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:
- Debt Covenants
- Financial Statements
- Government Regulations
- Managerial Labour Market
- Media Pressure