Corporate Governance in IndiaThe 1956 Companies Act as well as other laws governing the functioning

of joint-stock companiesand protecting the investors rights built on this foundation. The beginning of
corporate developmentsin India were marked by the managing agency system that contributed to the
birth of dispersed equityownership but also gave rise to the practice of management enjoying control
rights disproportionatelygreater than their stock ownership. The turn towards socialism in the decades
after independencemarked by the 1951 Industries (Development and Regulation) Act as well as the
1956 IndustrialPolicy Resolution put in place a regime and culture of licensing, protection and
widespread red-tapethat bred corruption and stilted the growth of the corporate sector.The situation
grew from bad to worse in the following decades and corruption, nepotism andinefficiency became the
hallmarks of the Indian corporate sector. Exorbitant tax rates encouragedcreative accounting practices
and complicated emolument structures to beat the system. In the absenceof a developed stock market,
the three all-India development finance institutions (DFIs) theIndustrial Finance Corporation of India,
the Industrial Development Bank of India and the IndustrialCredit and Investment Corporation of India
together with the state financial corporations became themain providers of long-term credit to
companies. Along with the government owned mutual fund, theUnit Trust of India, they also held large
blocks of shares in the companies they lent to and invariablyhad representations in their boards.In this
respect, the corporate governance system resembled the bank-based German model wherethese
institutions could have played a big role in keeping their clients on the right track.Unfortunately, they
were themselves evaluated on the quantity rather than quality of their lending andthus had little
incentive for either proper credit appraisal or effective follow-up and monitoring.Borrowers therefore
routinely recouped their investment in a short period and then had little incentiveto either repay the
loans or run the business. Frequently they bled the company with impunity,siphoning off funds with the
DFI nominee directors mute spectators in their boards.This sordid but increasingly familiar process
usually continued till the companys net worth wascompletely eroded. This stage would come after the
company has defaulted on its loan obligations fora while, but this would be the stage where Indias
bankruptcy reorganization system driven by the1985 Sick Industrial Companies Act (SICA) would
consider it sick and refer it to the Board forIndustrial and Financial Reconstruction (BIFR). As soon as
a company is registered with the BIFR itwins immediate protection from the creditors claims for at least
four years. Between 1987 and 1992BIFR took well over two years on an average to reach a decision,
after which period the delay hasroughly doubled. Very few companies have emerged successfully from
the BIFR and even for thosethat needed to be liquidated, the legal process takes over 10 years on
average, by which time theassets of the company are practically worthless. Protection of creditors
rights has therefore existedonly on paper in India. Given this situation, it is hardly surprising that banks,
flush with depositorsfunds routinely decide to lend only to blue chip companies and park their funds in
governmentsecurities.Financial disclosure norms in India have traditionally been superior to most Asian
countries thoughfell short of those in the USA and other advanced countries. Noncompliance with
disclosure normsand even the failure of auditors reports to conform to the law attract nominal fines
with hardly anypunitive action. The Institute of Chartered Accountants in India has not been known to
take actionagainst erring auditors.While the Companies Act provides clear instructions for maintaining
and updating share registers, inreality minority shareholders have often suffered from irregularities in
share transfers andregistrations deliberate or unintentional. Sometimes non-voting preferential shares
have been usedby promoters to channel funds and deprive minority shareholders of their dues. Minority
shareholdersCorporate Governance Page 9
10. have sometimes been defrauded by the management undertaking clandestine side deals with
theacquirers in the relatively scarce event of corporate takeovers and mergers.Boards of directors have
been largely ineffective in India in monitoring the actions of management.They are routinely packed
with friends and allies of the promoters and managers, in flagrant violationof the spirit of corporate law.
The nominee directors from the DFIs, who could and should haveplayed a particularly important role,
have usually been incompetent or unwilling to step up to the act.Consequently, the boards of directors
have largely functioned as rubber stamps of the management.For most of the post-Independence era
the Indian equity markets were not liquid or sophisticatedenough to exert effective control over the
companies. Listing requirements of exchanges enforcedsome transparency, but non-compliance was
neither rare nor acted upon. All in all therefore, minorityshareholders and creditors in India remained
effectively unprotected in spite of a plethora of laws inthe books.The years since liberalization have
witnessed wide-ranging changes in both laws and regulationsdriving corporate governance as well as
general consciousness about it. Perhaps the single mostimportant development in the field of corporate
governance and investor protection in India has beenthe establishment of the Securities and Exchange
Board of India (SEBI) in 1992 and its gradualempowerment since then. Established primarily to regulate
and monitor stock trading, it has played acrucial role in establishing the basic minimum ground rules of
corporate conduct in the country.Concerns about corporate governance in India were, however, largely
triggered by a spate of crises inthe early 90s the Harshad Mehta stock market scam of 1992 followed
by incidents of companiesallotting preferential shares to their promoters at deeply discounted prices as
well as those ofcompanies simply disappearing with investors money. These concerns about corporate
governancestemming from the corporate scandals as well as opening up to the forces of competition
andglobalization gave rise to several investigations into the ways to fix the corporate governance
situationin India. One of the first among such endeavours was the CII Code for Desirable
CorporateGovernance developed by a committee chaired by Rahul Bajaj. The committee was formed in
1996and submitted its code in April 1998. Later SEBI constituted two committees to look into the issue
ofcorporate governance the first chaired by Kumar Mangalam Birla that submitted its report in
early2000 and the second by Narayana Murthy three years later. The SEBI committee
recommendationshave had the maximum impact on changing the corporate governance situation in
India. The AdvisoryGroup on Corporate Governance of RBIs Standing Committee on International
Financial Standardsand Codes also submitted its own recommendations in 2001.Recommendations of
various committees on Corporate Governance in IndiaCII Code recommendations (1997) 1. No need for
German style two-tiered board. 2. For a listed company with turnover exceeding Rs 100 crores, if the
chairman is also the MD, at least half of the board should be independent directors, else at least 30%. 3.
No single person should hold directorships in more than 10 listed companies. 4. Non-executive directors
should be competent and active and have clearly defined responsibilities like in the Audit committee. 5.
Directors should be paid a commission not exceeding 1% (3%) of net profits for a company with (out) an
MD over and above sitting fees. Stock options may be considered too. 6. Attendance record of directors
should be made explicit at the time of re-appointment. Those with less than 50% attendance shouldnt
be re-appointed. 7. Key information that must be presented to the board is listed in the code. 8. Audit
Committee: Listed companies with turnover over Rs. 100 crores or paid-up capital of Rs. 20 crores
should have an audit committee of at least three members, all non-executive, competent and willing to
work more than other non-executive directors, with clear terms of reference and access to all financial
information in the company and should periodicallyCorporate Governance Page 10
11. interact with statutory auditors and internal auditors and assist the board in corporate accounting
and reporting. 9. Reduction in number of nominee directors. FIs should withdraw nominee directors
from companies with individual FI shareholding below 5% or total FI holding below 10%.Birla Committee
(SEBI) recommendations (2000) 1. At least 50% non-executive members. 2. For a company with an
executive Chairman, at least half of the board should be independent directors, else at least one-third.
3. Non-executive Chairman should have an office and be paid for job related expenses. 4. Maximum of
10 directorships and 5 chairmanships per person. 5. Audit Committee: A board must have a qualified
and independent audit committee, of minimum 3 members, all non-executive, majority and chair
independent with at least one having financial and accounting knowledge. Its chairman should attend
AGM to answer shareholder queries. The committee should confer with key executives as necessary and
the company secretary should be he secretary of the committee. The committee should meet at least
thrice a year -- one before finalization of annual accounts and one necessarily every six months with the
quorum being the higher of two members or one-third of members with at least two independent
directors. It should have access to information from any employee and can investigate any matter within
its TOR, can seek outside legal/professional service as well as secure attendance of outside experts in
meetings. It should act as the bridge between the board, statutory auditors and internal auditors with
arranging powers and responsibilities. 6. Remuneration Committee: The remuneration committee
should decide remuneration packages for executive directors. It should have at least 3 directors, all
Nonexecutive and be chaired by an independent director. 7. The board should decide on the
remuneration of non-executive directors and all remuneration information should be disclosed in annual
report. 8. At least 4 board meetings a year with a maximum gap of 4 months between any 2 meetings.
Minimum information available to boards stipulated.Narayana Murthy committee (SEBI)
recommendations (2003) 1. Training of board members suggested. 2. There shall be no nominee
directors. All directors to be elected by shareholders with same responsibilities and accountabilities. 3.
Non-executive director compensation to be fixed by board and ratified by shareholders and reported.
Stock options should be vested at least a year after their retirement. Independent directors should be
treated the same way as non-executive directors. 4. The board should be informed every quarter of
business risk and risk management strategies. 5. Boards of subsidiaries should follow similar
composition rules as that of parent and should have at least one independent directors of the parent
company. 6. The Board report of a parent company should have access to minutes of board meeting in
subsidiaries and should affirm reviewing its affairs. 7. Performance evaluation of non-executive directors
by all his fellow Board members should inform a re-appointment decision. 8. While independent and
non-executive directors should enjoy some protection from civil and criminal litigation, they may be held
responsible of the legal compliance in the companys affairs. 9. Code of conduct for Board members and
senior management and annual affirmation of compliance to it.Corporate Governance Page 11
12. Weaknesses of Corporate Governance In IndiaThe Satyam debacle has exposed the chinks in Indian
corporate governance mechanism and themonitoring authorities. It has raised many questions about
corporate governance in Indiathe role ofboards, of independent directors, of the auditors, of investors
and of analysts. Unanimously it has beena gross failure of corporate governance standards in India and
protection of rights of minorityinvestors.The board of directors is central to good governance, and the
role of the board has featuredprominently in discussions about Satyam. The board is the body charged
with having oversight of theoperations of the firm and setting its strategy. It should ensure that the
company is upholding highstandards of probity and conduct, and provide a probing analysis of the
activities of management. Inparticular, non-executive directors are supposed to give an independent
assessment of the quality ofmanagement. But time and time again, failures of corporate governance
suggest that they do not. Theinfractions of law have arisen despite independent directors which were
stopped by external forces.There are several reasons pointing to these anomalies-First, it is difficult to
appoint truly independent directors. This is particularly hard to achieve incountries such as India where
family ownership is widespread and there is a close-knit group ofcorporate leaders. It is difficult for non-
executive directors to perform a scrutiny objective at the bestof times, but it is particularly difficult to do
so when faced with a dominant CEO who expects supportnot criticism from the companys board. Many
countries have sought to separate the roles of chairmanand CEO. However, it can inhibit firms from
implementing effective strategies, especially incompanies operating with new technologies, such as
Indian IT/ITES firms, requiring visionarystrategies.Next, the very idea of independent directors is to
ensure commitment to values, ethical businessconduct and about making a distinction between
personal and corporate funds in the management of acompany. Yet, most independent directors have
become sidekicks for the management, eying theircommission and fees, forgetting their very purpose of
appointment. In the process, they implicitlytransform into dependent directors.To add to that the
present corporate governance modelled on the Western Anglo-Saxon model whichdoes not address
many of the current crises faced by India Inc. Professor Jayant Rama Verma of IIMBangalore had
extensively commented on the unsuitability of the Western Code of CorporateGovernance in his well
researched paper on the subject titled Corporate Governance in India -Disciplining the dominant
shareholder (1997):According to him, the governance issue in the Anglo-Saxon world aims essentially at
disciplining themanagement which is unaccountable to the owners. In contrast, the problem in the
Indian corporatesector, he pointed out, is disciplining the dominant shareholder and protecting the
minorityshareholders, vindicated in the recent Satyam case. To understand the issues that driving
corporategovernance in the West, a brief idea about it is inevitable. After successfully working over
thedecades separating ownership and management, owners, (especially, institutional owners)
realisedthat they have lost control over the management or the board. Professor Verma points out
succinctly,"The management becomes self-perpetuating and the composition of the board itself is
largelyinfluenced by the whims of the CEO. Corporate governance reforms in the US and the UK
havefocussed on making the board independent of the CEO.In contrast, the issues in India are entirely
distinct - primarily due to our overall social-economicconditions. Therefore the issue in Indian corporate
governance is not a conflict between managementand owners as elsewhere, but a conflict between the
dominant shareholders and the minorityshareholders. And Professor Verma rightly concludes, "The
board cannot even in theory resolve thisconflict" and that "some of the most glaring abuses of corporate
governance in India have beenCorporate Governance Page 12
13. defended on the principle of shareholder democracy since they have been sanctioned by resolutions
ofthe general body of shareholders."By now it is increasingly obvious that the very concept of corporate
governance modelled on theWestern system is un-workable in a country like India. These efforts are
akin to taking a hair of anelephant, transplanting it on the head of a bald man and making him look like a
bear. In the West thefocus is on ownerless, CEO-driven paradigm. In India, it is still family-controlled,
owner-drivenparadigm. CEOs do not matter much in the management of the company. Yet, the general
discussioncentres on a standard, global prescription to manage diverse situations. Needless to
emphasise, thesolution to these problems in India lies not within the company, but outside. This is
precisely whathappened in the Satyam case where outsiders of the company took the lid off the fraud.In
spite of numerous suggestions by the Securities and Exchange Board of India (SEBI), for peerreviews of
audits among the companies listed in the Nifty and Sensex indices they have fallen flat onthe industry
fraternity. Presumably, SEBI will allocate the audits to firms that are part of a panel ofreputed auditors.
The simple solution would be for the regulator to make this course of actionmandatoryauditors could
be allotted audits by the regulator. To avoid the allegations ofoverregulation, companies can submit a
list of their preferred auditors, from which the regulator willhave to choose. Audits could also be rotated
annually, keeping them on their toes. And these samerules could also be applied to rating agencies,
internal auditors, independent directors etc. From timeto time these mechanisms can be fine-tuned and
made more practical.The moot question is why these reformative suggestions have not been
implemented? The answer isthat it depends on whos got more lobbying power. In the US, the large
pension funds that have beeninstrumental in getting more transparency from company managements.
India, on the other hand, hasno tradition of shareholder activism, despite organisations such as the Life
Insurance Corporation ofIndia having substantial stakes in companies. The dependence of political
parties on business intereststo fund elections also doesnt help. The failure of governments and
regulators to pass what seems likevery basic safeguards preventing conflicts of interest, not only in
India, but across the world, clearlyestablishes the clout that corporate interests have. Corporate
governance is thus a charade, a cosmeticexercise rather than an attempt to get to the root of the
problem.Of course, too rigid a focus on the stock market also has its own set of problems. As
SatyamComputer Services Ltds founder B. Ramalinga Raju said in his confession, the apparent reason
whyhe inflated earnings was because he feared that bad results would lead to a fall in the stock and
atakeover attempt. We neednt take Rajus word for it, but the fact remains that too much of a focus
onquarterly earnings and the linking of executive compensation with the stock market via stock
optionscould act as powerful incentives for inflating earnings.Corporate Governance Page 13
14. Recommendations to Implement Corporate GovernanceAfter a slew of scandals, politicians and
regulators, executives and shareholders are all preaching thegovernance gospel. Corporate governance
has come to dominate the political and business agenda.There is a growing concern among executives
that hasty regulation and overly strict internalprocedures may impair their ability to run their business
effectively. CEOs have to bear in mind thepotential trade-off between polishing the corporate
reputation and delivering growthfor all theheadlines on corporate responsibility, are investors
prepared consistently to sacrifice earnings for thesake of ethics?Regulations are only one part of the
answer to improved governance. Corporate governance is abouthow companies are directed and
controlled. The balance sheet is an output of manifold structural andstrategic decisions across the entire
company, from stock options to risk management structures, fromthe composition of the board of
directors to the decentralisation of decision-making powers. As aresult, the prime responsibility for good
governance must lie within the company rather than outsideit.A key lesson from the Enron experience,
where the board was an exemplar of best practice on paper,is that governance structures count for little
if the culture isnt right. Designing and implementingcorporate governance structures are important, but
instilling the right culture is essential. Seniormanagers need to set the agenda in this area, not least in
ensuring that board members feel free toengage in open and meaningful debate. Not all board
members need to be finance or risk experts,however. The primary task for the board is to understand
and approve both the risk appetite of aparticular company at any particular stage in its evolution and
the processes that are in place tomonitor risk.Culture is necessary but not sufficient to ensure good
corporate governance. The right structures,policies and processes must also be in place. Transparency
about a companys governance policies iscritical. As long as investors and shareholders are given clear
and accessible information about thesepolicies, the market can be allowed to do the rest, assigning an
appropriate risk premium to companiesthat have too few independent directors or an overly aggressive
compensation policy, or cutting thecosts of capital for companies that adhere to conservative
accounting policies. Too few companies aregenuinely transparent, however, and this is an area where
most organisations can and should do muchmore.If any institution, inside or outside the company,
deserves scrutiny, it is the board of directors.Executives have a clear responsibility consciously to define
and implement corporate governancepolicies that offer a decent level of reassurance to employees and
investors. Thereafter, disclosure isthe most effective way for companies to resolve the thorny tensions
that do exist between vision andprudence, innovation and accountability.There is an inherent tension
between innovation and conservatism, governance and growth. Asked toevaluate the impact of strict
corporate governance policies on their business, executives thought thatM&A deals would be negatively
affected because of the lengthening of due-diligence procedures, andthat the ability to take swift and
effective decisions would be compromised. State-of-the-art corporategovernance can bring benefits to
companies, to be sure, but also introduces impediments to growth.Some procedures and processes that
companies can implement to enhance corporate governance aredetailed as follows.Scheduling regular
meetings of the non-executive board members from which other executives areexcluded. Non-
executives are there to exercise constructive dissatisfaction with the managementteam. They need
to discuss collectively and frankly their views about the performance of theCorporate Governance Page
14
15. executives, the strategic direction of the company and worries about areas where they
feelinadequately briefed.Explaining fully how discretion has been exercised in compiling the earnings
and profit figures. Theseare not as cut and dried as many would imagine. Assets such as brands are
intangible and withfinancial practices such as leasing common, a lot of subtle judgments must be made
about what goeson or off the balance sheet. Use disclosure to win trust.Initiating a risk-appetite review
among non-executives. At the root of most company failures are ill-judged management decisions on
risk. Non-executives need not be risk experts. But it is paramountthat they understand what the
companys appetite for risk isand accept, or reject, any radical shifts.Checking that non-executive
directors are independent. Weed out members of the controlling familyor former employees who still
have links to people in the company. Also raise awareness of softconflicts. Are there payments or
privileges such as consultancy contracts, payments to favouritecharities or sponsorship of arts events
that impair non-executives ability to rock the boat?Auditing non-executives performance and that of
the board. The attendance record of nonexecutivesneeds to be discussed and an appraisal made of the
range of specialist skills. The board should discussannually how well it has performed.Broadening and
deepening disclosure on corporate websites and in annual reports. Websites shouldhave a corporate
governance section containing information such as procedures for getting a motioninto a proxy ballot.
The level of detail should ideally include the attendance record of non-executivesat board
meetings.Leading by example, reining in a company culture that excuses cheating. If the company
culture hasbeen compromised, or if one is in an industry where loose practices on booking revenues
andexpenditure are sometimes tolerated, take a few high-profile decisions that signal change.Finding a
place for the grey and cautious employee alongside the youthful and visionary one. Hiringthrusting
graduates will skew the culture towards an aggressive, individualist outlook. Balance thiswith some
wiser, if duller headspeople who have seen booms and busts before, value probity andare not in so
much of a hurry. Making compensation committees independent. Corporate bossesshould be prevented
from selling shares in their firms while they head them. Share options should beexpensed in established
companiescash-starved start-ups may need to be more flexible.Corporate governance is not just a box
ticking exercise, companies need an exchange of practicalguidance in order to conceive and implement
successful governance mechanism. Instead of a menu ofcorporate governance options it would be more
appropriate to present best practice guidelinesapplicable to businesses. These will serve as a benchmark
for appropriate customization in differentcompanies. Corporate governance should be considered as an
obligation not a luxury. Its spirit isgoing to expand further and deeper in the future.Corporate
Governance