AN OVERVIEW OF CORPORATE GOVERNANCE –

IN THE INDIAN CONTEXT

With globalization of the Indian economy, there has been shift of economic policies in
favor of open, democratic and competitive environment. As a result of these reforms
process, for last almost two decades, the country has been passing through
unprecedented changes in the various economic fields.

One of the major areas has been the ‘capital market’ reform since corporates are
increasingly shifting to financial markets as the pre-eminent source for capital. As
a first step the Government has set up Securities and Exchange Board of India
(SEBI) on the lines of SEC (Securities and Exchange Commission) of USA. SEBI has
been doing a commendable job by taking various measures in order to protect the
Shareholder and Investors interest.

With a view to ensuring that we adopt international standards in this respect, SEBI set
up a Committee on ‘Corporate Governance’ to recommend the measures necessary
to promote and raise the standards of corporate governance in India, under the
Chairmanship of Shri Kumar Mangalam Birla, an eminent industrialist and member
SEBI board, with other specialists from various related fields as members.

The Committee after detailed deliberations and drawing from the various reports and
codes from advanced countries and taking into account the Indian environment
submitted its report in November 1999.

The SEBI board considered the recommendations at its meeting of January 25, 2000
and decided to implement the same through amendments to the listing agreements, as
suggested by the Committee (The listing agreement is the legal contract between the
Stock Exchanges and the Listed Companies for enabling the Companies to list their
shares for trading on the terms and conditions mentioned in the agreement) by

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introducing new clause 49. SEBI issued circular reference F.No.SMDRP/POLICY/CIR-
10/2000 dated 21.2.2000. Since than the same has been getting periodically reviewed
and amended to adept to the changing requirements.

The recommendations are broadly in two categories – mandatory and non-

mandatory. However, it has also been emphasized that the same should be reviewed
with the changing context and times, particularly, with the changing expectations of the
stakeholders and increased sophistication in the capital markets. The same will have to
be implemented in a staggered manner starting from financial year 2000-2001 to 2002-
2003, depending on the size of the entities.

Based on the terms of reference the committee had agreed that the fundamental
objective of corporate governance is the “enhancement of the long term shareholder
value while at the same time protecting the interest of other stakeholders”

The corporate structure separates management from ownership. As a result basic

underlying concept is of stewardship and of related concepts of accountability,
transparency and reporting.

The corporate governance depends mainly on three entities

- the Board of Directors
- Management, and
- Shareholders

In order for the corporate governance to succeed all the three entities need to
understand their role properly and act in harmony with each other. However, the
ultimate responsibility for putting the Code into practice lies directly with the
Boards of Directors.

The Board of Directors is responsible for the governance of the company. They
provide leadership, strategic guidance and objective judgment independent of
management to the company and exercises control over the company. There

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key function is to direct and control. There effectiveness will depend on how
efficiently they perform this dual function. They are primarily responsible to the
shareholders for creating, protecting and enhancing wealth and resources for
the company.

In this respect there is special emphasis on composition, structure and

responsibilities of the Board of Directors. The composition of the Board of Directors
is critical for the effective and independent functioning.

The Committee has observed, that till recently it has been the practice of most of the
companies in India to fill the board with representatives of the promoters of the
company, and independent directors if chosen were also handpicked thereby
ceasing to be independent. This has undergone a change and increasingly the
boards comprise of following groups of directors - promoter director, executive and
non-executive directors, a part of whom are independent

Under the new scheme of things, there will be combination of three categories of
Directors, namely, Executive, Non-executive and Independent (Independent
directors are directors who apart from receiving director’s remuneration do not have
any material pecuniary relationship or transactions with the company, its promoters,
its management or its subsidiaries, which in the judgment of the board may affect
their independence of judgment). There is a key role for the Non-Executive and
Independent Directors in the independent functioning. Due to their presence on one
hand no individual or a group is able to dominate the Board and on the other
hand they bring external and wider perspective to the decision-making. The
independence of the board is also critical to fulfill its oversight role objectively.

With the fresh directives, the Board of a company would have an optimum
combination of executive and non-executive directors with fifty percent of the Board
comprising the non-executive directors. If the Chairman is non-executive at least
one-third of the Board should comprise of independent directors and in case of an
executive Chairman, at least half of the board should be independent.

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 The code also lays special emphasis on the role of the Chairman. The Committee is
of the view that the Chairman’s role in principle be different from that of the chief
executive.

The Chairman has to maintain a balance of power in the board, make certain that all
directors participate and receive adequate information, well in time.

Similarly, the role of a nominee Director also will have to be specified whether he is
representing in the capacity as a Lender or an Investor.

This will provide the readers with the changed requirements, along with the broad
philosophies and logics applied by the Committee in their recommendations, to be
followed by listed companies only in respect of composition of the Board. Similarly,
the Committee has also made number of other recommendations, which have been
briefly highlighted and could be dealt with at greater length at a later date.

The companies would also now be required to have following Sub-committees in order
to assist the Board in efficient discharge of its responsibilities.

- Audit Committee shall be set up comprising of non-executive and independent

directors. One of them should have financial and accounting knowledge. Their
main role is to oversight the company’s financial reporting process. The
financial statement should be correct, sufficient and credible. In order to
unable them to perform the said function effectively they have also been given
sufficient powers and authorities.

- Remuneration Committee shall deal with remuneration policies and provides that
the board shall fix the remuneration of the non-executive directors. It also
requires complete disclosure on Directors remuneration in the Annual Report.

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 - Shareholder / Investors Grievances Committee to redress shareholder and
investors complaints.

The Board Procedures lays down detailed requirements regarding conducting of

number of board meetings, time gaps and the minimum information to be placed before
the board. The information includes the operating plans, budgets, capital budgets,
quarterly results, report of committees, material information on key personnel, HR / IR,
legal compliances/defaults etc. This will ensure that the directors are provided with
minimum critical information relevant to ensure efficient discharge of their
responsibilities and in performance evaluation of the company.

Management Discussions and Analysis Report is required to be submitted as part of

the annual report. This would provide shareholders with a information on the industry,
segment-wise performance, opportunities and threats and such other material
information which other wise is not available but at the same time is important enough
for them to know so as to take informed decisions, subject to the limits set by
company’s competitive position.

Report on Corporate Governance – there shall be a separate section in the annual

report on Corporate Governance, with a detailed compliance report. Non-compliance of
any mandatory requirements, with reasons thereof and the extent to which non-
mandatory requirements have been adopted should be high lighted. The report requires
suggested items for disclosure as:

- Company’s philosophy on the code, information on Directors, report on

Committees –Audit, Remuneration and Shareholders, General body meetings,
related party transactions, communication to Shareholders, general shareholder
information etc.

Compliance Certificate – the directors’ report shall be annexed with a certificate from
the auditors of the company regarding compliance of conditions of corporate

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governance as stipulated in the clause. A copy of the same shall also be forwarded to
the Stock exchange.

The Committee has also made important suggestion with regard to the role and
responsibilities of other two entities namely, Management and Shareholders.

Managements responsibility include the over-riding aim of maximizing shareholder

value without being detrimental to the interests of other stakeholders at the same time
to operate within the boundaries and the policy framework laid down by the board. It has
to translate into action, the policies and strategies of the board and implementing its
directives to achieve corporate objectives of the company. Simultaneously, to ensure
that control systems are in place to achieve the objectives laid down by the board, and
also to help the board discharge its responsibilities to the shareholders.

The shareholders’ can play a very effective role in good Corporate Governance at the
same time maintaining a high standard of corporate behavior and also without
getting involved in the day-to-day functioning of the company. General Body Meetings
provide an opportunity to the shareholders to address their concerns to the Board of
Directors and to ensure that the company is being stewarded for maximizing the
interests of the shareholders. The shareholders must therefore show a greater degree
of interest and involvement in the appointment of the directors and the auditors.
For this they should demand complete information about them before approving their
appointments.

In conclusion, while structures and rules are necessary the real success will lie with
taking proactive initiatives by corporates and treating it as a way of life. The breadth and
depth of a code or the stringent enforcement norms will not help much. The code should
be complied with in letter and spirit and while interpreting it, give precedence to
substance over form.

Ultimately, the quality of governance will depend to a great extent on integrity of

management, the ability of the board, their commitment level, quality of reporting and

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adequacy of the processes. The efficient corporate governance is far above compliance
– it builds on best corporate practices based on basic regulatory requirements.

It is now time for the Indian corporates to shade their image of Family Owned
Businesses. Get globalised and accept, adopt and master the rules of the modern day
International business norms so as to avail of the tremendous opportunities. This will
help to survive and grow in the new competitive world order.

C.S.Shah
CEO – CKPP Associates
E-mail: csshah01@yahoo.co.in
URL: www.smesolutions.in
Cell No. +91 93222 32039