Institutional EYE

Commentary on Corporate Governance Issues

Corporate Governance: The upgrade to 4G

June 17, 2016

A snap-shot of how corporate governance regulations have evolved over the last three decades.

 

 

 

First generation

Our journey began in 1997 with the Confederation of Indian Industry setting up a task force, under Rahul Bajaj, to look at CG. The final report, with a quirky title ‘Desirable Corporate Governance: A Code’ was presented a year later, in 1998 and it introduced the concept of CG to Indian markets. It shied away from defining CG and instead focused on a few elements – transparency, disclosures, boards, etc. It did recognize that ‘corporate governance goes far beyond company law’ – something that is usually forgotten.

 

A year later, SEBI formed a committee with Kumar Mangalam Birla in the chair. Its recommendations focused on two aspects, focusing on Boards’ responsibilities and pushing for better disclosures. It introduced the audit committee, the board composition with the need for independent directors. It also spoke of the need for quarterly reporting and the annual report containing an MD&A section.

 

Importantly, most of its recommendations were presented as mandatory - enforced on companies in a phased manner - as the committee was of the view that ‘a statutory rather than a voluntary code would be far more purposive and meaningful’. 

 

These recommendations, better known as Clause 49, were incorporated into the listing agreement and rolled out between 2000 and 2003.

 

Second Generation

ven as the Listing Agreement was being applied, the Enron scandal and a number of other accounting scandals rocked the US corporate establishment. The US quickly overhauled their accounting rules and investor protection oversight through the Sarbanes-Oxley Act of 2002.

 

This resulted in a series of reviews to the CG landscape in India. First the Naresh Chandra Committee, with a strong focus on the accounting framework – auditors, their appointment, fees, audit committees etc.). This was followed by the 2003 Narayan Murthy Committee – to review the progress of the Kumar Mangalam Committee and strengthen disclosures and then the 2005 JJ Irani Committee, to look at CG in the context of the proposed revision to the Companies Act, 1956. The recommendations broadened the remit of CG eg. risk management, related party transactions and deepened our understanding of issues.

 

Third Generation

The next wave of reforms hit after the Satyam scam in 2009. While industry viewed Satyam as one-off and cautioned against over-regulation, a series of regulatory changes, including the appointment of a qualified CFO, timelines on disclosures and rotation of auditor (albeit voluntary) were brought in. Unaccepted suggestions of the earlier committees were incorporated into codes, many of which subsequently found their way into regulations.

 

Satyam was important because it highlighted the primacy of good governance practices. Till the scam happened governance had remained an amorphous idea. Satyam quantified the cost of its failure.

 

Fourth generation

The fourth generation of CG are driven by two specific themes: The first is the emphatic use of regulation to enforce governance practices; the other is in empowering different stakeholders to assert their rights.

 

The Companies Act 2013, implemented in 2014 has completely modernized corporate law in India. It is far more current that half-acentury-old predecessor, and focuses very strongly on the corporate governance agenda and in aligning these to the G20-OECD guidelines.

 

Some of what has been incorporated includes:

  • Roles and responsibilities of the board

  • Definition of an independent director

  • Granular disclosures regarding CEO compensation

  • Mandatory auditor rotation

  • Tenure of independent directors

  • E-voting

  • Approval of related party transactions by the audit committee, and of majority of minority shareholders under specified situations

  • 2% of profits to be spent on Corporate Social Responsibility (comply or explain)

  • One women director on the board

  • Permits class-action suits against the board

  • National Financial Reporting Authority

Some of these provisions are global best in class. Afra Afsharipour from UC Davies provides a detailed account of this journey in her India CG Handbook.

 

Last December also saw the Listing Obligation and Disclosure Requirements Regulation 2015 (LODR): The LODR is the consolidation of the compliance requirements by every listed entity into one single document across various types of securities listed on a stock exchange. While a lot of the requirements are aligned with the Companies Act 2013, there are several provisions that are more stringent.

 

Stepping back and looking at the arc of regulatory changes, three elements stand out. One, to begin with regulators have viewed CG as something you cannot regulate and have usually prescribing best practices. Companies have pushed back citing the letter, and not spirit of then law. It is only then that CG practices have had to be codified. Two, regulations have increasingly come rely on disclosure as an enforcement tool: publicly disseminating information will create comparability, thereby fostering an environment of competitive behavior that serves shareholders and the corporate governance agenda. In addition they propagate robust internal controls to provide stronger oversight over on reign in the promoters. Three, there is a shift in thinking about how better governance will be achieved. In the first blush regulations dealt with the rights and responsibilities of companies. Today the focus is on the rights of stakeholders.

 

And today while the environment itself demands better governance, many companies, like mobile phone users, are yet to upgrade themselves.

 

A modified version of this article written by Amit Tandon was published in Business Standard on 16 Feb 2016. Read the article by clicking here.

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