Unit 2 - Conceptual Framework of Corporate Governance

Meaning of Corporate Governance

Corporate governance is the system of rules, practices, and processes by which a firm is
directed and controlled. Corporate Governance is how a corporate company is governed,
administered or controlled.
Corporate governance essentially involves balancing the interests of a company’s
stakeholders, such as shareholders, senior management executives, customers, suppliers,
financiers, the government, and the community.

Scope Of Corporate Governance

1. Accountability
- Ensure that management is accountable to the Board
- Ensure that the Board is accountable to shareholders.
2. Fairness
- Protect Shareholders rights, Resources
- Treat all shareholders including minorities, equally
- Provide effective redressal for violations
3. Transparency
- Ensure timely, accurate disclosure on all material matters
- Including the financial situation, performance, ownership
4. Independent Assurance
- Ensures Procedures and structures to minimize or avoid conflicts of interest
- Independent Reviews by Directors and Advisers i.e. free from the influence of others

Importance of Corporate Governance

1. Access Foreign Capital - Foreign capital markets want high standards for efficiency
& transparency of the company. Corporate governance is important to bring efficiency
& transparency to the company which helps the global market players to gains
credibility and trust.
2. Investor Protection - Corporate governance is an important tool that protects investors’
interests by improving efficiency of corporate enterprises.
3. Separation of Ownership from Management - A company is run by its managers.
Corporate governance ensures that managers work in the best interests of corporate
owners.
 4. Financial Reporting and Accountability - Good corporate governance ensures sound,
transparent and credible financial reporting and accountability to investors and lenders.
5. Improves Shareholder Communication - Shareholder communication refers to the
right to vote in the decision-making process. It is the way in which investors can
communicate with the companies. Corporate governance secures the right for
shareholder communication.
6. Enhancing Enterprise Valuation - Improved management accountability and
transparency fulfill the investors expectations and confidence on management &
corporations. This increase the value of the corporation.

Need of Corporate Governance

1. Avoid Scams - Misuse and misappropriation of public money are happening

everywhere i.e. stock market, banks, financial institutions, companies, and government
offices. In order to avoid these financial irregularities, companies need to start using
corporate governance.
2. Need of Social Responsibility - Today, social responsibility is given a lot of
importance. The Board of Directors has to protect the rights of the customers,
employees, shareholders, suppliers, local communities, etc. This is possible only if they
use corporate governance.
3. Takeovers and Mergers - There are many takeovers and mergers are going on in the
business world. The need of corporate governance is to protect the interest of all the
parties during takeovers and mergers.
4. SEBI Requirement - SEBI has made corporate governance compulsory for certain
companies. This is done to protect the interest of the investors and other stakeholders.

Elements of Corporate Governance

1. Good Board practices:

• Clearly defined roles and authorities.
• Duties and responsibilities of Directors understood.
• Board is well structured.
• Appropriate work and mix of skills.
• Appropriate Board procedures.
• Director compensation in line with best practice.
• Board self-evaluation and training conducted.
2. Control Environment:
• Internal control procedures.
• Risk management framework present.
• Disaster recovery systems in place.
• Business stability procedures in place.
• Independent external auditor conducts audits.
• Independent audit committee established.
• Internal Audit Function.
• Management Information systems established.
• Compliance Function established.
3. Transparent Disclosure:
• Financial Information disclosed.
• Non-Financial Information disclosed.
• Financials prepared according to International Financial Reporting Standards
(IFRS).
• Companies Registry filings up to date.
• High-Quality annual report published.
• Web-based disclosure.
4. Well-defined shareholder rights:
• Minority shareholder rights formalized.
• Well-organized shareholder meetings conducted.
• Policy on related party transactions.
• Policy on extraordinary transactions.
• Clearly defined and explicit dividend policy.
5. Board Commitment:
• The Board discusses corporate governance issues and has created a corporate
governance committee.
• The company has a corporate governance champion.
• Appropriate resources are committed to corporate governance initiatives.
• Policies and procedures have been formalized and distributed to relevant staff.
• A corporate governance code has been developed.
• The company is recognized as a corporate governance leader.
Regulatory Development & Year Objectives
1997 – CII Code on Corporate Governance CII was first to publish code of Corp.
Governance where constitution of Audit
Committee (AC) was recommended
2000 – Kumarmangalam Birla Committee This committee gave 25 recommendation of
Corp. Governance for Listed Companies and to
incorporate the same in Listing Agreement with
the Stock Exchange
2002 – Naresh Chandra Committee Committee major recommendation were to form
AC consisting of all independent directors,
rotation of Auditors after 5 years term
2003 – Narayan Murthy Committee The review of the Scope of Audit Committee
was deliberated and it was suggested to include
the MD&A, reports related to compliance & risks
and on Related Party Transaction
2003-SEBI Changes in Clause 49 of Listing Agreement
2011 – Co. Bill It brought about changes to bring Corporate
Governance norms reporting mandatory
2013 – Co. Act, 2013 Nomination and Remuneration committee,
Stakeholder Committee, Separate Committee
Meeting of Independent Directors, CSR
Provisions for social Outreach program was
implement
2015 – SEBI LODR, 2015 With a view to align and simplify the
Regulatory norms for Listed Entities, guidelines
were consolidated in 1 set
2017-18 Constitution of National Financial Reporting
Authority to place monitoring mechanism over
CA firm.

Whip on Shell Companies and disqualification of

Directors with 1.06 lakh (1,06,578) disqualified
directors with association to ‘shell or
on-paper companies’
 2017– Uday Kotak Committee recommendation:
1) Panel suggested that it was the the right time to split chairman, MD-CEO role of listed
companies
2) Panel suggested it should be mandatory for top 500 companies by market capitalization
to undertake D&O insurance for its independent directors. D&O Insurance stands for
Directors and Officers insurance,
3) Panel suggests minimum of 6 directors to be on board of listed entities; every listed
entity to have at least 1 independent woman director,
4) Panel suggested more transparency on appointment of independent directors; wants
them to play a more active role on the board ,
5) Panel suggested maximum number of listed entity directorship to be reduced to 8. At
least half of every listed entities board to have independent directors ,
6) Panel suggested Audit Committee must review use of loans/adv/ investment by holding
co in arm over Rs 100 crore ,
7) Panel suggested application to fill a casual vacancy of office of any Independent
Director must be okayed by holders; minimum number of Audit Committee meetings
be increased to five every year,
8) Panel suggested no person to be appointed as alternate director for an independent
director of a listed company,
9) Panel suggested a formal induction should be mandatory for every new Independent
Director appointed to the board ,
10) Panel suggested BoD to be updated on regulatory & compliance changes at least once
a year; as well as an interaction between NEDs & senior management

Regulatory and Other Development:

The Companies Act, 2013 & Secretarial Standards 1

• Board constitution, Board meetings, Board processes, independent directors and general
meetings
• Prior Approval of related party transactions, disclosure requirements in financial
statements in Board’s report
• Separate Meeting of Independent Directors meting
• CSR Provisions for sustainability initiatives
• Corporate Social Responsibility Policy
 • Whistle Blower Mechanism
• Anti-Bribery Policy
• Formation of NCLT and NCALT for early resolution of NPA

SEBI:

• Guidelines on Performance Evaluation of Board

• Clause 35 B The e-voting facility has to be provided to the shareholder for any resolution
is a legal binding for the company.
• SEBI Listing Obligations and Disclosure requirements, 2015 including Committee
Structure
• Other Regulatory Developments
• Implementation of GST
• Bankruptcy Code
• Data analytics on credit flow for CIC Companies & CERSAI

Accounts and Financial controls

• Additional Disclosure in Director’s report under Section 134

• Section 129 of the New Companies Act inter alia provides that the financial statements
shall give a true and fair view of the state of affairs of the company
• Internal Audit & Assurance
• Lot of Emphasis being placed on Mandatory list of items to be reviewed by Audit
committee and in Banking sector the Audit Committee calendar of reviews being fixed
• Terms of reference being covered under Companies Act, 2013 and LODR also to
broaden its scope.
• Internal Audit is being developed as assurance job wherein various activities are being
carried out in manner laid down in the process and suggest improvements.
• Audit has become more efficiency led approach then fault finding process.

Risk Management:

• Risk Management is focusing on taking advantage of Technological advancement both

to curb the risk of IT fraud and also to improvement in areas of implementation of Risk
Strategies.
Global Level Initiative for Corporate Governance:

• The Cadbury Committee on Corporate Governance–1992

• The Greenburg Committee–1995
• The Hampel Committee–1998
• The Combined Code–1998
• The Blue Ribbon Committee–1998
• The Turnbull Committee–1999
• The World Bank Initiative on Corporate Governance
• The OECD Principal on Corporate Governance
• The McKinsey Survey on Corporate Governance
• The Sarbanes-Oxley Act–2002
• The King Committee (I)–1993, The King Committee (II)–2003, The King Committee
(III)–2006, The King Committee (IV)–2016

SEBI Guidelines on Corporate Governance

SEBI Code of Corporate Governance: To promote good corporate governance, SEBI

(Securities and Exchange Board of India) constituted a committee on corporate governance
under the chairmanship of Kumar Mangalam Birla.

On the basis of the recommendations of this committee, SEBI issued certain guidelines on
corporate governance; which are required to be incorporated in the listing agreement between
the company and the stock exchange:

a) Board of Directors:
Some points in this regard are as follows:
1) The Board of Directors of the company shall have an optimum combination of
executive and non-executive directors.
2) The number of independent directors would depend on whether the chairman is
executive or non-executive.
3) In case of non-executive chairman, at least, one third of the Board should comprise
of independent directors; and in case of executive chairman, at least, half of the Board
should comprise of independent directors.
 4) The expression ‘independent directors’ means directors, who apart from receiving
director’s remuneration, do not have any other material pecuniary relationship with
the company.
b) Audit Committee:
Some points in this regard are as follows:
1) The company shall form an independent audit committee whose constitution would
be as follows:
• It shall have minimum three members, all being nonexecutive directors,
with the majority of them being independent, and at least one director having
financial and accounting knowledge.
• The Chairman of the committee will be an independent director.
2) The audit committee shall have powers which should include the following:
i) To investigate any activity within its terms of reference.
ii) To seek information from any employee.
iii) To obtain outside legal or other professional advice.
iv) To secure attendance of outsiders with relevant expertise, if considered
necessary.
v) The role of audit committee should include the following:
- Overseeing of the company’s financial reporting process and the disclosure
of its financial information to ensure that the financial statement is correct,
sufficient and credible.
- Recommending the appointment and removal of external auditor.
- Reviewing the adequacy of internal audit function
- Discussing with external auditors, before the audit commences, the nature
and scope of audit; as well as to have post-audit discussion to ascertain any
area of concern.
- Reviewing the company’s financial and risk management policies.
c) Remuneration of Directors:
The following disclosures on the remuneration of directors shall be made in the section
on the corporate governance of the Annual Report:
1) All elements of remuneration package of all the director i.e. salary, benefits, bonus,
stock options, pension etc.
 2) Details of fixed component and performance linked incentives, along with
performance criteria.
d) Board Procedure
Some Points in this Regards are:
1) Board meetings shall be held at least, four times a year, with a maximum gap of 4
months between any two meetings.
2) A director shall not be a member of more than 10 committees or act as chairman of
more than five committees, across all companies, in which he is a director.
e) Management:
A Management Discussion and Analysis Report should form part of the annual report
to the shareholders; containing discussion on the following matters (within the limits
set by the company’s competitive position).
1) Opportunities and threats
2) Segment-wise or product-wise performance
3) Risks and concerns
4) Discussion on financial performance with respect to operational performance
5) Material development in human resource/industrial relations front.
f) Shareholders:
Some points in this regard are:
1) In case of appointment of a new director or reappointment of a director,
shareholders must be provided with the following information:
i) A brief resume (summary) of the director
ii) Nature of his expertise
iii) Number of companies in which he holds the directorship and membership
of committees of the Board.
2) A Board Committee under the chairmanship of nonexecutive director shall be
formed to specifically look into the redressing of shareholders and investors’
complaints like transfer of shares, non-receipt of Balance Sheet or declared
dividends etc. This committee shall be designated as ‘Shareholders / Investors
Grievance Committee’
g) Report on Corporate Governance:
There shall be a separate section on corporate governance in the Annual Report of the
company, with a detailed report on corporate governance.
h) Compliance:
The company shall obtain a certificate from the auditors of the company regarding the
compliance of conditions of corporate governance. This certificate shall be annexed
with the Directors’ Report sent to shareholders and also sent to the stock exchange.