This article deals with ‘Corporate Governance.’ This is part of our series on ‘Ethics’ . For more articles , you can click here
Concept of Corporate Governance
Corporate = Any Organisation whether public or private which has separate legal entity.
Eg : Reliance Jio, BSNL etc => If you register case against them, it will against this organisation only
But Department of Communication or MEITY is not included in this because it has no separate legal entity. If you register case against MEITY case will be against Government of India
Corporate Governance : If any organisation ( whether private or public ) works with moral accountability towards its shareholders, employees, customers, society etc , it is known as Corporate Governance
Corporate Social Responsibility : Moral responsibility of any organisation (whether private or public) to positively impact the society in which it exists is known as Corporate Social Responsibility (CSR)
Concept of Corporate Governance is associated with gains that can accrue from following moral path. It means Ethical Governance. Every Corporation ie organisations like companies, societies etc should function in such a way that along it’s own development and growth, it should ensure the development of it’s employees, shareholders, customers , society, nation and world
World started to become aware of Corporate Social Responsibility and Corporate Governance with start of LPG in 1980s (because large number of private entities came in sectors where earlier only government was involved and obviously their main aim would be to maximize their profits) . In India , in order to strengthen CSR, Governement has amended Companies Act and added provision in it that big company with average turnover of previous 3 years exceeding ₹1000 crore has to spend atleast 2% of its Net Profit on CSR . Due to this provision, Corporate Governance has strengthened .
Main thing through which Corporate Governance is ensured
Main principle on which Corporate Governance works is SEPARATION OF OWNERSHIP AND CONTROL . If there will be such separation, it is assumed that they will act as Check and Balance on each other. Company is owned by the Shareholders but controlled by Directors (which are appointed by Shareholders) .
If those who own the Company and those who manage them are same, it is very likely that all their actions and decisions will be governed by motive of maximizing their profits even at the cost of other stakeholders
Corporate Social Responsibility vs Corporate Governance
Corporate Social Responsibility
Apart from Society, it also focuses on Customers , Employees and Shareholders. Hence, it has relatively larger scope
It focuses on Social Interests only. Hence, it has relatively narrow scope
It is expected from all Corporations whether it is small or large (size doesn’t matter)
It is expected mainly from comparatively bigger Corporations . (Although any company can do but it is expected from bigger companies only)
More Regulatory and Legal efforts are required to implement this
Comparatively, less Regulatory and Legal efforts are required . It can also be implemented on Moral Basis .
Types of Corporate Governance
There are two Models
Anglo Saxon Type
It is found in those countries where influence of rule of law is strong
It only focuses on interest of Shareholders
It’s impact is mainly seen in countries like Britain and USA
It is found in those countries where influence of Administrative Law is more.
Eg : France and Germany
In this , more emphasis is laid on the interests of shareholders, customers and employees
Situation of Corporate Governance in India
Bhopal Gas Tragedy
From Bhopal Gas Tragedy, we come to learn that even wrt dangerous industries, Regulatory and Legal aspects arent strong enough and who has ownership rights is not clear .
In Union Carbide case, it is not clear even today that who is legally accountable and answerable
They indulged in Creative Accounting showing large profits
In this Ramalingham Raju showed more profit and higher turnover through creative accounting & transferred funds of company to individual account. Hence, unethical business was going on in this company against the interests of shareholders and customers
Price Cooper Waterhouse Limited = SEBI imposed no penalty on them . Securities & Exchange Commission ( Regulator of USA) fined $500,000 . This shows that how serious we are towards such incidents
Sahara gathered funds from Sharemarket and like Satyam Fraud transferred property and funds of Shareholders and investors into private account. Hence, it acted against the interests of Shareholders and investors
In this case, SC & SEBI acted tough and sent Subarto (owner) to jail in order to recover the money
Presently various scams like
Sharda & Rose Valley Chit Fund Scam
Nirav Modi Scam
Sterlite Companies Scam etc
In which company either took large loans from PSBs and transferred them to their individual account or transferred funds gathered from sharemarket to their own account. They also indulged in creative accounting.
Hence, situation of Corporate Governance is bad
Why we need Corporate Governance in India
Liberalisation and de-regulation world over gave greater freedom in management. This demands even greater responsibilities
Players in the field are many . Hence , competition brings in its wake weakness in standards of reporting and accountability
Market conditions are increasingly becoming complex in light of global developments like WTO , Removal of Barriers & Reduction in duties.
Failure of Corporations due to lack of transparency & disclosures and instances of falsification of accounts / embezzelement and the effect of such undesirable practices in other companies
Absence of Corporate Governance leads to fraud, mismanagement , embezzlement and harm to society & environment.
We need that in times of Privatization and Liberalization, the values of Companies are aligned with the values of society . Companies should work for betterment of all it stakeholders and works for the better world.
Issues with Corporate Governance in India (according to Kotak Committee)
Nepotism in board appointments (Board members are relatives or known ones)
Independent directors have either played a passive role or they can be removed easily if they don’t side with promoters
Executive Compensation policies are not transparent
Family owned Indian companies have excessive controls and poor succession planning.
Lack of serious effort by board towards Corporate Social Responsibility (CSR) projects.
Steps taken till now to strengthen Corporate Governance
SEBI was formed in 1988
After Harshad Mehta Fraud, SEBI was given statutory status in 1992
1997 : CII accepted that there is need to strengthen Corporate Governance in India
2006 : Narayan Murthy Committee gave recommendations on Corporate Governance
2013 : Companies Act was amended to bring safeguards in company to protect stakeholders and strengthen Corporate Governance. 2% CSR also introduced (mainly due to Satyam Scam)
2017 : Kotak Mahindra Committee gave its recommendations on Corporate Governance
Recommendations of Narayan Murthy Committee
1/3rd to 1/2rd of the Total Directors of Company should be Independent Directors
Auditing of the accounts of Big Corporations should be done under the vigil eye of CAG & Indian Auditing Services
Whistleblowers Protection Act should be applicable to both Public and Private Sector
Above recommendations have not been implemented in true sense . Although Whistleblower’s Act has been formed but it has many lacunaes
Kotak Committee Recommendations
There should be atleast 6 Independent Directors in top 500 companies (earlier 3)
Atleast 50% of Directors should be Independent Directors.
1 Independent Director should be women
Board of Directors Meeting should be held 5 times (earlier 4) in which one meeting should be exclusively dedicated to Corporate Governance.
All the Independent Directors in Board of Directors should be compulsorily present in the meetings .
Reporting System should be of ‘Matrix Type‘
Permission of Minority shareholders necessary in case of payments to related parties exceeding 2% of revenue.
Disclosures of Auditor Credentials and Audit Fee
In this way, Kotak Mahindra Committee has emphasised on Corporate Governance and favoured feminism .
Areas of Importance within Corporate Governance include
Independent Directors : Directors who aren’t involved in day to day activities but who primarily attend board meetings. They protect interests of Minority Shareholders.
Remuneration Committee : Established to avoid directors setting their own remuneration levels high (a check on directors)
Audit Committee: Acts as an interface between the Board of Directors and the External Auditors . This is made up of Independent Directors
Public Oversight : this gives public an insight into the company (eg via Public open day) . Since , public can be affected with company’s decisions and are important stakeholders , hence they have right to know what is happening inside company
CoC & CoE should be inculcated in employees
There should be strong Whistleblower Policy
There should be CSR Policy
Benefits of Corporate Governance
Reduced risks of corporate scandals and frauds.
Ensures Adequate disclosure & Transparency in business transactions
Leads to Statutory & legal compliance
Protection of shareholder interests
Improves strategic thinking at the top by inducting independent directors who bring a wealth of experience, and a host of new ideas
Corporate Social Responsibility
Corporate Social Responsibility can be explained as
Corporate : Meaning Organised Business
Social : Meaning Dealing with People
Corporate Social Responsibility : Moral responsibility of any organisation (whether public or private) to positively impact the society in which it exists is known as Corporate Social Responsibility (CSR)
Basis /Reason /Rationale for CSR
Corporates utilises the resources of society – human & natural. So they have responsibility to pay back to societies.
Corporate plants create negative externalities in the form of pollution etc . In order to compensate for negative externalities, we can force them to work on interest of society
Triple Bottom Line Principle of CSR : Company should work on TBL Principle ie 3P’s
People (social justice)
And this can be achieved by following CSR
Creates a favourable image of company which attracts customers. Reputation & brand equity of companies which demonstrates its social responsibilities is very high . Eg : Tata
Provision in Company Act
Companies will have to spend 2% of their last three years average profit on Social development related activities eg schools, slum development etc
CSR rule applies only to companies having annual turnover above ₹1000 cr
Companies have to setup CSR Committee made up of 3 Board Directors.
Less Importance given to CSR : Most companies have not looked at their CSR strategies through the same lens as their core business functions.
Lack of clarity about regulations . Govt each passing month come up with new regulations
Most of the companies arent even spending what they are required to spend.
Large number of shell NGOs have come up which take up money from companies but don’t spend on targeted projects.
Since there is no way to measure the Impact that CSR spending has made, companies cant make informed choices . Starting Impact Assessment Program can help .
Administrative Reform Commission’s (ARC) Recommendation on CORPORATE PHILANTHROPY
When a community benefit project is taken up by a corporate entity, there should be some mutual consultation between the company and the local government so that there is no unnecessary overlap with other similar development programmes in the area.
Government should act as a facilitator and create an environment which encourages business and industry to take up projects and activities which are likely to have an impact on the quality of life of the local community.