Corporate Governance

Definition:

Corporate Governance may be defined “as a set of systems, processes and principles which ensure that a company is governed in the best interest of all stakeholders”. It is the system by which companies are directed and controlled. It is about promoting corporate fairness, transparency and accountability. The system of rules, practices and processes by which a company is directed and controlled. Corporate  governance essentially  involves  balancing  the  interests  of  the many  stakeholders  in  a  company  –  these  include  its  shareholders,  management,customers, suppliers, financiers, government and the community.

Corporate  governance  is  the  system  by  which  organisations  are  governed  and controlled. It is concerned with the ways in which corporations are governed generally and in particular with the relationship between the management of an organisation and its  shareholders.  In this  respect,  several  control mechanisms,  often  in  the form  of committees, are implemented within in order to monitor its management activities and functioning. As a part of critical corporate governance mechanisms, the audit committee has  an  oversight  function  dealing  with  different  managerial  activities,  corporate reporting, and auditing. This oversight includes ensuring the quality of accounting policies, internal controls, and independent auditors to enhance control mechanisms, anticipate financial risks, and promote accurate, transparent, and timely disclosure of corporate information to various users of the organisation’s financial information.

Concept

  • It involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders.
  • It deals with prevention or mitigation of the conflict of interests of stakeholders. Ways  of  mitigating  or  preventing  these  conflicts  of  interests  include  the processes, customs, policies, laws, and institutions which have an impact on the way a company is controlled.
  • An  important  theme  of  corporate  governance  is  the  nature  and  extent  of accountability of people in the business, and mechanisms that try to decrease the principal–agent problem.

Objective

  • A  properly  structured  board  capable  of  taking  independent  and  objective decisions is in place at the helm of affairs.
  • The board is balance as regards the representation of an adequate number of non-executive and independent directors who will take care of their interests and well-being of all the stakeholders.
  • The board adopts transparent procedures and practices and arrives at decisions on the strength of adequate information.
  • The board has an effective machinery to subserve the concerns of stakeholders.
  • The board keeps the shareholders informed of relevant developments impacting the company.
  • The board effectively and regularly monitors the functioning of the management team.
  • The board remains in effective control of the affairs of the company at all times.

 Advantage of corporate governance

  • Enhanced Performance- helps a company improve overall performance.
    • Without corporate governance, a company tends to be weak and sluggish.
  • Access to Capital- The better corporate governance a company has, the more easily it can access outside capital that the business can use to fund its projects.
    • Since corporate governance includes major shareholders, it connects investors with the business itself, and these investors use their resources and contacts to support the company monetarily.
  • Better Standards- Corporate governance makes many decisions about business operations,  but  one  of   the  most  important  decisions   involves   corporate standards.
    • Standards affect the quality of products and the goals that the business has in technology, customer service, and marketing.
  • Better Talent Utilisation- With a strong corporate governance structure, people can find positions that utilise their talents more effectively, and the board of directors and top leaders of the business are always looking to add more talented people to their numbers.

Disadvantage of corporate governance

  • Easily Corruptible-Corporate governance needs a certain level of government oversight to avoid increasing levels of corruption. The lack of governmental oversight in corporate governance leads to a misallocation of credit that actually worked against competition.
  • Family-Owned  Companies-  Corporate  governance  works  at  its  best  when shareholders and board members are able to make objective decisions that are in the best interest of the company. According to Ibis Associates, a business planning firm, family-run corporations (founding family members own controlling share of the company), such as Ford and Walmart, lose objectivity in business making decisions due to the family’s financial investment in the business’ performance  and  the  emotional  ties  associated  with  building  a  worldwide corporation from the ground up.
  • Costs  of  Monitoring-  To  effectively  govern  a  publicly  traded  corporation, shareholders must speak with one voice and have enough votes to allow that voice to have any real weight. This requires individuals that have a collective vision  for  the  company  to  pour  more  money  into  that  company  to  gain  a controlling share.

Factors affecting Corporate Governance

A) REGULATION & THEIR ENFORCEMENT

  • Since corporate governance failures have proved to be harmful not just for the organizations but also for the economy and the general public at large as well, there have been public pressures on the government and regulatory authorities to reform business practices and increase transparency.
  • Consequently,  it  has  become  a  part  of  the  government’s  duty  to  ensure accountability and responsibility in corporate behavior.
  • Effective disposal of this responsibility basically revolves around two things:
  • First, the designing of regulatory commands i.e. the regulations and laws to ensure good corporate governance; and
  • Second is the enforcement of regulations.

B) RISK MANAGEMENT & EFFECTIVE GOVERNANCE

  • In today’s world, frauds are an undeniable fact of business life.
  • Affecting all types of businesses. New technologies such as the Internet, and the development of fully automated accounting systems, have increased the opportunities for fraud to be committed.
  • Once suspected or discovered, investigating fraud is a specialist task
  • Requiring experience and technical skill and can be very costly. Thus, there is no doubt.
  • That fraud is best prevented, rather than dealt with after the fact. The most effective and appropriate response to the problem of fraud involves a combination of risk management techniques.

These techniques include:

  • Setting up inherent control based upon soft controls that occur continuously and c onsistently throughout the organization. Such controls should be embedded in normal business practice and be designed in such a way that they are to a large extent self sustaining; and
  • Setting up formal control processes of monitoring, reviewing and reporting

Factors affecting for investors and companies-

For Investors For companies
o Compensation

o Board Independence

o Shareholder Rights

o Risk Oversight

o Board Competence o Takeover

o Takeover Defences

o M&A/Proxy Fights

o Audit-Related

o Risk Oversight

o Compensation

o Board Competence

o Board Independence

o Shareholder Rights

o Audit-Related

o Environmental/Social

o Takeover Defense

For example, a significant issue many corporate executives face every year is their annual  meeting  planning as  well  as  understanding  current  shareholder sentiment.  Through  our  annual  meeting  planning  sessions,  we  are  able  to analyze your constituent bases to ensure even the vocal minority concerns are being addressed and heard.

Based  on  their  shareholder  makeup,  each  company  could  have  different concerns  on  both  sides  of  the  table.  One  of  the  first  steps  to  obtaining shareholder identification is to conduct a detailed shareholder analysis. We will identify the constituents; work with your team to build a plan, and create an outreach    program    that    is    in    step    with    your    annual    meeting    and board reelection efforts.

Principles of corporate governance

  • Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by openly and effectively communicating information and by encouraging shareholders to participate in general meetings.
  • Interests of other stakeholders: Organizations should recognize that they have legal,  contractual,  social,   and  market   driven   obligations   to  non-shareholder stakeholders,    including    employees,    investors,    creditors,    suppliers,    local communities, customers, and policy makers.
  • Role and responsibilities of the board: The board needs sufficient relevant skills and understanding to review and challenge management performance. It also needs adequate size and appropriate levels of independence and commitment.
  • Integrity and ethical behavior: Integrity should be a fundamental requirement in choosing corporate officers and board members. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making.
  • Disclosure  and  transparency: Organizations  should  clarify  and  make  publicly known the roles and responsibilities of board and management to provide stakeholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company’s financial reporting.  Disclosure of  material matters  concerning  the  organization  should  be timely  and  balanced  to  ensure  that  all  investors  have  access  to  clear,  factual information.

Models:

Different models of corporate governance differ according to the variety of capitalism in which they are embedded. The Anglo-American “model” tends to emphasize the interests of shareholders. The coordinated or Multi stakeholder Model associated with Continental Europe and Japan also recognizes the interests of workers, managers, suppliers,  customers, and  the  community.  A  related  distinction  is  between  market- orientated and network-orientated models of corporate governance

Indian model

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.”

Why corporate governance?

AT NATIONAL LEVEL:-

  • As barriers to the free flow of capital fall, it becomes imperative to recognize that the quality of corporate governance is relevant to capital formation and that sound corporate governance principles is the foundation upon which the trust of investors is built.
  • Corporate governance represents the ethical the moral framework under which business decisions are taken. Thus, any investor, when making investments across the borders or even otherwise, wants to be sure that not only are the capital markets or enterprises with which they are investing are being run competently but they also have good corporate governance.
  • Consequently, lack of sound corporate governance practices in any country can badly affect the confidence of foreign investors, in turn causing damage to the amount of foreign investments flowing in.

At the company and individual level:-

  • It is self evident that sound corporate governance is essential to the well being of an individual company and its stakeholders, particularly its shareholders and creditors.
  • We need only remind ourselves of the many companies, across the world, whose financial difficulties and,
  • Ultimate demise have been substantially attributable to weak corporate governance.
  • On the other hand, there are several areas of self-interest that should drive companies to embrace more effective governance. These areas are:
  1. Effective governance helps to minimize reputational risks and thus, protecting the brand;
  2. It helps to instill trust in customers and vendors;
  3. It also helps to assure effectiveness and integrity of a company’s business processes.
  4. Further, in many cases, the punishment, in terms of penalties or imprisonment, for White-collar crimes is now in excess for such criminal acts such as armed robbery, assault, and negligent murder. Even to escape such punishments, ensuring corporate governance compliance is a must.

 Corporate governance in different type of companies

Corporate governance in private companies-

Most of the regulations made, such as SOX in US and Clause 49 of Listing Agreement in India, are applicable only to publicly-registered or listed companies and private companies are out of the ambit of these regulations.

However, today we see that private companies are also becoming big in size and impact.

Very near examples would include joint ventures being organized as private companies within the insurance industry in India.

Thus, failure of corporate governance within these private companies as well can very badly harm the general public at large. And also since new standards of corporate governance, while only required by law at public companies, are for forming “best practices” in many will governed private companies, we strongly feel that the applicability of such regulations, after suitable modifications, be extended to private companies as well.

Apart from the necessity as above, it is also in the self-interest of private companies to ensure good corporate governance. This is primarily because:-

  1. Usually, in most private companies, controls are informal or even if there are formal controls, they tend to be detective rather than preventive. This makes private companies unprotected against risks, which needs to be mitigated.
  1. Good corporate governance increases creditworthiness of the company and thus, enables it to raise funds at cheaper cost. Good corporate governance is also a must for companies that are planning to seek stock exchange listing and raise money from markets by converting them into public company.
  1. Finally, if the owners of a private company are considering the sale of all or part of the entity, or are seeking private equity financing, effective controls can increase prospective buyers’ willingness to pay a premium for the acquisition. Controls enhancements can also help attract new business partners.

Public sector corporate governance-

  • Although the private sector model view shareholders as main stakeholders.
  • In public sector specific users group those directly responsible for funding and the community at large assumes great importance as stakeholders.
  • Stewardship  and  accountability  of  use  of  funds  and  assets  is  particularly important in public sector.
  • It is becoming more important to focus on corporate governance in public sector to maintain faith in system and promote better service to the public sector to maintain faith in the system and promote better service to the public.

Regulatory framework on corporate governance

The Indian statutory framework has, by and large, been in consonance with the international best practices of corporate governance. Broadly speaking, the corporate governance mechanism for companies in India is enumerated in the following enactments/ regulations/ guidelines/ listing agreement:

1. The Companies Act, 2013 inter alia contains provisions relating to board constitution, board meetings, board processes, independent directors, general meetings, audit committees, related party transactions, disclosure requirements in financial statements, etc.

2. Securities and Exchange Board of India (SEBI) Guidelines: SEBI is a regulatory authority having jurisdiction over listed companies and which issues regulations, rules and guidelines to companies to ensure protection of investors.

3. Standard Listing Agreement of Stock Exchanges: For companies whose shares are listed on the stock exchanges.

4. Accounting Standards issued by the Institute of Chartered Accountants of India (ICAI): ICAI is an autonomous body, which issues accounting standards providing guidelines for disclosures of financial information. Section 129 of the New Companies Act inter alia provides that the financial statements shall give a true and fair view of the state of affairs of the company or companies, comply with the accounting standards notified under s 133 of the New Companies Act. It is further provided that items contained in such financial statements shall be in accordance with the accounting standards.

5. Secretarial Standards issued by the Institute of Company Secretaries of India (ICSI): ICSI is an autonomous body, which issues secretarial standards in terms of the provisions of the New Companies Act. So far, the ICSI has issued Secretarial Standard on “Meetings of the Board of Directors” (SS-1) and Secretarial Standards on “General Meetings” (SS-2). These Secretarial Standards have come into force w.e.f. July 1, 2015. Section 118(10) of the New Companies Act provide that every company (other than one person company) shall observe Secretarial Standards specified as such by the ICSI with respect to general and board meetings.

Key legal framework for corporate governance in India

The Companies Act, 2013

The Government of India has recently notified Companies Act, 2013 (“New Companies Act”), which replaces the erstwhile Companies Act, 1956. The New Act has greater emphasis on corporate governance through the board and board processes. The New Act covers corporate governance through its following provisions:

  • New Companies Act introduces significant changes to the composition of the boards of directors.
  • Every company is required to appoint 1 (one) resident director on its board.
  • Nominee directors shall no longer be treated as independent directors.
  • Listed companies and specified classes of public companies are required to appoint independent directors and women directors on their boards.
  • New Companies Act for the first time codifies the duties of directors.
  • Listed companies and certain other public companies shall be required to appoint at least 1 (one) woman director on its board.
  • New Companies Act mandates following committees to be constituted by the board for prescribed class of companies:
    • Audit committee
    • Nomination and remuneration committee
    • Stakeholders relationship committee
    • Corporate social responsibility committee

Listing agreement – Applicable to the listed companies

SEBI has amended the Listing Agreement with effect from October 1, 2014 to align it with New Companies Act.

Clause 49 of the Listing Agreement can be said to be a bold initiative towards strengthening corporate governance amongst the listed companies. This Clause intends to put a check over the activities of companies in order to save the interest of the shareholders. Broadly, cl 49 provides for the following:

1. Board of Directors

The Board of Directors shall comprise of such number of minimum independent directors, as prescribed. In case where the Chairman of the Board is a non-executive director, at least one-third of the Board shall comprise of independent directors and where the Chairman of the Board is an executive director, at least half of the Board shall comprise of independent directors. A relative of a promoter or an executive director shall not be regarded as an independent director.

2. Audit Committee

The Audit Committee to be set up shall comprise of minimum three directors as members, two-thirds of which shall be independent.

3. Disclosure Requirements

Periodical disclosures relating to the financial and commercial transactions, remuneration of directors, etc, to ensure transparency.

4. CEO/ CFO Certification

To certify to the Board that they have reviewed the financial statements and the same are fair and in compliance with the laws/ regulations and accept responsibility for internal control systems.

5. Report and Compliance

A separate section in the annual report on compliance with Corporate Governance, quarterly compliance report to stock exchange signed by the compliance officer or CEO, company to disclose compliance with non-mandatory requirements in annual reports.


You can download the pdf of this article from the link given here – corporate-governance

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