Welcome to AJSH & Co.

Blog Banner

Corporate Governance: A New Start for Corporates

Meaning of Corporate Governance:

  • The system of rules, practices and processes by which a company is directed and controlled. Corporate governance essentially takes care of the interests of all the stakeholders in a company i.e. its shareholders, management, customers, suppliers, financers, government and the community.
  • Corporate governance broadly refers to the mechanisms, processes and relations by which corporations are controlled and directed to achieve their goals with legal compliance and social help.
  • Governance structures and principles identify the distribution of rights and responsibilities among different participants in the corporation (such as the board of directors, managers, shareholders, creditors, auditors, regulators, and other stakeholders) and suggests the policies for making decisions in corporate actions.
  • Corporate governance includes the processes by which corporations’ objectives are set and achieved within compliance of the social & regulatory environment.

Background/ Need for Corporate Governance:

  • In India, most companies are family-owned and/or closely held. Hence, the corporate governance framework in India should emphasize monitoring/regulating connected transactions involving controlling shareholders (so called “promoters”) and related entities.
  • In the wake of the Satyam fraud — in which the company chairman admitted in 2009 that the company’s accounts had been falsified, to the tune of some USD 1.5 billion, the need for reviewing India’s corporate governance framework came to the forefront. There was only technical compliance in that case, and decisions were taken without regard to the rationale underlying relevant accounting principles or whether the transactions made business sense. The Satyam case highlighted inadequacies in the existing legal provisions designed to prevent abusive Relate Party Transactions in India.
  • The Securities and Exchange Board of India Committee on Corporate Governance defines corporate governance as the “acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company.

Control, Ownership and Board Responsibilities:

  • Family interests dominate ownership and control structures of some corporations and the focus on family controlled corporations should be more than on corporations “controlled” by institutional investors or in which public held share capital.
  • The board is responsible for the successful continuation of the corporation. Board of directors are expected to play a key role in corporate governance.
  • The board has responsibility for: CEO selection and succession; providing suggestion to management on the strategy; compensating senior executives; monitoring financial health and performance; and ensuring accountability of the organization to its investors and authorities.
  • Corporate governance mechanisms and controls are designed to reduce the inefficiencies in day to day operations and decision of board. There are both internal monitoring systems and external monitoring systems.

Internal Corporate Governance Controls:

  • Monitoring by the board of directors:- Regular board meetings allow potential problems to be identified, discussed and avoided.
  • Internal control procedures and internal auditors:-  Internal control procedures are policies implemented by an entity’s board of directors, audit committee, management, and other personnel to provide reasonable assurance of the entity in achieving its objectives related to reliable financial reporting, operating efficiency, and compliance with laws and regulations.
  • Balance of power:- The President should be a different person from the Treasurer. This application of separation of power is further developed in companies where separate divisions check and balance each other’s actions.
  • Remuneration:- Performance based remuneration is designed to relate some proportion of salary to individual performance.
  • Monitoring by large shareholders and/or monitoring by banks and other large creditors

External Corporate Governance Controls:

External corporate governance controls encompass the controls external stakeholders exercise over the organization. Examples include:

  • Competition
  • Debt Covenants
  • Financial Statements
  • Government Regulations
  • Managerial Labour Market
  • Media Pressure
  • Takeovers

Clause 49: CEO/CFO Certification

Clause 49 required the CEO and CFO, to declare that they are responsible for establishing and maintaining internal controls which have been designed to ensure that all material information is periodically made known to them; and have evaluated the effectiveness of internal control systems of the company.

Director Responsibility Statement

To promote better disclosures and transparency, the 2013 Act, requires the company’s Annual Report to include a Director’s Responsibility Statement stating the following:

  • Applicable accounting standards had been followed in the preparation of the annual accounts
  • The directors have selected such accounting policies and applied them consistently and made judgments and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the company
  • Proper and sufficient care for the maintenance of adequate accounting records in accordance with the provisions of this Act for safeguarding the assets of the company and for preventing and detecting fraud and other irregularities
  • The annual accounts of the company are prepared on a going concern basis
  • The directors have laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively
  • The directors had devised proper systems to ensure compliance with the provisions of all applicable laws and that such systems were adequate and operating effectively.

Clause 49: Executive Remuneration

  • The 2013 Act and Revised Clause 49 mandate the formation of a Nomination & Remuneration Committee comprising of at least three directors, all of whom shall be non-executive directors and at least half shall be independent. The Nomination and Remuneration Committee is to ensure that the level and composition of remuneration is reasonable and sufficient; the relationship of remuneration to performance is clear and meets appropriate performance benchmarks; and the remuneration to directors, key managerial personnel and senior management involves a balance between fixed and incentive pay reflecting short and long-term performance objectives appropriate to the working of the company and its goals.

Clause 49: Whistle Blowing Mechanism

  • The 2013 Act and revised Clause 49 mandate establishing Whistleblower mechanism to let employees and directors blow whistles on financial and non-financial wrong doings and also that such mechanism should provide protection to the whistle blower from victimization and provide direct access to the Chairman of the Audit Committee in exceptional cases.

Role of Institutional Investors

  • Fast growing countries like India have attracted large shareholding by international investors and large Indian financial institutions with global ambitions.
  • So, if a company wants institutional investor participation, it will have to convincingly raise the quality of corporate governance practices. Indian companies thus need to adopt the best practices such as the OECD Corporate Governance Principles (revised in 2004) that serve as a global benchmark. In countries like India where corporate ownership still continues to be highly concentrated, it is important that all shareholders including domestic and foreign institutional investors are treated equitably.

Clause 49: Stakeholders Relationship Committee

  • As one of its mandatory recommendations, the Kumar Mangalam Birla Committee propounded the need to form a board committee under the chairmanship of a non-executive director to specifically look into the redressing of shareholder complaints like transfer of shares, non-receipt of balance sheet, non-receipt of declared dividends etc.
  • The Committee believed that the formation of shareholders’ grievance committee would help focus the attention of the company on shareholders’ grievances and sensitize the management to redress their grievances. The 2013 Act as well as the revised Clause 49 now mandate the formation of such a committee with broader remit to cover issues and concerns of all stakeholders and not just shareholders.
  • The 2013 Act now mandates companies with more than one thousand shareholders, debenture-holders, deposit-holders and any other security holders at any time during a financial year are required to constitute a Stakeholders Relationship Committee consisting of a chairperson who shall be a non-executive director and such other members as may be decided by the Board to resolve the grievances of security holders of the company.

Clause 49: Audit Committee

  • As per section 177 of the Companies Act, 2013 read with Rule 6 of Companies (Meetings of Board and its powers) Rules, 2014, every listed company and all other public companies with paid up capital of Rs. 10 Cr. or more; or having turnover of 100 Cr. or more; or having in aggregate, outstanding loans or borrowings or debentures or deposits exceeding Rs.50 Cr. or more, to have an Audit Committee which shall consist of not less than three directors and such number of other directors as the Board may determine of which two thirds of the total number of members shall be directors, other than managing or whole-time directors.
  • The revised Clause 49 expands the role of the Audit Committee with enhancing its responsibilities in providing transparency and accuracy of financial reporting and disclosures, robustness of the systems of internal audit and internal controls, oversight of the company’s risk management policies and programs, effectiveness of anti-fraud and vigil mechanisms and review and administration of related party transactions of the organization.