Over the past two decades, the investment world has seen a large numbers of
scandals relating to companies which are attributed to failure of governance.
This has been caused due to a combination of factors which can be principally
classified into three corporate sins.
·The executive directors of the company lost the sense of business ethics
and earnings became the only motive. Directors were not prepared to show losses
which led to the use of unethical practices like forging books of accounts to
show higher earnings.
·Other directors acted as a puppet in the hands of executive directors,
approving improper financial statements and condoning unfair practice. Managers
awarded themselves huge bonuses and stock options, often at the expense of other
·Auditors colluded or failed to stop executive directors from using
improper accounting policies. In the process they lost their independence which
they surrendered it in return for high audit fees.
The area of corporate governance has acquired heightened attention in the last
decade because of various notable scandals and collapses cited from the USA
(Enron, World com, Tyco), the UK (the collapse of Maxwell publishing group),
Germany (the cases of Holtzman, Berliner Bank, and HIH), Korea (the widespread
banking distress in 1997), Australia (Ansett Airlines and One Tel), France
(Credit Lyonnais and Vivendi), and Switzerland (Swissair), India (Satyam and
Reebok). The world reaction to these corporate wrongs was massive which led to
the development of law and codes for better corporate governance. Cadbury
Committee report 1992 (UK), Greenbury report 1995 (UK), The Combined code 1998
(UK), Turnbull report 1999 (UK), OCED principles of corporate governance 1999
etc were some of the international initiatives to regulate corporate affairs.
Especially the collapse of Enron in the USA in 2001 increased the importance of
corporate governance both in the USA and in other parts of the world.
II. Corporate Governance-The concept
Corporate refers to the most common form of business organisation, one which is
chartered by a state and given legal rights as an entity separate from its
owners. This form of business is characterised by the limited liability of its
owners. The process of becoming a corporation, called incorporation gives the
company separate legal standing from its owners and protects those owners from
being personally liable in the event that the company is sued.
The concept of corporate governance is gaining momentum because of various
factors as well as the dynamic business environment. The principles of good
governance are as old as good behaviour, which needs no formal definition.
However, in reference to the corporate world, it has been defined by various
persons, some of whom is described below just in order to satisfy that the vital
details and spirit of the term are not missed out. Sir Adrian Cadbury Committee,
which looked into corporate governance issues in U.K., defines Corporate
Governance "as the system by which the companies are directed and controlled.
The basic objective of corporate governance is to enhance and maximize
shareholder value and protect the interest of other stake holders".Further
the Kumar Mangalam Birla committee constituted by SEBI has observed that,
"Strong corporate governance is indispensable financial reporting
structure."According to ICSI, "We may define 'corporate governance as a
blend of rules, regulations, laws and voluntary practices that enable companies
to attract financial and human capital, perform efficiently and thereby maximise
long term value for the shareholders besides respecting the aspirations of
multiple stakeholders including that of the society."
Corporate governance is a multidisciplinary field of study it covers a wide
range of disciplines – accounting, consulting, economics, ethics, finance, law,
and management. The main function of corporate governance is to make
agreements that describe the privileges and tasks of shareholders and the
organization. In case of disagreements because of conflict of interest, it is
the responsibility of corporate governance to bring everyone together. It also
has the function of setting standards against which corporations work can be
managed and administered
Good governance is integral to the very existence of a company. It inspires and
strengthens investor's confidence by ensuring company's commitment to higher
growth and profits. It seeks to achieve following objectives:
(i) That a
properly structured Board capable of taking independent and objective decisions
is in place at the helm of affairs;
(ii) That the Board is balanced as regards
the representation of adequate number of non-executive and independent directors
who will take care of the interests and well being of all the stakeholders;
(iii) That the Board adopts transparent procedures and practices and arrives at
decisions on the strength of adequate information.
(iv) That the Board has an
effective machinery to sub serve the concerns of stakeholders;
(v) That the
Board keeps the shareholders informed of relevant developments impacting the
(vi) That the Board effectively and regularly monitors the functioning of the management team; and
(vii) That the Board remains in effective control of
the affairs of the company at all times. The overall endeavour of the Board
should be to take the organisation forward, to maximise long-term gains and
III. Need for and Importance of Corporate Governance
The need for corporate governance has arisen because of the increasing concern
about the non-compliance of standards of financial reporting and accountability
by boards of directors and management of corporate inflicting heavy losses on investors. Many large corporations are transnational in nature. This means that
these corporations have impact on citizens of several countries across the
globe. If things go wrong, they will affect many counties, some more severely
than others. It is, therefore, also necessary to look at the international scene
and examine possible international solutions to corporate governance
difficulties. Corporate governance is needed to create a corporate culture of
consciousness, transparency and openness. It refers to a combination of laws,
rules, regulations, procedures and voluntary practices to enable companies to maximise shareholder's long-term value. It should lead to increasing customer
satisfaction, shareholder value and wealth. With increasing government
awareness, the focus is shifted from economic to the social sphere and an
environment is being created to ensure greater transparency and accountability.
It is integral to the very existence of a company and can be summarised in the
a) Corporate scams: Scandals in the corporate world, whether centred around
corruption, bribery, fraud, or greed tend to have a significant impact on the
economy as a whole. The need for corporate governance is, then, imperative for
reviving investors' confidence in the corporate sector towards the economic
development of society.
b) Wide Spread Shareholders: In today's era, a company has a very large
number of shareholders spread all over the world. The idea of shareholders'
democracy remains confined only to the law and the Articles of Association which
requires a practical implementation through a code of conduct of corporate
c) Changing Ownership Structure: The pattern of corporate ownership has
changed considerably, in the present-day-times with institutional investors and
mutual funds becoming largest shareholders in large corporate private sector.
These investors have become the greatest challenge to corporate managements,
forcing the latter to abide by some established code of corporate governance to
build up its image in society.
d) Globalisation: Desire of more and more companies to get listed on
international stock exchanges also focuses on a need for corporate governance.
There is no doubt that international capital market recognises only companies
well- managed according to standard code of corporate governance.
IV. Issues in Corporate Governance
Corporate governance has been defined in different ways by different writers and
organisations. Some define it in a narrow perspective to include in it only the
shareholders, while others want it to address the concerns of all stakeholders.
Some talk about corporate governance being an important instrument for a country
to achieve sustainable economic development, while others consider it as a
corporate strategy to achieve a long tenure and a healthy imagine. But to all,
corporate governance is a means to an end, the end being long term shareholder,
and more importantly, stakeholder value. Thus, all authorities on the subject
are one in recognising the need for good governance practices to achieve the end
for which corporate are formed. Some governance issues are identified as being
crucial and critical to achieve these objectives.
·Distinguishing the roles of board and management: Constitutions of more
and more companies stress and underline that the business is to be managed "by
or under the direction of" the board. In such a practice, the responsibility for
managing the business is delegated by the board to the CEO, who in turn
delegates the responsibility to other senior executives. Thus, the board
occupies the key position between the shareholders (owners) and the company's
management (day-to-day managers of the company).
·Separation of the roles of the CEO and chairperson: The composition of
the board is a major issue in corporate governance as the board acts as a link
between the shareholders and the management and its decisions affect the
performance of the company. All committees that studied corporate governance
practices all over the world, starting with the Cadbury committee, have
suggested various improvements in the composition of boards of companies. It is
now increasingly being realised that the practice of combining the role of the
chairperson with that of the CEO as is done in countries like the US and India
leads to conflicts in decision making and too much concentration of power in one
person resulting in unsavoury consequences. Combining the role of both the CEO
and chairperson removes an important check on senior management's activities.
This is the reason why many authorities on corporate governance recommend
strongly that the chairman of the Board should be an independent director in
order to "provide the appropriate counterbalance and check to the power of the
·Directors and executive's remuneration: This is one of the mixed and
vexed issues of corporate governance that came into the limelight during the
massive corporate failures in the US between 2000 and 2002. Executive
compensation has also in recent time become the most viable and politically
sensitive issue relating to corporate governance. According to the Cadbury report:
"The over- riding principle in respect of Board remuneration is that
shareholders are entitled to full and clear statement of directors present and
future benefits, and how they have been determined." Other committees on
corporate governance have also laid emphasis on other related issues such as "
pay-for performance", heavy severance payments, pension for non- executive
directors, appointment of remuneration committee and so on.
·Disclosure and audit: The OECD lays down a number of provisions for the
disclosure and communication of "key facts" about the company to its
shareholders. The Cadbury Report termed the annual audit as "one of the
cornerstones of corporate governance". Audit also provides a basis for
reassurance for everyone who has a financial stake in the company. There are
several issues and questions relating to auditing which have an impact on
corporate governance. There are, for instance, questions such as: (i) How to
ensure independence of the auditor? (ii) Should individual directors have access
to independent resource? Etc.
·Composition of the board and related issues: A board of directors is a
"committee elected by the shareholders of a limited company to be responsible
for the policy of the company. Sometimes, full time functional directors are
appointed, each being responsible for some particular branch of the firm's
work".The composition of board of directors refers to the number of
directors of different kinds that participate in the work of the board. Over a
period of time there has been a change as to the number and proportion of
different types of directors in the board of a limited company. The SEBI
appointed Kumar Mangalam Birla Committee's Report defined the composition
"The Board of directors of a company shall have an optimum
combination of executive and non- executive directors with not less than 50
percent of the board of directors to be non- executive directors. The number of
independent directors would depend upon whether the chairman is executive or
non- executive. In case of a non-executive chairman, at least one-third of the
board should comprise independent directors and in case of executive chairman,
at least half of the board should be independent directors.
V. India and corporate governance
Corporate governance has played a very important role in the present economic
condition of India. India successfully started its move towards open and
welcoming economy in 1991 by following the LPG policy. From then onwards it has
seen an amazing upward trend in the size of its stock market, that is, number of
listed firms was increasing proportionatelyIf India wants to attract more
countries for foreign direct investments, Indian companies have to be more
focused on transparency and 'Shareholders value maximization'
Kumarmangalam Birla Committee described the concept of corporate governance
instead of defining or giving a meaning of it. Three key constituents of
corporate governance as the shareholders, the Board of Directors and the
Management and has attempted to identify in respect of each of these
constituents, their roles and responsibilities as also their rights in the
context of good governance. Fundamental to this examination and permeating
throughout this exercise is the recognition of the three key aspects of
corporate governance; namely, accountability, transparency and equality of
treatment for all stakeholders.
The pivotal role in any system of corporate governance is performed by the board
of directors. It is accountable to the stakeholders and directs and controls the
management. It stewards the company, sets its strategic aim and financial goals
and oversees their implementation, puts in place adequate internal controls and
periodically reports the activities and progress of the company in the company
in a transparent manner to the stakeholders. The shareholders role in corporate
governance is to appoint the directors and the auditors and to hold the board
accountable for the proper governance of the company by requiring the board to
provide them periodically with the requisite information, in a transparent
fashion, of the activities and progress of the company. The responsibility of
the management is to undertake the management of the company in terms of the
direction provided by the board, to put in place adequate control systems and to
ensure their operation and to provide information to the board on a timely basis
and in a transparent manner to enable the board to monitor the accountability of
management to it.
Naresh Chandra Committee 'Report of the Committee on Corporate Audit and
Governance' describe: The fundamental theoretical basis of corporate governance
is agency costs. Shareholders are the owners of any joint-stock, limited
liability Company, and are the principals. By virtue of their ownership, the
principals define the objectives of a company. The management, directly or
indirectly selected by shareholders to pursue such objectives, are the agents.
While the principals might wishfully assume that the agents will invariably do
their bidding, it is often not so. In many instances, the objectives of managers
are quite different from those of the shareholders. Such misalignment of
objectives is called the agency problem, and the cost inflicted by such
dissonance is the agency cost. The core of corporate governance is designing and
putting in place disclosures, monitoring, oversight and corrective systems that
can align the objectives of the two sets of players as closely as possible and,
hence, minimise agency costs.
Narayan murthy Committee on 'Report of the SEBI Committee on Corporate
Governance' commented on Corporate Governance in the following manner:
·A corporation is a congregation of various stakeholders, namely,
customers, employees, investors, vendor partners, government and society. A
corporation should be fair and transparent to its stakeholders in all its
transactions. This has become imperative in today's globalised business 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. Unless a corporation embraces and demonstrates ethical conduct, it
will not be able to succeed.
·Corporate governance is about ethical conduct in business. Ethics is
concerned with the code of values and principles that enables a person to choose
between right and wrong, and therefore, select from alternative courses of
action. Further, ethical dilemmas arise from conflicting interests of the
parties involved. In this regard, managers make decisions based on a set of
principles influenced by the values, context and culture of the organisation.
Ethical leadership is good for business as the organisation is seen to conduct
its business in line with the expectations of all stakeholders.
·Corporate governance is beyond the realm of law. It seems from the
culture and mindset of management, and cannot be regulated by legislation alone.
Corporate governance deals with conducting the affairs of a company such that
there is fairness to all stakeholders and that its actions benefit the greatest
number of stakeholders. It is about openness, integrity and accountability. What
legislation can and should do is to lay down a common framework- the "form" to
ensure standards. The "substance" will ultimately determine the credibility and
integrity of the process. Substance is inexorably linked to mindset and ethical
standards of management.
In this paper, we saw how important it is for a company to follow good corporate
governance practices. The paper started going deep into the root cause of
factors that affect corporate governance such as distinguishing the roles of
board and management, composition of the board and related issues, choice of
auditors and audit committee, directors and executives' remuneration etc. Then
we looked at the brief history of corporate governance in India. India being
an emerging economy needs to work more on regulating the corporate governance
policies. The future of corporate governance is becoming a little clear now; the
investors are promoted to behave more like owners rather than just traders.
Independent directors have more defined roles and responsibilities.
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