Corporate governance must be socially responsible

Ravi Singhania

As an aftermath of India’s liberalisation policies gaining entry into the international markets, it has become indispensable for companies to follow an international code of corporate governance while listing themselves on the stock exchanges. Corporate governance facilitates in managing the company well and assists in sharing the returns of profits and investment more equitably. The mental frame of corporate decision-makers is guided and influenced by various social phenomena. There is, therefore, a need for sufficient freedom to the boards of companies to take decisions for the progress of their companies within a framework of effective accountability, ensuring effective and impartial decisions while keeping social welfare in mind.

The present scenario is such that the capital markets are not performing well; in fact, they are reflective of the performance of ill-governed corporations. Various scams, which have become a constant part of the capital market, are the result of such malfunctioning. Thus there arises a need for beneficent governance.

A number of reports and codes on the subject have already been published and are being implemented internationally; notable among these are the Cadbury committee report, the Green Bury committee report, the OECD code on corporate governance and the Blue Ribbon committee on corporate governance in the United States.

In the present scenario, the focus on corporate governance and related issues is an inevitable outcome of a process which leads firms to increasingly shift to financial markets as the pre-eminent source for capital.
A large part of the recommendations are mandatory and are intended to be implemented by the listed companies wherein disclosures have to be made in a phased manner. The intention behind these disclosures in the annual report is to give a broad picture to the shareholders.

The composition of the board of directors must be such as to facilitate its independent functioning. Earlier, the board consisted of representatives of the promoters of the company. The other directors were chosen amongst them thus losing the essence of independence. As per the recommendations of the Kumarmangalam Committee, the boards would now comprise the executive and non-executive directors and independent directors being part of the non-executive directors, thus emphasising on true independence. The composition is important as it determines the ability of the board to collectively provide leadership and to ensure that no individual or group is able to dominate.

As per the directions of the Securities and Exchange Board of India (Sebi), the stock exchanges have amended their listing agreements. Clause 49 of the listing agreement as per the recommendations states that the board of the company should have an optimum combination of executive and non-executive directors with not less than 50 per cent comprising non-executive directors.

The number of independent directors would depend on whether the chairman is executive or non-executive. In case of a non-executive chairman, at least one-third of the board should comprise independent directors and in case of an executive chairman, at least half the board should comprise independent directors. Clause 49, as amended after the recommendations of the Kumarmangalam Committee report now defines independent directors as those who apart from receiving director’s remuneration do not have any material pecuniary relationship or transactions with the company, its promoters, its management or its subsidiaries which in the judgment of the board may affect their independence of judgement.

The committee has also recommended that the board should have an optimum combination of executive and non-executive directors with 50 per cent of the board comprising of the non-executive directors. But the fact that the executive directors on boards draw their salaries from the company may make them act as lobbyists and thus more prone to a biased decision. The non-executive directors must ensure an ‘independent judgement’ to bear on the board’s deliberation, especially on issues of strategy, performance etc.

However, the penalty that the committee has suggested is in the form of delisting the shares. Penalising the defaulters in terms of delisting is hardly a penalty. In fact, this will have an adverse effect on the investors and on the effective functioning of the capital market.

To strengthen corporate governance, certain amendments were made in the Companies Act, 1956 (Act) by introducing a new Section 292A in the Companies Amendment Act 2000. Its applicability governs public companies having a paid-up capital of not less than Rs 5 crore whereas Clause 49 of the listing agreement applies to all the listed companies. The listing agreement also encompasses companies even with a capital of, say, Rs 20 lakh where there may be no trading in shares at all. To bring such companies within the ambit of Clause 49 would virtually be of no use.

However, it might have been difficult for Sebi to enact Clause 49 to exclude such companies as it wanted to acknowledge trading possibility by such companies in future. In fact, private companies that are unlisted with a turnover of over Rs 10 crore, as referred to in the erstwhile Section 43A of the Act, should also have been encompassed.

The companies attract a large chunk of their capital inflow not only from the shareholders but also from the financial institutions. These financial institutions are in fact channelising public investments collected through various bonds and debentures. What is to be ensured is that this money is channelised in a proper way and not invested in share rigging.

An in-depth analysis of the theory of corporate governance suggests that for effective governance a company must symbolise a harmonious alignment of the various interests of the individual, corporation and the society. The specifications laid down in the listing agreement to enhance corporate governance relate to only one aspect i.e. company’s relation with the shareholders. When the companies are to be governed with the principles of social responsibility they must effectively acknowledge other role players, like the government and labour relations, which have been completely ignored.

There exists no exact demarcation between compliance in form and in substance. The code is to be followed by listed companies through their directors, management, employees and professionals associated with the companies. They should all be responsible for complying with the code in letter and spirit and interpreting it in a manner that gives precedence to substance over form. The real onus of achieving the desired level of corporate governance lies in the proactive initiatives taken by the companies themselves and not in external measures, like the breadth and depth of a code or stringency of enforcement.

The extent of discipline, transparency and fairness and the willingness shown by the companies themselves will be a crucial factor in achieving the desired confidence of shareholders and other stakeholders. The ultimate responsibility for putting the code into practice, however, lies directly with the board of directors.
Thus, corporate governance is a step towards corporate excellence achieved through constant watch of company affairs. It seeks to make the companies socially responsible and answerable to the public.

(The writer is Managing Partner, Singhania and Partners, Solicitors and Advocates)