We’ve all heard of corporate frauds, haven’t we? In the past century the world has witnessed numerous large scale corporate frauds. The frequency of these frauds has turned corporate frauds into a common affair. Every time we hear of a new corporate fraud, we baffle in the moment but instantly move on with our lives thinking “It’s just another fraud”, but the issue is far more concerning and serious than it seems to be. Corporate frauds lead to humongous loss of money, especially if the Company is listed on some Stock exchange. The investors investing in the company go in downward spiral as the shares start tanking the charts. It creates havoc and the intensity of such frauds on the lives of the people affected, directly or indirectly, is far worse than imagined. That being said, there ought to be a way to prevent such situations, right? Here is where the concept of ‘Corporate Governance’ comes into play. As the general understanding of the term suggests, the concept is concerned with the governance of a corporate entity. It concerns the shareholders, the directors, the functioning of the company, etc. In this Article we will be exploring the term corporate governance and how it’s been propounded in various Indian Laws.
Understanding Corporate Governance
In my opinion, the term ‘corporate governance’ could not be assigned a strict definition. The term has a broad meaning and spreads over an array of subjects concerning the management of a Company. Corporate Governance is something that helps easing the administrative, managing and regulatory process of a Company. It helps creating accountability for actions affecting the stakeholders and aids in mitigating risk. It also helps creating precautionary and security measures.
Why is Corporate Governance Essential?
Ensuring smooth corporate Governance not only benefits the stakeholders, but also helps the improving the credit worthiness of a company, especially if it is listed on any of the stock exchanges. Mandating a non-corrupt system of corporate governance will always help the Company create a goodwill, this goodwill may help retain and acquire new clients, reflect on the Company’s balance sheet in the form of increase in profits and revenue, attract investors and create faith amongst existing investors, etc. In fact, transparency, accountability and security form an essential part of corporate governance.
Deep Dive into History of Corporate Governance
It was the Securities Exchange Commission (hereinafter referred to as “SEC”) in the United States of America that highlighted the need for Corporate Governance. It can be observed that it was the Federal Register that had mentioned the term for the very first time. In the mid and late 1900s, the SEC caught on to what was happening in the corporate sector. In an endeavour to limit fraudulent practices like falsification of corporate records, misrepresentations of financial conditions and other misconduct, the aforementioned body created certain requirements where listed companies were required to maintain audit committee which would comprise of the independent board directors.
The 1980s witnessed quite some turbulence as it faced obstacles in successfully implementing the branches of Corporate Governance. Fast forwarding to 2008, America witnessed one of the worst crashes of it’s Stock Markets and the world learnt yet another lesson in the aspect of Corporate Governance.
Creating fiduciary responsibility is one of the most essential ways to ensure the successful implementation of corporate governance. It is safe to say that the need of corporate governance became the need of the hour after India opened her doors to the foreign markets. The Confederation of Indian Industry that is also known as “CII” has taken quite some endeavours in this aspect. In 1998, it had framed the Voluntary Code of Corporate Governance (hereinafter referred to as “VCCG”) to the Report of the CII Task Force. The VCCG acted like a base for various reports leading to Clause 49 of the Listing Agreement of the Stock Exchanges” by SEBI. The said Clause was further modified to be inclusive of more Companies. Introducing Companies Act, 2013 (hereinafter referred to as “the Act”) strengthened the foundation of corporate governance.
Changes brought about by the Introduction of Corporate Governance
The Act had introduced the concept of Woman Director and Resident director. CII introduced the Desirable Corporate Governance Code in 1998 where the concept of independent directors (hereinafter referred to as “ID”) came into being. It talked about the compensation paid to IDs and for their requirement in listed Companies. A key suggestion was made by the Kumar Mangalam Birla Committee. It was recommended that where a company has an executive Chairman, minimum 1/2 of the Board of Director (BOD) should comprise of independent directors and if not half, minimum 1/3 would be required. The Narayan Murthy Committee suggested for the inclusion of a good combination of non-Executive (comprising of half the total number of the BOD) and Executive Directors. The Act makes it possible to hold the independent director liable for certain Acts. The Annual Report must comprise of the Director’s Responsibility Statement, amongst other things. The directors are required to take the stakeholders’, other than the shareholders, interests into consideration while deciding on management decisions.
Increased Use of Technology
With the advent of technology, even the Ministry of Corporate Affairs has switched to the online mode for a lot of activities. The documents that are available to the public like certain incorporation documents like Memorandum of Association, Articles of Association, etc. can now be easily downloaded by anybody who wishes to do so by paying a meagre fee. It is now possible for companies to circulate notices of meetings and voting on various meetings via electronic mode. Companies listed on the recognized stock exchanges of India also send out notices for meetings via email to the respective shareholder. Maintenance of Books of Accounts and receipt of notice for voting can be easily monitored online.
Instituting an Audit Committee is one of the biggest pillars of Corporate Governance. Listing Agreement’s Clause 49 (hereinafter referred to as “Clause 49”) makes it a requirement for every company that is listed on stock exchange to institute an Audit Committee that may carry out well defined set of responsibilities. The Act goes beyond Section 49 to include other classes of companies as well. Section 138 has made it possible to impose mandatory internal audits for certain kinds of Companies. Amongst other responsibilities, checking the risk management system and smooth flow of internal financial controls is the job of the Audit Committee. The Act also recommends instituting a Nomination and Remuneration Committee [Section 178] which suggests names for directorship and their remuneration; assess the performance of the directors, recommending appointments of the Key Managerial Person (hereinafter referred to as “KMP”) and their remuneration of the and disclosing ratio of the pay for an average employee to that of a director. Corporate Social Responsibility Committee (hereinafter referred to as “CSR”) [Section 135] and Stakeholders Relationship Committee [Section 178].
Curtailment of Insider Trading
A strict bar on insider trading was propounded in the Act. As per Section 195 of the Act, no person can engage in insider trading, which includes the director as well as the Key Managerial Person.
As discussed before, an essential element of corporate governance is accountability. Certain Companies are mandated by law to reserve 2% of the last three financial years’ profits towards social causes. The Act does not fail to create a penalty on every officer that yields high degree of power. For instance, the KMP is liable to disclose his interest before attending a General Meeting. If the KMP incurs profits owing to such non-disclosure, he may be required to disgorge those profits. Notwithstanding that, KMP can still be held liable for quite a few activities which he would not have been held accountable for in the Old Companies Act. When it comes to auditing, an auditing firm cannot be appointed as the auditor for more than two consecutive terms of five years each. Further, in a listed public company, an individual auditor cannot be appointed for more than five years.
Whistle Blower Policy
Certain companies especially listed companies are mandated by law to ensure that they have a whistle blowing policy in place. This may help create a healthy environment for employees and directors to reveal fraudulent activities being carried out in the Company. Nonetheless, it shall be noted that baseless and frivolous complaints shall not be confused with fraudulent activities.
As discussed before, ensuring corporate governance is significant for the management of the company. It not only helps in stabilizing stakeholder relationships but also helps creating an anti-corrupt system for ensuring smooth management of the Company. Although the frequency of corporate frauds may have reduced significantly, we cannot presume that the system of corporate governance that we have in place is the most effective one. The laws concerning corporate governance in India could be a little more stringent and inclusive of more companies. Furthermore, simply keeping the Companies under stringent laws would not do the trick, it is also upon the Companies to be responsible towards their stakeholders and ensure transparency and accountability.
- Corporate Governance – Why Is It So Important In India (legodesk.com)