TITILE

 

Corporate governance: Indian perspective vis-à-vis international perspective.

The word ‘corporate governance’ has become a buzzword these days because of two factors. The first is that after the collapse of the Soviet Union and the end of the cold war in 1990, it has become the conventional wisdom all over the world that market dynamics must prevail in economic matters. The concept of government controlling the commanding heights of the economy has been given up. This, in turn, has made the market the most decisive factor in settling economic issues.

This has also coincided with the thrust given to globalisation because of the setting up of the WTO and every member of the WTO trying to bring down the tariff barriers. Globalisation involves the movement of four economic parameters namely, physical capital in terms of plant and machinery, financial capital in terms of money invested in capital markets or in FDI, technology, and labour moving across national borders. The pace of movement of financial capital has become greater because of the pervasive impact of information technology and the world having become a global village.

When investments take place in emerging markets, the investors want to be sure that not only are the capital markets or enterprises with which they are investing, run competently but they also have good corporate governance. Corporate governance represents the value framework, the ethical framework and the moral framework under which business decisions are taken. In other words, when investments take place across national borders, the investors want to be sure that not only is their capital handled effectively and adds to the creation of wealth, but the business decisions are also taken in a manner which is not illegal or involving moral hazard.

 

Corporate governance therefore calls for three factors:

a) Transparency in decision-making

b) Accountability which follows from transparency because responsibilities could be fixed easily for actions taken or not taken, and

c) The accountability is for the safeguarding the interests of the stakeholders and the investors in the organization.

 

Implementation of corporate governance has depended upon laying down explicit codes, which enterprises and the organisations are supposed to observe. The Cadbury’s code in United Kingdom was the starting point, which led to a number of other codes. In India itself we have the Kumaramangalam Birla code as a result of the committee headed by him at the behest of the SEBI. Earlier we had the CII coming up with the code for corporate governance recommended by the committee headed by Shri Rahul Bajaj. The codes, however, can only be a guideline. Ultimately effective corporate governance depends upon the commitment of the people in the organisation. The very first issue of corporate governance in India is, do the India managements really believe in corporate governance?

Corporate governance depends upon two factors. The first is the commitment of the management for the principle of integrity and transparency in business operations. The second is the legal and the administrative framework created by the government. If public governance is weak, we cannot have good corporate governance. The dramatic Enron case has highlighted how companies, which were the darlings of the stock market and held up as models for vigorous and innovative growth can ultimately collapse like a house of cards as they were based on fraud and dishonesty. The association of the accounting firm Anderson has also raised a doubt about the credibility of even well regarded global players.

In the Indian context, the need for corporate governance has been highlighted because of the scams we have been having almost as an annual feature ever since we had liberalisation from 1991. We had the Harshad Mehta Scam, Ketan Parikh Scam, UTI Scam, Vanishing Company Scam, Bhansali Scam and so on. I have been suggesting that we should learn from especially the United States to see whether we can replicate similar conditions in our capital market. It is not that the United States is free of scams. Right now the Enron issue is examined by a number of committees at different levels in the United States. At the end of all these examinations, they are likely to come with a better

model. In the Indian corporate scene we must be able to induct global standards so that at least while the scope for scams may still exist, we can reduce the scope to the minimum.

I. BRIEF HISTORY

The “revolution” started in the early 1990s with the Cadbury Report on the financial aspects of corporate governance, to which was attached a code of best practice. Aimed at listed companies and looking especially at standards of corporate behaviour and ethics, the “Cadbury Code” was gradually adopted by the City and the Stock Exchange as a benchmark of good boardroom practice. In 1995, the Greenbury Report added a set of principles on the remuneration of executive directors (in response to some particular “fat cat” scandals, notably that involving British Gas chief Cedric Brown, whose 75 per cent rise incensed both unions and small shareholders), and in 1998 the Hampel Report brought the two together and produced the first Combined Code. A year later, the Turnbull Report concentrated on risk management and internal controls.

In each case, the reports were prompted either by shareholder disquiet over perceived shortcomings in corporate structures and their ability to respond to poor performance, or to government threats of legislation if the corporate sector failed to put its house in order.

In 2002 Derek Higgs, an investment banker was given the brief to look again at corporate governance and build on the previous reports to produce a single, comprehensive code. Shortly afterwards, the full consequences of the Enron and WorldCom scandals were realised, leading to new unease. The Higgs Report came out in early 2003, but was greeted with horror by some leading companies, with claims that it placed an unrealistic burden on non-executives and marginalised the role of the chairman. The task of taking Higgs’s draft forward was passed to the Financial Reporting Council (FRC), a body established by government and comprising members from industry, commerce and the professions. The FRC consulted further and produced a revised Code that followed most of Higgs’s recommendations but softened a few of the more contentious points, and so gained general acceptance. With rather less fuss, at the same time Sir Robert Smith, chairman of the Weir Group, was leading a review of the role of audit committees and his recommendations were incorporated into the new Code. The 2003 Code was updated with minor amendments in June 2006, with the new version applying to financial years beginning on or after November 1, 2006.

Report of SEBI committee (India) on Corporate Governance defines corporate governance as the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company.” The definition is drawn from the Gandhian principle of trusteeship and the Directive Principles of the Indian Constitution. Corporate Governance is viewed as ethics and a moral duty. On January 1, 2006, India entered a new era of corporate governance as the reforms popularly known as “Clause 49” took full effect.1 A decade in the making—and complicated by Enron and the other corporate scandals of this time period—Clause 49 has brought broad new requirements related to board composition, audit committee activity, information disclosure, and top management certification. The similarities with Sarbanes Oxley and other governance reforms around the globe should be obvious.

II.         A BRIEF HISTORY OF CORPORATE GOVERNANCE REFORM IN INDIA

Corporate governance and financial regulation in India was generally considered quite poor until the economic reforms of the early 1990s. The Securities and Exchange Board of India (SEBI) was established in 1992 by an act of Parliament, and SEBI was given the job of regulating stock exchanges, brokers, fraudulent trade practices, and other areas of corporate activity.5 As its power grew over the decade, SEBI started to play a much more active role in setting minimum standards for corporate behavior. In addition, a voluntary code of corporate governance was developed by the Confederation of Indian Industry (CII), a group of well-regarded Indian firms.

Near the turn of the century, SEBI commissioned a series of projects to improve Indian corporate governance by building on CII’s code (and by converting the voluntary code into a mandatory one). This work would eventually lead to the Clause 49 reforms. The first SEBI committee, comprised of 17 prominent business leaders and chaired by Kumar Mangalam Birla, advocated a variety of new governance requirements— including a minimum number of independent directors, the creation of audit committees and shareholders’ grievance committees, and additional management disclosures on firm performance.

These recommendations were soon adopted, but, importantly, they were not imposed on every public company through legislation (in contrast with Sarbanes Oxley in the United States). Instead, SEBI implemented the Birla Committee reforms by modifying the listing requirements for firms seeking to go public on an Indian stock exchange. Thus was born Clause 49, a new collection of corporate governance obligations that individual firms would agree to when they signed listing contracts with any stock exchange in the country. As part of a gradual roll-out process, the Birla Committee reforms were not imposed immediately on all public firms. Instead, they were made mandatory in 2001 for the largest Indian companies (and for newly listing firms), and then expanded to smaller public companies over the next few years.

All of this seemed fine until 2002, when fallout from Enron, WorldCom, and other corporate governance catastrophes caused Indian regulators to wonder whether Clause 49 went far enough. SEBI decided to sponsor a second corporate governance committee chaired by Narayana Murthy, the renowned leader of Infosys Technologies. The Murthy Committee went to work and released its additional recommendations in 2003. SEBI quickly adopted these suggestions and issued a revised Clause 49 in 2004.

The Murthy Committee reforms expanded on the Birla Committee’s work in several areas. One main focus related to the qualifications for independent director status: a number of specific requirements were added to disqualify material suppliers and customers, recently departed executives, relatives, and other closely-related parties. A second set of changes affected the audit committee: it was now required to meet more frequently (four times per year), and members had to satisfy new financial literacy requirements. A third important change mandated CEO and CFO certification of financial reports and internal controls. And a number of additional shareholder disclosures, including expanded discussion of financial results, were added to the Clause 49 requirements. As before, these reforms were phased in gradually; all public firms were not required to comply with the Murthy Committee rules until January 1, 2006.

The fruits of this labor were generally well-received, and Clause 49 seems to have improved the overall state of Indian corporate governance. For example, a recent study by Bernard Black and Vikramaditya Khanna argues that stock prices of imminently affected firms jumped almost four percent when SEBI announced its decision to pursue the initial Clause 49 reforms. Similarly, the World Bank as part of its 2005 standards and codes initiative benchmarked India’s regulatory framework to the OECD principles of corporate governance. It announced that India has indeed come a long way over the past decade, reporting that “a series of legal and regulatory reforms have transformed the Indian corporate governance framework and improved the level of responsibility/accountability of insiders, fairness in the treatment of minority shareholders and stakeholders, board practices, and transparency.”

But in this same study, the World Bank also flags four areas of concern. First, many sanctions seem inadequate, and there is a need for stricter enforcement of governance violations in order to increase compliance with Clause 49. Second, the division of regulatory responsibility between SEBI, the Department of Company Affairs (DCA), and the individual stock exchanges needs to be clarified to prevent oversight from slipping between jurisdictional flagstones. Third, board practices need to be strengthened to avoid director “rubber stamping,” especially by establishing credible institutions for training board members on their fiduciary responsibilities.21 And finally, according to the World Bank, institutional investors and large independent shareholders still need to become “important forces to monitor insiders and play a disciplining role in the governance of corporations.”

                  

CONCLUSION

 

The ethical temperature of any business or capital market depends on three factors. The first is the individual’s sense of values. The second is the social values accepted by the business and industry. Let us not forget that when Harshad Mehta Scam took place, it was claimed that the manner in which the bank receipts were being treated was the prevailing norm. Perhaps a similar argument would have been given in the Ketan Parikh Scam. In other words, practices which were later on found to be highly objectionable become acceptable because that was the prevailing market practice. Social values will depend upon the standards set up by professional bodies like the Association of Chartered

Accountants or Cost Accounts of India and so on. The third and perhaps the most decisive factor is the system. It is here we face the main challenge. Our system encourages lack of corporate governance. Some of the specific steps that should be taken to improve corporate governance are the following:

a)         The Sick Industries Companies Act (SICA) has become so convenient for the unscrupulous managements that we find in our country industries become sick, the industrialist do not become sick. BIFR has also been called the Bureau of Industrial Funeral Rites! It is high time we scrap the entire system. This will mean the abolition of SICA and organisations like BIFR there under. Mere tinkering with the system by making amendments is not going to improve the situation.

b)         The entire banking system and the Banking Secrecy Act call for a review. Our banking system is such that if you borrow one lakh of rupees, you are afraid of the bank but if you borrow ten crores of rupees, the bank is afraid of you. With the amount of NPA going beyond 58000 crores, it is high time that we amend the Banking Secrecy Act to reveal those who are willful defaulters. The Narasimham Committee’s recommendation about putting this condition at the time of issuing new loans can cover only to some extent the moral hazard. It is high time that practice of disclosing the name of willful defaulters is made more practical and timely. Publishing the names in the case of suits, which have been filed, is of no value at all because by that time the matter is all but over.

c)         Laws like the Benami Transactions Prohibition Act and the Prevention of Money Laundering Act should be implemented effectively and vigorously. Agencies like the CVC can be used to ensure that corrupt practices are effectively punished because it is the atmosphere, which encourages proper corporate behaviour. In India today we have a system where the level of public governance is very poor. There is no fear of punishment at all. In such a situation it is only a saint who will be observing strictly the rules of corporate governance.