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TMI BlogCORPORATE GOVERNANCE- DESIRABLE BEST PRACTICESX X X X Extracts X X X X X X X X Extracts X X X X ..... CORPORATE GOVERNANCE- DESIRABLE BEST PRACTICES - By: - Dr. Sanjiv Agarwal - Corporate Laws / IBC / SEBI - Dated:- 8-8-2008 - - Preamble Good corporate governance practices are important to encourage investment in a country. The companies in a global economy where access to capital markets is in the interest of economy assume greater significance. A strong corporate governance is indispensable for growth of capital market and is an important instrument of investor protection. Studies of companies all over have shown that markets and investors do take notice of well managed companies, respond positively to them and reward such companies with higher valuations. Good corporate governance makes to the efficiency of a business enterprise, to the creation of wealth and to the country's economy. The need is for the entire corporate world to follow the principles of corporate governance. There is a need to monitor the functioning of corporates vis-à-vis guarding the interests of investors and creditors. With increasing awareness and access to information, investors do not depend on regulators to protect them. They are conscious of their rights and strive to maximise their wealth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , so does a company. The key differences, with every thing else being common, will be the ability to create self driven, self assessed, self regulated organisation with a conscience. That ultimate is all about corporate governance in India and elsewhere . Genesis of Governance One may govern life in accordance with the revealed truth as one sees it or natural law or a simple precept of not treating others as ends, or in pursuit of the good life of contemplation prized by Aristole . One may believe that morality lies in doing the best one can for oneself and one's children and giving something back to the society, when one can buy money or time. One may also think that morality is simple being responsible for one's actions, avoiding harm to others, when one can compensate them for their pain when one cannot. One may think that morality is simply doing whatever produces the greatest good for the greatest number ; one may believe that mortality is nothing more than maximising one's wealth. One may believe any of these things but one has a moral compass that directs one in one's daily life . One should have the sense that sometimes, at least, the ends do not justify the mea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns and that sometimes, at least, the ends themselves are not worth pursuing. But the corporation has one end to maximise its stock value. The directors and employees of corporation that animate it does so with this end in mind. Corporations have no mechanism called systems or beliefs. The result is that corporations are able to act without morality or accountability for they are formed for that one purpose to maximise pecuniary shareholders' value. Therefore, to maintain the sanctity of a corporate self, the corporations are required to follow a moral and ethical suit that has become more pronounced in the present scenario and has indeed exceeded the axiom of wealth maximisation. Corporates ought to be responsible citizens with a commitment to transcendent societal trust but the financial and ethical shenanigans, in last two decades have triggered a debate on the value of trust and confidence reposed in corporates in the garb of Corporates Social Responsibility. This backdrop provoked a revolutionary corporate concept and Corporate Governance gained momentum over the decade that resulted in formulating guiding principles , codes etc to govern the corporate world , incorporating a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n ethical angle to the corporate's vision. This has become one of the central issues in managing and regulating complex enterprises in today's dynamic world. The pre requisite for drafting effective corporate governance is a fully expanded intellect coupled with normal and ethical values. The phenomenon of good governance that is correlated with corporate governance, can be traced back to ancient Indian practices. Concept of Corporate Governance The concept of governance cannot be completed without acknowledging the contribution of the most celebrated scholar of ancient India, Kautilya . One the world's most complete manuscript on the science of governance was penned by Kautilya in third century B.C. Kautilya's discussions on administration and management are strikingly modern and scientific covering almost all facets of governance. According to him, an ideal king is one for whom. Praja sukhe, sukhamragyam, Prajanan ca hite hitam, Naatman priyam hitam ragyan, Parajanan tu priyam hitam. i.e. in the happiness and well-being of the subjects, lies the well being of the king, in the welfare of the subjects, is the welfare of the king, what is desirable an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d beneficial to the subjects and not his personal desires and ambitions, is desirable and beneficial for the king. He further elaborates that a king has a four fold duty as Raksha or protection, vridhi or enhancement, palana or maintenance, yogakshema or safeguard. It is the duty of the king to protect the wealth of the state and its subjects, to enhance the wealth, to maintain it and safeguard it and the interests of the subjects. If we for a moment assume the today's business CEO or corporate board as King and subjects as its shareholders, it brings out the quintessence of corporate governance as public good should be ahead of private good and company's resources should not be used for personal gains. The four duties in corporate parlance would imply protection of shareholders wealth, enhancement of wealth by proper utilization of assets, maintaining the wealth (without appropriating it otherwise) and safeguarding the interests of all stakeholders. Chankya endorsed this and said that " Arthavaan sarva lokasya bahumatah " - wealth, (inclusive of well being and welfare) generating capacity earns all round reverence. Kautilya's arthashatstra further says that "Sukhasay ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a moolam dharma "- root of all happiness is doing right; " Dharmasuya moolam artha " - root of doing right is the root of wealth, " Arthyasya moolam ragyam " - root of all wealth is enterprise. Therefore the ultimate end of earning all round reverence, from a corporate's perspective, should be the improvement of stakeholders' value. Corporate governance is traditionally defined as the system of laws, regulations and practices, which will promote enterprise, accelerate performance and ensure accountability. It stimulates for effectiveness in the performance and operations of a corporate. The effectiveness, in today's parlance, mean that business is run in a manner to enhance stakeholders' value, skewing radically from established enhancement of shareholders' value only and moving towards stakeholders' value maximization. It may also be defined as a system of structuring, operating and controlling a company with the following specific aims :- · Fulfilling long-term strategic goals of owners; · Taking care of the interests of employees; · A consideration of the environment and local community; · Maintaining excellent relations with customers and suppliers; · Proper compl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iance with all the applicable legal and regulatory requirements. Strong corporate governance is indispensable to resilient and vibrant capital markets and is an important instrument of investor protection. It is a blood that fills the veins of transparent corporate disclosure and high-quality accounting practices. It is the muscle that moves a viable and accessible financial reporting structure. Good corporate governance should result in · Enhancing the value for stakeholders. · A well-understood corporate vision/mission statement. · A broad-based board, comprising of directors with professional and expert acumen, with independent dispositions. · Establishment of relevant committees of the board, with their roles clearly defined, to oversee functions of the company in critical areas. · Setting standards for good corporate practices to - - Ensure a transparent and fair relationship between the stakeholders and the company; - Institute a comprehensive management evaluation system; - Proactively eliminate investor complaints and evolve a scheme for redressal of the grievances (of customers, investors and borrowers), and - Institute systems and processes to e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsure compliance with the statutes and laws concerning company. · A clearly enunciated code of conduct for dealing with the stakeholders. · Effective systems of internal control, monitoring and reporting mechanisms. · Communication to the shareholder to ensure a high degree of transparency. · The board to establish appropriate policies and monitor the performance at all levels of the organisation including self-evaluation. Corporate Governance Management Corporate management and corporate governancedeal with corporate form of business entities, principles of corporate management, corporate governance and management functions, board of directors, stakeholders and scope of corporate governance in Indian context corporate. Corporate Boards are at the core of the corporate governance. The corporate governance comes into play as the measure to ensure that the Board of Directors functions ostensibly to achieve the corporate objectives defined by the shareholders. It further extends to supervise the management and to ensure that it does all that is necessary by legal and ethical means to expand the business and maximize long-term corporate value. While the companies hav ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e advantage arising from corporate personality, perpetual succession, transferability of shares, buyback of shares, separate ownership and management, capacity to sue and be sued, it also carries accountability to its owners, i.e. shareholders or in a broader sense, stakeholders. The effectiveness of the board is determined by the quality of the directors and the quality of the financial information is dependent to an extent on the efficiency with which the auditors carry on their duties. The shareholders must therefore show a greater degree of interest and involvement in the appointment of the directors and the auditors. Indeed, they should demand complete information about the directors before approving their directorship. The main constituents of corporate governance are the shareholders, the board of directors and the management. The board of directors are responsible for the governance of the company. They set the strategic aim, the financial policy and oversee the implementation and the financial controls and report the activities and the progress of the company to the shareholders to whom they are accountable. The board's actions are subject to applicable laws, rules and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... regulations. The shareholders role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. The responsibilities of the management include ensuring that control systems are in place to achieve the objectives laid down by the board, and to help the board discharge its responsibilities to the shareholders. Corporate governance is about ethical conduct in business. Ethics is concerned with the code of values and principles that enables a person to choose between right and wrong, and therefore, select from alternative courses of action. Further, ethical dilemmas arise from conflicting interests of the parties involved. In this regard, managers make decisions based on a set of principles influenced by the values, context and culture of the organization. Ethical leadership is good for business as the organization is seen to conduct its business in line with the expectations of all stakeholders. Independence of directors of the company i.e. board is pivotal to the implementation o corporate governance code and achievement of its desired results. Independent directors are expected to take active intere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st and part in company's board functions including policy formulation and strategic business decisions. Board should function through committees comprising of majority of directors who are independent. These committees could be : - audit committee - remuneration committee - nomination committee - shareholder's committee - other committees specific to company's needs Audit committees exercise responsibility in three important areas - financial reporting, corporate governance and corporate control. In financial reporting, the responsibility of audit committee should be to provide assurance that financial disclosures made by management reasonably portray the company's financial position, results of operations and the company'' plans and long-term commitments. The responsibility of audit committees in corporate governance should be to provide assurance that the corporation is in reasonable compliance with all relevant laws and regulations; is conducting its affairs ethically, and is maintaining effective controls against any conflict of interest and fraud. In corporate control, the audit committee's responsibility should include an understanding of the company's key fin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ancial reporting, areas and the system of internal control and fiscal management. Regulatory Framework Legal and regulatory framework of corporate governance mainly covers legal regime as stipulated in SEBI guidelines and Companies Act 1956, covering various Indian codes and recommendations of committees. Corporate governance extends beyond corporate laws. Its fundamental objective is not 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. While enough laws exist to take care of many of the investor grievances, the implementation and inadequacy of penal provisions have left a lot to be desired. The real onus of achieving the desired level of corporate governance thus lies in the proactive initiatives taken by the companies themselves and not in the external measures. In Indian context, there is no single apex regulatory body which can be said to be the regulator of corporates but there exists a coordination mechanism among various functional regulators. For example, in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... India, we have different regulators for the following - - Corporates (MCA) - Capital Market and Stock Exchanges (SEBI) - Money Market and Banking (RBI) - Insurance - Life and Non life (IRDA) - Communication (TRAI) - Foreign business (FIPB) - Imports and Exports (FEMA, DGFT) - Professions (Professional Institutes like ICAI, ICSI, ICWAI etc.) Regulatory philosophy revolves around the regulatory roles and the powers vested in the regulation authorities along with basic principles like fairness, transparency in dealing of the regulator and the regulated, consistent compliance, pro activeness, quality, professionalism and the self regulation. The success of regulation rests on the intention and integrity of the regulator and the regulated. Global Trends Behind any corporate success or corporate failure lies the reasons to it in the form of corporate governance. Good governance in any corporation world over is an interplay of legal requirements, the ethics, effective ness, board relationships and group dynamics . Corporate governance is common to one and all-be it India, China, Africa or so called advanced countries like US or UK. In corporate sector, gover ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nance has been extrapolated to cover issues like corporate sustainability, social and financial inclusion, social responsibilities or even social inclusion etc. Infact, every such issue hinges on goods governance- be it any part of the world. Since India and its economy are no longer isolated and constitute an important part of the global economy, it is high time that Indian companies should also march towards global best practices. While operations, capital and risk management, technological innovations and customer satisfaction shall be the drivers of growth, it is going to be the corporate governance which will lead Indian corporates to match best business practices on the globe. Appraisal of Board Performance Unlike many developed countries like US, UK, in India, board level performance is yet to take off, though there are handful of companies which practice this as a governance tool. There is no wrong in having a board level appraisal when we do the same for employees, vendors, agents etc. It's not an easy proposition and as complicated as 'who would rate the rater'. If done properly, appraisals can help boards become effective by clarifying individual and collectiv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e contributions as well as responsibilities. It can also ensure healthy balance of power. The key is 'it should be done properly'. Evaluation should be done for CEO, whole board and individual directors and who does it ? No one can evaluate a board but the board it self. It could be done on the parameters of knowledge, experience, power, information, time, motivation, crises management etc. Lead Director Today is the age of empowered board of directors. There should be a clear majority of outside directors. In west, chief executive officer is the only inside director. Company boards in India should also have majority of independent directors and such directors should select one as lead independent director who should also meet with the management on a regular basis. It is imperative that independent directors should take responsibility for board procedures and lead director should serve as a facilitator of the governance process and board activities. The independent directors should also meet formally at a separate meeting of such directors. Such executive sessions of independent directors can be crucial for coalescing the interests of board as a whole and focusing on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... specific areas. It is imperative for the management or the CEO to be broad minded and not perceive it as a threat. In loose language, it is vital for the CEO and other directors to have proper chemistry amongst them. Management v. Governance Many people often mistake the meaning of the two terms and understand them as synonyms. Even well managed corporations could be badly governed and lead to corporate failure. While governance has to come form the top most layer- the board, the management is a function of one layer beneath the board, the executive or top management. The well governed model will come from more new ideas, more adaptable decision making and better accountability. Companies in India will have to shift from best managed companies to best governed companies where board's role will be to foster effective decision and reverse failed policies. Board Oversight- Strategic Audit Globally, directors are now seeking practical ways to have strategic oversight . The strategic audit can provide an orderly way for boards to review strategy without invading management territory. This could be triggered by events such as CEO's retirement, abnormal decline in p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rofitability or hike in NPA level etc. The task of strategic audit overview can be assigned to audit committee comprising of outside directors and it can anticipate problems and show stakeholders that boards as well as CMDs are committed to effective governance. However, there will be people who will resist this idea of yet another review process. Board Empowerment Effective board empowerment is missing on Indian corporate boards. This emanates from the composition itself which in most public sector units is Government controlled. In contrast, private sector bank boards are more effective, efficient, contributing, responsive and empowered. This gets reflected in quality and qualification of directors, selection process, contributions made and even the sitting fees paid to them. While private sector boards could be said to be assets, in many public sector cases in India, one finds many boards devoid of good people. Each board is a mix of all variants which dilutes the quality. The mis-governance in recent example of Punjab Sindh Bank is a glaring case before us to introspect. Moving towards global best practices, Indian banks are expected to move in the direction of boa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rd empowerment so that boards can be effective. One should not have any reservation about empowering outside directors but this is the only way to take out the best from them, of course with a defined code of conduct in place which we have. There have been several instances where independent directors participate more effectively in the board meetings and CEOs in such entities do not find their powers diminished. The practice of empowering the boards is followed in companies like Dayton Hudson Corporation, Monsanto, General Motors etc. One needs to be reminded that corporate governance, at its core, is not about power but about ensuring that decisions are made effectively. Recent Trends Recent trendsin corporate governance include issues such as social corporate responsibilities, value rating for governance and concepts like economic value added, market value added, total shareholder value and human resources. All these concepts tend to enhance the value of corporate governance practices and consider quality better than quantity so far as financial performance is concerned. Epilogue While corporate governance is a necessary tool for managerial performance, it also ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... leads to corporate growth and excellence. Corporate is a path on which a corporate can drive to reach the heights of excellence and from there, proceed for another milestones only through good corporate governance practices. It is an issue of mindset and attitude, some thing which can not be legislated, no where in the world. The big question that remains before all of us, those who are involved in corporate management is that whether one should follow the governance principles or not. If no, leave it. If yes, how and why show one follow? The answer is simple- use your conscience, your inner voice or be guided, as I was by noted poet, Robert Frost in his poem- "The Road not Taken" (1916) and that makes all the difference. Corporate governance is the path on which success can be experienced and excellence reached. It is the vehicle, which drives an institution to the stage of corporate excellence- a state of highest satisfaction in terms of value creation not only for the owners or contributors of capital and the contributors of labour - employees but all other stakeholders of an enterprise. The Road Not Taken "Two roads diverged in a yellow wood, And sorry I could n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot travel both And be one traveler, long I stood And looked down one as far as I could To where it bent in the undergrowth; Then took the other, as just as fair, And having perhaps the better claim, Because it was grassy and wanted wear Though as for that the passing there Had worn them really about the same, And both that morning equally lay In leaves no step had trodden black. Oh, I kept the first for another day! Yet Knowing how way leads onto way, I doubted if I should ever come back. I shall be telling this with a sigh Somewhere ages and ages hence; Two roads diverged in a wood, and I- I took the one less traveled by, And that has made all the difference." Robert Frost (1916) Ideals of Corporate governance primarily need transparency, full disclosure, fairness to all stakeholders and effective monitoring of the state of corporate affairs. The basic philosophy of corporate governance is to achieve business excellence and enhance shareholder's value while keeping in view the need to balance the interests of all stakeholders. The tool is collaborative governance. This, in turn needs an interplay of d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iverse factors. = = = = = = - - Scholarly articles for knowledge sharing authors experts professionals Tax Management India - taxmanagementindia - taxmanagement - taxmanagementindia.com - TMI - TaxTMI - TMITax ..... X X X X Extracts X X X X X X X X Extracts X X X X
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