order to tap the resources in accordance with the market requirements.
• The Labour Market for Managers: In controlling process, human capital is the concept which can be sometimes controlled and sometimes not. If the managers are highly conservative and strict to their employees than the labour market can go in against with the business and may harm the resources of the firm in order to fulfill their demands. This process needs a proper selection of competent manager (who controls the lower class employees) should be done in order to create a proper balance of coordination between the managers and the employees.

Issues/Mechanisms

The prevailing issue behind poor corporate governance mechanism found in Indian corporate sector is that most of the firms are family structure. Most of the so-called shareholders are related entities who does not need to enquire about the better governance of the firm. Therefore these types of firms need proper monitoring and controlling mechanism in order create proper governance. Further, the problem exaggerates that as the company has higher number of relatives in terms of stakeholders and  owners, it is certain that the most of the business transactions can be related to known parties. After research, it is found out that a big number of Indian listed companies are affiliates or divisions of MNC’s (Multinational companies). As per the FEMA Act and their regulations, the company must follow all statutory requirement while making transfers from Parent Company to Division Company. Here companies try to avoid following that statutory requirement due to having stuck in long procedures and formalities. All such activities are due to having business transactions with familiar parties and in order to get potential gains by doing fair dealings with mostly familiar parties or with businesses of related family members. Such issues undermine the financial market confidence and moreover, it may harm the process of investment mobility in between countries. In order to eliminate such malpractices government of India has set the certain statutory framework which enables in creating a better corporate governance mechanism in the corporate world.

Statutory framework of corporate governance

In general corporate governance is that mechanism with the help of which the management of the organisation can be properly managed, controlled and governed in a specific way. The main objective of governance mechanism is to make ensure that the rights of stakeholders could not be curbed by the internal management of the company and moreover company management should be held accountable towards their stakeholder in order to keep trust and safeguard their interest. In order to confirm a proper corporate governance mechanism, the government of India has built

a certain set of standards or in other words a statutory framework for the corporate world.

By taking into consideration of international best mechanisms, the Indian government has set these statutory framework concerning with corporate governance. Following list ensures the major agreements come under that statutory framework:

• Stock exchanges carrying standard listing agreement: these agreement are to be signed by the companies who have their stocks listed on stock exchanges.
• The Companies Act, 2013: this act ensures proper accountability and transparency of the firm as all companies must ensure that they follow all the statutory provisions related to board meetings and conferences, audit committees, business transactions related to other parties, disclosures of all financial statements and so on.
• Accounting norms and standards: Accounting norms and standards are the provisions set by Institute of Chartered Accountants of India (ICAI). According to New Companies Act, Section 129, there must be transparency in all companies’ accounts and policies. Moreover, ICAI ensures that the items involved in financial statements of the company must be as per the accounting norms and standards.
• SEBI (Securities and Exchange Board of India) guidelines: SEBI is the authority of regulation who controls the listed firms and issues various guidelines, rules and regulations in terms of keeping investors interest safe.
• Secretarial Standards issued by the Institute of Company Secretaries of India (ICSI): This regulatory body is an autonomous body which issues a certain set of standards and provisions come under New Companies Act. There are two standards issued by Institute of Company Secretaries of India i.e. SS-1, Meetings of the Board of Directors and another is SS-2, Secretarial Standards on General Meetings. These types of provisions came into force on July 1, 2015.

Further, the companies Act 2013, has increased the levels of discussion topics in the Board Meeting of India. New topics may include gender diversity not to be involved, the disclosure of norms and standards, women directors’ enhancement in management, delegating corporate social responsibility, increasing the role of Independent Directors, keeping safeguard for the interest of minority shareholders, and creating certain benchmarks for better corporate governance. In a global perspective, a good corporate governance mechanism must be created in order to improve the environment of the business in terms of faith, clarity, and answerability. Good mechanism helps in supporting sustainable growth and financial stability for the organization.