Context:

The exit of Vishal Sikka as the chief of multinational IT giant Infosys brings forth the issue of corporate governance once again

Introduction:

  • Recently, SEBI has constituted a committee on corporate governance under the chairmanship of Uday Kotak last month
  • The committee is expected to submit its report within four months.
  • The SEBI’s norms pare aligned with the new Companies Act and its objective is to encourage companies to “adopt best practices on corporate governance”.
  • The report highlighted the detailed corporate governance norms for listed companies providing for stricter disclosure and protection of investor rights, including equitable treatment for minority and foreign shareholders.
  • The new rules will came into effect from October 1.
  • The new rules would require companies to get shareholders’ approval for related party transactions, established whistle blower mechanism, elaborate disclosures on pay packages and have at least one women director on their boards.

What is Corporate Governance?

  • Corporate governance is the system of rules, practices and processes by which a company is directed and controlled.
  • Corporate governance involves balancing the interest of a company’s various stakeholders such as shareholders, management, customers, suppliers, financiers, government and the community.
  • Corporate governance provides the framework for attaining a company’s objectives.
  • It encompasses very sphere of management, from action plans and internal controls to performance measurement and corporate disclosure.
  • Corporate governance helps in balancing individual and societal goals, as well as economic and social goals.

The corporate governance framework consists of:

  • Explicit and implicit contracts between the company and the stakeholders for distribution of responsibilities, rights and rewards.
  • Procedure for reconciling the sometimes conflicting interest of stakeholders in accordance with their duties, privileges and roles.
  • Procedures for proper supervision, control and information flow to serve as a system of checks and balances.

Benefits of Corporate Governance

  • Good corporate governance ensures corporate success and economic growth.
  • Strong corporate governance maintains investors’ confidence, which raises company’s capital efficiently and effectively.
  • It lowers the capital cost.
  • There is a positive impact on the share price.
  • It provides proper inducement to the owners as well as managers to achieve objectives that are in interests of the shareholders and the organization.
  • Good corporate governance also minimizes wastages, corruption, risks and mismanagement.
  • It helps in brand formation and development.
  • It improves strategic thinking at the top by inducting independent directors who bring a wealth of experience, and a host of new ideas
  • It rationalizes the management and monitoring of risk that a firm faces globally.
  • It limits the liability of top management and directors, by carefully articulating the decision making process
  • The key aspects of good corporate governance include transparency of corporate structures and operations, the accountability of managers and the boards to shareholders; and corporate responsibility towards stakeholders.
  • Corporate Governance deals with determining ways to take effective strategic decisions.
  • The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of the company.

Weakness of corporate governance:

  1. No proper structure: Lack of awareness about its various issues such as quality and frequency of financial and managerial disclosure, compliance with the code of best practice, roles and responsibilities of Board of Directors, shareholder rights
  2. No government support: Strong governance standards focusing on fairness, transparency, accountability and responsibility are crucial not only for the healthy and vibrant corporate sector growth, as well as inclusive growth of the economy.
  3. Inside trading: Corporate insiders like officers, directors and employees by the virtue of their position have access to confidential information about the corporation and may misappropriate that information to reap profits.
  4. The problem in the Indian corporate sector is that of disciplining the dominant shareholder and protecting the minority shareholders.
  5. Other weaknesses:
  • Noncompliance with disclosure norms and even the failure of auditor’s reports to conform to the law attract nominal fines without any any punitive action.
  • Sometimes non-voting preferential shares are used by promoters to channel funds and deprive minority shareholders of their dues.
  • Minority shareholders have sometimes been defrauded by the management undertaking clandestine side deals with the acquirers in the relatively scarce events of corporate takeovers and mergers.
  • Misleading financial statements- There are many ways to present factually accurate information on a financial statement in a manner that is misleading to investors .

Example:

The Satyam Case:

The failure of corporate governance and of misleading accounts is a failure of both the management and of the auditors. The promoters decided to inflate the revenue and profit figures of Satyam. In the event, the company has a huge hole in its balance sheet, consisting of non-existent assets and cash reserves that have been recorded and liabilities that are unrecorded.

Solutions:

  1. Preventing insider trading by devising an internal procedure for adequate and timely disclosures and specific rules for the conduct of insiders and the power to punish offenders.
  2. Organisation for Economic Co-operation and Development (OECD) lays down certain principles for reforming corporate governance. They are-
  • The right of shareholders- These include a set of rights including secure ownership of their shares, the right to full disclosure of information, voting rights, participation in decisions.
  • The Equitable Treatment of Shareholders- It deals with protecting minority shareholders rights by setting up systems that keep insiders, including managers and directors, from taking advantage of their positions.
  • The Role of Stakeholders in Corporate Governance- the OECD recognizes that there are other stakeholders in companies in addition to shareholders whose rights needs to be protected on being associated with the company.
  1. The N.R Narayan Murthy Committee report also made some mandatory recommendations:-
  • Strengthening the responsibilities of audit committees.
  • Improving the quality of financial disclosures.
  • Requiring corporate executive boards to assess and disclose business risks in the annual reports of companies.
  • Introducing responsibilities on boards to adopt formal codes of conduct.
  • Striving to ensure that the code of conduct is understood and adhered to by all members of the organization.
  • The performance management system should recognize and reward ethical behavior.
  • Market participants suggested a three-tier system for firms, with at supervisory board at the top
  • Market participants said the capital market regulator, the Securities and Exchange Board of India (SEBI), needed to intervene in such matters to protect the interest of investors, especially the retail segment.
  • The supervisory board, comprising eminent personalities, will monitor performance as well as the value system for the company and this alone will create wealth for the company and keep it on the track.

Committees related to corporate governance in India:

Kumar Mangalam Birla Committee Report:

  • The report pointed out that the issue of corporate governance involves besides shareholders, all other stakeholders.
  • The committee’s recommendations have looked at corporate governance from the point of view of the stakeholders and in particular that of shareholders and investors.
  • The committee report establishes a set of recommendations.
  • The committee recognized that India had in place a basic system of corporate governance an

Naresh Chandra committee :

  • The committee was appointed in August 2002 by the Department of Company Affairs (DCA) under the Ministry of Finance and Company Affairs to examine various corporate governance issues.
  • The Committee submitted its report in December 2002.
  • It made recommendations in two key aspects of corporate governance: financial and non-financial disclosures: and independent auditing and board oversight of management.

Narayana Murthy committee

  • The committee was set up by SEBI, under the chairmanship of Mr. N. R. Narayana Murthy, to suggest measures to improve corporate governance standards.
  • Some of the major recommendations of the committee primarily related to audit committees, audit reports, independent directors, related party transactions, risk management, directorships and director compensation, codes of conduct and financial disclosures.

Conclusion:

In today’s market- oriented economy, the need for corporate governance arises. Globalization is significant factors urging corporate governance. Corporate Governance is essential to develop added value to the stakeholders. Corporate Governance ensures transparency which ensures strong and balanced economic development.

 

 

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