Ishika Jindal

MODULE 3: Corporate Governance

1. Corporate Governance- Basics and Concepts

2. Facets of Corporate Governance
3. Corporate Governance Failures- The Need for Regulation
4. Evolution, Scope and Relevance
5. Principles, Policies and Best Practices
6. Corporate Governance vis-à-vis Companies Act 2013
7. Various Committees on Corporate Governance

1. CORPORATE GOVERNANCE- BASICS AND CONCEPTS

1.1 Meaning of Corporate Governance

In a basic sense, it refers to the way in which a business operates. The rules, regulations, policies and
practices adopted by a business entity, the way in which it’s internal working functions, all form part of
corporate governance. The main theme of corporate governance is to integrate sound management
policies in the corporate framework in such a manner to bring economic efficiency in the organization in
order to achieve twin goals of profit maximization and shareholder welfare. Good corporate governance
is essentially ensuring that the management meets its obligations towards - the owners (shareholders),
creditors, employees, consumers, Government and society at large.

1.2 Definition of Corporate Governance

The Institute of Company Secretaries of India has defined Corporate Governance as “the application of
best Management Practices, Compliance of Laws in true letter and spirit and adherence to ethical
standards for effective management and distribution of wealth and discharge of social responsibility for
sustainable development of all stakeholders.”

1.3 Advantages of Corporate Governance (need/importance/relevance)

Good corporate governance is embedded to the very existence of a sound company. It is important for
the following reasons:

1. Compliance with laws

Corporate governance includes the rules, regulations and policies that enable a business to stay
compliant with the law throughout and function without any hassle or legal inconveniences whatsoever.
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2. Lesser fines and penalties

Since the legal compliance aspect is taken care of because of good corporate governance practices,
companies are able to save a fortune on unnecessary fines and compliances and can possibly redirect
those funds towards business objectives to achieve greater heights.

3. Better management
Since there is a structure in place with regard to how the entity operates, its day-to-day functioning,
managing the activities and achieving targets becomes a whole lot easier. It also strengthens strategic
thinking at the top management by taking independent directors on the board who bring intellectual
experience to the company and unbiased approach to deal with matters related to companies welfare.
The work atmosphere also takes care of itself under good principles of corporate governance fostering
teamwork, unity, efficiency and a drive for success.

4. Reputation and relationships

Companies with good corporate governance are able to attract investors and external financiers with
relative ease, going by their sterling reputation and brand image. One of the pillars of corporate
governance is transparency, which is the practice of sharing key internal information with the
stakeholders. This improves the relationship of the entity with its stakeholders and sows the seeds of
trust between the company and society at large. It also instills loyalty (degree of confidence) among
investors as their interest is looked after in the best manner.

5. Lesser conflicts and frauds

The rules instilled in the workplace encourage the employees to be morally conscious in every situation
that they encounter, thus eliminating the possibility of fraud and conflict between employees. It also
strives to achieve a healthy balance between management and ownership which is capable of taking
independent decisions for creating long-term trust between the company and its external stakeholders.

6. Fulfilling responsibility towards society at large

Society has greater expectations from corporations. They expect corporations to take care of the
environment, pollution, quality of goods and services, sustainable development etc. Fulfillment of all
these expectations is only possible with proper corporate governance.
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1.4 Disadvantages of Corporate Governance

When it comes to the matter of smaller corporations, there might be a bit of hassle where the
shareholders may serve as the directors and managers, having no segregation as such. Bearing this in
mind, it gives rise to:

1. The burden of staying legally compliant

Corporates generally have loads of compliance that have to be followed, attracting different laws based
on their industry. Corporate governance ensures legal compliance, but it does come at a very hefty price.

2. Increased costs
Administrative costs for companies with corporate governance are pretty exorbitant, considering all the
requirements to be met like maintaining documents related to stock sales and purchases, legal
compliance records, annual registration, etc.

3. Maintenance of segregation
Irrespective of the size of the corporation, the adherence to all formalities and requirements must be
met without any exceptions. Failure to comply with these rules leaves the company with huge exposure
such as “piercing of the corporate veil”, where the separate legal entity status of the corporation is
ignored in order to understand the goings-on behind the closed doors.

4. The conflict between the principal and the agent

Large corporations have made it a common practice to appoint a well-known manager, one with a good
track record to manage the day to day operations of the business. Unfortunately, this gives rise to
conflicts between the shareholders and the managers as they both may have very different objectives
and perspectives. This often leads to a clash between the two, thus affecting the overall ability of the
business to run its operations in a smooth and efficient manner.

2. FACETS OF CORPORATE GOVERNANCE

A company not only produces economic goods, but also social effects on the people involved in the
production, distribution and consumption of goods inside the company as well as in the society at large.
Good corporate governance practices fulfills such responsibility. Thus, a responsible management has to
ensure that the business serves various groups effectively and efficiently.
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2.1 Shareholders
Management is responsible towards the shareholders by way of ensuring a fair return on their
investments; treating them as business partners; ensuring capital appreciation of their stock and
redressal of their grievances with respect to matters such as delay in transfer of shares, delay in despatch
of share certificates and dividend warrants, and non receipt of dividend warrants.

2.2 Employees
Responsibilities towards employees include payment of fair wages and salaries; sympathetic treatment
by the supervisors; absence of favoritism; provision for leave; communication networks between
management and employees; setting up of norms and dispute resolution mechanisms; concern for
safety and provision of healthy and satisfactory working conditions.

2.3 Consumers
Responsibilities towards consumers include offering a variety of dependable quality goods and services
at reasonable prices and the creation of a good distribution network.

2.4 Community
Responsibilities towards the community include not to corrupt public servants, to sell goods and services
without adulteration and to follow fair trade practices.

2.5 Government
Responsibilities towards the government require the management to be law-abiding, to pay the taxes
and other dues fully and honestly, not to purchase political support by unfavorable means, and to
contribute to stable and balanced development of the economy.

Note: Everything good that is happening in Companies Law is a facet of Corporate governance.
Transparency, accountability, disclosure, reporting, independence - essentials and facets both. We can
also include effective and independent board structure, auditing, shareholders accountability, etc.

3. CORPORATE GOVERNANCE FAILURES- THE NEED FOR REGULATION

It provides a structure through which objectives of the company are set, and the means of attaining
those objectives and monitoring performance are determined. The collapse of international giants like
Eron, Worldcom, Tyco, AOL and financial scams like Satyam have been big eye-openers in the corporate
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arena to realize the need to regulate the company’s management, ownership and stakeholders. It is also
important for companies to ensure compliance with Corporate Governance principles in order to avoid
paying huge corporate criminal liabilities in future. These huge corporate giants paid the cost for lack of
good corporate governance practices and corrupt policies adopted by the management of these
companies and their financial consulting firms.

The significance of good corporate governance solutions has widened because of the:
● Increasing conflict between ownership and management disciplines.
● Non-compliance of financial reporting by auditors which inflicts heavy losses on investors.
● Lack of fair and transparent culture in the company which shook investor trust in the financial
viability of the company and its ethical standards.

3.1 Enron Scandal

● Enron was a Huston-based energy company founded by a brilliant entrepreneur, Kenneth Lay, who
later became the CEO and Chairman of Enron in 1986. The company was created in 1985 by a merger
of two American gas pipeline companies.
● Over time, the firm's business focus shifted from the regulated transportation of natural gas to
unregulated energy trading markets. In 1990, Jeffrey Skilling, an energy consultant was hired to run a
new subsidiary called Enron Finance Corp.
● Within a period of 16 years, the company was transformed from a relatively small concern, involved
in gas pipelines, and oil and gas exploration, to the world’s largest energy trading company. Enron
became one of the 10 largest companies in the USA (share price rising).
● Activities- aggressive multidimensional trading, mark to market accounting, liquid assets generation
in short term, investment in complex instruments, derivative contracts
● What went wrong:
○ Mark to market method of accounting and revenue recognition
○ The CEO hired accountants to do poor Financial Reporting to hide debt, like by transferring it to
Special Purpose Vehicles (SPVs).
○ The CFO misled the BoD and Audit Committee on financial issues.
○ Manipulation of financial statements like showing debt as equity
○ Managing the bankers, lawyers and auditors for personal benefit through insider trading
○ Auditing company (Arthur Andersen & Co. - giant) ignored the accounting issues and was paid
weekly fees of $1 million approx.
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○ Failure- Transparency, Disclosure, Auditing, Financial Reporting

● In 2001, Enron announced a third-quarter loss of $618 million. It later revealed that it overstated
earnings dating back to 1997 and it is under formal investigation by the Securities and Exchange
Commission (SEC).
● Enron claimed that it was confirmed to be purchased by a rival company, Dynegy for $9 billion.
Dynegy announced that it has terminated merger talks with Enron.
● Enron filed for Chapter 11 Bankruptcy protection. With $62 billion in assets, it would be the biggest
American company ever to go bankrupt. Despite its 2001 bankruptcy filing, it was America’s 5th
largest company by Fortune Magazine in 2002.
● Arthur Andersen & Co. disclosed that its employees destroyed Enron’s documents. Punishment -
barred from auditing listed companies/clients; whole business collapsed
● In 2002, the New York Stock Exchange suspended trading of Enron shares. It had dropped from $90
approx to $0.67 in 10 months - sale of insider trading stocks; employees, investors, shareholders -
massively affected.
● In 2006, Skilling and Lay were convicted of conspiracy and fraud.

3.2 Worldcom Scandal

● In the late 1990’s and early 2000’s, the largest telecoms company was WorldCom, a long-distance
and internet provider.
● WorldCom had grown throughout the 1990s through a series of poorly-managed acquisitions and
mergers into a corporation of competing divisions, redundant services and products, and multiple
billing systems—a chaotic environment perfect for fraud and corruption.
● Kim Emigh was a budget analyst at WorldCom. Soon after he was hired in 1996, Emigh witnessed
unscrupulous business practices, such as close personal relationships between company executives
and the vendors to whom they awarded contracts and contractors who were paid exorbitant rates.
When Emigh questioned these and other issues, management threatened him with termination.
● In late 2000, Emigh and others were asked to do something Emigh believed to be outright
illegal—misclassify costs in the accounting books. By shifting labor expenses from one category to
another, WorldCom could artificially boost its bottom line to show a profit, rather than a loss.
● That is misleading to investors; in actuality, it’s fraud. Emigh blew the whistle to the COO. The order
was halted before it was carried out but, soon after, Emigh was fired.
● Under the made-up term “prepaid capacity,” company accountants were instructed by executives to
book certain costs, such as the leases of network lines, as capital expenses, instead of as operating
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expenses. This change resulted in fiscal reports that showed a healthy, profitable company; in truth,
WorldCom was careening towards bankruptcy.
● Auditors uncovered $3.9 billion in operating expenses that had been transferred to capital expense
accounts. Furthermore, there was nothing to back up those entries—no invoices, receipts, or
supporting documentation of any kind.
● Activities: fabricated inflation, exaggeration of profits, entries without actual transactions,
overstatement of assets in balance sheets.
● Failures: Auditing, Accounting, Transparency, Disclosure
● The Securities and Exchange Commission (SEC) launched its own investigation into WorldCom’s
accounting and found that the company had overstated assets by a staggering $11 billion. At the
time, it was the largest corporate accounting fraud case in US history.
● WorldCom filed for Chapter 11 bankruptcy protection.

NOTE
In the aftermath of WorldCom, Enron, and other corporate accounting scandals, the US government
passed the Sarbanes-Oxley Act (SOX), 2002, a corporate governance law which, among other things,
holds top executives personally liable for the accuracy of a company’s financial statements. SOX covers a
range of elements, such as maintaining auditor independence, conflicts of interest, financial disclosures,
responsibilities of a corporation’s board, and penalties for white-collar crime. The law also mandates that
companies provide a means for employees to anonymously report questionable accounting or other
dubious acts.

3.3 Tesla Case Study

Tesla’s managerial structure put the company at risk for major losses. In a 1-year period, from March
2018 to March 2019, Tesla stock suffered a major drop. In some cases, these drops were caused by bad
earnings reports, or mechanical problems with their cars, but in many cases, they are attributable to a
careless tweet or other statements made by Elon Musk:
1. In March 2018, Tesla fell by 22% in a single month because of a fatal crash involving a Model X
car, and a slower-than-expected rate of Model 3 production.
2. In June, Tesla rapidly ramped up its Model 3 production to meet their production objectives.
Though they eventually met the goal, they ran into several mechanical problems. To make
matters worse, on June 18th, Elon Musk said that their computer systems had been
compromised by a disgruntled employee.
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3. He accused the leader of the operation of being a pedophile. For the entire month of July, when
this controversy was going on, Tesla’s stock was on a downward trajectory.
4. Elon Musk suddenly tweeted on August 7th that he was planning to take Tesla private at $420
per share. Later, on August 24th, Musk publicly abandoned the plan. This month-long saga was
less-than-profitable for Musk’s company.
5. On August 17th, Elon Musk gave an interview to the New York Times in which he described his
profound troubles working at Tesla for the past year. The story gave the impression of a
desperate situation at the company, in which Musk had to work incredible hours to keep up with
expectations. The stock fell 9% in the next session.
6. September 6th was the now infamous Elon Musk interview with Joe Rogan, in which Musk
smoked marijuana on video. Tesla stock dropped 9% the next day.
7. Later in September, the SEC announced that they were suing Musk for his tweet concerning
taking Tesla private, sending Tesla down 14%.
8. Rumors, later confirmed, of dropping sales for the flagship Model 3 led to over two weeks in
which Tesla stock consistently declined.

If an executive officer selectively discloses material nonpublic information, the company can correct the
situation by filing a Form 8-K to disclose the information. Given the potential confusion for investors
resulting from Musk’s tweets about going private and his claim that he made the statements in his
“personal capacity,” Tesla should have immediately filed a Form 8-K. No Form 8-K was filed though.

The core issue was that the structure of the company meant the CEO (Musk) wasn’t accountable to the
board of directors, and the board of directors wasn’t accountable to the shareholders. Musk’s public
attitude and the way his company is built have had a material negative impact on people who are
invested in Tesla.

3.4 Satyam Computers Scandal

3.4.1 Background
● Satyam Computer Services Limited set up by B. Ramalinga Raju in 1987. Quickly established itself as
a major IT player specializing in outsourcing.
● In 1991, a successful debut on BSE. In 1995, launched SIFY to offer back office services to clients in
US and Europe. In 2001, listed on the New York Stock Exchange. B. Ramalinga Raju made Satyam
India’s fourth largest IT company.
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● In 1988, Raju founded the Maytas group along with his family members and in 2008 proposed that
Satyam should buy out the Maytas group. The proposal fell through. Share prices crashed and Raju
confessed to accounting frauds.

3.4.2 Description of the Crisis

● Raju maintained two sub accounts under a single bank account.
● Fake invoices in the name of genuine clients and fictitious debtors existed in the books of account.
● Fake FDRs
● Insider trading by promoters.
● Web of 356 group companies used to divert funds from Satyam in the form of inter-corporate loans
and investments.
● Ghost workers

3.4.3 Major Governance Failures

Complied with all Regulations and had eminent people on Board and reputed international auditors yet
there were lapses at Satyam with regard to corporate governance.
● Powerful Executive
● Absence of Checks and Balances
● Dubious Role of Auditors
● Unethical Conduct

3.4.4 Aftermath
● GOI appointed independent directors.
● Satyam purchased by Tech Mahindra.
● Raju and associates were sentenced to imprisonment.
● PWC fined by SEC and four auditors of PWC debarred by ICAI.
● SEBI and GOI took a slew of measures to improve corporate governance in India.

3.5 Tata-Mistry Tussle

● Tata Sons are the principal holding company of the Tata Group. In 2006, Cyrus Mistry was one of the
directors of Tata Sons and thereafter appointed as the chairman of the Board.
● But certain disagreements happened between Cyrus Mistry and the Tata Sons Board relating to the
functioning of the company and decisions taken by Cyrus Mistry. This led to the removal of Cyrus
Mistry as the Chairman of Tata Sons in 2016.
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● Cyrus Mistry challenged the removal from the position in the National Company Law Tribunal (NCLT).
The same was rejected by NCLT and held that the parent company has the power to remove him as
the chairman.
● The removal was further challenged in NCLAT which allowed the appeal and held that the removal
was illegal and was oppressive to its minority shareholders, particularly Cyrus Mistry and his family
enterprises which include Shapoorji Pallonji Group.
● Tata Sons opposed the order as it weakened the board’s corporate democracy and rights and
therefore pursued the matter in the Supreme Court. The court held that no oppression or
mismanagement was done and the Board was justified in removing Cyrus Mistry as the Chairman in
accordance with the articles of association of the company.
● Governance issues revolving around the dispute:
○ Dominant powers are given to the promoters (Tata Trusts)
○ Affirmative voting rights give significant power to promoters to manage and control the activities
of the company.
○ Removal of Independent Directors by BoD questions the independence of directors appointed
○ power imbalance between the promoters and shareholders, conflict of interest
○ Restriction of the rights of minority shareholders if it is not in the interest of the promoters

3.6 PNB-Nirav Modi Scam

● One of the country's biggest banking scams, involving a huge sum of around Rs. 11,400/- crores.
● Fraud was committed by Nirav Modi and Mehul Choksi who were involved in exporting and
importing of diamonds under the listed company called Gitanjali Gems.
● An LOU is a guarantee by the issuing bank to the receiving bank and the companies that it would
undertake to pay a certain amount of money on a specific date.
● As per the bank, employees provided LOUs (Letter of Understanding) without taking any cash
reserve or collateral and didn't even enter the transaction in the bank’s software. LOUs were issued
by these suspected bank officials through Swift, which is the medium for international cash transfer.
● These LOUs were used as leverage in Hong Kong for obtaining credits from various banks such as SBI,
Axis Bank etc by Nirav Modi and his company. These banks were aware that PNB had not
incorporated Swift in their core banking network. They made the decision not to document these
transactions in the bank's system.
● The scam was exposed in 2018, when the three diamond firms approached PNB for obtaining bank
credit through LOU to import stones from overseas. The bank’s official in charge requested a 100%
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cash margin because these firms had no pre-sanctioned limit. The diamond firms challenged the
bank's demand, claiming that they had previously used this facility. The branch documents, however,
revealed no evidence of such a facility being provided to the aforementioned firms. This triggered an
alarm, prompting the bank to conduct an internal investigation into past bank credits.
● The internal investigation found that two banks had previously fraudulently given LOU to the
aforementioned firms without following the proper process.
● PNB case study is an example of bad corporate governance. It is necessary to realize that:
○ A company that has good corporate governance has a much higher level of confidence amongst
the shareholders associated with that company.
○ Transparency implies an accurate, adequate and timely disclosure of relevant information about
the operating results of a corporate enterprise to its stakeholders.
○ Accountability indicates the responsibility of the Chairman, the BoD and the chief executive for
the use of a company's resources in the best interest of the company and its stakeholders.
○ Good corporate governance requires independence on the part of the top management.

3.7 Harshad Mehta Scam

● Harshad Mehta was the son of a peon. He was born in abject poverty and when he migrated to
Mumbai, he had a mere Rs 40 in his pocket. However, over the years Harshad Mehta rose
meteorically to become one of the most influential and powerful brokers on the Bombay Stock
Exchange.
● India had two very different but parallel markets in operation. One market was for corporate
securities i.e. the stock exchange and the other was the government securities market.
● Mr Mehta had colluded with the banks to change the very nature of the government securities
market. Earlier, the role of a broker was only to bring the parties (banks) together whereas the banks
would undertake the transaction of securities and lending of money themselves.
● In the new market established by Mr Mehta, the broker was more of a market maker. This meant
that both the banks were dealing with the broker and neither knew who the counterparty was.
● Therefore, Mr Mehta could get the banks to deposit a check in his account and have the funds for
himself for a short period of time.
● There was a time lag in the disbursement of money and depositing of collateral. For this short time,
the money was essentially an unsecured loan to the broker and could be used to rig the markets.
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● He would then invest this money in a few selected securities and drive their prices insanely high.
When people would get excited about a particular security, Harshad Mehta would slowly liquidate
his holdings, pay off the embezzled money and pocket the huge difference caused by rising prices.
● The scale at which Harshad Mehta was doing this was unimaginable. In one year, he had driven the
Sensex i.e. the index of the Bombay Stock Exchange from 1000 to 4500. It was an unprecedented bull
run, never seen in the history of a conservative Indian market.
● The Harshad Mehta scam was discovered when attention was paid to the money missing from the
government securities market. As the scam broke loose, the valuations in the Bombay Stock
Exchange collapsed. People lost their life savings in the scam. Some investors were heavily leveraged
and as a result committed suicide as a result of the fallout.
● The issue rose to national prominence. Institutions like the RBI, CBI and Parliamentary Committees
had to be involved. The matter became even more convoluted as Harshad Mehta coughed up the
name of Prime Minister of India, Shri P.V. Narsimha Rao was a beneficiary from the corruption and
threatened to reveal many more names.
● Finally, the committee found Harshad Mehta directly responsible for embezzling worth Rs 1439
crores ($3 billion) and causing a scam that led to the loss of wealth to the tune of Rs 3542 crores ($7
billion).

3.8 Ketan Parekh Scam

● Ketan Parekh was a protégé of Harshad Mehta. He was a chartered accountant by professional
training and had started managing his family’s brokerage business.
● He was said to be a believer in the Information, Communication and Entertainment sector i.e. the
ICE sector. The late 90’s and early 2000’s were the time when the IT boom took place and these were
the stocks which were actually growing by leaps and bounds worldwide.
● Hence, it seemed to appear that the stocks Ketan Parekh was picking were growing because of their
fundamentals. The massive 200% growth in his shares was therefore not as astounding and did not
attract as much attention as Harshad Mehta’s escapades did.
● In reality, he was looking out for stocks which had a low market capitalization and low liquidity. He
would then pump money into these shares and start fictitious trading within his own network of
companies. The average person may begin to believe that his stocks were rising and they too would
start investing, driving the prices even higher. Then, as the market took over, Ketan Parekh would
liquidate his holdings slowly, once again making less noise than Harshad Mehta would have done.
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● He did this repeatedly for 10 stocks which he had picked. These stocks came to be known as the K-10
stocks and the market always seemed to be bullish about the future of these stocks.
● He conducted the majority of his trading in the Calcutta stock exchange (CSE). The lack of regulation
in this exchange provided more flexibility. He did not trade on his account but instead instructed
other brokers to hold securities and paid them a commission to do so while making good any losses
that they might have accrued on the position.
● The problem with Ketan Parekh’s dealings was two-fold:
○ He had been accepting money from the promoters of many companies to take their share prices
up. This can be seen as insider trading.
○ He had also embezzled large amounts of cash from the Madhavpura Mercantile Commercial
Bank (MMCB). He was believed to have bribed the officials of the said bank to persuade them to
lend against shares to a greater extent than was permitted by law. Then, the bank basically
started making unsecured loans to him. The loans would be sanctioned first and the collateral
would be collected a few days later, making the loans unsecured for the interim duration.
● As a bear cartel started hammering the K-10 stocks, Ketan Parekh found himself locked out of cash.
The MMCB bank was also not able to lend out credit and bail out Mr Parekh. The brokers that were
holding positions on his behalf in the Calcutta Stock Exchange were forced to liquidate too, causing a
massive sell off in the market. Investors lost money to the tune of Rs 2000 crores ($4 billion).
● Ketan Parekh was immediately arrested and tried in court. He has been prohibited from trading in
the Bombay Stock Exchange for 15 years i.e. till 2017. Also, he had been sentenced to one year
rigorous imprisonment for his economic crimes.
● The courts have now mandated disclosures and greater transparency in the Indian Financial system
to secure the stock market and create an investor-friendly environment.

4. EVOLUTION, SCOPE AND RELEVANCE

4.1 Emergence of Corporate Governance in India

● Corporate Governance is the new golden term coined in the corporate sector in the late 1990’s by
the Industry Association on Confederation of Indian Institute (1998) which was the first initiative in
India as a voluntary measure to be adopted by Indian companies. It has outlined a series of voluntary
recommendations to integrate best-in-class practices of corporate governance in listed companies
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which touches the four cornerstones of fairness, transparency, accountability and responsibility in
managing the affairs of the company.
● The second major initiative was when SEBI established the first formal regulatory framework for
corporate governance in India owing to the recommendations of the Kumar Mangalam Birla
Committee (2000). It was undertaken to improve the standards of corporate governance in India.
This came to be known as clause 49 of the Listing Agreement.
● The third key initiative to effectively introduce Corporate Governance was taken by the Naresh
Chandra Committee (2002) and Narayana Murthy Committee (2003) who previewed the Corporate
Governance model working in companies from the viewpoint of shareholders, investors and other
stakeholders of the company.
● Corporate governance guidelines both mandated and voluntary, have evolved since 1998, due to the
sincere efforts of several committees appointed by the Ministry of Corporate Affairs (MCA) and the
SEBI.
● The real change in the corporate sector could be felt with the introduction of the Mandatory
Corporate Governance Voluntary Guidelines (2009) by MCA which have to be followed by companies
listed on the stock exchange under Clause 49 of the Listing Agreement. It includes mandatory codes
to be followed by companies pertaining to board of directors, audit committees and various
disclosures with respect to related party transactions, whistleblower policies etc.
● The final assent to Corporate Governance practices in the effective management of the company can
be seen as introduction of new significant provisions in the Companies Act, 2013 in form of
independent directors, women directors, corporate social responsibility and mandatory compliance
of Secretarial Standards issued by Institute of Company Secretaries of India as per Section 118 of
Companies Act, 2013.

4.2 Scope of Corporate Governance

Corporate governance instills ethical standards in the company. It creates space for open dialogue by
incorporating transparency and fair play in strategic operations of the corporate management. The
significance of corporate governance lies in:
● Accountability of Management to shareholders and other stakeholders
● Transparency in basic operations of the company and integrity in its financial reports
● Component Board composed of Executive and Independent Directors
● Checks & balances
● Adherence to the rules of company in law and spirit
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● Code of responsibility for Directors and Employees of the company.

● Open Dialogue between management and stakeholders of the company
● Investor Loyalty

4.3 Relevance of Corporate Governance

Advantages mentioned above.

5. PRINCIPLES, POLICIES AND BEST PRACTICES

5.1 Transparency
The policies must be formulated in a manner which ensures transparency. The stakeholders should be
informed about the company’s activities, financial statements, and the organization’s performance and
also at the same time it is very important to give accurate and precise information to the shareholders.
Poor transparency reduces the ability to raise more capital as the investors will be unaware of vital
information. It also leads to reduced trust among the investors as a company that is financially stable and
doing well will not have anything to hide. Moreover, companies that are doing well will like to make the
financial statements public to promote their activities. Transparency in financial reporting increases the
confidence of the shareholders and this will help the company. Transparency should also be maintained
between directors and employees. The directors should be easily accessible by the employees and
directors should be open to ideas of the management and employees. This makes employees more
committed to the vision of the company. Lack of transparency will always lead to confusion and it will
hinder the productivity of the management and employees.

5.2 Accountability
To achieve the goals and objectives of the company, people should be held accountable at all levels.
Employees should be accountable to the management, management should be accountable to the board
of directors and the board of directors should be accountable to investors and shareholders. Employees,
management staff and directors will learn from their mistakes if they are made accountable and it also
leads to better utilization of the available resources. In this way, the organization will grow faster as the
scope for mistakes will be reduced considerably. It is the duty of directors to encourage accountability in
the organization.
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5.3 Responsibility
The directors of the company are primarily responsible to the shareholders, employees and the whole
society. The directors of the company should work in the best interests of the company and its
employees. It is the duty of the directors to determine the responsibility of the management and
employees. Also, management and employees should be held accountable to make sure that
responsibilities are carried out properly. Shareholders want directors to be responsible to their needs
and maximize the value of the firm.

5.4 Fairness
Fairness principle not only enhances corporate value but it also leads to efficiency in resource allocation.
All shareholders and investors should receive equal treatment by the company and the directors should
try to prevent conflict of interests. It is very important to ensure fairness in transactions which are
entered by the company (like: a company should not enter into related party transactions without
getting the approval of the shareholder). Effective communication mechanisms should be adopted by
the company to make sure policies and financial statements are informed to the shareholders.

5.5 Shareholder Engagement

Shareholders should not be kept in the dark and must be informed of the financial position and
organizational objectives. Minority and majority shareholders should be treated equally. All transactions
must be avoided which might lead to conflicts with the shareholders.

5.6 Leadership
Board of directors is the brain of any company and it is under their leadership and guidance that any
company expands and prospers. The directors should be committed to fulfilling the vision and mission of
the company which is mentioned in the constitution documents. Leadership also includes motivating the
employees so that they reach their maximum potential. It also includes effective decision making and
capitalizing on opportunities to benefit the firm. Poor leadership by the board can create problems for
the company which may eventually end in bankruptcy or shutting down.

Note: The first four are core principles, the rest two can also be mentioned.

6. CORPORATE GOVERNANCE VIS-À-VIS COMPANIES ACT 2013

 Ishika Jindal

The Companies Act, 2013 has incorporated a number of provisions to promote good corporate
governance. Some of the key provisions in this regard are as follows:
1. Passing of Resolutions through Postal Ballots - true democracy in management
2. Compulsory Audit Rotation
3. Auditors not to perform specified services
4. Responsibility Statement of Directors
5. Internal Audit
6. Secretarial Audit
7. Audit Committee - consisting of at least 3 independent directors forming a majority
8. Vigil Mechanism - allow directors and employees to raise genuine concerns
9. Board Composition - 1/3rd directors of every listed company to be independent directors
10. Code of Conduct for Independent Directors [Schedule IV]
11. Disclosure of Interest
12. Related Party Transactions
13. Forward dealing and Insider trading - prohibited
14. Class Action
15. Corporate Social Responsibility - CSR Committee and CSR Policy, 2% average net profit

Q. Relationship between CG and CSR

● Explain CG and CSR
● With the evolving concept of CSR and its application by many corporations in their management
systems, it has been seen that CSR positively impacts the governing rules of corporate governance.
To name a few corporate-like Hyundai, Samsung, Unilever, and P&G, they publish their CSR reports
and the company’s annual reports. This is an immediate consequence of the push to broaden the
agenda of good corporate governance by including CSR within its ambit. Additionally, many other
corporates now publish a routine report of how much cost they are imposing on society (negative
externalities) and the efforts done by them towards minimizing it. So, corporate governance
principles are no longer restricted to transparency and accountability within the business regulatory
framework; it has been broadened to consolidate the whole gamut of social and environmental
concerns within the corporate governance agenda.
● Multilateral bodies such as the United Nations and the WTO, have also established normative rules
of conduct under classifications like the Corporate Sustainability- UN Global Compact. The UN Global
Compact has guidelines for the corporations to follow that bind them to social and environmental
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responsibility. There are many corporate signatories to the compact who are expected to follow the
guidelines, though voluntarily, as part of their sustainability drives.
● However, looking at the current global climate situation, it is necessarily required to combine both
voluntary and enforced rules of conduct and behavior that corporate must follow as part of their CSR
related to corporate governance.

7. VARIOUS COMMITTEES ON CORPORATE GOVERNANCE

7.1 Cadbury Committee (1992)

The concern for good corporate governance in the world seems to be the result of the creation of the
Cadbury Committee in the UK. It was appointed by the London Stock Exchange to look into various
aspects of corporate governance as there was a growing concern due to lack of reliability in reports and
accounts and the audit statements attached by various companies after the collapse of some prominent
UK companies. The cause of anxiety was not that the companies have failed but rather, prior to their
failure, these statements gave no forewarning of the true state of their financial affairs.

The recommendations of the Cadbury committee resulted in the creation of the Code of Best Practice
which was published in 1992. The code is divided into the following four sections:

1. First Section
It is concerned with the role of the board of directors and covers such matters as the duties of a board,
its composition (especially the balance between executive and non-executive directors), and the
separation of the posts of the Chairman and of the chief executive.

2. Second Section
It deals with the role of non-executive directors on which the Committee places considerable emphasis.
The Committee recommended that:
● Majority of them should be independent and defined independence as being “free from any
business or other relationship which could materially interfere with the exercise of their
independent judgment”.
● They should be appointed for specific terms with the possibility of reappointment depending on
the contribution which the director concerned was making to the work of the board.
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● They should be selected through a formal process which should involve the board as a whole.
This was to avoid directors considering that they owed their place on the board to the
chairman’s patronage.

3. Third Section
This section covered executive directors and was mainly concerned with their remuneration. It
recommended that there should be full and clear disclosure of directors' emoluments and that the pay
of the executive directors should be set by a Remuneration Committee made up wholly or mainly of
non-executive directors.

4. Fourth Section
The final section addressed important questions of financial controls. It recommended a properly
constituted Audit Committee of the Board and that directors should report on the effectiveness of their
systems of internal financial control.

7.2 OECD Principles of Corporate Governance (1999)

In 1999, the Organization for Economic Cooperation and Development (OECD) published Principles of
Corporate Governance and have since become a global benchmark for policymakers, investors, firms,
and other stakeholders. They have been revised from time-to-time. The OECD principles urge businesses
to ensure that they have processes in place to resolve any potential conflicts of interest, and provide a
framework for internal complaints about management or board appointments.

The six OECD Principles are:

1. Ensure the basis of an effective corporate governance framework

The corporate governance framework (CGF) should promote transparent and efficient markets, be
consistent with the rule of law and clearly articulate the division of responsibilities among different
supervisory, regulatory and enforcement authorities.

2. The rights and equitable treatment of shareholders and key ownership function
CGF should protect and facilitate the exercise of shareholders’ rights and ensure the equitable treatment
of all shareholders, including minority and foreign shareholders. All shareholders should have the
opportunity to obtain effective redress for violation of their rights. Basic shareholder rights should
include the right to:
● Secure methods of ownership registration;
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● Convey or transfer shares;

● Obtain relevant and material information on the corporation on a timely and regular basis;
● Participate and vote in general shareholder meetings;
● Elect and remove members of the board; and
● Share in the profits of the corporation.

3. The Institutional investors, stock markets, and other intermediaries

CGF should provide sound incentives throughout the investment chain and provide for stock markets to
function in a way that contributes to good corporate governance.
● All shareholders of the same series of a class should be treated equally.
● Insider trading and abusive self-dealing should be prohibited.
● Members of the board and key executives should be required to disclose to the board whether
they, directly, indirectly or on behalf of third parties, have a material interest in any transaction
or matter directly affecting the corporation.

4. The role of stakeholders in corporate governance

CGF should recognize the rights of stakeholders established by law or through mutual agreements and
encourage active cooperation between corporations and stakeholders in creating wealth, jobs, and the
sustainability of financially sound enterprises.

5. Disclosure and transparency

CGF should ensure that timely and accurate disclosure is made on all material matters regarding the
corporation, including the financial situation, performance, ownership, and governance of the company.

6. The responsibilities of the board

CGF should ensure the strategic guidance of the company, the effective monitoring of management by
the board, and the board’s accountability to the company and the shareholders.

7.3 Kumar Mangalam Birla Committee (2000)

The Securities and Exchange Board of India (SEBI) in 1999 set up a committee under Shri Kumar
Mangalam Birla to promote and raise the standards of good corporate governance. The primary
objective of the committee was to view corporate governance from the perspective of the investors and
shareholders and to prepare a ‘Code’ to suit the Indian corporate environment.

The committee divided the recommendations into two categories:

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7.3.1 Mandatory Recommendations

These are absolutely essential for corporate governance, can be defined with precision and which can be
enforced through the amendment of the listing agreement.
1. They apply to the listed companies with paid up share capital of 3 crore and above.
2. Composition of the BoD should be an optimum combination of executive & non-executive
directors.
3. Audit committee should contain 3 independent directors with one having financial and
accounting knowledge.
4. Remuneration committee should be set up.
5. The Board should hold at least 4 meetings in a year with a maximum gap of 4 months between 2
meetings to review operational plans, capital budgets, quarterly results, minutes of committee’s
meeting.
6. Director shall not be a member of more than 10 committees and shall not act as chairman of
more than 5 committees across all companies.
7. Management discussion and analysis reports covering industry structure, opportunities, threats,
risks, outlook, internal control system should be ready for external review.
8. All Information should be shared with shareholders in regard to their investments.

7.3.2 Non-mandatory Recommendations

These are either desirable or may require a change in law. The committee made recommendations with
reference to:
1. Role of chairman
2. Remuneration committee of board
3. Shareholders’ right to receive half yearly financial performance.
4. Postal ballot covering critical matters like alteration in memorandum
5. Sale of whole or substantial part of the undertaking
6. Corporate restructuring
7. Further issue of capital
8. Venturing into new businesses

7.4 Naresh Chandra Committee (2002)

● ​The Department of Company Affairs constituted the Naresh Chandra Committee, an elite advisory
board under the chairmanship of Mr. Naresh Chandra.
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● The primary objective of this committee was to scrutinize and recommend radical amendments, if
necessary, for the laws governing auditor-client relationships and the role of independent directors.
● The theme of the report was to enunciate additional guidelines that can elevate corporate
governance in both theory and practice.
● Some of its recommendations were:
○ Certain disqualifications for audit assignments
○ Certain services that the audit firm shall not provide to any of their audit clients
○ Compulsory rotation of auditors
○ Appointment of auditors by the audit committee
○ Auditor’s annual certification of independence
○ CEO and CFO certification of audited accounts
○ Setting up Independent Quality Review Board (QRB)
○ Percentage of independent directors
○ Audit committee charter
○ Exempting non-executive directors from certain liabilities

7.5 N.R. Narayan Murthy Committee (2003)

The Committee on Corporate Governance, headed by Shri Narayanmurthy was constituted by SEBI, to
evaluate the existing corporate governance practices and to improve these practices as the standards
themselves were evolving with market dynamics. The committee’s recommendations are based on the
relative importance, fairness, accountability, transparency, ease of implementation, verifiability and
enforceability related to audit committees, audit reports, independent directors, related parties, risk
management, directorships and director compensation, codes of conduct and financial disclosures.

The key mandatory recommendations are as follows:

● At least one member should be ‘financially knowledgeable’ and at least one member should
have accounting or related financial management proficiency.
● Improving the quality of financial disclosures, including those related to related party
transactions, compensation paid to non-executive directors, etc.
● Companies raising money through an IPO should disclose to the Audit Committee, the uses /
applications of funds by major category.
● Requiring corporate executive boards to assess and disclose business risks in the annual reports.
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● Should be obligatory for the Board of a company to lay down the code of conduct for all Board
members and senior management of a company.
● Nominee Directors of the Government on public sector companies shall be similarly elected and
shall be subject to the same responsibilities and liabilities as other directors.
● Non-mandatory recommendations include moving to a regime where corporate financial
statements are not qualified; instituting a system of training of board members; and the
evaluation of performance of board members.

7.6 Dr. JJ Irani Committee (2005)

The Government constituted an Expert Committee on Company Law under the Chairmanship of Dr. J.J.
Irani. The Expert Committee comprised experts drawn from trade and industry associations, professional
bodies and institutes, chambers of commerce, leading senior advocates and auditors. The Report
addressed a range of issues and made the following recommendations:
● one-third, instead of 50 per cent (as recommended by SEBI in the revised Clause 49 of listing
agreement) of the board of a listed company should comprise independent directors.
● A company should be allowed to maintain only one layer of the pyramidal corporate structure.
● More power to the shareholders and owners than the company administration.
● Concept of the single-person company as against the current stipulation of at least two persons
to form a company.
● Allowing the companies to self-regulate their affairs.
● Mandated publication of information relating to convictions for criminal branches of the
Companies Act on the part of the company or its officers in the annual report.
● Providing stringent penalties which will help the regulator to control the fraudulent behavior of
companies.