Corporate Governance

Corporate Governance 

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) .
Corporate Governance
Corporate Governance

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 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
Continental Type
  • 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

 

Satyam Computer
  • 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 Fraud
  • 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)

  • Creative Accounting
  • Insider trading
  • 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

 

  • Others
        • 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
  • Responsibility

 

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
        • Profit(economic benefits)
        • People (social justice)
        • Planet (ecology)

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.

 

Problems faced

  • 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.

 

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