+ Corporate Governance and Business Ethics in India - CII Blog

Charting Change, Enabling Development

India has one of the most stringent corporate governance framework in the world. The legislators have been introducing various changes in the governance structure of companies and various other investment vehicles to make them more transparent and robust.

In 2013, the parliament enacted the Companies Act 2013 (“Act”), which brought in the concept of having two independent directors and proposed the mandatory appointment of a woman director on the board of directors of public companies having a paid-up capital above a certain threshold. This was done to protect the interest of all the public stakeholders, remove gender inequality and bring in professional management. The concept of rotation of auditors was introduced to ensure that the auditors’ independence was not influenced over a period of time. For the first time, the Act codified the fiduciary duties of directors, which provided all directors an understanding of their basic duties.

To address one of the major concerns faced by the economy, pertaining to non-performing assets (NPAs) and bankruptcy, a separate code namely Insolvency and Bankruptcy Code, 2016 was enacted, which consolidates all the laws relating to insolvency and bankruptcy and deals with NPAs. The new code though is in the process of evolution and is a concrete step to ensure that a proper insolvency resolution mechanism is created which does not become merely a debt recovery process.

Further, on the basis of the Kotak Committee recommendations, SEBI recently introduced a comprehensive set of corporate governance principles which are expected to improve upon the existing governance regime for listed companies. The concept of business responsibility reporting for top 500 listed companies is being introduced to bring out the corporate’s ideology in dealing with various stakeholders. Further, Risk Committees are being mandated to ensure that they appropriately identify the risks associated with business. Related party transactions for making any payments for brand usage or royalty exceeding two percent of the annual consolidated turnover of the listed entity, requires approval of a majority of public shareholders. The payment to a single non-executive director of more than fifty per cent of the total annual remuneration to all non-executive directors requires the shareholders’ special resolution. The separation of the office of Managing Director and Chairperson is being introduced to ensure the ‘Maker – Checker’ concept.

However, even after having one of the most comprehensive and robust corporate governance frameworks, there are umpteen number of instances of poor governance. Recently, an alarming number of corporate frauds and banking scams, both in private banks as well as in public sector banks, came to light for various reasons viz, gross negligence, misuse of internal banking checks and balances, conflict of interest of the top executives and mis-classification of the NPAs. Instances of the collapse of institutionally controlled large corporates, raised serious issues and created an alarming situation thereby eroding the worth of many NBFCs and debt funds. These instances demonstrated a complete failure of the governance mechanism, wherein the management, board of directors including the statutory auditors failed to raise red flags to the stakeholders at the appropriate time or take corrective measures. The instance of unjustifiably high remuneration packages to senior employees’ including promoter directors’ not corresponding with the company’s performance, diversion of funds as inter corporate loans through complex subsidiary structures without adequate disclosures to the investors, etc. have led to financial crises in many corporates. These instances have led to some shareholder activism which have forced some corporates to step back. However, there is a still a long road ahead.

There is no doubt that regulations are being complied with in the letter by most, but the intent or the spirit still needs to be inculcated. Regulation by itself cannot lead to good governance. Whilst no one can deny the efforts and the intent of the regulators in bringing in various regulations to ensure transparency, proper disclosures and alignment of the interest of all the stakeholders, often personal interest takes precedence, and this is manifested in the form of various failures and frauds. At this juncture, it is important for the key players who participate in the decision making for corporates to understand that the need of the hour is to strike a fine balance between transparency, good governance and profits both in the short as well as in the long term. This balance is important to restore the element of confidence in businesses and investors. It is of utmost important to focus on the ethical framework which will create greater trust amongst stakeholders which will result in the enhanced value creation for business. In this context, the actions taken by the government and regulating agencies in the recent past to book economic offenders’ including enactments like Fugitive Economic Offenders Act, 2018 to seize properties of offenders including benami properties is commendable. Strong action needs to be taken by the regulators in a time bound manner against the economic offenders, perpetrators and willful defaulters. But to ensure that the assets are protected, guilty needs to be severally punished and unlawful gain and profits be recovered and restored.

Call ‘spade a spade’ attitude needs to be adopted by the boards. Independent directors ought to spend adequate quality time to ensure they have understanding of the business and get to bottom of the critical decisions brought before them. Proper disclosure relating to financial statements, business decision, relating party transactions, cases of errors failure in control system and frauds need to be made. It is prudent that board should regularly run a conflict check exercise. The rating agencies should discharge their duties more diligently. Auditors should act with high integrity and not hesitate to raise red flag. Joint efforts of all the parties entrusted with the responsibility of ensuring good governance can lead to resolution of the current issues.

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Contributed by:

Inder Mohan Singh

Senior Partner, Shardul Amarchand Mangaldas & Co