REFORMS IN CORPORATE GOVERNANCE

[Dr. Sanjiv Agarwal]

Corporate governance deals with the rights and responsibilities of a company's management, its board shareholders and various stakeholders. How well companies are run affects market confidence as well as company performance. Good corporate governance is therefore essential for companies that want access to capital and four countries that want to stimulate private sector investment. If companies are well run, they will prosper. This in turn will enable them to attract investors whose support can help to finance faster growth. Poor corporate governance on the other hand weakens a company's potential and at worst can pave the way for financial difficulties and even fraud.

Corporate governance is 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 and corporate funds in the management of a company.

Principles of Good Governance

There are four basic principles against which governance practice can be assessed; those of fairness, transparency, accountability, and responsibility. These principles are equally relevant whether business are privately, publicly, or state-owned, or are subject to a controlling shareholder. The objective, therefore, of the agencies with responsibility for the way in which corporations are governed - whether businesses themselves, the states who regulate them, or those who provide them with funds - should be to encourage the firm application of these principles. The more widely the four principles are applied, the more equitably and effectively will resources be allocated. Resources will flow to companies which inspire trust, through their approach to governance and through the integrity of those who manage them. Responsible governance is the basis on which trust is established and enterprise encouraged.

Corporate governance is a process, not a state and the field is continually evolving. Its initial focus was on the way in which individual corporations are directed and controlled. This led to the introduction of national codes of best practice. As the wider economic and social significance of corporate governance became apparent, international guidelines were published to advance its cause more broadly. These guidelines reflected the part which good governance can play in promoting economic growth and business integrity.

Board Responsibility

The pivotal role in any system of corporate governance is performed by the board of directors. It is accountable to the stakeholders and directs and controls the management. It stewards the company, sets its strategic aim and financial goals and oversees their implementation, puts in place adequate internal controls and periodically reports the activities and progress of the company in the company in a transparent manner to the stakeholders. The shareholders' role in corporate governance is to appoint the directors and the auditors and to hold the board accountable for the proper governance of the company by requiring the board to provide them periodically with the requisite information, in a transparent fashion, of the activities and progress of the company. The responsibility of the management is to undertake the management of the company in terms of the direction provided by the board, to put in place adequate control systems and to ensure their operation and to provide information to the board on a timely basis and in a transparent manner to enable the board to monitor the accountability of management to it.

Legal Reforms for better Corporate Governance

Following are the key areas where legal framework has to be strengthened -

- Insider trading should be considered as a significant aspect of corporate governance.

- Empowering SEBI and increase in SEBI's workforce for effective implementation.

- Stringent punishments to defaulters / offenders

- Introduction of whistle blower provisions in law.

Regulatory framework is required to be broad based, objective and in harmony with international standards. This calls for  -

 selection of board members through nomination committee

 defining 'independence' of directors by having a internationally acceptable definition.

 legislative framework for board member's duties.

 harmonisation and compliance with international accounting standards and practices.

 creating a cadre of professionally qualified independent directors including women.

 obligating institutional investors to take active participation in company's affairs and exercise their voting rights. This would certainly enhance governance level.

 evolving a system where misuse of proxy voting system can be checked.

Sufficient legal protection should be provided to minority shareholders so that they are not oppressed and liquidity and exit route is offered to them, if they so desire.

It is suggested that private corporate sector need a specific focus keeping in mind liberal control and lesser involvement of public funds, providing autonomy in operation but without compromising on values and stakeholder's interests. It should have a set of well defined norms for disclosure and information to be disseminated to different stakeholders. Corporate responsibility should be placed on boards. Compliance of financial disclosures and regulatory framework should be ensured and role of regulatory bodies be defined with minimal of operational interference.

Regulators are external pressure points. Mere compliance with regulatory pressure is a minimal requirement of good Corporate Governance. The road to efficiency lies in minimizing regulatory prescriptions and maximizing voluntary codes (encompassing internal pressures, peer pressures and market pressures) to ensure excellence in Corporate Governance among corporates including financial institutions.

Global Reforms

The following reforms are needed to enhance corporate governance levels across the globe -

a) roles and responsibility of auditors need to be precisely defined and understood.

b) rules for punishing the negligent professionals need to be strict and exact, so as to be exemplary and such rotten lot ought to be weeded out from the entire lot.

c) independence of auditors need to be ensured.

d) CFO's and CEO's to be made explicitly accountable for their actions.

e) board structure should be balanced with independence, professional and interested directors.

f) the role of auditors need to be changed from watchdog to that of whistle blowers.

g) audit committees to keep a vigil on financial issues and oversee financial discipline.

h) shareholders and institutional members need to take active part in company meetings and voting on resolutions.

Suggestions for Effective Audit Committee(Audit Oversight Function)

Following suggestions may be borne in mind to ensure that audit committee functions effectively -

The audit committee should be composed entirely of independent and non executive directors.

It should make recommendations to shareholders on appointing company's auditors and also non audit work to be undertaken by auditors.

Role and effectiveness of members of audit committee should be continuously reviewed.

Rotation of auditors (partners/ lead staff) should be done on a three -five year basis.

Concentration of audit to select few firms may be checked keeping in view the reasonable time availability for each audit by an appropriate authority.

Non-audit functions of auditors may be subjected to some regulatory test.

Audit committee should not play policemen to the auditors.

Audit committee should also have a legal expert.

Internal audit function should be independent and should not be part of, or report through, the finance function.

An auditor who have direct financial interest in the company or who receives any loans or guarantee from the company or who has any business relationship (other than as an auditor) with the company should not be appointed as auditor. He should not accept any assignment like accounting book-keeping, internal audit, broker, financial services, management functions, valuation services etc.

Consultancy work and internal audit should not be given to the same audit firm that is dong external audit of a company i.e. statutory auditors need to be independent in terms of their attestation function and while doing so, no consideration should come in. This can be ensured when auditors are truly independent.

Most of the misdoings of the corporations (narrated earlier) reveal that they either inflated their revenues wrongly or reduced the operating expenses by transferring them to capital account. It is high time that the standard setting bodies of the different countries revisit principles of recognition of revenue and determination of expense. Also, there should be no off balance-sheet items. Every transaction in which the company is involved directly or indirectly must be brought within the ambit of the financial statements.

Corporate leaders should be required to announce in advance (30 days to 60 days before) plans to sell company stock so that they cannot take advantage of inside knowledge that allows them to predict fluctuation of shares better then the investing public and thus check possible insider trading.

The executive compensation given in the form of salary in cash, bonus restricted stock, stock options and other perks to the senior executives (CEO, CFO and others) should be disclosed in detail.

To root out corporate greed, the corporations that are most generous to their executives should be red-flagged early, either by DCA or SEBI.

The auditors should be prohibited from offering certain types of consulting services to corporate clients. This would be an attempt to reduce conflicts of interests arising from audit firms earnings substantial consulting fees from client.

The CEOs and CFO should be required to certify the financial reports. If earnings are restated due to securities fraud, they should forfeit profits and bonuses.

The executives should be prohibited from selling company stock during blackout period. The insiders should be required to report all company stock trades within one or two days.

The law or companies should prevent the executives from receiving company loans unavailable to outsiders.

Material changes to company's financial condition should be required to be disclosed immediately.

Credit rating

SEBI has worked with the credit rating agencies to prepare 'corporate governance Index' as a measure of wealth creation, management and its distribution by the corporates. Presently, this index is voluntary. It is expected that over a period, as more and more companies will get themselves rated voluntarily and the rating methodology is refined. This index would be regarded as a valuable indicator of corporate governance of companies and will be widely used by the markets. It is suggested that more and more corporates should voluntarily adopt these ratings and convey to all stakeholders to themselves see the positive difference in respect, valuations and premium.

Companies with good corporate governance model are value builders. Such companies achieve above average revenue and shareholder value growth over a long period. Good governance provides values driven approach to growth. And this is what companies should follow. Good corporate governance is a key to growth. Since level of corporate governance practices may vary, the rating agencies have to evolve a methodology to grade the level of corporate governance. Models of best corporate governance need to be transmitted continuously through all means of communication.