Why Corporate Governance?

27th Feb 2009
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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'être of every corporate body is to ensure predictability, sustainability and profitability of revenues year after year.


N.R.NarayanaMurthy


Introduction

A company is a congregation of various stakeholders, namely, customers, employees, investors, vendor partners, government and society. A company should be fair and transparent to its stakeholders in all its transactions. With the opening of the economy towards globalization, our corporate world requires a world-class governance system. The essence of the corporate world lies in promoting compliance of the law in letter and in spirit, with transparency and accountability, and above all, fulfilling the fair expectations of all the stakeholders. Unless a corporation embraces and demonstrates ethical conduct, it will not be able to succeed. Corporate governance is one such tool to achieve this goal. Corporate Governance is a combination of strong commitment of the management to safeguard the interest of various stakeholders, openness in ideas, fresh air for enterprises and corporate ethics. Therefore, it provides broad parameters of accountability, control and reporting system by the management and it encompasses the interactive relationship among various constituents in determining direction, and performance of the corporate. It is an indisputable fact that, scams and scandals are increasingly undermining our lives. Therefore, one of the most urgent tasks of our times is to understand the implications of corporate degradation and failures that we witness today. The issues and challenges, before the corporate sector have never been as turbulent and unpredictable as they are today. The proper governance of companies is as crucial to the world economy as the proper governing of countries.


Corporate governance refers to the set of systems, principles and processes by which a company is governed. According to Milton Friedman “Corporate Governance is to conduct the business in accordance with owner or shareholders’ desires, which generally will be to make as much money as possible, while conforming to the basic rules of the society embodied in law and local customs” It is the responsibility of the board of directors to ensure good corporate governance. This involves a set of relationships between the management of a corporation, its board, its shareholders and other relevant stakeholders. Good corporate governance requires that the board must govern the corporation with integrity and enterprise. While the board is accountable to the owners of the corporation (shareholders) for achieving the corporate objectives, its conduct in regard to factors such as business ethics and the environment for example may have an impact on legitimate societal interests (stakeholders) and thereby influence the reputation and long-term interests of the business enterprise.


Corporate governance can be defined narrowly as the relationship of a company to its shareholders or, more broadly, as its relationship to society It is palpable these days that a company’s relationship to society, is often blurred by the distinction between corporate governance and corporate social responsibility. In fact, Corporate Governance is not just a legal compliance but is a need to have a balance between economic and social goals and between individual and communal goals .Corporate governance is about promoting corporate fairness, transparency and accountability. Corporate governance is about working ethically and finding a balance between economic and social goals. It includes the ability to function profitably while obeying laws, rules and regulations. The traditional analysis of corporate governance focused on the allocation of power and duty among the Board of Directors, management, and shareholders. As the sole residual claimants on company assets, shareholders were presumed to have the most incentive to maximize company value. According to that perspective, the Board of Directors acted as the shareholders' agent and management was responsible for daily operations. In today's scenario, the Board and the Management play the role of trustees.


Why Corporate Governance?

In the recent years, there has been a considerable concern in India and other countries about the standards of corporate governance. According to Company Law, directors are obliged to act in the best interests of shareholders, but there have been many instances where we find contradiction to such obligation. There have been many cases of excessive debt financing laced with fraud, disproportionate rise in payments for executives, which have been less than transparent. The latest imbroglio involving one of India's largest IT companies, Satyam Computer Services has virtually discredited the concept of corporate governance. Satyam sought to invest into another company i.e Maytas, involving a conflict of interest for its promoters. This in turn involved a change in the fundamental character of the company and utilization of virtually its entire cash balance.


Satyam was also being accused by the World Bank for bribing its employees to get certain contracts awarded in the company's favor. While these are allegations at this point in time, it may be noted, that the company had earlier approached suitable independent professionals to get the necessary clearances under the law of the land as well as appoint independent directors. Ostensibly, the idea is to 'comply' with the code of corporate governance on paper. Ironically, this same company won the prestigious Golden Peacock Global Award for excellence in Corporate Governance as well as World Council for Corporate Governance .The 'Satyam fraud’ is symptomatic of the Economy of shock and surprise that we live in.Satyam gives India an opportunity to lead the world by better enforcement of Clause 49 through proper selection, training , evaluation and monitoring of directors.


Need for Corporate Governance

Corporate governance is important for the following reasons:

  • It lays down the framework for creating long-term trust between companies and the external providers of capital.
  • It improves strategic thinking at the top by inducting independent directors who bring a wealth of experience, and a host of new ideas
  • It rationalizes the management and monitoring of risk that a firm faces globally
  • It limits the liability of top management and directors, by carefully articulating the decision making process
  • It has long term reputational effects among key stakeholders, both internally (employees) and externally (clients, communities, political/regulatory agents)

Objectives of Corporate Governance

Good governance is integral to the very existence of a company.


It inspires and strengthens investor's confidence by ensuring company's commitment to higher growth and profits.


It seeks to achieve following objectives:

  • That a properly structured Board capable of taking independent and objective decisions is in place at the helm of affairs;
  • That the Board is balanced as regards the representation of adequate number of non-executive who will take care of the interests and well-being of the independent directors and all the stakeholders;
  • That the Board adopts transparent procedures and practices and arrives at decisions on the strength of adequate information;
  • That the Board has an effective machinery to sub serve the concerns of stakeholders;
  • That the Board keeps the shareholders informed of relevant developments impacting the company; 
  • That the Board effectively and regularly monitors the functioning of the management team, and          
  • That the Board remains in effective control of the affairs of the company at all times, The overall endeavor of the Board should be to take the organization forward to maximize long-term value and shareholders’ wealth.

Factors Influencing Quality of Corporate Governance:


Quality of governance primarily depends on following factors:Integrity of the management;

  • Ability of the board;
  • Adequacy of the process;
  • Commitment level of individual board members;
  • Quality of corporate reporting;
  • Participation of stakeholders in the management.

Elements of good Corporate Governance


Role and powers of Board

Good governance is decisively the manifestation of personal beliefs and values, which configure the organizational values, beliefs and actions of its Board. The foremost requirement of good governance is the clear identification of powers, roles, responsibilities and accountability of the Board, CEO, and the Chairman of the Board.


Legislation

Clear and unambiguous legislation and regulations are fundamental to effective corporate governance. Legislation that requires continuing legal interpretation or is difficult to interpret on a day-to-day basis can be subject to deliberate manipulation or inadvertent misinterpretation.


Management environment

Management environment includes setting-up of clear objectives and appropriate ethical framework, establishing due processes, providing for transparency and clear enunciation of responsibility and accountability, implementing sound business planning, encouraging business risk assessment, having right people and right skill for the jobs, establishing clear boundaries for acceptable behavior, establishing performance evaluation measures and evaluating performance and sufficiently recognizing individual and group contribution.


Board independence

Independent Board is essential for sound corporate governance. This goal may be achieved by associating sufficient number of independent directors with the board. Independence of directors would ensure that there are no actual or perceived conflicts of interest.


Code of conduct

It is essential that the organization's explicitly prescribed norms of ethical practices and code of conduct are communicated to all stakeholders and are clearly understood and followed by each member of the organization. Systems should be in place to periodically measure adherence to code of conduct and the adherence should be periodically evaluated and if possible recognized.


Strategy setting

The objectives of the company must be clearly documented in a long-term corporate strategy and an annual business plan together with achievable and measurable performance targets and milestones.


Business and community consultation

Though basic activity of a business entity is inherently commercial yet it must also take care of community's obligations. Commercial objectives and community service obligations should be clearly documented after approval by the Board. The stakeholders must be informed about the proposed and ongoing initiatives taken to meet social responsibility obligations.


Financial and operational reporting

The Board requires comprehensive, regular, reliable, timely, correct and relevant information in a form and of a quality that is appropriate to discharge its function of monitoring corporate performance.


Audit Committees

The Audit Committee is inter alia responsible for liaison with the management; internal and statutory auditors, reviewing the adequacy of internal control and compliance with significant policies and procedures, reporting to the Board on the key issues. The quality of Audit Committee significantly contributes to the governance of the company.


Risk management

Risk is an important element of corporate functioning and governance. There should be a clearly established process of identifying, analyzing and treating risks, which could prevent the company from effectively achieving its objectives.


For this purpose the company should subject itself to periodic external and internal risk reviews.


The above improves public understanding of the structure, activities and policies of the organization. Consequently the organization is able to attract investors, and to enhance the trust and confidence of the stakeholders.


Indian Experiences

India has comprehensive laws governing corporate governance. The Companies Act, 1956 covers corporate governance widely through its various provisions such as inclusion of directors' responsibility statement in the directors' report under Section 217(2AA), constitution of audit committee under Section 292A fixing maximum ceiling on remuneration that can be drawn by a director under Schedule XIII, and those relating to oppression, mismanagement, etc. Further, environmental and other pieces of legislation also protect different stakeholders' interest, ensuring, in the process, good corporate governance. The Confederation of Indian Industry (CII) published India’s first comprehensive code on corporate governance (Desirable Corporate Governance: A Code) in 1998. This was followed by the recommendations of the Kumar Mangalam Birla Committee on Corporate Governance, which was appointed by the Securities and Exchange Board of India (SEBI). The recommendations were accepted by SEBI in December 1999, and are now enshrined in Clause 49 of the Listing Agreement of every Indian stock exchange. Another committee appointed by SEBI under the chairmanship of Mr. N. R. Narayana Murthy which recommended enhancements in corporate governance. SEBI has incorporated the recommendations made by the Narayana Murthy Committee on Corporate Governance in Clause 49 of the listing agreement. The revised Clause 49 has been made effective from January 1, 2006. In addition, the Department of Company Affairs, Government of India, constituted a nine-member committee under the chairmanship of Mr. Naresh Chandra, former Indian ambassador to the U.S., to examine various corporate governance issues in 2002.Moreover,Ministry of Corporate Affair actively facilitates for the cause of good corporate governance.


Conclusion

Corporate Governance has become the latest buzzword today. Almost every country has institutionalized a set of Corporate Governance codes, spelt out best practices and has sought to impose appropriate board structures. Despite the ‘Corporate Governance revolution’ there exists no universal benchmark for effective levels of disclosure and transparency. There are several corporate governance structures available in the developed world but there is no one structure, which can be singled out as being better than the others. There is no "one size fits all" structure for corporate governance. Corporate governance extends beyond corporate law. Its fundamental objective is not the mere fulfillment of the requirements of law but in ensuring commitment of the board in managing the company in a transparent manner for maximizing long term shareholder value. Effectiveness of corporate governance system cannot merely be legislated by law. As competition increases, technology pronounces the death of distance and speeds up communication. The environment in which companies operate in India also changes. In this dynamic environment the systems of corporate governance also need to evolve. The recommendations made by different expert committees will go a long way in raising the standards of corporate governance in Indian companies and make them attractive destinations for local and global capital. These recommendations will also form the base for further evolution of the structure of corporate governance in consonance with the rapidly changing economic and industrial environment of the country in the new millennium.


Syed Burhanur Rahman, Attorney ,New Delhi

Syed Burhanur Rahman is an alumnus of St.Stephen’s College and Campus Law Center, Delhi University. A Quiz aficionado, he has featured in premier quiz shows including mastermind India(BBC),University Challenge Quiz(BBC) and Nat Geo Genius(National Geographic Channel).An Attorney working with INDUS G&D Law(Delhi),his practice areas include Corporate Law.IPR and Taxation Law.

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