characteristics of corporate governance

7/29/2019 Characteristics of Corporate Governance

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CHARACTERISTICS OF CORPORATE

GOVERNANCE IN INDIA


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Corporate Governance

The primary purpose of corporate leadership is to

create wealth legally and ethically. This translates to bringing a high level of

satisfaction to five constituencies --customers,

employees, investors, vendors and thesociety-at-large.

The raison d'tre of every corporate body is toensure predictability, sustainability andprofitability of revenues year after year.

N R Narayana Murthy


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History of Corp Gov in India

Unlike South-East and East Asia, the corporategovernance initiative in India was not triggered by anyserious nationwide financial, banking and economiccollapse

Also, unlike most OECD countries, the initiative in

India was initially driven by an industry association,the Confederation of Indian Industry In December 1995, CII set up a task force to design a

voluntary code of corporate governance The final draft of this code was widely circulated in 1997 In April 1998, the code was released. It was called Desirable

Corporate Governance: A Code Between 1998 and 2000, over 25 leading companiesvoluntarily followed the code: Bajaj Auto, Hindalco, Infosys,Dr. Reddys Laboratories, Nicholas Piramal, Bharat Forge,BSES, HDFC, ICICI and many others


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Following CIIs initiative, the Securitiesand Exchange Board of India (SEBI) setup a committee under Kumar MangalamBirla to design a mandatory-cum-

recommendatory code for listedcompanies

The Birla Committee Report wasapproved by SEBI in December 2000

Became mandatory for listed companiesthrough the listing agreement, andimplemented according to a rollout plan


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Following CII and SEBI, the Department of

Company Affairs (DCA) modified the CompaniesAct, 1956 to incorporate specific corporategovernance provisions regarding independentdirectors and audit committees

In 2001-02, certain accounting standards weremodified to further improve financialdisclosures. These were: Disclosure of related party transactions

Disclosure of segment income: revenues,profits and capital employed

Deferred tax liabilities or assets

Consolidation of accounts


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Constituents of Corp Gov

The Board of Directors Pivotal role

Accountable to stakeholders

Directs management

The Shareholders & Stakeholders To participate in appointment of directors

To hold the BoD accountable for governance

through proper disclosures

The Management To act on the direction of the BoD

To provide requisite information to the BoD for

decision making

To implement and monitor control systems


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Rationale for Disclosures

An effective disclosure based

regulation (DBR) implies greater

responsibilities on the company

directors, its management andadvisers

An effective DBR promotes investor

activism Markets believe that perceived benefits

outweigh perceived costs


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Disclosure based Regulation

Components & types of disclosureDisclosures Disclosures

by whom for whom

Public Listed Cos. Shareholders

Intermediaries Investors

Stock Exchanges MARKET Intermediaries

Mutual Funds RegulatorAnalysts & advisors Government

Other stake -

holders


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Disclosure Based Regulation

Components & types of disclosures Initial Disclosures Disclosures forraising capital by companies,mutual funds in offer documents

- Public Offers

- Private Placement

Continuous disclosures financial /non-financial

Frequency of disclosure

Dissemination process electronic,physical, centralized, dispersed

Accessibility of information


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Disclosure Based Regulation

Initial Disclosures

Continuous disclosures

Corporate Governance

Financial disclosures

Risk based disclosures for

intermediaries Disclosures for stock exchanges


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Board of Directors: information that must be

supplied Annual, quarter, half year operating plans, budgets and

updates

Quarterly results of company and its businesssegments

Minutes of the audit committee and other board

committees Recruitment and remuneration of senior officers

Materially important legal notices and claims, as well asany accidents, hazards, pollution issues and laborproblems

Any actual or expected default in financial obligations

Details of joint ventures and collaborations Transactions involving payment towards goodwill,

brand equity and intellectual property

Any materially significant sale of business andinvestments

Foreign currency and other risks and risk management

Any regulatory non-compliance

Disclosures


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Disclosures to shareholders in addition to

balance sheet, P&L and cash flow statement Board composition (executive, non-exec, independent)

Qualifications and experience of directors

Number of outside directorships held by each director

(capped at director not being a member of more than 10

board-level committees, and Chairman of not more than

5)

Attendance record of directors

Remuneration of directors

Relationship (familial or pecuniary) with other directors

Warning against insider trading, with procedures to

prevent such acts Details of grievances of shareholders, and how quickly

these were addressed

Date, time and venue of annual general meeting of

shareholders

Disclosures


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balance sheet, P&L and cash flow statement Dates of book closure and dividend payment Details of shareholding pattern Name, address and contact details of registrars

and/or share transfer agents

Details about the share transfer system Stock price data over the reporting year, andhow the companys stock measured up to theindex

Financial effects of stock options Financial effects of any share buyback Financial effects of any warrants that are to be

exercised Chapter reporting corporate governance

practices

Disclosures


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balance sheet, P&L and cash flow statement Detailed chapter on Management Discussion

and Analysis focusing on markets, operations,

finances, accounts, risks, opportunities and

threats, internal control systems

Consolidated financial statement,incorporating accounts of all subsidiaries (over

50% shares held by reporting company)

Details of all significant related party

transactions

Detailed segment reporting (revenues, costs,

operating profits and capital employed)

Deferred tax liabilities and assets and

debit/credit in the P&L for the reporting year

Disclosures


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Disclosures(A) Basis of related party transactions

I. A statement in summary form oftransactions with related parties in theordinary course of business shall beplaced periodically before the auditcommittee.

II. Details of material individual transactionswith related parties which are not in thenormal course of business shall be placedbefore the audit committee.

III. Details of material individual transactionswith related parties or others, which are

not on an arms length basis should beplaced before the audit committee,together with Managements justificationfor the same


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Disclosures(B) Disclosure of Accounting Treatment

To disclose in the financial statements,if an accounting treatment other thanprescribed in Accounting Standard hasbeen followed alongwith explanation.

(C) Board Disclosures Riskmanagement

Internal and external business risks

Procedures to inform Board membersabout the risk assessment andminimization.

Periodically reviewed


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Disclosures

(D) Proceeds from public issues, rightsissues, preferential issues etc.

To disclose to the Audit Committee, onuse/application of funds as and when anyissue is made

(E) Additional disclosures:

In the Annual Report the criteria of makingpayments to NEDs to be disclosed or areference to be made that the same isavailable on the companys website

number of shares and convertibleinstruments held by NEDs.

NEDs shall disclose their shareholding(both own or held by / for other personson a beneficial basis) in the company inwhich they are proposed to be appointedas directors, prior to their appointment.


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Disclosures

F) Management

A Management Discussion andAnalysis report to form part of theAnnual Report.

G) ShareholdersDisclosures to shareholders in case ofappointment /reappointment ofdirectors, quarterly results and

presentations made, shareholdersgrievance committee and sharetransfer committee, shareholdingpattern-change


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CEO/CFO certification

The CEO, i.e. Managing Director and the CFO

i.e. whole-time Finance Director or head ofthe finance function to certify to the Boardthat:

(a) They have reviewed financial statementsand the cash flow statement for the year and

these statements:(i) do not contain any materially untrue statement

or omit any material fact or contain statementsthat might be misleading;

(ii) together present a true and fair view of thecompanys affairs and are in compliance with

existing accounting standards, applicable lawsand regulations.

(b) no transactions entered into by thecompany during the year which arefraudulent, illegal or violative of thecompanys

code of conduct.


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CEO/CFO certification (contd)

(c)They accept responsibility for establishing and

maintaining internal controls and that they haveevaluated the effectiveness of the internal controlsystems of the company and they have disclosed tothe auditors and the Audit Committee, deficienciesin the design or operation of internal controls, ifany, of which they are aware and the steps theyhave taken or propose to take to rectify thesedeficiencies.

(d)They have indicated to the auditors and the Auditcommittee(i) Significant changes in internal control during the

year;

(ii) Significant changes in accounting policies duringthe year and that the same have been disclosed inthe notes to the financial statements; and

(iii)Instances of significant fraud of which they havebecome aware and the involvement therein, if any, ofthe management or an employee having a significantrole in the companys internal control system


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Board composition and structure

Some key functions should be fulfilled by Board: Strategy formulation, budgets, business plans, etc. Monitoring the effectiveness of the companys governance practices;.

Selecting, compensating, monitoring key executives and overseeing successionplanning.

Executive and board remuneration;

Ensuring a formal and transparent board nomination and election process.

Monitoring and managing potential conflicts of interest of management, boardmembers and shareholders, including misuse of corporate assets and abuse inrelated party transactions.

Ensuring the integrity of the corporations accounting and financial reportingsystems, including the independent audit, ensuring control systems for riskmanagement, financial and operational control, and compliance.

Overseeing the process of disclosure and communications.

Ability to exercise independent decision: The most current theme is the number and role of independentdirectors

Sufficient independent directors

Mandate of committees to be clear


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Who are Independent Directors

As per Clause 49 of the Listing Agreements an independent director shall meannon-executive director of the company who

a. apart from receiving directors remuneration, does not have any materialpecuniary relationships or transactions with the company, its promoters, itssenior management or its holding company, its subsidiaries and associatedcompanies;

b. is not related to promoters or management at the board level or at one levelbelow the board;

c. has not been an executive of the company in the immediately preceding threefinancial years;

d. is not a partner or an executive of the statutory audit firm or the internal auditfirm that is associated with the company, and has not been a partner or anexecutive of any such firm for the last three years. This will also apply to legalfirm(s) and consulting firm(s) that have a material association with the entity.

e. is not a supplier, service provider or customer of the company. This shouldinclude lessor-lessee type relationships also; and

f. is not a substantial shareholder of the company, i.e. owning two percent or more

of the block of voting shares.[Institutional directors on the boards of companies shall be considered asindependent directors whether the institution is an investing institution or alending institution.]


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Selection of Independent Director

The selection and appointment of independent directors should betransparent and on certain valued basis.

Therefore, the companies should have an entirely independent nominationcommittee which should determine the qualifications for Board membershipand should identify and evaluate candidates for nomination to the Board.

It would be more appropriate that the code of Corporate Governance of a

company should specifically include the qualifications and attributes that thecompany seeks of an independent director.

A critical element of a director being independent is his independence to themanagement both in fact and perception by the public.

In considering the independence, it is necessary to focus not only onwhether a director's background and current activities qualify him asindependent but also whether he can act independently of the management.

In other words, the independent directors must not only be independentaccording to the legislative and stock exchange listing standards but alsoindependent in thought and action i.e. qualitatively independent.

Such qualitative independence will ensure that directors think and actindependently without regard to management's influence.


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Roles & Responsibilities

The role and responsibility of an individual director, of course, would depend

upon the nature of his directorship.

Broadly, there are three types of directors.

Full time, executive director who is normally a paid employee of a company

having some functional responsibility.

Non executive but non independent director who is normally a promoter ofthe company or having high stakes in the company.

And finally independent directors who are not full time directors. There is

another class of directors known as nominee directors representing some

interests like lending institutions etc.

An executive director, by very nature has much more responsibilities thannon executive directors. In law it is their responsibility to ensure compliance

with provisions of law failing with they could be held liable as officers in

default. As far as independent directors are concerned, the position of law isnebulous.


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Role of Independent Directors Independent directors broadly fit into the overall structure of corporate

governance, and are necessary to ensure effective, balanced boards The board is the most significant instrument of corporate governance

Role Of Independent DirectorsThe non-executive directors should:* Contribute to and constructively challenge development of companystrategy.* Scrutinize management performance.* Satisfy them that financial information is accurate and ensure thatrobust risk management is in place.

* Meet at least once a year without the chairman or executive directors- and there should be a statement in the annual report saying whethersuch meetings have taken place.* Be prepared to attend AGMs and discuss issues relating to their roles(especially chairmen of committees).* Have a greater exposure to major shareholders (particularly thesenior independent director).

Effectiveness of the board as the oversight body to oversee what the

management does Is there a better way to do it, in view of Recent scandals of disclosures and audits Size and scope of present day enterprise Complexity of operations


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Responsibilities of Independent Directors Independent Director shall however periodically review legal compliance

reports prepared by the company as well as steps taken by the company tocure any taint. In the event of any proceedings against an independent

director in connection with the affairs of the company, defence shall not be

permitted on the ground that the independent director was unaware of this

responsibility.

To function to properly according to the spirit of corporate governance as o

director on the board and as Member/Chairman across various committees

viz. the Audit Committee, the Shareholders Grievance Committee and the

Remuneration Committee of the company.

A director shall not be a member in more than 10 committees or act as

Chairman of more than five committees across all companies in which he is

a director. Furthermore it should be a mandatory annual requirement for

every director to inform the company about the committee positions he

occupies in other companies and notify changes as and when they takeplace.

At least one independent director on the Board of Directors of the holding

company shall be a director on the Board of Directors of the subsidiary

company.


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Independent Directors under Listing

Agreement in India

Composition of the Board:

Not less than 50% of the board to be non-executive directors Independent Directors:

If the chairman executive:

At least half of the board should comprise of independent directors

If Chairman non-executive:

At least one- third of the board should comprise of independentdirectors

Non-executive directors remuneration to be approved by shareholders Board meetings to meet at least 4 times, with gap not exceeding 3 months. Minimum

information for board meetings laid down

Committees of Directors

Audit Committee: requirements other than those u/s 292A

shall have minimum 3 members all of them being non-executive and majorityof them being independent

Chairman of the committee shall be an independent director To meet at least thrice a year

Company Secretary to act as secretary to the committee

Remuneration Committee

Shareholders/Investors Grievance Committee

Limits on committee memberships and chairmanships


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Recommendations of the Irani Committee on

Independent directors There cannot be a single prescription for all companies

Number may be prescribed by rules

A minimum one third recommended for a company havingpublic interest

Nominees of institutions should not be considered

independent as they represent sectional interests Suggests a definition:

Based on pecuniary interest that may affect independence

Lays some statutory illustrations of situations whereindependence does not exist

Independent directors should make self-declaration ofeligibility to be so appointed


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Companies Act and Independent Directors

The Companies Act looks at all directors alike: Throws some extra compliances in case of whole time directors

Requires some disclosures by interested directors

Defines officer in default giving a degree of immunity todirectors other than the whole time directors

Does not exempt independent directors from any of theduties, liabilities, responsibilities of the Board

Independent directors as much as part of the corporategovernance team as any other director

Independent directors have the same power that otherdirectors have


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NEW COMPANIES ACT

Provisions like mandatory internal audit forspecific companies,

Provision for rotation of auditors,

Increased role of audit committee, Restriction on providing certain specified servicesby auditors and restricting the financial year toApril to March without any provision ofextension,

Place more responsibilities and accountability oncompany management.


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In order to ensure investor protection, powers

have been given to courts and tribunals to re-

open accounts and the Serious Fraud

Investigation Office has been designated asthe main investigating agency for frauds

relating to companies.

NEW COMPANIES ACT


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Under the provisions of new Act, much emphasis has been laid ongood governance practices and better disclosures. The new law haskept in mind the necessity of transparency in corporate functioningand has provided for provisions for better disclosure like statementof compliances of all laws in board reports, more disclosures infinancial statements and includes associated companies and jointventures in the ambit of consolidated accounts.

It also mandates applicability of postal ballot for private companies,introduces auditing and secretarial standards, envisages mandatoryappointment of independent directors and further mandates therequirement of quorum of a general meeting based on number of

members in the company. The new Act, with an aim to strengthen the rights of minoritystakeholders, has introduced the concept of class action suits,which are already well established in countries like the UK and theUS.

NEW COMPANIES ACT


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Not only does it give more power to stakeholders, it also tends toenhance the sense of responsibility and diligence of companies.However, the benefit of class action suits has only been extended tomembers and deposit holders whereas for now, other stakeholderssuch as creditors, bankers, debenture holders are still not coveredunder its purview.

Another step designed for investor protection under the new law isthe provision of an exit opportunity for dissenting shareholders onvariation in terms of contract or objects in a prospectus.

The new law envisages that whenever there is a change in theterms of contract or objects in a prospectus, dissenting

shareholders shall be given an exit opportunity by the promoters orcontrolling shareholders at a definitive exit price.

NEW COMPANIES ACT

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