Corporate Governance in India – Challenges and Way Forward

Recently, it has been reported that a well-known venture capital firm – Sequoia Capital’s India partners have engaged in governance scandals at startup companies in its portfolio. The events indicate towards the company facing governance-related challenges in India. The incident highlights the issue of corporate governance in India that never fails to draw the attention of regulators as well as investors time and again.

This topic of “Corporate Governance in India – Challenges and Way Forward” is important from the perspective of the UPSC IAS Examination, which falls under General Studies Portion.

Corporate Governance – Definition

• As per the Cadbury Committee of the U.K, “Corporate governance is the system by which companies are directed and controlled.”
• In other words, it is the system, structure or mechanism of rules, practices and processes by which a firm or company is governed.
• The very goal of the mechanism is to balance the interests of a firm or company’s many stakeholders such as shareholders, senior management executives, customers, suppliers, financiers, the government, and the community simultaneously adding value to the company.
  • In short, the objective of corporate governance is to balance individual and societal goals as well as economic and social goals in long run.

Components

• As it provides a framework for attaining a company’s objectives, it encompasses almost every sphere of management starting from action plans and internal controls to performance management and corporate disclosure.
• The explicit and implicit contracts between the company and the stakeholders for the distribution of responsibilities, rights and rewards.
• Procedures for reconciling the conflicting interests of stakeholders as per their duties, privileges and roles.
• Procedures for proper supervision, control, and information that flows for serving as a system of checks and balances.

Importance

The increasing concern about the non-compliance of standards of financial reporting and accountability by boards of directors and management of corporate leading to heavy losses for investors has given rise to the need for a robust corporate governance mechanism in India. However, several other factors are working simultaneously that highlight the need for corporate governance in India.

• Security of investors and invested capital
  • Corporates often project a wrong picture of the company’s performance and profitability to raise capital from the market at a high valuation of their shares.
  • Lack of adequate standards of financial reporting and accountability help them do so which ultimately leads to the loss of investors.
  • A robust corporate governance mechanism may help the investors to be protected from unscrupulous management of corporate bodies and ensure the protection of their interests.
• Countering mismanagement and corruption
  • Top-level corporate executives often get high monetary payments and packages out of corporate funds which are the property of shareholders and society.
  • Most often the companies do not pay heed to the investors’ grievances or disseminate the required information timely.
  • Fraudulent practices of corporate boards of directors and management form the other set of problems.
  • Such precedents necessitate the need for corporate governance that may counter the ill-management of corporate bodies.
• Healthy and vibrant stock market
  • Growing awareness and consensus among Indian investors to invest in companies which have a record of observing practices of good corporate governance encourages investors to invest adequately in the stock of corporate companies.
  • Corporate officials often engage in insider trading taking undue advantage at the expense of investors in general. A robust corporate governance structure may help counter such problems and may eventually help in boosting up rate of growth of the economy.
• Boosting foreign investment
  • In the era of globalization and reducing trade barriers foreign investment has become crucial.
  • Foreign investors often keep a track of well-managed companies and respond positively to them.
  • If Indian companies adhere to basic principles of good corporate governance, this may help in attracting a huge flow of FDI or capital flows leading to high economic growth.
• Protection of the rights of various stakeholders
  • Takeovers and mergers have become a regular affair. However, it also brings in ruckus and chaos due to conflicting claims of rights of various stakeholders in the company.
  • Corporate governance may help deal with such issues effortlessly.
• Boosting public confidence
  • Corporate scams or frauds in the recent years of the past have shaken public confidence in corporate management.
  • Thus, well-established corporate governance practices may revive investors’ confidence and boost public confidence in the economy.
• Ensuring efficiency and accountability of the firm owners and managers
  • Nowadays, a corporate body has numerous stakeholders with differing attitudes towards corporate affairs.
  • To deal with the unorganised and indifferent attitude of the stakeholders a set of rules and regulations with a practical implementation of a code of conduct is necessary. This brings in the need for corporate governance.
• Ensuring social responsibility of stakeholders
  • Apart from responsibility towards investors, corporate bodies also have several other responsibilities.
  • These include corporates taking care of the environment, pollution, quality of goods and services, sustainable development etc.
  • Fulfilment of all these expectations can be ensured only through a proper corporate governance structure.

Government Initiatives

• Organisational framework
  • Ministry of Corporate Affairs
    • The Ministry through its various appointed committees and forums such as National Foundation for Corporate Governance (NFCG), facilitates the exchange of experiences and ideas amongst corporate leaders, policymakers, regulators, law enforcement agencies and non-government organizations.
  • The Securities and Exchange Board of India (SEBI) monitors and regulates the corporate governance of listed companies in India through Clause 49.
    • Clause 49 is incorporated in the listing agreement of stock exchanges with companies and listed companies must comply with its provisions.
    • It includes the appointment of IDs (independent directors), audit committee, and code of conduct, disclosures of related party transactions, remunerations, compliance with accounting standards, certifications of CEO & CFO, compliance certification & whistle-blower policy etc.
    • The Clause is amended from time to time to incorporate changes introduced by new acts or regulations.
  • The Companies Act, 2013 provides a formal structure for inducing good corporate governance practices through self-regulation, a responsive legal framework based on shareholders’ democracy; a disclosure-based regime; rational penal provisions with built-in deterrence and effective protection.
    • It helps in enhancing disclosures, reporting and transparency through enhanced as well as new compliance norms.
• Amendments to acts governing prominent professional institutes engaged in corporate work and audits such as (ICAI/ICSI/ICWAI) thus help in strengthening the disciplinary mechanism and bringing transparency to their work.
• The Confederation of Indian Industries (CCI) set up a task force in 1995 following which it released the code called “Desirable Corporate Governance” in 1998.
• Appointment of several committees from time to time to suggest reforms in corporate governance. These include:
  • Kumar Mangalam Birla Committee (1999)
  • Naresh Chandra Committee (2002) 
  • Narayana Murthy Committee (2003)
• The recommendations were incorporated as various rules and regulations reforming the corporate governance structure.
• Introduction of Limited Liability Partnerships (LLPs), transformation in the service delivery mechanism for transparency and certainty, setting up of Investor Education and Protection Fund, and empowering the investors through awareness programmes through investor associations, VOs, NGOs, etc. are some other initiatives.

Challenges

• Selection process and term of Board
  • The law requires a healthy mix of executive and non-executive directors, independent directors, and woman directors.  However, companies only comply on papers and often appointments are done in a way that may be contrary to the law.
  • Board members of most of the corporate bodies in India are the friends and family of promoters. The Board members serving for life terms often tend to gain too much authority and impose their fixed set of beliefs.
• Lack of independence of independent directors
  • The independent directors have failed to make any remarkable impact since the appointment of IDs is often done at the discretion of promoters and excessive power of promoters in the appointment and dealing of IDs may often hamper the latter’s performance.
  • Most often a contrary opinion or decision of an independent director to a promoter’s decision may lead to his removal.
• Lack of accountability
  • A corporate body has to be accountable to its stakeholders and environment. However, they often tend to limit and escape the liability towards the stakeholders.
• Excessive role of founder or promoter in the business
  • As the founders have a significant portion of shareholding in the company, they influence the business decisions by influencing the board and management resulting in the derailment of the corporate governance system.
• Performance evaluation of directors and its disclosure being a critical issue
  • Disclosure of performance evaluation reports in public to achieve the desired results on governance practices is important. However, corporate firms often avoid sharing such details to avoid scrutiny or negative feedback.
• Business structure and internal conflicts hindering the implementation of corporate governance practices
  • Multiple layers of management, executives and other officers hinder the passing of accurate information to the higher levels as they may be distorted at lower levels.
  • Conflicting relationships between boards and managers often influence the implementation of decisions and policies.
• Lack of trust regarding the effectiveness of corporate governance practices
  • The occurrence of several scams, frauds, misappropriation of public money, and corrupt practices in the stock market, banks, financial institutions, companies and government offices in recent times has made the effectiveness and success of corporate governance laws, and reforms and practices questionable.

Recommendations

• The method of selection of independent directors should be made transparent.
• There should be more focus on the sustainability of business models in comparison to the quantity of profit.
• The supervision of functions of management is necessary to make them accountable and transparent to shareholders.
• Corporate culture should imbibe in itself ethics, principles, values and beliefs.
• Compliance with established norms and laws may help the firms to have a good score on corporate governance indices.
• Timely and accurate disclosure of information on the matters like the financial position, performance etc. may help ensure transparency and accountability.
• Regulators should enhance penalties for non-compliance.
• The framing of the code of conduct and whistle-blower policies should be made in such a way that it becomes possible to practise them.

Conclusion

Good corporate governance is an essential factor for the good health of finance, taxation, banking or any legal framework. It ensures total transparency, integrity and accountability of the management and the board of directors. The introduction of global standards in corporate governance may reduce the chances of corruption and scams and thus such practices must be adopted by both public and private sector undertakings to ensure the good health of the economy in the long run.

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