Corporate Governance in India: Legal Reforms and Global Best Practices

Abstract

Due to the failures and bankruptcies of many well-known corporations in recent decades, corporate governance has attracted considerable attention in both developed and developing countries worldwide. Corporate governance is the framework for managing and directing businesses, with the governance of corporations being the responsibility of boards of directors. Therefore, corporate governance is separate from daily operational administration. Corporate governance depends on the decisions of the board of directors and how these decisions increase the company’s market value. By assuring accountability, transparency, and enforcement in the capital market, good governance policies help to decrease risk. The present study describes the structure of corporate governance, including the Anglo-American model, German model, Japanese model, and Indian model, as well as weaknesses, importance, and steps to be taken to improve corporate governance in India.

Keywords: Corporate governance, accountability, transparency, enforcement, legal reforms, Companies Act, SEBI, RBI

I. Introduction

A few decades ago, governance as a term was rarely used by businessmen. Now, almost all organizations follow governance principles with specific emphasis on accountability, integrity, and risk management. Primarily, it is well established that corporate governance encompasses relationships among a company’s board, management, shareholders, and other stakeholders. Corporate governance also provides “the structure through which the objectives and monitoring performance are determined.”[1] In other words, “corporate governance is about promoting corporate fairness, transparency and accountability.”[2]

Basically, two factors were accountable for underlining corporate governance worldwide. First, the wave of financial crises in 1998 in Russia, Brazil, and most Asian countries seriously affected and destabilized the global financial system. Second, growing corporate scandals surfaced in the United States and European countries due to poor corporate governance practices by commercial entities. In India, corporate governance gained significant importance after the Satyam fraud. This scam prompted businessmen to focus on efficient, transparent, and impeccable corporate governance in their companies for better stability, profitability, and desired growth.

Further, the rapid pace of globalization and liberalization compelled companies to adopt effective corporate governance strategies and improved standards to run their businesses. To minimize cases of fraud, malpractices in companies, and financial instability, both policymakers and business managers stressed the importance of improved corporate governance standards. At the international level, the Organisation for Economic Co-operation and Development (OECD) and the World Bank continuously worked toward better corporate governance and adopted a set of principles to strengthen the structure of companies. Similarly, in India, several reforms were undertaken through different paths by the Securities and Exchange Board of India (SEBI) and the Ministry of Corporate Affairs (MCA), Government of India, to improve corporate governance. Recently, the Government passed the Companies Act, 2013, which is one of the significant steps to improve corporate governance in India. This article focuses on the development and emergence of the new Companies Act, 2013, and the good practices incorporated in this Act. Before examining these developments, it is essential to understand corporate governance and its evolution in India.

II. Legal Reformation in Corporate Governance

A. First Phase: 1996-2008
This stage, also known as the primary phase of India’s corporate governance, focused on establishing audit committees and making boards more independent, focused, and powerful to supervise management and lead shareholders, including institutional and foreign investors, in governance matters.

1. Confederation of Indian Industry (CII) – 1996
In 1996, the CII took the first institutional initiative in Indian industry by establishing a special committee on corporate governance. The aim was to promote and develop a code for companies in both the public and private sectors, including financial institutions and banks, applicable to all corporate entities. The steps taken by the CII addressed public concerns regarding the security of investors’ interests, particularly small investors, and encouraged transparency within industry and business as a means to approach international standards of disclosure by corporate bodies. Through all these measures, the objective was to build a high level of trust in business and industry from the public’s perspective. The final draft of the code was introduced in April 1998.

2. Kumar Mangalam Birla Committee Report on Corporate Governance
Mr. Kumar Mangalam Birla, an industrialist, was appointed by SEBI as chairman to provide comprehensive details on concerns related to insider trading and to secure the rights of various investors. The recommendations insisted on listed companies making initial and continuing disclosures in their annual reports separately, including a report on corporate governance and all steps taken to comply with the committee’s recommendations. The objective was to enable shareholders to understand where the companies in which they invested stood with respect to specific initiatives taken to ensure growth in corporate governance.

3. Clause 49
This committee realized the importance of the auditing function and made many specific suggestions related to the constitution and function of board audit committees. Subsequently, SEBI revised its listing agreement to include all the recommendations put forward. These rules and regulations were listed in Clause 49, a new section of the listing agreement that came into force in phases during 2000 and 2003.

4. Advisory Group Report on Corporate Governance on International Financial Standards and Code – March 2001
The advisory group compared corporate governance in India with international best standards and advised improvements to corporate governance standards in India, through which the market structure of India with respect to small investors and shareholders could improve in a competitive manner.

5. Report of the Group on Corporate Governance of Banks – April 2001
A group constituted by the Reserve Bank of India reviewed corporate governance in banks and financial institutions and examined the supervisory role of boards of banks and financial institutions to assess board activities related to compliance, transparency, audit committees, etc. The group also provided suggestions for enhancing the role of boards of directors to make the entire structure more effective with a view to mitigating risks.

6. Naresh Chandra Committee Report on Corporate Audit and Governance – December 2002
This committee undertook the task of analyzing and suggesting changes in different areas, including the relationship between statutory auditors and companies, procedures for appointment of auditors, determination of audit fees, and restrictions on non-audit services if required. It also provided measures to ensure that company management presented a true and fair statement of the financial affairs of the company.

7. SEBI Report on Corporate Governance (N.R. Narayana Murthy Committee) – February 2003
To improve governance standards, SEBI constituted a committee to study the role of independent directors, related party transactions, and risk management in companies, ensuring that management presented a true and fair statement of the company’s financial affairs.

8. Naresh Chandra Committee II Report on Regulation of Private Companies and Partnerships
As a large number of private sector companies were emerging, there was a need to revisit the law. To strengthen the legal framework, the Government constituted a committee in January 2003 to ensure a scientific and rational regulatory environment. The main focus of this report was on the Companies Act, 1956, and the Partnership Act, 1932.

9. Clause 49 Amendment – Murthy Committee Recommendations
In 2004, SEBI further amended Clause 49 in accordance with the Murthy Committee’s recommendations. Implementation of these changes was postponed until January 1, 2005, due to lack of preparedness and industry resistance to such wide-ranging reforms. The Murthy Report was directly responsible for numerous changes in Clause 49. The requirements related to corporate boards, audit committees, shareholder disclosures, and CEO certification of internal controls constituted the largest transformation of governance in Indian companies.

B. Second Stage of Corporate Governance: Post-Satyam Scam
India’s corporate sector experienced a significant upheaval in January 2009 with the revelations about the failure and massive fraud in Satyam’s financials. The Satyam scandal served as a catalyst for the Indian government to rethink corporate governance, disclosure, and accountability mechanisms. Shortly after news of the scandal broke, the CII began examining corporate governance issues arising from the Satyam incident. In 2009, a CII task force put forward corporate governance reform recommendations.

In its report, the CII emphasized the unique nature of the Satyam scandal, noting that it was an isolated incident and that the overwhelming majority of corporate India is well-run, well-regulated, and conducts business legally. Furthermore, the Confederation of IT & BPO Industries in India, along with the National Association of Software and Service Companies (NASSCOM) as the premier trade body, formed a corporate governance and ethics committee chaired by N.R. Narayana Murthy, one of the founders of Infosys and a leading figure in Indian corporate governance reforms. The committee issued its recommendations in 2010.

III. Why Are Best Practices Important for Effective Corporate Governance?

There are many benefits to following corporate governance best practices, and the potential impact is boundless. Here are a few ways they lead to more effective corporate governance:

1. Enhanced Performance and Trust: Best practices improve overall performance and promote trust among shareholders and other stakeholders.

2. Strategic Planning and Risk Management: They provide for sound strategic planning and better risk management.

3. Long-term Sustainability: Corporations that embrace best practices in corporate governance continually move toward long-term sustainability.

4. Legal Protection: Good governance prevents litigation and provides far-reaching legal protections for corporations.

IV. Global Best Practices India Should Embed

Best practices incorporate many different aspects of board work. They entail critically examining board directors’ qualities and characteristics—who they are as people and how they approach governing an organization. Effective corporate governance can incorporate many different practices. Specifically, some of the primary corporate governance best practices include:

1. Recruiting and Building a Competent Board: Ensuring board members possess the necessary skills, experience, and diversity to guide the organization effectively.

2. Aligning Strategies with Goals: Establishing clear connections between corporate strategy and organizational objectives to drive focused decision-making.

3. Exercising Accountability: Holding board members and management accountable for their decisions and actions through transparent reporting mechanisms.

4. Maintaining High Ethics and Integrity: Establishing and enforcing ethical standards that guide all corporate activities and decisions.

5. Defining Roles and Responsibilities: Clearly delineating the duties and expectations of board members, management, and other stakeholders to avoid confusion and overlap.

6. Managing Risk Effectively: Implementing comprehensive risk management frameworks to identify, assess, and mitigate potential threats to the organization.

V. Nine Effective Corporate Governance Best Practices

1. Recruit Effective and Diverse Board Directors: Diversity in board composition—including gender, ethnicity, professional background, and expertise—brings varied perspectives that enhance decision-making and problem-solving capabilities.

2. Establish Proper Board Composition: The board should have an appropriate mix of executive, non-executive, and independent directors with clearly defined roles and responsibilities.

3. Onboard All Directors Comprehensively: New directors should receive thorough orientation about the company’s business, culture, governance framework, and their specific responsibilities.

4. Foster Effective Presentations: Board meetings should feature clear, concise, and informative presentations that enable directors to make well-informed decisions.

5. Align Strategies with Goals: Corporate strategies should be directly linked to measurable organizational goals, with regular monitoring of progress.

6. Hold Directors Accountable: Implement performance evaluation systems for directors and establish consequences for failure to meet established standards.

7. Emphasize High Ethics and Integrity: Develop and enforce a robust code of conduct that applies to all levels of the organization, with whistleblower protection mechanisms.

8. Define Roles and Responsibilities Clearly: Document and communicate the specific duties, authorities, and limitations of each governance role to prevent conflicts and ensure efficient operations.

9. Produce Accurate Financial Reports: Ensure timely, accurate, and transparent financial reporting that complies with all applicable accounting standards and regulations.

VI. Conclusion

This article outlines the salient features of the Indian corporate governance system. While on paper the Indian legal system provides one of the highest levels of investor protection in the world, in reality, it is very different, with slow judicial processes and significant corruption. Much of the small and medium-sized enterprise sector in India displays relationship-based informal control and governance mechanisms that inhibit financing and keep the cost of capital at levels higher than necessary. Even though India ranks high on the ease of getting credit and has a well-functioning banking sector, it has one of the lowest proportions of non-performing assets.

Corporate governance remains an unfinished agenda in India. Improving corporate governance standards has been a matter of priority for Indian policymakers for the past two decades. While scandals heightened awareness of corporate governance issues and forced the government to protect public interest and restore confidence in the market, corporate governance reform has been driven by economic growth and the desire to remain competitive in the context of international capital flows and the growth of global financial markets. Laws have been strengthened and regulations have been made stricter to prevent further corporate misdeeds. The compliance regime has been tightened, and criminal and administrative penalties have been made tougher. It can be stated that awareness of the importance of good corporate governance is now reasonably widespread in the corporate landscape. Still, scandals emerge every few months, each time in a different manner. This only reinforces the view that many experts hold: that strong laws and tough regulations do not offer a complete solution to all corporate governance issues.

There is strong momentum for continuing reforms, and the monumental changes that have already taken place have paved the way for further improvements. All these positive developments should arguably help Indian industry ensure financial gains and reach investors fairly and transparently, enabling it to sustain its newfound prosperity and growth.

Footnotes
[1] Organisation for Economic Co-operation and Development (OECD), OECD Principles of Corporate Governance (2004). ↩
[2] Id. ↩