1.

INTRODUCTION:
Corporate governance refers to the set of rules, practices, and processes that guide and control a
company. It focuses on balancing the interests of a range of stakeholders—including
shareholders, management, customers, suppliers, financiers, government, and the community. As
it establishes the framework for achieving a company's goals, corporate governance covers
nearly every area of management, from strategic planning and internal controls to performance
evaluation and transparency in reporting.
According to Investopedia.com, corporate governance gained heightened importance with the
2002 enactment of the Sarbanes-Oxley Act in the U.S., which aimed to restore public trust in
companies and markets following the high-profile collapses of Enron and WorldCom due to
accounting fraud. Today, most companies seek to uphold strong corporate governance standards.
It is no longer sufficient for a company to simply be profitable; it must also exemplify good
corporate citizenship by embracing environmental responsibility, ethical conduct, and sound
governance practices.
Corporate governance refers to the systems, processes, and relationships that guide and control
corporations. It defines how rights and responsibilities are shared among different participants in
a company—such as the board of directors, managers, shareholders, creditors, auditors,
regulators, and other stakeholders. It also sets the rules and procedures for making important
decisions. Corporate governance involves the processes by which companies set and work
toward their goals, considering the social, regulatory, and market environment. This includes
keeping track of the actions, policies, and decisions of the company and its representatives.
Efforts to align stakeholder interests influence corporate governance practices.
“Corporate Governance is the acceptance by management of the inalienable rights of the
shareholders as the true owners of the corporation and of their own role as trustees on behalf of
the shareholders. It is about commitment to values, about ethical business conduct and about
making a distinction between personal and corporate funds in the Management of the Company.”
i. Need for Reform in India:
The committee was formed in response to high-profile corporate scandals in the early 2000s,
notably the collapses of Enron and WorldCom in the United States. These events revealed major
flaws in corporate governance, such as poor accountability, weak board oversight, and auditors'
conflicts of interest. Following these scandals, countries around the world began to re-evaluate
their corporate governance frameworks to prevent similar incidents.
The evolution of corporate laws in India has been marked by notable contrasts. At the time of
independence, despite being one of the poorest economies globally, India had a factory sector
contributing to about 10% of the national output, along with four operational stock markets that
followed well-defined rules for listing, trading, and settlements. Additionally, there was a
developed equity culture, albeit limited to the urban elite, and a banking system equipped with
solid lending norms and recovery procedures. As a result, India inherited a more advanced
corporate legal and financial framework than most other former colonies.
Since liberalization, corporate governance laws and awareness in India have seen extensive
reforms. One of the most significant advancements in corporate governance and investor
protection has been the establishment of the Securities and Exchange Board of India (SEBI) in
1992, with its regulatory authority steadily expanding over time. Initially formed to oversee
stock trading, SEBI has been instrumental in setting foundational rules for corporate conduct
across the country.
Concerns about corporate governance in India were, however, largely triggered by a spate of
crises in the early 90’s – the Harshad Mehta stock market scam of 1992 followed by incidents of
companies allotting preferential shares to their promoters at deeply discounted prices as well as
those of companies simply disappearing with investors’ money.
Corporate governance in India is evident from the various legal and regulatory frameworks and
Committees set relating to corporate functioning comprising of the following:
• The Companies Act, 1956
• Monopolies and Restrictive Trade Practices Act, 1969 (replaced by new Competition
Law)
• Foreign Exchange Management Act, 2000
• Securities and Exchange Board of India Act, 1992
• Securities Contract Regulation Act, 1956
• The Depositories Act, 1996
• Arbitration and Conciliation Act, 1996
• SEBI Code on Corporate Governance
In India, similar concerns arose over corporate misconduct, though not as prominent as the Enron
and WorldCom cases. Investors and stakeholders were increasingly demanding that companies
be more transparent and accountable in their financial reporting. The Indian government
recognized the need for a system that could rebuild public trust and ensure accurate, reliable
information from companies. While the SEBI was making efforts to introduce corporate
governance standards among Indian corporates, the Department of Company Affairs took
another initiative in this direction. The Naresh Chandra Committee was tasked with identifying
gaps in corporate governance and recommending reforms to enhance transparency,
accountability, and ethical conduct.
As India’s economy opened up to global markets, there was a need to align Indian corporate
governance practices with international standards. Strengthening corporate governance became
critical for maintaining investor confidence, both domestically and internationally. The
committee’s recommendations were aimed at making Indian companies more attractive to global
investors by adhering to practices that were increasingly becoming the norm in other major
economies.
ii. Formation of the Naresh Chandra Committee:
Global Corporate Scandals (Late 1990s and Early 2000s): Several high-profile corporate
collapses globally—most notably Enron (2001) and WorldCom (2002)—shook investor
confidence. These scandals exposed severe deficiencies in corporate governance, particularly in
auditing, financial reporting, and the role of independent directors. These collapses brought to
light the deep-rooted conflicts of interest between auditing firms and their corporate clients, with
audit firms often providing non-audit consulting services, leading to compromised independence
and oversight.

Indian Corporate Environment: In India, similar concerns were growing, though not on the same
scale as the U.S. scandals. However, there were issues with corporate governance structures, the
role of auditors, and independent oversight of companies. Indian corporate sector was witnessing
rapid growth in the early 2000s, with increased globalization and investments. However, the
governance frameworks at the time were considered inadequate to deal with the complexities of
modern corporate practices, especially concerning transparency, accountability, and ethical
conduct. The Kumar Mangalam Birla Committee had earlier (in 1999) recommended reforms
that led to the introduction of Clause 49 of the Listing Agreement by SEBI, which laid down
some corporate governance norms. However, these measures were seen as insufficient in the
evolving corporate landscape.

Government's Initiative: Recognizing the need to overhaul the corporate governance system in
India to restore investor confidence and to align with international standards, the Ministry of
Corporate Affairs (MCA) set up the Naresh Chandra Committee. The committee was tasked with
examining and recommending changes in the existing regulatory framework to enhance the
independence of auditors, strengthen corporate governance norms, and improve overall
transparency in the corporate sector.

The Government of India established the Naresh Chandra Committee as a crucial step towards
overhauling corporate governance standards nationwide. Led by Naresh Chandra, a distinguished
public servant with an extensive background in administration, the committee was charged with
reviewing current corporate governance practices and recommending enhancements to meet
international standards. Its formation was spurred by a wave of corporate scandals around the
world, which had undermined investor confidence and underscored the need for strong
governance structures.

2. THE NARESH CHANDRA COMMITTEE: OBJECTIVES AND MANDATE

The Naresh Chandra Committee on Corporate Governance was established by the Government
of India in 2002, with the primary objective of strengthening corporate governance mechanisms
in India. The committee was tasked with addressing gaps in the regulatory framework to enhance
transparency, accountability, and ethical practices in corporate functioning. Below are the key
objectives and mandates of the committee:

i. Objectives of the Naresh Chandra Committee:

• Strengthening Auditor Independence: One of the core objectives was to reduce conflicts
of interest by reinforcing the independence of auditors. This involved examining the relationship
between auditors and their clients to ensure objectivity and transparency in financial reporting.
• Enhancing Financial Disclosures: The committee aimed to improve the quality of
financial disclosures, requiring companies to provide more detailed information on their financial
status. This included the disclosure of related-party transactions, off-balance-sheet transactions,
and other financial risks that could impact stakeholders.
• Improving Board Oversight: The committee focused on the role of the board of directors,
particularly independent directors, in corporate governance. It aimed to clarify the duties,
responsibilities, and independence of board members to ensure better oversight and
accountability.
• Aligning with Global Standards: Another key objective was to bring Indian corporate
governance practices in line with global standards, fostering investor confidence and enhancing
India’s appeal to international investors.
• Investor Protection: Protecting the interests of shareholders and other stakeholders was a
priority for the committee. By promoting ethical practices and strengthening regulatory
mechanisms, the committee sought to build a more investor-friendly environment.

ii. Mandate of the Naresh Chandra Committee:

The committee was mandated to review existing corporate governance practices and recommend
reforms, specifically in areas such as:
• Auditor-Company Relationships: It reviewed the relationship between auditors and their
corporate clients, including restrictions on non-audit services provided by auditors to the same
companies to avoid conflicts of interest.
• Board and Director Roles: The committee assessed the role of independent directors and
recommended measures to ensure their independence and effectiveness. This included guidelines
on the composition of the board and the responsibilities of independent directors.
• Disclosure Norms: To promote transparency, the committee was mandated to suggest
guidelines for mandatory disclosures by companies, covering financial risks, significant
transactions, and governance practices.
• Ethics and Corporate Responsibility: The committee emphasized the need for ethical
practices and corporate responsibility, recommending frameworks that encourage sustainable and
ethical business operations.

The objectives and mandate of the Naresh Chandra Committee on Corporate Governance are
pivotal in reshaping the corporate governance landscape in India. By focusing on key areas such
as enhancing auditor independence, improving financial disclosures, and strengthening the roles
of boards and independent directors, the committee has set forth a comprehensive framework
aimed at increasing transparency and accountability within corporate structures.

Its commitment to aligning Indian practices with global standards reflects a strategic effort to
bolster investor confidence and protect the interests of stakeholders. As these objectives are
progressively implemented, they hold the potential to foster an ethical corporate environment
that not only encourages responsible business practices but also promotes sustainable economic
growth. The Naresh Chandra Committee’s recommendations serve as a cornerstone for a more
resilient and trustworthy corporate governance framework in India, ultimately contributing to a
healthier and more transparent market ecosystem.

3. RECOMMENDATIONS OF THE NARESH CHANDRA COMMITTEE

In the year August 2002, the Government of India constituted the Naresh Chandra Committee,
which began its work to address concerns related to corporate governance and auditing practices
in India. On December 2002, the committee submitted its report to the Ministry of Corporate
Affairs. The report contained a set of 17 recommendations aimed at improving corporate
governance, ensuring the independence of auditors, and enhancing the role of independent
directors in companies.
The recommendations are as follows :
a. Disqualification for audit assignments- The committee recommended certain
disqualification for audit assignments which prohibits the audit firm, the partners, or their direct
relatives to:
• Financially benefit directly from the client.
• Receive loans and/or guarantee from or on behalf of the audit client.
• Have any business relationship with the client.
• Have any personal relationship with the client.
• Have undue dependence on audit clients.
• Incur service or cooling off period unless a period of 2 years has elapsed from the date of
the audit engagement.

b. Prohibited non-audit services- The committee recommended certain services that the
audit firm shall not provide to any of their audit clients:
• Internal audit
• Accounting and bookkeeping
• Actuarial services
• Investment banking
• Outsourced financial service
• Valuation service
• Financial information systems design and implementation
• Staff recruitment

c. Compulsory rotation of auditors- Audit partners and not less than 50% of engagement
team engaged in an audit of any listed company, or such companies whose paid-up share capital
and free reserves exceed Rs. 10 crores, or companies whose annual turnover exceeds Rs 50
crores must be rotated every five years.
d. Appointment of auditors- For audit committees to have a larger role in audit procedures,
the audit committee shall have the first power to appoint an auditor.

e. Auditor’s disclosure of contingent liabilities- Management shall specify each of the

material risks and liabilities of contingent nature in a clear description, followed by auditor’s
comments on the management view, which shall be specified in the auditor’s report.

f. Auditor’s annual certification of independence- Before agreeing on the terms of the audit
engagement, the audit firm is required to submit a certificate of independence to the Audit
Committee or Board of Directors (BoD) of such company, as the case may be.

g. CEO and CFO certification of audited accounts- Designated CEO (or MD) and CFO of
listed companies and public limited companies whose paid-up share capital and free reserves
exceed Rs. 10 crores or whose turnover exceeds Rs 50 crores, should certify their companies’
annual accounts.

h. Setting up Independent QRB- Three independent Quality Review Board (QRB) should be
set, one for each ICAI, ICSI and ICWAI, to examine audit quality.

i. Percentage of independent directors- At least 50% of the BoD of any listed company and
unlisted public limited companies having paid-up share capital and free reserves of Rs. 10 crores
or more, or a turnover of Rs 50 crores or more, should be the independent directors. The
minimum board size of such companies should be 7, with at least four independent directors.
Audit committees of such companies should consist of only independent directors.

j. Audit committee charter- The role and functions that an audit committee shall discharge
in a company should be laid out in an audit committee charter.

k. Exempting non-executive directors from certain liabilities- The non-executive and

independent directors shall be exempted from criminal and civil liabilities mentioned in the
Negotiable Instruments Act, Provident Fund Act, ESI Act, Factories Act, Financial disputes Act,
etc.
l. Whistleblower Policy: The committee proposed a whistleblower policy to protect
employees who expose fraudulent or unethical practices within a company. This would
encourage transparency and accountability in business operations.

m. Corporate Governance Reporting: The committee suggested mandatory reporting of

corporate governance practices in annual reports. These reports were to include detailed
disclosures on compliance with governance norms and the functioning of the board and its
committees.
Other recommendations:
• Disclosure: Full disclosures of accounts and decisions of management involving the
funds of the company to all its stakeholders is a need of good corporate culture. The auditors
should disclose implications of contingent liabilities so that investors and shareholders have a
clear picture of contingent liabilities.
• Qualification in Audit Report: In addition to the existing provisions in the Companies Act
regarding qualifications in audit reports, the committee has made further recommendations that
the auditor should read out the qualifications with explanations to shareholders at the company’s
AGM and audit firm is mandated to send separately a copy of the qualified report to the ROC,
SEBI and Principal Stock Exchange with a copy of the letter of the management of the company.
• Replacing Auditors: In the event of an auditor being appointed in the place of a retiring
auditor, the committee has recommended that Section 225 of the Companies Act be amended to
require a special resolution for the purpose and that an explanatory statement giving reasons for
such replacement be provided. The outgoing auditor will have the right to comment on the
statement.
• Formation of Board for Monitoring Audit Process: The committee has suggested setting
up of the Corporate Serious Fraud Office with specialists inducted into a multi-disciplinary team
that not only uncovers the fraud but is able to direct and supervise prosecutions under various
economic legislations through appropriate agencies.
• Penalties: According section 539 of the Companies Act, 1956, if an auditor is found to be
involved in unethical practices, he will be punishable with imprisonment, which may extend to 7
years and also be liable to a fine. u/s 21 of Chartered Accountants Act, such an auditor will be
prevented from exercising his duty and his License will be cancelled by the ICAI.

4. IMPLEMENTATION AND LEGISLATIVE IMPACT

The Naresh Chandra Committee Report (2002) had a profound influence on the legal framework
governing corporate governance in India. Its recommendations led to significant reforms, many
of which were later incorporated into legislation and regulations by bodies like the Ministry of
Corporate Affairs (MCA) and the Securities and Exchange Board of India (SEBI). The report’s
impact on Indian companies through the legal framework, supported by key legislative changes.

i. Influence on the Companies Act, 2013:

• Independent Directors: One of the key recommendations of the Naresh Chandra
Committee was the inclusion of independent directors on company boards to ensure objectivity
and reduce conflicts of interest. This recommendation became law under Section 149 of the
Companies Act, 2013, which mandated the appointment of independent directors for listed
companies and certain large unlisted companies. These independent directors play a crucial role
in improving corporate governance by providing unbiased oversight.
• Audit Committees: The Committee's emphasis on audit committees with independent
directors led to their legal requirement under Section 177 of the Companies Act, 2013. The law
now mandates that every listed company and certain other classes of companies must have an
audit committee, with a majority of its members being independent directors. This strengthened
financial oversight and accountability within companies.
• Auditor Independence and Rotation: The committee proposed stricter guidelines for the
appointment and independence of auditors, including limits on the non-audit services that
auditors can provide to the same clients. These recommendations were legally reinforced under
Section 139 of the Companies Act, 2013 , which mandates the rotation of auditors every five
years for listed companies and large unlisted companies. Furthermore, the Act restricted auditors
from offering certain non-audit services to their audit clients, in line with the committee's
suggestions. The objective was to avoid conflicts of interest and ensure unbiased audits, thereby
promoting the integrity of financial reporting within Indian companies.

ii. Impact on SEBI’s Listing Obligations and Disclosure Requirements (LODR)

Regulations, 2015:

SEBI's LODR Regulations, 2015 were heavily influenced by the Naresh Chandra Committee’s
focus on improving disclosures and ensuring the integrity of financial statements. The
regulations require listed companies to provide detailed disclosures on related-party transactions,
financial performance, and risks, in addition to mandating the role of independent directors and
robust audit committees. These reforms improved transparency and accountability in Indian
companies, contributing to stronger investor confidence.
iii. Reforms in Corporate Governance under Clause 49 of the Listing Agreement:
Many of the recommendations of the Naresh Chandra Committee were adopted by SEBI under
Clause 49 of the Listing Agreement (introduced in 2005). This clause required listed companies
to adhere to certain corporate governance standards, including the appointment of independent
directors and the formation of audit committees. These changes strengthened the governance
structure of listed companies by providing a legal framework for better oversight and
accountability.

iv. Whistleblower Policy and Legal Protections:

The committee also recommended mechanisms for employees to report unethical practices or
financial irregularities, leading to the introduction of whistleblower policies. This was
incorporated into the corporate governance framework through the Companies Act, 2013
(Section 177), and SEBI regulations, which made it mandatory for companies to establish such
mechanisms and protect whistleblowers from retaliation. This has had a significant impact on
promoting ethical practices within Indian companies by providing a legal safeguard for those
exposing corporate misconduct.

v. Impact on the Role of Credit Rating Agencies:

The Naresh Chandra Committee also highlighted the role of credit rating agencies in providing
reliable assessments of a company's financial health. Following the committee’s
recommendations, SEBI and the Reserve Bank of India (RBI) took steps to improve the
regulation of credit rating agencies, ensuring greater transparency in their methodologies and
processes. The regulatory frameworks were enhanced under SEBI (Credit Rating Agencies)
Regulations, 1999 (as amended), providing investors with better information and more
trustworthy assessments of corporate risks.

vi. Legal Codification of Corporate Social Responsibility (CSR):

Although not a direct recommendation of the Naresh Chandra Committee, the broader focus on
corporate accountability laid the groundwork for the introduction of mandatory CSR under
Section 135 of the Companies Act, 2013. The law requires companies meeting certain financial
thresholds to spend at least 2% of their average net profits on CSR activities. This legal
framework aligns with the committee’s emphasis on ethical business practices and corporate
responsibility.
5. LONG-TERM IMPLICATIONS FOR INDIAN CORPORATE GOVERNANCE
The Naresh Chandra Committee’s work laid the groundwork for the modernization of India’s
corporate governance framework.

i. Enhanced Corporate Accountability:

The Naresh Chandra Committee's emphasis on accountability has fundamentally changed how
companies operate in India. The recommendations regarding the independence of directors and
auditors aim to create a more accountable corporate environment where management decisions
are subject to scrutiny. The role of Independent Directors, the requirement for independent
directors to have no material relationship with the company ensures that board decisions are
made in the best interests of shareholders, not just management. This has fostered a culture of
accountability, encouraging directors to act ethically and responsibly. CEO and CFO
Certification, the mandate for CEOs and CFOs to certify financial statements has made
executives more accountable for the accuracy of disclosures. This personal accountability helps
prevent fraudulent activities and ensures that financial reporting is transparent and reliable.

ii. Improvement in Corporate Governance Standards:

The committee’s recommendations laid the groundwork for improved governance standards
across Indian corporations. The Audit Independence ensured by enforcing stricter rules on
auditor independence and requiring the rotation of audit firms, the committee reduced the
potential for conflicts of interest and improved the quality of audits. This shift encourages
auditors to operate with greater integrity and diligence. Moreover, the ethics and compliance
programs ensured for stronger corporate governance has led many companies to adopt formal
ethics and compliance programs. These programs promote ethical behaviour, enhance
compliance with laws, and help to identify and mitigate risks.
iii. Strengthening of Regulatory Frameworks:
The recommendations from the Naresh Chandra Committee were instrumental in shaping
subsequent regulatory frameworks in India, including: Companies Act, 2013, where many of the
committee’s suggestions were incorporated into the Companies Act, significantly transforming
corporate governance in India. The Act introduced mandatory provisions for independent
directors, corporate social responsibility (CSR), and audit committee requirements, reflecting a
more modern and transparent corporate governance structure. Secondly, the Securities and
Exchange Board of India (SEBI) Guidelines, SEBI has continued to refine its regulations
regarding corporate governance, often referencing the foundational principles established by the
Naresh Chandra Committee. This has led to an evolving regulatory environment that adapts to
emerging challenges and international best practices.

iv. Increased Investor Confidence:

One of the most critical long-term implications of enhanced corporate governance is the increase
in investor confidence, both domestic and foreign. Attracting Foreign Direct Investment (FDI)
has improved corporate governance practices and have made Indian companies more attractive to
foreign investors. Transparency, accountability, and ethical business practices in-still confidence
in investors, reducing perceived risks associated with investing in Indian firms. Moreover,
strengthening of Minority Shareholder Rights ensured to focus on protecting minority
shareholders by ensuring that their rights are upheld and that they have a voice in corporate
governance matters. This focus has encouraged more widespread investment and participation in
the equity markets.

6. CONCLUSION:
The significant impact of the Naresh Chandra Committee on Corporate Governance in India. It
underscores the necessity of reforming corporate governance structures in response to global
corporate scandals and the evolving complexities of the corporate landscape. The committee's
recommendations aimed to enhance auditor independence, improve financial disclosures, and
strengthen the roles of independent directors, thereby fostering a culture of accountability and
ethical conduct within corporations.

The implementation of these recommendations has led to a more robust regulatory framework, as
seen in the Companies Act, 2013, which incorporated many of the committee's suggestions. This
has resulted in improved governance standards, increased transparency, and greater investor
confidence, ultimately contributing to a healthier corporate environment. Furthermore, the long-
term implications of these reforms, including the promotion of ethical business practices, the
establishment of whistleblower protections, and the enhancement of credit rating agency
regulations. These measures not only protect the interests of shareholders and stakeholders but
also align Indian corporate governance practices with international standards.

In summary, the Naresh Chandra Committee's work has laid a solid foundation for a more
resilient and trustworthy corporate governance framework in India, fostering sustainable
economic growth and enhancing the overall integrity of the corporate sector. The ongoing
commitment to these principles will be crucial in navigating future challenges and ensuring the
continued evolution of corporate governance in India.