rticles

Effective Corporate Governance – A Reassessment

Dr. V.R. Narasimhan*, ACS, Executive Vice President, Kotak Mahindra Bank Ltd.,
Mumbai.

Shareholder value creation should be an outcome of a business effort of pursuing a

socially relevant objective. This effort requires business to continuously adapt itself
e-mail : to changing needs of the society. The power/management that governs the company
[email protected] should have the vision, understanding and flexibility to steer the business to adapt to
changing needs of the society.

INTRODUCTION society in general and stakeholders in the company in particular.

Corporate governance is to be examined in the context of a N.R.Narayan Murthy explains ethical behaviour as “to me,
corporate being a part of the open society on the one hand and ethical behaviour is putting the interest of the company above
separation between ownership of business and management that of one’s own personal interest in all transactions. It is
on the other. Any corporate is a part of society and can thrive about:
only so long as such corporate is relevant to the society  Fairness to all stakeholders
comprising a range of stakeholders viz., shareholders,  Transparency
customers, employees, government, market in general,
 Rising trust and confidence of stakeholders in the way
environment, etc. John Kay, a British Economist, in his
the company is run
interview to DNA published on June 19, 2010 gave the example
of ICI, a chemical giant with about 100 years history which  Understanding and discharging societal
disappeared in 2007 as it altered its course from the objective responsibilities
of “responsible application of chemistry to business” to  Long term thinking
“shareholder value creation” objective.
 Overcoming greed, insecurity and lack of self
It is now well established that the widespread ownership of confidence
company entrusts the management/governance to professional
 Following every law of the land even when the law
management/managers. It is expected that such managers will
enforcers may not be able to detect your violation.”
govern the corporate to maintain the relevance. In order to
(emphasis supplied)
ensure that the managers work in the overall context of the
society, several laws and regulations are formulated. However, WHAT IS GOVERNANCE
it may not be possible for society/State to formulate laws/
regulations to structure managerial behaviour under every Every resource available in the society has multiple
perceivable exceptional condition and therefore it is necessary applications whether it is human resource, raw materials,
that managers work not only within the realm of statutes/ electricity, etc. Corportes draw upon these resources to run
regulations but also based on strong value systems and ethos their business. Managers of the corporates have implied
of ensuring that the company works for the satisfaction of the responsibilities of efficient application of these resources.
“Corporate governance is concerned with holding the balance
* Views expressed in this article are the personal views of the author and do between economic and social goals and between individual
not in any way reflect the views of his employer. The author acknowledges and communal goals. The governance framework is there to
that some quotations have been extracted from the book on Corporate encourage the efficient use of resources and equally to require
Governance by Dr. Sanjeev Agarwal.

180 (A - 63) FEBRUARY 2011

Effective Corporate Governance – A Reassessment
rticles
A

accountability for the stewardship of those resources. The on humility of character strength is one of the fundamental
aim is aligning as nearly as possible the interests of reasons for the above stated misconnections. “In the financial
individuals, corporations and society. The incentives to sector, Lehman would be an archetype of this. Organisations
corporations and to those who own and manage them to adopt that were not really organisations at all but were a collection
internationally accepted standards is that these Standards will of individually greedy people. The objective of making profits
help them to achieve their corporate aims and to attract as an organisation is not one which is going to appeal to anyone
investments. The incentive for their adoption by States is really. People who have a profit orientation would rather make
that these standards will strengthen the economy and profits for themselves which is what people in these businesses
discourage fraud and mismanagement.” 1 It is also the did. A corporate culture that extols greed is, in the end, unable
responsibility of managers in charge of the affairs to ensure to protect itself against its own employees. Nor does the
Corporate Excellence which establishes continued relevance business with such a culture attract public sympathy when
of the organisation to the society. “Corporate governance is things go wrong.” 4 When personal character and inner
about creating an outperforming organisation, which leads conscience submit to greed, there arises a need to impose
to increasing customer satisfaction and shareholder’s value. character conditioners externally. Thus, we find in this attempt
…..If the corporation has to prosper in this changing context, to improve corporate governance (read improve the character
governance must transcend beyond the Boardroom and and integrity of persons in power) and keep a check on
permeate the organisation as a totality, through every managerial behaviour. “Enough has been written and far more
employee and function. Corporate governance therefore has already been said about the various reports beginning with
hinges on creating an ethos around values shared by every those of Sir Adrian Cadbury and Kumar Mangalam Birla,
employee.”2 Thus it is very clear that both the corporate and ending with the Securities and Exchange Board of India
the State have adequate incentives to insist and ensure good Guidelines and the Listing Agreement.” 5 All these writing
corporate governance. focus on setting up certain procedures and some checks and
The World Bank observed that “Corporate Governance is a balances. However, “It is wiser to change the man and not
Blend of law, regulations and appropriate voluntary private restrict him to playing around with the system that man himself
sector practices which enable corporations to attract financial has created”.6
and human capital, perform efficiently and perpetuate itself
INDEPENDENT DIRECTORS
by generating long term economic value for its shareholders
while respecting the interests of stakeholders and society as a The regulatory stipulations relating to board composition,
whole.”3 independent directors, audit committee, etc are all external
conditioners to ensure better corporate governance.
HOW TO IMPROVE GOVERNANCE The concept of “independent directors” being a part of the
Managers are expected to ensure corporate governance as Board is one of the methods of creating a pressure on the
described above. When the managers disconnect themselves persons in charge of governance of the company to behave
from the rest of the society in which they live in, connect well within the statutory/regulatory/ethical framework.
themselves with the ownership on the resources at their Independent directors on the Boards play a critical role in
command attributable to their official position (though they overseeing the business operations, check managerial greed
are not the owners of the resources) and fall into the illusion not taking over the interest of the company in situations of
that resources they command are subservient to their personal conflict of interests between the individual interests of the
needs and desires, they fall into temptation of benign or management and the interest of the stakeholders of the business.
malicious defrauding, embezzlement and such adverse actions. “If one goes by corporate governance reports, codes and
Such adverse actions range from using the office stationary governance principles, independent directors are one of the
for personal use, indulging in transactions with associates for independent tools for ensuring and effecting good corporate
their personal financial benefit, to window dressing the accounts governance. Different people talk of independence of directors
in the lure of higher bonuses, etc. The premium placed by the in their own diverse ways. Ideally, independent directors are
society on flaunting things indicative of financial success than

1. Sir Adrian Cadbury. 4. John Kay in his interview to DNA published on June 19th, 2010.
2. K.B.Dadisheth. 5. S. Jayashree.
3. World Bank.. 6. S. Jayashree.

181 (A - 64) FEBRUARY 2011

 rticles Effective Corporate Governance – A Reassessment
A

non executive external directors independent of the and routine matters. Even where the Board is briefed
management and are free of any interest, monetary or about the major developments or strategic changes, there
otherwise, and who can be easily perceived to be independent is hardly sufficient time or data made available in advance
by outsiders, insiders and stakeholders”.7 for the outside directors for meaningful participation.”9
The question then is as independent directors also are human  “We can do a lot of back biting, but when we meet
beings potentially susceptible to greed, how can one ensure formally we want a harmonious and clubby atmosphere”10
that they can exercise the expected check on greed of other  “The Corporate sector wants well educated persons of
managers. In order to ensure this, the theory on corporate high personal integrity and a docile temperament. These
governance so far has taken a view that if these independent are people who could offer good advice on neutral
directors do not have any pecuniary interests in the success of decisions, not trouble management on sticky ones and
the business on which they are directors and do not benefit in lend appropriate professional weight to management sub-
any way from the transactions that the company enters into committees”.11
but have the same fiduciary responsibility like the directors
who manage the business, they will be able to exercise The behaviour of independent directors can make a difference
“independence” dispassionately and objectively. “The company to the standards of corporate governance. However, there are
boards are a mix of executive directors, non executive directors no studies in India that have brought out the effectiveness of
and independent directors. The difference between the later the role of independent directors in policing and preventing
two is that while both are non executive, the independent conflicts of interests. On the other hand, occasions of corporate
directors have, or represent, no financial stake in the business. fraud and compromise of stake holders’ interest against the
The distinction between the executive directors and the interests of promoter groups/managerial persons were seen in
independent directors is two-fold; firstly the former are the recent past even in companies that are listed and having
employed, normally on a full time basis, to run the business, independent directors.
whereas the independent directors are not. As far as the law is Investment Company Institute, USA12 created an Advisory
concerned, even as far as the Stock Exchange is concerned, Group on Best Practices for Fund Directors (Mutual Fund
they are all simply directors. They carry equal responsibility companies). The objective of the Advisory group was to
for the business. They have the same fiduciary responsibility, identify best practices used by Fund Boards to enhance the
carry the same obligations, and face the same personal independence and effectiveness of investment company
liability.”8 However, there is a raging skepticism about the directors and to recommend those practices that should be
effectiveness of the institution of independent directors as can considered for adoption by all fund boards. The
be seen from some reflections on the institution of independent recommendations of the Advisory group to a great extent can
directors given below: be extended not only to mutual fund companies but also all
 “In large number of companies hardly any relevant other public limited companies. The following table shows
business information is passed on to the directors. In the the extent to which the recommendations have been
meetings of the Board they generally discuss only trivial implemented under the Corporate Governance Frame work in
India (i.e., Clause 49 of the Listing Agreement) :

Recommendation of the Advisory group Arrangement under the Listing Agreement

1. Super majority of independent directors: Two thirds of 1. The Board should have at least half the number of
the directors of all investment companies be independent directors who are non-executive directors; if an executive
directors. director is the Chairman of the Board and if a non-
executive director is the Chairman, not less than one
third should be non-executive directors. Rule of Super
majority of independent directors is not implemented
in India.

7. P.L. Sanjeeva Reddy 9. Dr.Madhav Mehra.

8. “The corporate sector wants well-educated persons of high personal 10. Prof KSR Murthy.
integrity and a docile temperament. These are the people who would offer
good advice on neutral decisions, not trouble management on sticky ones 11. Sucheta Dalal.
and lend appropriate professional weight to management sub-committees. 12. ICI is industry body set up by mutual funds in the USA.

182 (A - 65) FEBRUARY 2011

Effective Corporate Governance – A Reassessment
rticles
A

2. Persons formerly associated with the adviser, principal 2. The definition of independence is comprehensive enough
underwriter and certain underwriter. Former officers or that a director to qualify as independent director does
directors of a fund’s investment advisor, principal not have pecuniary or family relationship with the
underwriter or certain of their affiliates not to serve as company/promoters or that director was not an executive
independent directors. of the company in the last three years before
appointment.
3. Control on the Nomination process by independent 3. There is no specific rule as to who should nominate
directors: Independent directors be selected and independent director. However, some companies have
nominated by the incumbent independent directors. constituted “nomination committee” to nominate
independent directors.
4. Compensating independent directors: Independent 4. Remuneration of the independent directors is determined
directors decide the appropriate compensation for by the Board and approved by the company in general
serving on fund boards. meeting.
5. Fund ownership policy: Fund directors invest in funds 5. The rule is specific to Mutual Funds. In listed companies,
on whose boards they serve. independent directors are not expected to hold more
than 2% in the company to be able to establish their
independence.
6. Qualified independent counsel and other experts: 6. There is no specific rule enabling or disabling
Independent directors may have investment company independent directors from seeking advise from experts.
counsel who is independent from the investment However, in practice, if the independent directors seek
advisor (AMC). The independent directors shall have such advice, managements do not come in the way.
the express right and authority to consult independent
counsel, auditor or other experts, as appropriate, when
faced with issues which they believe require special
expertise.
7. Annual questionnaire on relations with the advisor and 7. All directors, including independent directors, file
other service providers: The independent directors declarations under the provisions of the Companies Act
complete on an annual basis a qustionnaire on business, relating to their shareholding, other directorships, family
financial and family relationships, if any with the advisor, details, interest in contracts with the company, etc. It is
principal underwriter, other service providers and their already implemented as a part of the legislation.
affiliates.
8. Organisation and operation of the Audit Committee: 8. The Audit Committee shall be constituted by all non-
The audit committee shall be constituted entirely by executive directors out of which at least two thirds should
independent directors; independent directors shall meet be independent directors. However, there is no stipulation
with the independent auditors at least once a year outside or an observed practice that Audit Committee should
the presence of management representatives; shall secure meet the Auditors outside the presence of management
from the independent auditors a representation of representatives.
impendence from the management on annual basis and
audit committee shall have a written charter of its
duties and powers.
9. Separate Meetings of independent directors: Independent 9. There is no such requirement under the law nor is it
directors shall meet separately from management in observed as a corporate practice.
connection with their consideration of the fund’s advisory
and underwriting contracts and otherwise as they deem
appropriate.
10. Lead independent director or directors: One or more 10. There is no such concept.
independent directors be designated as lead independent
director.

183 (A - 66) FEBRUARY 2011

 rticles Effective Corporate Governance – A Reassessment
A

11. Insurance coverage and indemnification: Fund board 11. There is no such legal requirement. However, in practice,
shall obtain directors’ and officers errors and omissions most companies take D&O policy.
insurance coverage and/or indemnification from the
fund that is adequate to ensure the independence and
effectiveness of independent director.
12. Retirement policy: Board should adopt a retirement 12. There is no requirement. Some companies voluntarily
policy. enunciate retirement policy.
13. Evaluation of Board Performance: The fund directors 13. There is no such requirement or practice.
should evaluate periodically the board’s effectiveness.
14. Orientation and education: New fund directors receive 14. It is a voluntary effort.
appropriate orientation and that all fund directors keep
abreast of industry and regulatory developments.
15. Unitary or Cluster Boards: The company board of directors 15. The rule is fund specific. However, if we apply to holding
generally be organized either as a unitary board for all the and subsidiary company structure, under the Indian Law,
funds in complex rather than as separate board for each each company has to have its own Board and therefore
individual fund. it is unitary board structure.

As can be seen from the above, the Corporate Governance that greater board independence is associated with better
Framework created under the Listing Agreement (Clause 49) governance are mixed. Indeed, the Literature Review
does not provide for all the best practices as perceived suggests that the optimal board structure may vary from
elsewhere in the world. It is also pertinent to note the results firm to firm.
of examination conducted by The Office of Economic  Neither OEA study finds any compelling evidence that
Analysis (OEA) of Securities Exchange Commission, USA, independent chairs enhance shareholder protection.
to assess the effectiveness or the potential benefits of
independence of mutual fund boards. The studies included In the ultimate analysis, it appears that the character of the
Literature Review and Power Study. The Literature Review persons in charge of the governance of the company matters
provides summary of recent academic research related to for whether the quality of governance will be of a specific
mutual fund governance. The Power Study discusses the standard. Any regulatory Corporate Governance Framework
strength of the statistical tests used in some of the academic may help setting up symptoms of corporate governance in the
papers cited in the Literature Review. Taken together, the technical sense rather than ensuring corporate governance in
OEA studies provide not compelling evidence that the board spirit. So long as the directors behave fairly (Fairness is not
independence requirements are necessary or that they would an attitude. It’s a professional skill that must be developed
provide any benefits that would justify their attendant costs. and exercised.) ‘without greed’(Greed is excessive desire to
More specifically: possess wealth and property), ‘with courage’ (control the fear
of disapproval by colleagues on the Board, face the
 The Literature Review discusses several potential market disapproval, if it comes), ‘with confidence’ (being calm, cool
imperfections that could motivate regulatory intervention, and composed and do/say what is necessary to be said in the
but it does no conclude that the board independence given context), ‘without fear’ (stating an honest thought
requirements would enhance current regulations that seek without being afraid of personal image and relationships) and
to address these same market imperfections. ‘retaining individuality’(ability to stand by one’s own
 The Literature Review discusses market forces that help convictions) and ethically (“In law a man is guilty when he
align the interests of advisers and fund investors. The violates the rights of others. In ethics he is guilty if he only
market forces are much stronger than the independence thinks of doing so.”), a socially meaningful and successful
of directors in achieving the alignment. governance regime will get established whether the Board has
 The OEA studies indicate that the arguments and evidence a super majority of independent directors or not. 

184 (A - 67) FEBRUARY 2011