CORPORATE GOVERNANCE

Good business practice is no longer just about ensuring the absence

of any red ink in the annual report. It isn’t just about keeping the
ultimate owners of the enterprise, the shareholders, happy.

Today, if an organization has to survive and thrive in a

commercial environment that is becoming increasingly
global in its outlook, it has got to factor in the interests and
concerns of every stakeholder in the business. And that
includes not just the shareholder, but also the domestic and
global customer, the vendor, the creditor, the lawmaker, the
community in which the enterprise operates, and
environmental groups.

It is in this context that corporate governance has assumed

greater significance, particularly with companies that are
seeking to establish a global footprint.

The deep-rooted belief that as long as the performance is

good, corporate governance is not an issue of great
significance has outlived its relevance in view of the periodic
crises experienced the world over in recent times.

It has now been widely recognised that outstanding

performance, higher profits and expanded reach, nothing act
as safeguards for a company when good governance and
ethics are at back burner.

There is ample evidence to establish that a single

wrongdoing is enough to ruin the reputation of a company, it
took ages to build, while the culture of strict adherence to
good governance practices keeps them ahead on
sustainable basis.
Definitions of Corporate Governance
Corporate governance is the set of processes, customs,
policies, laws, and institutions affecting the way a
corporation (or company) is directed, administered or
controlled. Corporate governance also includes the
relationships among the many stakeholders involved and the
goals for which the corporation is governed. The principal
stakeholders are the shareholders, management, and the
board of directors. Other stakeholders include employees,
customers, creditors, suppliers, regulators, and the
community at large.

Corporate Governance is concerned with holding the balance

between economic and social goals and between individual
and communal goals. The corporate governance framework
is there to encourage the efficient use of resources and
equally to require accountability for the stewardship of those
resources. The aim is to align as nearly as possible the
interests of individuals, corporations and society. ( Definition
by Sir Adrian Cadbury in 'Global Corporate Governance
Forum', World Bank, 2000 )

“Corporate governance is about “the whole set” of legal,

cultural, and institutional arrangements that determine what
public corporations can do, who controls them, how that
control is exercised, and how the risks and return from the
activities they undertake are allocated.” ( As said by
Margaret Blair , Professor of Law, Vanderbilt University Law
School )

Good corporate governance is characterized by a firm commitment

and adoption of ethical practices by an organization across its entire
value chain and in all of its dealings with a wide group of
stakeholders encompassing employees, customers, vendors,
regulators and shareholders (including the minority shareholders),
in both good and bad times

Commonly Accepted Principles of Corporate

Governance
1. 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 effectively
communicating information that is understandable and
accessible and encouraging shareholders to participate in
general meetings.
2. Interests of other stakeholders: Organizations should
recognize that they have legal and other obligations to all
legitimate stakeholders.
3. Role and responsibilities of the board: The board needs
a range of skills and understanding to be able to deal with
various business issues and have the ability to review and
challenge management performance. It needs to be of
sufficient size and have an appropriate level of commitment
to fulfill its responsibilities and duties. There are issues about
the appropriate mix of executive and non-executive directors.
4. Integrity and ethical behaviour: Ethical and responsible
decision making is not only important for public relations, but
it is also a necessary element in risk management and
avoiding lawsuits. Organizations should develop a code of
conduct for their directors and executives that promotes
ethical and responsible decision making. It is important to
understand, though, that reliance by a company on the
integrity and ethics of individuals is bound to eventual failure.
Because of this, many organizations establish Compliance
and Ethics Programs to minimize the risk that the firm steps
outside of ethical and legal boundaries.
5. Disclosure and transparency: Organizations should clarify
and make publicly known the roles and responsibilities of
board and management to provide shareholders 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.

CORPORATE GOVERNANCE CONCERNS IN INDIA

1. Independent directors need significant empowerment :
Many Indian companies operate in a family-owned
culture. There has been an implicit assumption
amongst boards that senior managers know their job
and have the best interests of companies they manage
at heart. This has sometimes resulted in
boardsrefraining from asking the difficult questions to
senior managers when the company has been
performing well or until there is a crisis.

Solution:
Adoption of a formal and transparent process for director
appointments. The conflict of interest involved in
managements appointing independent directors should be
tackled through nomination committees (comprising
independent directors) for identification of directorial
candidates.

2. Principle of trusteeship - appropriate protection for

minority shareholders : As minority shareholders do not have
a complete understanding of their rights or the avenues
through which these rights could be exercised, increased
activism from institutional shareholders and reinforcing the
role of independent directors on the board is likely to take
shape in the near future.
In the context of meeting expectations of stakeholders
beyond the minority shareholders (eg. employees,
customers, vendors
etc.) a number of initiatives need to be embraced such as:
• Informative Management Discussions and Analysis
disclosures that focus on improving level of detail around
operations and key risks
• Openness and transparency in dialogue with shareholders
• Objective and transparent whistle blower policies that are
available to key stakeholders (employees, customers and
vendors)
and provide adequate safeguards against victimisation of
whistle blowers
• Have minority shareholders’ representatives on boards as
independent directors.

3 Committees of boards may not have high effectiveness

: In present times, companies have numerous
committees of the board such as ESOP Committee,
Audit Committee, Remuneration Committee, Risk
Management Committee etc. There is a need for
establishing a framework around the functioning of
committees of boards so that their effectiveness is
demonstrated.

4. Quality of Management Discussion and Analysis in

annual reports : Quality of Management Discussion and
Analysis (MD&A) , which highlights the structure,
developments, opportunities, threats, concerns, etc, of
the company is moderate

5. Audit committee skill-sets may need to be

enhanced :Audit committees, largely comprising
independent directors, are entrusted with the
responsibility of ensuring the integrity of the company’s
financial statements, managing risks through internal
control system and functioning of its internal audit
function and regulatory compliance. While it is the duty
of all directors to act in the interests of the company,
the audit committee, which acts independently of
executive management, has a specific responsibility of
acting in the interests of stakeholders through effective
 oversight of the company’s financial reporting and its
risk management and internal control systems.

Companies should address the challenges that their audit

committees face and focus on enhancing skills in some of
the most important areas listed below:
• Better understanding of risk, strategy and business models
• Understanding implications of the external environment on
financial forecasts and performance
• Comprehend complex accounting policies and practices –
how their application impacts results
• Monitoring fraud risk especially relating to senior
management override of internal controls
• Effective oversight of internal and external auditors
• Ensuring that the board’s strategic direction is in the best
interest of all including minority shareholders
• Evaluation of audit committee and its members based on
an established framework for its functioning.

All these informations regarding Corporate Governance concerns in

India are according to a poll “The State of Corporate
Governance in India: 2008”, conducted by KPMG in India’s
Audit Committee Institute.The poll, conducted between late
November 2008 to early January 2009, involved over 90
respondents comprising CEOs, CFOs, independent directors
and similar leaders, who were asked about the journey,
experience and the outlook for corporate governance in
India. The respondents are predominantly from private
equity firms, financial services and the manufacturing sector.
SATYAM SCANDAL AND CLAUSE 49 REVIEW

Satyam Computers, the fourth largest IT industry of India, The

member of Nifty 50, BSE Sensex, winner of golden peacock award
for best corporate governance, and many more laurels that it has in
its kitty did not stop it from drowning like a rock in its dirty waters.

The Satyam Computer Services scandal was publicly

announced on 7 January 2009, when Chairman Ramalinga
Raju confessed that Satyam's accounts had been falsified.
Ramalinga Raju of Satyam computers, confessed in a four
page letter, stating that the accounting books of Satyam had
been hugely inflated and that the company did not have that
much of money as it was showing.

About $1 billion, or 94 per cent of the cash, on the company's books

was fictitious and manipulation of the cash flow may be a reason
why the fraud was undetected (as said by Ramalinga Raju )

Auditors generally assume if there is cash, things are OK. But there
are plenty of accounting and governance loopholes.

It was after a rare revolt by minority shareholders — who

objected to Raju's plan to drain Satyam's cash reserves to buy two
property companies run by his sons — that brought Satyam down

New York-listed Satyam did everything by the rulebook, with an

international firm auditing its books, declaration of accounts in
accordance with Indian and U.S. standards, and the requisite
number of independent directors with excellent credentials,
including a Harvard business school professor and a former federal
cabinet secretary.

Regulators were blindsided, and analysts and experts said there are
"systemic flaws" in accounting and audit practices.

Considering the role of independent directors in the light of the

Satyam scam, Mr. Madhav Mehra (President of London based World
Council for Corporate Governance) said that there is need for
directors with independent minds. There is a need for independent
boards. The independent directors are not bothered about anything
as long as they get salaries. That is why the Satyam fraud
happened.

He further said: "There are people who are directors of 15

companies. How can you be an independent director of 15
companies? People have not been able to understand the
role of corporate governance."

All these deficiencies and loopholes forced SEBI to tighten

rules for accounting and corporate governance, including
appointment of independent directors by selection
committees, and greater oversight from regulatory and
government authorities.

Clause 49 of the Listing Agreement

Every company wishing to list its securities on a stock
exchange has to sign an agreement with the latter, called
the Listing Agreement. It has 51 clauses. These deal with
various guidelines on listing and responsibilities of the
company management. Clause 49, one of the longest, deals
with corporate governance. It lists mandatory and non-
mandatory norms for companies to comply with.

With a view to promote and raise the standards of Corporate

Governance, SEBI on the basis of recommendations of the
Committee for Corporate Governance under the Chairmanship of
Shri N.R. Narayan Murthy and public comments received on the
report submitted by the Committee and in exercise of powers
conferred by Section 11(1) of the Securities and Exchange Board of
India Act, 1992, revised the existing clause 49 of the Listing
agreement vide its circular SEBI/MRD/SE/31/2003/26/08 dated
August 26, 2003.
Important Highlights Of Revised Clause 49

Schedule of Implementation
The circular specifies following schedule of implementation of the
revised clause 49 :
(i) All entities seeking listing for the first time, at the time of
listing,
(ii) All listed entities having a paid up share capital of Rs 3 crores
and above or net worth of Rs 25 crores or more at any time in
the history of the company.
1. Widening the Definition of Independent
Director
Under the revised clause 49, the definition of the
expression ‘independent director’ has been expanded.
The expression ‘independent director’ mean non-
executive director of the company who —
(a) apart from receiving director’s remuneration, does
not have any material pecuniary relationships or
transactions with the company, its promoters, its senior
management or its holding company, its subsidiaries
and associated companies;
(b) has not been an executive of the company in the
immediately preceding three financial years;
(c)is not a partner or an executive of the statutory audit firm or
the internal audit firm that is associated with the company,
and has not been a partner or an executive of any such firm
for the last three years. This will also apply to legal firm(s) and
 consulting firm(s) that have a material association with the
entity.
2. Compensation to Non Executive Directors and Disclosure
thereof
As per earlier clause 49, the compensation to be paid to non-
executive directors was fixed by the Board of Directors, whereas
the revised clause requires all compensation paid to non-executive
directors to be fixed by the Board of Directors and to be approved
by shareholders in general meeting. Placing the independent
directors and non-executive directors on equal footing, the revised
clause provides that the considerations as regards compensation
paid to an independent director shall be the same as those applied
to a non-executive director. The companies have been put under
an obligation to publish their compensation philosophy and
statement of entitled compensation in respect of non-executive
directors in its annual report.

3. Periodical Review by Independent Director

The revised clause 49 requires the Independent Director to
periodically review legal compliance reports prepared by the
company and any steps taken by the company to cure any taint.

4. Non–Executive Directors – Not to hold office for

more than Nine Years
Revised clause 49 limits the term of the office of the non-
executive director and provides that a person shall be
eligible for the office of non-executive director so long as
the term of office does not exceed nine years in three
terms of three years each, running continuously.
5. Audit Committee
Two explanations have been added in the revised clause
49. The first explanation defines the term “financially
literate” to mean the ability to read and understand basic
financial statements i.e. balance sheet, profit and loss
account, and statement of cash flows. It has also been
clarified that a member is considered to have accounting
or related financial management expertise if he or she
 possesses experience in finance or accounting, or
requisite professional certification in accounting.

6. Disclosure of Accounting Treatment

The revised clause 49 requires that in case a company has
followed a treatment different from that prescribed in an
Accounting Standards, the management of such company
is required to clearly explain the alternative accounting
treatment in the footnote of financial statements.
7. Whistle Blower Policy
Companies have been required to formulate an Internal
Policy on access to Audit Committees. Personnel who
observe any unethical or improper practice (not
necessarily a violation of law) can approach the Audit
Committee without necessarily informing their
supervisors.
Companies have also been required to affirm that it has
provided protection to “whistle blowers” from unfair termination
and other unfair or prejudicial employment practices.

8. Report on Corporate Governance

The companies have been required to submit a quarterly
compliance report in the prescribed format to the stock
exchanges within 15 days from the close of the quarter.
The report has to be submitted either by the Compliance
Officer or the Chief Executive Officer of the company after
obtaining due approvals.
9. Company Secretary in Practice to Issue Certificate
of Compliance
This is a landmark amendment authorizing Company
Secretaries in Practice among other professionals to issue
certificate of compliance of clause 49. The revised clause
requires the company to obtain a certificate from either
the auditors or practicing company secretaries regarding
compliance of conditions of corporate governance and
 annex the certificate with the directors’ report, which is
sent annually to all the shareholders of the company.

The revised clause 49 of the Listing Agreement provides

much needed disclosure requirements, widened definition
of independent director, periodical review by independent
director, whistle blower policy, quarterly compliance report
in the prescribed format and issue of certificate of
compliance. Hence it can be said that the revised clause
49 would go a long way in providing corporates good
governance framework.
ACGA White Paper on Corporate Governance

The Asian Corporate Governance Association (ACGA), based

in Hong Kong, had released a 55-page white paper on Indian
corporate governance , which suggests that many of the
conditions that helped facilitate Raju's $2.5 billion fraud still
exist, despite efforts to reform.

According to ACGA critical areas of corporate governance were

sidestepped in spite of the reforms enacted in recent years.
The report draws on the views of more than a dozen foreign
institutional investors, like the California Public Employees'
Retirement System, auditors, like KPMG, and law firms, like
White&Case.

The White Paper is of importance for two reasons. First, it seeks to

supplement the existing reform process in India that is already
underway and one that has culminated, at least for the moment,
with the issue of the Corporate Governance Voluntary Guidelines
2009 by the Ministry of Corporate Affairs. Second, and more
importantly, it side-steps most of the conventional issues that have
inundated the corporate governance discourse in India recently and
offers some different perspectives, like a whiff of fresh air.

The goal of the effort is set out as follows:

The aim of the “India White Paper” is to provide officials,

financial regulators, listed companies, investors and others
with constructive and detailed suggestions for the
broadening and deepening of sound corporate governance in
India. While India has undertaken numerous reforms in
corporate governance over the past decade, especially in the
area of company boards, independent directors and
disclosure and accounting standards, certain critical areas
remain to be addressed—particularly relating to the
accountability of promoters (controlling shareholders), the
regulation of related party transactions, and the governance
of the audit profession.
The White Paper states that despite “wide-ranging developments in
regulation and policy, what becomes apparent in India is that the
reform process has not addressed, or effectively addressed, a key
challenge at the heart of the governance problem, namely the
accountability of promoters to other shareholders”. In other words,
this is recognition of the fact that a large number of governance
problems in Indian companies are related to the position of
controlling shareholders or promoters relative to that of minority
shareholders. The White Paper finds that the overwhelming focus
on board reforms is misplaced and is not adequate to deal with
these problems.

In this context, relying largely on independent directors

(appointed by controlling shareholders), independent board
committees and greater corporate disclosure as the primary
mechanisms to check abuses of power by promoters and to
safeguard the interests of minority shareholders is likely to
prove weak and insufficient (as indeed it did in the Satyam
case). Board reform is fundamentally important, and is a
major issue of concern to institutional investors, but it needs
to be complemented by other regulations that directly
address the relationship between controlling and minority
shareholders—in other words, a proper regime for the
regulation of related-party transactions.

According to ACGA some of the issues which needs to be

urgently addressed are as follows :-

1. Controlling shareholders have too much power, a

situation which roots in Indian culture and the nation's
corporate regulations. Many Indian businesses are
rooted in old family empires run by men who are happy
to take money from public shareholders but loathe to
cede control. As a result, minority shareholders and
independent directors often have little real power. That,
plus inadequate regulation and lax oversight, means
controlling shareholders can often manipulate a public
company for their personal profit, What is required is a
 balance of power between the promoters and other
shareholders .

ACGA argues that one good way to fix the problem is to

empower institutional investors. It was, after all, a rare
revolt by minority shareholders — who objected to Raju's
plan to drain Satyam's cash reserves to buy two property
companies run by his sons — that brought Satyam down.

2. Selective disclosure of information by management,

poor quality financial reporting and the absence of
meaningful punishment for flouting the law remain serious
problems.

Poor disclosure rules mean investors don't necessarily

know what a company's holdings are and give controlling
shareholders scope to abuse corporate linkages by, for
example, overpaying for the assets of a private company
they also own.

The Indian regulators have implemented some reforms,

like requiring greater disclosure of the holdings of
controlling shareholders and any pledging of those shares.

3. Voting by show of hands, the norm in India, gives every

investor one vote, irrespective of the number of shares he
or she owns. Proxies for foreign investors aren't allowed to
vote by hand count or speak at shareholder meetings
under Indian law.

4. ACGA calls for changes to shareholder meetings.

Investors want earlier notification of meetings and to be able
to instruct their proxies to speak at the gatherings.

5. Annual meetings are often held in out of the way places

( for instance, ICICI Bank, India's largest private sector bank,
holds its meetings in Baroda, a small city in Gujarat ) and
weak representation at shareholder meetings means
minority investors "did not have a voice".
6. Audits require closer scrutiny by both accountants and
company management and the audit profession is highly
fragmented and hamstrung by regulations that protect the
small firm at the expense of the market .

In order to tackle the issues recommended by ACGA, the

Ministry of Corporate Affairs released a set of voluntary
guidelines on Corporate Governance.
CORPORATE GOVERNANCE VOLUNTARY GUIDELINES 2009

The Ministry of Corporate Affairs in India had released a

set of voluntary guidelines on Corporate Governance .It
was released at the conclusion of the first-ever India
Corporate Week ( 14 – 21 December ). The guidelines
incorporate all Ten Principles of the United Nations Global
Compact.

The Ministry of Corporate Affairs after examining the

committee reports as well as suggestions received from
various stakeholders on issues related to corporate
governance released the guidelines. Keeping in mind that
the subject of corporate governance may go well beyond the
Law and that there are inherent limitations in enforcing
many aspects of corporate governance through legislative or
regulatory means, it has been considered necessary that a
set of voluntary guidelines called “Corporate Governance
-Voluntary Guidelines 2009” which are relevant in the
present context, are prepared and disseminated for
consideration and adoption by corporates.

These guidelines provide for a set of good practices which

may be voluntarily adopted by the Public companies. Private
companies, particularly the bigger ones, may also like to
adopt these guidelines. The guidelines are not intended to
be a substitute for or addition to the existing laws but are
recommendatory in nature.

After taking into account the experience of voluntary

adoption of these guidelines by the corporates and
consideration of relevant feedback, the Government
would initiate the exercise for review of these guidelines
for further improvement after one year.
The CGV Guidelines suggest guidelines with reference to the
below:

I Board of Directors A. Appointment of Directors

B. Independent Directors

C. Remuneration of Directors
II Responsibilities of Board A. Training of Directors

B. Quality Decision Making

C. Risk Management

D. Evaluation of Performance of
Directors

E. Board to ensure compliance

of law
III Audit Committee A. Constitution

B. Powers

C. Roles and Responsibilities

IV Auditors A. Appointment

B. Certificate of Independence

C. Rotation of Auditors

D. Clarity of Information

E. Internal Auditor
V Secretarial Audit

VI Whistle Blowing
Mechanism
Some of the guidelines are as follows:

I. BOARD OF DIRECTORS
A. APPOINTMENT OF DIRECTORS
A.1 Appointments to the Board
(i) Companies should issue formal letters of appointment to Non-
Executive Directors (NEDs) and Independent Directors - as is done
by them while appointing employees and Executive Directors. The
letter should specify:
• The term of the appointment;
• The fiduciary duties that come with such an appointment
alongwith accompanying liabilities;
• The list of actions that a director should not do while
functioning as such in the company; and
• The remuneration, including sitting fees and stock options
etc., if any.
(ii) Such formal letter should form a part of the disclosure to
shareholders at the time of the ratification of his/her appointment
or re-appointment to the Board.
A.2 Separation of Offices of Chairman & Chief Executive Officer
To prevent unfettered decision making power with a single
individual, the roles and offices of Chairman of the Board and that
of the Managing Director/Chief Executive Officer(CEO) should be
separated, as far as possible, to promote balance of power.
A.3 Nomination Committee
(i) The companies may have a Nomination Committee comprising
of majo-rity of Independent Directors, including its Chairman. This
Committee should consider:
• proposals for searching, evaluating, and recommending
appropriate Independent Directors and Non-Executive
Directors [NEDs], based on an objective and transparent set
of guidelines.
• determining processes for evaluating the skill, knowledge,
experience and effectiveness of individual directors as well as
the Board as a whole.
(ii) With a view to enable Board to take proper and reasoned
decisions, Nomination Committee should ensure that the Board
comprises of a balanced combination of Executive Directors and
Non-Executive Directors.
(iii) The Nomination Committee should also evaluate and
recommend the appointment of Executive Directors.
A.4 Number of Companies in which an Individual may become a
Director
(i) For reckoning the maximum limit of directorships, the following
categories of companies should be included:—
• public limited companies,
• private companies that are either holding or subsidiary
companies of public companies.
Conclusion
Good corporate governance helps an organization achieve
several objectives and some of the more important ones
include:

• Developing appropriate strategies that result in the

achievement of stakeholder objectives

• Attracting, motivating and retaining talent

• Creating a secure and prosperous operating environment

and improving operational performance

• Managing and mitigating risk and protecting and

enhancing the company’s reputation.

“Good corporate governance practices are a sine qua non for

sustainable business that aims at generating long term value
to all its shareholders and other stakeholders”. It is strong
fundamentals and ethical behavior in a company that can
help it overcome huge crisis. Compliance with good
governance practices should not be regarded as regulatory
requirement but rather as an opportunity and value
proposition for organisations. Investors all around the world
notice companies with clean governance, and this
appreciation leads to higher valuation of such organisation.

Some positive steps towards improving Corporate

Governance:

• Codes of conduct and whistle blower policies are

important, but more important is how they are
communicated and practiced. It is vital for board members
and senior management to lead by example.
• The concept of having independent directors is a good one
in theory but more important is the process underlying
selection of independent directors – is this process rigorous,
transparent and objective and is it aligned to the company’s
needs?

• It is important to focus on not just earnings but on the

sustainability of business models.There is a need to focus on
not just “How much?” but on “How?”, “At what cost?” and
“At whose expense?”

• Rating agencies need to develop criteria that focus on

substance rather than the form of governance.

• Compensation of executive directors should flow from an

objective performance evalution process conducted by the
board

• Greater transparency and disclosure of executive

performance criteria are required which should include
financial and non-financial measures

• Regulators should send clear signals that they shall be

proactive in imposing substantial penalties for non-
compliance, so that compliance is strictly adhered to.