Principles of Corporate Governance

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“Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.”

Introduction

The system of governance that deals with the methodology of governing a corporate entity are known as corporate governance. It comprises of Rules, Regulations and Bylaws by which a corporate firm is run, managed, governed and controlled. It works on the principle of balance of interests, balancing the interest of the company, stakeholders, customers, suppliers, financiers, government and shareholders on one hand and the community at large on the other hand. Corporate Governance refers to the way a corporation is governed; the technique by which companies are directed and managed. It means carrying the business as per the desires of the various stakeholders. Corporate Governance can be defined as the involvement between various participants (shareholders, the board of directors, and the company’s management) in shaping the performance of the corporation and the path on which it is proceeding. The relationship shared between the owners and the managers in any organization must be healthy and no conflict should arise between the two. The owners need to make sure that individual’s actual performance is at par with the standard performance. The abovementioned dimensions of corporate governance should not be neglected.

Corporate Governance deals with deliberating the course of action to take effective strategic decisions. It provides the board with the ultimate authority and complete responsibility. Owing to the market-oriented economy, today, the need for corporate governance has arisen. Further, Corporate Governance is essential to develop added value to the stakeholders and efficiency, as well as globalization, are significant factors urging corporate governance. The scope of corporate governance is pretty broad and encompasses both social and institutional aspects. Corporate Governance encourages a trustworthy, moral, as well as ethical environment.

Hence, corporate governance can be defined as the conglomeration of rules, processes or laws through which businesses are regulated, operated or controlled. 

Corporate governance in Indian Context

Corporate governance plays a vital role in the present economic condition of India. The economy of the nation has been booming since 1991. Subsequent to that, it has witnessed an astonishing upward trend in the stock size, that is to say, the listed firms have been proliferating. So as to attract increased foreign policies and investments in India, transparency and maximisation of shareholders value must be focused upon. Even when Corporate Governance in India has started as early as 1961, we still lack behind in some or the other way. 

The wave of Globalisation hit us in 1991 owing to which the concept of Corporate Governance gained international prominence. The admirable initiative taken in this area includes the reform of the Securities and Exchange Board of India (SEBI), in the year 1992. SEBI set in motion with the intention of standardizing and supervising the trading of stocks, however, it lately got broader and made many more rules and regulations relating to Corporate Governance. The next major overhaul was the formation and establishment of the Confederation of Indian Industry (CII) in 1996. It inaugurated the set of laws for Indian companies to initiate the act towards corporate governance. Subsequent to the two major establishments, a couple of committees titled Kumar Mangalam Birla and Narayan Murthy under the Securities and Exchange Board of India started modelling the base for formalizing the most befitting and yielding practices on Corporate Governance. Taking into consideration the committees’ suggestions, Clause 49 was introduced as part of the listing contract for the companies listed on the Indian stock exchange.  However, various scandals including Satyam, Enron, WorldCom etc. necessitated the reform of Clause 49 for the purpose of incorporating and overcoming the issues inducing these companies to collapse and shatter the economies of the respective countries. 

Clause 49 of the listing agreement of the Indian stock exchange took effect from 2000 to 2003. It enumerated various regulations and requirement of the minimum number of board directors, independent directors, different necessary committees, audit committee rules and limits, code of conduct etc. Firms that failed to follow the aforementioned principles were removed from the listing and were awarded monetary penalties. Clause 49 resembles the Sarbanes-Oxley Act of 200, as they predominantly share the same spirit. It was developed for the companies listed on the US stock exchanges. In terms of the responsibilities of management and the number of directors that were concerned, they are both the same. They also have identical rules regarding insider trading, refusal of loans to directors and various other head. The key difference between the two is under Sarbanes-Oxley legislation in cases of fraud or annihilation of reports imprisonment extending up to 20 years can be awarded, but Clause 49 lacks this condition. 

Also Read  Sarla Verma & Ors. v. Delhi Transport Corporation & Anr. (2009)

While there is no absolute structure of corporate governance and it is subject to variances, most companies incorporate the following elements. 

Principles of Good Corporate governance 

Good corporate governance has always been about organisations achieving the best possible results, but the vision of those results has changed since they were first articulated by the UK Cadbury Commission in 1991. The first principles of corporate governance were largely concerned with shareholder protection – ensuring that the interests of shareholders could be aligned as closely as possible with the actions of management.

The OECD principles also take into account the importance of good corporate governance to the economy as a whole:

“The Principles are developed with an understanding that corporate governance policies have an important role to play in achieving broader economic objectives with respect to investor confidence, capital formation and allocation. The quality of corporate governance affects the cost for corporations to access capital for growth and the confidence with which those that provide capital – directly or indirectly – can participate and share in their value-creation on fair and equitable terms. Together, the body of corporate governance rules and practices, therefore, provides a framework that helps to bridge the gap between household savings and investment in the real economy. As a consequence, good corporate governance will reassure shareholders and other stakeholders that their rights are protected and make it possible for corporations to decrease the cost of capital and to facilitate their access to the capital market.”

The principles of good corporate governance today

The board is at the centre of good corporate governance is any organisation. The basic principles of corporate governance involve the development of the board, its action and accountability. Transparency is a key principle of good corporate governance, hence accounting and reporting constitute a crucial part of it. Corporate governance has evolved around certain key principles, which form the premise of rules and guidelines set for the corporate.

Shareholder Primacy

For all one knows, recognition of shareholders is perhaps one of the prime principles of corporate governance.  There is the basic recognition of the significance of shareholders to any company, owing to the fact that these are the people who buy the company’s stock and consequently, fund its operations. Equity is one of the prime sources of funding for businesses. The policy of permitting shareholders to appoint the board of directors is critical.  The board of directors hires and oversees the executives who compose the team responsible for the management of the daily operations of the company, which signifies that shareholders, effectively, have a direct say in the management of the company.

Transparency

Transparency denotes the authorisation that anyone, whether inside or outside the company, review and verify the company’s actions. This promotes trust and is likely to encourage more individuals to promote the company and possibly become shareholders as well. Disclosure of the relevant information about corporate in a timely and accurate manner is necessary and helps the stakeholder to know their rights and daily activities of the corporate.

Accountability and Responsibility

The Board of Directors is bestowed with the authority to act on behalf of the company and hence it is expected to accept complete responsibility for the powers so granted and the authority exercised by it. The Board of Directors is responsible for overseeing the affairs of the company, management of the business, monitoring the performance of the company and appointing the chief executive and while doing so, it is required to act in the best interests of the company.

Accountability and responsibility are complementary to each other. The Board of Directors should be made accountable for the way in which the company has carried out its responsibilities.

It ensures the liability of the person responsible for taking decision for the interest of the others. Hence persons including the chairman, directors, managers and other officers should be accountable to other stakeholders of the corporate.

Independence

Independence of the top manager is cardinal for the smooth functioning of the corporate. Independence can be defined as the ability to make decisions without any sort of constraint or undue influence. The Board of Director must work without the interference of any interested party in the corporate. 

Also Read  Sarla Verma & Ors. v. Delhi Transport Corporation & Anr. (2009)

Independence can be elucidated as:

The ability to adhere to professionalism and do right by the company and to being able to stand firm in the face of inappropriate influences. it also includes the ability to make firm and unadulterated decisions on any given issue.

It permits the person to act with integrity and make decisions and form judgments keeping in mind the best interests of the stakeholders. This is the prime reason behind the appointment of independent directors in a company. The appointment of an independent director ensures the absence of any unwanted force of hand being used along with ensuring that the director does not have any personal interests with the company thereby hampering his ability to make free and fair decisions.

Security

Security is an increasingly important aspect of corporate governance. Shareholders need to assured about the safety of their personal information, that is to say, that is not being leaked or subject to unauthorised access. It’s equally important to ensure that the company’s trade secret and proprietary processes are secure. A data breach is not merely expensive but it further also weakens public trust in the company, which can drastically hamper its reputation and have a negative effect on its stock price. Everyone in a company is required to be well-versed with the incorporated security procedures such as passwords and authentication methods.

Financial and business reporting  

The board must present a fair, balanced and understandable assessment of the company’s position and its future prospects.

Risk management and internal control

 The board is accountable for determining the nature and extent of the principal risks it is willing to take in order to achieve its strategic objectives. The board needs to maintain a sound internal control system and risk management systems.

Audit committee and auditors

 The board must establish transparent and formal and arrangements for considering the method to apply the corporate reporting and risk management and internal control principles and for maintaining an appropriate relationship with the auditors of the company.

Consequences of Poor Corporate Governance

One of the biggest purposes of corporate governance is to create a system of rules, policies, and practices for a company – in other words, to hold people accountable. The fact that the board of directors publishes financial statements to shareholders on a regular basis, which represents the corporate governance concept of disclosure, is part of this accountability. The best way to illustrate poor corporate governance is with an example, and there is no better example than Enron Corp. in order to hide the fact that many of the executives were stealing from the company, they resorted to shady tactics and covert accounting method. The board of directors was presented with inaccurate and erroneous figures, who failed to report the information to shareholders. With responsible accounting methods gone out the window, shareholders were unaware that the company’s total debts and liabilities exceeded the amount company could ever repay. The company went bankrupt and the executives were eventually charged with a number of felonies. It obliterated employee benefits and wreaked havoc on shareholders. When a company’s good corporate governance is neglected, it runs the risk of failing, and shareholders stand to suffer the most.

Conclusion

The higher the standard of corporate governance, more vigorous is the company in the eyes of the shareholders of the company. The active and independent directors are the ones who actively contribute towards displaying the corporate as that of having a positive prospect. When it comes to investment, the investors search for businesses that have stronger corporate governance in them. The corporate governance requirements in India deliberate the companies to audit their working culture and provide the shareholders community with a more optimistic view as their actions have moral and legal implications. Since the advent of the new norms under the Companies Act 2013, the new norms are very balanced and innovative and have helped to reform the growth of Indian companies in compliance with the international standards. Shareholders are involved in the decision making of the companies and various safeguards have been introduced to ensure that the interests of the shareholders and the society as a whole are not ignored. Corporate Governance instils the much-required transparency in the corporates. As a result, it propels India ahead in the global race of emerging economies.

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