CHARACTERISTICS OF CORPORATE GOVERNANCE IN INDIA

Corporate Governance
The primary purpose of corporate leadership is to create wealth legally and ethically. This translates to bringing a high level of satisfaction to five constituencies -- customers, employees, investors, vendors and the society-at-large. The raison d'tre of every corporate body is to ensure predictability, sustainability and profitability of revenues year after year. N R Narayana Murthy

History of Corp Gov in India

Unlike South-East and East Asia, the corporate governance initiative in India was not triggered by any serious nationwide financial, banking and economic collapse Also, unlike most OECD countries, the initiative in India was initially driven by an industry association, the Confederation of Indian Industry
In December 1995, CII set up a task force to design a voluntary code of corporate governance The final draft of this code was widely circulated in 1997 In April 1998, the code was released. It was called Desirable Corporate Governance: A Code Between 1998 and 2000, over 25 leading companies voluntarily followed the code: Bajaj Auto, Hindalco, Infosys, Dr. Reddys Laboratories, Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI and many others

History of Corp Gov in India

Following CIIs initiative, the Securities and Exchange Board of India (SEBI) set up a committee under Kumar Mangalam Birla to design a mandatory-cumrecommendatory code for listed companies The Birla Committee Report was approved by SEBI in December 2000 Became mandatory for listed companies through the listing agreement, and implemented according to a rollout plan

History of Corp Gov in India

Following CII and SEBI, the Department of Company Affairs (DCA) modified the Companies Act, 1956 to incorporate specific corporate governance provisions regarding independent directors and audit committees In 2001-02, certain accounting standards were modified to further improve financial disclosures. These were: Disclosure of related party transactions Disclosure of segment income: revenues, profits and capital employed Deferred tax liabilities or assets Consolidation of accounts

Constituents of Corp Gov

The Board of Directors
Pivotal role Accountable to stakeholders Directs management

The Shareholders & Stakeholders

To participate in appointment of directors To hold the BoD accountable for governance through proper disclosures

The Management
To act on the direction of the BoD To provide requisite information to the BoD for decision making To implement and monitor control systems

Rationale for Disclosures

An effective disclosure based regulation (DBR) implies greater responsibilities on the company directors, its management and advisers An effective DBR promotes investor activism Markets believe that perceived benefits outweigh perceived costs

Disclosure based Regulation Components & types of disclosure

Disclosures by whom Public Listed Cos. Intermediaries Stock Exchanges MARKET Mutual Funds Analysts & advisors Disclosures for whom Shareholders Investors Intermediaries Regulator Government Other stake holders

Disclosure Based Regulation

Components & types of disclosures Initial Disclosures Disclosures for raising capital by companies, mutual funds in offer documents Public Offers Private Placement Continuous disclosures financial / non-financial Frequency of disclosure Dissemination process electronic, physical, centralized, dispersed Accessibility of information

Disclosure Based Regulation

Initial Disclosures Continuous disclosures Corporate Governance Financial disclosures Risk based disclosures for intermediaries Disclosures for stock exchanges

Disclosures
Board of Directors: information that must be supplied
Annual, quarter, half year operating plans, budgets and updates Quarterly results of company and its business segments Minutes of the audit committee and other board committees Recruitment and remuneration of senior officers Materially important legal notices and claims, as well as any accidents, hazards, pollution issues and labor problems Any actual or expected default in financial obligations Details of joint ventures and collaborations Transactions involving payment towards goodwill, brand equity and intellectual property Any materially significant sale of business and investments Foreign currency and other risks and risk management Any regulatory non-compliance

Disclosures
Disclosures to shareholders in addition to balance sheet, P&L and cash flow statement
Board composition (executive, non-exec, independent) Qualifications and experience of directors Number of outside directorships held by each director (capped at director not being a member of more than 10 board-level committees, and Chairman of not more than 5) Attendance record of directors Remuneration of directors Relationship (familial or pecuniary) with other directors Warning against insider trading, with procedures to prevent such acts Details of grievances of shareholders, and how quickly these were addressed Date, time and venue of annual general meeting of shareholders

Disclosures
Disclosures to shareholders in addition to balance sheet, P&L and cash flow statement Dates of book closure and dividend payment Details of shareholding pattern Name, address and contact details of registrars and/or share transfer agents Details about the share transfer system Stock price data over the reporting year, and how the companys stock measured up to the index Financial effects of stock options Financial effects of any share buyback Financial effects of any warrants that are to be exercised Chapter reporting corporate governance practices

Disclosures
Disclosures to shareholders in addition to balance sheet, P&L and cash flow statement Detailed chapter on Management Discussion and Analysis focusing on markets, operations, finances, accounts, risks, opportunities and threats, internal control systems Consolidated financial statement, incorporating accounts of all subsidiaries (over 50% shares held by reporting company) Details of all significant related party transactions Detailed segment reporting (revenues, costs, operating profits and capital employed) Deferred tax liabilities and assets and debit/credit in the P&L for the reporting year

Disclosures
(A) Basis of related party transactions
I. A statement in summary form of transactions with related parties in the ordinary course of business shall be placed periodically before the audit committee. II. Details of material individual transactions with related parties which are not in the normal course of business shall be placed before the audit committee. III. Details of material individual transactions with related parties or others, which are not on an arms length basis should be placed before the audit committee, together with Managements justification for the same

Disclosures
(B) Disclosure of Accounting Treatment To disclose in the financial statements, if an accounting treatment other than prescribed in Accounting Standard has been followed alongwith explanation.

(C)

Board Disclosures management

Risk

Internal and external business risks Procedures to inform Board members about the risk assessment and minimization. Periodically reviewed

Disclosures
(D) Proceeds from public issues, rights issues, preferential issues etc. To disclose to the Audit Committee, on use/application of funds as and when any issue is made (E) Additional disclosures: In the Annual Report the criteria of making payments to NEDs to be disclosed or a reference to be made that the same is available on the companys website number of shares and convertible instruments held by NEDs. NEDs shall disclose their shareholding (both own or held by / for other persons on a beneficial basis) in the company in which they are proposed to be appointed as directors, prior to their appointment.

Disclosures
F) Management A Management Discussion and Analysis report to form part of the Annual Report. G) Shareholders Disclosures to shareholders in case of appointment /reappointment of directors, quarterly results and presentations made, shareholders grievance committee and share transfer committee, shareholding pattern-change

CEO/CFO certification
The CEO, i.e. Managing Director and the CFO i.e. whole-time Finance Director or head of the finance function to certify to the Board that: (a) They have reviewed financial statements and the cash flow statement for the year and these statements:
(i) do not contain any materially untrue statement or omit any material fact or contain statements that might be misleading; (ii) together present a true and fair view of the companys affairs and are in compliance with existing accounting standards, applicable laws and regulations.

(b) no transactions entered into by the company during the year which are fraudulent, illegal or violative of the companys code of conduct.

CEO/CFO certification (contd)

(c)They accept responsibility for establishing and maintaining internal controls and that they have evaluated the effectiveness of the internal control systems of the company and they have disclosed to the auditors and the Audit Committee, deficiencies in the design or operation of internal controls, if any, of which they are aware and the steps they have taken or propose to take to rectify these deficiencies. (d)They have indicated to the auditors and the Audit committee
(i) Significant changes in internal control during the year; (ii) Significant changes in accounting policies during the year and that the same have been disclosed in the notes to the financial statements; and (iii)Instances of significant fraud of which they have become aware and the involvement therein, if any, of the management or an employee having a significant role in the companys internal control system

Board composition and structure

Some key functions should be fulfilled by Board:

Strategy formulation, budgets, business plans, etc. Monitoring the effectiveness of the companys governance practices;. Selecting, compensating, monitoring key executives and overseeing succession planning. Executive and board remuneration; Ensuring a formal and transparent board nomination and election process. Monitoring and managing potential conflicts of interest of management, board members and shareholders, including misuse of corporate assets and abuse in related party transactions. Ensuring the integrity of the corporations accounting and financial reporting systems, including the independent audit, ensuring control systems for risk management, financial and operational control, and compliance. Overseeing the process of disclosure and communications.

Ability to exercise independent decision:

The most current theme is the number and role of independent directors Sufficient independent directors Mandate of committees to be clear

Who are Independent Directors

a. As per Clause 49 of the Listing Agreements an independent director shall mean non-executive director of the company who apart from receiving directors 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; is not related to promoters or management at the board level or at one level below the board; has not been an executive of the company in the immediately preceding three financial years; 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. is not a supplier, service provider or customer of the company. This should include lessor-lessee type relationships also; and is not a substantial shareholder of the company, i.e. owning two percent or more of the block of voting shares. [Institutional directors on the boards of companies shall be considered as independent directors whether the institution is an investing institution or a lending institution.]

b.
c. d.

e. f.

Selection of Independent Director

The selection and appointment of independent directors should be transparent and on certain valued basis. Therefore, the companies should have an entirely independent nomination committee which should determine the qualifications for Board membership and should identify and evaluate candidates for nomination to the Board. It would be more appropriate that the code of Corporate Governance of a company should specifically include the qualifications and attributes that the company seeks of an independent director. A critical element of a director being independent is his independence to the management both in fact and perception by the public. In considering the independence, it is necessary to focus not only on whether a director's background and current activities qualify him as independent but also whether he can act independently of the management. In other words, the independent directors must not only be independent according to the legislative and stock exchange listing standards but also independent in thought and action i.e. qualitatively independent. Such qualitative independence will ensure that directors think and act independently without regard to management's influence.

Roles & Responsibilities

The role and responsibility of an individual director, of course, would depend upon the nature of his directorship. Broadly, there are three types of directors. Full time, executive director who is normally a paid employee of a company having some functional responsibility. Non executive but non independent director who is normally a promoter of the company or having high stakes in the company. And finally independent directors who are not full time directors. There is another class of directors known as nominee directors representing some interests like lending institutions etc. An executive director, by very nature has much more responsibilities than non executive directors. In law it is their responsibility to ensure compliance with provisions of law failing with they could be held liable as officers in default. As far as independent directors are concerned, the position of law is nebulous.

Role of Independent Directors

Independent directors broadly fit into the overall structure of corporate governance, and are necessary to ensure effective, balanced boards The board is the most significant instrument of corporate governance Role Of Independent Directors The non-executive directors should: * Contribute to and constructively challenge development of company strategy. * Scrutinize management performance. * Satisfy them that financial information is accurate and ensure that robust risk management is in place. * Meet at least once a year without the chairman or executive directors - and there should be a statement in the annual report saying whether such meetings have taken place. * Be prepared to attend AGMs and discuss issues relating to their roles (especially chairmen of committees). * Have a greater exposure to major shareholders (particularly the senior independent director). Effectiveness of the board as the oversight body to oversee what the management does Is there a better way to do it, in view of Recent scandals of disclosures and audits Size and scope of present day enterprise Complexity of operations

Responsibilities of Independent Directors

Independent Director shall however periodically review legal compliance reports prepared by the company as well as steps taken by the company to cure any taint. In the event of any proceedings against an independent director in connection with the affairs of the company, defence shall not be permitted on the ground that the independent director was unaware of this responsibility. To function to properly according to the spirit of corporate governance as o director on the board and as Member/Chairman across various committees viz. the Audit Committee, the Shareholders Grievance Committee and the Remuneration Committee of the company. A director shall not be a member in more than 10 committees or act as Chairman of more than five committees across all companies in which he is a director. Furthermore it should be a mandatory annual requirement for every director to inform the company about the committee positions he occupies in other companies and notify changes as and when they take place. At least one independent director on the Board of Directors of the holding company shall be a director on the Board of Directors of the subsidiary company.

Independent Directors under Listing Agreement in India

Composition of the Board: Not less than 50% of the board to be non-executive directors Independent Directors: If the chairman executive: At least half of the board should comprise of independent directors If Chairman non-executive: At least one- third of the board should comprise of independent directors Non-executive directors remuneration to be approved by shareholders Board meetings to meet at least 4 times, with gap not exceeding 3 months. Minimum information for board meetings laid down Committees of Directors Audit Committee: requirements other than those u/s 292A shall have minimum 3 members all of them being non-executive and majority of them being independent Chairman of the committee shall be an independent director To meet at least thrice a year Company Secretary to act as secretary to the committee Remuneration Committee Shareholders/Investors Grievance Committee Limits on committee memberships and chairmanships

 There cannot be a single prescription for all companies

Number may be prescribed by rules

Recommendations of the Irani Committee on Independent directors

A minimum one third recommended for a company having public interest Nominees of institutions should not be considered independent as they represent sectional interests Suggests a definition:
Based on pecuniary interest that may affect independence Lays some statutory illustrations of situations where independence does not exist

Independent directors should make self-declaration of eligibility to be so appointed

Companies Act and Independent Directors

The Companies Act looks at all directors alike:
Throws some extra compliances in case of whole time directors Requires some disclosures by interested directors Defines officer in default giving a degree of immunity to directors other than the whole time directors

Does not exempt independent directors from any of the duties, liabilities, responsibilities of the Board Independent directors as much as part of the corporate governance team as any other director Independent directors have the same power that other directors have

NEW COMPANIES ACT

Provisions like mandatory internal audit for specific companies, Provision for rotation of auditors, Increased role of audit committee, Restriction on providing certain specified services by auditors and restricting the financial year to April to March without any provision of extension, Place more responsibilities and accountability on company management.

NEW COMPANIES ACT

In order to ensure investor protection, powers have been given to courts and tribunals to reopen accounts and the Serious Fraud Investigation Office has been designated as the main investigating agency for frauds relating to companies.

NEW COMPANIES ACT

Under the provisions of new Act, much emphasis has been laid on good governance practices and better disclosures. The new law has kept in mind the necessity of transparency in corporate functioning and has provided for provisions for better disclosure like statement of compliances of all laws in board reports, more disclosures in financial statements and includes associated companies and joint ventures in the ambit of consolidated accounts. It also mandates applicability of postal ballot for private companies, introduces auditing and secretarial standards, envisages mandatory appointment of independent directors and further mandates the requirement of quorum of a general meeting based on number of members in the company. The new Act, with an aim to strengthen the rights of minority stakeholders, has introduced the concept of class action suits, which are already well established in countries like the UK and the US.

NEW COMPANIES ACT

Not only does it give more power to stakeholders, it also tends to enhance the sense of responsibility and diligence of companies. However, the benefit of class action suits has only been extended to members and deposit holders whereas for now, other stakeholders such as creditors, bankers, debenture holders are still not covered under its purview. Another step designed for investor protection under the new law is the provision of an exit opportunity for dissenting shareholders on variation in terms of contract or objects in a prospectus. The new law envisages that whenever there is a change in the terms of contract or objects in a prospectus, dissenting shareholders shall be given an exit opportunity by the promoters or controlling shareholders at a definitive exit price.