Corporate Governance in India
Corporate governance is one of the oldest concepts that date back to the 19th century. It holds its relevance in relation to the profitability, expansion and business continuity. The collapse of high profile companies, such as Enron and WorldCom, due to unethical business behaviour followed brought into the significance of implementing corporate governance in the organisations.
Table of Content
- 1 Corporate Governance in India
- 2 Legal Statutes and Committees
- 3 SEBI Guidelines
- 4 Accounting Standards Issued by the ICAI
- 5 Listing Agreements With the Stock Exchange
- 6 Kumar Mangalam Birla Committee
- 7 Cadbury Committee
- 8 Corporate Governance and Ethics Committee
- 9 Reports on Corporate Governance
- 10 RBI Report on International Financial Standards and Code (March 2011)
- 11 Reports of Naresh Chandra Committee I (2002) and II (2003)
- 12 Murthy Report
- 13 Violation of SEBI’s Takeover Guidelines
Corporate governance is a multi-level and multi-tiered process that is distilled from an organisation’s culture, its policies, values and ethics, especially of the people running the business and the way it deals with various stakeholders.
For the duration of 1947 to 1991, the socialist policies were followed and implemented by the Indian Government, where all banks were nationalised and were responsible for funding private business organisations.
The main criterion for providing funds was capital investment only. Moreover, the government did not promote foreign investment so as to restrain competition. Private companies offering equity and debt had to undergo many complications, while public companies had to just comply with limited governance and disclosure standards given in the Companies Act 1956, the Listing Agreement, and the accounting standards given by the Institute of Chartered Accountants of India (ICAI).
When in 1991, India came across a fiscal crisis, the then Finance Minister Mr. Manmohan Singh brought many economic liberalisation reforms. Securities and Exchange Board of India (SEBI) was founded in 1992 with the aim of regulating the securities market.
The need for capital formed the framework for the concept of corporate governance in 1996 after economic liberalisation and deregulation of businesses and industries took place. It helped in developing a strong financial system that further helped in stimulating the growth of economy.
According to La Porta (1997), Effective corporate governance enhances access to external financing by firms, leading to greater investments as well as higher growth and employment. The proportion of private credit to GDP in countries in the highest quartile of creditor right enactment and enforcement is more than double that in the countries in the lowest quartile.
Legal Statutes and Committees
Corporate governance is a process that defines the set of laws and provides directions and guidelines to corporations for tracking the actions of the management and finding as well as mitigating the risk associated with it. Various legal laws and committees have been formed to protect the rights of shareholders. Let us discuss these committees in the next sub-sections.
Companies Act, 1956
The Companies Act, 1956 is an Act of the Parliament of India. Enacted in 1956, it enables companies to be formed by registration, and set out responsibilities of companies, their directors and secretaries.
The Companies Act, 1956 is governed by the Ministry of Corporate Affairs, Government of India as well as the Office of Registrar of Companies, Official Liquidators, Company Law Board, and so on.
This Act contains all the provisions on following:
- Forming a company
- Fee procedure
- Registration of name
- Board members of the company
- Company’s motive
- Issue of share
- Board meetings
- Responsibilities and liabilities of the company
- Winding up process
The Companies Act, 1956 provides the power to the Central Government for registering the formation of a company, its functioning and winding up procedure. According to this Act, the Central Government has the right to examine the books of a company, conduct special audit, inspect the company’s processes, and act against any violation made by the company.
This helps in knowing that if any unethical or unfair practices are followed by the company that may affect the interest of various parties involved such as shareholders, creditors, customers and employees.
Companies Act, 2013
The Companies Act, 2013 was passed by the Parliament of India on 29th August 2013. It regulates the incorporation, responsibilities and dissolution of a company. It is divided into 29 chapters containing 470 sections as against 658 Sections in the Companies Act, 1956 and has 7 schedules.
The Companies Act, 2013 replaced the Companies Act, 1956 after getting the permission from the President of India. It was enforced in September, 2013 after making few changes. Some of the changes or new provisions made in this Act are as follows:
One Person Company
It means a company has only one person as a member and at least one director. According to Sec 3 (1) of 2013 Act, The 2013 Act introduces a new type of entity to the existing list, i.e. apart from forming a public or private limited company, the 2013 Act enables the formation of a new entity ‘one-person company’ (OPC). An OPC means a company with only one person as its member. Holding annual meeting is not necessary in this company.
It is mandatory that every Listed Company/ Public Company with paid up capital of ₹100 crore or more/Public Company with turnover of ₹300 crore or more should have at least one Woman Director.
A company with net worth of ₹500 crore or more or turnover of ₹1000 crore or more should be a part of corporate social responsibility committee.
According to Sec 455 of 2013 Act, A company can be classified as dormant when it is formed and registered under 2013 Act for a future project or to hold an asset or intellectual property and has no significant accounting transaction. Such company should register for obtaining the status of a dormant company.
According to Sec 2 (59) of 2013 Act, The definition of officer has been extended to include promoters and key managerial personnel.
Key Managerial Personnel
According to Sec 2 (51) of 2013 Act, The term ‘key managerial personnel’ has been defined in the 2013 Act and has been used in several sections, thus expanding the scope of persons covered by such sections.
According to Sec 2 (69) of 2013 Act, The term ‘promoter’ has been defined in the following ways:
- A person who has been named as such in a prospectus or is identified by the company in the annual return referred to in Section 92 of 2013 Act that deals with annual return; or
- who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or
- in accordance with whose advice, directions or instructions, the Board of Directors of the company is accustomed to act. The proviso to this section states that sub-section (c) would not apply to a person who is acting merely in a professional capacity.
According to Sec 2 (47), 149 (5) of 2013 Act, The term ‘Independent Director’ has now been defined in the 2013 Act, along with several new requirements relating to their appointment, role and responsibilities. Further some of these requirements are not in line with the corresponding requirements under the equity listing agreement.
According to Sec 2 (87) of 2013 Act, The definition of subsidiary as included in the 2013 Act states that certain class or classes of holding company (as may be prescribed) shall not have layers of subsidiaries beyond such numbers as may be prescribed. With such a restrictive section, it appears that a holding company will no longer be able to hold subsidiaries beyond a specified number.
According to Sec 2 (41) of 2013 Act, It has been defined as the period ending on the 31st day of March every year, and where it has been incorporated on or after the 1st day of January, the period ending on the 31st day of March of the following year, in respect whereof financial statement of the company or body corporate is made up.
The Securities and Exchange Board of India (SEBI) was formed in 1988. However, it was given statutory powers in 1992 with the aim of regulating the securities market. It is headquartered in Mumbai with its offices in New Delhi, Kolkata, Chennai and Ahmedabad. Initially, SEBI was formed as a non-statutory; however in 1992, the Government of India provided it statutory powers by passing a special resolution.
According to Management of the Board, SEBI (Sec 4),
- The Board shall consist of the following members, namely:
- A Chairman;
- Two members from amongst the officials of the Ministry of the Central Government dealing with Finance and administration of the Companies Act, 1956;
- One member from amongst the officials of the Reserve Bank;
- Five other members of whom at least three shall be the wholetime members to be appointed by the central Government.
- A Chairman;
- The general superintendence, direction and management of the affairs of the Board shall vest in a Board of members, which may exercise all powers and do all acts and things which may be exercised or done by the Board.
- Save as otherwise determined by regulations, the Chairman shall also have powers of general superintendence and direction of the affairs of the Board and may also exercise all powers and do all acts and things which may be exercised or done by that Board.
- The Chairman and members referred to in clauses (a) and (d) of sub-section (1) shall be appointed by the Central Government and the members referred to in clauses (b) and (c) of that sub-section shall be nominated by the Central Government and the Reserve Bank, respectively.
- The Chairman and other members referred to in clauses (a) and (d) of sub-section (1) shall be persons of ability, integrity and standing who have shown capacity in dealing with problems relating to securities market or have special knowledge or experience of law, finance, economics, accountancy, administration or in any other discipline which, in the opinion of the Central Government, shall be useful to the Board.
The main functions of SEBI are as follows:
- Safeguarding the vested interest of the investors in securities market
- Supporting the development of the securities market
- Controlling and directing the stock exchange
- Regulating and directing the securities market
- Promoting awareness among investors
- Registering and directing the functioning of Venture Capital Funds and Mutual Funds
- Registering and tracking the functioning of Foreign Institutional Investors (FIIs) and Credit Rating Agencies
- Regulating and controlling any unfair or fraudulent trade activities
Accounting Standards Issued by the ICAI
The Institute of Chartered Accountants of India (ICAI) is a corporate body that works under the Chartered Accountants Act, 1949 and was constituted by the Parliament of India. It is a financial audit regulating body that is ranked as the second largest professional accounting body.
ICAI is also known for providing license to the accounting professionals as well as for setting auditing and assurance standards. It is closely associated with Government of India, RBI and SEBI for framing and implementing these standards.
According to Accounting Standards Board, As of 2010, the Institute of Chartered Accountants of India has issued 32 Accounting Standards. These are numbered AS-1 to AS-7 and AS-9 to AS-32 (AS-8 is no longer in force since it was merged with AS-26).
Compliance with accounting standards issued by ICAI has become a statutory requirement with the notification of Companies (Accounting Standards) Rules, 2006 by the Government of India.
The Accounting Standards that are mandatory as on 1st September, 2014 are as follows:
- AS 1 Disclosure of Accounting Policies
- AS 2 Valuation of Inventories
- AS 3 Cash Flow Statements
- AS 4 Contingencies and Events Occurring after the Balance Sheet Date
- AS 5 Net Profit or Loss for the period, Prior Period Items and Changes in Accounting Policies
- AS 6 Depreciation Accounting
- AS 7 Construction Contracts (Revised 2002)
- AS 9 Revenue Recognition
- AS 10 Accounting for Fixed Assets
- AS 11 The Effects of Changes in Foreign Exchange Rates (revised 2003)
- AS 12 Accounting for Government Grants
- AS 13 Accounting for Investments
- AS 14 Accounting for Amalgamations
- AS 15 Employee Benefits (revised 2005)
- AS 16 Borrowing Costs
- AS 17 Segment Reporting
- AS 18 Related Party Disclosures
- AS 19 Lease
- AS 20 Earnings Per Share
- AS 21 Consolidated Financial Statements
- AS 22 Accounting for Taxes on Income
- AS 23 Accounting for Investments in Associates in Consolidated Financial Statements
- AS 24 Discontinuing Operations
- AS 25 Interim Financial Reporting
- AS 26 Intangible Assets
- AS 27 Financial Reporting of Interests in Joint Ventures
- AS 28 Impairment of Assets
- AS 29 Provisions, Contingent Liabilities and Contingent Assets
The non-mandatory Accounting Standards are as follows:
- AS 30 Financial Instruments: Recognition and Measurement and Limited Revisions to AS 2, AS 11 (revised 2003), AS 21, AS 23, AS 26, AS 27, AS 28 and AS 29
- AS 31, Financial Instruments: Presentation
- Accounting Standard (AS) 32, Financial Instruments: Disclosures, and limited revision to Accounting Standard (AS) 19, Leases
Listing Agreements With the Stock Exchange
When a company listed on the stock exchange agrees on implementing the regulations of stock exchange and signs an agreement, it is known as listing agreement. When a company is listed on the stock exchange, then it means that the company has been granted permission to deal in the specific stock exchange.
When a company agrees to get listed on the stock exchange, then it has to follow various clauses. According to Bombay Stock Exchange (BSE), these clauses are as follows:
The Company is required to close its transfer books at least once a year at the time of the Annual General Meeting if it has not been otherwise closed at any time during the year. The Company must ensure that there is a gap of at least 30 days between 2 book closure and/or record date.
The Company shall give an advance notice of at least 7 working days (Excluding the date of the intimation and record date/book closure start date) to the Stock Exchange for corporate actions (Book closure/Record date) fixed for the purpose of corporate benefits like mergers, de-mergers, split, bonus, dividend, rights, etc.
The Company shall give an advance notice of at least 2 working days (Excluding the date of the intimation and date of the meeting) to Stock Exchange, of board meeting fixed for recommendation or declaration of a dividend or convertible debentures or of debentures carrying a right to subscribe to equity shares or the passing over of the dividend or the issue of right or proposal for buyback of securities is to be considered.
Further, the company will recommend or declare all dividend and/or cash bonuses at least five days before commencement of the book closure or record date fixed for the purpose.
The Company has to intimate the outcome of the board meeting (as intimated under clause 19) immediately on the day of board meeting once concluded. Further, the company shall intimate to the Stock Exchange the date on which dividend shall be paid/dispatched.
The Company has to intimate to the Stock Exchange of any change in the Issuer’s directorate by death, resignation, removal or otherwise; of any change of Managing Director, Managing Agents or Secretaries and Treasurers; of any change of Auditors appointed to audit the books and accounts of the Issue.
The Company is required to submit to the Stock Exchange certified copy of amended Memorandum and Articles of Association of the company.
The Company shall give an advance notice of at least 7 clear calendar days (Excluding the date of the intimation and date of the meeting) to the Stock Exchange, of board meeting fixed to consider financial results.
In case the company opts to submit unaudited financial results, they shall be subjected to limited review by the statutory auditors of the issuer (or in case of public sector undertakings, by any practicing Chartered Accountant) and such limited reviewed results (financial results accompanied by the limited review report) shall be submitted within forty-five days from the end of the quarter.
Kumar Mangalam Birla Committee
Mr. Kumar Mangalam Birla in collaboration with SEBI founded a committee in 1999. It was known as the Kumar Mangalam Birla Committee that had 18 members and had the aim of advancing the standards of corporate governance.
This committee was crucial in developing a Code of Corporate Governance in India with respect to the current market conditions of Indian companies and capital market. It was responsible for realising the importance of Annual General Meeting (AGM) as it maintained that it will help in knowing the concerns and issues related to shareholders.
Moreover, the Committee suggested that while selecting a director for the company, shareholders should be provided information regarding director’s educational qualification specialisation, and give the details of the organisations where he is already working as a director.
The Committee also provided the following recommendations:
- Quarterly reports should be made public on the company’s website and also provided to the stock exchange where it is listed.
- Sharing semi-annual financial results with the shareholders’ as well as the key financial decision taken
- Encouraging shareholders’ participation and right to vote
- Redressal of shareholders’ grievances or complaints
According to the Report of the Committee on the Financial Aspects of Corporate Governance (1992), The Cadbury Committee was appointed by the Conservative Government of United Kingdom in 1991 with a broad mandate to address the financial aspects of corporate governance.
The Chairman of this Committee was Mr. Adrian Cadbury who was responsible for defining the best practices followed by organisations.
The first report of the Cadbury Committee was published in December, 1992 that gave the regulations to be followed for implementing best practices. It divided the roles in four different sections and provided following recommendations:
- Board of directors: It is important to conduct regular meeting of board of directors for controlling the organisation and monitoring its functioning. Non-executive directors should be part of the board of directors and should be equal in number such that they can also take equal part in the board’s decision-making process.
- Non-executive directors: They should be able to provide unbiased judgement on the matters related to organisational strategy, performance, or code of conduct. They should be hired as non-executive directors for specific purpose and their reappointment should not be direct.
- Remunerations: Directors should not hold a financial interest in the organisation. Moreover, the remuneration committee should include non-executive directors for the purpose of deciding director’s remuneration. This will help in deciding upon fair remuneration to the directors without any vested interest.
- Providing details regarding any financial query: The balance sheet of the organisation should be made available to the shareholders. Moreover, regular audit of the organisation should be conducted.
Corporate Governance and Ethics Committee
The National Association of Software and Services Companies (NASSCOM) set up Corporate Governance and Ethics Committee in 2009. The main aim of this Committee is to provide a framework where organisations in the Information Technology (IT) or Business Process Outsourcing (BPO) can follow good corporate governance practices.
The Committee discussed the role and responsibilities of the following:
- Board of directors: It discussed the responsibilities of the board of directors as mentioned under Clause 49 as well as disclosure about their qualifications, remuneration, evaluation and successions.
- Audit committee: The Corporate Governance and Ethics Committee defined that audit plays a crucial role in an organisation; thus, it is important to pay heed to constitution of audit committee, its charter, review and responsibilities of auditors in identifying any fraud or illegal activity.
- Shareholder empowerment: The committee identified that a twoway communication helps the organisation to grow and increase the trust of its investors. It allows the shareholders to participate and exercise their vote, and provides key information about the company and its directors to them.
Reports on Corporate Governance
SEBI establishes various committees to bring effectiveness in corporate governance practices of organisations. These committees work to establish corporate governance practices as per the requirement of the industry, society, organisation and international environment.
Frequent changes are made in these guidelines as per the level of development and modernisation taking place in the country. Various reports have been published that we will discuss in the next sub-sections.
The Confederation of Indian Industry (CII) has played a crucial role in the industrial development of India. It helps in sustaining an environment that is conducive to the development of India. It is a non-profit organisation that was established in 1895. CII is closely associated with the Government of India on the matters related to competence and growth of economy.
Some of the recommendations given by the CII report are as follows:
- A listed organisation, whose revenue is more than ` 100 crore should have professionally qualified, independent and non-executive directors. They should comprise:
- Minimum 30 per cent, when the Chairperson of the board is a non-executive director
- Minimum 50 per cent, when the Chairperson and Managing Director is the same person
- Minimum 30 per cent, when the Chairperson of the board is a non-executive director
- One single person should not be director in more than 10 companies.
- It is the responsibility of the non-executive director to be more actively involved in the decision-making process of the organisation.
- When taking the decision related to reappointment, it is important to review the attendance record of the non-executive director.
- Key information given to board should include annual operating plans and budget; capital and overhead budgets; quarterly financial reports of the organisation.
RBI Report on International Financial Standards and Code (March 2011)
As capital markets become global in nature, many countries such as Australia, France, Germany and Mexico recognise the need for harmonising the global accounting practices and policies. Thus, the International Accounting Standards Committee (IASC) was constituted in 1973.
The standards issued by IASC were called International Accounting Standards (IAS). In 2001, IASC was reformed as International Accounting Standards Board (IASB). The standards issued by IASB are called International Financial Reporting Standards (IFRS).
The IFRS set rules for preparing and presenting the financial statement. The IAS that get revised are issued as IFRS. In India, in April 2012, ICAI announced that IFRS are mandatory for financial statement but this plan failed. Till now, there is no clear adoption of IFRS and many Indian companies are following Indian Generally Accepted Accounting Principles (GAAP).
RBI has formed a Working Group for addressing the implementation issues and guidelines related to IFRS for Indian banking system.
IFRS would help India to have access to international capital markets. The main benefits of IFRS are that it leads to lowering the cost of raising funds, enable faster access in markets and reduction in accounting fees. In India, IFRS will be mandatory from the Financial Year 2016–17.
Reports of Naresh Chandra Committee I (2002) and II (2003)
The Naresh Chandra Committee I was formed in August, 2002 with the aim of addressing various issues related to corporate governance. It gave insightful recommendations on the following:
- The relationship between auditor and company
- List of services that are not allowed in audit
- Appointing an auditor
- Providing training to independent directors
- Disclosing contingent liabilities
- Disclosing professional qualifications of the director
Besides these issues, the Committee was responsible for taking issues raised by Kumar Mangalam committee one step ahead. The Naresh Chandra Committee Report is also known as ‘Corporate Audit and Governance Report’.
The Naresh Chandra Committee has given stringent guidelines regarding the professional relationship between the auditors and the customers. Moreover, it believed that auditors should be regarded with more freedom and gave following recommendations for the auditing firms:
- Accurately disclose the audit findings without any biasness
- While verifying or certifying the accounts of company, it is important for auditing committee to be assured that Chief Executive Officer (CEO) or Chief Financial Officer (CFO) is present at that time
For revisiting the laws related to private companies, Indian government constituted a committee in 2003 called Naresh Chandra Committee II. It was constituted for suggesting a rational regulatory environment for the private companies. Naresh Chandra Committee II gave the report on the regulation of private companies and partnership.
The recommendations given by the Committee are as follows:
- Providing adequate flexibility to companies/firms conducting, or intending to conduct business or provide professional services;
- Providing a structural environment conducive to growth and prosperity of the entities, being mindful of the impact on various stakeholders, and effective regulation in a manner that minimises and deters exploitation of the liberalised provisions by unscrupulous elements; and
- Simplifying and rationalising entry and exit procedures (especially for non-functional companies)
The Narayana Murthy Committee was formed in February, 2003 for encouraging corporate governance practices and evaluating the current practices followed by companies in India.
The main aims of the Committee were following:
- Measuring the corporate governance performance
- Identifying and specifying the role of independent directors
- Observing and evaluating the role of organisations when dealing with rumour or price-sensitive issues
- Advancing and promoting transparency and integrity
The Narayana Murthy Committee came forward with some mandatory and non-mandatory recommendations. The mandatory recommendations are as follows:
- Timely disclosure of financial and audit reports
- Discussing financial and managerial issues
- Reporting risk management
- Preparing reports on current transactions
The non-mandatory recommendations include the following:
- Managing the performance of directors
- Providing training to the board of directors for their roles
Violation of SEBI’s Takeover Guidelines
Nowadays, takeover of companies is a popular and easy-to-follow strategy for corporate growth. According to this strategy, an ‘acquirer’ acquires a significant amount of shares characterised by voting rights in the ‘Target Company’. It is important to note that the process of takeover can be in either direct or indirect manner with an objective to obtain control over the management of the target company.
The process of takeover comes with several economic implications in an economy. Acquiring substantial shares in a target company by the acquirer affects the existing shareholders. Therefore, it is important for the acquirer to comply with shareholding/ disclosure norms under SEBI’s takeover code.
As per the norms, the acquirer has to make an open offer to the public shareholders of the target company if the acquisition of shares exceeds the threshold level. In addition, they have to disclose their holding to the exchanges on a continual basis.
The norms stipulated by the SEBI have been made for safeguarding the interest of an investor. However, there are numerous cases revealing that Indian investors have been victimised of malpractices in the context of ‘takeover’.
The involvements of big Indian corporate houses are often seen in undesirable takeover practices resulting negative outcomes over the Indian capital markets and their investors. The untimely disclosure of shareholding and acquisition of shares over the stipulated limit without making an open offer causes loss to small investors.
In order to protect the interest of these investors, SEBI has formulated regulations for Substantial Acquisition of Shares (SAST). Any violation of SEBI (SAST) regulations will lead to monetary penalties or debarment from accessing capital markets.
- Regulations to protect the interest of investors:
|SEBI Takeover Regulations 2011|
|Regulation 3–11||Substantial acquisition of shares with voting rights||Provides threshold limit for open offer and exemptions|
1. Open offer for crossing initial threshold – 25%
2. Open offer for creeping acquisition limit 5%
|Regulations 12–23||Open offer process||Deals with concepts related to open offer|
|Regulations 24–27||Other obligations||Obligations of acquirer, target company, merchant banker|
|Regulations 28–31||Disclosure norms||Provides limits for making disclosures|
- A Takeover Regulations Advisory Committee (TRAC) was set up by SEBI in September 2009. This Committee examines the existing takeover regulations and suggests suitable amendments to it.
Let us discuss an example of unhealthy takeover practices done by Reliance Industries Limited (RIL) followed by the SEBI’s action.
In March 2011, the combined shareholding of RIL, RIIHL and Reliance Capital Limited (Reliance Group) in L&T was 6.62% and decreased to 3.92% in October 2011. RIL increased its stake in L&T to over 10%. Thereafter, it sold the entire lot to Aditya Birla Group (Grasim).
According to the SEBI takeover regulations, any company which that buys more than 5% shares of another company (Target Company) has to inform the target company. However, in this case, RIL did not inform L&T when its stake in the company crossed the aforesaid limit. When RIL sold over 10% of its stake in L&T to Grasim, Investors Grievance Forum (IGM) complained to SEBI saying that RIL did not disclose any information regarding its purchase of shares in October 2011 and November 2011.
Hence, RIL violated the takeover regulations of the SEBI. So, a penalty of ₹4.75 lakh was imposed by SEBI on Reliance Industries Ltd. for the violation of takeover code while increasing its stake in L&T in 2011.