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Men in Suits

Understanding the State of Corporate Governance in India Through 4 Crucial Analysis

Introduction

In contemporary business discourse, corporate governance stands as a prominent subject of discussion. Corporate governance emerged as a prominent concept during the 1990s, a term that should be remembered.  It is a set of principles that mandates business houses operate by the principle of equal justice, which includes the separation of ownership and management, as well as adherence to other relevant legislation and regulations that pertain to companies. 


Although corporate governance in India is not a novel notion, it will continue to develop in response to the shifting business environment. Corporate governance in India is a broad concept that encompasses the entire society through the company's activities and its constituents. The matter pertaining to the appointment of a Managing Director/CEO within an organisation is Corporate Governance. Similarly, statutory defaults committed at a branch office of a corporation would fall under the purview of corporate governance. The principles of corporate governance apply to all corporations, regardless of size, worldwide.


Corporate governance refers to a collection of procedures, regulations, statutes, and establishments that influence the direction, management, and oversight of a corporation. The principal stakeholders in corporate governance are the Board of Directors and the shareholders. Employees, suppliers, customers, financiers, lenders, regulators, and the general public are the remaining stakeholders.


At this time, the question pertains to which of the largest corporations in India comply with the prescribed and anticipated principles of corporate governance in India . Can the corporate leadership of India be relied upon to advance the company's future while acting in the shareholders' best interests? In what ways did the pandemic impact the standards of corporate governance in India?


For the top one hundred companies in India, the third edition of the Survey of Corporate Governance in India by Excellence Enablers, an initiative of former Securities and Exchange Board of India (SEBI) chairman M Damodaran, provide responses to a part of these questions. The following six charts summarise several significant findings from the report.


The status of compliance with respect to independent and non-executive directors has improved.


SEBI's 2015 Listing Obligations and Disclosure Requirements (LODR) stipulate that company boards must maintain a minimal proportion of independent and non-executive directors. The report indicates that the number of businesses that failed to adhere to this standard experienced a significant decline in 2021-22, representing a positive deviation from the upward trajectory observed over the preceding three years.


Corporate Governance

Analysis No. 1: Number of organisations in violation of NEDs and IDs standard


Gender equality is a phenomenon that develops from the top down rather than the bottom up.

According to gender equality headlines, an increasing number of women are attaining boardroom positions in India. The total number of women directors has increased from 167 in 2018-19 to 194 in 2021-22. A comprehensive analysis of this figure, however, indicates that increasing gender diversity in boardrooms is a process that begins at the highest levels and progresses downward. During this time period, the number of independent women directors has increased from 109 to 138, while the number of non-independent women directors has decreased from 58 to 55.


Considering that LODR regulations solely require the inclusion of female independent directors and not executive directors (who are required to advance within the organisation hierarchy), this implies that women's advancement within the ranks is still hampered.


Analysis No. 2: Number of women directors (independent and non-independent)

Insufficient consideration is attributed to innovation expertise during the composition of committees.


Which skill sets do organisations seek in prospective directors? Proficiency in finance and economics, as well as industry experience, are highly desirable competencies. One of the most disappointing results of the survey indicates that companies place minimal value on competencies related to innovation and research and development when recruiting directors.


Analysis No. 3: Top skills among Directors

The pandemic has led to increased multi-tasking in companies.

As an indication that the leadership of companies may have been burdened with a greater caseload as a result of the pandemic, the report reveals that the number of organisations where key management personnel (KMP) had additional responsibility increased during the pandemic years. "Given the responsibilities and the need for concentration among the KMPs, it would be detrimental to their core functions to assign any of them additional work, particularly for an extended period of time," the report states.


Analysis No. 4: KMPs having additional charge

The available data regarding compensation inequality is insufficient.

The salary ratio between average employees and senior executives is a crucial metric for determining the extent of inequality within organisations. During the pandemic, there has been an increase in the proportion of organisations where the remuneration ratio of whole-time directors (WTD) to the median employee is below 50 or falls within the range of 51-100. Conversely, there has been a decline in the number of organisations where this ratio was between 101-500 and 501-1000. Although this appears to indicate a decline in income inequality within corporations, insufficient data exists to draw definitive conclusions at this time.


Emergence Of Corporate Governance In India

Reed and other analysts compare the evolution of corporate governance in India to a transition between three distinct models: the "managing agent" model, the "business house" model, and the "Anglo-American" model. The last two models are particularly significant to us. Reed explains further that the closely regulated capitalism of the Nehruvian welfare state was primarily responsible for the emergence of the "business house" model.

 

The Industrial Policy Resolution of 1956 and the Industries (Development and Regulation) Act of 1951 implemented socialism in the decades that followed independence. This policy shift fostered corruption and impeded the growth of the private sector," Chakrabarti, Megginson, and Yadav assert. "The transition to socialism in those decades was characterised by a culture of licencing, protection, and extensive red tape." The corporate sector in India became notorious for corruption, nepotism, and inefficiency in the decades that followed, as the situation progressively worsened.


This led to the emergence of promoters, who obtained licences for new industries by capitalising on their proximity to power centres. Promoters typically served the principal purpose of facilitating the initiation of new ventures by providing a minimum amount of equity capital and securing the remaining funds via public offerings or public financial institutions (PFIs).


To acquire control of multiple companies, promoters frequently established several unrelated enterprises. This resulted in the formation of entities referred to as "business houses," in which family members held controlling stakes in a variety of unrelated issues. Several repercussions resulted from such arrangements. Small shareholders and their interests were frequently marginalised in corporations (and, presumably, business houses as well), primarily because of the immense power wielded by the business families that possessed them, as noted by Reed. Mainly as a result of nationalised financial institutions (which possessed substantial amounts of equity) failing to exercise the levels of control to which they were entitled, Gollakotta and Gupta highlight a widespread disconnect between equity ownership and actual control. Such institutions lacked motivation to actively participate in the day-to-day operations of the companies in which they invested because they were not "responsible for the profitability of the investments they invested in.


Through a series of reforms commonly known as "liberalisation," the previously mentioned stringent regulations commenced being dismantled in the 1990s. Enhancing disclosure standards, forming a National Advisory Committee on Accounting Standards, and other modifications were implemented within the corporate legal framework. This period saw the beginning of numerous corporate governance reforms because various committee reports' recommendations served as the impetus for these initiatives.


Key elements of good Corporate Governance principles include: 

Honesty, trust, integrity, openness, performance orientation, responsibility, accountability, mutual respect, and commitment towards the organisation. 


The guiding principles of corporate governance have persisted throughout history when conducting business with the collective welfare of society in mind. The novelty of these principles lies in the fact that they are recognised by country-specific legislation. 


The Current State of Corporate Governance in India

In recent years, the Indian government has implemented several measures to improve corporate governance. To increase corporate governance's accountability and transparency, the Securities and Exchange Board of India (SEBI) has implemented several regulations. Listed companies, for instance, are obligated to appoint a minimum of one independent director to their board, in addition to a minimum of one female director. The Companies Act of 2013 has further fortified the legal structure governing corporate governance in India. The legislation mandates that corporations maintain a board of directors tasked with comprehensive oversight of the organisation's operations. A minimum of three directors is mandated for the board, with one of these directors being a resident of India. Even with these regulatory adjustments, India has a considerable distance to travel before corporate governance is significantly enhanced. Numerous businesses continue to conduct business in a manner inconsistent with the concerns of their stakeholders. Multiple high-profile instances of corporate fraud and mismanagement have tarnished the corporate sector's reputation in India.


Important areas concerning Independent Directors

Numerous Indian businesses adhere to the family-owned business model. Boards have developed an implicit presumption that senior executives are well informed about their responsibilities and act in the best interests of the organisations they oversee. As a consequence, boards have been known to abstain from posing challenging inquiries to senior executives during periods of strong company performance or until a crisis arises. 


The appointment of independent directors who are familiar with promoter directors has made the situation worse. Boards should, from a governance perspective, explicitly address the following critical areas about independent directors: 


  • Implementation of a structured and transparent procedure to appoint directors. The inherent conflict of interest in managerial positions. To identify directorial candidates, nomination committees (comprising independent directors) should be utilised to address the appointment of independent directors.

  • Alignment between the skills required in the boardroom and the requirements of the organisation.

  • Segregation of the roles of CEO and Chairman of the Board of Directors. The practice of separating the CEO and board chair is gaining traction in the United States and is already widely accepted in Europe. The Chairman of the Board ought to be an autonomous director who assumes a pivotal role in establishing the board's priorities.

  • Preparing for the succession of the CEO and Board of Directors in various scenarios.

  • An annual formal evaluation of the performance of the CEO and senior management team. Implementing a CEO performance evaluation process during a period of strong company performance is advisable. A healthy balance of power is established and it is abundantly clear that the CEO is answerable to the board through the evaluation of his or her performance.

  • Peer evaluation ought to be implemented for independent directors. This would empower independent directors to engage in candid discussions with their group members regarding their performance and implement concrete measures to enhance both their individual and collective operations.

  • It is important for independent directors to proactively educate themselves regarding their rights, obligations, and liabilities.


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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