doing things right: corporate governance in india

1© Confederation of Indian Industry

Doing Things Right:Corporate Governance in India

Omkar Goswami

Chief Economist

Confederation of Indian Industry

11-13 November, Mumbai, India


Contents

Brief history of corporate governance in India

What are the mandated CG guidelines and disclosures

How does India measure up with Sarbanes-Oxley

New corporate governance moves that are expected


• Unlike South-East and East Asia, the corporate governance initiative in India was not triggered by any serious nationwide financial, banking and economic collapse

• 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 companies voluntarily

followed the code: Bajaj Auto, Hindalco, Infosys, Dr. Reddy’s Laboratories, Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI and many others



• Following CII’s initiative, the Securities and Exchange Board of India (SEBI) set up a committee under Kumar Mangalam Birla to design a mandatory-cum-recommendatory code for listed companies

• The Birla Committee Report was approved by SEBI in December 2000

• Became mandatory for listed companies through the listing agreement, and implemented according to a rollout plan:• 2000-01: All Group A companies of the BSE or those in

the S&P CNX Nifty index… 80% of market cap• 2001-02: All companies with paid-up capital of Rs.100

million or more or net worth of Rs.250 million or more• 2002-03: All companies with paid-up capital of Rs.30

million or more



• Following CII and SEBI, the Department of Company Affairs (DCA) modified the Companies Act, 1956 to incorporate specific corporate governance provisions regarding independent directors and audit committees

• In 2001-02, certain accounting standards were modified to further improve financial disclosures. These were:• Disclosure of related party transactions• Disclosure of segment income: revenues, profits and

capital employed • Deferred tax liabilities or assets • Consolidation of accounts

• Initiatives are being taken to (i) account for ESOPs, (ii) further increase disclosures, and (iii) put in place systems that can further strengthen auditors’ independence



Board of Directors: frequency of meetings and composition• Board must meet at least at least four times a year, with a

maximum time gap of four months between two successive meetings

• If the chairman of the Company is a non-executive then one-third of the board should consist of independent directors, and 50% otherwise

• ‘Independent’ defined as those directors who, apart from receiving director’s remuneration do not have any other material pecuniary relationship or transactions with the company, its promoters, management or subsidiaries, which in the view of the board may affect independence of judgement • This definition may be soon strengthened



Board of Directors: frequency of meetings and composition• The frequency of board meetings and board committee

meetings, with their dates, must be fully disclosed to shareholders in the annual report of the company

• The attendance record of all directors in board meetings and board committee meetings must be fully disclosed to shareholders in the annual report of the company

• Full and detailed remuneration of each director (salary, sitting fees, commissions, stock options and perquisites) must be fully disclosed to shareholders in the annual report of the company

• Loans given to executive directors are capped (no loans permitted to non-executives), and must be fully disclosed to shareholders in the annual report of the company



Board of Directors: information that must be supplied• Annual, quarter, half year operating plans, budgets and updates• Quarterly results of company and its business segments• Minutes of the audit committee and other board committees• Recruitment and remuneration of senior officers• Materially important legal notices and claims, as well as any

accidents, hazards, pollution issues and labor problems• 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 and investments• Foreign currency and other risks and risk management• Any regulatory non-compliance



Board of Directors: Audit Committee• Audit Committee is mandatory• Must have minimum of three members, all non-executive

directors, the majority of whom are independent• Chairman must be an independent director, and must be

present at the annual shareholders’ meeting to answer audit or finance related questions

• At least one member must be an expert in finance/accounts• Must have at least three meetings per year, including one

before finalisation of annual accounts• Must meet with statutory auditors and internal auditors;

have the powers to seek any financial, legal or operational information from the management; obtain outside legal or professional advice



Board of Directors: Audit Committee functions• Oversight of the company’s financial reporting process to ensure

that the financial statement is correct, sufficient and credible• Appointment / removal of external auditor and fixing of audit fees• Reviewing with management the annual financial statements

before submission to the board, focusing on:• Changes in accounting policies and practices• Major accounting entries• Qualifications in draft audit report• Significant adjustments arising out of audit• The going concern assumption• Compliance with accounting standards, with stock exchange

and legal requirements• Any related party transactions



Board of Directors: Audit Committee functions• Adequacy of internal audit and internal control systems,

through discussion with internal and statutory auditors as well as management

• Significant findings, follow-up and action taken reports• Discussion with internal and statutory auditors about scope

and design of audits• Reviewing financial and legal risks and company’s risk

management policies• Examining reasons behind any materially significant default

to creditors, bond-holders, suppliers and shareholders



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




• 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, and how the

company’s stock measured up to the index• 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




• 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




Sarbanes-Oxley Indian situation What might be needed

Certification of annual accounts by CEO, CFO

At least two directors must sign, of whom one must be the Managing Director

Need to change to have MD/CEO plus Finance Director/CFO to sign

Fully independent audit committees

Fully non-executive, majority independent audit committees

Need to consider (i) fully independent (ii) tighter definition of independence

Disgorgement of CEO/CFO compensation in event of restatement

Accounts and profits once published cannot be re-stated

Need to see if ESOP payments need to be disgorged if there is a restatement

Prohibition of insider trading

Prohibits insider trading Nothing is needed

Prohibition of insider loans to directors

Strict cap on insider loans to directors; requires prior government approval

Caps are stringent enough to prevent insider abuse



Sarbanes-Oxley Indian situation What might be needed

Real time disclosure concerning changes in financials and operations

Listing agreement mandates companies to report quarterly results and material changes

Nothing is needed

Mandatory periodic review of company’s filings once every three years

No such provision Need to consider how this can be done without creating administrative hassles

Auditors prohibited from nine types of non-audit services to audit clients

These services are already prohibited in India

Nothing is needed

Auditors to report to Audit Committee on critical accounting policies

Mandated by the listing agreement and the Companies Act amendments

Nothing is needed

Rotation of audit partners every five years

No such provision exists A committee is considering such a change

Up to 20 years in prison for fraud and destruction of records

No such provision Need to consider tougher penalties, including longer imprisonment


Contents






• There are five reasons why one doesn’t expect the corporate sector in India to exhibit the excesses that occurred in the US

1. The amount of stock options to be granted to employees is strictly limited. Expensing options (if adopted) will create a further natural limit

2. In general, companies are controlled by a sizeable shareholder, typically owning over 35% of stocks. This tends to limit agency costs of dispersed ownership

3. The variable compensation package is much more linked to profits and/or EVA, than stock prices or P/E

4. Much greater importance is given to accumulating cash. “Profit is an opinion; cash is fact”

5. For better or for worse, most Indian companies still don’t have to give forward looking earnings estimates



• After the US crises, there have been some initiatives:

1. A committee has been set up to examine stock options, including expensing them

2. Another committee has been set up to recommend tighter enforcement by DCA and stiffer penalties, including longer prison terms

3. A third committee has been set up to examine auditor-company relationships and the role of independent audit committees

4. A fourth committee is examining what additional disclosures and accounting standards are needed to have even better corporate governance



Concluding remarks• By and large, Indian listed companies have been legally

mandated to follow fairly strict standards of corporate governance and disclosure

• Comparisons will show that the standards are far stronger than all Asian countries, and in general stronger than most OECD countries

• Indian corporate sector regulators and companies have been quick to incorporate some of the best international corporate governance and disclosure practices

• The need of the day is more training… of directors, audit committee members and senior executives of companies

• The challenge is to design and sustain a system that imbibes the spirit of corporate governance… and not merely the letter of the law

doing things right: corporate governance in india

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