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INTRODUCTION
Companies pool capital from a large investor base both in the domestic and
in the international capital markets. In this context, investment is ultimately
an act of faith in the ability of a companys management. In order to
manage the affairs of a company and to act in the best interests of all at all
times, there must be a system whereby the directors are entrusted with
responsibilities and duties in relation to the direction of the company
affairs.
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A means whereby society can be sure that large corporations are well-run
institutions to which investors and lenders can confidently commit their
funds.
Considering the ethical failures in the last several years and the resulting
crisis in confidence...A sincere commitment to creating and sustaining an
ethical business culture in public and private sectors (has never been so
important).
As per ICSI:
Corporate Governance is the best Management practices compliance of law
in true letter and adherence to ethical standards for effective management
and distribution of wealth and discharge of social responsibility for
sustainable development of all stakeholders.
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HISTORICAL BACKGROUND
Duties of a King
Corporate governance
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Corporate governance are the policies, procedures and rules governing the
relationships between the shareholders, (stakeholders), directors and
managers in a company, as defined by the applicable laws, the corporate
charter, the companys bylaws, and formal policies.
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Improving performance
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INDIAN SCENARIO
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INTERNATIONAL SCENARIO
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The important legislations for regulating the entire corporate structure and
for dealing with various aspects of governance in companies are Companies
Act, 1956 and Companies Bill, 2004. These laws have been introduced and
amended, from time to time, to bring more transparency and
accountability in the provisions of corporate governance. That is, corporate
laws have been simplified so that they are amenable to clear interpretation
and provide a framework that would facilitate faster economic growth.
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Companies Laws
The Ministry of Corporate Affairs (MCA) is the main authority for
regulating and promoting efficient, transparent and accountable form of
corporate governance in the Indian corporate sector. It is constantly
working towards improvement in the legislative framework and
administrative set up, so as to enable easy incorporation and exit of the
companies, as well as convenient compliance of regulations with
transparency and accountability in corporate governance. It is primarily
concerned with administration of the Companies Act, 1956 and related
legislations.
The main objectives with which this Act has been introduced are to:- (i)
help in the development of companies on healthy lines; (ii) maintain a
minimum standard of good behaviour and business honesty in company
promotion and management; (iii) protect the interests of the shareholders
as well as the creditors; (iv) ensure fair and true disclosure of the affairs of
companies in their annual published balance sheet and profit and loss
accounts; (v) ensure proper standard of accounting and auditing; (vi)
provide fair remuneration to management and Board of Directors as well as
to company's employees; etc.
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Every company shall in each year, hold in addition to any other meetings, a
general meeting as its annual general meeting and shall specify the meeting
as such in the notices calling it; and not more than fifteen months shall
elapse between the date of one annual general meeting of a company and
that of the next. At each annual general meeting, every company shall
appoint an auditor or auditors to hold office from the conclusion of that
meeting until the conclusion of the next annual general meeting and shall,
within seven days of the appointment, give intimation thereof to every
auditor so appointed.
Every auditor of a company shall have a right of access at all times to the
books and accounts and vouchers of the company, whether kept at the
head office of the company or elsewhere, and shall be entitled to require
from the officers of the company such information and explanations as the
auditor may think necessary for the performance of his duties as auditor.
The auditor shall inquire: - (i) whether loans and advances made by the
company on the basis of security have been properly secured and whether
the terms on which they have been made are not prejudicial to the
interests of the company or its members; (ii) whether transactions of the
company which are represented merely by book entries are not prejudicial
to the interests of the company; etc.
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Every company shall keep one or more registers in which shall be entered
separately particulars of all contracts or arrangements, including the
following particulars to the extent they are applicable in each case,
namely:- (i) the date of the contract or arrangement; (ii) the names of the
parties thereto; (iii) the principal terms and conditions thereof; (iv) in the
case of a contract or arrangement to which this Act applies, the date on
which it was placed before the Board; (v) the names of the directors voting
for and against the contract or arrangement and the names of those
remaining neutral. Further, every company shall keep at its registered office
a register of its directors, managing director, managing agent, secretaries
and treasurers, manager and secretary.
Every public company having paid-up capital of not less than five crores of
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The Audit Committee should have discussions with the auditors periodically
about internal control systems, the scope of audit including the
observations of the auditors and review the half-yearly and annual financial
statements before submission to the Board and also ensure compliance of
internal control systems. It shall have authority to investigate into any
matter in relation to the items specified by the Board and for this purpose,
shall have full access to information contained in the records of the
company and external professional advice, if necessary. The
recommendations of the Audit Committee on any matter relating to
financial management, including the audit report, shall be binding on the
Board. If the Board does not accept the recommendations of the Audit
Committee, it shall record the reasons thereof and communicate such
reasons to the shareholders.
Besides, a listed public company may, and in the case of resolutions relating
to such business as the Central Government may, by notification, declare to
be conducted only by postal ballot, shall, get any resolution passed by
means of a postal ballot, instead of transacting the business in general
meeting of the company. Where a company decides to pass any resolution
by resorting to postal ballot, it shall send a notice to all the shareholders,
along with a draft resolution explaining the reasons thereof, and requesting
them to send their assent or dissent in writing on a postal ballot within a
period of thirty days from the date of posting of the letter. If a resolution is
assented to by a requisite majority of the shareholders by means of postal
ballot, it shall be deemed to have been duly passed at a general meeting
convened in that behalf. However, if a shareholder sends his assent or
dissent in writing on a postal ballot and thereafter any person fraudulently
defaces or destroys the ballot paper or declaration of identify of the
shareholder, such person shall be punishable with imprisonment for a term
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The important step in this direction has been the Companies Bill, 2004,
which has been introduced to provide the comprehensive review of the
company law. It contained important provisions relating to corporate
governance, like, independence of auditors, relationship of auditors with
the management of company, independent directors with a view to
improve the corporate governance practices in the corporate sector. It is
subjected to greater flexibility and self-regulation by companies, better
financial and non-financial disclosures, more efficient enforcement of law,
etc.
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SEBI Laws
Every recognised stock exchange shall furnish the Central Government with
a copy of the annual report, and such annual report shall contain such
particulars as may be prescribed. It may make rules or amend any rules
made by it to provide for all or any of the following matters, namely:- (i) the
restriction of voting rights to members only in respect of any matter placed
before the stock exchange at any meeting; (ii) the regulation of voting
rights in respect of any matter placed before the stock exchange at any
meeting so that each member may be entitled to have one vote only,
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irrespective of his share of the paid-up equity capital of the stock exchange;
(iii) the restriction on the right of a member to appoint another person as
his proxy to attend and vote at a meeting of the stock exchange; etc.
If, in the opinion of the Central Government, an emergency has arisen and
for the purpose of meeting the emergency, the Central Government
considers it expedient so to do, it may, by notification in the Official
Gazette, for reasons to be set out therein, direct a recognised stock
exchange to suspend such of its business for such period not exceeding
seven days and subject to such conditions as may be specified in the
notification, and, if, in the opinion of the Central Government, the interest
of the trade or the public interest requires that the period should be
extended, it may, by like notification extend the said period from time to
time.
This Act was enacted to protect the interests of investors in securities and
to promote the development of, and to regulate, the securities market and
for matters connected therewith or incidental thereto. For this purpose,
the SEBI (the Board), by regulation, specify:- (i) the matters relating to issue
of capital, transfer of securities and other matters incidental thereto; and
(b) the manner in which such matters shall be disclosed by the companies.
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may be associated with securities market shall buy, sell or deal in securities
except under, and in accordance with, the conditions of a certificate of
registration obtained from the Board in accordance with the regulations
made under this Act.
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I. Board of Directors
iii. For the purpose of the sub-clause (ii), the expression independent
director shall mean a non-executive director of the company who:
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ii. the legal firm(s) and consulting firm(s) that have a material
association with the company.
Explanation
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i. The board shall meet at least four times a year, with a maximum
time gap of four months between any two meetings. The minimum
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Explanation:
1. For the purpose of considering the limit of the committees on
which a director can serve, all public limited companies, whether
listed or not, shall be included and all other companies including
private limited companies, foreign companies and companies
under Section 25 of the Companies Act shall be excluded.
iii. The Board shall periodically review compliance reports of all laws
applicable to the company, prepared by the company as well as
steps taken by the company to rectify instances of non-
compliances.
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i. The Board shall lay down a code of conduct for all Board members and
senior management of the company. The code of conduct shall be posted
on the website of the company.
ii. All Board members and senior management personnel shall affirm
compliance with the code on an annual basis. The Annual Report of the
company shall contain a declaration to this effect signed by the CEO.
Explanation:
For this purpose, the term senior management shall mean personnel of
the company who are members of its core management team excluding
Board of Directors. Normally, this would comprise all members of
management one level below the executive directors, including all
functional heads.
A qualified and independent audit committee shall be set up, giving the
terms of reference subject to the following:
Explanation 1: The term financially literate means the ability to read and
understand basic financial statements i.e. balance sheet, profit and loss
account, and statement of cash flows.
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The audit committee should meet at least four times in a year and not
more than four months shall elapse between two meetings. The quorum
shall be either two members or one third of the members of the audit
committee whichever is greater, but there should be a minimum of two
independent members present.
The audit committee shall have powers, which should include the following:
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10. Discussion with statutory auditors before the audit commences, about
the nature and scope of audit as well as post-audit discussion to
ascertain any area of concern.
11. To look into the reasons for substantial defaults in the payment to the
depositors, debenture holders, shareholders (in case of non payment
of declared dividends) and creditors.
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IV. Disclosures
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(D) Proceeds from public issues, rights issues, preferential issues etc.
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(F) Management
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(G) Shareholders
i. In case of the appointment of a new director or re-appointment of
a director the shareholders must be provided with the following
information:
a. A brief resume of the director;
b. Nature of his expertise in specific functional areas;
c. Names of companies in which the person also holds the
directorship and the membership of Committees of the Board;
and
d. Shareholding of non-executive directors as stated in Clause 49
(IV) (E) (v) above
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V. CEO/CFO certification
The CEO, i.e. the Managing Director or Manager appointed in terms of the
Companies Act, 1956 and the CFO i.e. the whole-time Finance Director or
any other person heading the finance function discharging that function
shall certify to the Board that:
a. They have reviewed financial statements and the cash flow statement
for the year and that to the best of their knowledge and belief :
ii. these statements together present a true and fair view of the
companys affairs and are in compliance with existing accounting
standards, applicable laws and regulations.
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ii. significant changes in accounting policies during the year and that
the same have been disclosed in the notes to the financial
statements; and
iii. instances of significant fraud of which they have become aware and
the involvement therein, if any, of the management or an employee
having a significant role in the companys internal control system
over financial reporting.
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VII. Compliance
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According to experts from Wharton and elsewhere, the Satyam debacle will
have an enormous impact on India's business scene over the coming
months. The possible disappearance of a top IT services and outsourcing
giant will reshape India's IT landscape. Satyam could possibly be sold -- in
fact, it had engaged Merrill Lynch to explore "strategic options," but the
investment bank has withdrawn following the disclosure about the fraud. It
is widely believed that rivals such as HCL, Wipro and TCS could cherry pick
the best clients and employees, effectively hollowing out Satyam. Another
possible impact could be on the trend of outsourcing to India, since India's
IT firms handle sensitive financial information for some of the world's
largest enterprises. The most significant questions, however, will be asked
about corporate governance in India, and whether other companies could
follow Satyam's Raju in revealing skeletons in their own closets.
'Riding a Tiger'
The matter didn't die there, as Raju may have hoped. In the next 48 hours,
resignations streamed in from Satyam's non-executive director and Harvard
professor of business administration Krishna Palepu and three independent
directors -- Mangalam Srinivasan, a management consultant and advisor to
Harvard's Kennedy School of Government; Vinod Dham, called the "father
of the Pentium chip" and now executive managing director of NEA Indo-US
Ventures in Santa Clara, Calif.; and M. Rammohan Rao, the dean of the
Indian School of Business in Hyderabad (ISB). Rao had chaired both
December 16 board meetings. On January 8, he resigned his position as the
ISB dean. In a letter to the ISB community, he explained: "Unfortunately,
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"If there were one or two more such accounting scandals in the next six
months, it would make international investors more wary," says Wharton
management professor Michael Useem. "One example would put people
on guard; several examples would be enough to tell big investment money
managers that they have to be especially careful working in that
environment."
Useem also warns against overreacting. "Don't assume other firms are
guilty," he says. But he considers the situation to be an "alerting call" for
investors to check where their money is, and for auditors and independent
directors in all major firms to take a look at the books.
"When you have companies that are ostensibly growing their top lines at
30%, 40% or 50%, it is possible to paper over things," Singh says. "Satyam
was doing it by boosting sales and profits; Bernie Madoff was doing it by
boosting rates of return. When growth rates slow down, you are unable to
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hide the financial reality of how much cash you actually have. It is possible
that during this slowdown period, more scandals will come to light." (U.S.
financier Madoff last month admitted to running a $50 billion Ponzi scheme
to keep his hedge fund afloat.)
Singh adds that companies with "the bluest of blue-chip reputations [such
as] Infosys and TCS" could actually gain in the current environment,
because of a potential "flight to quality" among client companies. "The
third-tier and weaker companies will probably undergo a lot more
scrutiny," he says.
According to Ravi Aron, senior fellow at the Mack Center for Technological
Innovation at Wharton, the Satyam fallout could affect India's IT offshoring
and outsourcing firms in several ways. An immediate impact could be
skepticism on the part of clients about whether Indian IT firms can be
entrusted with sensitive financial information. "Clients could begin to ask,
'How much do I know about this IT company and its governance?'" says
Aron. "Is the IT service provider doing anything that could jeopardize the
client's compliance with FASB, Sarbanes Oxley, Basel II or other financial
regulations?"
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Guillen notes that what makes Satyam's case unusual is that it had listed its
ADRs on the NYSE. "Companies in emerging economies have trouble raising
capital at low costs. The literature shows that is the reason they want to list
in the U.S., where they accept a higher level of governance in order to raise
capital at a lower cost. The fact that Satyam listed its ADRs in the U.S. but
still had such serious governance problems makes this case particularly
disturbing."
Guillen adds, though, that India has several well-regarded IT companies. "If
one or two of them don't make the grade, it should not shake investor
confidence. It shows that investing in emerging markets is risky. Investors
always balance risks and rewards. If the IT sector in India continues to
remain competitive, the Satyam episode will just be a footnote in India's
business story. If the sector becomes uncompetitive, then that would
create a serious problem."
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Useem says that if one were to take an inference from recent high-profile
scandals outside of India, "there would be a redoubled effort [in India] on
the part of investors and independent directors at other companies to
ensure that nothing like what happened at Satyam happens under their
noses."
Useem recalls the CEO and promoter of a Chinese solar panel company
who "wanted his company to be extremely well governed" and therefore
listed it on the New York Stock Exchange. "He wanted a great board of
directors and thus listed the company fully on the NYSE -- not as an ADR --
for the sole purpose ... of forcing himself to be disciplined in the
governance policies his company pursues."
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Singh adds that the Satyam scandal doesn't necessarily warrant more
regulation. "There is no need to strengthen corporate governance
regulations [in India]," he says. "The issue is really more one of leadership
at the board level. The tone gets set by the chairman of the board; it's
much more a matter of culture within the board room, of the group
dynamics within the board."
Truth in Numbers
Singh says he drew "a level of confidence" from the accounting rigor and
governance mechanisms at Infosys, where he was an independent director
from 2000 to 2003. He recalls how T.V. Mohandas Pai, the company's then-
chief financial officer (now a director overseeing human resources) "would
take so much time going into accounting details."
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been puzzled that the company was proposing to invest $1.6 billion in real
estate at a time when a competitor as formidable as HCL was gunning for
one of its most lucrative markets. "IT is a highly capital-intensive business,
especially in India," says Aron. "What on earth would compel Satyam to
invest $1.6 billion in real estate at a time when competition with HCL was
about to grow more intense? That is what the directors should have been
asking." Instead, he adds, like the dog that didn't bark in the Sherlock
Holmes story, the matter was allowed to slide.
Independent Defectors
Useem wonders if the Satyam directors who resigned actually did the right
thing. "The leadership dictum is that you need to stay the course, stay in
the game, face the problem and solve the problem," he says. "Did the four
directors who resigned have an option of banding together, staying on the
board and changing governance?" Useem adds that "it is often very hard to
stay the course. I am empathetic with people who have difficulty [making
that decision]."
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Several studies in India and abroad have indicated that markets and
investors take notice of well managed companies and respond
positively to them. Such companies have a system of good corporate
governance in place, which allows sufficient freedom to the board
and management to take decisions towards the progress of their
companies and to innovate, while remaining within the framework of
effective accountability.
In today's globalised world, corporations need to access global pools
of capital as well as attract and retain the best human capital from
various parts of the world. Under such a scenario, unless a
corporation embraces and demonstrates ethical conduct, it will not
be able to succeed.
The credibility offered by good corporate governance procedures
also helps maintain the confidence of investors both foreign and
domestic to attract more long-term capital. This will ultimately
induce more stable sources of financing.
A corporation is a congregation of various stakeholders, like
customers, employees, investors, vendor partners, government and
society. Its growth requires the cooperation of all the stakeholders.
Hence it imperative for a corporation to be fair and transparent to all
its stakeholders in all its transactions by adhering to the best
corporate governance practices.
Good Corporate Governance standards add considerable value to the
operational performance of a company by:
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Contracts with related parties will require prior approval by the board and,
in some cases, by shareholders. By a unique provision, shareholders
interested in the matter cannot vote on these general meeting resolutions.
Small shareholders are ensured board participation by one director
representing them. Related-party contracts must be justified and fully
disclosed in the Director's Report. These approvals will, however, not be
required if the transactions are on arm's-length basis. The directors,
promoters, key management personnel and top 10 shareholders in listed
companies must report any share purchase or sale within 15 days to the
registrar.
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Working directors and senior management staff have been prohibited from
entering into any call or put option on securities of the company, subsidiary
or associates. Insider trading in any company will fetch penalties. The
Remuneration Committee, headed by an ID, shall decide a remuneration
policy, having fixed and variable pay, and pay relationship between
directors and senior management, and to be disclosed to shareholders.
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statutory board.
For private companies, many exemptions have been withdrawn. All loans to
working directors and other parties, related-party transactions, a business
diversification or capital raising, etc, will need board or general body
approval. Disclosure requirements to shareholders have been enhanced.
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