External Corporate Governance

External Corporate Governance

An organisation does not work in isolation and is driven by several macro factors such as markets, service providers, media and government of a country. As discussed earlier, corporate governance focuses on the interests of both internal and external stakeholders.

In the previous post, we studied the role of internal stakeholders in corporate governance. Now, let us explore the role of external stakeholders in the corporate governance practices of an organisation.

Role of Government

Every country has some minimum legislative requirements to be followed by organisations operating in that country. For instance, in India, organisations need to abide by the Company Act, 1956 and other listing requirements.

However, some organisations are subject to further external control by the government. Such control is exercised by the government on those organisations or sectors that are strategically and politically important to the government, for example, defence and medical supplies.

The government exercises control by setting regulations related to pricing, supply contracts and tax. Moreover, it is responsible for preventing malpractices such as formation of monopolies or illegal supply of utilities such as power, water and energy. Regulations are levied to protect the interests of stakeholders; thereby attracting more investors and increasing tax revenues in the country.

Role of SEBI and Other Regulators

For a long time, the concept of corporate governance was an alien concept to Indian businesses. There were weak governance norms, which were evident in India’s huge public sector and nationalised banks. After the fiscal crisis of 1991, the Indian government rolled down a series of liberalisation, privatisation and globalisation reforms.

This brought new governance models that focussed on new business opportunities and funding avenues. In addition, a need of a mechanism to check the capital market and keep the trust of investors intact was felt. Consequently, to develop India’s capital market, the Central Government established the Securities and Exchange Board of India (SEBI).

SEBI is an independent statutory authority that regulates the securities market in India. It has delegated powers to two exchanges (Bombay Stock Exchange and National Stock Exchange) to ensure that their members adhere to the regulations and instructions of the authority.

SEBI has set out corporate governance standards for the listed organisations in India. Introduction of Clause 49 of the Listing Agreement is the most important step taken by SEBI for establishing a new corporate governance regime.

The Clause includes the following norms:

• Independent directors are appointed in the board
  
  
• Audit committee is appointed, composed and powers are given
  
  
• Investors’ grievances redressed committee and remuneration committee is functioned
  
  
• Compensation that is to be paid to non-executive directors
  
  
• Internal control of conduct is adhered by Board of Directors and other top executives
  
  
• Accounting policies, related party transactions, contingent liabilities and IP proceed utilisation needs to be disclosed
  
  
• Certification by CEO/CFO on adequacy of internal control system and correctness of the reported financials
  
  
• Whistle-blower policy

The above compliance terms contained in Clause 49 are required to be signed by the directors and auditors of the company and need to be annexed to the annual report. The companies that are listed in the stock market must submit a consolidated compliance report to SEBI within 30 days after the end of each quarter. After the enactment of Companies Act, 2013, SEBI introduced a new set of norms on corporate governance.

The key changes proposed by SEBI are as follows:

Board of Directors and Its Committees

• BoDs should maintain a healthy relationship with the stakeholders
  
  
• BoDs should form a nomination and remuneration committee having an independent chairman.
  
  
• BoDs shuld have at least one women director.
  
  
• The role of the audit committee should be increased.
  
  
• BoDs should engage in succession planning for the board positions and other key positions.

Independent Directors

• Nominee directors should not be considered as independent directors.
  
  
• Stock options should be prohibited.
  
  
• Performance of the independent directors should be evaluated compulsorily
  
  
• Independent directors cannot serve in more than 7 companies or in 3 companies, if serving as whole-time directors.
  
  
• Independent directors cannot serve for more than two terms of 5 years each.

Other Governance Aspects

• Getting prior approval of all material related party transactions from an audit committee
  
  
• Defining Companies Act and accounting standards
  
  
• Makings whistle-blowing mechanism compulsory
  
  
• Mandatory discloure of remuneration policy.
  
  
• Specifying principles of corporate governance
  
  
• Defining policy risk management

Promoters

A promoter is a person who performs the necessary formalities of registering a company, finding directors and shareholders for the new company, acquiring business assets and negotiating business contracts on behalf of the company. Promoters are usually considered to be the most important external actors in corporate governance.

In order to improve corporate governance practices in an organisation, the role of promoters is quintessential. Promoters and directors have a principal–agent relationship where the promoters (principals) expect the agents (directors) to act in their best economic interests and observe a fiduciary duty towards them.

Promoter-driven organisations outperform other organisations over the years, provided they are governed well. Investors are likely to invest in organisations that are proactively implementing better governance practices.

The characteristics of promoter-driven organisations are as follows:

• Separate ownership and management so as to establish a professional management team
  
  
• Farsighted mission and formal succession plan
  
  
• Unifying corporate culture and social responsibility
  
  
• Long-term relationship with suppliers and customers

Promoter-driven organisations aim to achieve environmental and social goals along with pursuing the goal of wealth creation. Promoters lead from the front and inculcate values and good governance practices.