Corporate Governance

Corporate governance refers to the system of rules, practices, and processes by which a company is directed and controlled. It encompasses the mechanisms through which companies, and those in control, are held to account. Good corporate governance ensures that companies operate in a manner that is fair, transparent, and accountable to all stakeholders, including shareholders, employees, customers, and the broader community.

Key Principles of Corporate Governance

1. Transparency: Ensuring timely and accurate disclosure of all material matters regarding the corporation.
2. Accountability: Ensuring that management is accountable to the board and the board is accountable to the shareholders.
3. Fairness: Ensuring the equitable treatment of all shareholders, including minority and foreign shareholders.
4. Responsibility: Ensuring that corporate actions comply with relevant laws and regulations and that corporate strategies and policies consider environmental and social impacts.

 

Examples of Corporate Governance in India

1. Infosys

Background: Infosys is a globally recognized IT services company known for its strong commitment to corporate governance.

Governance Practices:

• Independent Board: Infosys has a significant number of independent directors, ensuring decisions are made in the best interests of all stakeholders.
• Transparency: Infosys is known for its comprehensive reporting practices, providing detailed disclosures on financial performance, management decisions, and risk factors.
• Audit Committee: An independent audit committee oversees financial reporting and disclosure, ensuring accuracy and integrity in financial statements.
• Ethical Practices: Infosys has a strong focus on ethical business practices and has established a global code of conduct that applies to all its employees.

Impact: Infosys’s governance practices have earned it a high level of trust among investors and stakeholders globally, contributing to its sustainable growth and strong market position.

2. Tata Group

Background: The Tata Group is one of India’s largest conglomerates, known for its ethical governance and commitment to corporate social responsibility.

Governance Practices:

• Ethical Leadership: The Tata Group emphasizes ethical leadership and integrity. It has a comprehensive code of conduct applicable to all employees and management.
• Corporate Social Responsibility (CSR): Tata companies invest significantly in CSR activities, focusing on areas such as education, healthcare, and community development. Tata Steel, for example, has numerous community programs that benefit the regions where it operates.
• Board Practices: Tata Group companies maintain high standards of board governance, including a mix of executive and non-executive directors to provide diverse perspectives and oversight.
• Sustainability: Tata Group companies are committed to sustainability, regularly reporting on their environmental and social performance.

Impact: The Tata Group’s governance practices have contributed to its long-term success and reputation as a responsible and ethical corporate entity. This has enhanced stakeholder trust and loyalty, which is crucial for sustainable business operations.

3. Wipro

Background: Wipro is a major player in the global IT services industry, well-regarded for its corporate governance standards.

Governance Practices:

• Sustainability Reporting: Wipro is committed to sustainability and regularly publishes reports on its environmental, social, and governance (ESG) performance. The company integrates sustainability into its business strategy, ensuring long-term value creation.
• Whistleblower Policy: Wipro has a robust whistleblower policy that encourages employees to report unethical practices without fear of retaliation. The policy provides multiple channels for reporting concerns, ensuring they are addressed promptly and appropriately.
• Board Independence: Wipro ensures that its board comprises a majority of independent directors who provide unbiased oversight and strategic guidance.
• Diversity and Inclusion: Wipro promotes diversity and inclusion within its workforce and at the board level, recognizing the value of diverse perspectives in decision-making.

Impact: Wipro’s strong governance practices have enhanced its credibility and stakeholder trust, making it a preferred partner for clients worldwide and contributing to its sustained competitive advantage.

Corporate governance is crucial for the integrity and long-term success of companies. It involves a set of practices and principles that ensure companies are managed in a way that is accountable, transparent, fair, and responsible. Indian companies like Infosys, Tata Group, and Wipro exemplify strong corporate governance, setting benchmarks in ethical management and transparency. These practices not only boost investor confidence but also contribute to sustainable business growth and positive societal impact.

By adhering to the principles of good corporate governance, companies can ensure that they operate efficiently and ethically, fostering trust and loyalty among all stakeholders. This, in turn, leads to improved performance, better risk management, and long-term sustainability.

 

Key Practices and Trends concerning Corporate Governance

1. Increased Transparency and Disclosure

• Companies are required to disclose detailed information about their financial performance, board composition, management policies, and risk management practices.
• Annual reports now include comprehensive corporate governance sections, providing insights into board practices, committee activities, and governance policies.

2. Strengthening of Independent Directors

• The role of independent directors has been strengthened to ensure they can provide unbiased oversight. They are essential in committees such as the audit committee, nomination and remuneration committee, and stakeholders’ relationship committee.

3. Focus on Corporate Social Responsibility (CSR)

• Companies meeting specific criteria are mandated to spend at least 2% of their average net profit on CSR activities. This has led to increased corporate involvement in social, environmental, and community development initiatives.

4. Enhanced Role of Institutional Investors

• Institutional investors, such as mutual funds and insurance companies, are playing a more active role in corporate governance by engaging with companies on governance issues and voting on resolutions.

5. Digital Transformation and E-Governance

• The adoption of digital tools for governance, such as e-voting, online board meetings, and real-time disclosure of financial information, has improved efficiency and transparency.

 

Challenges and Areas for Improvement

1. Enforcement of Regulations

• While India has a robust regulatory framework, the enforcement of corporate governance regulations remains inconsistent. Regulatory bodies need to enhance their capacity to monitor and enforce compliance effectively.

2. Board Diversity

• Despite regulatory requirements, the diversity of boards, particularly in terms of gender diversity, remains a challenge. Companies need to make more concerted efforts to bring diverse perspectives into the boardroom.

3. Corporate Frauds and Scandals

• High-profile corporate scandals, such as the Satyam scandal and the PNB fraud, have highlighted weaknesses in corporate governance practices. These incidents underscore the need for stronger internal controls and better risk management practices.

4. Whistleblower Protection

• Although whistleblower protection mechanisms exist, their implementation is often inadequate. Ensuring the safety and anonymity of whistleblowers is crucial to encourage the reporting of unethical practices.

5. Aligning Interests of All Stakeholders

• Balancing the interests of various stakeholders, including shareholders, employees, customers, and the community, continues to be a challenge. Companies need to adopt a stakeholder-centric approach to governance.

 

Initiatives and Improvements

1. Code for Responsible Investing in India (CRII)

• The CRII aims to encourage institutional investors to incorporate environmental, social, and governance (ESG) factors into their investment decisions and engage more actively with investee companies on these issues.

2. Corporate Governance Scorecards

• The introduction of corporate governance scorecards by stock exchanges helps in assessing and benchmarking the governance practices of listed companies, promoting competition and improvement.

3. Greater Role of Proxy Advisory Firms

• Proxy advisory firms are gaining prominence, providing independent advice to shareholders on voting matters and governance issues, thus enhancing shareholder activism and engagement.

Corporate governance in India has made significant strides, driven by comprehensive regulatory frameworks, proactive regulatory bodies, and evolving corporate practices. While challenges remain, ongoing reforms and initiatives are aimed at enhancing transparency, accountability, and stakeholder trust. Continuous improvement in corporate governance practices is essential for fostering a sustainable and ethical business environment in India. By addressing existing challenges and embracing best practices, Indian companies can further strengthen their governance standards, contributing to long-term economic growth and stability.

 

Recommendations of Uday Kotak Committee on corporate governance

The Uday Kotak Committee on Corporate Governance was constituted by the Securities and Exchange Board of India (SEBI) in June 2017 to review corporate governance norms in India and suggest improvements. The committee’s report, submitted in October 2017, provided a comprehensive set of recommendations aimed at enhancing the transparency, accountability, and effectiveness of corporate governance practices in Indian companies. Here are the key recommendations of the Uday Kotak Committee:

1. Board Composition and Functioning
2. Enhanced Role of Independent Directors

• Minimum Number: At least half of the board members of listed companies should be independent directors.
• Separation of Roles: The roles of the Chairman and the Managing Director/CEO should be separated to avoid concentration of power.
• Lead Independent Director: Introduce the position of a lead independent director in case the Chairman is not independent.

1. Attendance and Quorum

• Board Meetings: At least five board meetings should be held annually.
• Quorum: The quorum for board meetings should be one-third of the board size or three directors, whichever is higher, with at least one independent director present.

1. Board Diversity

• Gender Diversity: At least one independent woman director should be on the board of listed companies.
• Board Skills: Companies should disclose a matrix of skills/expertise/competence that the board members possess.

2. Improved Monitoring and Evaluation
3. Performance Evaluation

• Annual Evaluation: The performance of the board, its committees, and individual directors should be evaluated annually.
• External Evaluation: An independent external agency should conduct the evaluation of the board and its committees once every three years.

1. Committee Composition and Functioning

• Audit Committee: At least two-thirds of the members of the audit committee should be independent directors.
• Nomination and Remuneration Committee (NRC): All members of the NRC should be non-executive directors, with at least two-thirds being independent directors.
• Risk Management Committee: The risk management committee should be constituted, and its role should be clearly defined.

3. Enhanced Disclosure and Transparency
4. Disclosure of Related Party Transactions (RPTs)

• Detailed Disclosures: Enhanced disclosure requirements for related party transactions, including the rationale and terms of such transactions.
• Approval Process: All RPTs that are material should require approval from the audit committee and shareholders.

1. Disclosure of Auditor Credentials

• Audit Quality: Disclosure of the credentials and profile of the audit firm, including details of the audit team.
• Audit Fees: Disclosure of the total fees paid to auditors for audit and non-audit services.

1. Quarterly Results and Annual Reports

• Enhanced Disclosures: Detailed disclosures in quarterly results and annual reports, including segment-wise revenue, profitability, and capital employed.

4. Accounting and Auditing Standards
5. Rotation of Audit Partners

• Audit Partner Rotation: Mandatory rotation of audit partners every five years.
• Audit Firm Rotation: Rotation of the audit firm every ten years, in line with existing regulations.

1. Strengthening of Audit Quality

• Internal Controls: Disclosure of the effectiveness of internal financial controls in the annual report.
• Auditor Independence: Strengthening auditor independence by prohibiting certain non-audit services to audit clients.

5. Shareholder Rights and Participation
6. Voting and Shareholder Meetings

• Electronic Voting: Encourage the use of electronic voting and other technology to increase shareholder participation.
• AGM Timelines: Listed companies should hold their Annual General Meetings (AGMs) within five months of the end of the financial year.

1. Protection of Minority Shareholders

• Shareholder Approval: Enhanced approval requirements for related party transactions and other significant decisions to protect minority shareholders’ interests.

6. Corporate Social Responsibility (CSR)
7. CSR Committee

• CSR Oversight: Strengthen the role of the CSR committee in overseeing the implementation and monitoring of CSR activities.

1. CSR Disclosures

• Enhanced Reporting: Detailed disclosures on CSR activities, including the impact assessment of such initiatives.

7. Governance of Listed Companies
8. Group Governance

• Governance Framework: Listed companies should disclose the governance framework of their subsidiaries and significant associate companies.

1. Risk Management

• Risk Management Policy: Listed companies should disclose their risk management policy and strategy, including risk mitigation measures.

Implementation and Impact

Many of the recommendations from the Uday Kotak Committee have been accepted and implemented by SEBI, leading to significant improvements in corporate governance standards in India. The emphasis on transparency, accountability, and shareholder rights aims to enhance investor confidence and promote sustainable business practices.

The recommendations of the Uday Kotak Committee on Corporate Governance represent a significant step towards strengthening corporate governance in India. By enhancing board composition and functioning, improving monitoring and evaluation, ensuring better disclosure and transparency, and protecting shareholder rights, these recommendations aim to create a more robust and trustworthy corporate governance environment. The successful implementation of these recommendations will contribute to the long-term growth and stability of the Indian corporate sector.

 

 

Reasons for Weak Corporate Governance in Indian Public Sector Undertakings (PSUs) – Tabular representation

1. Government Ownership and Control
   • Political Interference: Frequent political interference in the management and operations of PSUs leads to decisions that may not align with the best interests of the company or its stakeholders.
   • Appointments and Transfers: Key positions in PSUs are often filled based on political considerations rather than merit, affecting the efficiency and effectiveness of governance.
2. Lack of Autonomy
   • Limited Decision-Making Power: PSUs often lack the autonomy to make strategic decisions due to stringent government controls and regulations.
   • Bureaucratic Procedures: Excessive bureaucratic procedures slow down decision-making processes, making it difficult for PSUs to respond swiftly to market changes.
3. Ineffective Board Structure
   • Lack of Independence: Boards of PSUs often lack a sufficient number of independent directors who can provide unbiased oversight and guidance.
   • Limited Expertise: Board members may lack the necessary industry-specific knowledge and experience, hindering effective governance.
4. Inadequate Accountability and Transparency
   • Insufficient Disclosure: PSUs often have inadequate disclosure practices, leading to a lack of transparency in their operations and financial performance.
   • Weak Internal Controls: Internal control systems in PSUs may be weak or ineffective, allowing for mismanagement and corruption.
5. Performance Issues
   • Low Efficiency: Many PSUs suffer from low efficiency and productivity due to outdated technologies, overstaffing, and lack of incentives for performance.
   • Financial Dependence: PSUs often rely on government funding and subsidies, reducing their incentive to operate efficiently and profitably.

How to Improve Corporate Governance in Indian PSUs

1. Enhancing Board Independence and Expertise
   • Increase Independent Directors: Ensure that a significant proportion of board members are independent directors with relevant industry experience and expertise.
   • Training and Development: Provide training programs for board members to enhance their understanding of corporate governance and their roles and responsibilities.
2. Reducing Political Interference
   • Merit-Based Appointments: Implement a merit-based system for the appointment of top executives and board members to ensure that the most qualified individuals are selected.
   • Fixed Tenures: Establish fixed tenures for senior management to reduce political interference and provide stability.
3. Granting Greater Autonomy
   • Operational Independence: Grant PSUs greater operational independence to make strategic decisions without excessive government control.
   • Flexibility in Decision-Making: Allow PSUs to operate with the flexibility needed to respond to market dynamics and competition.
4. Improving Accountability and Transparency
   • Enhanced Disclosure: Mandate comprehensive and timely disclosure of financial and operational information, including details of related party transactions and executive compensation.
   • Strengthening Internal Controls: Implement robust internal control systems and regular audits to detect and prevent fraud and mismanagement.
5. Performance-Based Incentives
   • Incentivize Efficiency: Introduce performance-based incentives for employees and management to encourage higher efficiency and productivity.
   • Benchmarking: Compare the performance of PSUs with their private sector counterparts and set performance benchmarks to strive for improvement.
6. Corporate Social Responsibility (CSR)
   • CSR Initiatives: Encourage PSUs to actively engage in CSR activities and disclose their CSR spending and impact in annual reports.
   • Sustainability Practices: Integrate sustainability practices into the core operations of PSUs to ensure long-term value creation for stakeholders.
7. Strengthening Regulatory Oversight
   • Regulatory Reforms: Implement regulatory reforms to provide clear guidelines and frameworks for the governance of PSUs.
   • Independent Oversight Bodies: Establish independent bodies to oversee the governance practices of PSUs and ensure compliance with regulations.

Improving corporate governance in Indian PSUs requires a multifaceted approach that addresses the root causes of weak governance. By enhancing board independence and expertise, reducing political interference, granting greater autonomy, improving accountability and transparency, introducing performance-based incentives, encouraging CSR, and strengthening regulatory oversight, PSUs can achieve higher standards of governance. These improvements will not only enhance the efficiency and profitability of PSUs but also contribute to overall economic growth and development.

 

PRACTICE QUESTIONS

Q1: Define corporate governance and explain its importance in the contemporary business environment. How does effective corporate governance contribute to a company’s sustainability and ethical reputation?

 

Q2: “Corporate governance is not just corporate management, it’s also about promoting corporate fairness, transparency, and accountability.” Comment on this statement with examples from the Indian corporate sector.

 

Scam 1992 (2020 – Web Series):

• This web series revolves around the life of stockbroker Harshad Mehta and the famous financial scam he orchestrated in the Indian stock market.
• Corporate Governance Theme: It highlights corporate fraud, insider trading, and how a lack of governance and regulatory oversight can lead to financial crimes and collapse in public trust.

Rocket Singh: Salesman of the Year (2009):

• Harpreet Singh Bedi (Ranbir Kapoor) starts his own company after being disillusioned by the corrupt practices in his organization. He emphasizes integrity, transparency, and honesty in his business dealings, contrasting with the unethical behavior of his former employer.

 

 

Case Study

Rajat Mehra, a successful businessman and CEO of a large manufacturing company, is at a crossroads. His company has recently expanded into new markets, and the board of directors is pushing for rapid growth to keep up with competitors. However, Rajat is aware of several ethical concerns within the company’s operations, particularly related to environmental compliance and labour practices in its overseas factories.

The company’s profits are growing, but Rajat has received reports that some of the suppliers in developing countries are violating labour laws, underpaying workers, and operating in unsafe conditions. There are also concerns about the company’s disregard for environmental regulations, which could result in significant fines if regulators conduct an inspection.

Rajat is caught in a dilemma. On one hand, he knows that addressing these ethical issues by enforcing strict compliance with labour and environmental laws could result in increased operational costs and slower growth, which would upset shareholders and the board. On the other hand, if he ignores these issues, the company’s reputation could be damaged if these violations become public, and it could face regulatory penalties in the future.

The Dilemma:

• Option 1: Address the ethical issues by implementing stricter compliance measures, even if it leads to slower growth and potential backlash from shareholders and the board.
• Option 2: Ignore the ethical concerns and continue focusing on rapid growth, satisfying shareholders and the board, but risking long-term reputational and regulatory damage.

Stakeholders:

1. Rajat Mehra (CEO): The main decision-maker, responsible for both the company’s profitability and its adherence to ethical standards.
2. Company Board of Directors: Focused on rapid growth and profitability, pressuring Rajat to keep costs low and expand quickly.
3. Employees in Overseas Factories: Workers potentially facing unsafe working conditions and unfair wages.
4. Environmental Regulators: Monitoring the company’s adherence to environmental laws, with the power to impose fines if violations are discovered.
5. Shareholders: Primarily concerned with the company’s profitability and growth, but unaware of the ethical concerns.
6. Customers: Expect the company to uphold high ethical standards and may boycott the company if ethical violations become public.
7. Media and Civil Society: Observing the company’s operations and likely to expose any unethical practices that come to light.

Question 1: What are the alternatives available to Rajat?

1. Implement Strict Compliance Measures:
   • Pros: Upholds corporate governance standards, protects the company’s long-term reputation, and ensures compliance with labour and environmental laws.
   • Cons: Increases operational costs, may result in slower growth, and could upset shareholders and the board of directors.
2. Ignore the Ethical Concerns and Focus on Rapid Growth:
   • Pros: Maintains high profitability and rapid growth, keeps the board and shareholders satisfied, and ensures short-term financial success.
   • Cons: Risks long-term reputational damage, potential regulatory fines, and public backlash if the unethical practices are exposed.
3. Find a Compromise (Gradual Implementation):
   • Pros: Rajat could initiate a gradual plan to improve labour conditions and environmental compliance, minimizing short-term cost increases while moving toward long-term sustainability.
   • Cons: May still face criticism for not acting quickly enough, and could be seen as merely delaying the resolution of the ethical issues.

Question 2: What is the best alternative?

The best alternative is to implement strict compliance measures to ensure that the company adheres to ethical labour and environmental standards. Although this may slow growth in the short term, it will protect the company’s reputation, avoid regulatory penalties, and foster long-term sustainability.

Solution:

Rajat should prioritize ethical corporate governance by addressing the unethical practices in the company’s supply chain and environmental compliance. This decision aligns with the principles of integrity, transparency, and accountability in business, which are essential for maintaining public trust and avoiding future regulatory or reputational risks.

Steps to Implement the Solution:

1. Conduct a Thorough Internal Audit: Rajat should initiate an independent audit to investigate the unethical practices within the company’s supply chain and environmental compliance. This will provide him with a clear understanding of the scope of the issues.
2. Develop and Enforce a Strict Corporate Governance Policy: Rajat should work with the board to establish a comprehensive governance policy that includes strict adherence to labour laws and environmental regulations. This policy should be communicated to all suppliers and partners.
3. Engage with Stakeholders: Rajat should engage with shareholders and the board to explain the importance of addressing these ethical concerns. By highlighting the long-term risks of ignoring the issues, he can gain support for the new compliance measures.
4. Improve Labour Conditions and Environmental Practices: Rajat should implement changes in the company’s overseas factories to improve working conditions and ensure fair wages. Additionally, the company should invest in more sustainable practices to comply with environmental regulations.
5. Communicate with the Public: Rajat should proactively communicate the company’s commitment to ethical business practices, engaging with customers, the media, and civil society to rebuild trust and demonstrate transparency.

Justification:

By choosing to enforce strict compliance with labour and environmental standards, Rajat demonstrates a commitment to ethical corporate governance. This approach will protect the company from potential reputational and legal risks, ensure long-term sustainability, and uphold the trust of customers, employees, and society. While there may be short-term financial costs, the decision to prioritize ethics over profits will result in a stronger, more resilient company in the long run.

This case highlights the ethical responsibility of business leaders to balance profitability with social and environmental responsibilities, and the importance of corporate governance in maintaining ethical standards in business operations.

 

 

Glossary: Corporate Governance: Corporate governance refers to the system of rules, practices, and processes by which a company is directed and controlled, ensuring transparency, accountability, and fairness in its relationships with stakeholders.

Corporate Social Responsibility (CSR): CSR is a business model in which companies integrate social and environmental concerns into their operations, aiming to contribute positively to society while balancing profit-making objectives.

Ethical Leadership: Ethical leadership involves guiding and influencing others based on a foundation of ethical principles, integrity, and fairness, ensuring that decisions and actions align with moral values and the broader good.