CORPORATE GOVERNANCE

IN INDIA –

EVOLUTION AND CHALLENGES

Call for good Corporate Governance fortified
in the late 90’s when the markets expanded
immensely due to liberalization and when the
investor’s conviction in the corporations were
titled by the infamous security scam and its
aftermath which perhaps blanched the trigger
for setting up standards of good Corporate
Governance.
 Introduction
 Concerns about Corporate Governance in India is a recent
phenomenon.

 It is a result of a spate of corporate scandals in the early 90’s – the

Harshad Mehta Stock market scam of 1992 that shook the country
during the early liberalization era

 Obscure companies quickly listed on the exchanges during the stock

market boom of 1993-94 only to disappear after siphoning off public
funds and leaving the retail investors with illiquid stock.

 The sudden appearance of fly-by-night operators during the period

coupled with the emergence of a new breed of shareholders and their
demands for better governance practices has compelled the policy
makers to think of the governance anomalies in corporate India.
 Concept
 The concept of Governance is incomplete without
mentioning the contribution of the Ancient Indian
Scholar, Kautilya. One of the world’s most complete
manuscripts on the science of Governance was
penned by Kautilya in 3rd Century BC.

 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.
 Definition
 Corporate Governance is traditionally defined as the “system of laws,
regulations and practices, which will promote enterprise, accelerate
performance and ensure accountability”.

 ‘Corporate Governance is concerned with ways of bringing the

interests of investors and manager into line and ensuring that firms are
run for the benefit of investors’.

 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 compliance with all the applicable legal and regulatory
requirements.”
 Importance of Corporate Governance
 It improves strategic thinking at the top by inducting independent directors who
bring a wealth of experience, and a host of new ideas;

 It enhances access to external financing by firms, leading to greater investment, as

well as higher growth and employment;

 It also lowers the cost of capital by reducing risk and creates higher firm valuation
boosting real investments (La Porta et al.,1997, 1998, 2000, henceforth LLSV);

 It significantly reduces the risk of nation-wide financial crisis, as there is a strong

inverse relationship between the quality of Corporate Governance and currency
depreciation;

 It limits the liability of top management and directors, by carefully articulating the
decision making process;

 It removes mistrust between different stakeholders, reduce legal costs and improve
social and labor relationships and external economies like environmental protection.
 Need for Regulation
 Bad Corporate Governance practice by a firm can be seen as a
negative externality. One corporate scandal can potentially erode
shareholders trust in the whole of the corporate sector and thus
negatively affect the businesses of honest firms as well. This theory is
reinforced by the recent corporate scandals in India, as seen in the
case Satyam. Thus in such cases, the state has the responsibility to
intervene to provide a level playing field and also to prevent market
failure;

 In case of dispersed shareholding, small shareholders cannot

effectively manage the firm and hence have to delegate the control
over the firm to professional managers. However, the separation of
ownership and control leads to a divergence of interests between the
managers and shareholders (Berle and Means, 1932). The managers
may forgo the shareholders’ wealth maximization objective and
undertake actions which maximize their personal interests but not the
value of the company. Thus to provide adequate protection to their
investors, regulatory intervention is necessary;
 Need for Regulation
 Regulatory intervention helps markets to achieve the
maximization of social welfare rather than the welfare of
individual investors;

 It forces companies to commit credibly to a higher quality

of governance. Even if companies initially design
efficient governance rules, they may break or alter them at
a later stage,

 Absence of regulations distorts an efficient allocation of

resources, undermines the ability of companies to
compete internationally, and hinders investment and
economic development.
 Initiatives in India
 The CII Code - More than a year before the onset of the Asian crisis, CII set
up a committee to examine Corporate Governance issues, and recommend a
voluntary code of best practices. The committee was driven by the conviction
that good Corporate Governance was essential for Indian companies to access
domestic as well as global capital at competitive rates. The first draft of the
code was prepared by April 1997, and the final document ( Desirable
Corporate Governance: A Code), was publicly released in April 1998. The
code was voluntary, contained detailed provisions, and focused on listed
companies.

 Kumar Mangalam Birla committee report and Clause 49 - While the CII
code was well-received and some progressive companies adopted it, it was felt
that under Indian conditions a statutory code would be more purposeful, and
meaningful. Consequently, the second major Corporate Governance initiative
in the country was undertaken by SEBI. In early 1999, SEBI set up a
committee under Kumar Mangalam Birla to promote and raise the standards of
good Corporate Governance. In early 2000, the SEBI board had accepted and
ratified key recommendations of this committee, and these were incorporated
into Clause 49 of the Listing Agreement of the Stock Exchanges.
 Initiatives in India
 The Naresh Chandra committee report on Corporate Governance - The
Naresh Chandra committee was appointed in August 2002 by the
Department of Company Affairs (DCA) under the Ministry of Finance and
Company Affairs to examine various Corpoarte Governance issues. The
Committee submitted its report in December 2002. It made
recommendations in two key aspects of Corporate Governance: financial and
non-financial disclosures: and independent auditing and board oversight of
management.

 Narayana Murthy committee report on Corporate Governance –

The fourth initiative on Corporate Governance in India is in the form of the
recommendations of the Narayana Murthy committee. The committee was
set up by SEBI, under the chairmanship of Mr. N. R. Narayana Murthy, to
review Clause 49, and suggest measures to improve Corporate Governance
standards. Some of the major recommendations of the committee primarily
related to audit committees, audit reports, independent directors, related
party transactions, risk management, directorships and director
compensation, codes of conduct and financial disclosures.
  “A code of Corporate Governance cannot be
imported from outside, it has to be developed based
on the country’s experience. There cannot be any
compulsion on the corporate sector to follow a
particular code. An Equilibrium should be struck
so that Corporate Governance is not achieved at
the cost of the growth of the corporate sector”
 -Sir Adian Cadbury
 The OECD principles and India
 Since the mid-1990s, several Corporate Governance
guidelines and regulations have been prepared in different
parts of the world. Some of these are:
 Cadbury Committee Report (1992)
 CalPERS- Global Corporate Governance Principles (1996)
 Market Specific Principles- UK and France (1997)
 Market Specific Principles- Japan and Germany (1997)
 Core Principles and Guidelines- USA (April 1998)
 TIAA-CREF- Policy Statement on Corporate Governance (September
1997)
 Business Roundtable- Statement on Corporate Governance (September
1997)
 Hampel Report on Corporate Governance- UK (January 1998)
 The Sarbanes-Oxley Act – USA (August 2002)
 The Higgs Report- UK (January 2003)
 The OECD principles and India
 Given the increasing interdependence and integration of financial
markets around the world it is important that some degree of
uniformity is established in laws of all the countries.

 With this in mind the OECD Council, meeting at Ministerial level on

27-28 April 1998, called upon the OECD to develop, in conjunction
with national governments, other relevant international organizations
and the private sector, a set of Corporate Governance standards and
guidelines.

 In order to fulfill this objective, the OECD established the Ad-Hoc

Task Force on Corporate Governance to develop a set of non-
binding principles that embody the views of OECD countries on this
issue.
 Challenges
 First, challenge of existing practices themselves. Following are some
examples:
 failure by the boards of direction to understand the risks their firm is
taking;
 transactions, and organizational structures, deigned to reduce
transparency;
 conflicts of interest and a lack of “independent” Board members;
 weak or non-existent internal controls or controls which appeared to be
adequate on paper, but which were not implemented in practice;
 internal and external audit failure, either through negligence or through
incompetence or through aiding and abetting fraudulent behaviour,
 And more importantly, a corporate culture which fosters unethical
behaviour.
 Challenges
 Second, there are often attitudes which are impediments to change, for
example:
 “short-term” thinking - in particular by companies that might only
be surviving for the moment because of a continuation of poor
Corporate Governance within that entity in which it operates;
 a lack of commitment and leadership driving change at political,
regulatory, and Board and executive levels.
 a culture that sees a company as proprietary to one or more
directors or shareholders, with minorities, the public, other
stakeholders, simply being “along for the ride”;
 a feeling that there is a lack of a sound legal, judicial and
regulatory structure providing sufficient incentives for good
Corporate Governance,
 Challenges
 Third, impediments arising because of the nature of a particular
sector, for example:
 Conflicting objectives, commercial and non-commercial;
 Lack of independence of boards;
 Not appointing suitably qualified or independent thinking directors
with relevant business skills;
 Political interference at board level;
 Different and insufficient monitoring regimes by shareholders.
 Research Methodology
 Secondary data in the form of books, journals, magazines,
websites, newspapers was used.
 CONCLUSION
 The next few years will see a flurry of activity on the
Corporate Governance front. New aggressive companies
place a great deal of value on Corporate Governance and
transparency. While to a certain extent, this activity will be
driven by more stringent regulations, to a greater extent, the
momentum will come from the forces of competition, and
demand for low cost capital. Thankfully, many Indian
companies have already seen the writing on the wall and are
concentrating on good Corporate Governance practices.
THANK YOU !