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Men in Suits

The Evolution of Corporate Governance- Exploring how corporate governance has changed over the years

Academic literature often views corporate governance as dealing with issues that arise from the separation of ownership and control. From this perspective, corporate governance would focus on the internal structure and procedures of the board of directors, the development of independent audit committees, standards for information disclosure to shareholders and creditors, and management control. Sir Adrian Cadbury, chairman of the Cadbury Committee, defined corporate governance as maintaining a balance between economic and social aims, as well as individual and communal interests.


The Organisation for Economic Cooperation and Development (OECD) defines corporate governance as "the system by which business corporations are directed and controlled." According to their definition, "the corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs" (OECD, April 1999, p. 1). This provides the structure for setting organisational objectives as well as the mechanisms to achieve those objectives and monitor success.


It's interesting to note that the OECD and Cadbury Committee both use the same definition.


The aforementioned definitions, which prioritise the interests of shareholders above all else, encompass critical issues that govern organisations at large and society at large.


These are:

  • management accountability,

  • providing adequate investments to management,

  • disciplining and replacing bad management,

  • enhancing corporate performance,

  • transparency,

  • shareholder activism,

  • investor protection,

  • improving access to capital markets,

  • promoting long-term investment and encouraging innovation.

Evolution of Corporate Governance

Pillars Of Corporate Governance

The principles and pillars of corporate governance are:


  1. Accountability:

Disclosure of the outcomes resulting from a decision made in the best interest of others constitutes a liability. Within the field of corporate governance, accountability pertains to the chairman, the board of directors, and the chief executive officer being held responsible for the utilisation of company resources (which fall under their jurisdiction) in a manner that serves the company's and its stakeholders' best interests.


  1. Transparency:

It refers to the standards of information disclosure that are transparent and provide shareholders and stakeholders with the means to readily ascertain and comprehend the truth. Therefore, within the framework of corporate governance, it entails providing the company's stakeholders with expeditious, accurate, and sufficient information regarding all pertinent material matters, such as the organization's financial position and performance. Financial statements are prepared in adherence to international financial reporting standards (IFRS) to uphold transparency. To ensure that all investors are provided with accurate, factual information that precisely reflects the organization's financial and environmental standing, high-quality annual reports are published.

 

  1. Fairness:

Fairness simply refers to how corporations and their officers treat stakeholders, employees, and foreign investors, in contrast to the treatment of dominant actors as majority shareholders, which is impartial or devoid of bias towards all shareholders in proportion to their respective shareholdings. Employees and public officials should be treated equitably by the organisation, which should provide effective redress for violations. 


  1. Independence:

An essential element of effective corporate governance is the independence of the corporation's upper management. To this end, the Board of Directors must be a robust and nonpartisan institution, capable of rendering all corporate decisions by sound business judgment. Thus, procedures and standards are established to minimise or eliminate conflicts of interest, and the Board is comprised of independent non-executive members and advisors to further this objective.


Theories Of Corporate Governance

  1. Agency theory:

The relationship between the principal and the agents is defined. As per this theoretical framework, the proprietors of the organisation engage agents to carry out their duties. The operations of the company are entrusted to the directors or managers, who act as representatives of the shareholders, by the principals. The shareholders anticipate that the principal will be put first in all actions and decisions. Agency theory is predicated on the division between ownership and control.


  1. Shareholder theory:

It is the corporation that is considered to be the property of the shareholder, they can dispose of their property as they like. The shareholder invests in a corporation to obtain a return on their investment. However, this previously limited function has now encompassed the supervision of the corporation's activities and guarantees adherence to governmental-established ethical and legal principles. When it comes to the corporation itself, the directors bear liability for any injury or damage inflicted.


  1. Stewardship theory:

Stewardship is defined as the guardianship and optimisation of shareholder wealth via the performance of the organisation. "Stewards" refers to company executives and managers who serve, safeguard, and generate profits for the benefit of shareholders in this context. To maximise shareholder returns, the executive should exercise greater autonomy.


  1. Stakeholder theory:

This theory integrated the notion that management should be held accountable to a diverse array of stakeholders. It is stated that managers within an organisation maintain a network of relationships with employees, suppliers, and business partners, among others. This theory emphasises managerial decision-making and the intrinsic value of all stakeholders' interests; no particular set of interests is presumed to be more significant than the others. All of the company's stakeholders—creditors, customers, employees, and the government—are regarded as inputs in an output model, by this theory.


  1. Resource dependency theory:

The resource dependency theory emphasizes the function of the board of directors in facilitating the firm's access to essential resources. It states that directors provide input and access to critical stakeholders, including buyers, suppliers, and public policymakers, in the form of information and expertise.

 

  1. Political theory:

Developing shareholder support for voting is most effectively accomplished through political theory as opposed to purchasing voting power. It emphasises how financial gains and privileges are determined by the government's inclination.


  1. Transaction cost theory:

Numerous contracts exist either between a business and its internal customers or between the business and the markets through which it generates revenue. A transaction cost is the expense that is incurred for each contract entered into with an external party. The company execute the transaction internally if the cost of doing so on the market is greater.


Evolution Of Corporate Governance Legal Framework In India


Before Independence and Four Decades into Independence


Indian corporations and organisations were governed by colonial policies, several which were influenced by the preferences and desires of British employers.  The Companies Act of 1866 underwent revisions in 1932, 1882, and 1913. The Partnership Act came into effect in 1932. Individuals or organisations that wished to regulate other organisations were required to enter into legal contracts under these regulations, thereby emphasising the managing organisation model.


Misuse and abuse of resources ensued, as well as the evasion of responsibilities by management specialists, as a result of the disorganised and unprofessional ownership at this time. Shortly after achieving independence, industrialists demonstrated a keen interest in manufacturing several essential commodities, provided that the government regulated production and established reasonable prices.


Reforms brought in by SEBI Committees

The Government of India implemented measures in 1991 with the objective of economic liberalisation, privatisation, and globalisation of the domestic economy. As a result, India commenced the performance process to effectively address global developments. The Confederation of Indian Industry (CI), the Associated Chambers of Commerce and Industry (ASSOCHAM), and the Securities and Exchange Board of India (SEBI) established committees to propose Corporate Governance initiatives in response to the interest generated by the Cadbury Committee Report.


1998- Desirable Corporate Governance: A Code


CIl undertook a unique institutional initiative on Corporate Governance, which was the first of its kind in Indian industry. The aim was to establish and advocate for a code of Corporate Governance that would be embraced and adhered to by Indian corporations, including those in the Public Sector, Private Sector, Banks, and Financial Institutions—all of which qualify as corporate entities. In 1997, the final draft of the aforementioned Code was widely distributed. April 1998 marked the release of the Code. It was called Desirable Corporate Governance A Code.


1999- Kumar Mangalam Birla Committee


On May 7, 1999, the Securities and Exchange Board of India (SEBI) established the Kumar Mangalam Birla Committee, which Birla presided over, to advance and elevate corporate governance standards. The committee's report represented the initial formal and all-encompassing endeavour to establish a code of corporate governance, taking into account the existing state of governance in Indian companies and the condition of capital markets during that period. As a result of the Report's recommendations, Clause 49 was incorporated into the Listing Agreement in 2000.


2002-Naresh Chandra Committee


Significant events that prompted the Indian Government to take notice included the Enron scandal of 2001, which exposed a close-knit relationship between the auditor and the corporate client, as well as the frauds that precipitated the demise of corporate behemoths in the United States, including WorldCom, Qwest, Global Crossing, and Xerox, and the subsequent implementation of the rigorous Sarbanes Oxley Act in the United States. In 2002, the Indian Government appointed the Naresh Chandra Committee to investigate and make recommendations, among other things,


2003- N R. Narayana Murthy Committee


In 2002, SEBI analyzed the compliance statistics of listed companies with clause 49. The report concluded that in order for corporate governance to effectively safeguard the interests of investors, more must be done than examining systems and procedures. In light of its recommendations, SEBI established a Committee, led by Shri N.R. Narayana Murthy, to review the implementation of the corporate governance code by publicly traded companies and to recommend the re-issuance of clause 49.


2004-Dr JJ Irani Committee


The Government appointed Dr J. J. Irani, Director, Tata Sons, as a Chairman to preside over the Committee on Company Law, which was charged with advising the Government on the proposed revisions to the Companies Act, 1956. The committee's objective was to have streamlined and concise legislation that could effectively address the evolving national and international landscape, facilitate the integration of globally recognised best practices, and ensure sufficient provisions for compliance with these changes.


2009-Task Force on Corporate Governance


In 2009, CIl's Task Force on Corporate Governance gave its report and suggested certain voluntary recommendations for the industry to adopt.


2012- Policy Governance


To develop a policy document on corporate governance, the Ministry of Corporate Affairs established a Committee chaired by Mr. Adi Godrej and included the President of the Indian Chemical Society as a member-secretary/convenor. The objective of the Policy Document was to consolidate the varied components found in the diverse guidelines, incorporate current global trends, utilise innovative best practices implemented by specific companies, and forecast forthcoming expectations regarding corporate governance in organisations of different sizes and sectors. The report, presented by the Adi Godrej Committee, comprised seventeen guiding principles of corporate governance. 


Companies Act 2013


The implementation of the Companies Act, 2013 caused significant transformations in the domain of corporate governance in India. It aimed to significantly transform Corporate Governance standards and had the potential to significantly impact the way corporations function in India. Since then, the Act has undergone three amendments: in 2018, 201%, and 2019. The Amendments affect various facets of business management in India, including essential requirements for disclosure, compliance, and structuring.


SEBI (Requirements for Listing Obligations and Disclosures) Regulations, 2015.


To streamline and consolidate the stipulations of previous listing agreements for various sectors of the capital market and those applicable to listed entities under the Companies Act of 2013, the Securities and Exchange Board of India (SEBI) issued the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. These regulations apply to listed entities that have listed designated securities on recognised stock exchanges.


2017- Uday Kotak Committee


Under the leadership of Mr. Uday Kotak, the SEBI Committee on Corporate Governance was established in June 2017 to improve the corporate governance standards of publicly traded companies in India. To enhance the corporate governance standards of publicly traded companies in India, the Committee was tasked with providing SEBI with recommendations on the subsequent matters:


  • Facilitating the active engagement of Independent Directors in the operations of the organisation while upholding their independent spirit;

  • Enhancing disclosures and safeguards concerning related party transactions;

  • Matters concerning the auditing and accounting practices of publicly traded companies;

  • Enhancing the efficacy of assessments conducted by boards

  • Participating in general meetings to discuss issues that investors face, etc.


Landmark Cases of Failure of Corporate Governance


Satyam Scam


Satyam Computer Services, an organisation headquartered in India, became entangled in a corporate scandal in 2009 when its chairman, Ramalinga Raju, admitted to amending the organization's financial records. A business scandal involving tampered accounts valued at Rs 7000 crore befell Satyam.  Ramalinga Raju admitted to falsifying the cash and bank balances of the organisation in an email to SEBI dated 7-1-2009. A few weeks before the collapse of the scheme, he famously asserted that he was appointing himself to a tiger and was unable to evacuate without risking his life.  Raju asserted in an interview that the cash balance of the fourth-largest IT company, Satyam, was Rs. 4,000 crore, which the company could use to acquire additional funds.


Ricoh case


The Ricoh India saga demonstrates that the reputation of multinational corporations for good governance does not invariably ensure success. Intriguingly, the Ricoh incident mirrored the Satyam incident almost verbatim in terms of accounting fraud and the subsequent manipulation of stock prices, with no promoter in the driver's seat.


Notwithstanding legislative amendments aimed at strengthening the governance framework [Companies Act, 2013, SEBI (Listing Obligations and Disclosure Requirements) Regulations, etc.] and administrative intervention after the Satyam scam, this remained the case. The collapse of the entire system was caused by a small number of dishonest managers, while the principal regulatory bodies—auditors, credit rating agencies, reputable independent directors, boards of directors, and influential audit committees—continued to perform inadequately.


ICICI Bank Scam


The ICICI Bank Fraud Case: The Board appeared to have contributed to the evident case of nepotism through its hasty acquittal of the CEO of any wrongdoing, failure to disclose the results of an independent inquiry to the public, and refusal to respond to inquiries regarding the matter.


Kingfisher Airlines and United Spirits Case


In particular, about internal corporate financing that is unlawful and account falsification and provision to third parties. Assets were improperly expressed, reviews were staged, intercorporate credits were extended to related groups without the Board's approval, and United Spirits Ltd. (USL) assets were transferred to subsidise Kingfisher. During the tenure of Mr. Vijay Mallya as the leader of USL, it was abundantly clear that United Breweries (UB) Holdings was used as a conduit to borrow money and reimburse his group for it. True, but sad. Each month, more corporate frauds are added to the list and discovered at businesses and institutions that once led the way in good corporate governance.


Conclusion

India has made significant strides in enhancing its corporate framework through the adoption of numerous regulations and acts that safeguard the interests of investors and key stakeholders. It has come a long way since the Securities Contract (Regulation) Act, 1956 was implemented until the present LODR Regulations 2015, which contribute to the maintenance of good corporate governance principles.


Our Directors’ Institute- World Council of Directors can help you accelerate your board journey by training you on your roles and responsibilities to be carried out in an efficient manner helping you to make a significant contribution to the board and raise corporate governance standards within the organization.





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